Let’s be blunt; fear and greed suck.  No matter how long you have been in the markets the “pull” of these two emotions is ever present.  Basically, instead of having an angel on one shoulder and a devil on the other, it’s more like having a different devil on each shoulder.

One devil whispers things like “buy the bottom”, “increase your position size”, “this one could be a big winner”. The other whispers things like, “this looks like the top”, “the market WILL crash”, and the quintessential ‘sell NOW” (as the market bottoms out).

The fiends.

The truth is that although I have been in this business awhile (basically since what I refer to as “The Hair Era” in my life) and am a huge proponent of systematic trading, I still fight these “demons” all the time. To wit, I keep wanting to get bullish on gold, silver, gold stocks, silver stocks, and commodities in general (and I do think ultimately that will pay off).  But the metals/commodities world has been sort of like a front-loading washer- up, down, roll over, fall down, climb back up, wash, rinse repeat.

And still I have it in my mind that they are “setting up for a big move” (I think that comes from the devil on the left shoulder).  When I look at the ever narrowing range I see for ticker SLV in Figure 1 I think it’s got to break out soon and when it does….”Figure 1 – Ticker SLV in narrowing range (Courtesy AIQ TradingExpert)

So imagine my delight when I saw the chart displayed in Figure 2 from www.KimbleChartingSolutions.com displayed in Figure 2 on the McVerryReport.

Figure 2 – Silver – forming a “mega” cup & handle pattern? (Courtesy www.KimbleChartingSolutions.com)

William O’Neil, founder of Investor’s Business Daily popularized the “cup and handle” formation in his classic book “How to Make Money in Stocks.”  Well, if the formation depicted in Figure 2 really is the “Mother of All Cup and Handle Formations’, then something spectacular lies ahead for silver.  But still I had certain reservations.  So I asked some professionals what they thought and got varying responses.

This reminded me once again, that a lot of things – chart formations especially – are in the eye of the beholder.

One response that sort of opened my eyes was from famed trader and Market Wizard Linda Racshke.  One of the charts she posted appears in Figure 3.

Figure 3 – Long-Term Silver;1972-2018 (Courtesy: Moore Research Center, Inc.)

When I look at Figure 3 – i.e., the “Big Picture” with no ones interpretation added things look a little different.  When I look at the recent consolidation at the far right of Figure 3, I suddenly don’t see any reason why silver is “destined” to explode to the upside anytime soon.  A perusal of Figure 3 reveals that there were plenty of times when silver “consolidated” into a tight range – and then drifted sideways to lower for literally years at a time.

So What Now?

I see two possible courses of action:

1. Put a small amount of capital into long-term call options on GLD, SLV, GDX, etc., and settle in.

2. Wait for an actual confirmation of an uptrend in metals before taking the plunge.

The Bad News is that “actual confirmation of an uptrend” is a lot like “a consolidation setting up for a big move”, in that there is more than one way to make this designation so again it’s all in “the eye of the beholder.”

That caveat in place, one possibility for someone opting for Choice #2 above appears in Figure 4.  Gold futures have a resistance level somewhere in the range of $1,380 an ounce.

Figure 4 – Gold futures with key “line in the sand” resistance near $1,380 (Courtesy ProfitSource by HUBB)

A breakout above $1,380 could signal that it’s time to move into metals.  As long as gold remains below that level it seems pretty ambitious to call the trend in metals “bullish.”

Some lessons we (re)learn the hard way I guess.

Now if I could just get these guys on my shoulders to shut up…..

Jay Kaeppel

Disclaimer:  The data presented herein were obtained from various third-party sources.  While I believe the data to be reliable, no representation is made as to, and no responsibility, warranty or liability is accepted for the accuracy or completeness of such information.  The information, opinions and ideas expressed herein are for informational and educational purposes only and do not constitute and should not be construed as investment advice, an advertisement or offering of investment advisory services, or an offer to sell or a solicitation to buy any security.

In this article I wrote about an index I follow that combines the biotech sector with the gold stock sector. I also wrote about “one way” to trade that index.  This article builds on that piece and adds a new “rule” to create more trading opportunities.

