Thursday, December 8, 2011

Trade of the Decade

There are very few sure things in markets and investing. So I don't say this lightly: the price of a barrel of crude oil will average over $125 this decade.

Even if I'm wrong, you will want to explore my logic. Because even if I'm too bullish by $25 per barrel, there will still be lots of money made by smart traders exploiting the swings of the global energy megatrend in the 21st century.

My petroleum bullishness is based on three driving "mega forces" affecting global energy supply and demand. And my focus on these secular trends helps me pick winning stocks and ETFs in a half-dozen energy industries. Let's talk about the mega forces first, and then I'll tell you how to join me trading them.

Mega Force #1: Emerging Markets

Between the BRIC countries (Brazil, Russia, India and China) and dozens of other developing economies in Africa, Asia, South America and the Middle East; one could estimate that there are at least two billion people who aspire to the lifestyles of the West. These emerging middle class populations want the same jobs, housing, food, clothes and transportation we have.

As their governments and entrepreneurs oblige, this rapid development means lots of new urban infrastructure, including the roads, bridges, schools, hospitals and energy grids of any modern city. All of this means an incredible growth rate for energy demand. Plus, nearly every new automobile purchase in an emerging economy adds incrementally to oil consumption.

But don't take my amateur economist view on emerging economic development and the energy demands that go along. Here are some forecasts from the International Energy Agency (IEA) in its November 2011 "World Energy Outlook" report...

  • World primary demand for energy increases by one-third between 2010 and 2035.

  • In 2035, China consumes nearly 70% more energy than the United States, the second-largest consumer, even though by then per-capita energy consumption in China is still less than half the level in the United States.

  • The rates of growth in energy consumption in India, Indonesia, Brazil and the Middle East are even faster than in China.

  • The share of fossil fuels in global primary energy consumption falls slightly from 81% in 2010 to 75% in 2035. Natural gas is the only fossil fuel to increase its share in the global mix over the period to 2035.

The last point is especially worth noting if you are an investor in "alternative" energy like solar and wind power. While global energy demand rises by over 30% in the next few decades, fossil fuels only drop off 6% in the total consumption pie.

Mega Force #2: Peak Oil

You have no doubt heard of the theory of "peak oil". In case you've forgotten its premise, this is the idea that we have reached, or are soon about to cross, the threshold where the majority of known global oil reserves in the ground are at their maximum and will only decline going forward.

There is a heated debate going on right now as we speak between the "peak oilers" and those who say this is mere big oil -- and small oil for that matter – commercial and political propaganda. It's clear how lots of petroleum companies would benefit from the idea that there will be less supply going forward.

You already know I'm not an economist. You will also not be surprised to learn that I am not a geophysicist either. My expertise is clearly limited in the realm of "peak oil" theories.

But just like I can make broad-stroke conclusions about the European debt crisis that guide my trades (without knowing all the micro-economic details), I can also do some classical inductive reasoning about global oil supplies. Since a new oil field bigger than Saudi Arabia's hasn't been discovered in decades of exploration, it's not a stretch to assume we may be very close to the "peak".

The price of oil and the awareness of a peak in natural supplies have driven the recent explosion in shale exploration and production in the US. Natural gas E&P companies are using "fracking" technology to unlock oil and gas from their vast fields in the Eagle Ford shale in Texas and the Bakken shale in North Dakota. The environmental concerns about shale only reinforce the idea that we are much closer to "peak" petroleum than to finding our own Saudi Arabia in the US.

Mega Force #3: Geopolitical Eruptions

We all know that the problems in the Middle East are not going away any time soon. No matter how many peace negotiations, wars or regime changes, the ages-old conflict between religions and cultures will persist for decades more.

The recent bid keeping crude oil near $100, even with so much economic uncertainty over Europe, is likely due to tensions out of Iran. Why is Iran so important? Because it forms the east coast of the Strait of Hormuz, the world's most important oil "chokepoint" due to its daily flow of over 15 million barrels per day.

Nearly 20% of global consumption must pass from the Persian Gulf through the Strait of Hormuz to the Gulf of Oman and on to the Arabian Sea. A war involving Iran and disrupting that seaborne cargo could spike crude to over $125 very quickly.

