Where are you ? - In The Investor Psychology Cycle.

Are we in denial, despair - or just widespread panic?

As the pendulum swings between greed and fear, investors typically behave in 1 of 2 ways: They either become over-enthusiastic during bull markets and over-despondent as the bear’s growl grows louder.

It stands to reason that in order to be a successful investor, it's important to distance yourself from the herd mentality and to take objective decisions based on fundamental reasons.

The typical behaviour of investors is linked to the so-called investor psychology cycle (courtesy RMB Unit Trusts), as illustrated above.

Before seeking to apply the cycle to the present stock market situation, let’s consider a short definition of each of the stages.

Contempt: According to the cycle, a bull market typically starts when a market is at a low and investors scorn stocks.

Doubt and suspicion: They try to decide whether what they have left should be invested in a safe haven, such as a money market fund. They've burnt their fingers on stocks, and vow never to invest again.

Caution: The market then gradually starts showing signs of recovery. Most remain cautious, but prudent investors are already drooling at the possibility of profit.

Confidence: As stock prices rise, investors’ feeling of mistrust changes to confidence and ultimately to enthusiasm. Most investors start buying stocks at this stage.

Enthusiasm: During the enthusiasm stage, prudent investors are already starting to take profits and get out of the stock market, because they realize that the bull market is coming to an end.

Greed and conviction: Investors’ enthusiasm is followed by greed - often accompanied by numerous IPOs on the stock market.

Indifference: Investors look beyond unsustainably high price-earnings ratios.

Dismissal: As the market declines, investors show a lack or interest that quickly turns to dismissal.

Denial: They then reach the denial stage, where they regularly affirm their belief that the market definitely cannot fall any further.

Fear, panic and contempt: Concern starts to take hold; fear, panic and despair soon follow. Investors again start scorning the market. Once again, they vow never to invest in stocks again.

In order to determine where in the stock market cycle we find ourselves, the challenge is to identify the prevalent stage of the psychological cycle.

I would, for starters, argue that we are on the right-hand side of the curve - but how far down we find ourselves on that slippery slope is less clear. It would seem that we're possibly in the region of the denial/ fear/ panic phases.

Although enduring investor panic and fear haven't really set in, the January, March and July sell-offs did witness climatic -- albeit short-lived -- bouts of despair.

Time will tell whether we're dealing with a typical investor psychology cycle, and how it will play itself out. It does, however, seem that we are at not at the “contempt” stage yet, i.e. when investors scorn shares en masse and a bull market typically starts.

I do believe we are still in a primary bear market where stock markets are, at best, faced with a prolonged convalescence period characterized by sub-optimal returns. Whether significant further declines take place from these levels -- and whether valuations will overshoot to bargain levels, triggering bouts of panic and fear -- is anybody’s guess.

However, in the short term, I give the nascent stock market rallies the benefit of the doubt, provided the mid-July lows are sustained. For any rally to become more enduring, further base building will be necessary -- possibly wearing investors out to the point of contempt -- and an eventual shift in central bank policy to targeting GDP growth rather than inflation.

Gold Is The Only Hard Currency Left For Investors.

Gold’s action has been particularly interesting this week, and I believe it's very bullish as well.


For example, as the euro sank to a new low on the back of weak Ifo Institue data early Tuesday morning and the dollar index squirted up to a new high for the year, gold sank to as low as $812 in European trading.


I attribute the slide in gold that morning to selling from those who believe gold is just another way play the euro. However (much to this crowd’s surprise, I’m sure), gold never even sniffed its $775 August low, even as the euro plunged well below its own August low.


Some early morning commentary predicting gold would collapse if the euro made a new low, which was forwarded to me by a friend, gives you an idea of just how these “the euro and gold are the same” types think:


"Turning to the precious metals, we fear that far too many traders and investors are long of gold, silver et al, and find themselves in a rather awkward position. If the EUR were to trade downward through 1.4600 today, gold shall have a very, very difficult time holding above $800/oz, Indeed we are certain that if 1.4600 is 'given,' $800 will seem like a distant memory.
"

The euro indeed did punch through 1.46 to a new 6-month low early Tuesday morning. But rather than collapse “below $800,” gold began to rally and proceeded to melt up into the US open, which I’m sure was a shock to anyone who agreed with the commentary above (which no doubt put them in a “rather awkward position” if they were short).


After cutting its losses in half, the yellow metal opened down just $9 in the US and continued to melt up during the US session to as high as $836 (or up about $8), which was a $24 move from its lows during the European trading session.


Thursday, gold was breaking out of a bullish inverted H&S bottom on the charts and trying to climb back above $850 even as the dollar index remains near its high for the year.

