Friday, April 15, 2011

Silver Could Rise Well Above $50 To Even $100 As Physical Demand Grows

We recommended silver Nov. 11, 2010 at $27.16. In just 4 months, as predicted then, silver has risen almost 50% to over $40 an ounce– beating by a wide margin the % advance in gold prices.

This morning my silver guru, young Ananthan Thangavel of Lakshmi Capital in California says he is looking for another 25% run to $50 an ounce in the next year as “silver is being taken out of world supply by physical buyers and the tremendous growth of the silver ETFs.” The largest silver ETF, iShares Silver Trust(SLV) has grown from a modest $263.5 million in assets to $13.7 billion in assets 2 days ago.

Thangavel also believes currency interventions, such as the G7 is doing on the yen or Brazil on the real “continue to lower confidence in paper currencies.”

By comparison the speculation in silver futures has declined to 35% of its all-time peak set on September 28, 2010, The short interest held by large banks, rumored to be JP Morgan Chase and HSBC, has been steadily reduced since November.

Nevertheless, Thangavel suggests that $100 an ounce for silver is “not out of the question,” if the physical demand for the metals used in many industrial applications, continues to grow.

Energy Outlook: Natural Gas Options Opportunity

Recent activity in energy markets has obviously been influenced heavily by unrest in the Middle East and North Africa. For the year, West Texas Intermediate crude oil is up 20.75%, while the more internationally-influenced Brent Crude is up an astounding 33.36%.

However, in the same period Henry Hub natural gas is down 8.86%. One futures contract worth of natural gas (1 mmbtu) should have about one-fifth the energy content of one contract worth of crude oil (1,000 barrels). It follows that in a normally functioning, perfectly efficient energy market, crude oil should be about five times more expensive than natural gas. However, with natural gas at 4.04 and WTI crude at 112.79, this ratio currently stands at an incredible 27 times.

In the past, we have discussed the extremity of such a ratio as being a catalyst for either a fall in crude oil prices, a rise in natural gas prices, or both. Unfortunately for natural gas, such is not the case today.

The following chart shows natural gas managed money net shorts against the price of natural gas.

Graph-Natural Gas Price vs Managed Money Long Chart

Since 3/1/11, managed money net shorts have decreased 53%. However, in the same period, the price of natural gas has increased by only 0.5%. To put this in perspective, this means that approximately 111,000 contracts of natural gas have been bought back by short sellers, but even that gargantuan amount of short-covering has only produced a 0.5% rise in the price of this commodity. Such a low price increase with such dramatic purchasing by managed money indicates that there must be another factor at play: producer selling.

The following chart shows the same elements as above, but overlayed with natural gas producer net shorts in green.

Graph-Natural Gas Price vs Managed Money Long vs Producer Short Chart

As can be seen, producer shorts have hit an all-time high (as producer chart is below zero, a further increase in short positions shows the line on the chart heading downwards). Practically, what this means is that Producers of natural gas [i.e. the Chesapeake Energy (CHK) and Exxon Mobils (XOM) of the world], are hedging their natural gas production at the fastest rate ever. The natural gas producers are incredibly eager to lock in prices between the 4-4.5 level. While this seems downright insane considering that natural gas was above 10 just 3 years ago, the amount of new natural gas production coming online each day is huge.

The fact that prices are already at $4 with natural gas managed money shorts hovering around 2-year lows means that renewed managed money selling could drive prices significantly lower than where they are today. Cheap domestic natural gas drilling has made some Producers profitable down to prices of even $3 per mmbtu or even lower in some cases, so these Producers will keep drilling even if prices continue to head south. Rather than shut down production and wait for better prices, natural gas producers are ramping up production and selling futures contracts heavily in order to lock in prices.

Trade Recommendation
The extreme willingness of producers to sell natural gas at these prices yields a very attractive risk/reward trade. We recommend selling calls above natural gas’ recent high of 4.48. Such a trade would entail selling the June 4.5 calls for .07, or $700, per contract. As long as natural gas closes below 4.5 on May 28 (9.6% higher than where it currently trades), the investor keeps all $700 per contract.
In order to effect the same trade using the UNG, investors could sell the May 12 calls for 0.13.

