Pick a Side If You Want to Start Losing Money

The financial industry, newsletter writers included, has become rife with calls for deflation or inflation. Virtually every commentator on the planet has a strong opinion on these topics and 99% of them are firmly entrenched in one camp or the other.

I want to clear this subject up because a lot of very smart people are taking very narrow-minded views of the world, and they’re spreading these views around as though they are facts. This is alright when the views are based on reality, but when someone chooses opinion over facts in the markets, then big money gets lost.

The fact of the matter is that deflation and inflation are NOT mutually exclusive.

Forget all the clever arguments for a moment and look at the world around you. Housing prices and incomes are falling. Employment and the average work-week are down while industrial capacity has considerable slack. Those are DE-flationary items.

However, at the same time, food prices and the cost of many goods are RISING. In general the cost of living is going UP. Ditto for quite a few commodities: oil is up nearly 30% year over year while Gold has risen 20%. And don’t even get me started about grain prices in the last few months. These are IN-flationary items.

In plain terms, BOTH inflation and deflation are occurring simultaneously.

To argue otherwise is to ignore what’s taking place right in front of you or to choose opinion over fact. The world, in general, is far more complicated that people give it credit for. And these binary arguments (something can ONLY be either A or B, but not both or a shade of gray) are foolish and misguided.

They’ve also lost people a lot of money.

Consider the performance of Gold vs. the US Dollar (the inflationists and deflationists respective darlings) ever since July 2007 when the credit crisis first gripped markets with the implosion of two Bear Stearns hedge funds:

As you can see, BOTH the US Dollar and Gold have rallied during this time. On a relative basis Gold has outperformed (20% vs. the Dollar’s 12%), but we have not been in a world in which one asset exploded higher while the other collapsed.

Which brings me to my next point: the financial world is not an “all or nothing” place, it is a place of relatives and relationships. And those who choose to become fixated on one outcome or mind-set will ultimately find they lose money because of their convictions.

Case in point, the inflationists who bet big on the “Gold will explode because the Dollar is doomed from all the bailouts” thesis in 2008 got take to the cleaners when the exact opposite happened and Gold fell from $900 to below $750 while the Dollar rallied to multi-year highs in a matter of months.

Similarly, the “Dollar will rise and Gold is doomed because there’s too much debt” deflationists got taken to the cleaners for most of 2009 and early 2010 as stocks put in a 60% rally and the Dollar came within a few percentage points of its 20 year low.

To return to my primary point: the financial world is relative. The various asset classes, whether they be stocks, bonds, currencies, or commodities, move in relation to one another. This is ESPECIALLY true in today’s highly correlated market dominated by computer trading and the Fed and other central banks’ “funny money” policies.

All investors need to account for this fact and act accordingly. This means shifting your investment focus from emphasizing one “ation” (inflation or deflation) or one asset class (stocks, bonds, etc) to another depending on what’s going on in the markets.

This is not particularly hard to do. If you’re a passive investor who doesn’t actively trade the markets, then focus on the weekly charts and investor sentiment to determine when it’s time to shift capital. Whenever things get tilted too heavily to one side, it’s a good time to start shifting to the opposite camp.

For example, back in November only 3% of investors were bullish on the US Dollar. Given this sentiment and the fact that the Dollar was down for nearly 9 months and approaching a 20-year low while stocks had rallied, the “anti-Dollar” trade was extremely lopsided. The odds favored a Dollar rally and so it would have been a good time to shift from anti-Dollar hedges to pro-Dollar investments.

Indeed, if you’d shifted to cash then and waited until sentiment became lopsided again in June 2010 (at that time 98% of investors were bullish on the US Dollar) you would have seen a nice 12% gain from your move. I don’t know about you, but a 12% gain in seven months from a single decision strikes me as a decent return for little effort.

Not to mention the peace of mind of not sitting through stocks’ AWFUL volatility in 1Q10 and 2Q10. To most passive investors, that kind of peace of mind is priceless.

Bear in mind, I’m talking about general portfolio allocation for passive investors here, NOT active traders.