This highlights something I have tried to explain before: Gold’s bull market isn't just a weak-dollar phenomenon. It’s a function of global inflation, just as oil and other commodities’ bull markets have been.


That’s also why many commodities and gold have been making new all-time highs in all currencies - not just in dollars.


If foreign central banks are going to be willing to sacrifice the purchasing power of their own currencies in order to prop up the dollar, that makes all the G7 confetti currencies now somewhat suspect. Is it any wonder that gold is now rallying strongly in all the G7 currencies regardless of where the “dollar index” goes?


That’s not a coincidence. Gold is a currency, and if the G7 is going to prop up the dollar, it may be the only “hard currency” that investors have left to flee to.

Inflation - Seen Around The world..Yeah, Yeah, Yeah, Yeah...!

It was one of those sessions that we haven’t seen since before the credit crisis smacked resolve around and sent the bulls heading for the hills.

Equities and crude oil were up big and maybe for the same reasons. How at one point a solid economy justified higher oil and stock prices? Yesterday we saw economic data that underscored that theory. A powerful durable goods report released yesterday morning sent equity futures sky-rocketing and the larger-than-expected draw downs on crude kept oil higher into the close. People and businesses made the kind of demand adjustments free marketers expected but those changes were probably at the margins and maybe we are at a point were any cuts will be more than subcutaneous.

With the latest GDP update in the mix yesterday one has to look at the possibility things could get better sooner rather than later. Sure, I’ve brought up this premise before, most recently Monday morning ahead of what turned out to be a devastating session that saw the Dow lose more than 200 points. Still, it's there and you have to feel it even if you don’t want to acknowledge it. (Of course it could be folly to pour one’s faith into a bullish stance unless that person is nimble enough to take profits or has the patience to hang tough… maybe for a very long time.) Of course the overwhelming amount of investors and would-be investors are looking for a situation that could borrow from the title of one of Tom Clancy’s biggest sellers, “A Clear and Present Bull Market”.

It will be easy to jump on the bandwagon down the road but it's much more difficult when there are daily gyrations that make even the most ardent fundamentalist want to chuck their spreadsheets out the window. When the Xs and Os crowd begins to feel emotions I give more credence to my gut as well.

One of the weird things about the world is how awful other stock markets are faring and the economic threats they face. Inflation is a serious threat around the world and yet, according to most market watchers, only Ben Bernanke and the US Fed have gotten it wrong.

Incidentally, there are also a couple of folks within the Federal Reserve that feel that way, too. Yet when we look at stock markets around the world and individual threats of inflation, it makes the good ole U.S.A. look like a pretty compelling place to invest. If inflation is an economy-killer then a lot of countries are in a lot more trouble then America right now. Of course that doesn’t mean that the US is out of the woods, or in fact, could move deeper into the woods before it gets better. But, wow..., the rates of inflation around the globe are something akin to nuclear meltdowns.

Inflation is grappling the world, in the European Union it's running at 4.1%, or two times as much as the central bankers say is an acceptable level. According to a recent article in the New York Times, Argentina’s inflation is running at 9.24%. Russia’s inflation rate is running at 15% and Japan’s 1.9% is an all-time high. There are different ideas on how to combat inflation so we will see how it all plays out with various Central Banks, but it's clear that interest rates are going to increase in most places, include America. According to Morgan Stanley, 50 out of 190 countries are enduring double-digit inflation.

The Light You See, At The End Of The Tunnel..Is An On-Coming Train !

IoI Bhd.
Sime Darby Bhd.

IOI still have an impending date with destiny at the RM4.40 objective right after the brief on-going technical correction towards the RM5.23/5.35 area. The bears are getting agitated by the day.. On or before 26th Aug'08, would be a good day to square out all those speculative positions.

As for the overweight SIME, the force of gravity is not something to fight against for the immediate-term. Giving up the RM8.38 support -the last bull defense, does not bode well for "((L-A-R-G-E-S-T)) Palm Oil Plantation In the World !", just when the CPO futures bears are scheduled for a pow-wao at RM2'135/MT - circa next week!

So, don't feel relief when you see the tides retreating during a Tsunami !

Oil Has Been Trading In Tandem With Stocks.

Okay, this week has been one of those lazy summer periods where thin volume and light participation leads to erratic action in the stock market, right?

As much as I’d like to write of the odd goings on in the market I think it would be a mistake. Thursday, oil and equities moved in tandem, but only after stocks climbed off the canvass. I think it was an amazing session because of the backdrop of angst and fear. Of course the book says that’s when the market typically makes big moves to the upside.