These trades carry the risk of selling uncovered calls. In the event of a large, unexpected rally in natural gas, investors could be left short natural gas in the face of a large rally. However, we would view any rally in natural gas as being short-lived due to the likelihood that producers will utilize any rally to increase long-term hedges. With natural gas producers this willing to sell at prices between 4-4.5, a sustained rally past 4.5 is highly unlikely. Furthermore, managed money will most likely begin to realize Producers’ predicament and start to increase their short positions again. Such a development could cause severe downside for natural gas, and cause a retest of the 3.5 level seen in late October 2010.

More aggressive traders may wish to short natural gas futures outright, or buy put options on natural gas futures. An intriguing trade could be to short or buy puts on the UNG instead of futures due to UNG’s documented underperformance of natural gas futures. short nat gas calls long nat gas puts.

3 Preferred Stock ETFs with Huge Dividends: PFF, PGF, PGX

The allure of high dividends yields makes the idea of investing in the preferred stock of a company very appealing to many investors. Most notably, in the midst of the financial crisis of 2008, investors witnessed Warren Buffett's $5 billion investment into Goldman Sachs (NYSE:GS) through a preferred stock offering yielding 10%. Prior to Goldman Sachs' buyback, Buffett received $500 million in annual dividend payments. (Looking for more information on Buffett? Then check out Warren Buffett: How He Does It.)

Although corporations are typically the largest buyers of preferred stock, individual investors also have an opportunity to participate through the use of Preferred Stock ETFs. In this article we'll examine some of the top preferred stock ETFs.

TUTORIAL: Exchange-Traded Funds


Dividend Yield

Year to Date Return

Market Cap

iShares S&P U.S. Preferred Stock Index




PowerShares Financial Preferred (NYSE:PGF)




PowerShares Preferred Portfolio








The Preferred Stock ETFs mentioned are not the place to look if your searching for an investment vehicle that is non-correlated to a broad market index like the S&P 500. Each of the Preferred Stock ETFs mentioned has been rising along with the S&P 500 index, but the high yield dividends can offer a level of protection to investors.

Heavy on Financials
All of the Preferred Stock ETFs mentioned tend to be heavily concentrated in financials. The PowerShares Financial Preferred Portfolio ETFs top holdings include Bank of America (NYSE:BAC), HSBC Holdings (NYSE:HBC) and ING Groep (NYSE:ING).Wells Fargo (NYSE:WFC). Citigroup (NYSE:C) and Metlife (NYSE:MET) are among theleaders in the iShares S&P U.S. Preferred Stock Index Fund ETF. Among the top holdings of the PowerShares Preferred Portfolio ETF include Morgan Stanley (NYSE:MS) andJPMorgan Chase(NYSE:JPM).

Final Thoughts
The Preferred Stock ETFs overexposure to the financial services industry may make them a particularly risky investment, but for an investor with a long investment time horizon and a preference for dividend paying investment vehicles the preferred ETFs are an option to consider.

The Defensive Team Takes the Field

Tobacco, food and drug stocks start to lead the market while tech and small-caps fade, suggesting investors are starting to shun risk.

Technology and small-capitalization have been leaders at various times in the stock market's climb from last August's lows, and some see their continued leadership as critical in sustaining the market's advance.

onversely, traditionally defensive groups such as tobacco, food and drug stocks seem to do better than more discretionary areas when the bears are flexing their muscles.

I recently wrote that technology and semiconductors in particular had turned the corner from bull to bear (see Getting Technical, "Don't Buy Chips on the Dip," April 4, 2011). At about the same time, relative performance by defensive sectors started to improve. The divergence suggests the market's tone has changed: Investors are starting to shun risk.

To be sure, sentiment surveys, such as Investors Intelligence and the Hulbert Stock Newsletter Sentiment Index, still point to happy bulls and complacent investors. The Chicago Board Options Exchange volatility index—known better by its ticker, the VIX—dipped to a low level not seen since before the Libyan conflict began, implying there is little fear out there.