I make no political or value judgments about the problems or solutions in these parts of the world. I am not smart enough to do so because these difficulties are as giant and complex as they are ancient.

But I think I am a good enough student of the markets to accept what I cannot control and simply to invest accordingly when faced with 3 unstoppable megatrends that will continue to interact and make energy "the trade of the decade".

Gold Miners Quietly Perking Up: AUY, DROOY, GLD, RGLD

Gold has been quietly consolidating for several months following a surge to all-time highs. While the initial pullback was violent and well publicized, gold has been much quieter in recent months. The, metal as represented by the SPDR Gold Trust (NYSE:GLD) ETF, is currently forming a large triangle, as its trading range continues to narrow considerably. GLD swung from $185 per share to under $155 in just a few weeks in September, whereas it has been confined to a $5 range the past few days as the triangle comes to a climax. GLD has also been oscillating between a key horizontal price level near $165. This would be a key area to watch in the next few days, as a drop under this level could imply a retest of the September lows. However, any strength from this area could imply that the correction in GLD may be coming to an end.

One group to watch in the case of strength in gold is, of course, the gold miners. Several miners have been perking up recently and may get a boost from strength in the metal. DRDGOLD Limited (Nasdaq:DROOY), for instance, surged in October and has since been trading in a bull flag pattern. Volume has been tapering off throughout the consolidation, which is a healthy sign. DROOY would be worth watching on any strength that carried it over the trendline that is marking the outer confines of the bull flag.

Royal Gold, Inc. (Nasdaq:RGLD) is another gold miner that may be close to a breakout. While it is not as strong in the short term as DROOY, RGLD is sitting just under all-time highs after a several-month-long consolidation. This stock is certainly volatile, so traders should take that into account, but any strength that carries it above $82.50 could signal an important breakout. (For more, see How Gold Performed In 2011.)

Yamana Gold, Inc. (NYSE:AUY) is another gold miner that is near the top of a recent consolidation. It has been trading between $17 and $13 since August, as it builds a base. AUY may need some more time before it can sustain a breakout, but the $17 level is certainly worth monitoring. Any close above this level could signal the next trend move higher.

The Bottom Line
Gold has really been out of the limelight for a few months after a much-publicized rally. Talk of a bubble has subsided and gold is really not that far off its all-time highs. While it may not head directly back to test its recent highs, there is a chance that the metal can gain some momentum. Gold mining stocks have typically followed the metal higher and are showing signs of strength, so it is very possible that this group catches a bid soon. If this is the case, then traders certainly don’t want to be late to the party.

Underperformance and profiting from it – TSX:HNU‏

The Horizon BetaPro NYMEX Natural Gas Bull+ ETF (TSX: T.HNU, Stock Forum) has been one of, if not THE most profitable trades in natural gas for the last four years, yet my sense is retail investors have missed it completely.

Why? The reason is simple—you have to short it. Most retail investors don't short, and fewer think about shorting an "Up" ETF. I admit, it's not a trade for novices. But it's available to everybody.

I'm going to outline just how lucrative this trade has been over the last four years, and how you can capitalize on this downtrend in natural gas. I'll explain the two "built-in" factors to this ETF that add to the profits of a short position—and lose you money if you're long. I'll even tell you when, historically, the best time of the year is to initiate this trade—and it's coming up VERY SOON.

“Shorting” means selling first and buying back later, as opposed to the more common convention of buying first and then selling. The short seller profits by selling at a higher price and buying later at a lower price. The difference in the price between where he sold and where he bought is the realized profit of the trade. This is how money is made on downtrends like we are witnessing in HNU.

(If you just learned what "shorting" is by reading this, do not attempt this trade;-))

HNU started its steep downtrend in July, 2008 just a few months after its January inception. The ETF is down 99.86% from that high, far underperforming the underlying commodity it is supposed represent. Now, this is very bad news if you're long.

But if you're short, this underperformance is a key; if you're short it's kind of like being The House in Vegas.

The ETF actually represents one of the most reliable trades in the sector—and it is not too late to get in. And as I mentioned, one of the ideal annual entry points over the last three years is coming up very soon! If retail investors want to ride a trend this is it. The trend in natural gas is currently down, and even if the trend reverses, there are two built-in features within the fund that are likely to stifle long-term upward price appreciation: “contango” and re-balancing. I will explain both of these.

