Why Trend Following is Your Only Hope for Investment Survival

Buy and hold. Stocks for the long run. Diversify. These investment mantras were gospel during the great bull market of the 80s and 90s.

Drinking this Kool-Aid will get you slaughtered today.

There is no freaking way I would "buy and hold" anything right now. Too dangerous. Buy and hold hasn't worked over the past ten years, and it's unlikely to work for the next ten. We're in a secular bear market, and these things take time...usually 15 to 20 years...to run their course.

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View the full INDEX:.SPX-E chart at Wikinvest

Buying and holding the S&P was a crappy trade over the last 10 years.

No doubt, we are in uncharted financial waters right now. Anyone who says they 100% know what's going to happen next is lying, or dilusional.

We've got historic deleveraging taking place, as unprecedented debt levels are slowly paid down. In the meantime, we've got the US government, among others, running the printing presses at full steam, and tossing boatloads of money down rat holes like Government Motors and socialized medicine.

The foundation of the system has been permanently rocked, and stability, or even just the illusion of it, won't be back anytime soon.

With the Fed's printing press (an irresitable force of hyperinflation) battling massive deleveraging (an immovable deflationary object), the crux of any investment thesis today starts with "inflation, or deflation?"

There's no shortage of arguments on both sides, many made by folks much smarter than I. For awhile, I was reading them until my head spun...first I'd read a very well thought out argument on why hyperinflation will win out...then I'd read a perfect counterargument for the deflation case.

So I thought - what the heck can a guy like me do, if these smart dudes can't reach the same conclusion themselves?

Then it hit me - trend following.

If gold and commodities go up - get in those vehicles, because the market is screaming "inflation"! Gold at $1100 could go much, much higher...real, real fast.

On the other hand, gold still has not decisively broken through $1000. It could very well retest it's lows below $700. So if it breaks down below, say, $900 - that's the market telling us that inflation is not in the cards...at least not yet.

Early this week, gold stocks hit a 3-week low...so I sold all of them. And I'll stay out until they once again "break out" to the upside. That's the only way I can see to play these insane markets - buy the breakouts, and follow your stops. It's OK to have a hypothesis, but don't wed yourself to it. If the market says you're wrong...then you probably are!

My friend Brian Hunt (editor-in-chief of The Daily Crux, an excellent investment website) made a great point to me on Friday about investing in China. Nobody knows what's going to happen in China. Some think it's a trainwreck waiting to happen. Others think China will be just fine, still the growth story of the 21st century.

So what's an investor to do? Watch the price of copper, he says. As long as copper's doing fine, that means China's doing fine. Let Dr. Copper show you the way.

To facilitate my trend following strategy, I've pared my investment assets down significantly. I used to own 40-50+ different stocks, a few currencies, a few commodities...if something looked good in one of my many newsletters, I bought it!

Then I learned during the Great Deleveraging of '08 that diversification does not prevent bad things from happening. Overnight, the correlation of almost all assets went to 1, and everything dropped 40% in a matter of 6 months!

Because I believe the inflation/deflation question is the only important one, I only need a few asset classes to play it. That makes trend following much, much easier for an armchair investor like myself - get into positions and back out quickly - no problem.

Remember the market is the judge and jury combined, the final arbiter of your investment decisions. So let's listen to what it's telling us in the turbulent years ahead...after all, the trend is our friend! And this friend may be our only lifeline to investment survival right now.

In Case You Missed It...This Week's 5 Most Popular Posts...

1. How Herbert Hoover Put the "Great" in Great Depression
2. Richard Russell: We're Nearing Gold's Mania Stage
3. Marc Faber on American Economic Policy
4. Jim Rogers' favorite country (surprise: not China!)
5. Chinese students laugh Tim Geithner out of town

Positions Update

Last week in this spot, I mused:

"Nice week but I have to admit – I’m starting to get quite cautious that some of these trends have played out"

It looks like the caution I expressed last week was warranted...commodities got hit hard across the board this week.

