Maximum Confusion for a Time of Transition

By Dr. Duru written for One-Twenty

May 17, 2006

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During times of market madness such as now, I like to take a step back and spend more time studying and reading than worrying about current market prices. The Kirk Report provided a treasure trove of reading Tuesday night for just such an occassion. OK. I admit that I was more inclined to troll through the bounty of links after I discovered my latest missive was amongst them, but that is beside the point!

I was particularly struck by the cacophony of conflicting opinions on the commodities markets. I went from one powerful piece arguing that the jig is up to an equally convincing meolody singing the praises of the long-term secular commodities bull. As far as I know, the bullish story has remained the same for many years. I have also understood that typical commodities bull markets are measured in decades, not years. Finally, I also know that steep corrections are opportune times for the bears to press their case anew before the buyers force them back into the caves. Will the current correction in commodities eventually be bought? We saw fear and dismay for much of the first half of 2005 in many commodities from steel to gold and yet, even after many days of selling, all these commodity plays remain well above the levels of those dark days. It is easy to be confused overall as to what to think. Even I wrote a missive stubbornly defending silver (more specifically PAAS) only to write a missive the following week proclaiming that the bull is looking more and more tired with each rally. Do we not have a clue? What is wrong with this picture?

First, no pronosticator has a crystal ball, so we make the best guesses based on the information available sprinkled with the bias of our personal experiences. You faithful readers know that this year, I have been more prone to look for opportunity when all else seems lost. I think the market is getting to the despair phase in the current moment, but there remains plenty of faith and optimism over the longer-view (meaning the rest of the year). Admittedly, I have to wonder whether this optimism only resides in the small handful of big money players who move the majority of money in the markets. After all, President Bush and company have stumped the country repeatedly trying to convince a skeptical country that the economy could not be in better shape. And they continue to fail miserably. Anyway, I am prone to think that buying opportunities are opening up all over the place, but I am not inclined to believe that bets placed now can be held for long. This means that the first source of confusion can come from a blurring of time frames. The bears are jumping all over the current pain and extrapolating as if the overall up-trends in strong financial instruments like commodities has been irreparably broken. The bulls keep their eyes trained on the horizon and speak as if the flames approaching the porch will be obediently doused by a resurgence of optimism just in time to resume the good memories from multi-year and multi-decade highs.

A second source of confusion comes from the natural wariness we have developed about bubbles. Whenever anything soars in price it sure looks and feels like a bubble. The financial markets have seen wave after wave of bubbles from technology stocks, to real estate, to education stocks, to all manner of the latest fad and financial savior of the day. Thus, it is natural to see the soaring prices of oil, steel, gold, copper, and silver and think bubble. Whenever I go there, I am reminded of how busted and broke all these bad boys were back in the late 90s and 2000. Is it not possible we are seeing a normalization or re-balancing? We see the cost of health care and college education soaring out of control every year and yet does anyone call these dynamics symptoms of a bubble? (Oh, if only they were bubbles, right!?).

A third source of confusion emanates from the Federal Reserve. The Fed is now forced to act on the latest data rather than a well-mapped plan. In essence, anything can happen, and the market does not like that (as if it collectively can truly know what will happen!). The market also has a low threshold of tolerance for the volatile twists and turns that each new economic report will provide. Moreover, central banks worldwide are adding to the market's nervousness as easy money policies are going out of style. While Japan seems prepared to stick to easy money, most everyone else with a central bank of importance seems to be looking to apply some kind of screws to global growth. "Everyone" knows you are supposed to sell stocks when interest rates rise and the threat of inflation looms larger, but long-term rates have only just recently started rising here in the U.S. The economy has defied the odds in a sense with consumer spending remaining robust and companies ramping up investment of their huge cash reserves. I am sure the big players would like to sell now, but the apparent stubborn behavior of the market is keeping their attention. In the end, I think commodity prices will only get slowed down by the onset of a real economic slowdown, probably a recession. Of course, at that point, we will regret asking for lower commodity prices!

One thing I can be sure of is that all the confusion is symptomatic of a time of transition. Whenever it seems like change is afoot, all manner of strong opinions pound the tables harder. A lot of folks have made good money sticking with some very good up-trends. During times like these, these paper profits can turn into nervous money. The nervous money is trying to decide which voice is the loudest. If they resolve to exit the market, we should get some kind of wash-out type of selling that will mark at least a short-term buying opportunity. If these folks resolve to take some Valium and cross their fingers for good luck, your buying opportunity is already passing before your very eyes...and the wash-out is delayed for another day or month or...

Regardless, as always, be careful out there!

DrDuru, 2006