The Structure of Underperformance

HNU is a leverage ETF which attempts to “seek daily investment results equal to 200% the daily performance of the NYMEX Natural Gas futures contract for the next delivery month” according to Horizons website.

This is accomplished through purchasing natural gas futures contracts, and then at specified dates rolling the contracts which are nearing expiry into new futures contracts. According to Horizons website “This mechanism also allows the investor to maintain an exposure to commodities over time.”

Yet those who have bought, or gone long the ETF since the start of 2011 have lost 64% of their capital, while the underlying commodity has lost 22.77%. The ETF is leveraged. Therefore the theoretical loss HNU should have experienced so far this year is negative 45.54%. Investors have lost about 17% more than anticipated this year alone (the fund charges a 1.15% management fee). Since inception the picture is grimmer—but only if you're long It's actually a beautiful thing if you're short.

Adjusted for four reverse stock splits, the stock hit a high of $7,710.40 in 2008, and currently trades at $10.48 as of Friday, December 2. It should be noted that the actual price paid at the high in 2008 was not $7,710.4 (it was $48.19). This price reflects the equivalent value in retrospect based on the reverse stock splits that have occurred.

If an investor picked the top and shorted 1000 shares at $48.19 ($48,190 invested) in 2008 the trade is showing a profit of $48,124.68!

Whereas if an investor bought 1000 shares at $48.19 in 2008, the first split would have left him 250 shares (1 for 4), the second split with 50 shares (1 for 5), the third split with 25shares (1 for 2) and the fourth split with 6.25 shares (1 for 4). The original investment of $48,190 is therefore worth $65.5(6.25 times the current $10.48 share price) reflecting a 99.86% loss in capital (that is why the shorts have nearly doubled their money). The prices on the chart are adjusted to reflect the reverse stock splits and the appropriate percentage decline of the ETF.

Figure 1. TSX: HNU - January 16, 2008 to December 2, 2011 Logarithmic Weekly Chart with Reverse Stock Splits

HNU-Dec 3

Source: FreeStockCharts and split information from Yahoo Finance.

Horizons does point out that “These ETFs do not seek to meet their investment objectives over any period other than daily.” This is clearly stated multiple times in the ETF prospectus, indicating the ETF does not track the commodity over the long-term, rather only on a daily basis.


A major factor in the decline witnessed in HNU over the long-term—and something that stacks the deck in favour of being short--is due to a phenomenon known as “contango.” Futures contracts, which HNU purchases, are an agreement to buy an asset at a fixed price at a forward or future date. When the futures price is higher than the spot price, it is known as "contango". The natural gas market is usually in contango; futures prices are higher due to storage costs and uncertainty; so a premium is paid for that uncertainty.

But as that more expensive futures contract approaches its expiry date—the date the gas must be delivered--it will converge with the spot price—which by definition means it declines in price. Since HNU does not take physical delivery of the commodity it trades, it must continually “roll”, or sell futures contracts which are expiring and buy longer-term contracts—usually the next month.

By continually paying a higher price than the spot price each time the contract is rolled, there is an inevitable long-term systematic erosion of value within the fund, and a continual slide in the value of the ETF.

This is GREAT—if you're short. The House Rules are in your favour. But it's a profit killer if you're "long" though.

As for December 5, January 2012 Natural Gas is trading at $3.465. February, 2012 Natural Gas is trading $3.492. Not only does the fund lose money because of the downtrend (sells expiring contracts at a lower price) but it then pays a 2.7 cent (this will fluctuate) premium for the next futures contracts. Compounded and leveraged each month, the losses become staggering, as shown by the ETFs decline. Keep in mind the fund is leveraged-essentially doubling the premium and magnifying losses. . . Month after month, all else being equal, this occurs. The contracts HNU is forced to sell will almost always be lower than the price which is paid for the new contracts they must purchase. This will offset any long-term gains the fund could theoretically make, even if natural gas rises over the long-term. The fund loses if natural gas drops, stays the same or even rises slightly. These regular losses and inefficiencies continually drive down the value of the ETF. Again, if you're short, this is adding profits to your wallet.

