Melt-ups and pullbacks

This week I have a nearly 11% drawdown. My TLT calls were off a lot, my index puts and mining stocks were off a little, and nothing really went up. Here’s a visual representation of what happened:

One of my biggest mining stocks, EQX, dropped hard from the low $9 range last week to the low $7 range at the end of this week due to labor disputes/work stoppages at some of their mines. I have to admit I chased into it a bit on Wednesday, but I stopped after that … it’s a common rookie mistake to cut from winners and add to losers as we’re emotionally wired to expect a mean-reversion in these things. Right now I’m planning on holding my EQX position but not adding any more regardless of price action.

I added a small amount to MTA, which I had been meaning to increase my stake in. Everything else was added to diversify my holdings a bit including a bigger stake in NOVRF (copper/nickel), CRLBF (Cannabis), and ADA (Crypto). All three were struggling and bought on dips. My thinking there is that base commodities are a different bucket than precious metals, and cannabis and crypto won’t move with either one. At this point I’m at my limit with NOVRF and close to my limit with ADA, so I may end up either building cash or just running back into CCJ with covered calls immediately sold on my positions.

The markets are still in a bit of a narrative struggle here, with the main questions of where is inflation going, where are interest rates going, and what should we invest in. Some reflationary plays have been strong, such as oil, small caps, and emerging markets – though its hard to tell in some ways because IWM is dominated by meme stonks such as GME and AMC which are at eye-popping highs and EEM is dominated by Chinese tech companies.

Financials (XLF) did really well this week, and they usually follow expectations of a steeper interest rate curve. However, expectations that the bank stress tests will allow them to start stock buyback programs weighed heavily in their favor.

Growth companies and tech (QQQ) tend to do well when interest rates are low because a lot of their perceived earnings are in the future, but they are also dominated by companies like AAPL with high earnings and big stock buyback programs. Stock buybacks have been absolutely soaring this year and their shares are doing well.

Cryptocurrencies are still in a big correction as China clamps down on companies supporting them. Much of the selling is done on the weekends during Chinese daytime hours, as their citizens reduce their crypto holdings.

Precious metals are still pulling back from last year’s high. They tend to do well on a weak dollar or negative real interest rates, but the dollar is strong and interest rate expectations aren’t low enough to move the needle. They are currently pulling back to test support after failing to break out to the upside.

TLT launched higher last week, then pulled back and quickly bounced of the 20 day moving average. It looks to favor the upside, but bond market volatility (MOVE) has been falling, which significantly reduced the value of my Jan 2023 TLT call positions.

Here’s where my portfolio ended up:

  • DOWNSIDE BETS (38.8%)
    • 27.9% TLT Calls
    • 5.2% IWM Puts
    • 4.3% QQQ Puts
    • 1.5% EEM Puts
  • GOLD (19.6%)
    • 10.0% SAND Calls
    • 4.8% EQX Calls
    • 2.4% WPM & GOLD Calls
    • 2.4% LGDTF
  • SILVER (24.7%)
    • 10.1% AG
    • 0.8% AG Calls
    • 5.1% SILV
    • 3.6% SILVRF
    • 2.9% MTA
    • 1.6% RSNVF
    • 0.7% SSVFF
    • 4.4% NOVRF (Nickel/Copper)
    • 0.8% BQSSF (Uranium)
  • CANNABIS (6.3%) split btw CRLBF, GTBIF & TRSSF
  • CRYPTO (3.3%) all ADA
  • CASH (2.1%)

It’ll be interesting to see how this all plays out, but I’m actually not that worried about it for a number of reasons.

  1. Cashflow positive. I have regular money coming in from my job, and I keep my expenses low.
  2. No leverage. If my accounts go to zero I’ll still have no debt. If you use margin, then a significant drop can lead to forced sales which push your account to zero – but without margin your positions will hold positive value even in big drops.
  3. Directional diversification. I am clearly betting on a slowdown and pullback in interest rates with my heavy long positions in precious metals, long-dated treasuries (TLT), and index puts. However, splitting between those makes it less likely that all three blow up. Then I have some counter-trend plays such as base metals, cannabis, and crypto which should do well if we’re back to soaring stock prices with no worries.

The final thing I should add is that I’m still relatively young and my portfolio is still relatively small. I need to take risk to get anywhere, and I can still recover from missteps. That’s why my investments are highly directional – because I’m looking for an outsized win.

As for inflation, the main problem with the debate is that people who discuss it are generally talking about different things. The cost of living in the US has been soaring over the last 20 years and I have no doubt it will continue to do so. However, the CPI will remain weak for the following reasons:

  1. CPI inflation is greatly reduced by technological improvements (they call it Hedonic Adjustments) which mean that automobiles have been relatively flat in the CPI during a time when new car prices have been soaring and the majority of buyers had to turn to the used car market. This works with computers, software, electronics, and many other things.
  2. The CPI also tends to favor discretionary purchases over necessary ones. Flat nominal wages with rising costs of living means less money is spent on these discretionary purchases, which pressures the CPI downward. In fact, the CPI tends to correlate better with wages which have been going nowhere for years.
  3. Sustained inflation requires continued demand beyond current capacity. We are in a period of massive worldwide lockdowns and high unemployment. Productive capacity has been reduced while stimulus checks kept demand from collapsing, leading to higher prices, but the phaseout from Covid means that production will be increasing while government support will be pulled so that capacity will increase while demand stays subdued.
  4. Many people are led to believe that the growth of central bank balance sheets represents new money creation which is injected into the economy. It doesn’t work that way – it really has to do more with replacing high duration debt such as mortgages and treasuries of various durations with overnight reserve assets. In other words, it is a way of reducing long duration interest rates while spurring banks to lend. Lending in a weak economy greatly favors corporate debt (for stock buyback programs) and asset-backed debt (for mortgages, cars, and forms of stock portfolio leverage). The result is a debt-driven asset bubble, not a one-sided addition of cash to the system.
  5. Many people point to large and growing government fiscal deficits as a source of renewed inflation. They are correct that this is new money injected into the economy which adds to inflationary pressures. However, they often neglect the enormous counterweight of high debt levels. Debt servicing regularly pulls money out of the economy. Inflation from newly issued debt is short lived, while deflation from existing debt lasts a long time. This is why Japan saw very little inflation despite decades of government spending on big projects … their public sector growth merely counterbalanced the continued private sector weakness as high debt levels kept a chokehold on the private sector.

Anyway, I still do expect some kind of 2008 Lehman moment, when a hedge fund collapse leads to a bout of forced selling as stop loss orders trigger and margins are called. This in a market that has few price-sensitive buyers as passive funds and corporate buybacks are oblivious to prices, very little money is positioned short, momentum funds are not designed to chase dips, and value funds are few and far between (Berkshire is the most famous of those). When this happens I expect that the index puts will pay off, TLT will spike, and precious metals will both fall less than the US market indexes and recover faster after the next reaction. If this doesn’t happen in the next 18 months, my “downside bets” will go to zero but the rest of my portfolio will hang in there.

Good luck, happy trading, and be careful out there!

About johnonstocks

I've been trading stocks since 2003, active on Motley Fool's discussion boards and using first Hidden Gems, then Global Gains. I no longer have the newsletters, but I keep up on the WSJ and read David Rosenberg everyday at Education: CFA level 2 candidate MBA-focus in Finance, Marshall, University of Southern California - expected Dec 2010. BS Mechanical Engineering, UC San Diego, June 2002
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