But sector action tells us something has changed. For example, tobacco stocks such as Altria Group (NYSE: MO - News), Lorillard (NYSE: LO - News) and British American Tobacco (NYSE: BTI - News) are at all-time highs. In contrast, the Standard & Poor's 500 has failed to eclipse its February 2011 high, let alone come close to its 2007 peak.

Drug stocks are not quite as strong, but the Merrill Lynch Pharmaceutical Holdrs Trust (NYSE: PPH - News) quickly shook off last month's weakness to touch a 52-week high (see Chart 1).


Aside from breaking through chart resistance, this exchange-traded fund shows a clear shift from market laggard to market leader in February. Along with tobacco stocks, food producers such as Ralcorp Holdings (NYSE: RAH - News) and H.J. Heinz (NYSE: HNZ -News) have moved atop the leaderboard.

The last piece of the shift from offense to defense puzzle is the small-cap sector. While the Russell 2000 index still is leading its bigger cousins on a relative basis, it now sports a potential technical failure (see Chart 2).


In early March, the small-cap gauge moved below the rising trendline from its August low. Events following the Japanese earthquake and tsunami sent the entire market lower, but unlike most major indexes, the Russell 2000 came roaring back to set a new high. That is the good news.

The bad news is that, over the past week, it has fallen back below its February high. That is arguably already what chart watchers call a "breakout failure." In technical lore, a move above a resistance level that does not hold suggests that the index used up its last bits of fuel. Demand then gives way to supply and prices move lower.

The shift from traditional leaders in rallies to traditional hiding places in troubled times is clear. It does not mean the bull market is necessarily over. But with major indexes failing to break respective resistance levels, and the only one that did—the Russell 2000—now failing to hold, the bears' arguments are growing more persuasive.

Big Rounded Arc Playing Out on SP500 April 14

There’s a large-scale (from the perspective of the intraday chart) “Rounded Reversal” or “Price Arc” pattern playing out in the stock market right now, which is one of my favorite patterns.

Let’s take a look at the current “arc” structure and note two levels of Fibonacci Retracements to watch as the Arc continues.

I’ve been tracing out this pattern each night in the Daily Member Reports and wanted to update you on this pattern and the current levels to watch.

First, “Rounded Reversals” or “Arc Trendline” structures are among my favorite price patterns to trade, as they tend to be easy to recognize in advance (note the massive negative momentum divergences at the resistance high at 1,340) and give a clear pathway forward providing the market “rolls over” and moves on the downside of the arc as expected.

If the market ‘breaks’ the arc, then you know the pattern failed – all you have to do is draw a rounded arc trendline (can be done by hand if you print out your chart) and note whether or not price continues to bounce down from the curved trendline, or whether it continues in the down direction.

So far, the pattern has been good for a 35 to 40 point move and now faces its first critical “Will it Continue?” challenge at the 1,300 level which is a triple confluence:

  • The 38.2% Fibonacci Retracement as drawn
  • “Round Number” at 1,300
  • Prior Price ’spike’ low from March 29

So now we play the famous intraday game: “Will it Break or Will it Hold?” which gives intraday traders a bit of advantage over swing traders (or at least traders who watch price all day vs. those who watch end-of-day price levels).

By that, I mean intraday traders can look at the ‘internals’ or ‘guts’ of the market on the lower (including 5-min and 1-min) charts to see if there are any bullish reversal (divergences, etc) signals or bearish breadown signals (no divergences, increase in volume and momentum as price falls, etc).

That’s another story, though.

For now, watch price very closely at the 1,300 pivot level and if we see a firm breakdown there, our next “T2″ (target #2, as we just hit “T1″ today) Arc Pathway level is likely to be the 61.8% Fibonacci Retracement along with the March 23rd “spike” low at the 1,285 level.

A failure for buyers to hold support at 1,285 opens the door for a “Full Arc” or “Mirror Image Reversal” pattern down to 1,250.

