Mixed feelings

Well, the markets have staged quite a strong rally so far since my last post and is knocking on the door of all time highs once again. The S&P is actually already there. This week we have FANG earnings on deck and it's happening at a time where the market is ST overbought. It's an interesting junction because although we are ST overbought I get the sense that there are trapped bears out there who shorted the bounce in the market mid October. Why? Because I myself was tempted to make a ST bearish bet and so if I was tempted I'm thinking many of the bearishly inclined must have pulled the trigger and are now underwater. Being short the market as it's making new all time highs is usually not a good spot to be in because fresh all time highs tend to result in more all time highs. It would appear to me that barring some significant negative bad news,  pullbacks should be relatively shallow.  

Energy stocks sold off earlier in the month but are rebounding today as oil and nat gas are rallying today. The more I think about the energy complex, the more I'm becoming a weak holder. I mentioned in my last post how the cat is now out of the bag with respect to the energy crisis. This awareness has resulted in a major shift towards energy stocks from so called "institutional money" as indicated from BOAs  most recent Global Fund Manager survey. It's the exact opposite of what they did in August when energy stocks had been selling off and making a low. Financial are also being chased.  Rising energy prices are not necessarily bearish for the market in general until they get to the point where they have risen "too much" . Where is that point? I've read that it could be around $140 oil. 

In addition to the exuberance in the energy complex there's evidence of extreme pessimism in bond which goes hand in hand. All of this suggests we are close to the peak inflation narrative. If that's the case and we see energy prices and bond yields cool off, that could provide fuel for the markets to power higher barring that the decline in inflation pressures are not the result of collapsing economic growth. I'm seeing hockey stick charts when it comes to inflation related pressures and rates of change in commodity prices. Some might say that this constitutes a long term break out, but it could easy well be largley the result of the supply chain disruptions were a seeing which not only results in lower supply but also hoarding. I've been reading stories about how the warehouses for major commodities like copper, zinc and nickle are a very low levels.

This whole supply chain disruption is making me rethink my thesis about the commodities complex in the short to medium term. Once we start to normalize we could see at least a 6-12 month period of disinflation which would hurt the entire commodities space, especially energy. Although there has been a lack of new investment in energy cap ex, there is more ability for a supply response compared to that of  metals. In addition, high energy prices may speed up the transition to electric vehicles and so you could have negative demand pressures on energy forthcoming. With metals on the other hand, the demand side is slated to have positive demand pressure long term for the same reasons - electrification.  So, if 2022 ends up being the year of disinflation which hurts commodities in general, I could be a strong holder of my copper/mining plays but not my energy plays which I have already reduced by 50% and am looking to sell more into strength. 

I am also looking to initiate a position in LT calls on TLT given the contrarian condition of bonds. It will also nicely offset my positions in commodity related stocks. I also have a healthy level of cash. You always need to put yourself in a position where you could be strong holder. This is what I'm doing. 

The energy cat is out of the bag

 First off some market comments. September was rather nasty living up to its reputation. We had Evergrande fallout fears, debt ceiling fears and inflation fears creating the jitters. It's the latter that you should be most focused on, the other 2 are just noise in my opinion. Rising inflation fears creates selling pressure on bonds and when yields rise it is typically negative for the markets.  The culprit is rising energy prices, we saw a similar thing happen in May. This time around the nat gas price is taking the spotlight. It hit all time highs in Europe due to perfect storm of low nat gas storage, coal shortage and below average power generation from wind power. Sentiment wise, we are seeing a marked rise in pessimism and unwinding of bullishness, mind you, there wasn't as extreme bullish sentiment condition at the recent market peak. There is room for sentiment to become more bearish before I think there would be an all clear. I also read about how coming into September Global Fund mangers were complacent and had a low level of hedges in place.  That complacency no doubt has been at least partially washed away. There's also signs that economic growth will be downshifting....not a good time for this when energy prices are rising.  Bottom line is that at this moment,  I expect to see the market chop here and possibly retest or break the recent low by a bit, but nothing more than that. Take a step back here and look at the bigger picture. The market is still up nicely for the year and the correction so far has only been about 6% in the SPX. Even a 10% correction would not be that serious if you look at how much ground the market has gained in the past 18 or so months. 

