A Tale of Two Cities (part 2)

Here's the bad news for equities. This graph (click to enlarge) charts the DJIA relative to the price of 1 ounce of gold. At the height of the internet bubble, the DJIA/gold ratio was 44--and clearly unsustainable. At the depths of previous bear markets, the ratio was unity (1:1).

Currently, the ratio is around 10:1, and trending downward in the short- and mid-term. In order for the ratio to reach unity, the Dow Jones index has to either decline by a significant amount, or the price of gold per ounce has to increase by a significant amount--or both have to occur simultaneously. Simply put, the numerator (DJIA) has to match the denominator (gold price per ounce).

The take away message from the disaggregation of both charts is that while financial asset values may increase appreciably in nominal terms, in real terms (i.e. inflation-adjusted or indexed against gold), the returns for equities do not appreciate nearly as much when measured over a long period of time. In other words, the rate of return for equities is impaired due to the devaluation of the USDollar.

No one has a crystal ball, but the short US equities / long gold trade seems like the logical play going forward. Of course, with governments and central bankers wreaking havoc by manipulating markets worldwide, logic doesn't always win out initially. Fundamentals become distorted beyond recognition as bubbles are created and burst, causing investors to lose money, despite making correct market calls. Timing becomes the enemy, not the ally. So tread carefully. Read the disclaimers in the sidebar. Perform your own due diligence.

Disclosure: long biotech and energy sector equities, long gold and silver mining shares.

APT

Alpha Protech N-95 masks for swine flu protection were covered by CNBC today. We got in a couple months ago in the $2's. Shares surged almost $1 above $5 this morning after the segment. Take away message: better early than late.

http://www.cnbc.com/id/15840232?video=1280599599&play=1

Here's a history of my blogs on APT:

http://gregnguyen.blogspot.com/2009/08/apt-announces-record-earnings.html

http://gregnguyen.blogspot.com/2009/08/apt-and-sva.html

I've made a killing by being early, but based on revisiting these previous blogs, I could have actually made even more had I trusted my initial instincts. Another take away message: if your investment thesis is solid, your timing doesn't have to be perfect.

Disclosure: I am long shares of APT.

GM on the ropes

I've stated for months that General Motors will be insolvent within 18 months (now 12 months--see previous blogs), and now CNBC is splashing it all over the headlines today. Shorting it was the call. It may go down further, but if this trade was put in a while back, it's time to cover and take profits. I may miss out on further gains, but there's no need to be greedy.

The larger issue is the cascading of financial crises from one sector to another, and to the general economy overall. The capitulation is coming (despite several false proclamations already), and we want to see a definitive bottom forming before jumping back in. I will confess that I nibbled at quality yesterday on long-term plays, but it is still too early to catch the falling knife. Warren Buffett stepped up big with Goldman Sachs and GE, and in hindsight, could have bought better (and lower). Even the best of the best can be early. But let's face it--even he admits he is a lousy market timer--he is a long-term value buyer, being a Benjamin Graham disciple. His participation means we're closer to a bottom than a top, but the market and the economy still need to unwind some more before I feel confident we indeed have reached bottom. My rule (and one I don't always follow, to my detriment), is to sell early (to avoid the bulk of the carnage), and buy late (even if it means I don't catch the exact bottom). Specifically, I want to see confirmation, and right now, we're not anywhere near close to that.

As usual, I am not dispensing advice and please consult your investment advisor, but the call here is to play some more golf--you'll save money for now.