I exited all positions on Monday morning, after seeing the rough start to the week - that was enough to chase me out of all positions. On Thursday, I did reinitiate an Australian dollar position, after reading how the Reserve Bank of Australia was working very hard to keep their currency down in the month of May.

Current Account Value: $31,483.93

Cashed out: $20,000.00

Total value: $51,483.93

Weekly return: -6.8%

2009 YTD return: -38.0%

Prior year's results:

2008: -8%

2007: 175%

2006: 60%

2005: 805%

Initial stake: $2,000.00

Stocks Down Today...So What Commodities Did Well?

Regular readers know that we've been anxiously awaiting the decoupling of commodities and currencies from stocks.  These asset classes are historically uncorrelated.  That changed late last year when the financial world ended, and everything went down the crapper at about the same speed.

Except, of course, the US dollar and bonds...but I digress...

Today stocks were down...the DOW dropped about 100.  These are the days I love to watch...so we can pick out the notable performers.  

Good performances from today...

• Gold...up $13.80 to close at $951
• Silver...up $0.16 to close at $14.44
• Coffee...up 2.50 to close at 135.80
• Sugar...up 0.24 to close at 15.62 (this is why you never take profits, like I recently did, to wait for a pullback...it may never pullback, and you lose your position)
• Soybeans...up 6 to close at 1175

The dollar got hit today...long dated US Treasuries got slammed BIG...makes you wonder if we're starting to see a return to fundamentals.

Gold and silver look like they could be gearing up for some big moves.  Sell in May and go away?  Maybe not quite yet.

Also, it's nice to see sugar up on a day when oil was down.  It was dumb of me to give up that position...

Can Commodities Decouple From Stocks? This Week in Commodities

The biggest investing mistake I ever made was not getting out of commodities during the Great Deleveraging of '08/'09.  

I had a pretty good beat on the major trends - stocks were highly vulnerable, the US could be in for some very bad things, etc - but I failed to project the effect that a complete financial collapse would have on commodities.  I followed my stops but kept trying to re-enter the market too early.  Being on the wrong side of a trade, well, sucks.

In 2004, I read Hot Commodities by Jim Rogers, and my investing outlook and thesis completely changed.  I realized that commodities, not stocks, were the place to be for the next 15-20 years.  That spawned my foray into trading, and eventually this blog as well.

The fundamental factors of the commodity bull market are still intact, I believe.  No market goes straight up...commodity markets are certainly no exception...and now we've got a very attractive entry point for many commodities.  Prices have come down considerably, and as a result of this financial mess, supply has come offline a great deal, laying the ground work for a doozy of a boom, if/when the global economy picks up again.

Now here's the risk I see - during the Great Deleveraging, correlation of all assets basically went to one (exceptions were the US dollar and Treasuries).  So any well laid out diversification plans were all in vain.  In fact, I think we're starting to see that diversification is a load of crap, a product of the 1980's/1990's bull market in equities.  Probably something we could discuss at length in a separate piece.

Van Tharp, an excellent trading coach and author, is fond of saying that you do not trade markets - you trade your beliefs in the markets.  Every decision you make is filtered through your belief system.

So while I believe in the commodity bull market in the medium to long term - I also believe this is a bear market rally we're currently experiencing.  I believe stocks are still overvalued, and that we haven'tyet  seen the final lows on the S&P and the DOW.  I believe the DOW/Gold ratio will eventually settle close to 1, before a new bull market in stocks begins.

Now these are my beliefs.  You have your own beliefs about the market, and if they're not aligned with mine, then my trades and thinking won't make any sense to you.  (Actually if I am making sense to you, that's when we should all be worried!)

OK so here's my dilemma - stocks are going lower I think - maybe sooner, maybe later.  The last time stocks went lower, commodities got slammed.  Therefore I have reason to be nervous that the next leg down in stocks could wallop commodities as well in the process.