On the topic of energy, I mention in my last post and also back in May how there could be a energy crisis due to the shunning and subsequent underinvestment in fossil fuels due to ESG and green tech. Well, this is what's happened and now the cat is out of the bag. I've seen several articles pop up in the financial media stating the exact same thing. So, now that this narrative is out there front and center, I'm debating what to do here with my all my energy holdings because I know from experience that this could be a signal that the bullish news for energy could be priced in, at least in the short term. The stocks are at or close to very ST overbought levels. To quote Jesse Livermore "be right and sit tight" which means you have resist the urge to exit your positions prematurely. Selling just because you are showing a profit is not necessarily the right or even prudent thing to do if you have good reason to expect higher prices in the future. Sitting tight was easier for me to do when I initially bought my positions back in March/April because I had good reason to believe that I was still picking low hanging fruit. But now that the cat is out of the bag, the stocks are overbought and I'm seeing victory lapping on twitter from energy longs we could be close to a ST peak here. As such I'm  looking to trim 40% of my positions. The risk of me doing this is that we are at one of those long term inflection points where the generalist investor capitulates and gets back into the energy sector in a big way. If that's the case, there will be a relentless bid in these stocks and pullbacks will be shallow. Tough to tell if we are at that point yet. If not, we could see quant funds and retail types bail en mass if energy prices cool off in the near term  like what happened in July. US crude inventories are building and Russia says it will provide increased supply of gas to Europe. This is all happening at a time when global growth is cooling.

So, bottom line here is that there's good reason to be ST cautious on energy but even if O&G prices see a notable correction the stocks in the sector will still be relatively cheap generating tons of cashflow. Of course, there's always the bearish case that this energy move is a one and done thing and the green energy revolution will accelerate faster than expected. Tough call here for me. So, this is why I'm looking to exit 40%, this way no matter what happens I won't have too much regret either way. There's also a ST opportunity to deploy the money in other other commodity plays. Copper stocks for example have been drifting lower since May despite the fact that copper has has been holding above $4/lb.  Again, the cash flows that are being generated  for copper producers will be quite substantial making a  lot them look quite cheap. Given the current growth slowdown, this will be a good test of how durable the copper price is in the ST. In the LT there is a huge underpinning bullish force in place if you assume that we continue the quest for decarbonization. It will require copper prices of at least $5-$6/lb to produce the quantity of copper that is required to fully or mostly electrify energy consumption cleanly.  

Steady as she goes

Since my last post the market has been grinding higher with a couple of modest dips along the way. It's been acting as I'd expected. There is still a tug of war between value and growth with the latter getting the upper hand as of late but there's some burgeoning signs that value has taken back control, the energy sector in particular, which had a notable correction in July and early August. The correction was mainly triggered by fears of the Delta wave and its potential impact on demand. The correction appears to have washed away the weak handed johnny come lately and momo traders. I saw a report from BOA mid August that showed global money mangers had fled the sector in July after having piled in a couple months prior. With natural gas and oil prices remaining firm, the energy sector won't be able to be held back for much longer. The FCF generation relative to market value is already high but it's going to be enormous come Q4 and Q1 2022 because a lot of companies in the O&G sector put on hedges in 2020 which for the most part will be will rolling off in Q3. These hedges have been capping profits this year, especially in the nat gas sector.  With nat gas prices well north of $4/mcf  these companies are absolute monster cash cows once those 2020 hedges roll off. Even at $3/mcf, most of these companies will produce a gusher of cash flows. This should result in significant dividend hikes and/or share buybacks and also acquisitions. 

Nat gas prices have been notoriously volatile and in the doldrums for 15 years, however, because of the anti-fossil fuel movement and ESG push, new investment in oil and gas has been well below average for quite some time and was cut to the bone in 2020 due to COVID.  We've been  shunning  O&G too much. This will have consequences and we could very will have an energy crisis in the next year or 2 because although the future appears to be one of electric vehicles and clean energy, we aren't gong to get there overnight like what the clean energy and ESG hypesters are implying in my opinion.  And here's another thought...what if there's a breakthrough in carbon capture technology that either makes it more affordable and/or more effective? That could provide a new lease on life for the O&G sector. Don't get me wrong. I do envision a future where we no longer use fossil fuels and the solar and wind sectors will continue to be growth sectors in the long run, but we can't just turn off the fossil fuel taps as abruptly as Gretta and her ilk want us to. 