Albeit, stocks were only fractionally higher and the NASDAQ Composite actually closed lower but the rebound from the bottom was impressive. So, what now for an encore? Could oil and equities remain connected at the hip? Remember, stocks enjoyed a heck of a run even as oil began to takeoff a few years ago and only decoupled last year.

If we take the situation with Russia as the only thing that is slightly different as the week has progressed then it's going to be interesting to see how the world reacts to the country's move to halt participation with NATO. On the surface this is a strange sentence anyway. The North Atlantic Treaty Organization was created to combat the old Soviet Union but since 2002 the organization and Russia have been involved in creating a framework for consultation on current security issues. The aim is to advance a number of joint venture projects and hold regular political dialogue. Of course the latest communiqué from Putin & Co was a shot across the bow of NATO with the invasion of Georgia.

I realize this guy is drunk on a combination of absolute power and buckets of oil cash but how twisted is the mind of the Russian leader to actually attack a country ready to join NATO and then ask the west to pick sides? Of course whenever Russia gets antsy the so-called Doomsday clock begins to tick louder and edge toward midnight, that moment in time when man will wipe himself off the face of the planet. I have always been intrigued with the Doomsday Clock but it’s gotten too cute with the inclusion of climate change and bio-security as inputs. It’s only a nascent problem at the moment but we need to be afraid of a newly emboldened Russia led by an ex-KGB bigwig.

So when things get shaky on the world stage there is an asset class that normally increases in value. Gold, which has been a dog of late, came on strong on Thursday. The move in gold gives some legitimacy to the theory that Russian shenanigans were the main culprit for the spike in crude. Of course commodities are enjoying one of their biggest weeks in history and that tips the scale back to the weak dollar being the key factor.

Shak'in Em Out ! - Those Leverage Gold Guys.

If there was anything that would make me sell gold? Yea, I’d sell if I thought the secular uptrend in gold had changed or if gold stocks became vastly overpriced relative to not only where the metal was but also where it could go in the near future.

John Maynard Keynes' quote of the markets staying irrational longer than anyone can stay solvent doesn’t really apply to me. As the market recovers (and it will, just like it did last year from its July-August panic), I’ll still be here and will have been able to add to my positions at absolutely fantastic prices.

It’s probably going unnoticed by most, but even with spot gold plunging below $800 overnight, the gold shares indices (AMEX Gold Mines Index, Market Vectors Gold Miners ETF (chart above), etc) aren’t making new lows like the metal has. That’s a positive divergence. It also indicates that all of the leveraged guys have been blown out of the stocks at this point. The metal obviously still had some levered guys in it apparently, which may or may not be now finally cleaned out. Hence, gold traded the way it did last night as margin clerks effectively took over and the December futures actually traded at a momentary discount to spot due to the intense level of selling in the paper gold market. One thing is for sure though; any leverage that existed in the precious metals is going to be washed out completely as a result of this decline.

Meanwhile, the disparity between the physical market for gold and silver and the paper market in the futures continues to widen, as physical demand for gold and silver continues to explode. Many US dealers are apparently out of inventory, and pandemonium continues to break out overseas to buy the dip.

Also note, commodity cargo fees increased the most since January 30th last night in Asia. The Baltic Dry Index advanced 323 points, or 4.6 percent, to 7,420 yesterday on speculation Chinese demand for raw materials will increase after the Olympics.

Shipping rates are climbing while commodity sellers puke? How long can that last? Five trading days now remain until the Olympics end. The lack of Chinese buying over the past month in the commodity complex due to shutting down for the Olympics (to clear the air) has had a huge impact on demand for commodities, and anybody leveraged in them is now being cleaned out as a result. When China returns to the buy side, it’s going to have a huge impact on prices, especially in light of the declines that have occurred over the past 4 weeks, which incidentally also play right into the hands of the Chinese buyers. Neat, harh?

Corrections in bull markets happen. Sometimes you see them, sometimes you don’t. This one has certainly gone a lot further than I ever could have imagined, but then again, I don’t think the perfect storm of the Chinese exiting the commodity markets in mid-July plus coordinated intervention to support the dollar, plus the SEC changing the rules on short selling and the unwind that it would cause were a very predictable combination (nor the chain reaction it would trigger as guys unwound positions that were correctly aligned with the fundamentals: short financials/long inflation).

It is what it is, but as long as the Fed is forced to keep real interest rates negative in order to prop up the crippled U.S. banking system and U.S. economy then global inflation is going to continue to accelerate (especially if foreign central banks begin to ease as well), and that’s bullish for gold. As I have said repeatedly since last August, if the Fed and other central banks want to keep the financial system functioning in the wake of the housing bust, their only option is to inflate, period. That’s what they have done, and that’s what they will continue to do (no matter what they might “say” to the contrary). That’s the long-term trend to keep your eye on.