Take a minute to browse a few other posts I’ve written about Rounded Reversals/Arcs:

Lesson in Trading Intraday Arc Trendline Breaks/Reversals

Gold Trapped Between Rounded Arc Support and Horizontal Resistance

Log-View of the Arc Trendlines on the US Market Indexes (April 2010 ahead of “Flash Crash”)

Updated Arc Patterns on the US Indexes (again, ahead of “Flash Crash”)

Sell-off in Crude Oil from Intraday Rounded Reversal (May 10, 2010)

TLT “Arcs” Down into Support

In summary, there’s two main ways to play Arc patterns on any timeframe:

1. Play the Continuation of Price through the duration of the “Arc”

2. Play a Reversal/Breakout through an Arc Trendline

Arcs aren’t as popular or well-known as Head and Shoulders or Flag patterns, but they certainly have their place in a trader’s growing arsenal of patterns.

Corey Rosenbloom, CMT

Unemployment Claims Unexpectedly Jump by 27,000

The Department of Labor's Unemployment Insurance Weekly Claims Report was released this morning for last week. The 27,000 increase in claims is on top of a 3,000 upward revision to the previous week's claims. Here is the official statement from the Department of Labor:

In the week ending April 9, the advance figure for seasonally adjusted initial claims was 412,000, an increase of 27,000 from the previous week's revised figure of 385,000. The 4-week moving average was 395,750, an increase of 5,500 from the previous week's revised average of 390,250.

The advance seasonally adjusted insured unemployment rate was 2.9 percent for the week ending April 2, a decrease of 0.1 percentage point from the prior week's unrevised rate of 3.0 percent.

The advance number for seasonally adjusted insured unemployment during the week ending April 2 was 3,680,000, a decrease of 58,000 from the preceding week's revised level of 3,738,000. The 4-week moving average was 3,728,750, a decrease of 20,750 from the preceding week's revised average of 3,749,500.

Today's number was slightly below the consensus estimate of 385,000 claims. ('s own estimate was for a higher 390,000).

As we can see, there's a good bit of volatility in this indicator, which is why the 4-week moving average (shown in the callouts) is a more useful number than the weekly data.

Occasionally I see articles critical of seasonal adjustment, especially when the non-adjusted number better suits the author's bias. But a comparison of these two charts clearly shows extreme volatility of the non-adjusted data, and the 4-week MA gives an indication of the recurring pattern of seasonal change in the second chart (note, for example, those regular January spikes).

Because of the extreme volatility of the non-adjusted weekly data, a 52-week moving average gives a better sense of the long-term trends.

The Bureau of Labor Statistics provides an overview on seasonal adjustment here (scroll down about half way down). For more specific insight into the adjustment method, check out the BLSSeasonal Adjustment Files and Documentation.

For a broader view of unemployment, see the latest update in my monthly seriesUnemployment and the Market Since 1948.

BNN: Top Picks

Josef Schachter, President and CIO, Schachter Asset Management shares his top picks.

Beijing March New House Prices Plunge 26.7% M/M: Press

BEIJING (MNI) - Prices of new homes in China's capital plunged 26.7% month-on-month in March, the Beijing News reported Tuesday, citing data from the city's Housing and Urban-Rural Development Commission.

Average prices of newly-built houses in March fell 10.9% over the same month last year to CNY19,679 per square meter, marking the first year-on-year decline since September 2009.

Home purchases fell 50.9% y/y and 41.5% m/m, the newspaper said, citing an unidentified official from the Housing Commission as saying the falls point to the government's crackdown on speculation in the real estate market.

Beijing property prices rose 0.4% m/m in February, 0.8% in January and 0.2% in December, according to National Bureau of Statistics data.

The central government has launched several rounds of measures since last year designed to cool the housing market, though local government reliance on land sales to plug fiscal holes mean enforcement hasn't been uniform.

The NBS is expected to release March house price data on April 18.