Getting back to the general market, it continues to be a goldilocks type environment. Everyone seems to be looking over their shoulder for the next big correction but that's tough to get without sentiment becoming excessively bullish. The lack of extreme bullishness continues to be case. Anytime that sentiment starts showing early signs of giddiness it quickly gets washed away on just a modest dip. That's wall of worry behavior which underpins a bull market. We're seeing the market roll over a bit here...let's see how people react it. So far I'm already seeing fear pick up notably. There's a concern out there about market valuations being high which does appear to be the case when you look at traditional measures such p/e ratios and such. I don't want to cherry pick bullish arguments, but Fidelity Sector Strategist Denise Chisholm (who I find is a hidden gem) makes the case that earnings are poised to accelerate more that what's being expected which means the market isn't as overvalued as people think. The concern about valuation is also indicative of the wall of worry. Near a bull market peak you will probably not have such concerns. People will find justifications for high valuation like in the late 90's rather than worry about it as they do now. 

Bottom line is continue to look for long set ups and resist the temptation to short.  If you must, raise some cash if that's gong to make you a strong holder. People who have used stops loses and  made trades based on trend lines, support/resistance lines and such have been chewed to bits. 

Goldilocks Market

I nailed it with my value is overbought vs growth call. Growth has handily trounced value since late May. It's been like a tennis match with growth and value - a back and forth. And if you chased the momentum for either you got burned. So now what? Value's time to shine again? I'm not so sure this time. In late May it was a easier call to make. But whether it's been value or growth taking the leadership role, the one constant is that the market is making new all time high after new all time high with very little in the way of pullbacks. The last pullback we got was triggered by the Fed's blinking in their timeline to start raising rates. So now they are saying 2 hikes in 2023. Big fucking deal. This change in course was enough though to create knee jerk reactions in financial markets. The dip in the stock market was short lived, however the jump in the USD has been sustained. LT government bond yields have actually dropped since that announcement after an initial knee jerk move higher. Inflation pressures is what make the fed blink but are they behind the curve? Aside from energy prices, commodities have notably cooled off. There is definitely a decoupling in the commodities space right now. It used to be that the oil price was the leader of the complex but not anymore. It seems now that that each individual commodity is beating to its own drum. The fact that oil has been rising despite the strength in the US dollar is impressive and tells you that its own supply/demand dynamics are what's mainly driving it. If the US dollar starts heading down again it will act as a further tailwind.  

Let's get back to the general stock market. I hear a lot of griping lately about the poor breadth of the market and how this is a warning sign to not trust the strength of the market. This poor breadth is due to the rotation into growth, namely. the FANG stocks which have a large influence on the indicies. Last year when FANG type stocks were leading the charge there was the same complaining of bad breadth. Then what eventually happened? The bulk of the small stocks played catch up as the big value rotation took hold. When this happened the FANG stocks didn't collapse, they just stagnated. The end result was the market making significant new highs. This back and forth rotation from value to growth and vice versa has being going on for sometime now and so long as the in favor style is not rising solely at the expense of the out of favor style, the market can continue to make new highs. 

People are trying hard to find reasons to doubt this market but aside from the high valuation argument (which hardly ever works, not to mention it's subjective), it's really hard to find them.  The recovery continues with buoyant earnings trends. Short and long term interest rate levels are near rock bottom/historically low levels  with the long end now trending sideways/lower for the past 3-4  months.  Stress levels in corporate bond markets are non-existent. Just look at junk bond yield spreads. It's at a record low. The fizzling out of the speculative sections of the market earlier this year i.e. the SPAC, meme and hype growth stocks appears to have not infected the broad markets. This was a concern many people had, including me. There was ominous parallels to the dot com bubble bursting but from the looks of it, this fallout will end up being a sideshow given how the broader market has been able to soldier on including the NASDAQ. I pointed out before that the main difference then compared to now is that monetary and fiscal conditions were tight whereas now they are ultra loose. This gave me reason to be open minded about the fallout. 