The second big structural factor in HNU that is in favour of the "shorts" is the issue of leverage and compounding losses. HNU attempts to reflect 200% of the movement of natural gas on a daily basis. Assume you invest $100 in the ETF, on the first day natural gas rises 5%. This means your investment will be worth $110 (you make 10% because of leverage). But assume the following day natural gas falls by 5%. Your investment is worth $99 (you lose$11 or 10% of $110). Many investors think they should just be back at $100, but compounding and leverage create a loss.

If you're short, you just made $1 in two volatile days. If you're long, you just lost $1.

How to Make Money

Investors don’t usually think about short-selling but in this case, shorting the ETF has historically been the way to make money over the long term. Short selling is taking advantage of both sides of the market—up and down—movements which occur regardless of short-seller involvement.

“Market participants are permitted to sell Units of an ETF short and at any price...” according to the prospectus for the ETF. Short selling is a legitimate way to trade the ETF and is noted in the fund’s legal documents.

Shorting ETFs is often more efficient than shorting an individual stock or commodity:

  • The ETF is not prone to short-squeezes since the fund is rebalanced every day to reflect the value of its holdings-which seems systematically doomed to continue its decline. The ETF moves intra-day as the underlying assets move, therefore all traders (long and short) are simply volume, as the price is determined by underlying assets, in this case natural gas contracts and how those contracts are managed.

NOTE: The underlying commodity may be prone to a short-squeeze where buyers push up the price and people with short positions are forced to cover their position (pushing the price even higher) or receive a margin call on their short position. Investors should be aware this can cause sudden, sharp short-term rises in the ETF.

  • HNU can be shorted at any time. This differs from a regular falling stock as the stock may not be shortable at all, or subject to the uptick rule. An uptick rule means traders can only initiate short positions when the price is above the last trade price. This is common on the TSX exchange, but this ETF is excused from the regulations.

In an ETF which has proven very inefficient for buyers over the long-term going short is the logical strategy. (The industry jargon for buying is called "going long".) Couple this with an overall downtrend in natural gas—even if natural gas begins an uptrend the rise in the ETF is likely to be muted—the trade sets up very well for investors who are willing to incorporate short selling as one of their tools.

The fund is leveraged which means on a daily basis there can be big percentage moves. Short-selling blindly is not wise.

Pic of the Day

Marc Faber - Financial Sense Newshour - 07 Dec 2011

A Bottom for Home Prices ?

Housing prices will stop sinking next spring. But recovery will be a gradual process -- too slow to help the economy much next year. Look for prices, which have fallen an average of 31% since 2006, to drop an additional 2% or so in the early months of 2012 and then recover that lost ground by the end of the year.

The growth in 2013 won’t be dramatic Come 2013, expect home prices to rise only 3% to 4% -- not too far from the pre-boom average of 4.8% a year, but well short of the bounce that usually follows a housing slump. After the milder housing downturn in the early 1980s, home prices grew an average of 6.5% for six years.

A key signal that the bottom is near: A change in the ratio of average homes prices to personal income
-- houses are affordable again. After soaring to 4-to-1 during the housing boom, the ratio is now well below the long-term average of 3-to-1.

Another reason for optimism: Foreclosure numbers are set to level off after a recent surge to clear up the backlog that developed when banks were found to be rushing though the paperwork for seizing homes. Although the 3.5 million foreclosures still in the pipeline are weighing heavily on the housing market, that effect will diminish when it is clear that the worst has passed.

Look for home sales to tick up next year as well, hitting 5.5 million for new and existing homes. That’s up 4% from 2011, the low point since the housing bubble burst.

Demand from abroad will help. Canadians are buying homes in Phoenix; Brazilians are investing in Miami; and Chinese are buying in California, Las Vegas and New York City. To these investors with bulging pockets, good values can be found where the price declines have been greatest.

U.S. investors remain more conservative, largely avoiding single-family homes and diving into the multifamily rental market. It has heated up in recent years, thanks in part to the crowds of former homeowners who need a place to live, as well as to would-be home buyers who are waiting to see if prices have further to fall.

Home starts will jump 15% next year, driven largely by construction of new apartment buildings. Among the strongest areas are Texas, Louisiana, Oklahoma and the Dakotas, where the robust energy industry is lifting local economies and earlier overbuilding was avoided. Other states that have benefited from past restraint are Montana, Washington, Iowa and Nebraska.