Bank of America: Oil Could Hit $160 by Year-End

Oil prices have jumped to 2 ½-year highs this week, and the party may just be getting started. Bank of America Merrill Lynch says Brent crude could hit $160 a barrel this year, as global demand expands and Libyan oil remains offline, CNBC reports.

That level would represent a 31 percent gain from $122 Tuesday morning. BofA sees a 30 percent chance of that target being reached.

“Commodity prices should move broadly higher in 2011 on robust economic growth in emerging markets, despite relatively weaker growth in developed markets,” Sabine Schels, a commodity strategist at BofA, wrote in a research note.

Oil refinery workers
(Getty photo)
“With oil demand expanding rapidly and Libya production down by at least 1 million barrels per day, we forecast (the) Brent crude oil price to average $122 a barrel in the second quarter.”

Brent could break through $140 in the next three months, she says. And, “Under our upside risk scenario, Brent prices could average between $125 dollars a barrel and $160 this year.”

Goldman Sachs sees things differently. In a research note Tuesday, it said oil will soon see a “substantial pullback,” The Wall Street Journal reports.

Things are much different now than in 2008, when prices last hit these levels, Goldman analysts say. “Both inventories and spare capacity are much higher now, and net speculative positions are four times as high as in June 2008.”

Late Wednesday, U.S. crude for May delivery settled up 86 cents at $107.11 a barrel. In London, Brent May crude was up $1.89 to $122.81.

Losing The Middle Class

In many capitalist economies, the middle class label is a financial definition largely based on the lifestyle that you can afford. A nice house in the suburbs, two cars, good schools for the kids and a few weeks of vacation somewhere warm and sunny are the traditional rewards for achieving middle class status.

In recent years, however, the decline of the middle class has been the stuff of headline news. So who is the middle class, and how much money do you need to earn to make it to the middle? Interestingly, the experts can't agree on a standard, although most people in the United States believe that they fall into this category. Regardless of how you measure the middle, however, it's simply not possible for everyone to be there. In this article, we'll examine what "middle class" really means, examine why the number of members in this class may be shrinking and give you some tips to help you hold your spot.

The Mathematics of the Middle
Statistics from the Census Bureau use data on U.S. households to put some parameters around the subject.

U.S. Household Mean/Upper Limit Earnings (2008)
QuintileMean (average)Upper Limit

A Question of Numbers
After looking at the numbers, some experts rank the middle as those earning between about $20,000 and $100,000 per year. Others count only those fitting into the third quintile, earning between $39,001 and $62,725. Of course, a family in Arkadelphia, Arkansas earning $39,001 and a family in Beverly Hills, California earning the same amount would be living very different lifestyles - even at the six-figure salary level, nobody in Beverly Hills would consider themselves rich.

A Look at the Top and the Bottom
At the highest end of the income scale, $180,000, was the lower limit of the top 5%. The median earnings for households in the top 5% was $294,709. We can assume half of all those top-5% households earned more.

At the lower end of the scale, data from the United States Department of Health and Human Service Poverty Guidelines is used to define poverty. The statistics are based on income and the number of persons in the household. The lowest quintile ranking from the Census Bureau survey is roughly equivalent with the U.S. government's definition of poverty for a family of three.

2008 Poverty Statistics

Persons in Household48 States and D.CAlaskaHawaii

The Disappearing Middle
By most measures, the middle class is in decline. The U.S. Census Bureau's report on income, poverty and health insurance coverage released in September 2009 reported that real median income fell by 3.6% between 2007 and 2008 to $50,303. The lowest quintiles experienced earnings declines, the third quintile was flat, and only the top quintile showed a slight gain. The top 5% enjoyed the largest gain. The official poverty rate came in at 13.2%, accounting for some 39.8 million people in 2008.

Not so long ago, most families in the middle could get there and stay there on the earnings of a single breadwinner. Today, many two-income families are a paycheck away from losing their middle-class status and, in some cases, their homes because they are living beyond their means.