To test this hypothesis, I'd like to pull up some charts, and see how some of our favorite investment ideas have been performing relative to the S&P 500 - and figure out which ones, if any, have managed to decouple from stocks.  (All charts courtesy of Barchart.com)

Observations:

• I had expected a tighter price correlation between oil and the S&P
• The Aussie dollar looks like trouble!  It could be quite vulnerable to a downturn in stocks.
• OJ looks like it may have decoupled from the S&P

CONCLUSION: I think it's safe to get back in the water on some select commodities - but be careful!  I still believe agriculture is our best bet, and right now I like OJ's chances the best...especially given it's performance on crappy days for the S&P.

In Case You Missed It...This Week's 5 Most Popular Posts...

1. The Dumbest Inflation Explanation I've Ever Heard - thanks to our friends at The Daily Crux for picking this one up
2. A Bear Market Rally on Roids?  This Week in Commodities
3. Richard Russell Blasts Government Sachs
4. Jim Rogers: The US is About to Have a Currency Crisis
5. Is Oil Going to $30 or $300?

Positions Update - Feels Like Old Times!

I got out of both sugar contracts on Friday...booking a nice profit on one, and a very slight loss on the second.

My pyramid was beginning to invert - not a desirable thing - so I pared back the second sugar contract after it went negative.  Then after thinking about it, I pulled up the long term sugar chart and thought that the market, while definitely trending up, may have gotten a bit ahead of itself.

So, we'll book some profits there, and look for an attractive entry point.  

I have to admit - I much prefer having a long sugar position than not.  Having no sugar position is like my wife being out of town - a little bit of an empty feeling, like I'm incomplete.  Sugar, you complete me - let's get this price pull back out of the way quickly, so we can reunite.

By the way, I think I pretty much guaranteed myself a crappy week after my self congratulatory post last Sunday.  I was starting to feel pretty smart...which is always dangerous...in fact, here were my exact words:

What a week! And the recent weekly winning streak rolls on...in a big way...

Now that I've got my confidence back a little bit, I'm probably quite dangerous to myself at the moment!

Anytime you read crap like that from me in the future, you may want to just short everything I own - a guaranteed winning trade.

Current Account Value: $28,539.11

Cashed out: $20,000.00
Total value: $48,539.11
Weekly return: -8.3%
2009 YTD return: -43.8% (Don't call it a comeback!? :( )

Prior year's results:
2008: -8%
2007: 175%
2006: 60%
2005: 805%

Initial stake: $2,000.00

A Bear Market Rally on 'Roids? This Week in Commodities

How Bout a Little Shot of Inflation With Your Bear Market Rally?

Well we've finally got the bear market rally many of us have been waiting for, kicking into high gear.  I know I don't have to remind you, dear reader, that most of the largest stock market rallies in history occurred during nasty bear markets.  

To illustrate this point, check out this graph of the stock market crash during the Great Depression - and if you've been drinking Bernanke's "green shoots" Kool Aid, you may want to even print it out and tape this to your desk to help detox your system.  No market ever goes straight up or straight down, so this rally was to be expected, perhaps even overdue.

So where are we at now?  Since a low of 666 on the S&P earlier this year, we closed Friday's trading at 929 - a gain of 40% in roughly two months!

Here's the interesting thing - market indicators are now screaming "overbought" - and have been for the past couple of weeks - yet the market's ascent continues, without a pullback...at least yet.  My favorite short-term trader, Jeff Clark, was at least a little early on his call for a market downturn.  So what gives?

One theory I've been noodling on for the past couple of weeks is that inflation may be starting to creep into the system already.  And the first place that will be reflected will be in asset prices - particularly in commodity prices.  Which we're starting to see already.  

On Friday I spoke with our friends at Stansberry Research, and they seem to share similar sentiments.  So the next few weeks will be very interesting to say the least.  

How should you play this?  Yesterday I sold about half of my stocks - I had held them throughout the entire crash, and decided not to look at the portfolio until we got a bear market rally - which we have now.  You may want to do the same.  Don't be too greedy - if you were offered these prices two months ago, would you have hit the "sell" button?