Even so, new construction will be only around 750,000 in 2012, down from 2 million in 2005 and far below the pre-crash average of 1.5 million from 1959 through 2006.

Farther down the road, there is plenty of pent-up demand. The lousy housing market has muffled the typical rate of household formation, deterring many young folks from getting their own homes. As a result, there are 2 million new households waiting for an improvement in economic conditions: recent graduates eager to leave their parents’ nests and 30-something couples who have delayed marriage or having children. As the economy picks up steam, they will emerge, helping to soak up the glut of foreclosed homes and putting construction on a faster track.

By 2014, the housing market will start to look more like its old self, with housing starts near the long-term average of 1.5 million a year, sales of about 6 million and price gains of over 4% a year.

Shorter term, even the modest reversal likely in 2012-2013 is crucial, easing the crushing weight the housing market has imposed on the economy. Homeowners, who lost a large share of their net worth in the housing crash, have been trying to rebuild their wealth by saving more in recent years. Since the market crash, consumers have held on to more than 5% of income, up from less than 2% during the housing boom. Since consumer spending accounts for two-thirds of economic activity, this uptick in saving and correlating downtick in spending has spelled the difference between a solid recovery and the shaky one the U.S. is experiencing.

Since a good deal of this saving is due to uncertainty -- not knowing just how much more home prices will drop -- reaching a clear turning point is important. Once homeowners know the worst is over, they’ll take a breath, start planning their saving for the long term and spend more in the short term.

Of course, the market shift won’t make much immediate difference for the millions of homeowners who owe more than their homes are worth. But for the majority with equity in their homes, even a modest gain in prices can change their spending behavior.

McAlvany Weekly Commentary

Massive Emergency Bailout Temporarily Saves European Implosion

A Look At This Week’s Show:
- Disaster temporarily averted when 6 Central Banks dump 357 billion into Europe. How long this will work is anyone’s guess.
- Lower wages and higher debt imply slow growth and a collapse in equity prices. This trend could last years.
- Learn and use a “back of a napkin” financial solution to show your holiday guests and family.

Google Running Out of Steam – Sell Now

Google (NASDAQ:GOOG) — The world’s largest Internet company may see an increase in revenues in 2012, but a decrease in net profits in likely due to costs from recent acquisitions and a slowing world economy.

On the long-term weekly charts, GOOG has been in a rectangle for over four years without a successful breakout. Major support is around $460, and a break below that line could lead to a serious decline.

Buying momentum is falling and internal indicators are universally overbought. The recent advance may be an early present to those that cash in on Google. At the very least, holders should take protective steps to limit losses by selling calls or buying puts on the stock.

Trade of the Day – Google (NASDAQ:GOOG)

Exclusive Interview – Jim Willie: “The Public Will Not Wake Up Until At Least One Million Private Accounts Are Stolen”

I had the chance to speak with the “Golden Jackass” this afternoon out of Costa Rica, namely, Jim Willie, publisher of the Hat Trick Letter. It was a riveting interview, as Jim’s global information and news sources paint a blackening financial future for participants in the Western financial system.

According to Jim, US & European investors are at incredible risk. “The entire financial system of the Western world is imploding,” said Jim. “There is exponentially rising risks for individuals and their money…the risk right now–is people losing their entire life savings. I cannot seem to get people to understand this”

silver12As we began discussing the MF Global collapse, Jim articulated his belief in a financial slight-of hand originating from “notice to deliver” requests for gold and silver submitted through MF before the collapse, which had the potential to cause a Comex delivery default. “Comex was ready to default on gold and silver in November, and rather than honor the notices for delivery, JP Morgan stole the funds in the accounts that were calling for delivery…notices for delivery were replaced by stolen accounts.” The evidence of this according to Jim is that, “JPM increased the amount of silver in their registered vaults by precisely the amount that was suppose to be delivered…JPM effectively averted both a Comex default and a European Sovereign Debt implosion.

Before closing Jim provided a stark warning, saying, Several million private accounts may vanish–Brokerage accounts, Pension funds, Mutual funds, they’re all at risk. We are getting into the middle stages of implosion, where I believe the public will not wake up until at least one million private accounts are stolen, and completely vanish.