The BIOGOLD Index

Figure 1 displays the index that I created using AIQ TradingExpert.  It combines ticker FBIOX (Fidelity Select Biotech) with ticker FSAGX (Fidelity Select Gold).Figure 1 – Jay’s BIOGOLD Index (Courtesy AIQ TradingExpert)

Also included in the lower clip is an indicator referred to as RSI32, which is the 2-day average of the standard 3-day RSI.

The Old System

In the original article I tested an approach that works as follows using monthly data:

*When the RSI32 drops to 32 or below, buy BOTH FBIOX and FSAGX

*After a buy signal, sell both funds when RSI32 rises to 64 or higher

For results, please see the original article.

The New System

The “new rules” are as follows:

A “buy signal” occurs when either:

*The RSI32 drops to 32 or below

*The RSI32 drops below 50 (but not as low as 32) and then reverses to the upside for one month

After either of the buy signals above occurs, buy BOTH FBIOX and FSAGX

*After a buy signal, sell both funds when RSI32 rises to 64 or higher

Figure 2 displays the BIOGOLD Index with various buy and sell signals marked.Figure 2 – Jay’s BIOGOLD Index with RSI32 signals (Courtesy AIQ TradingExpert)

To test results we will:

*Assume that after a buy signal both FBIOX and FSAGX are bought in equal amounts

*We will assume that both funds are held until RSI32 reaches 64 or higher (i.e., there is no stop-loss provision in this test)

For testing purposes we will not assume any interest earned while out of the market, in order to highlight only the performance during active buy signals. Figure 3 displays the hypothetical growth of $1,000 (using monthly total return data) using the “system”.Figure 3 – Hypothetical Growth of $1,000 using Jay’s BIOGOLD System (1986-present)

Summary

For the record, I am not “recommending” that anyone go out and initiate trading biotech and gold based on what I have written here.  Before trading using any approach it is essential for a trader to do their own homework and carefully consider all of the pro’s and con’s associated with any specific approach.  For example, while the trade-by-trade results for the above look reasonably good, it should be noted that there have been 4 separate drawdown’s in excess of -19% along the way, including a maximum drawdown of -37% in 2008.  In considering any approach to trading it is essential to first think long and hard about how well one would “weather the storms”, BEFORE focusing on potential profitability.

To put it more succinctly is the simple phrase “Don’t cross the river if you can’t swim the tide.”

Jay Kaeppel

Disclaimer:  The data presented herein were obtained from various third-party sources.  While I believe the data to be reliable, no representation is made as to, and no responsibility, warranty or liability is accepted for the accuracy or completeness of such information.  The information, opinions and ideas expressed herein are for informational and educational purposes only and do not constitute and should not be construed as investment advice, an advertisement or offering of investment advisory services, or an offer to sell or a solicitation to buy any security.

Although I do a lot of my own analysis, I also recognize that there is a heck of a lot that I don’t know and a lot that I don’t see unless someone else points it out.  So here is a handful that caught my eye.

Stock Market Valuation

While I am primarily a trend follower and am in the “the major trend is still bullish” camp, I also recognize that over time the stock market swings from undervalued to overvalued and – much to the chagrin of everyone – back again.  At this point in time there are two things to keep in mind:

1) When the stock market gets overvalued something bad invariably follows

2) The stock market is presently near the high end of the long-term valuation range

Figure 1 is from Advisors Perspective at dshort.com and displays an index of various valuation measures at the top and the subsequent 10-yr average rate of return for stocks going forward.Figure 1 – Stock Market Valuation and subsequent 10-year average annual returns (Beware); (Source: Advisors Perspectives; www.dshort.com)

If you feel that the stock market is impervious and that there is little downside risk in the next several years I encourage you to analyze this chart closely.  The two things I mentioned above will become fairly obvious.

This chart is NOT a reason to panic, nor to “sell everything.”  But it should serve as a reminder that when the next bear market rolls around it will likely be “one of the painful kind.”