However, if you’re an active trader who spends most of your time in front of the computer playing the market, markets like the one we have today couldn’t be more profitable. With volatility increasing and price swings becoming more extreme between assets classes the potential to produce outsized profits has increased dramatically provided you’re willing to “get in and get out” quickly.

On that note, I’m just completing the testing phase for a trading system designed specifically for this purpose. It’s called Rapid Fire Options Alert, and it’s an options based day-trading newsletter devoted entirely to producing BIG gains as quickly as possible.

How big and how profitable?

Since June 25, this system has produced 13 trades. Of these 13 trades, nine were winners including gains of 25%, 26%, 57%, 101% and a whopping 266%.

The average holding period was two days.

Granted, no one is perfect, and this system has produced losers: four total. But since June 25, the model portfolio is up a total of 27%. Compare that to the S&P 500’s return of 1% over the same time period and you see just what I mean by BIG GAINS.

I want to be clear here: this system is ONLY for people who actively trade the markets on a daily basis. The trades come in real time so you NEED to be in front of your email during market hours to utilize this system.

If this sounds like the kind of returns and trading results you’re looking for, drop me an email at graham(at)gainspainscapital.com with “Rapid Fire Options Alert” in the subject line and I will reserve you a slot for the official launch next week.

However, DO NOT write me if you are not serious about subscribing to this trading system at launch time. Given the returns and track record there are going to be many investors interested and I am only making 50 slots available at an introductory low offer price at the launch.

Again, if this sounds like something you’re interested in and you’re SERIOUS about taking your trading to the next level, drop me a line at graham(at) gainspainscapital.com with “Rapid Fire Options Alert” in the subject line.

Good Investing!

Graham Summers

The Stinging Critique of a Worker Bee

A little while back, a Fed Economist by the name of Kartik Athreya, wrote a piece urging the public to only listen to economists who have PhDs from top level universities when searching for economic insights. Regarding other sources of macro-economic analysis, specifically bloggers, Mr. Athreya writes, “it is exceedingly unlikely that these authors have anything interesting to say about economic policy.”

Obviously this paper was a lot of fun for me to read. So I thought I’d present some thoughts on Mr. Athreya and the group of “experts” he represents.

For starters, Mr. Athreya introduces himself as the following:

The relevant fact is that I work as a rank-and-file PhD economist operating within a central banking system. I have contributed no earth shaking ideas to Economics and work fundamentally as a worker bee chipping away with known tools at portions of larger problems.

Now, the primary thrust of Mr. Athreya’s arguments is that one needs to have taken some form of graduate work on economics to provide any commentary on the subject that is “meaningful.”

Seeing as this is essentially a “leave the difficult stuff to us experts,” argument, I want to start with the self-description of the “expert” writing it. I wonder, when reading Mr. Athreya’s self-description, if worker bees do in fact “chip away” at things?

I realize that bees make honey and build hives… but chip away? What do they chip away with? “Known tools”? Do bees use tools? Which ones are these? And what “portions of larger problems” do bees “chip away” at? Building hives? Making honey? How do you produce honey by "chipping away"?

More to the point, what on earth is Mr. Athreya talking about?

We’re not even past page one of his “us experts are the only ones who know what they’re talking about,” diatribe and already it’s not even clear that he has a firm grasp on how to use basic metaphors. And he is meant to represent the sort of people us ordinary folk should listen to when it comes to explaining things that are “very complicated”?

I also wonder if Mr. Athreya, when making his somewhat self-deprecating introduction, was aware that most “worker bees” are in fact sterile females? Moreover, did he intend, by using the “worker bee” metaphor, to imply that the Central Banking System is in fact a metaphoric “hive” of which Fed Chairman Ben Bernanke is the “queen”?

I’ve written some pretty critical words regarding Chairman Bernanke and his policies, but implying that he is a large female whose only role is to sit around laying eggs all day is too rough even for my taste. A charlatan and a fool? Certainly. But a insect whose sole purpose is to lay eggs? That’s a bit much.

