1001 BOUL. DE MAISONNEUVE O., BUREAU 950,
TEL: (514) 939-2221 FAX: (309) 417-0942
e-mail: sidklein@sidklein.com
“THIS IS THE END, MY FRIEND”
July 6, 2005
Nikkei: 11,603.53
*April 2003 low: 7,603.76
*- See March 31 &
NB: Due to the
effects of evolving industry regulations, whereas SKC publications had
previously occurred on the first weekend of the month, final copy may only be
ready for transmission 2 – 3 business days thereafter.
The
They’re not far off.
In any event, in deference for a possible decline in the Dow
to 6500, our last report surmised:
“2006 could be
preceded by a decline in the Nikkei, while also providing a lifetime investment
opportunity. It would remain to be
seen what the effect of such a decline would actually be on Domestic Demand
Oriented Value Stocks (DDOVS).”
We therefore
concluded:
“A Nikkei rally
toward the mid-11,000’s, could be used to lighten positions, in deference for
the possible negative implications for equities, for the next year.”
The Nikkei has
indeed rallied to just over 11,600, with stocks rallying into a seasonally weak
period. This is consistent with the Yen’s recent peak, from which a 7.5%
correction very quickly ensued. The Yen has tended to precede the Nikkei’s
activity by about two months.
This report’s
title borrows from the first words of Jimmy Morrison’s “The End”, a piece that
was subsequently and appropriately popularized by the film, “Apocalypse Now”. The
song described that soul’s sinking into the sunset, a conclusion that took
place in
In the first
quarter of 2004, the US economy saw peak leading indicators and a top in stock
prices, when denominated in foreign currencies (at the Dow’s October 2002 low,
SKC had forecasted February 2004 to be the Dow’s next major peak). Therefore,
SKC has held the view that the past 18 months’ “Last Tango in New York” could
only spell an eventual precipitous decline, as the markets had experienced in
2001 – 2002 and 1973 – 1974, when the Dow also held up in the clouds, only to then
decline, reflect and come into line with deteriorating fundamental, valuation
and technical indicators, “all at once”.
Finally, then,
we have come unto the one market that SKC is so profoundly bearish on: New York,
with respect to which, for good measure, Desjardins Securities has reported on
June 20, 2005 that nine of the last twelve leading US economic indicators
reports were negative, as have been the last four.
Along with the
divorce from the activity in the price of oil (see last quarter’s special
Desjardins Securities study), the above fundamentals bolster and support eerily
bearish valuation and technical arguments, all of which are consistent with SKC’s view that the Dow
has an appointment with 6500 in 2006, with a “fair-value-stop” at 8000. Of
course, “not inconsistent with” is not the same as “consistent with”, but SKC’s
views are well known and clear, as is our open-ended promise to review
forecasts as time progresses.
The key right
now is that the risk over the coming six to nine months is extremely high,
against a background of extremely cheap long-dated puts that serve both as
contrary indicators, as well as vehicles that provide extraordinary gains
potential, or significant efficiency in hedging, for those who will have held
equities despite the prevailing landmines.
VALUATION: The Dow’s PE multiple is at a premium to forecasted
earnings growth rates. Those forecasts are not even being contested here. The
reader is merely being reminded that the reason given for the new paradigm that
allowed for premium multiples were that interest rates were headed toward zero.
With the underpinning of that new paradigm argument gone, the Dow’s fair value
is at 7,900, or so, based on a PE that reflects those consensus forecasted
growth rates. Bye the bye, do markets ever stop at presumed fair value, or do
they then discount the future’s negatives, to the extent that they had
previously ignored basic valuation criteria?
FUNDAMENTALS: According to my interpretation of the above
referenced Desjardins oil study, the Dow’s coming into line with oil’s activity
could take that index down to 8000 fast.
TECHNICALS: Long term stochastics join other indicators in also
supporting the analysis that the Dow’s decline to 8000 could be speedy, taking
volatility indicators up, just as fast. The combination would spike put prices
in stunning fashion.
Due to recent market events, the May 7, 2005 report is
quoted below, largely to seek benefit from similar circumstances as what
prevailed then:
“The two-year puts
doubled, due to a spike in the volatility index and falling market. Puts
benefit from higher volatility and a lower market. Puts expiring
one year before the contemplated two-year options, rallied to the level of the
two-year puts, thereby allowing put holders the opportunity to turn their long
put positions into a spread, by selling the shorter dated put, thereby
recouping the entirety of their initial investment, if they so wished, while
still holding the initial position, which enjoys a full additional year. From
the April report, then:
“Meanwhile, all this occurred with the Volatility
Index rallying back to what can only be referred to as washed-out
levels, historically! This is why such very long term puts provide the leverage
today that approximates what was available via 9-month put spreads a year ago.