Commodities Cheap Relative to Stocks

I wrote about this in greater detail here, but in a nutshell, over time there is an interplay between hard assets (commodities, real estate) and paper assets (stocks in particular).  One vastly outperforms for awhile, and then everything reverses.

Figure 2 strongly suggests that commodities are extremely cheap compared to stocks.  History strongly suggests that this relationship is not permanent.Figure 2 – GSG/SPX Ratio (i.e., commodities versus stocks) (Source: Dr. Torsten Dennin, Incrementum AG)

The upshot of Figure 2 is that investors should NOT be surprised if commodities (which can be traded as, well, a commodity, using ETFs such as GSG, DBC or RJI) vastly outperform stocks over the next 5-10 years.  I am not “ringing a bell” and shouting “sell stocks, buy commodities” – but am simply pointing out that the tide will eventually turn – likely in a significant way.

Bonds May Be Overdone on the Downside

I recently subscribed to www.sentimentrader.com and absolutely love the wealth of hard market data they provide.  The one chart I want to point out here displays the 10-day average of their “Investment Grade Bond Up Issues Ratio” (i.e., low readings mean most bonds are declining) versus ticker LQD – which is an ETF that tracks an index of investment grade corporate bonds.  As you can see in Figure 3, sentiment is getting very negative.  Likewise, previous readings down in this range have typically been followed by upside reversal in price.

This potential setup fits well with what I wrote about here and here.Figure 3 – Sentiment may be suggesting that bonds are overdone on the downside and are due for a bounce (Source: www.sentimentrader.com)

Two caveats: 1) there is no guarantee that will happen this time, and 2) history suggests that bonds could sell of even more before finding a bottom.  So don’t take this as a buy signal but simply as an alert that a buying opportunity may soon be at hand.

Jay Kaeppel

Disclaimer:  The data presented herein were obtained from various third-party sources.  While I believe the data to be reliable, no representation is made as to, and no responsibility, warranty or liability is accepted for the accuracy or completeness of such information.  The information, opinions and ideas expressed herein are for informational and educational purposes only and do not constitute and should not be construed as investment advice, an advertisement or offering of investment advisory services, or an offer to sell or a solicitation to buy any security.

OK, if you are pretty sure that you will never trade an option credit spread then “class dismissed”.  Thanks for stopping by and please come back again soon.

Alright option junkies, we have the class to ourselves so here is a quick and dirty lesson about one of the most important aspects of establishing a credit spread.

The Short Version

Your stop-loss point for a bull put credit spread should be BELOW an obvious support level to ensure that you do not get stopped out by “market noise”.

The Longer Version

OK wait, first – just in case – for the record, a “bull put” credit spread involves selling a put option with a higher strike price and buying a put option lower strike price put option.

For example, consider the example trade displayed in Figures 1 and 2 which involves:

*Selling 6 IBB March 100 puts @ $1.10

*Buying 6 IBB March 95 puts @ $0.55

For the record, I am NOT “recommending” this trade.  It simply serves as a useful example of something I consider important in establishing a credit spread.

Figure 1 – IBB Bull Put Credit Spread (Courtesy www.OptionsAnalysis.com)Figure 2 – IBB Bull Put Credit Spread risk curves (Courtesy www.OptionsAnalysis.com)

With IBB trading at $107.18 a share, this trade has:

*31 days left until expiration

*A maximum profit potential of $330 (or 12.36% of risk) which would be realized if IBB closes above $100 a share at expiration.

*A breakeven price of $99.45

*A maximum risk of -$2,670 which would be realized if this trade was held until expiration and IBB was at $95 or below at the time

Because of the lopsided reward/risk it is recommended that a trader establish an “Uncle” point, i.e., a price which, if reached, would cause the trader to exit the trade, presumably with a loss.

OK – finally – here comes “the lesson”.

1) Ideally there should be an obvious support level visible on a chart.  As you can see in Figure 3, for IBB that level is $100.67, i.e., the low of the double bottom established in November 2017.Figure 3 – IBB Price chart with support at $100.68

Now here comes the actual “point”

2) The “breakeven price” and/or your “Uncle” point for a credit spread you are looking do enter should be BELOW the obvious support level that appears on the price chart. (NOTE: you do not have to  use the breakeven price as your “Uncle” point.  You can choose another price level.  However, ideally both price levels should be belowthe obvious  support level on chart.)