Of course, I am making an intensive examination of Mr. Athreya’s choice of words. However, if Mr. Athreya wishes to write a paper elevating himself and those of his profession as the only ones qualified to discuss difficult topics such as macro-economics, I would assume he would be intelligent enough to make a cogent metaphor (I am, of course, assuming Mr. Athreya was not aware of the implications of his “worker bee” self-description… for all I know he may in fact want us to believe he and his ilk are sterile females working for a queen).

However, in the interest of taste and decorum, let’s set aside my analysis of Mr. Athreya’s creative language and focus on the brunt of his intellectual argument. Rather than analyzing his entire essay, I thought it best to summate his points in a few bullets:

1. Macro-economics is very hard
2. Only those with at least some advanced PhD-level coursework can comment on macroeconomics knowledgably
3. Everyone who pretends they understand macroeconomics without having pursued said coursework is doing the world a disservice and misleading the general public

Mr. Athreya then goes on step further and points out that while many bloggers focus on the Financial Crisis, they fail to provide a similar amount of commentary regarding two other major crisis, specifically the earthquake in Haiti and the Tsunami in East Asia.

He writes:

I find the comparison between the response of writers to the financial crisis and the silence that followed two cataclysmic events in another sphere of human life telling. These are, of course, the Tsunami in East Asia, and the recent earthquake in Haiti. These two events collectively took the lives of approximately half a million people, and disrupted many more. Each of these events alone, and certainly when combined, had larger consequences for human well-being than a crisis whose most palpable effect has been to lower employment to a rate that, at worst, still employs fully 85% of the total workforce of most developed nations.

I chose this passage because it shows, in clear terms, just how self-righteous and clueless economists like Mr. Athreya are. To be clear, I do not think ALL economists are clueless. Moreover, I do not think all economists AT the Federal Reserve are dolts. It is quite clear from several of the papers published by folks at the Fed that some of them understand exactly what is going on and that they are as fed up as the rest of us.

So, if you have a PhD in Economics or work for the Fed, do not think that the following is necessarily directed at you. It is, instead, directed at those Economists who, like Mr. Athreya, believe they are somehow smarter than the rest of us, when in fact the vast majority of them missed the biggest Financial Crisis in 80+ years all the while promoting theories and policies that have done severe damage to American savers, the value of the US Dollar, and American living standards.

Over the last 40 years, Americans has seen a dramatic decline in incomes, living standards, and generalized quality of life while their savings and wealth were transferred to Asia, OPEC, and Wall Street.

Indeed, when you adjust for inflation using the Bureau of Labor Statistics OWN data, REAL incomes have declined some 40%+ from 1972 to today (weekly earnings of $143 in 1972 are worth $746 in 2010 dollars… compare that to the ACTUAL weekly earnings of $355 today).

Between 1970 and December 2009, the US Dollar lost 81% of its purchasing power courtesy, at least partially, of the Federal Reserve and the economists who decide policy there. This, combined with the drop in weekly earnings, is why, in the ‘70s, only one parent worked and families got by whereas today both parents typically work and are struggling to make ends meet.

In plain terms, the Fed’s policies eviscerated the middle class while funneling their money into Asia (per capita income in China doubled twice from 1978 to 1987 and again from 1987 to 1996), OPEC, and Wall Street (the financial industry’s profits as a percentage of total S&P 500 profits rose form 10% to 31% from 1970 to 2003).

In 1979, the top 10% of income earners in the US took in 67% of all capital income (income from stocks, bonds and the like). By 2006, this group was snagging over 80% of all capital income. Talk about concentration of wealth in the hands of the few!

Economists like Mr. Athreya and their “very precisely articulated model(s)” are indirectly if not directly responsible for this happening. Their work was used to back up policies that were in fact horrible for the American people and their living standards. In plain terms, they dressed up a bunch of theories that were complete and utter CACA all the while claiming these theories were facts. And all 300+ million of us in the US have suffered because of it.

Mr. Athreya decries the fact that bloggers focus on the Financial Crisis instead of the earthquake in Haiti or Tsunami in South East Asia. He implies that this focus indicates bloggers are in some way not concerned with the welfare of others.