A study released by the Brookings Institute think tank in June 2006 highlighted the decline of middle class neighborhoods and the increase in upper-class real estate. According to the study, the share of middle-class neighborhoods in the 100 largest metropolitan areas declined from 58% in 1970 to 41% in 2000. Large new homes with good school districts sprang up across the country and consumers took on massive debt through the use of adjustable-rate mortgages in order to get a piece of ground in the right zip code.

Big cities moved in the same direction as the suburbs, as upscale properties replaced affordable housing. The Brookings study notes that New York City lost 205,000 affordable homes between 2002 and 2005. The homes were lost to what Mayor Michael Bloomberg called "luxury product" living.

The trends of relying on two incomes and spending more than the household earned weren't limited to the United States. Globally, an increasing number of families relied on the use of two incomes and some serious leverage to achieve their middle class dreams.

Fast forward to 2010, and the aftermath of the global credit crisis had firmly underscored the folly of these practices. When housing prices collapsed and unemployment soared, the middle class shrunk further. In the United Kingdom, the Consumer Credit Counseling Service (CCCS) reported a 257% increase in clientèle among those earning in excess of £30,000 (about $57,000 U.S. dollars) per year. The individuals in question lived in homes valued in excess of £500,000 and supported their lifestyles through the use of an average of 13 different sources of credit. Between October, 2008 and May, 2009, the CCCS reported a 12% decline in the average income of couples requesting assistance. The situation was so grim in the second quarter of 2009 that 30% of those seeking help were told that their only recourse was to find a way to earn more money. In 2008, only 4% found themselves in that position.

Rising mortgage default rates in the U.S. tell a similar story. The housing crisis and lack of jobs in the city of Detroit, Michigan were so severe that city planners spent the first half of 2010 looking at proposals for how to shut down entire neighborhoods and convert them to green space. The well-paying manufacturing jobs once offered by the automakers and their suppliers were no longer plentiful enough to support would-be homeowners and the city services that support healthy neighborhoods.

Tips for Making It to the Middle (and Staying There)
Although there are varying arguments about the definition of middle class, nobody disputes that highly-educated, white-collar professionals generally have a spot in the ranking. A college education was, and still is, often considered to be the fastest way for young people to enter the ranks of the middle class. Thanks to globalization and advertising, it's an objective shared by college students from California to China - and most places in between.

Once you've got the education, you need to master your finances. Rather than race out to put the latest smartphone on your credit card or put a new luxury automobile in your garage, take some tips from the financially frugal and minimize the amount of debt that you take on. Limit the use of credit cards and, if your household brings in two incomes, spend them wisely and don't forget to save for a rainy day.

Why Phase II Trials Are the Best Time for Biotech Investing

I recently received a call from an investor relations representative who wanted to know if I'd be interested in hearing about a small biotech company with a drug candidate in Phase II trials.

Would Rory McIlroy have liked a do-over on Sunday at Augusta?

Phase II trials are my favorite time to get involved in a biotech company. I'll explain why in a moment. But first, a quick review of the phases of clinical trials …

The Three Distinct Phases of Clinical Trials

Before a new experimental drug is tried in humans, it's put to work in test tubes and then animals. Once it's ready for human trials, it's tested in three distinct phases.

The Phase I trial is conducted with a limited number of subjects, usually fewer than 50. In cancer trials, the drug will be given to patients, sometimes as a last resort. For drugs targeting many other diseases, they're given to healthy volunteers so doctors can better understand how the drug reacts inside the human body.

If a drug is deemed safe after this period, the company will proceed to Phase II. This trial usually consists of a few dozen to several hundred patients receiving varying dosage levels of the particular drug.

The data that's considered most accurate is from a trial that's "double blind" (neither the patient nor the doctor know if the patient has received the drug) and placebo controlled (compared to a placebo or standard of care). Some, but not most, Phase II trials are double blind and placebo controlled.

In Phase III, companies test hundreds to thousands of patients. If the data proves that the drug is safe and effective, the company will usually apply for approval.

Naturally, the more patients who take part in a trial, the greater the chance the drug fails. For example, the drug may not work, or there may be unexpected side effects. This is especially common in cancer trials, where the response rates are low, even with approved drugs.

