Martin Kronicle

Charles Goyette Dollar Meltdown Video Interview from Michael Martin on Vimeo.

Charles Goyette’s book The Dollar Meltdown is a best seller. Charles and I recorded an audio-only podcast and I’ve also written about his book at Mises and The Dollar Meltdown: Surviving the Impending Currency Crisis with Gold, Oil, and Other Unconventional Investments.

One of the oldest tricks to avoid saying something negative about the market is to re-frame anything bearish into something much more neutral so that the negativity will be short-lived and certainly endurable if you “invest for the long-haul.”

According to Bloomberg’s BusinessWeek, formerly Harvard Endowment’s Mohamed El-Erian, now chief executive officer of Pacific Investment Management Co., said he expects the U.S. economy to experience a “slow resetting” this year. This is typical language from a person who’s management company provides long-only investments.

My take on it is that the stock market is a discounting mechanism and it reflects financial voting of its constituents. It technically resets every trade, in both the cash market and in the S&P 500 stock index futures.

Since that information is readily available, you can decide what part of the resetting you want to participate in. By using protective Sell Stop Orders to preserve your gains, you can offset the risk to your portfolio and be in cash, especially if you are a long-only trader or investor.

You can also use Sell Stop Orders to enter the market short by entering them below the current market. They will be triggered if the price of the futures contract trades at or through the price you set on the Stop Order.

The number of oil barges floating full of crude has been decreasing according to the WSJ. The paper reported yesterday that “some analysts have seized on the contraction as evidence that world oil balances are tightening and the surplus that built up during the recession, when energy demand in industrialized countries plummeted, is eroding.”

Let’s break down the story and look at a few quotes:

The phenomenon of floating storage took off early last year. Oil on the spot market traded at a big discount to forward-dated contracts, in a condition known as contango. Traders took advantage of that by buying crude and putting it into storage on tankers for sale at a higher price at a future date. Profits from the trade more than covered the costs of storage.

Contango means a carry charge market – whereby successive futures contracts trade at a higher price from the previous month and so on, and so on.

Here’s what the Strip (Calendar 2010) looks like (click image to enlarge):

Crude Oil Calendar 2010

One oil analyst suggested that the “…contango has narrowed to around 40 cents a barrel, and ‘to cover your freight and other costs you need at least 90 cents.’”

Here are those calculations:

Carry Charges, as of the Close February 1

You can see that the right-most column contains what are called the carry charges. These differences are often referred also as the spreads. According to that analyst, they had been as wide as 90 cents and now they are much lower: they have narrowed.

Carry charge markets usually mean there is ample, current supply, and that the commodity in question can be stored generally speaking. That had been the case previously with crude oil as large traders who had access to cheap money (low/no interest financing) and cheap(er) tanker rates could arb out the difference for profit. The traders were hedged: they were long the physical and short the futures. No gambling and nothing reckless here for all my Huff Post fans!

Their storage and interest costs were calculable and much lower than what the spreads were in the futures market. Hence, traders long the crude could sell distant futures and wait for the prices to come down.

Now that the spreads have come in (narrowed), those easy profits aren’t there anymore, and hence the barges are coming into port delivering crude.

Lastly, in the article, J.P. Morgan is quoted as saying “prices could even go into backwardation at the end of the second quarter, where spot prices are higher than those in forward contracts.”

There’s another SAT word – backwardation. Look it up on Google (go to google.com and enter “define backwardation”) and tomorrow I’ll discuss how you would put on a spread trade in crude oil if you thought it would go from a carry-charge market to a market in backwardation.

The 2 books that Victor refers to during this interview are End The Fed, by Ron Paul and Monetary Regimes and Inflation: History, Economic and Political Relationships by Peter Bernholz.

Trends Persist, Regardless of What You Think You Know

Media reports on the health of the markets. Earning reports from firms around the world. Central banks and their policies. Influential analysts upgrading and downgrading stocks. The quarterly number. The Whisper number. The aftermarket activity. Fast Money. Mad Money. Madmen. How do you filter all these electrons to make sense out of them?

There are too many of these valuable electrons being flung around the world each day. White noise and statistical noise. Those are trends unto themselves. Nothing wrong with it. Just know it for what it is. I talked about Ritual versus Process in one of my blog posts. Know what makes you money and what feels good. Sometimes they are not related.

But you can’t trade on most of this knowledge, especially about the economy or the market health. That information you can use to formulate a macro call as a discretionary trader. Another difficulty is that you might be right on your ideology, but horrible with your timing and thus lose money. Traders, especially new students of the markets, need to have a definable and measurable action plan each day.

