Monday, November 9, 2009

Is a correction coming?

Shorts have been torched since the March lows, betting on a market correction as traders climb the wall of worry, waiting for the next shoe to drop. The problem is the Fed has flooded the market with liquidity, lending to banks at zero interest rates, encouraging the carry trade as these banks invest in equities, bonds, and commodities. Hence, the elevation in these assets, despite a lousy economy.

In essence, a cheapened dollar is bullish for other asset vehicles. The Fed, and now the G-20 countries, have declared easy money policies will be extended to at least mid-2010, when they may take the punch bowl away.

Having said that, I expect a correction in both equities and gold soon, albeit temporary, as the short dollar trade is getting really crowded. When a a consensus builds, it's usually prudent to take the opposing side--at least until sentiment becomes less lopsided. Additionally, as the dollar keeps getting trashed, foreign governments are becoming increasingly concerned at their stronger currencies vis-a-vis the dollar, making their exporting industries less competitive (although their consumers enjoy the weak dollar when they travel as tourists to the US).

So I believe their central banks will intervene in unison in buying dollars and selling their own currencies. It'll be a death race to the bottom---to see which countries can devalue their currencies the most, in order to stimulate their own domestic economies.

This (temporary) strength in the dollar will tank gold, commodities and stocks, in my opinion. This is what happened in Quarter 4 2008, although the dip won't be as pronounced this time around, as there are many more buyers to stem the decline, including big hedge funds and foreign central banks. The bullion shorts have more formidable opponents with deeper pockets now.

Obviously, President Obama, the Fed and US Treasury don't want a repeat of 2008, so they will keep printing dollars. After the correction, the dollar will resume its downward trajectory. The only question is WHEN this correction will occur.

I'm not selling everything, especially if I'm waiting for a biotech event, but I sold a small portion of my gold positions today. I will look to add to my gold position on any pullback. If it doesn't occur, I won't beat myself up. It's been a good run with the yellow and white metals already, up triple digits in the mining stocks. But when I see Bank of America forecasting $1500/ounce gold, and mainstream pundits predicting $3,000 gold, I get nervous.

Where were these analysts last year when gold was $675, and some of these mining shares were penny stocks? The answer was they were still in the major equities indices--and subsequently got hammered in the financial meltdown.

I'm not selling all my current positions in gold, because 5 years from now--or less, we could see $2500 gold. Trading in and out of positions is seldom rewarding. I'm just taking profits, only because I can, without running for the exits.

It's similar to when I sold some BCRX at $6.70 price per share (pps), after buying in the $2's and $3's after the initial swine flu outbreak earlier this summer. Do I regret it now that it's at $11? Yes, but after being honest about it, it was the right thing to do. I won't get rich on this one trade, but I'll be around to play another day. I still have house money on the table, and even added a little today on the dip, so I'm still in the game.

I'm not trying to optimize my returns--I'm trying to play the probabilities, and hedge my longs. Since the short dollar / long gold trade is too crowded, I'm stepping back from the cliff, but I'm not leaving the beach.

See disclaimers on the sidebar. Do your own due diligence. These are not specific recommendations on assets or positions. Good luck.

Disclosure: I am long gold and silver mining stocks, and long BCRX shares. But obviously, I am expecting pullbacks in both asset classes.

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