I'm trying to focus all of my investments around a few key themes, such as agricultural commodities, that I can monitor.  I've realized that it only takes 1 good idea to make money investing - so why have a portfolio of 30-40+ different investments that you need to keep track of?  

Big Picture Scenarios

So if we take a step back and look at the big picture - I think we're seeing these two theories as the dominant ones:

1. Green shoots - Things are getting less bad.  We'll have a long, slow recovery.  In the end, things will be OK.  Good time to buy stocks, they are still undervalued.  This seems to be the theory supported by the mainstream financial press and Bernanke.  So that's enough for us to throw it out.


2. Inflation soon - Governments are printing money at an alarming rate.  This will eventually result inflation once the money works its way into the system.  Most of the smart investment minds I track seem to believe this.

My only problem with #2 is that it's too obvious.  It is the universal contrarian viewpoint, and almost seems to be too widely shared.  Just like how the dollar should have gone down last year, and interest rates should have risen...and what happened in reality?  The exact opposite.

So if we try to "expect the unexpected" - what could happen now that few people are expecting?

1. Outright deflation that can't be stopped - a la Robert Prechter.  He believes the DOW will eventually reach it's low below 1000 - now THAT'S a contrarian viewpoint!  


2. Inflation right now - the horse is out of the barn, interest rates have bottomed and are on their way to the moon, commodity prices are already starting to move, and we're going to reach the "uh oh" inflation phase much sooner than expected.

Regular readers know that I'm starting to warm up to the possibility of #2, and will trade accordingly as long as the commodity charts continue to agree.  I'm keeping an open mind to all of these scenarios, and will do my best to let the markets guide my actions, rather than being wed to and stubbornly trading on a preferred theory, which is usually a quick way to financial ruin!

In Case You Missed It...Top Commodity and Economic News...

• Demand for US Treasuries Poor in Latest Auction
• A Long Overdue Sugar High
• Marc Faber: We've Begun a 15-20 Year Bear Market in Bonds
• Australian Dollar Still Kicking Ass
• Why Paulson and/or Bernanke Could Do Jail Time

You Can't Kiss All the Girls...Other Notable Potential Trades and Performances

• Natural Gas - Strong rally off it's lows - great call by Jeff Clark!
• Treasuries - Long term interest rates have broken out...are they on a one way track to the moon?
• Cotton - Continues it's steady climb, supported by strong fundamentals.

Positions Update - Feels Like Old Times!

What a week!  And the recent weekly winning streak rolls on...in a big way...

Now that I've got my confidence back a little bit, I'm probably quite dangerous to myself at the moment!

It must have been something in the air, or the tequila, on Cinco de Mayo, as I decided to grow some onions and do a little pyramid action.  Sugar continued to look strong, and I figured if it's heading higher, I'd rather have two contracts than one.

The big trade came later that night - after much deliberation and a couple of beers, I decided that I owed it to myself to buy the breakout in the Australian dollar.  I have to admit, I didn't sleep well that night after making the trade - I was concerned that we'd see a pullback in the Aussie driven by a pullback in the equity markets.  And being fairly overleveraged at this point, a loss on this trade was not really something I could handle.

By the way - I don't condone this use of leverage.  If I had practiced proper risk management, maybe I wouldn't have pissed my account down from it's heights last spring.  Do as I say, not as I do.  Of course you're reading this blog for entertainment purposes only...and these trades are all hypothetical...so I'm glad we have a mutual understanding.

Anyway back to the story - the Aussie did drop about half a cent, then rallied STRONG to end the week!  So it's a happy ending for now.

What could possibly go wrong from here?  For what it's worth, sugar was down on Friday, with most of the markets up.  Hopefully just a technical correction.  The real risk to each position below is a correction downward in the equity markets.  This is certainly overdue...so we'll watch and see.  It's also possible, as discussed, that we're getting a little swig of inflation right now, and this "bear market rally" could have more legs than many have anticipated.