Sentiment has turned bullish recently but I wouldn't categorize it as extreme. Another concern is that we are at the peak of growth acceleration in the economy and the rate of growth is destined to come down. That's probably true, but slower growth is tolerable in the case where fixed income markets are yielding so little. So long as we don't go from growth to contraction, what you got is a market that for now at least, is in a goldilocks type situation which means that as I've said before, only mild/moderate pullbacks can be expected at this point unless something really nasty comes out of nowhere.  Whenever someone comes up that creates a drop in the market ask yourself this question”is this going to result in a material change in general earnings?” If the answer is no which it typically is, then all you’re going to get are pullbacks, not bear markets. The more sentiment/positioning is bullishly lopsided the greater the pullback will be. The other thing to watch for is rising yields. The higher they get the more of a headwind and pressure builder it becomes on the  market as it makes valuations of stocks less attractive.

It could be that this tranquil period in the market ends up being the calm before some sort of storms arrives but the burden of proof is on the bears. Lot's of people  including me, have a worry in the back of their mind  (and many in the front of their mind) that something is coming to sideswipe this market. That's actually a bullish thing as it indicates a wall of worry. But let's try to keep it real here. The SPX is up about 16% YTD. That's quite a bit and suggestive that the 2nd half of the year won't be as good. 

I've had some really good moves in my portfolio. FOM turned out to be a huge winner. I have exited 60% of my position, keeping the remainder 40% come hell or high water. Given recent developments there is clear pathway for them to go from exploration company to an actual producing mining company which means another 5 x  potential from here.  I've also done well with my overweight in natural gas/liquid stocks PD, ARX, PEY and PRQ. These stocks, in particular the latter 2 have been significantly re-rated because they were on the brink about a year ago. Now thanks to strong gas/liquid prices they are cash flow machines trading at low multiples to cash flow even despite the big moves they've had. I believe that natural gas will be a bridge fuel used in the global quest for zero emission, electricity generation.  It is however a notorious volatile commodity which has been in the doldrums for 10+ years.

I became attracted to this sector first and foremost because of the gorgeous charts. It's what I call low hanging fruit set up.  Look at for example the beauty of a chart that is PRQ. It is so similar to the chart of a big winner I had in 2010 Bennet Environmental. Bennet ended up going from $0.50 to $3+ in under 6 months. 

Secondly, as just as important, these stocks have improving fundamentals and low valuations after having been out of favor for so long.  This gives you plenty of upside potential as there's lot of room for new people to get into the pool before it becomes too crowded. 

My only dud is BKI. It had a good run to 0.70 but now back to 0.44 which is about my average cost. They have a great project but it seems like management could be weak in that they are having difficulty generating the interest of bigger players to get into the stock, unlike with FOM. They are now undertaking a financing. Let's see if the underwriter,  Cannacord is able to generate some interest. They better because I'm starting to lose patience.  

It's been a long time since I've been so exposed to Canadian resource related stocks. It does make me feel a little uncomfortable but the market has been telling me to get into these stocks and so I have...At some point I will harvest more gains and ride the remainder so that I can be a strong holder. I need to find the courage of my convictions to be able to do this. 

Is value over growth overbought? Crypto crash

The commodities complex has cooled off a bit as I had expected. If you look at long term futures prices some key commodities such as lumber, corn and  iron ore are trading at significant discounts to spot prices. This strongly suggests that their recent spikes are not sustainable. If you look at copper however, the discount is modest and so that suggests current prices are more likely to have limited downside. If that's the case, copper producers and exploration companies with attractive late stage projects are going to do quite well longer term. Shorter term, it can be dicey. I'm definitely seeing a lot of inflation talk which is giving me contrarian vibes to expect at least a reprieve in such concerns, but as I stated, some commodities appear much more vulnerable than others. 

I'm also sensing a lot of negatively towards tech relatively speaking. If inflation pressures cool this will be a positive for tech. At the same time, the love for financials and to a lesser degree energy may be indicative that the value over growth trade is due for at least a temporary reversal. Am I getting too cute? Maybe, but as I said before, you don't chase. You gotta zig when others are zagging. I saw a recent chart showing that according to a BOA survey, Fund managers have fled the tech sector by a historically extreme amount and have embraced value/cyclical sectors. Again, not the ideal time to be embracing such a trade.  

