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Long America, Short Gold

“Never give a sword to a man who can't dance.”

Chaos theorists will remind us that any complex system of consequence requires predictable patterns of behavior. Without an understanding of the deep simplicity associated with those repeatable patterns, one can surely lose his mind in trying to figure out what exactly is going on... that’s why using a global macro investment process is such a powerful weapon. Behavioral patterns repeat.

Confucius reminds us that the scariest part about this investing game is issuing swords to men who can’t dance. Women, on balance, are simply better dancers. Sorry guys. Last night, my favorite contrarian market indicators – the men of CNBC’s Fast Money – we’re at it again. God bless America for their presence in this game – without being able to take advantage of their predictable patterns of behavior, we wouldn’t be able to consistently outperform the market. These guys are consensus.

Dylan and Joey kept talking about this “long gold, short America” trade… given that I just started investing more aggressively in America over the course of the last 48 hours (and started shorting gold for the first time in forever) I found their comic relief fascinating, particularly given the timing…

Today’s markets do not trade on valuation. They trade on price. Price momentum governs predictable human behavior, and within the bounds of this interconnected global market place of interrelated factors, those behavioral patterns can be profited from.

Timing in these volatile markets is everything. When American stocks are hitting 3 months lows, and gold 7 month highs – you do not enter the game “long gold, short America” and call that a unique investment idea. I call that risk.

If you use a one factor model (price), and all you know is that you need to chase it, that’s cool – at least it’s a process. But don’t for one second think that there aren’t a world full of global macro pros out there who aren’t watching you, and waiting on you to do the perfectly predictable.

Fundamentally, I get the gold trade. I have been talking about it since 2005. Until recently, I was long gold in our Asset Allocation Portfolio, and if I get the momentum correction that I am looking for, I will cover my short position and consider it on the long side once again. This isn’t an emotional relationship – this is math.

The intermediate “Trend” in gold remains bullish, but at a price. The real support line for gold is all the way down at $824/oz. Understanding that some of the Fast Money traders who love gold up here are the same cats that loved crude oil at $140/barrel, I hope someone is at least mindful that what goes straight up can indeed come down. Support is -16% lower from where I shorted gold yesterday afternoon.

Gold is what you own as a safety currency when everything around you is in crisis. Asset classes like Gold and Cash can “re-flate” while other asset classes like stocks, bonds, real estate, etc… deflate. 

After we took a good hard look at yesterday’s intraday low in the SP500 of 782, we issued a note to our macro clients titled “Buying/Covering” (www.researchedgellc.com <http://www.researchedgellc.com> ). At 782, the US market was only 4% away from its November 20th, 2008 capitulation low. Yesterday’s lows came on much lower volatility (VIX 50 rather than VIX 80), and much lower volume. The only volume of consequence in my macro model was the audible kind – that sound of Fast Money traders chirping something about “long gold, short America”… C’mon guys… at least try to respect that there is a fiduciary aspect to this profession.

As always, putting that 782 SP500 line in context is critical. This had the SP500 down -50% from the Fast Money “buy everything Chindia” highs of 2007, and down a stiff -15.4% for 2009 to-date. Are we really investors “for the long run” here folks, or are we one factor model price chasers? My Dad, who is a firefighter, has always warned me of the psyche of those who chase his fire engines – they are not emotionally stable.

On an intermediate basis, Volatility (VIX) remains bearish. Unless the VIX can close above $53.44, I am very comfortable buying American stocks. I have not minced words and I am accountable for this call – unless we have another 6 standard deviation event, I do not think that the US stock market will penetrate that November 20th low.

What other signals in my 27 factor global macro model are signaling my conviction?

1.      The US$ is overbought anywhere north of the 88.11 line in the US Dollar Index

2.      Gold is overbought on an immediate term basis anywhere north of $983/oz

3.      The SP500 is oversold on an immediate term basis anywhere under the 790 line

4.      Other than the Russian stock market, there are NO major global equity indices that have penetrated and closed below their Oct/Nov lows

5.      China and Brazil continue to add to their YTD positive performance

6.      Credit has improved materially, particularly when it comes to global counterparty risk; the TED spread is 400 basis points lower than Oct/Nov

The inverse correlation between the US Dollar and the SP500 has been the anchor of this year’s call to remain bearishly positioned on US stocks. With the exception of one week where the US$ weakened, the US$ has been as relevant a heavyweight champion of global macro as gold has – but guess what, these factors are now very much correlated.

