FLECK: Don't trust stocks' bear-market bounce
Bill Fleckenstein
6/19/2006
Stocks are bouncing because buyers realize fears of a tough Fed were overblown. But the bear market in stocks remains, and ultimately our problems will help metals.
After looking at Wednesday's higher-than-expected consumer price index data, and the markets' response, I decided to replace a good chunk of my foreign-currency holdings, which I had sold around the last Federal Open Market Committee meeting (FOMC).
I also bought gold and silver for my trading position (with my investment position already being full). Then, once stocks opened on Wednesday, I reduced my shorts further. The thought process behind my actions is something I would like to share with readers.
Time to emote on a lopsided boat
In essence, psychology has now come full-circle, since just prior to the last FOMC meeting. Heading into it, I basically took the "other side" of the "Fed is done" enthusiasm -- shorting stocks, buying puts and selling my foreign currencies and metals. I wanted to fade that idea, as it was so popular, even though I believed (incorrectly -- we now know) that the Fed was done. However, I thought the "bet" being placed on this was so lopsided in the market that the risk in the other side was small.
Currently, it seems to me that sentiment has swung 180 degrees, to "Who knows when the Fed will be done?" I want to take the other side of that idea, as I think the risk of doing so has been squeezed out of these markets.
A short-seller caveat emptor
Consequently, I want to be aggressively long metals and foreign currencies, and not aggressively short stocks. However, I don't want to be long stocks, either, for reasons that were eloquently stated last week by long-time market observer Justin Mamis:
"Keep in mind that the underlying trend has now changed to a bear market. And just because you think you're nimble enough to get in and get out well, you have to do it four times out of four. Because, if your batting average is only three out of four, the one loss will eat up at least one of the gains, and often more -- so that except for keeping your ego busy, it won't have been worth the risk."
That's pretty much how I feel about it. Covering shorts is a lot different than being long -- because, for whatever reason, nothing seems to go up as fast as stocks you are short. Last Wednesday, for example, Intel (INTC, news, msgs) gained approximately 4% on the back of a dead-fish recommendation -- and another 2.2% on Thursday. (I still own all my Intel puts.)
The commercial-paper-tiger Fed
Another reason why I'm anxious to take the other side of the tough-Fed trade: Even though the Fed is talking tough, the Fed is in fact not tough.
Recently, we've seen a couple of coupon passes (i.e., Fed purchases of Treasury securities from dealers). And, as economist Carl Pellegrini pointed out last Wednesday:
"The Fed is not tightening. If it were, do you really believe that the growth in commercial paper outstanding would be 18.4% for the last few weeks; and that bank loans and commercial paper outstanding would be up a seasonally adjusted rate of 24.6% for the last seven weeks, 15.7% for the last 13 weeks, and 13.35% for the last 52 weeks?" Thus, not only is the Fed not tough, it has no real intention of being tough."
Of course, if the Fed wants to save its reputation -- while trying to act dovish -- it has to talk that way. To quote my daily column last Tuesday: "The Fed knows the economy is slowing down. It's really dying to pause. But since so many have essentially laughed at it, the Fed feels as though it has to do something to make sure it's still perceived as being in charge."
Precious pariahs
That brings me to the subject of the precious metals -- an asset class favored by those of us disinclined to confer credibility on the Fed. The recent carnage came about because:
• We experienced an enormous spike in prices.
• There is still too much confidence in the Fed.
• Tough-Fed fears have precipitated selling.
• That selling "fed" on itself (both in metals and in stocks generically).
• The liquidation took on a life of its own.
Given last week's action, I think that we have probably seen the lows. My firm belief is that the metals went to where they did on panic liquidation, and those lows should be "good" lows. (Markets which have been in liquidation and dislocation take a while to settle down.) Meanwhile, I think I can say with some degree of confidence that the hot money that had been chasing the metals, for no other reason than they were going up, has now been flushed out.
Miners pining for a mother lode
Turning to precious-metal stocks, they have been quite toxic for a couple of months now, for reasons I have discussed on several occasions in my daily column. Recently, they've shouldered their own particular brand of angst: Unable to muster any leverage when the metals themselves were going up, the stocks were really slapped around when the metals were headed straight down.
However, I continue to think that on the next leg up in metals, the metal stocks will do better than they did on the most recent one. It's worth noting that Newmont Mining (NEM, news, msgs) is the same price now that it was when gold was at $650. In fact, Newmont has been a better performer than just about anything over the last three weeks.
As to what lies in store for the markets in stocks and metals, I believe that at some point, the tough-Fed trade will have been completely discounted by the markets, and then both stocks and metals will rally. But while stocks will just be rallying in a bear market, the metals' rally will be a continuation of the bull market they've been in -- although it's sometimes hard to keep that in perspective when the action gets as ugly as it has been.
Remember the reason to own metals in the first place: The Fed is not in charge. At some point, when the world understands that, it will cause an acceleration of the bear market in the dollar, and that will be the source of additional problems for the stock market. Metals, among other things, are an insurance against that outcome.
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