Can Investors Trust Official Statistics?

Investing is about information. Having more - and better - information allows an investor to paint a more complete picture about the financial health of a company, or even of an entire country's economy. This is especially important as companies grow their multinational presence, entering markets in areas that are rapidly developing and have an insatiable appetite for the world's goods and services. But venturing into these markets can mean entering a world in which the rule of law can be overlooked, and in which the principles that drive business in developed countries come face to face with a different reality.

Economic Data Collection
Economists and investors alike look to certain statistics to judge the health of an economy, and thus get an idea of what threats and opportunities companies operating in those economies may face. Statistics such as unemployment, public debt, inflation, poverty rates and other macroeconomic and socioeconomic figures form the backbone of this type of analysis.

To compile these statistics governments create agencies to come up with the appropriate methodology and hire personnel to go through the cities and countryside to collect information. Examples of government agencies include the Bureau of Labor Statistics and Census Bureau (United States), Eurostat (European Union), Federal State Statistics Service (Russia) and National Bureau of Statistics (China). Personnel interview residents to find out how big their households are, check local prices for goods and services, visit schools to check attendance and gauge the general opinion of the population. This data is then brought back for analysis.

There are several reasons why a country may manipulate the information coming in from the field.

International Investors Want Healthy Economies
Multinational corporations don't want to invest millions of dollars in new markets if they think that things will collapse. Growth in consumer demand, stable government policies and access to transport are important factors that contribute to a venture's success. For example, favorable education figures make the country look more attractive to companies who need an educated workforce to manufacture products.

Credit Markets Want Stability
Lower inflation rates give the country more flexibility in its monetary policy, as it may want to continue to print money to bolster its reserves or fend off accusations of scarcity. For countries obtaining credit through inflation-linked bonds, understating inflation can amount to significant savings for the home government and the equivalent amount of losses for investors. (more)

Lesson on Intraday Divergence Reversal Signals in Gold

I wanted to follow-up from the post “Lessons from Gold’s Three-Push Divergence into $1,800” from last week with an additional trading example of how to piece together the chart puzzle into a successful low-risk, high probability trade on the very short-term structure.

Let’s take a look at the chart and study the lesson from the “Divergence Plus Trendline Break” Reversal Trade:

Be sure to read my prior commentary on the first trade set-up: The Short-Sale into $1,800 (on dual divergences and a “Three Push” Pattern).

The main idea was that price rallied into the key overhead “Round Number” of $1,800 per ounce on lengthy (multi-swing) negative momentum divergences.

Very aggressive traders like to short-sell INTO higher timeframe resistance, particularly if some sort of divergence (momentum, volume, etc) is present – it’s a low-risk trade in the context of a potential short-term reversal (or at least retracement) against the resistance.

Conservative traders prefer to watch the set-up develop and THEN take a position AFTER price triggers/signals entry on a corresponding price trendline or EMA (moving average) break/cross.

When you’re playing this type of set-up on the short timeframes (intraday like the 5-min chart above), the common question becomes:

“I see where I put on the trade, but where do I exit?”

Let’s keep it simple and discuss the answer:

“When price – in real-time – gives you a similar reversal signal.”

Of course, an alternate method would be playing for a specific price or percentage-gain target (such as $1,750 or $1,700) but let’s take it a step beyond super-simplicity (price level targeting).

If you’re playing a short-term reversal signal, try holding the position until price gives you a similar counter-reversal signal in real-time.

Admittedly, this isn’t as comfortable as trading for a specific target in mind, but it can help you generate a higher potential profit if the price swing has more power in it that takes it beyond a simple price level target.

In this case, let’s assume that we entered short at the red highlighted region which played off the negative dual divergences and inflection down from $1,800 that triggered an entry on the break of the $1,780 region which soon-after resulted in a 20/50 EMA bearish cross-over (August 10th).

We would place our stop-loss above the chart swing high at $1,800 and then play for an indefinite target until price gave us a reversal signal.

Price reversed its trend with a series of sequential lower lows and lower highs (price structure) which eventually resulted in a clear positive multi-swing divergence into the spike to $1,730 on August 12th (Friday).

Divergences are NOT flip-reverse position signals by themselves, but they can be position-exit signals for conservative traders (exit a profitable position into a clear positive momentum divergence with price).

Alternately, a trader can see the divergence but then demand that price break a falling trendline or EMA, which would serve as a trend reversal entry position – similar to the signal generated at the $1,780 short-sale trigger.

The price confirmation – breakthrough signal – occurred at $1,740 which triggered a reversal entry signal and of course exit signal for any remaining short-sale position.

The process starts over again with a reversal BUY signal at $1,740 with a stop-loss now under the $1,730 swing low.

To Summarize:

Let Exit Logic Equal Entry Logic.

If you’re entering a short-term reversal trade with divergences, hold the position until price generates a similar reversal signal in the opposite direction.