Why?  Because any drop to the obvious support level that does not break out to the downside is nothing more than “noise”.  In fact, it could even serve to strengthen the support level if price retests and then holds above support.

3) You DO NOT want to get stopped out by market “noise”.

See Figure 4.

Figure 4 – IBB Bull Put Credit spread with breakeven price below support (Courtesy www.OptionsAnalysis.com)

1) The obvious support level is $100.68

2) The breakeven price (potential “Uncle” point) is $99.45

3) If market noise takes IBB back down to $100.68 but no lower, this trade will NOT get stopped out.

In Sum: Your stop-loss point for a bull put credit spread should be BELOW an obvious support level to ensure that you do not get stopped out by “market noise”.

Here ends the lesson.

Jay Kaeppel

Disclaimer:  The data presented herein were obtained from various third-party sources.  While I believe the data to be reliable, no representation is made as to, and no responsibility, warranty or liability is accepted for the accuracy or completeness of such information.  The information, opinions and ideas expressed herein are for informational and educational purposes only and do not constitute and should not be construed as investment advice, an advertisement or offering of investment advisory services, or an offer to sell or a solicitation to buy any security.

Few securities hold the mystical lure that gold stocks seem to possess.  The seeming never ending allure of gold as the ultimate “store of value” (whatever that means) and the volatile nature of gold stocks themselves create a combination that draws in traders and speculators – often not unlike a moth to the flame.  “Hi, my name is Jay” (For record, I recently did a “swoon to the gold stock tune” here. An update on this example trade appears the end of this article).

(If you want to read the bullish case for the stock market, read this How to tell a bear market from a bull market blip

If you want to read the not so bullish case for the stock market, read this Valuations and Bear Markets)

The History

Figure 1 displays a 5-stock index that I created as a proxy to track the gold stock sector. Whether this is the “definitive” gold stock index or not (it’s not) is not the point. The point is that, clearly, if you get on the right side of a big move there is money to be made.Figure 1 – Gold stocks have a history of making big moves; currently coiling in a relatively tight range (Courtesy AIQ TradingExpert)

The Here and Now

As you can also see in Figure 1 at the far right is the fact that gold stocks are mired in an exceptionally tight range. The obvious question is, “will the breakout be to the upside or the downside?”  I don’t claim to know, but based on what I wrote about here my expectations for commodity prices in the next several years, I might be willing to bet that the breakout will ultimately be to the upside.

The key item in the linked article is the chart in Figure 2 below that shows the ratio between the Goldman Sachs Commodity Index (GSCI) and the S&P 500 (SPX).  Commodity prices were recently about as low as they have ever been in relation to stock prices.  This type of extreme is typically followed by a major advance in commodity prices.Figure 2 – GSCI/SPX Ratio (Source: Dr. Torsten Dennin, Incrementum AG

One Way to Play

So let’s assume someone wants to play the bullish side in the months ahead.  The most straightforward approach would be to buy 100 shares of ticker GDX (a gold stock ETF).  As I write 100 shares of GDX would cost $2,197. Let’s consider a less costly alternative.  For the record – and as always – the position highlighted below is not a “recommendation” only an “example” for educational purposes.  This example trade involves:

*Buying 2 Jun2018 22 calls @ 1.61

*Selling 3 Jun2018 25 calls @ 0.62

*Buying 2 Jun2018 28 calls @ 0.26

The particulars appear in Figure 3 and the risk curves in Figure 4.

Figure 3 – GDX Directional Butterfly Spread (Courtesy www.OptionsAnalysis.com)

Figure 4 – GDX Directional Butterfly Spread Risk Curves (Courtesy www.OptionsAnalysis.com)

As you can see this trade has:

*123 day left until expiration

*Unlimited profit potential

*Maximum risk of -$388.  A trader could choose to cut his or her loss if support is taken out near $20.20 a share.

*A “delta” of 96 – which means that the trade will behave roughly like a position that involves holding 96 shares of GDX.