The crypto crash has been the main focus in the financial headlines. It started with TSLA no longer accepting BTC as payment followed up by a China ban on their banks dealing with crypto in any way. Has the bubble burst? I think it has. A 40% drop in BTC is reminiscent of the NASDAQ bubble bursting in 2000. A lot of crypto bulls are saying "we've seen this movie before. BTC has crashed several times but always came back". True but that's only because on each revival of BTC it  was able to recruit a fresh batch of greater fools. Where are the greater fools going to come from this time? At the recent peak you had institutional money embracing BTC. They were the last bastion of fools. Now, they are bag holders. I suspect now that the only thing that will keep BTC afloat are short squeezes and greater fool buying from ST traders.  You may also get one last hurrah from those who were waiting to "buy the dip". That can only get you so far however. I suspect most of the would be buyers are already in which means only one way to go longer term and that's down.  I suspect we will see lower highs and lower lows now with BTC and it will ultimately go sub $10K within 6-12 months maybe even less. 

Commodities rush

First off some general market comments. So far the implosion of the frothiest parts of the stock market i.e. SPACS and the momentum growth names i.e. ARKK stocks has not bled into the general market. Even the stagnation of the FAANGS hasn't prevented the SPX from hitting new all time highs. Last year  I saw so many people on Twitter post a pie chart showing how  5-7 stocks dominate the  performance of SPX implying that once these giants start faltering, the market is toast. But somehow, someway the market has managed to soldier on...at least for now. The value to growth and growth to value rotations have continued to play out and so far YTD value is winning the battle but it's been treacherous to those who chase in either direction. Friday's job report is creating a narrative that the Fed is not going to raise rates sooner than scheduled which is becoming a concern lately given Yellen's comments, the surge in certain commodity prices and the chatter in general about how inflation pressures are building.  Any kind of abatement in interest rate hiking fears will probably help the underperforming tech sector you would think. When I look at the main sentiment indicators the message I'm getting is neutral which suggests either a continued uptrend or a sideways market with only modest dips. 

So let's talk about commodities, specifically copper and oil. Goldman recently came out with research which paints a very bullish picture for copper in the long term and oil in the short term. Goldman came out with a report in April titled "Copper is the new oil"  Their thesis is that the transition to a green economy is going to lead to substantial demand for copper for several years given its use in wind, solar, energy grid/storage and EVs and since copper and commodities in general have gone through a lost decade from basically 2010-2020, not enough was invested in new mining supply to cope with this newfound demand which will keep copper prices elevated. If this thesis turns out to be true, junior mining companies that have advanced copper projects are going to have the most torque. I happen to own one such stock which I have had for several years -  Foran mining. The stock has been on a tear because they are in the right space and in the right development stage of their project. They are also being ESG conscious with their marketing and approach. They recently had a new CEO come on board who was so attracted to their prospects that he chose not to take a salary but to rather get paid by stock incentives which are tied to company milestones. Copper has recently hit an all time high yet there's nothing even close to the same enthusiasm for resource/materials stocks as there was back in 2010-2011. It's been relatively under the radar.  

In late March/early April I found my self loading up on other resource stocks because the market was telling me to do so. The charts were all showing what I like to call rare "sweet spot" setups whereby you have favorable technicals (uptrend with higher highs, higher lows), fundamentals and valuations. The setup reminds me of  the stocks that I had picked out and had success with in 2009 and 2010.  What's probably creating a lot of surprise this year is how fiercely the energy sector has come back to life. This was the most hated sector for years. Most people, including myself had called this sector "un-investable" because of the ESG movement and all the hype surrounding EVs and then in 2020 the absolute unfathomable happened when oil prices  traded negative. Now, oil is having its revenge and I doubt it's over yet. Because of all the hatred and avoidance of oil and gas companies these past 4-5 years we may soon find ourselves with an acute shortage of oil because of the lack of development in new supply. This is what Goldman thinks. Some energy bears think that fracking will come back on line in a hurry now that prices are higher. I say not so fast. All this ESG awareness will make fracking a much more difficult proposition than in the recent past.  And we're not going to all transition to EVs overnight and so it could very well be the case that this oil rally has legs. Even though I can sense that more people are warming up to this sector it's still  under-owned. 