The US$ is trading down overseas this morning to the tune of -77 basis points. The S&P Futures are trading up +106 basis points. And looky here Joey… gold is trading down off of its 7 month highs as a result. How ironic…

Other than telling CNBC’s viewers that you love gold and hate US stocks based on a revisionist price, I have one question for Dylan and Joey… what is it exactly that you do? I know what it is that I do … and I am now Long America, Short Gold - thanking you for your predictable behavior. Sincerely,

Keith R. McCullough

Long America, Short Gold - etfs021909

Trading Gold?

By my math (using my immediate term duration model), gold has now had a 3 standard deviation move. While “Fast Money” may indeed buy high here in hopes of selling higher – hoping and praying is not an investment process that is repeatable. If I am right in that the US market is setting up to lock in another higher low, the last thing you want to be holding at this level in the SP500 is a bag full of gold.

Below I have painted a dotted red line whereby you can short Gold for an immediate term “Trade” – at effectively any price north of $973/oz, the risk associated with being short gold actually goes down, in the immediate term. You can cover at the green dotted line ($927/oz). This isn’t a huge projected return, but it pays for lunch.

I understand and support the bullish case for gold as a safety currency – I have been pitching that for the better part of a year. The intermediate “Trend” line of support for gold is all the way down at $886/oz however, and we need to be mindful of that. I will likely buy it again down there, if I am so lucky to see that price. In the meantime, don’t confuse the hype with the reality of the math. Gold, right here and now, is overbought.

Keith R. McCullough
CEO & Chief Investment Officer

Buying/Covering: SP500 Levels Into The Close...

Today feels like we’re playing that game where we have the banker sitting on the stool of the dunk tank. Lift him up, then drop him… lift him up, then drop him… and all the while Bloomberg TV is talking about ways to play the “double and triple down” financials ETFs… the groupthink that’s taken hold of this market is borderline sad.

While it may be their goal to entertain, this is not a circus… and shooting fish in a barrel on the short side is not going to last forever. Below I have outlined the possible depth of the water that remains in that proverbial dunk tank (shaded green like the oceans that Allen Stanford is probably sailing on right about now) in the 752-790 range.

If you can’t be buying and covering in this SP500 range, you probably think the apocalypse cometh – good luck with that – that’s not the unique thought that it was 12 months ago.

I have invested another 9% of the Cash I was holding in the Asset Allocation Model, dropping Cash down to 58% of the Model Portfolio.

Buy low… for the immediate term Trade up to the dotted red line at SP500 831.

Keith R. McCullough
CEO & Chief Investment Officer

Daily Trading Ranges

20 Proprietary Risk Ranges

Daily Trading Ranges is designed to help you understand where you’re buying and selling within the risk range and help you make better sales at the top end of the range and purchases at the low end.

Eye On Taiwan: Man Down!

GDP data for Q4 2008 confirms that the bottom has fallen out for the island Republic…

Taiwanese GDP released today for Q4 2008 showed a year over year contraction of -8.36%, marking the worst recorded performance for the economy of the ROC, declining more sharply than during either the post tech bubble recession in 2000-01 or the drop in 1974-75 following the end of US involvement in Vietnam.

The Central Bank’s reaction to the data was a 25 basis point cut reducing the benchmark 10 Day Loan Rate to 1.25%, the seventh cut approved by the Board of Governors in the past four months.

The government stimulus program unveiled last year includes 320 billion TWD to be spent on public works projects in 2009 but, with global demand contracting at a such a sharp pace, there seems little doubt that ultimately the driving force for recovery in the export dependent island economy will be measures taken in Beijing rather than Taipei.