Summary

Once again I must reiterate that this trade is not a recommendation. It is intended solely as an example of one way to:

*Play a bullish outlook (assuming you have one) for gold stocks over the next four months (so note that if no up move unfolds in the next four months this trade could lose 100%).

*While investing and risking less than it would cost to buy 100 ETF shares.

Addendum

The latest risk curve for the example trade I wrote about here appears below. This trade can benefit from either a big price move up, a big price move down and/or an increase in volatility.

Figure 5 – GDX “Volatility Bomb” example trade

As you can see in Figure 6, implied volatility or options on GDX (black line) rose sharply in recent days (which actually pushed this example traded into profitable territory).  There is still plenty of “upside” left for volatility and GDX just reversed back to the upside at support.Figure 6 – Ticker GDX with implied option volatility (black line)  (Courtesy www.OptionsAnalysis.com)

Jay Kaeppel

Disclaimer:  The data presented herein were obtained from various third-party sources.  While I believe the data to be reliable, no representation is made as to, and no responsibility, warranty or liability is accepted for the accuracy or completeness of such information.  The information, opinions and ideas expressed herein are for informational and educational purposes only and do not constitute and should not be construed as investment advice, an advertisement or offering of investment advisory services, or an offer to sell or a solicitation to buy any security.

In this article titled “A Useful Inflation Indicator (and a Decent Bond Market Model)” – dated 12/14/2017 – I wrote about a simple model that, as the name implies, has a decent tracking record as a bond market indicator. For what it is worth, this model has turned “bullish” for bonds.

This signal combined with the potentially bullish signals detailed in this article last week, give me hope that the bond market – currently oversold (and seemingly universally loathed in full “interest rates are certain to go” mode) – may be due for a bounce once this latest selloff runs its course.

Rather than recreate how the whole thing works please see the original article for details. For the record though, the equity curve for $1,000 invested in ticker TLT when the model is bullish (any reading less than +2) versus bearish appears in Figure 1.

Figure 1 – Growth of $1,000 invested in TLT when Test Bond Model <2 (red line) versus growth of $1,000 invested in TLT when Test Bond Model =+2 (blue line) (daily, 12/5/2003-2/9/2018)

Summary

For the record I am not making any recommendations regarding bonds. I am simply highlighting the fact that several models that I follow have flipped to the bullish side.

This means two things:

1) These systematic “buy” signals – combined with the near universal fear and loathing of the bond market these days  – suggests there is a chance that the bond market will bounce sometime in the near future

2) If the bond market does NOT bounce sometime in the near future it may bode very ill for the longer-term trend

Jay Kaeppel

Disclaimer:  The data presented herein were obtained from various third-party sources.  While I believe the data to be reliable, no representation is made as to, and no responsibility, warranty or liability is accepted for the accuracy or completeness of such information.  The information, opinions and ideas expressed herein are for informational and educational purposes only and do not constitute and should not be construed as investment advice, an advertisement or offering of investment advisory services, or an offer to sell or a solicitation to buy any security.

In this article titled “World, Meet Resistance” – dated 12/21/2017 – I noted the fact that many single country ETFs and regional indexes were closing in on a serious level of potential resistance.  I also laid out three potential scenarios.  So what happened?  A fourth scenario not among the three I wrote about (Which really pisses me off.  But never mind about that right now).

As we will see in a moment what happened was:

*(Pretty much) Everything broke out above significant resistance

*Everything then reversed back below significant resistance.

World Markets in Motion

Figure 1 displays the index I follow which includes 33 single-country ETFs. As you can see, in January it broke out sharply above multi-year resistance. Just when it looked like the index was going to challenge the all-time high the markets reversed and then plunged back below the recently pierced resistance level.

(click to enlarge)Figure 1 – Jay’s World Index broke out in January, fell back  below resistance in February (Courtesy AIQ TradingExpert)

The same scenario holds true for the four regional indexes I follow – The Americas, Europe, Asia/Pacific and the Middle East – as seen in Figure 2.

