Urgent: Day of the Turtles

Last week after a rather slow start to 2014 in the financial markets, we saw some interesting price action in two of the most talked about markets.  We had decisive 20 day price breaks in US equities and gold.  In the 1980s Richard Dennis, a commodities speculator once known as “Prince of the Pit”, gave a new meaning to the word “turtles”.

 

The Turtles were a small group of novice traders that Dennis trained in a short period of time to follow a basic trend following system. When the experiment ended five years later, his Turtles had reportedly earned an aggregated profit of $175 million.

 

The trading rules were simple. They were based on price breaks from the last 20 and 55 day ranges that established a potential new trend. Rigid stops were placed if “the trend to be your  friend” didn’t develop. Arguably the longer-term trend mentality is less productive in today’s high-frequency trading but our systematic analysis at Hinde always red-flags 20 day breaks. A price break of the recent range is a fairly arbitrary and basic premise for trading but it does take on rather more significance if it comes after a prolonged advance or decline when it gives you a warning that the trend may no longer be your friend.

Enter the most loved asset class of 2013 and recent years, US equities.  The rolling returns speak for themselves.

There has been a tremendous amount of back slapping and blowing of trumpets, rightly so. However the valuations are a growing concern.

While John Hussman of Hussman funds provides us with phenomenal historical analysis, the ever recurring theme, “ the market can remain irrational longer than you can remain solvent” (or at least your reputation) haunts us.  It has not paid to be early, QE has potentially changed the game, for we certainly have irrationality today.

 

Twitter at 64X price/sales and Amazon at 150X forward P/E.  Can you say Tulip-mania anyone? Of course the most hated asset class of 2013 and recent years is gold and the mining stocks. The rolling returns are appalling.

 

At year end the bearish sentiment was near 100%, (of course by all those who called the downtrade).  At least two top investment houses predicted it was a slam dunk to reach $900-1000 /oz with the infallible logic that as the US economy is in full recovery mode stocks will go higher and gold will go lower.  Let’s just think about how many ways that logic could be wrong briefly.

 

  1. Gold went up by 75% from $400/ oz to $700 from 2004 to 2007 when the Dow rallied from 10000 to 14000 on the “ economy going great guns”. Of course we now know that was built on quicksand.
  2. Is it possible that stocks have already advanced too far based on the miraculous recovery post crisis, doing what they usually do, anticipating the future?
  3. Is the US economy actually having the great recovery with amazing employment gains that the government would like us to believe.

A look at the chart below should be a concern.

 
Source: Variant Perception
 

We have spoken many times about the precious metals’ mining shares over the last few years and the problems they face, namely hugely rising extraction costs with a declining gold price leading to severe profit margin challenges (negative in many cases). Many mining stocks are down 90% from the highs of August 2011.   They are bombed out by any measure. Many will still go out of business as free cash flow remains elusive at current gold prices but the ones that can survive have the best leverage to the gold price in history. Focusing on the one year-cash-in-the-bank and a high-grade deposit-base might throw up some amazing gems.  The maths tells us that after an 80% decline, a 100% advance still leaves us 60% worst off but, as they say, timing is everything.  With the GDX mining index closing 2013 at 21.13, I expect this to be one of the best performers for 2014.

 

There are various possibilities from all the evidence currently available of course. The future is far from certain.  But it’s time to pay attention because the most overvalued, best loved and best performing asset class has had a 20 day price break DOWN and the cheapest, most hated and worst performing asset class has had a 20 day price break UP.

 

If we need a ‘Balkans-moment’ catalyst, we look no further than a chart of the Argentine peso which fell 15% last week to 8 pesos/dollar official rate (13 on the streets of Buenos Aires apparently). Other emerging markets have also been affected.  It has at least one hallmark of significance. At least two politicians/central bankers have commented that it’s an isolated case and contagion is unlikely (heard that one before). A small country far away…

 

Most people reading this article will currently have a high exposure to equities and a high corporate/government bond ratio in their portfolio with no precious metal exposure at all. In fact many of the largest UK wealth managers appear to have 85% equity correlation in their client portfolios and unaware of the draw down they face, possibly the biggest of all time. My friend and ex-colleague David Zervos of Jeffries talks of spoos for winners and gold is for haters. He had a great call last year but the trade is over.  Gold closed at 1202 at year end with S&Ps at 1841.

 

Book the money and rebalance your portfolio now because now is all the time there may be.

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