Also, it’s worth reviewing the trigger tactics for the Divergence + Price Break Trade:

1. Observe a Multi-Swing Divergence
2. Trade when Price BREAKS through (confirms) a trendline or key EMA (20 or 50 period)
3. Observe the confirmation with a 20/50 EMA Crossover

Remember that this is one among many trading strategies, but it’s worth studying if you’re not familiar with the concept.

Though I’m using gold as a teaching example, this principle tends to work just as well in stocks, ETFs or other futures markets.

Corey Rosenbloom, CMT

Market Stages Tremendous Rally.... On 40% Of Recent Volume

When witnessing this latest vapor volume melt up, what can one say but victory for the bulls... Oh yes, ignore that the relentless rally is on 40% of the past 10 day average volume. 1.8 million ES contracts on 4.46 million 10 DMA. Irrelevant: inverse distribution or something is the conventional spin. Europe is fixed, and no recession is coming - just cover any and all shorts before Google buys them all. Also ignore when a month from today we are back to the level when two ES contracts send the market limit up.

And for those wondering why ES volume actually matters, here is your answer - ES afterhours.

Don't Fall Into a 'Value Trap' : JNS, HUM, BDX, AKS, DLB

Is that cheap stock you have your eye on really a "value trap"?

After a 9.3% drop in the Standard & Poor's 500-stock index this month, most stocks are looking cheap—but some seeming bargains may have more room to fall. Investors need to do more than simply look at price history and buy the most beaten-down stocks, say strategists.

The temptation to load up on such stocks is surely there. Using 12-month earnings forecasts, the S&P 500's average price/earnings ratio is now about 9.9, down from 13.2 at the beginning of the year, according to S&P. And the median stock among the 1,800 tracked by Morningstar Inc. is trading at about 85% of fair value, as measured by the investment-research firm—the lowest percentage since April 2009.

Yet in today's volatile market environment it isn't clear whether a stock is truly cheap or if earnings estimates haven't caught up to falling share prices. That is because analysts cut their earnings estimates more slowly in selloffs than prices fall, meaning the "earnings" in a price/earnings ratio may be seriously inflated.

Now that analysts have started cutting their estimates to account for slower economic growth, investors should assume that many P/Es actually will be higher in a month or two than they are now.

"They're only cheap because their prices are falling faster than their earnings are deteriorating," says Savita Subramanian, head of quantitative strategy at Bank of America Merrill Lynch. "It's too early to buy many segments of the market."

So how do investors spot a value trap? Ms. Subramanian identifies two characteristics: The stock has dropped more than the average stock in the S&P 500 during the past three months, and its earnings estimates are being revised downward faster than its peers. Among industries, capital-market firms and semiconductor companies look to be among the most susceptible to value traps, she says.

Consider money manager Janus Capital Group Inc., which Merrill Lynch cites as a potential value trap. It has a P/E of just 6.7, well below its five-year average of 16.9, and has dropped 33.5% during the past month, compared with 11.1% for the S&P 500. Analysts also have been cutting estimates since the end of April, with earnings per share cut by about eight cents, according to FactSet Research Systems.

Health insurer Humana Inc., by contrast, may actually be a value at current prices. Its P/E is currently 9.3, well below its five-year average of 12. The stock, however, has dropped 13.8% during the past month, less than the S&P 500's 16.5% loss, while analysts have boosted profit estimates more than 9% in August, according to FactSet.

Another way to determine whether a stock may not be as cheap as it looks: Look at analysts' expectations of a company's profit margins and compare them to historical margins, says Adam Parker, head of U.S. equity strategy at Morgan Stanley. If expectations are significantly higher than historical levels, it could be a sign that a company is poised to disappoint.

"If margins are usually 30% and expectations are for 50%, we get concerned," Mr. Parker says. He says health-care stocks have the most compelling estimates, while expectations for industrials and consumer-discretionary stocks look inflated.

For example, Becton Dickinson & Co. is expected to generate operating profit of $1.8 billion in 2011 on sales of $7.8 billion, for a net margin of 22.8%, only slightly higher than the five-year average of 21.4%. Robert McIver, co-portfolio manager of the Jensen Portfolio mutual fund, which owns the stock, likes that stability. "The value of the actual business hasn't changed to the extent the stock price has," he says.

Investors looking to place a high-risk bet on a market bounce should buy the cheapest "cyclical" stocks possible, says Vadim Zlotnikov, chief market strategist at AllianceBernstein, since such stocks should rebound more when the selling finally stops. That means focusing on industrials, energy and telecommunications companies, and financial companies, among others—especially those that have been among the worst 10% of decliners this month and have low price/book or price/sales ratios.

Among this group, says Mr. Zlotnikov: AK Steel Holding Corp., which dropped 38.3% through Aug. 8 and has a price/sales ratio of 0.1, below its five-year average of 0.4 and the industry average of 0.6, and Dolby Laboratories Inc., which dropped 30.8% and has a price/book ratio of 2.1, below its five-year average of 4.7. If the market rebounds, these types of stocks should outperform during the next three months, he says.