(click to enlarge)Figure 2 – Jay’s Regional Index all broke above resistance, then failed (Courtesy AIQ TradingExpert)

So where to from here?  Well I could lay out a list of potential scenarios. Of course if history is a guide what will follow will be a scenario I did not include (Which really pisses me off.  But never mind about that right now).

So I will simply make a subjective observation based on many years of observation.  The world markets may turn the tide again and propel themselves back to the upside.  But historically, when a stock, commodity or index tries to pierce a significant resistance level and then fails to follow through, it typically takes some time to rebuild a base before another retest of that resistance level unfolds.

Here’s hoping I’m wrong

Jay Kaeppel

Disclaimer:  The data presented herein were obtained from various third-party sources.  While I believe the data to be reliable, no representation is made as to, and no responsibility, warranty or liability is accepted for the accuracy or completeness of such information.  The information, opinions and ideas expressed herein are for informational and educational purposes only and do not constitute and should not be construed as investment advice, an advertisement or offering of investment advisory services, or an offer to sell or a solicitation to buy any security.

The question on many investors’ minds is “are we in a bond bear market?”  Given that long-term treasuries have lost roughly 17% since July of 2016 it is a fair question.

The main model that I use is still bearish on bonds (more on this topic below).  Still, there are a few potential “lights at the end of the bond tunnel” – at least potentially in the near-term.

Long-Term Rates

My mega long-term “fail-safe” bond trend indicator appears in Figure 1.  It is the yield on 30 year treasuries (ticker TYX – which is multiplied by 10 for some unknown reason) with a 120-month exponential moving average.

Figure 1 – 30-Yr. Treasury yields (Ticker TYX) with 120-month average (Courtesy AIQ TradingExpert)

When the day comes that TYX breaks out above the 120-month moving average I for one will officially designate the great bond bull market as “over.”  And that day is coming.  But for what it’s worth – it’s not quite here yet.

Metals Positive for Bonds

In this article I wrote about a bond timing model that uses the relationship between gold and copper.  Like a lot of timing models of all stripes it does a good job of differentiating good times for bonds from bad times for bonds, but is very far from perfect.

It goes like this:

A = Gold / Copper

B = 30-day moving average of A

C = 80-day moving average of A

D = B – C

If D > 0 = Bullish for bonds*

If D < 0 = Bearish for bonds*

*- with a 1-day lag

This indicator flipped to bullish at the close on 2/7/18 after being bearish since 7/10/2017.

Figure 2 displays the action of ticker TLT since the last “sell” signal in July 2017.  As you can see, in the end it ended up being “correct” as TLT was lower on 2/7/18 than it was on 7/10/17.  But that was not the case until the last week or so.  So for most of the time during this bearish period TLT traded higher. Figure 2 – Ticker TLT with recent Jay’s Metal Model signals (Courtesy AIQ TradingExpert)

What is most important however is to focus on the long-term results. In Figure 2 the blue line depicts the growth of equity achieved by holding long 1 t-bond futures contract ONLY when the model is bullish while the red line depicts the growth of equity achieved by holding long 1 t-bonds futures contract ONLY when the model is bearish (red line).

Figure 2 – T-bond futures $ gain/loss when Jay’s Metal Model is bullish (blue line) versus when model is bearish (red line)

The long-term difference in performance is fairly obvious.  That being said it should also be noted that the blue line is by no means a series of straight line advances, i.e., there is no guarantee that this latest bullish signal will prove fortuitous, especially given that we may be transitioning from a long-term bond bull market to a long-term bond near market.

One More Possible Piece of Good News

In this article I applied an indicator I originally learned from Tom McClellan at http://www.mcoscillator.com to weekly TLT.  This indicator looks at the number of times TLT has been up minus the number of times down over the past 20 weeks. Very often a drop to -2 or below followed by an upside reversal of 2 points (i.e., it drops to -2 then subsequently rises to 0, or drops to -3 then rises to -1 and so on) has presaged a favorable up move in bonds. This indicator applied to TLT recently fell to -2 and may flash a favorable signal soon (please note that it HAS NOT given a buy signal yet and that it  could take several weeks before it does).