Bears Are Wrong - Just Like They Were In 2007.

Despite gold's breaching $850 yesterday, gold ETF sold zero gold, as its holdings remained unchanged at 659 tonnes. I repeat: They sold no physical gold yesterday.

We also know:

-That Indian imports were up 25% in July.
-That they’re even stronger here in August, now that the price of gold has fallen.
-That the ECB is done selling gold for its fiscal year and its member banks haven't sold gold in months.

Gold falling below $850 therefore appears to have been caused purely by selling in the US futures market - and purely futures-driven moves don't typically stick for long.

As for the miners, the XAU/Gold ratio fell 0.5% to a marginal new low at 0.165 yesterday, a ratio not seen since the 20-year bear market low in gold and gold mining shares back in 2000. The miners were priced relative to the metal as if they’d all soon be out of business: Gold was at $250 when mining was unprofitable. In other words, at today's prices, the market seems to be pricing the gold miners as if gold will collapse soon and put them all out of business. Is that rational?

Let me stress again: If the equity market is wrong about gold collapsing back to its August 2007 lows (as has been priced into the gold miners already) -- just as it was wrong about gold collapsing last August -- then the rubber band is going to snap back to the upside in an even more violent fashion than it’s gone down.

That may be hard to believe, given the collapse that the miners have had, but that was precisely what occurred last year after the August low. And I obviously continue to believe that the market is indeed overreacting, just as it did last August.

Remember, those who held on to their gold and gold stocks last year because they (correctly) believed the Fed would aggressively ease and begin inflation in reaction to the housing bus recovered from the August slide. They went on to finish the year up huge. Those who panicked and sold on the lows got left behind.

Just as they were last August, gold investors seem scared of their own shadows. This time, we’re being told that the US economy and banking system will soon recover and that the dollar will rally as a result of the US coming out of the slump before the rest of the world does (Oh, and inflation will magically go to zero all by itself). We’re told that gold’s therefore going to collapse.

This is complete crap, just as the theory that the Fed wouldn’t run the printing presses last year was carp. The only option for the Fed is to inflate. At this point, the problem’s simply too big. Inflation’s the only option, and in precisely the same stagflationary path we've been on since last August.

Just wait until China ramps back up once the Olympics are over, and global inflation reaccelerates in September. The short-term impact of nearly every industry within 100 miles of Beijing being shut down for the Olympics isn’t yet fully appreciated, but come September, it will be - violently so.

Lastly: My indicator continues to flash buy signals on nearly a daily basis for gold and gold shares. To top it off, yesterday I even received end-zone dancing hate mail from gold bears.

Are these the sort of conditions that mark a bottom (just as they did in August 2007)? Time will tell.

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The Storm Isn't Going Away Just Yet.

They say what the market knows isn’t worth knowing. Investors around the world hope that once again proves true.

The US housing market is in its worst shape since The Great Depression.

Japan is about to declare a recession.

China is technically broken in front of the Olympics.

Iran snubbed its nose at the Western deadline on its nuclear program.

Consumers are grappling with the worst inflation in 27 years.

HSBC Chairman Stephen Green described financial markets as being “the most difficult they’ve been for several decades.”

The Royal Bank of Scotland (RBS) is expected to post the biggest loss in British banking history.

The doom and gloom is palpable and it’s enough to make the most fervent bears run for cover.

If only it were that easy.

As John Maynard Keynes once said, markets can remain irrational longer than investors can stay solvent. Widespread anxiety, in and of itself, isn’t a valid reason to swim against the tide.

With the markets however—as with life..—the destination we arrive at pales in comparison with the path that we take to get there. Therein lies the opportunity—and yes, the risk—in trading that journey.

Here's the Jedi Mind Trick :

We may be seeing the manifestation of an upside agenda into the US election. The two components of that dynamic were higher equity prices (so corporate America can issue secondary offerings) and lower crude, possibly to $100/barrel.

The key to affecting that reality is collective perception and that speaks to the importance of “higher lows.” Since the S&P closed at 1235 on July 15th, the bulls held higher ground at S&P 1235 on July 28th and S&P 1250 on Monday. Through a pure trading lens, those latter levels can be used for near-term risk definition.

Should they remain underfoot, an upside scamper becomes more likely with time. When and if that manifests, performance anxiety would percolate as fund managers eye their third quarter letters. It’s a bit forward-looking but that’s how the market trades and we must as well if we’re to keep up.

