There is a lot of gloom and doom talk on Wall St at the moment, including fears of a double-dip recession. The odds of this were 5% only two weeks ago, and are now according to the Financial Times 30%. So in other words it is still unlikely and these sort of predictions tend to give false reactions because of market movement. The current dip in the market was not unanticipated and fits with general seasonal patterns, and is also quite plausible considering various macro events such as the end of QE, the debt crisis in Europe and the US, etc. In other words, I don’t think financial doomsday is upon us. Of course we must always manage risk so we should take the possibility into account and hedge ourselves, particularly if you don’t believe markets to be entirely efficient; we believe market prices to be a reflection of trader emotion, and emotions are gloomy. This could become self-fulfilling. Nonetheless I believe the talk of doom to be an overreaction which will probably come to a crescendo in Oct, when we can anticipate seasonal lows for the SPX. However, as a hedge, the Company primarily holds cash at the moment.
In the mean time, as we discussed previously, it is advantageous to take the opportunity the VIX presents us to put on spreads.
The Fed, if you read carefully, is starting to conduct reverse repos today. The intention here is to put a floor on rates, which should put some calm into the massive dash we have witnessed away from capital destruction, primarily into gold, cash, and the Swiss franc.
This may also stabilize the dollar. May being the operative word, but we see the possibility primarily because gold is likely to correct in the short term and the Swiss franc should be falling sharply. People need to keep their cash somewhere and the dollar and treasuries remain the most liquid instrument.
The Swiss franc appears to have reversed its parabolic rise. The SNB intervention has been helpful here. There is a seasonal trend for the franc to rise along with gold from Sept-Dec, but I am inclined to think this will not happen this year. The company holds puts on FXF, some of which are already profitable. We anticipate the franc to continue to fall.
The Company holds Aug ZSL calls which we have written off as a loss, though we will attempt to liquidate them at profit if the opportunity miraculously presents itself. This is unlikely but gold may reverse sharply this week, and silver may follow. We do not believe in going into hope mode however, and silver appears to be trading in a channel. We believe silver and gold be be grossly overvalued, however, because real yields are negative, we can anticipate about a 16% appreciation in gold per annum. We are looking for gold to correct, whereupon we will take a long position, probably with vertical spreads to take advantage of the very high current volatility of gold. Silver is a different matter, with lackluster industrial demand and an oversupply; further, industry will use other metals if silver continues to trade high. Silver is extremely difficult to trade however. We made a huge profit last spring in silver’s plunge and are content, and not inclined to trade silver, which we do not see performing in a predictable manner. Silver has become largely a speculative instrument of late (as opposed to being a store of value, as most people perceive it to be). As I said, we have written off our ZSL puts as a loss. We have approximately 100 puts which, if silver falls to ~25, we would have made over $100,000, but it is key to observe that we are value investors, and our total loss in the puts is only $1000. In other words, our risk exposure with silver was always minimal, and this is the only way we trade, particularly with an instrument like silver.
We used to trade Citibank a lot. C was good to us. Now with the reverse split C is no longer cheap, and we like cheap trading, so we have shifted our focus to BAC. Totally pointless transparency statement, BAC is the Company’s bank.
The Company sold May12 7/10 vertical bull put spreads last week in BAC and will likely add to the position if and when we see advantageous short premiums. We do not think BAC is doomed. The Company is, again, interested in value investment, and we see BAC as presenting great value, being almost 50% undervalued. Fair value for BAC is about $12, and this is a pessimistic fair value N.B., and even in a catastrophic worst-case scenario of recession, etc, fair value would be around $10. We do not think BAC will recover share price quickly, however. As we have discussed in a previous post, we can anticipate a seasonal rise in the SPX Nov-May, and the financials should rise with it. Now, given general investor sentiment at the moment, we are slowly building a BAC position; for example, the broad market may drop further. People might start to panic sell BAC. We will be waiting to buy, but we are in no rush, particularly given that the SPX tends to bottom in Oct. Calling a bottom is often a pointless exercise and we are not fully convinced BAC has bottomed, which is why we are slowly legging into our position. However the clamor of doom is suggestive of a bottom, and BAC seems to be holding at current support levels.
Regarding the RUT, we find the recent selloff to be overblown, but then again, we also regard the prior rally as a fake rally induced by Fed liquidity. We are not inclined to trade the RUT at the moment, we believe it will be volatile and unpredictable through Oct. We do however plan on going long at the end of Oct to take advantage of seasonal patterns. This plan may change but that is our general strategy at the moment.
Investor panic and the talk of doom and recession is suggestive of a bottom. The average investor sells at the bottom and buys at the top. As contrarians, we are inclined to think the RUT has just about finished its drop, and we anticipate it moving in a very volatile sideways range through Oct. We will wait at least until mid-Oct however before we even consider taking positions on the RUT. This is unfortunate because our bread and butter is iron condor spreads on the RUT, but again, we are not inclined to trade the RUT currently.
If we actually do see a crash, the Company will move in. We are over 80% cash right now. We are interested in blue chips such as GE, C, F, etc. We will probably maintain our high cash levels as we are somewhat risk averse at the moment.
The Company was begun incremental investment in PRPFX, following permanent portfolio theory. We regard this as a savings account, given that holding the dollar in cash presents little advantage at the moment. Though our high cash ratio shields us from risk, the blunt fact is it is earning no interest and is suffering from the general malaise of the dollar, and the massive capital destruction we have witnessed in recent years. Given our international operations, the capital destruction of dollar held assets and the dollar itself is of great concern. We probably feel this more acutely than investors back home in the States (I type these words in Bangkok at the moment); for example, much to our surprise, our Philippine peso assets are actually growing nicely in value, which we certainly never expected (we maintain Philippines operations).
We like the long term performance of the permanent portfolio fund and the theoretical basis behind risk management in permanent portfolio theory. We would generally be inclined to keep most of our cash here, but permanent portfolios are subject to huge market gyrations, and we would like to see investor sentiment improve a bit (ie we don’t want to hear any more talk of double dips and recession). As things stand we are incrementally building a PRPFX position, and the recent market swoon has been helpful, as long as it doesn’t swoon any further, and in general we don’t think it will to any large degree. Again, it is important to remember that most people buy at the top and sell at the bottom. Permanent portfolio theory has built-in hedging, which is why we like it, but again, it is not immune to large market gyrations. Permanent portfolio theory is a mode of conservative investing diversification for the Company. We would probably build a permanent portfolio with ETFs ourselves, but PRPFX is performing well and we like its asset allocation, so the fund saves us trouble and commissions.
We are interested in taking out spreads on the VIX. Volatility is much easier to predict than market prices. We will discuss this in a later post.