Figure 3 – Weekly TLT with UpDays20 Indicator (Courtesy AIQ TradingExpert)

One Piece of “Still Bad News”

In this article I wrote about one of the main bond models I use that uses the trend in Japanese stocks to trade bonds inversely, i.e., if Japanese stocks are bearish it is bullish for bonds and vice versa. I use a 5-week and 30-week moving average to quantify Japanese stocks as “bullish” or “bearish”.

In Figure 4 when the blue line in the top clip is above the red line this is considered bearish for bonds and when the blue line is below the red line it is considered bullish for bonds. For now the blue 5-week average line is still well above the red 30-week average, so this indicator still  designates the trend for bonds as “bearish”.

Figure 4 – Ticker TLT tends to trade inversely to ticker EWJ (Courtesy AIQ TradingExpert)

Summary

So are bonds due to rally?  Well, it seems like at least a short-term bounce could be in the offing.  That being said, with bonds breaking down sharply at the moment, 1) this “idea” is geared for “traders” who are not afraid of (and are unacquainted with) taking risks, 2) it might make sense to wait for the UpDays20 indicator discussed above to tick higher by two points – which could take up to several weeks to play out – before “taking the plunge.”

As always I am not “recommending” anything, just highlighting what I see.  For longer-term investors the “Boring Bond Index” bond strategy I wrote about here remains a viable  long-term approach to bond investing.

Jay Kaeppel

Disclaimer:  The data presented herein were obtained from various third-party sources.  While I believe the data to be reliable, no representation is made as to, and no responsibility, warranty or liability is accepted for the accuracy or completeness of such information.  The information, opinions and ideas expressed herein are for informational and educational purposes only and do not constitute and should not be construed as investment advice, an advertisement or offering of investment advisory services, or an offer to sell or a solicitation to buy any security.

The one trait among investors that is most “everlasting” is the tendency to extrapolate current trends ad infinitum into the future.  Until very recently, an entire generation of investors has no idea what a bond bear market looks like – or how to prepare or react for that matter.  Despite the fact that interest rates have demonstrated a tendency to rise and fall in roughly 30 year waves, too many investors have never given much thought to the possibility that rates might rise again someday even though rates had been declining steadily since the early 1980’s.

And don’t even get me started on the stock market.  The stock market had been on such an unprecedented run (the longest in history without so much as a 3% pullback) until recently that it seemed that no one wanted to even raise the possibility that the market could do anything other than rise indefinitely.  Never mind that the stock market by many measures is (or at least was) as overvalued as before the 1929 crash and the 2000 dot com bubble.  It is OK to be upset about the recent action in the stock market. It is OK to wonder if this is simply a pullback in a larger ongoing uptrend or the beginning of something much worse.  But if you are absolutely stunned that the stock market declined with a bit of ferocity – I hope I am not being indelicate but – WAKE UP! You need to set aside sometime to peruse a 100-year stock market chart and reacquaint yourself with the reality that “the market fluctuates.”

A lot.

Commodities Rising?

Another “thing” that “everybody knows” – or more accurately has become conditioned to believe – is that “stocks are investments” and that commodities are for the “inflation whackos.”  The problem of course is that “everybody” doesn’t know squat.

Figure 1 displays a very enlightening chart that displays the ratio between the Goldman Sachs Commodity Index (GSCI) and the S&P 500 Index (SPX). As you can see this ratio clearly “goes to extremes”.  And does so  on a fairly regular basis.  For a period of years commodities vastly outperform stocks and the ratio rises to a peak, and then everything turns and stocks outperform commodities for years at a time.  Forgetting even trying to actually time these swings for the moment, note the current reading.

Figure 1 – GSCI Commodity Index / S&P 500 Ratio (i.e., Commodities versus Stocks)

Will the average investor end up being caught completely unaware if commodities vastly outperform stocks over the next 3 to 8 years?  I have to believe the answer is “Yes”.  But given the extreme recent reading in the GSCI/SPX Ratio I for one am pretty confident that that will be the case.