Another interesting commodity which is not getting much headlines is iron ore. It's also making all time highs. I hold a position in a speculative company called Black Iron Inc. They have a mining project in the works which is highly leveraged to iron ore. They also have a high premium  ore which not only commands higher prices but is also ESG friendly as it cleaner to process than regular grade ore. The more ESG friendly a company is the most likely they will get access to capital and attract institutional investors. The project they have has excellent economics with an assumed iron ore price of $60 and right now the price is $195!   I also scooped up positions in small cap companies leveraged to natural gas and condensates. Again, the charts were screaming at me to buy them. 

My timing in purchasing all my resource names (aside from Foran which I have held for years) has been exquisite as all of them had huge moves almost instantly after I bought. Now, I do realize  that after such a great run we could get a breather in the commodity space soon especially if part of the reason fueling the rise in the ST was supply disruptions due to COVID. The US dollar has been declining steadily as of late and so any sharp reversal of that would put pressure on commodity prices as well. But I'm not going to mind such things. I'm in a position where I can be a strong holder and ride out any counter trend moves. I will not take profits just for the sake of taking profits. That's a rookie mistake. The market doesn't a give a shit about what price you bought in. I will sell when either the fundamentals say so,  I see some sort of blow-off move which makes the stock over valued or I have a better idea to invest the money. The stocks I own are either cheap fundamentally or in the case of the junior exploration companies, have a lot of "story" left to be told i.e. important announcements which pertain to the development of their mining projects. I'm also in a situation whereby  I have a regular stream of good income such that I don't rely on my portfolio gains to make my living as I once did. That puts me in much better position mentally to be able to hold on to positions if they start going against me. My portfolio can get chopped in half or even more and I'll still be fine. With my junior miner plays, I intend to keep at least 25% of my position invested until the very end i.e. until they develop their mine or possibly get acquired because the gains you can make in such cases are massive. If  you're going to play the long game you have to resist the temptation of getting out too early. If we are indeed in the early innings of a commodities run there will still be big money to be made but you gotta be prepared to hold during periods where the stocks do nothing for several months maybe even up to a couple of years.  I've been very lucky to have experienced instant gratification but I know that's not sustainable in the long run. If I am to fully capitalize I must be prepared for the inevitable corrections and stagnations and resist ST trading.  Most people can't do such a thing because they watch their stocks every day tick by tick. Doing so leads you make hasty decisions and  not having the patience or mental fortitude to handle adverse moves.  

China-like GDP growth?

 First off, some comments on recent market action. In my last post I talked about  frothy sentiment indicators but a funny thing happened the next day after that post - the main short-medium term indicators I look at reversed course to a moderate degree thus leaving a window for the market to advance and advance it did! Even the left for dead Cathy Wood stocks i.e. ARKK caught a bid....OK left for dead is over the top in describing it. 

The job number on Friday absolutely blew away expectations.  Usually the permabear types will find something to pick on when you get a report like this but this time...crickets. Goldman Sacks and JPM have come out with reports claiming that there's going to be a massive spring boom in economic activity as vaccine rollouts allow major locked down states like California, Illinois and New York to re-open. We could see growth rates that challenge China.(temporarily) even when excluding base effects. If this bullish scenario was to happen, then it's going to take off the charts level of bullish sentiment to mark a top of any significance. The SPX has made a new all time closing high. That has to be respected. Fresh all time highs tend to be beget further new highs. My bearish inclinations are premature it would seem.  However, I will not let emotions take hold and still be disciplined and on guard. Sentiment can be fickle and we could see the recent caution be thrown to the wind on a dime. 

Lets say we do this get massive surge in economic activity. It's going to put tremendous pressure on Powel to change his "no rate hikes until 2023" tune. Any hint of him doing that would cause a knee jerk market correction you would think. We're just going to have to wait and see how this all plays out...it will be interesting no doubt.  Commodities is one area I have been focusing on...more on this in a future post.