Open positions

Date	Position	Qty	Month/Yr	Contract	Strike	Call/Put	Entry	Last	Profit/Loss	Mkt
05/05/09	Long	1	JUN 09	Australian Dlr			0.7385	0.7666	$2,810.00
04/08/09	Long	1	JUL 09	Orange Juice			81.95	90.70	$1,312.50
04/20/09	Long	1	JUL 09	Sugar #11			13.38	15.30	$2,150.40
05/05/09	Long	1	JUL 09	Sugar #11			15.16	15.30	$156.80
Net Profit/Loss On Open Positions									$6,429.70

Current Account Value: $31,135.73

Cashed out: $20,000.00
Total value: $51,135.73
Weekly return: 15.7% (!)
2009 YTD return: -38.7% (Don't call it a comeback!?)

Prior year's results:
2008: -8%
2007: 175%
2006: 60%
2005: 805%

Initial stake: $2,000.00

A Long Overdue Sugar High

This morning, I authored a guest piece for the folks at Commodity News Center, breaking down the recent sugar rally.  Regular readers will be quite familiar with the fundamental factors discussed.  I always try to constantly re-examine my assumptions to make sure I'm not falling in love with a trade - if you've got a sugar position, or are thinking about initiating one, you may want to review the article - and let me know what you think!  I always appreciate and learn from outside perspective.

A Long Overdue Sugar High

Sugar futures are soaring – to their highest levels since 2006 - buoyed by strong supply/demand fundamentals, along with freshly printed US dollars. How long can this rally continue? Let’s review the driving factors. 

Contents:

• Supply/Demand Fundamentals
• Money Printing
• What Could Go Wrong
• Outlook for Sugar

Read this piece at Commodity News Center...

Soft Commodities are Starting to Scream: "Inflation!"

Milton Friedman said that inflation is "always and everywhere a monetary phenomenon."  Judging by the recent price action in many of the soft and agricultural commodities, they appear to agree.

Ben Bernanke, a student of the Great Depression, is making a bet the Friedman was wrong.  Bernanke believes that because Friedman did much of his work during a period of time when the velocity of money was relatively constant, he did not properly account for this factor in determining inflation.

Helicopter Ben is conducting this "Great Experiment" of money printing to stave off a Depression based on the monetary theory developed by economist Irving Fisher, who believed the Depression occurred because money velocity dropped off a cliff, and there was no increase in money supply to counter this.  Thus the US slipped into a deflationary spiral.

This is the big question - when the velocity of money drops, as it is today, should the money supply be increased?  Who's right - Fisher or Friedman?

We don't yet know - though, as always, the market will decide the winners and losers.  And lately it's hard not to notice what the commodity markets have been telling us, especially agriculture.

First, let's see Exhibit A - the adjusted monetary base of the US, which still appears to be in a "bull market":

Many of us saw the initial spike and immediately yelled "Inflation!"  We loaded up and gold and ran for the hills.  And what happened?  The spike in monetary growth continued to grow to the sky, and gold got slammed - along with almost every other asset class.  (Save the US Dollar and US Treasuries - hats off if you had that trade, as you are a true "contrarian's contrarian"!)

Fast forward to a few weeks ago, and we noticed that not only had commodities appeared to have formed a bottom, but they were starting to climb.

This week, we saw a full fledged break out in the softs and the grains - let's quickly have a look at three of our current favorites.

Sugar futures - our old favorite - rallied over 5% this week, to close a shade under 15-cents.  Sugar's been on a steady climb - fundamentals look quite appealing, as we discussed last week, and there's no arguing with this chart:

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View the full YO/K9-NM chart at Wikinvest

Cotton futures continued their strong rally, breaking right past the low 50's resistance we were keeping an eye on:

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Finally take a look at Soybeans!  This rally was kicked off when soybean acreage came in below expectations, and it's been off to the races ever since:

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View the full S/K9-CB chart at Wikinvest

So which will it be, inflation or deflation?  Don't get too hung up in economic theory - remember that the markets are always right.  And right now, these markets, buoyed as well by strong fundamentals, appear to be casting an emphatic vote for inflation!

 

Top Commodity and Economic News...