Unfortunately for his arguments, neither the earthquake nor the Tsunami were man-made catastrophes. The Financial Crisis, in contrast, WAS man-made (actually IS, since it’s still going).

Moreover, the risks of the Tsunami and the earthquake were not well known to the experts well in advance (a handful of studies warned about a potential earthquake in the Caribbean, but the Tsunami came “out of left field” so to speak).

In contrast, as early as 1998, soon to be chairperson of the Commodity Futures Trading Commission (CFTC), Brooksley Born, approached Alan Greenspan, Bob Rubin, and Larry Summers (the three heads of economic policy) about derivatives. She said she thought derivatives should be reined in and regulated because they were getting too out of control. The response from Greenspan and company was that if she pushed for regulation that the market would implode.

So, the Economists and experts knew a full ten years in advance what the risks were in the financial system. And they did NOTHING to rein them in.

Finally, neither the Tsunami nor the earthquake resulted in the Federal Reserve channeling TRILLIONS of taxpayer dollars into the corrupt bank oligarchs’ coffers, often times paying 100 cents on the Dollar for worthless assets that are now poisoning the Fed’s balance sheet and assuring that the very issues plaguing Europe will one day hit the US.

The Financial Crisis DID all of this and more.

In no way shape or form am I belittling those who were killed or continue to suffer from the earthquake in Haiti or Tsunami in East Asia. My primary point is that both of those incidents were natural catastrophes that could not have been prevented. The Financial Crisis, which wiped out $50 trillion in wealth and has resulted in millions losing their jobs, COULD have been prevented.

And yet, consumers are supposed to listen to the guys whose entire careers are meant to focus on forecasting economic events when less than one percent of them forecast the Crisis (despite those at the top of the economist food chain knowing a full decade in advance of the risks in the financial system)?

Truly, Mr. Athreya and his ilk are “chipping away… at larger problems.” However, those problems are not economic models or unemployment, they are the following:

1. That ANYONE listens to economists like Mr. Athreya
2. That the US Dollar still has a value greater than toilet paper

However, do not be alarmed, I am sure that as long as the Fed keeps publishing this kind of nonsense while funneling taxpayer money into the Wall Street banks, both of these problems will soon be fixed… permanently.

When that happens, we can all toast Mr. Athreya and his ilk with $100 beers and take comfort that the experts knew what they were doing all along.

Good Investing!

Graham Summers

PPS. Gains Pains & Capital is my free investment newsletter aimed at keeping investors abreast of the most crucial developments in the financial markets.  In the last two month’s alone I’ve called the Small Cap top, had my analysis confirmed by Warren Buffet, and revealed the one leading indicator that the S&P 500 is following literally tick for tick.

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A Market Timing Correlation That’s Flawless

Pop Quiz: what do you get when you combine a stock market completely overrun by computer programs with central bankers who believe currency debasement is a means to generate real wealth?

Answer: insane volatility in which the entire market follows various asset classes tick for tick.

Let’s take a trip down memory lane.

After the Federal Reserve announced its Quantitative Easing program in March 2009, the US stock market (as illustrated by the S&P 500) began to trade in an absurd correlation to the US dollar.

Of course, stocks and the US Dollar had maintained something of an inverse correlation for years (meaning one fell when the other rose). I use the word “absurd” for the relationship between the two assets in 2009 because for much of that year the correlation was -0.98 (see below).

Let’s be blunt: correlations of this perfection ARE NOT supposed to happen in the financial world. To give you an idea of how ridiculous a -0.98 correlation is, consider that historically, Gold and the US Dollar, which are generally considered to have a perfect inverse relationship, have actually maintained a correlation of around -0.27.

A -0.98 correlation is only possible when you’ve got two things:

1. A market dominated by computer trading programs that trade based on correlations
2. A Central Banker intent on debasing a currency to reflate the stock market

Unfortunately for Bailout Ben Bernanke, his debasement efforts were thwarted when Europe began to implode courtesy of Greece’s debt issues. Consequently, the Euro collapsed forcing the US Dollar higher (the Euro accounts for more than 50% of the US Dollar index).

