Monday Meltdown: Commodities Collapse Ahead of the Fed

Brent crude is down almost $5 since Thursday morning.

That's over 10% off and getting much worse this morning as people are beginning to lose faith in the Global Economy due to the endless amounts of bad data I kept telling you it was a bad idea to ignore (see my entire last quarter of posts).  Well, I love to say "I told you so", so there it is - now we can move on...

You'll notice that, at the bottom of each of those posts on Seeking Alpha, there is a disclosure statement and that statement has said since early August: "currently mainly cash and an otherwise slightly bearish mix of long and short positions."  That about sums it up for us.  In fact, we just did a review of our virtual portfolios for our Members and those are over 80% in cash and actually made a little money (very little) in last week's collapse.  

You'd be making money too if you followed our FREE advice on Dec 2nd and used our Futures hedges or even our SDS hedge, which is very much like the kind we use to protect our Long-Term Portfolio.  Our trade idea at the time was:

  • Sell 20 SDS March $19 puts for $1.25 ($2,500 credit)
  • Buy 20 SDS Jan $18 calls for $1.20 ($2,400 debit)
  • Sell 20 SDS Jan $20 calls for $0.48 ($960 credit)

SDS hasn't even moved up $2 yet but the short puts have fallen to 0.72 ($1,440) while the long calls are $2.72 ($5,440) while the short $20s are $1.37 ($2,740) for net $1,260 out of a potential $4,000 + the original $1,060 credit means we've got $2,320 out of our potential $5,060 gain already - well ahead of schedule.  I urge you to go back and read that post (it was just two weeks ago) and look at the charts at the time so that, hopefully, next time you will be ready to act when we have another cycle.  

Most of the adjustments we'll be making today are BULLISH adjustments on our portfolio positions.  We're putting more money into our losing trades - as we don't expect this sell-off to be any more severe than the August flash crash (1,850 on the S&P), though that's still another 10% down from here.  We're still taking advantage of the Futures to take up short positions and this morning we grabbed Nikkei Futures (/NKD) short at 18,800, looking for at least 100-point gain ($500 per contract) but very tight stops above that line.  

We're already below 2,000 in the S&P Futures and the Fed is supposed to be tightening on Wednesday, which seems crazy while the market is in free-fall, but they don't have any choice if they want to maintain their credibility.  Of course, the Fed maintaining their credibility is like Congress maintaining their likeability (26%) but I guess it's better than hitting single digits.  Still, the Fed, via Hilsenrath, did some serious back-peddling this weekend:

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Any number of factors could force the Fed to reverse course and cut rates all over again: a shock to the U.S. economy from abroad, persistently low inflation, some new financial bubble bursting and slamming the economy, or lost momentum in a business cycle which, at 78 months, is already longer than 29 of the 33 expansions the U.S. economy has experienced since 1854.
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Among the risks to the economy are financial booms that could turn to busts. One is in commercial real estate. Another in junk bonds is already fizzling. Each of the past three expansions was accompanied by an asset price bust--residential real estate in 2007, tech stocks in 2001 and commercial real estate in the early 1990s.


Barrons', meanwhile, could not find a SINGLE economoron who didn't think the S&P was heading higher next year - not one!  The 10 prognosticators surveyed predicted an average gain of 10% for the S&P - from 2,100 (+5%) on the low end to 2,500 (+25%) by Federated's madman, Steven Auth.  Interestingly with Auth, he only predicts 2.6% earnings growth so, essentially, he's saying we should be paying 10x for each incremental earnings dollar.  

Kudos to Zero Hedge for pointing out that these same 10 knuckleheads predicted the S&P would be at 2,209 (up 10%) THIS YEAR with our man Auth once again leading the pack at 2,350.  The fact that they missed by 10% last year is not, of course, mentioned in this year's article.  Instead Barron's presents their "prominent market strategists" as the best and the brightest and caveat emptor if you didn't read last year's post so you'd know how clueless these people are.  

China is the top concern for 2016 - a hard landing there could sink the entire planet.  We're already in the midst of a major melt-down in Junk Bonds - something I've warned people to stay out of for years.  Third Avenue Management is liquidating their $800M fund and the Junk Bond ETF (JNK) is now down 12% since June.  This, of course, is why Junk Bonds usually pay 12-18% interest, which is why buying bonds that pay 6-8% is INSANE!  The default risk is the same (10% in a downturn) - you just end up accepting lower rates because competing interest rates are so low but THAT IS STUPID!!! 

And we are only, just now, heading into default season at the energy patch as companies have to restate their viable reserves at the end of 2015 based on their average cost of extraction vs the average price of oil ($47.50).  The reserves considered "proven" on the books of energy companies now are based on last year's average price of $85, so this will be about half.  That means that all these hundreds of Billions of Dollars of loans made to all these energy companies are only backed by about half as many assets as were previously thought at the same time as the financial condition of those companies is rapidly deteriorating.  

CASHY and CAUTIOUS is how we're continuing to play the markets into the holidays.  We're not going to miss anything by sitting out the next couple of weeks and, as noted in our review - there are certainly plenty of bargains to be had.  

IBM is our 2016 Stock of the Year and it's back at the $135 line.  Rather than buying the stock, you can sell the 2018 $110 put for $10 and that then obiligates you to own IBM at net $100, which is 22% off the current price.  All IBM has to do is hold $110 and you make $10 but I'd pair it with the more aggressive 2018 $125 calls ($19.50), offset by the sale of the $150 calls ($9) for net $10.50.  

Overall, on this trade, your net cash outlay is just $50 per contract set and, at $150 in Jan of 2018, you would collect $2,500 per contract set for a gain of 49x the cash you put in (4,900%).  There is, of course, a margin requirement as you are promising to buy IBM for $110 if it goes the other way, probably about $1,000 per contract set so your return on margin is "just" 250% in two years.  Still, for many reasons, I think IBM will be well over that mark at the end of 2017.

We pressed a lot of our commodity trades in our Long-Term Portfolio in anticipation that the Fed will either not raise rates very much or will indicate a very slight slope for further increases.  Also, we expect more stimulus around the globe - some of it based on infrastructure and, for another thing - the prices are just too darned low with oil (/CL) at $35, gasoline (/RB) at $1.20 and Natural Gas (/NG) at $1.89.  We like all those for longs with tight stops below the lines in the Futures and we'll discuss playing the USO, UNG and UGA ETFs in Tuesday's Live Trading Webinar.