"Sure, it's scary," Mr. Zlotnikov says. "But you get paid for the risk with these types of stocks."

Talking Numbers: S&P 500 Heading Up?

What Would a USD Collapse Mean for the World?

Lorimer Wilson

I came to the conclusion several years ago that it was just a matter of time before the world realized that the relative functionality of the U.S. dollar was about to go belly up – to collapse – and that that time happened to coincide with that fateful date all the prophecies are going crazy about – 2012! Words: 881

So said Chris Laird (www.Prudentsquirrel.com) in paraphrased comments from his original article* which Lorimer Wilson, editor of munKNEE.com (It’s all about Money!), has further edited ([ ]), abridged (…) and reformatted below for the sake of clarity and brevity to ensure a fast and easy read. Please note that this paragraph must be included in any article re-posting to avoid copyright infringement. Laird goes on to say:

I find this coincidence remarkable because, were the USD to actually collapse, just think of the many economic and political disasters that would indeed unfold. The U.S. economy would stop dead for a period of time and the rest of the world, hitherto dependent on the old industrial/consumer economic model, would have to find a new economic paradigm to plan their economies.

A USD collapse means the entire structure of the world economy would collapse for a period of time, with a collapsed supply chain, among other things. The world would also go through cataclysms politically during that period. That usually leads to massive wars, starvation and mass homelessness around the world. Interesting. That’s the same stuff being prophesied in many of the numerous 2012 prophecies of various major religions! That is quite the coincidence. The demise of the USD will collapse the entire world economy and lead to collapsed policies, and then a massive world war. Yep, it fits like a glove.

Of course, some people cringe at an analyst such as myself talking about ‘religious bunkum prophecies’ but consider that I am a mathematician and also a former Oracle database systems engineer. I’m not exactly some dreamer. I certainly know the analytical methods. So, why am I saying this stuff then? How can I combine prophecies with analytical methods? Well, for one thing, I have a thinking paradigm where ‘if it works, it must be true, don’t leave out weird things in analysis, insisting only on some calculation based prediction’. That’s what chartists do. I don’t. Everything must be analytical to lots of people, and that is totally wrong often! The trouble with being analytical all the time is that there are times, and this is proven, where chaos enters the picture and everything changes. Chaos, by definition, is not predictable…

What Would Happen in a USD Collapse?

• The U.S. and Western economies would all face insolvency simultaneously, with the U.S. first in line.
• The entire Western industrial/consumer/credit economy would fall apart so fast it would make your head spin. The supply chain would stop and stores would empty quickly.
• The USD would fall over 50% in one week’s time and then temporarily stabilize before its final last gasp…
• Worldwide currency panic would set in paralyzing what’s left of the world economy which means the ‘emerging markets’ would stop dead too.
• China would have a revolution, or go into military mode, which would be even worse.
• A one-world currency would be demanded and implemented.
• Asia would fare fare horribly…If Western consumerism goes away, then the entire foundation of the Asia macro economy would instantly crash and stop cold. Do you remember what happened that fateful last quarter of 2008, after the Lehman debacle, and the world banking system almost collapsed en masse? Exports from China and Japan for example collapsed over 30%! Don’t think economic demand cannot stop on a dime, because we already had one very scary case of this in 2008. So, all the pundits aside, Asia would get killed too economically. The big question is, could they successfully adapt to a new economic paradigm before they had their own revolutions? I do not think so.

It would be a dark time worldwide.

Gold Video of the Day: When to Sell Your Gold – Sprott

Ok, you bought a dip.

Now what? What are the forces behind the 10 year bull market – and how will you know when they’re played out, spent, finito? Eric Sprott has some thoughts on that topic that he shares with us today.

Sell Signal #1: Mania

This is also known as a Bubble. It’s characterized by wild price swings and irrational exuberance. Not only do all the funds own gold in various forms, but so does your Aunt Judy and the guy who does your dry cleaning. And they’re all talking about gold and how they’re going to buy more. When everybody is in and there are no more buyers – guess what happens to the price? We are nowhere near this mania/bubble stage.

Sell Signal #2: Governments/Central Banks Become Responsible

The temptation to make a joke out of this idea is tempered by the fact that government irresponsibility has delivered the world’s economies to the end of a road – and that really isn’t very funny. Post-collapse, governments will be forced to become responsible again. Exactly how that collapse will play out is unclear but there is no sign that the guilty governments (you know who you are!) are willing or able to act responsibly anytime soon.

Sell Signal #3: Gold Standard is Reinstated

Advocacy of a return to the gold standard is no longer considered goofy. The president of the World Bank floated the idea last year and since then, discussion of how it would be implemented is fairly common amongst the exalted poobahs – not just the Ron Pauls of the world. Assume that this is under active consideration by the people with the ability to make it happen. But if it does happen, it will be sprung on the world as a surprise. And part of the surprise might include confiscation at bargain basement prices.

Thanks Eric Sprott! You provide the ideas and we’ll flesh em out!