As “Panda diplomacy” softens the road to closer ties with the mainland, the hard ideological divide of the past will likely give way to further pragmatic trade agreements like those adopted late last year which opened the way for direct shipments to mainland ports for the first time.

Andrew Barber


Not all European economies are created equal…

It now appears clear to most observers that the European recovery will lag America’s as the difference in economic resilience of the various continental economies become more apparent and the cracks in the European Union become more pronounced. GDP figures released on Friday by Germany, Europe’s largest economy posted Q4 GDP at -1.65 % year-over-year, whereas Italy’s figure, was -2.61% over the same period.

Yesterday, the Eurozone reported a trade deficit of €32.1 Billion in 2008, its biggest since the Euro’s inception ten years ago. The lack of global appetite for European exports is pronounced, in particular European carmakers have been severely hit by the credit crunch. The European Automobile Manufacturers’ Association reported that European car sales plunged 27% percent in January to the lowest level in two decades. Total December Eurozone exports fell 0.9% from a month earlier.

Politically, cross EU dialogue is heating up. Today German Finance Minister Peer Steinbrueck said euro-region countries may be forced to bail out other members of the Union that face problems refinancing their debt, despite the previous understanding that no Union member is obligated to come to the rescue of insolvent members.

While Steinbrueck didn’t mention any countries that may need a bail-out, a quick look at European bond yields helps answer this question. We’ve noted the divergence between Europe’s “most stable” country, Germany, and countries such as Spain, Portugal, and Greece, which have shown widening yields over the recent weeks. Further, Eastern Europe (in particular the Baltic countries, Hungary and Romania) has posted some of the worst GDP declines in 2008 and projected forecasts for 2009/10 as they deal with currency devaluations, the repayment of IMF loans, and major contraction due to weakening European demand for goods and services.

We continue to diagnose the European patient. Respecting that some of these points are rear view, the declining GDP figures and rising deficit numbers still confirm our bearish view of the region. We do not own anything in Europe, and we do not intend on buying anything there for the foreseeable future. At this stage of the global economic meltdown, and at these prices, we prefer being long Chinese, Brazilian, and American Equities.

Most importantly, European investors need to consider that there is tail risk here. Tail risk, after all, is what no one thinks can happen. Steinbrueck’s statement further suggests the fear, however faint, of a potential unwinding of the EU in its present form. Should Europe’s economically stronger countries need to bail out the weaker ones it will only increase Europe’s recovery lag. We continue to trade around the region (on the short side) on a country-per-country basis. We covered our short position on the UK via the etf EWU yesterday in order to capitalize on market weakness.

Matthew Hedrick

Andrew Barber

Monitoring The Patient: The VIX

With the US stock market making fresh 3 month lows this morning, it doesn’t surprise us to see a notable lack of conviction. When it comes to volatility however, the game has changed here, and materially so – bears who are pressing the lows, beware.

Looking back at the capitulation lows of October/November one is reminded of the math. The fact of the matter is that the VIX was spiking at an unprecedented 80 during those dark days in American history (see chart) – today, despite pervasive bearish commentary coming out of the manic media, the VIX is struggling to hold its head above 50. The market patient is no longer under cardiac arrest.

The reality is that we have ourselves a New Reality. Some investors have been rightly burned by not proactively managing risk BEFORE that November 20th, 2008 low… but now… AFTER the fact… those reactive managers are just as wrong in straight lining that risk management environment of 2008 into today’s.

Today the TED spread (measures counterparty risk) and liquidity overall have improved significantly versus November (central banks dropping trillions of free moneys from the sky does that) and, as importantly, the VIX remains broken on an intermediate “Trend” line basis.

I have “Trade” (immediate term) resistance in the VIX is the dotted red line below (overbought today), while “Trend” (intermediate term) resistance is plenty higher up at the 53.46 line. Unless that 53.46 line can be penetrated, I think the SP500 lows are in.

I have been getting invested over the course of the last 36 hours as a result. As always, this market patient needs to be monitored, but please do so objectively. Emotions create heartache.

Keith R. McCullough
CEO & Chief Investment Officer

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