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This blew up the US Dollar carry trade (traders were borrowing in US Dollars at 0% to invest in higher yielding assets, pocketing the difference in the yield spread). Which helps explain the collapse of the S&P 500 in late January 2010.

With the US Dollar now rallying, traders needed another “debasement-friendly” currency to borrow in. Not surprisingly, they turned to “Old Faithful,” the one currency that has been a carry-trading investor’s best friend for years: the Japanese Yen:

As traders moved into this trade, the momentum chasing computer programs followed suit. What followed was the market shifting away from its correlation to the US Dollar and into a near perfect correlation to the Euro/ Japanese Yen. Indeed, the perfection of the correlation is even more absurd when you take the chart down to 5-minute increments:

As you can see, the S&P 500 (blue) is now following the Euro (priced in Yen) tick-for-tick.

Will this relationship last forever? No. Like the US Dollar/ S&P 500 correlation of 2009, at some point this will blow-up, most likely when the Euro finally puts in a serious dead-cat bounce.

However, in the meantime this is a market timing indicator that is darn near flawless. Day traders take note, this is the correlation the computers are favoring. Use it while it lasts.

Good Investing!

Graham Summers

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Baguettes Vs. Bratwursts

The situation in Europe has officially passed “crazy” and gone into total Looney-Tune-ville. Let’s review how this once great economic entity has shifted from producing anything of value to an economy primarily involved in the production of insane headlines that look like something from The Onion or some other satirical newspaper.

December/ January: Greece virtually defaults on its debt. The markets dive and the Euro comes under fire.

January/February: Various Greek “officials” announce imminent bailouts, various German “officials” say it’s a load of hogwash.

February/ March/ April: Greece brings up German war crimes, threatens the EU if it doesn’t get a bailout (try figuring that one out), then begs for a bailout, then acts as though it doesn’t need one.

Greek politicians condemn the evil “speculators” who are destroying their country, only to find that said speculators are in fact mainly Greek state owned banks. Meanwhile, Greek protestors re-enact “The Clash of the Titans” with various public and private buildings in Athens.

Throughout this period, Germany plays hard to get, then acts as though it will help if the IMF does, then pulls out, then throws in the towel and helps. France, who in this tragic-comedy is Germany’s less attractive cousin (from a fiscal standpoint) pretty much follows German policy wearing an “I’m with Germany” t-shirt.

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Meanwhile, the IMF, which in reality is the US, says it’s happy to throw Dollars at the problem. And Ben Bernanke has a special second “Print” button made to celebrate his new “Double Handed Dollar Dump ” approach to Dollar Devaluation.

May: After five months of failing to fix the problem, Greece implodes and the Euro collapses. The stock market in the US disappears for 30 minutes, and then comes back. CNBC and Bloomberg reporters blink and miss it.

Europe, which was largely opposed to bailouts, suddenly announces the largest bailout in recorded history. The Euro bounces for one day, before traders realize that “bailing out yourself,” doesn’t solve a debt problem if you’re already broke. The Euro breaks down again.

The most interesting new development is that France has apparently gotten sick of playing second fiddle to Germany and is discussing breaking away from the Euro completely and re-instating the Franc.

At this point the whole thing reads like a WWE plotline. All we need now is for German Chancellor Angela Merkel to challenge French President Nicolas Sarkozy to a Cage match to be titled the “Baguettes vs. Bratwurst Beatdown.”

The only clear thing from this whole process is that the Euro as a currency is finished and the markets are likely to collapse. The reason for the collapse is that the Dollar is rallying strongly which kills the carry-trade most financial institutions have been using (borrow in Dollars and invest in something else like stocks or Brazilian bonds, etc).

If this continues to unwind look for another round of Deflation to hit markets across the board. This means pretty much everything falling as the Dollar rallies. How Gold holds up will determine if the precious metal is now completely a standalone currency.

Good Investing!

Graham Summers

PS. If you want insights on how to play all of this madness and the volatility in the markets, sign up for my exclusive Private Wealth Advisory, newsletter. In it I'll detail what's going on in the markets and provide you with specific investment ideas to profit from what's to come.

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