Positive results in Phase III can push a stock higher as investors begin focusing on approval and the sales and profits that could follow. However, it doesn't always work that way. Many drugs with seemingly strong Phase III results have been rejected by the FDA for one reason or another. This can crush investors who followed a drug stock all the way to the end.

For example, MannKind (MNKD) has seen its stock rise and fall sharply several times. Investors got their hopes up on the company's inhaled insulin product Afrezza, only to see the FDA reject it time and again over safety issues.

This is one reason why Phase II is the real sweet spot for biotech investing…

Phase II Trials: A Profitable Time to be Involved in Biotech Stocks

Phase II is often the most profitable time to be involved in a small cap biotech stock. Many times, Phase II results are positive. Sometimes it's because the drug works. And other times it's because the trial is rigged to provide positive results.

For example, Cel-Sci (CVM), a company that stirs passion (both positive and negative) among biotech investors, ran a Phase II study on the head and neck cancer drug Multikine. However, rather than test the drug against other existing treatments, Multikine was given along with an existing treatment.

At the end of the trial, Cel-Sci boasted of a 12 percent complete response rate. But it was impossible to determine if the two out of 19 patients who had a complete response saw their tumors disappear due to Multikine or due to the other treatment.

So, why would a company do that?

To show good results in the hopes of raising additional capital.

There are also times when the science is conducted properly and Phase II claims are valid, but the drug isn't able to replicate results in a Phase III trial. Remember, a Phase II trial usually contains a much smaller sample size, which can easily distort results.

Very often, when a company reports strong Phase II results, the stock takes off as it is the first real indication that it might be approvable. Investors get excited; potential partners begin sniffing around; and the media begins to cover the drug's potential. Even though at this point things are just starting to get promising, it's often a great time to take the money and run.

Phase III, on the other hand, is fraught with risk. These trials are expensive to run, and there's no guarantee that the drug will again show strong results. For example, there have been some instances where the drug replicated its earlier results, but there was a stronger than expected response from the placebo group, narrowing the difference that the drug made and making it appear less effective.

Phase II Takes Off and Fails in Phase III

There are many instances of stocks that have taken off during or after Phase II results, where investors made lots of money but then suffered losses when the drug failed in Phase III.

A few real world examples — my subscribers made money on Medivation(MDVN) despite a disastrous Phase III trial that resulted in the stock plummeting.

Medivation had a drug for Alzheimer's called Dimebon. The Phase II results were outstanding. They showed a slower deterioration and fewer side effects than the existing therapies, including Pfizer's (PFE) Aricept. Despite skeptics' doubts, the stock ran in anticipation of Phase III results. If the data was strong and the drug got approved, it would likely be an immediate blockbuster.

After the stock doubled, I recommended that subscribers take half of their profits off of the table. Note, this is not the usual Oxford Clubphilosophy, but with small-cap biotech stocks that can plummet on one piece of news, I often suggest readers take their risk capital off the table once the stock has risen 100 percent or more.

So with investors now playing with the "house's money" after taking their initial investment back, we waited for the Phase III results.

It turns out, the drug didn't work.

The stock got crushed, and we sold out our remaining position. But because we had sold half at a 100 percent profit, we still pocketed a 37 percent gain. Not bad for a failed drug…

If The Smart Money Leaves … Take Your Profits and Follow

There have been several other instances where something similar has occurred. We made 102 percent gains on Delcath Systems (DCTH) and 42 percent gains on MELA Sciences (MELA), despite FDA rejections.

Although in these cases the Phase III trials were not deemed a failure, the FDA has rejected the applications for approval until more questions are answered.

Lastly, after positive Phase II results, you sometimes see the early investors and the venture capitalists exit the position. They've made their money and don't want to stick around for the risky Phase III. If the smart money is leaving, it may be a good idea to follow them out the door. At least with part of your investment.

There's nothing wrong with hanging around and seeing if a small biotech company can get the ball across the goal line and get its drug approved. But considering that less than half of all drugs in Phase II actually make it to the market, it's a smart idea to take profits along the way when you can.