This Week’s Commentary – September 22, 2007 – Baseball and the Market

So last night I decided to do something I haven’t done for the past few months: I watched T.V. I clicked over to the Toronto Blue Jays – New York Yankees game; I joined the game when the Blue Jays were up 2 – 0. Alex Rios hit a two run home run to give the Jays a 4 run lead, which is where it was at the start of the bottom of the ninth. Roy Hallady, the Blue Jay’s ace and former Cy Young winner, was pitching a shutout, and he had only thrown 90 pitches. The Jays chances were looking good.

Doc had his good stuff, but some miscues behind him in the infield caused the manager to pull him (a stupid move if you ask me) and next thing you know the game is tied.

I then went to bed. This morning I learned that the Jays came back to win it in the 14th inning.

So what does this prove: it ain’t over till it’s over.

Alas, that’s where I think we are in the market at the moment.

2006 was a great year; we were all pitching a shut-out going into the bottom of the ninth, and we assumed we would win the game. Then the wheels fell off in 2007, and now I’m down for the year. The low point was on August 16.

Since then the market has recovered somewhat. Is the damage over? Is it the 14th inning yet?

I don’t think so. I still stubbornly believe that we have to retest the lows before we can rise again. Let me cite some examples. First, PNP.TO – Pinetree Capital Corp:

Everyone was thrilled when Pinetree bounced from $4 to $7, but as I read the chart, we are still in an obvious down trend. Until Pinetree breaks above the 50 day moving average (which it hasn’t done decisively since May) and breaks the down trend line I would not be a buyer.

Also, effective on Monday, Pinetree will be removed from the S&P/TSX Index (you can read the press release here). This is very bad news, because all of the index funds that try to match the index will be selling Pinetree, if they have not done so already. I don’t like it, and I don’t own it, and won’t until it starts to turn upward.

(Mr. Dines issued his newsletter yesterday. Unfortunately, it appears he is having some problems with his new e-mail system; I haven’t received it yet, so I have no idea if he is still positive on Pinetree; I guess we will let the market decide on Monday, although looking at the chart, it looks like the market has already made it’s decision).

Here’s another example: DML.TO – Denison Mines Corp.:

Denison’s chart looks slightly better than Pinetree’s; at least it’s now over it’s 50 DMA. However, it’s also still in a down trend, and the Money Flow Index is getting toppy, so I’m not buying at these levels.

What About Gold?

The same, I’m afraid. It looks very toppy at these levels.

Gold has obviously made a new high, which is normally cause for rejoicing, and buying. But sometimes a four run lead with your best pitcher on the mound in the bottom of the ninth is not enough. Sometimes you go back to even before you finally win it in the 14th. That’s what I expect to happen with gold.

The Relative Strength Index is just under 80, a level not seen since the previous top in May, 2006, and we all know what happened from there. I continue to operate under the assumption that the gold market is being manipulated. It was driven up in anticipation of the Fed rate cut,and now that everyone is watching gold again, the cartel, or central bankers, or whomever, will drive it back down to around the $700 level so they can all say “see, gold is irrelevant in today’s modern world.” That’s when we buy, and watch gold run quickly to over $800.

The Gold Bugs Index shows a similar pattern:

For those who are not aware of it, the AMEX Gold BUGS (Basket of Unhedged Gold Stocks) Index represents a portfolio of 14 major gold mining companies.The Index is designed to give investors significant exposure to near term movements in gold prices – by including companies that do not hedge their gold production beyond 1 1/2 years. The HUI is a great picture of the true expectations for the price of gold, since forward hedging is factored out of the equation. However, the RSI and MACD still look toppy, so I still believe waiting for the pause is the correct strategy.

To be clear, I believe gold will be the investment story of the next six months, but I still believe that the time to buy will be October or November, not today. I just don’t believe a flagpole formation from these levels will continue.

Covered Writing

Last week I described my covered writing strategy as a way to kill some time and make a few bucks while waiting for the bull market in gold and uranium to decisively resume.

On September 6 I bought 1,000 shares of AAPL – Apple Inc. I paid $135.16 per share, so with commissions of $9.99 my total cost was $135,169.99. On September 10, 2007 I then sold 10 contracts of the Apple September 140 call at $2.55; commissions were $22.49, so I received net proceeds of $2,527.47

Apple closed on Friday above $140 (at $144.15, actually). The options are “in the money”, so my shares were called, and I get $140 for them, and I get to keep the $2,527.47 I took in. In other words, my shares are called for $140, so my profit on the stock is $140.00 – $135.16, or $4.84, plus $2.55 on the option, for a total of $7.39, or 5.5% (ignoring commissions). Earning 5.5% over a two week period sounds good to me.

The actual numbers, after commissions and interest, were a profit of $7,079.26, or 5.2%, which is still not bad for two weeks work.

Was this a good trade? Well, it wasn’t as good as it sounds, because I trade in Canadian dollars, so by the time I convert my U.S. profit into Canadian dollars, my profit will be a lot less, since the U.S. dollar depreciated considerably over the last two weeks.

And yes, for those of you who are paying attention, I would have been better off to buy the Apple stock at $135.16 and sell it on Friday for $144.15, for a pre-commission profit of 6.6%. However, the covered writing strategy limited my profit, but also reduced my risk, so again, I’m satisfied.

I also did one other covered write on GOOG – Google Inc. On September 13 I bought 500 shares of Google for $525.67 (Unlike the Apple trade above that I did in my US trading account, this trade was done in my Canadian account, so the numbers I am quoting here have been converted to Canadian dollars; the conversion rate was 4.39%, since the Canadian dollar trades at about the same level as the U.S. dollar, so in U.S. dollars the numbers are basically the same). I then sold 5 contracts of the Google September 530 call for $4.80

On Thursday, since Google was already trading well over the $530 strike price, I re-purchased the options and sold the stock. On paper I made a nice profit, but in practice I lost about $7,000 on the conversion from U.S. to Canadian dollars.

In other words, my technical analysis of Google and Apple was perfect, but I did not take into consideration the crashing of the U.S. dollar, so I lost money.

As well, as one of my colleagues pointed out, “some investors may not be comfortable with $135K of Apple stock and $260K of Google stock from a diversification standpoint – general guidelines refer to no more than 10% of portfolio in any one stock.”

So, even though I was perfect on the stock picking, I screwed up the currency component, and I was under-diversified.

All in all, a not-too expensive lesson. Perhaps I’ll do a bit more thinking before I attempt this again.

Finally, since there was some discussion on the Forum about where we are all from, I posted an analysis of where we are all from. Food for thought, I hope.

I’m expecting a down week, although lately I’ve been wrong more than I’ve been right, so I guess time will tell. Let’s see what happens this week. I assume volatility will return, so let’s keep our seatbelts fastened.

I don’t think it’s the 14th inning, yet.

Thanks for reading, and as always please feel free to post your comments on the Buy High Sell Higher Forum. I’ll let you know next week how it all worked out.