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I figured out
early in my career that arguing with the market more often than not ends up
costing one money. If you are one of those people
who are unable to change your mind, this business will almost certainly chew
you up and spit you out. Never has that been more true than today.
Folks, we are
in the middle of an ongoing currency war. That is creating investing
conditions unlike anything most of us have ever seen before. There's a reason
why very few money managers have been able to make any profits over the last
year and most of them have lost money. That reason is an ever-changing
investing environment.
As most of
you probably already know my investing strategy is based around cycles,
sentiment, a long-term bull market in precious metals, and a dash of
technical analysis thrown in to help spot entry and exit points. Those tools
give me a rough outline of what to expect going forward. I then place my
trades based on the best odds for success. However, none of that excuses me
of the responsibility to change my mind if the market tells me my
expectations are wrong. It is precisely the ability to reverse direction
180° that enabled us to generate a 25% plus gain in the model portfolio
during the last six months, despite being in a market that has confounded
most professional money managers. Additionally, our portfolio has always been
unleveraged with never more than 75% of capital invested at any one time. I
daresay that, on a risk-adjusted basis, the SMT model portfolio has
outperformed probably 99% of the money managers in the world.
As an example
let's use my recent expectation for 2012 to be one of the worst years in
history. First off, let me explain how I came to that expectation. To begin
with, the dollar's three year cycle low was due to bottom in the spring of
2011. And indeed, it actually did bottom in May of 2011. Further, the stock
market's four year cycle low is due to bottom in the fall of 2012.
Since most
bear markets tend to last about 1 ½ - 2 ½ years it was
reasonable to expect that the next bear market would begin as the dollar
started to rally out of its three year cycle low. Low and behold what
happened in May as the dollar cycle bottomed? That's right, the stock market
started to collapse as deflationary forces began to push the dollar higher
and asset prices down. Everything was unfolding exactly as our cycles tool had suggested it would.
 
However, in
late November the markets started to deviate from our expectations. As the
dollar continued to rally stocks began to decouple from the strong dollar. At
this point one could either stubbornly hold on to their bearish outlook and
lose money, or they could accept that the market was doing something
different than what they expected, change their mind, and deal with reality
as it is, instead of how they wished it to be.
The fact that
the S&P wasn't doing what it should have been doing was the main reason
I've been warning (pleading really) with traders not to sell short. This
market should have begun the move down into a daily cycle low two weeks ago.
The fact that it refuses to move down into that overdue correction is sending
a strong message that something else is going on.
The inability
to change one's mind when the market tells you that you are wrong is one of
the toughest habits to break, but one that is absolutely necessary if you are
going to make money in this business. For whatever evolutionary reason, human
beings have a very hard time admitting when they are wrong, and an even
harder time reversing their thinking 180° even after they know they're
wrong. For the vast majority of traders it is less painful to lose money than
it is to admit an error and reverse a trade.
In my
previous post I went over my expectation for gold to move down into its daily
cycle low along with the stock market. This should have corresponded with the
dollar rallying out of its cycle low. On Wednesday morning everything was set
up perfectly for this to unfold. Gold had formed a swing high and was
beginning the move down into its daily cycle low, stocks were in the process
of reversing back down through the coil, and the dollar had bounced off of
the 50 day moving average and was holding strongly above support at 80,
clearly in the process of putting in a cycle bottom.
However, as
you can see from the chart all of that changed Wednesday afternoon on the Fed
statement. The stock market reversed the early-morning weakness, closing
strongly. Gold reversed dramatically, closing up over $40, and the dollar
collapsed back down through 80 negating what would have almost certainly been
a powerful rally out of that cycle bottom. One could either ignore what had
just happened, thus exacerbating losing trades, or they could recognize that
something fundamentally changed that afternoon and quickly get on the right
side of the market.
That is
exactly what we did. When the dollar reversed and gold started to rally we immediately bit the bullet on our long UUP trade, took
a small loss, and reentered GDX. None of our tools (cycles, sentiment, or technicals) were predicting this. However, that still
doesn't give us an excuse to ignore what had happened and quickly make the
correct adjustment.
Bernanke
didn't actually confirm QE3 Wednesday afternoon, but the market obviously
perceived the Fed statement as a guarantee that QE3 is in the works. That has
the potential to break the dollar's rally out of its three year cycle low and
derail the expected move by stocks down into a four year cycle low later this
year.
If Bernanke
can break the dollar rally and get the dollar moving south again there is no
way we are going to experience a deflationary bear market this year. In this
scenario 2012 would be the beginning of an inflationary period, culminating
in a dollar crisis at the next three year cycle low, due in late 2014. If
this is what is about to unfold then we need to alter our expectations from a
deflationary bear market to an inflationary bull market.
The four year
cycle low for stocks, instead of occurring in late 2012 would probably get
stretched out to late 2014. And the recession we should experience this year
will be pushed out to 2013/2014 once inflation raises high enough to poison
the economy.
The big
question now is; did Bernanke break the dollar rally? Confirmation will come
once the dollar finds its daily cycle low, and if the rally out of that low
fails to move to new highs and rolls over quickly forming a new pattern of
lower lows and lower highs.
If this
scenario plays out then we can jettison the deflationary bear market
hypothesis and begin positioning for the inflationary scenario which should
culminate with a dollar crisis in late 2014. This scenario also has the
potential to drive the bubble phase of the gold bull market.
A lot is
riding on the dollar right now.
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