• Why gold is going much higher than $2,000
• Jim Rogers interviewed by GoldSeek Radio
• The US is now "swimming" in Natural Gas
• Atlas Shrugged sales are soaring!

Current Futures Positions

Nothing new...unfortunately!  I thought about adding to the sugar position on Thursday - and I should have!  Will seriously look at adding another contract tomorrow or Tuesday on continued strength.

Date Position Qty Month/Yr Contract Entry Last Profit

04/08/09  Long  1 JUL 09 Orange Juice 81.95 85.10 $472.50

04/20/09  Long  1 JUL 09  Sugar #11     13.79  14.91$1,713.60

Net Profit/Loss On Open Positions $2,186.10

Current Account Value: $26,920.49

Cashed out: $20,000.00
Total value: $46,920.49
Weekly return: 3.5%
2009 YTD return: -47.0% (Don't call it a comeback!)

Prior year's results:
2008: -8%
2007: 175%
2006: 60%
2005: 805%

Initial stake: $2,000.00

Editor's Note: This article was also published by SeekingAlpha.com.

Daily Show Spoof Investigates Socialism

The Daily Show sent correspondent Wyatt Cenac to Sweeden to "invesigate" the effects of socialsm in person.  Hilarious bit - perfect for a Friday. 

The Daily Show With Jon Stewart	M - Th 11p / 10c
The Stockholm Syndrome
thedailyshow.com
Daily Show Full Episodes Economic Crisis First 100 Days

The Daily Show With Jon Stewart	M - Th 11p / 10c
The Stockholm Syndrome Pt. 2
thedailyshow.com
Daily Show Full Episodes Economic Crisis First 100 Days

Related articles about socialism:

• Ayn Rand, Atlas Shrugged Book Sales Skyrocket
• A Socialist Plea From My Local Utility Company
• Greater Depression Investment Trends - And How To Play Them

Sugar Futures Rally, OJ Takes a Breather - This Week In Commodities

Sugar Futures Surge to a 6-Month High

Sugar futures rallied nearly 4% on Friday, over half a cent, to close the week at 14.18.  Looks like we've got a new breakout to the upside!

Sugar futures continue their steady climb.  (Source: Barchart.com)

The market continued to focus on the news that India may turn into a net importer of sugar this year.  Indian production is falling to a 4-year low, which, surprise surprise, is spurring prices up.  Don't worry though, Indian politicians are on the scene, with rhetoric and threats of banning futures trading to "halt" this price rise - ha!  

Also bullish for sugar is continued strength in oil prices, which means Brazil will use more of its sugar for fuel.  Last report I recall reading had Brazilian ethanol profitable at roughly $50 oil, so that's the number I keep an eye on.

Finally demand for sugar is still projected to outpace supply this year, so we've got some strong underpinnings for a sustained rise in sugar in the months to come.  

OJ Takes a Breather

Orange juice futures took a bit of a breather this week.  Appears to be just a technical correction and profit taking, as I was not able to find any fundamental news to challenge our initial hypothesis for going long OJ.

Orange juice cooled off this week.

Other Commodity and Economic News

• Oil supply is coming offline at a breathtaking clip
• Natural gas is nearing its cost of production
• How bad will the financial crisis get?

Current Futures Positions

Rolled the May contract over to July earlier in the week.  Other than that, not much new. 

Thinking about adding to OJ, sugar positions on further strength.

Date Position Qty Month/Yr Contract Entry Last Profit

04/08/09  Long  1 JUL 09 Orange Juice 81.95 85.00 $457.50

02/27/09  Long  1 JUL 09  Sugar #11     13.79  14.12 ($672.00)

Net Profit/Loss On Open Positions $1,286.30

Current Account Value: $26,020.69

Cashed out: $20,000.00
Total value: $46,020.69
Weekly return: 0.1%
2009 YTD return: -48.8% (Don't call it a comeback!)

Prior year's results:
2008: -8%
2007: 175%
2006: 60%
2005: 805%

Initial stake: $2,000.00