The last time I saw such incredible relative risk-averse leverage was in the
2-year European traded Nikkei put warrants in December 1989.
“This is
why capital recuperation and profit maximization is so easily achieved in a
falling market against such long term puts. Simply, put prices are driven by
market levels (the lower the better) and Volatility Index levels (the higher
the better). When the Dow declines - and it should again do so speedily, to
slam the door shut on the bulls - the Volatility Index spikes up, as we just
saw in March.
“The effect
is the ability to sell shorter term puts against the outstanding long term
puts, thereby recuperating most or all of the initial investment in the longer
term options, which are held to take advantage of the time owned, so as to
capitalize on a greater crash into 2006. The ability to track option
(volatility) prices will figure greatly into the larger performance picture,
which SKC believes will exceed 1000% per cent anyway, from desired and recently
seen prices, based on the here anticipated move in the Dow……without
contemplating time premiums!
“In 23
years, I have never seen a greater leveraged long term opportunity and when
things are this stretched, it tends to spell violence ahead. One must be
positioned in advance, since the nature of such bull moves is to lull everyone
to sleep, as hedgers and speculators await a confirmation that would dramatically
appreciate very long term puts.
“Remember: Leverage is
established/achieved on the buy side!”
CONCLUSION: Here too, we find our conclusion as having been
well-expressed in the April report.
“The Dow is
… highly susceptible to a 2000-point drubbing at any time, to get the ball
rolling en route to 6,500 in 2006. Multi-year, low risk (for options) puts are
here expected to return over 1000%.”
GOLD:
The following two paragraphs and quotes are taken from
recent issues of “Bullion Buzz”:
"Sooner or later,
the world's investors will realize that neither the US, nor the EU, nor the
yuan, can offer what they promise - and people will figure out that the Chinese
were right to advise their citizens to accumulate gold bullion (which by the
way is a first in the history of modern government, to my knowledge).
Consequently, investors will start accumulating gold bullion themselves very
soon."
"There is a growing realization that gold,
commodities and commodity derived products offer far more stable investment
prospects than European or US financial products."
James
Moore - TheBullionDesk.com
While the above pertains to fundamentals and valuation, the
following technical summary is taken from the last issue of SKC (
“If this is in fact
the scenario that is playing out, it may indeed be correct to conclude that
exchange-traded gold funds have siphoned off some otherwise available cash for
gold investment. As equities are well into a still young bull market, and as
they may be discounting a re-test of gold $410, their underperformance versus
the metal since gold hit that level weeks ago, is giving this bull market a bad
name. Of course, that’s good for buyers.
“With gold stocks
trading at levels last seen at definitively lower gold prices, risk is to the
upside, as the equities contain a lot of leverage to the metal from here. Gold
stocks have a history of shaking the tree to dispose of weak holders, who doubt
the only legitimate North American equity theme that I see.
“CONCLUSION:
SKC had correctly forecast $410 for gold, though that made no money for stock
investors. That level is still seen as a worst-case scenario and the view is
maintained that one should be 100% long the metal from that level. Gold and
silver equity investors should be 50% long, prepared to increase to 100% around
gold $410, if it does actually get there, with an intermediate term view to
reduce positions to as little as 33%, on a spike to $460 in gold. I suspect
that we’ll have opportunity for revision.”
Gold did attempt to re-test $410
but savvy investors got out in front of it and caused a slightly higher low.
Precious metal stocks, meanwhile, flushed out to new lows. Therefore, within
the context of the preceding paragraph, investors went 100% long, according to
their experience (talent and inclination). As for reducing positions “…to as
little as 33%, on a spike to $460…”, forget it?
CONCLUSION: The
metal shot up to $440 very quickly, while breaking out versus the Euro.
Investor apathy and ignorance of precious metal stocks suggests that a rather
unheralded low has again been seen. This will again yield extraordinary
profits. The sharp downward spikes are typical of BULL markets. Tree-shaking (headlines that cause
retail investors to back off or sell) doesn’t occur in a bear market. Rather, the
latter was marked by slow multi-year erosion.
DOLLAR:
There
is no change from recent commentary or asset allocation.
Careful and prosperous
investing to all,
Sid Klein
________________________________________________________________
LEGAL NOTICE. On this 17th day of December, 2005, Mr. Sidney Klein has donated
this
market letter to the public domain.