To better understand the Yinn and Yang nature of commodities versus stocks (i.e., hard assets versus paper assets) consider the results in Figure 2 which displays the performance of the GSCI Commodity Index and the S&P 500 between the peaks and troughs in the GSCI/SPX Ratio highlighted in Figure 1.          Figure 2 – % Gain/Loss for GSCI Index and S&P 500 Index during various “Trough to Peak” and “Peak to Trough” movements in the GSCI/SPX Ratio

During the 4 “Green trough to Red peak” periods in Figure 1:

*GSCI Index average gain = +289.7%

*S&P 500 Index average gain = +12.4%

During the 4 “Red peak” to “Green trough” periods in Figure 1:

*GSCI Index average loss = (-35.4%)

*S&P 500 Index average gain = +117.3%

Being in the right asset class at the right time clearly makes a difference.

For the record, I am NOT “recommending” commodities.  I am simply highlighting the historical back and forth between hard assets and paper assets and the current extreme nature of that relationship.

Also for the record, it is possible to own commodities without trading commodity futures via  the use of  ETFs.  For those interested in exploring further, tickers DBC, GSG and RJI may merit a closer look.  These ETFs got crushed between 2008 and 2016, have since rallied sharply and may now actually be a bit overextended.

Summary

So are stocks finished?  Is it time to pile into commodities and hard assets?  The truth is that it is impossible to identify the exact moment that “the turn” occurs.  Still, given the history displayed in Figure 2 and the extreme low recent reading in the GSCI/SPX ratio that appears at the lower right in Figure 1, now might be exactly the time to at least start envisioning an investment future that is significantly different from the current one that “everybody knows”.

Jay Kaeppel

Disclaimer:  The data presented herein were obtained from various third-party sources.  While I believe the data to be reliable, no representation is made as to, and no responsibility, warranty or liability is accepted for the accuracy or completeness of such information.  The information, opinions and ideas expressed herein are for informational and educational purposes only and do not constitute and should not be construed as investment advice, an advertisement or offering of investment advisory services, or an offer to sell or a solicitation to buy any security.

I am as guilty as anyone of overanalyzing the markets on a regular basis. Luckily there is a tiny corner of my brain that constantly reminds me that it doesn’t necessarily have to be that way.

This article will illustrate this point by expanding on something I wrote about regarding retailing stocks in this article.

The Retailing Annual System (RAS)

For our test we will use the following:

*Ticker FSRPX (Fidelity Select Retailing Sector fund)

*1-3 Year Treasury Index (Bloomberg Barclays Treasury 1-3 Yr. Index)

*We will hold FSRPX during the months of February March, April, May, November and December

*During all other months we will hold short-term treasuries

Figure 1 displays the growth of $1,000 for the “system” above (blue line) versus buying and holding FSRPX (red line) since April 1986.Figure 1 – Growth of $1,000 invested using Jay’s RAS (blue) versus buying and holding FSRPX (red); 4/1986 through 12/2017

For the record:

*The average 12-month % gain was +17.2%

*The median 12-month % gain was +14.0%

*The largest 12-month decline was -13.0%

*The largest drawdown was -15.3%

*The System has had 30 Up Calendar Years

*The System has had 2 Down Calendar Years (-3.9% in 1994 and -0.2% in 2008)

Figure 2 displays the calendar years performance year-by-year.

Figure 2 – Year-by-Year Results for Jay’s RAS

Summary

Does investing in just one sector for six months out of every calendar year (and holding short-term treasuries the rest of the time) really qualify as a “System”?  Does it really matter?  The numbers are what they are. One investor may consider this a viable approach to investing and another may not.

The point remains….when it comes to investing in the financial markets, it doesn’t necessarily have to be complicated in order to work.

Jay Kaeppel

Disclaimer:  The data presented herein were obtained from various third-party sources.  While I believe the data to be reliable, no representation is made as to, and no responsibility, warranty or liability is accepted for the accuracy or completeness of such information.  The information, opinions and ideas expressed herein are for informational and educational purposes only and do not constitute and should not be construed as investment advice, an advertisement or offering of investment advisory services, or an offer to sell or a solicitation to buy any security.