The Fed Lets The Market Fall–Finally!

Even the Fed’s non-stop POMO could not prevent stocks from falling today, as major markets declined 1.7% across the board. This is in contrast to the never ending POMO melt-up over the last 4 months where the markets churn higher by 0.2-0.4% on ever decreasing volume.  It looks like we may finally have Marc Faber’s anticipated correction (about 2 months late but I will take it). All it took to scare markets was an S&P downgrade of Spanish debt (not surprising) and some chatter about riots and demonstrations in Saudi Arabia. Not to mention the fact that Portugal, the soon to be EU welfare recipient, watched its CDS trading to 500 bps–signaling that a EU bailout is not only guaranteed, but that a debt restructuring is almost a given sometime in the next few years.

The only real surprise during today was the decline in gold and silver. Contrary to what your hear on garbage TV channels like CNBC, precious metals are not part of the risk trade, like other commodities. Gold and silver are the anti-currency fear trade. They are your go to currencies when you do not trust fiat paper money to retain its value. Gold, in particular is a safe haven because demand is not correlated to economic growth, while silver is somewhat more sensitive to global growth. So why on earth is gold and silver down more than 1 and 2% respectively? Fears in Saudi Arabia should be bullish as investors digest the potential for a crisis in the world’s largest producer of crude oil. No doubt JP Morgan and HSBC (the largest holders of short positions in the metals) played some role.

Despite the fact that the market is likely headed for a 5-10% correction, I am not shorting the market. The risk/reward is not on your side as the government along with the all-powerful Federal Reserve are doing everything they can to pump stocks–even if it means destroying the dollar in the process. So with that in mind I am getting a list of stocks to buy during the correction

Here are a few stocks and plays I have my eyes on:

1. 3D Systems (TDSC) – leader in 3d printing–promising growth story despite high valuation. Volatile stock!

2. Allana Potash (AAA) – I am still long this name and will continue to add on weakness. Drill results have dramatically increased their Ethiopian potash deposit. This is probably one of the largest potash reserves outside of Canada.

3. Manas Petroleum (MNAP) – oil exploration company with interests in Albania, Mongolia, and Kyrgyzstan. It is a gamble play with big potential and high risk. This is one of those plays that either goes up 500% or goes to 0. It like these types of plays because if you are right you make a huge profit. On the downside you know exactly how much you can lose (100%). So treat it like an option. (2% of my portfolio is in this stock)

4. Gold/Silver – Have to agree with Faber that you should always be adding to gold and silver on weakness. On the gold stock side, be very careful as they have been lagging bullion for a while. Just look at GOLD, AEM, etc. Looking at these pathetic charts, one would falsely conclude that gold must be plunging. This is the problem with owning gold stocks–they are not necessarily correlated with the gold price. There are management problems, production difficulties, and other mining risks. Another reason to avoid gold stocks is the rising price of oil which, hurt margins. For gold stocks to really outperform bullion, you would need to see a prolonged period of rising gold (to say $1800-2000) and stable to declining oil to help margins. Seeing $2000 gold is of no benefit to the gold producers if oil is at $185.

5. Uranium – While it is hard to be bullish on commodities after their huge run-up over the last two years, uranium stands out as the most attractive energy commodity. Here is a good article on why uranium has a good future. In short, by 2013/2014 there will be a large uranium shortage worldwide as Russia stops converting nuclear warheads into uranium. This is a simple suppl/demand situation where the price of uranium has to rise.

Because you cannot buy uranium directly, you have to focus on the stocks. In particular, I like the small exploration plays with marginal deposits, which are highly leveraged to the price of uranium. One I am looking at is Bannerman Resources. It has a large, low grade deposit with high production costs. The mine is not economical at $50-$70 uranium, which is why the stock is cheap. But if uranium continues to go up (as I think it will) Bannerman’s deposit will look much more economical.

6. Emerging Markets – Most of the EM complex has already sold off over the last few months due to inflation fears, etc. These markets should continue to fall along with the developed markets. This in my opinion, provides a good entry point for adding new positions. Favorite emerging markets are India (INP), Russia (RSX), and Chile

7. Short Volatility (XIV) – this is a relatively new and more efficient way of shorting volatility. If the VIX got to around 30, I would be willing to go long XIV. This is a product that trades inverse to the VIX. Because the VIX is mathematically guaranteed to go down thanks to the nature of volatility (short upward spikes followed by prolonged periods of declining volatility.) Furthermore, volatility futures are almost always in contango, which benefits XIV. To me, XIV is superior to shorting VXX and other volatility products because you do not have to short it (and get the borrow), which can be very expensive. All you have to do with XIV is go long. The only time you will lose is during brief spikes in volatility.

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About Nathaniel Crawford 21 Articles

Nathaniel Crawford is a research analyst at an asset management firm in Los Angeles; He has a degree in History from Occidental College and enjoy trading stocks, options, and bonds.

Visit: Black Swan Insights

1 Comment on The Fed Lets The Market Fall–Finally!

  1. Regarding the VIX.
    I agree with you that it is preferable to go long XIV rather than short VXX, however, over the last month or so, XIV has been lossing ground to VXX. I do not know why.
    When I verified this, I closed out my long XIV position and used all the money to (once again) short VXX.
    I initially thought XIV was a good alternative to shorting VXX, and it was for about the first 2 months of it’s existence, but now it is not.
    Your thoughts?

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