This was a truly sobering interview, and given the real losses borne by MF Global account holders in the past month, Jim’s comments cannot be taken lightly.

To listen to the interview, left click the following link and/or right click and “save target as” or “save link as” to to your desktop:

Interview with Jim Willie

Big Name Financials Putting In A Bottom: AIG, C, GS, MS, XLF

So far this year, the financial sector has been hit hard by selling. The SPDR Financial ETF (NYSE:XLF) is down 19.2% so far this year, to $13.17, from $16.30. Some big names have seen extensive selling, and at some point these stocks become a value. Four big name stocks are showing indications of a turning tide, and a buying opportunity may be presenting itself in a handful of big-name financial companies.

Morgan Stanley (NYSE:MS) has been one of the hardest hit major financial players; in the last six months the stock is down 26.42% to $16.57, from $22.52. In November, the stock could not reach the low it hit in October, indicating buying support. Prior to this, in late October the stock had surged above September highs. The combination of these price moves indicates an uptrend could be underway. The ultimate test will be $20 (October resistance) - if the price can push through, it would confirm the uptrend. On-balance volume is rising aggressively, and this signals that buyers are willing to step in at these levels. If the stock drops back below $13, it is a sign of weakness. (For more, see Support & Resistance Basics.)

Citigroup (NYSE:C) has also had a rough past six months, down $21.64% to $29.83, from $38.07. This stocks also created a higher high in October, followed by a higher low in November. This provides evidence that an uptrend is underway. On-balance volume is rising, and it is also in an uptrend, showing there is buying interest in the stock. $34.40 was the October high and the level to watch on the upside. If Citigroup can push through that level, the uptrend is confirmed. On the other hand, a drop below $24 is a negative signal.

Goldman Sachs (NYSE:GS) is one of the most recognizable names in finance, yet it is down 25.45% in the last six months to $99.82, from $133.90. Similar to Morgan Stanley and Citigroup, Goldman also made a higher high in October and a higher low in November. The higher low in November was not as pronounced, though - a sign the stock still had some aggressive selling taking place. On-balance volume is rising though, and this confirms the recent moves higher.

There are obstacles for the stock. Mainly it has failed to significantly push past the 50-day moving average, and GS must also still push through the psychological $100 level. If it can do this, it still has a long way to go to reach the October high at $118.07. If that level is surpassed, though, the uptrend is confirmed. A drop below $88 would point to continued downward pressure.

American International Group (NYSE:AIG) has lost more than half its value so far this year, and is down 13.44% in the last six months to $23.57, from $27.23. The stock has a very similar outlook to GS. It is facing some headwinds, but also showing some positive signs. The stock made a higher high in October and a higher low in November - although not by much - which are signs an uptrend is emerging. On-balance volume is rising and the stock has cleared its 50-day moving average. A drop below $20 indicates this stock is still under significant selling pressure.

The Bottom Line
Four big names in the financial sector are at a potential turning point. All have seen a higher high in October and a higher low in November, which are signs of a potentially emerging uptrend. Rising on-balance volume indicates there is buying interest in these stocks at these levels, yet until the stocks clear resistance overhead, the uptrend is not confirmed. Support levels should be monitored closely, as this sector still poses risks. If support is broken to the downside, the uptrend is taken off the table, at least for the short term.

The Inflation Deception by Obama Bernanke

These are 2 TV spots developed by Phoenix-based Swiss America Trading Corp a firm specialized in selling U.S. gold and silver bullion coins and bars , both commercials have been rejected by major television networks, including Fox News , Fox Business, NBC, MSNBC, CNBC, ABC, CBS, CNN/HLN and the Discovery Channel, for apparently political your debt and start saving in Gold, as Gold is Money and is more valuable than the dollar. Gold has been used as currency for 2000 years. There is no way a country can survive by printing money from thin air, the consequences are hyperinflation and devaluation, this is basic economics , you need to have money to back up the assets or products you buy or sell

Hyperinflation is coming. The Federal Reserve is printing trillions of bogus dollars every year with no end in sight. Now is the time to stockpile a year's supply of food and water while you still can. Buy guns, ammo, gold, and silver. Have wood and a wood stove. Or kerosene stoves, heaters, and kerosene. We will see a complete collapse of our economy in the coming years.