Television, Twitter, Facebook fan pages, and RSS feeds & emails from leading blogs provide us with great entertainment. Some, and I mean very few, actually teach us something. And as a teacher, I believe in knowledge for the sake of knowledge. But the best teachers are not always easy to find.

Michael Covel has done a great job in bringing together some of the most hibernating, reclusive, and socially awkward people in his film, Broke: The New American Dream. There are cool poker players and some hot (and very stupid) models who punctuate the screens.

But listen closer and you’ll get learned wisdom from Larry Hite, a guy I first read about in Market Wizards. He founded a firm called Mint Management which he had had as 50/50 partners with what was then called E. D. & F. Man, now MF Global. (There is a physical cash market commodity trading firm that spun off when Man Financial IPO’d and separated the brokerage from the physical commodity business). Mint is still around, albeit with yet another name. Mint was the first CTA to have over $1 billion in AUM.

In Broke, you’ll see a lot of Salem Abraham of ATC. He lives in God’s country – Canadian, Texas. He’s not too flashy, the way the media would make your believe commodity traders are supposed to be. No, he likes to fish and go on bike rides with his kids. Abraham, who learned the craft from Jerry Parker Jr. of Chesapeake Capital, is equally talented as he is unassuming.

Very refreshing to listen to Salem and Larry compared what’s on TV. I tend to enjoy their electrons much more that what had come off my HDTV before I turned off my cable. Watching their interviews reminded me of my interview with Bill Dunn of Dunn Capital Management and the Reason Foundation. I think what makes them so refreshing and informative is that we’re not bombarded with their electrons every day in one form or another.

At the end of the day, there’s not much to say about any trading vehicle. It’s either up, down, or flat. And you’ll never know which of the fundamentals is at work. You might be smart, you might be lucky, you might be both. You still need to have a plan. Position sizing and Risk Management are what save lives.

In order to capitalize on your luck and smarts, and to develop a career as a trader, you need to be able to systematize your thoughts. Once you do that, you can test your ideas and see how they would have done over time. Think that’s a waste of time? Tell that to Bill Dunn who revealed in my interview with him that he’s not taken a single discretionary trade in his WMA, which has a track record going back to 1984. Are you smarter than Bill Dunn? Maybe you are, but it’s going to take a few decades to convince others. And, you’re competing against his system that has performed well consistently.

“But MM, trading system software is so expensive…”

Yes, probably true. You get what you pay for usually. If you want a cheap way to test an idea on the S&P for example, go to Yahoo! finance and download the free data there and upload it to a Google Docs spreadsheet. You can calculate the moving averages and “the highest high of the past 20 days” etc. by hand. Have fun!

“But MM, hypothetical results are not predictive – so why bother?”

You don’t need predictions. And you don’t need the Platinum league education that you have either. You need to learn to trust that birds fly south for the winter on some level. Trends persist. I won’t bet you the actual day that they leave, but I’ll bet you they leave. See the difference? One is a day trader, the other is a trend follower. Rather corny, yes, but it makes the point and as a teacher that’s all that matters to me. Oh, one more thing: don’t go get an MBA. Save your money. Learn to trade and you’ll have all the liberty and independence you’ll ever want.

“MM, Trading is legalized gambling.”

Please click the X in the corner of the screen and go back to focusing on obtaining tenure or getting paid for 8 hours of work while only putting in 5 hour of quality work. Please be serious. There are similar tools that traders and professional gamblers can use, such as Mathematical Expectation or Bayes Theorem. Anything else is your imagination.

Earnings Drive Stocks. What Drives Commodity Markets?

Unlike stocks, commodities are cyclical in nature. (Stocks are secular). Cycles repeat themselves too. Each year decades and decades of economic power descends upon the grains, metals, softs, and credit market futures to name a few. Human behavior is measured in the supply and demand numbers for each commodity. And those forces cause prices to rise or fall.

There are old crops and new crops, there are seasonal tendencies, there are investors, and there are hedgers. Each party comes to the market and they are happy to meet one another. They look at the price as the single most important piece of information you can input into your decision making process.

What do you look at to make your trading decisions? Do you make a watch list from Fast Money? Or do you buy what Dennis Gartman says to buy? Or Jim Rogers and Victor Sperandeo? No one is going to care about your money more than you. You are responsible for it’s growth and decay. Not Obama. Not your failed bank. Not your broker or RIA. And certainly not the jackass who gave you the last tip on investing. You are responsible for your own plan.

Covel’s site is full of free information and he’s been providing it for 11 years on my count. I’ve been a reader of his sites for almost that long. I don’t think there is a better site that offers as much free information on system trading in the world.

This post was written as a Guest Post for Michael Covel and originally appeared on his blogs.