Successful trading is about ascertaining an advantageous risk-reward. This particular set-up, as it stands, continues to do just that.

In the end, markets will do what markets do. The only elixir for what ails us after years of financial engineering is time and price. The government will give the market all sorts of drugs but in the end, it must take its medicine.

That reality has crept into our consciousness but it’s a process until the point of collective recognition. The shifting social mood and the attendant risk reduction will last for years as learned behavior and behavioral excess is unwound. Once it has, we’ll be ready to build anew.

Just as everyone was bullish last spring and summer, however, nothing comes easy in a bear market and the crowd is rarely rewarded as a whole. We can debate our standing on the denial-migration-panic continuum but mainstream psychology is a toggle not a toss. It’s called the path of maximum frustration. Get used to it because it’ll be with us for a while.

When we chew through this prolonged period and find our way to the other side of the cycle, we’ll likely see an inside-out recovery—one that turns investors inside out by the time we recover!

Oil Spills Or Thrills ?

Once again those nefarious oil traders that had their way with crude oil prices for so long are now feeling the heat. I bet many are saying to themselves: “Darn, I wish the federal government kicked me out of oil while I was still ahead.” The thing now is, when there was rotation out of oil speculators were able to transition into stocks.

Now, immediately upon exiting crude oil, speculators check into a triage center. Of course, for some there's no sympathy for those "mean old people that make a lot of money and leave us small fishes out in the cold," literally and figuratively.

I think Congress has bigger fish to fry and blame for the oil crisis. Oil companies are a much better villain than oil speculators. Those "evil, evil folks" that dare make money in a capitalistic system are facing the burden of subsidizing US citizens' recreational travel, frivolous travel and choice to own gas-guzzling vehicles.

While we’re at this whole notion that American oil companies control the price of oil let's go after the farmer because food prices are so much higher than they were. Lets take it a step even further, the guy who cut my lawn grass should be paying me because the more he cut it the more it needs to be cut, a vicious cycle to be sure, someone should pay for this hellish scheme. I could go on and on with this line of thinking.

Now is not the time to make the largest companies weaker or to vilify them when OPEC is milking this for all its worth, taxes are adding to the pain and supply and demand has shifted markedly over the last few years.

The good news yesterday is that the market held up and displayed a little spunk. The bad news: Stocks couldn’t feed off the nose dive in crude oil to spring it forward. With earnings season winding down one has to wonder what could spark the market higher. Heck, the next employment report is a month off and the Federal Reserve will probably be on pause tonight and for the foreseeable future.

Sure, oil could breakdown and that would help the airlines but the rational for the move lower in crude wouldn’t bode well for stocks. At this point a weaker global economy, while beneficial with respect to crude oil, isn’t the kind of backdrop for massive stock market rallies.

I will say inflationary pressures are really beginning to abate and maybe that could spark or germinate a rebound in equities. Stocks are cheap but that doesn’t mean they can’t get cheaper. Although oil took a hit it held at $120.00 which has become a major support point. By the same token, the S&P 500 failed to cross above its 200-day moving average, a clear red flag. Meanwhile, Oil slipping below $120, has no reliable support till it hits $110/barrel. It's time to grab hold of those greebacks.

The S&P 500 now sees support at 1,240 then it would be highly likely the index would form a double bottom at 1,200. One the upside 1,260 is early resistance but the big move to the upside... the trading trigger... comes with a close above 1,300.

Stocks Go Down Faster Than Up.

A friend recently told me one of his favorite stocks was in crouch position and “ready to leap.” I'd never heard that saying before, and it seemed almost comical to me since the stock was under considerable pressure and looked more like it was in crouching position and ready to croak. Yes, there's much talk about the worst is over and time to shop for values. This came when there was a full solar eclipse on the 1st of August, not too wise! - a possible pivot-turning point for all markets.

However, I thought about the saying a lot yesterday because for the overwhelming majority of the day the market was acting like it was ready to leap. Then there was the last hour of trading.
The market was flattened, leaving me to wonder if stocks could leap from their prostrate position. I was duly impressed, nonetheless, with the way the market held up and fought back. I think the market may want to leap ahead .

By the same token, stocks go down a lot faster than they go up.

Yesterday night, was a compelling session in the fact that equities and oil were lower out of gate and trading in tandem for different reasons. Actually, I’m not sure why crude was lower as there were enough reasons... excuses... er... factors... you get the point: The Wednesday update on gasoline draw downs, the changing political landscape in Israel and the defiance of Iran in the face of international pressure to squelch its nuclear ambitions.