Crypto, Gold, Hedges, and Options

An interesting point that Raul Pal made on RealVision Friday is that asset managers finish their annual performance in Q4 and start building a new number from scratch in Q1. With US stock markets all at all-time highs, they often take profits around February or March and then scramble to find the next trend that can get the year’s gains rolling. Point is, just another reason to be cautious right now.

I’ll start with Crypto because I’ve been doing a lot of thinking on how to continue playing the space. Here’s a 3-month chart:

I really had no interest in Crypto assets until last summer, and started a Coinbase account around August (you can see my posts around then if you’re interested in why). First I started with buys in Bitcoin and then with Etherium with a simple separate from my portfolio and hodl idea – ultimately getting to a peak of 1 Bitcoin and 10 Ether. Late December after Ripple crashed, I bought some and it jumped 30% overnight – which reminded me of a time losing money after a dead-cat bounce in penny stocks back in the mid 2000’s. I dumped XRP and then downsized my BTC and Ether to take out my initial buy-in at the end of the year.

I dumped the rest of my Ether when it hit $1200 – partly because it went so far so fast and partly because it was getting near its all-time high (around $1400) which is typically a strong zone of resistance.

With Bitcoin, the momentum and story are so strong (a lot of money squeezing into a relatively illiquid asset) that I didn’t want to dump it, but I didn’t want to risk too much either. The idea I came up with is to keep a constant dollar-value of around $20k – so I’ve been selling off at every significant rise. If theres a big dip, I can buy back to hit around $20k and feel comfortable because I know I sold higher … but this hasn’t occured yet for me.

Back to the rest of my portfolio. I’ll start by laying out my allocations.

  • MAIN POSITIONS
    • 30.8% Gold Miners (FNV, GOLD, NEM & WPM), Shares
    • 16.4% EQX (gold miner), Shares
    • 2.8% SLV (silver), Shares
    • 20.3% Gold Miners, Calls
    • 10.9% SLV, Calls
    • 2.7% SAND (gold), Calls
    • 2.2% PVG (gold), Calls
  • HEDGES
    • 4.2% TLT (long 20+ year US treasuries), Calls
    • 8.5% IWM (russell 2000), Puts
    • 1.3% EEM (emerging markets), Puts

Recent trades:

It’s been a very active trading week for me, partly because I had all the gains from Crypto to re-invest. Gold dumped a bit on Wednesday, so I decided to increase my stake. I saw that even though GDX went down significantly, NEM was still rising – which seemed a very bullish sign so I got more exposure there. I also went significantly longer in TLT calls this week.

My thinking on precious metals:

As you can see I’ve been very bullish on gold miners and silver. I’ve been into gold ever since 2008 – and I rode it on past the peak and through the downside. It didn’t matter much at the time because I spent nearly all my savings on an MBA and then struggled through a lousy job market, so I really didn’t have much to lose. Today I strongly believe we’re in the mid stages of a long-term bull market in precious metals, but I know from experience that corrections go on longer than you think and much patience is required in this particular asset class. Recently (starting November), I started moving into call options for leverage and all of them expire Jan 2023.

My biggest positions are merely the top 4 holdings of GDX. I figure that GDX is the most obvious liquid play in precious metals, and most of the money will be allocated to the top 4, and that these top 4 are most likely candidates for big institutional interest, like with Berkshire’s previous dip into Barrick (GOLD). For the smaller ones, I really think you need to trust the leadership so I’m mainly in Ross Beaty’s fund. SAND was a gold streamer I was interested in back in 2010 and I figured it would be well levered to Gold’s rise, and PVG just sounded interesting so I bought a few calls.

My thinking on hedges:

The biggest danger I see with precious metals is a March-style risk-off event which would cause everything to sell off. That is where my hedges come in. They have been losing money of course, but I really like the idea that I would have significant money to invest at a time when everything is selling off.

EEM: I started hedging here back around June because I liked Rauol Pal’s idea about the demand drop from the pandemic causing dollar shortages in emerging markets. Their heavy exposure to Chinese tech companies didn’t bother me because of their relatively high valuations at a time combined with a significant chance of US sanctions. I stopped adding here around August because it seemed to be going terribly wrong – but all the puts are dated Jan 2022 so I’m just holding them for now.

IWM: I started hedging here around June as well, selling off all of my Aug 2020 and Jan 2021 SPY puts which had been going horribly wrong (I lost less than 50% which is why I like long-dated puts). After listening to Mike Green talk about passive investing, I decided that I really didn’t want to bet against the tide of a never-ending passive bid, so I’d stay short the smaller companies instead … they’re more likely to have insolvency issues than SPY anyway. After these started working against me, I decided to only buy one put for every 100 point rise in the russell and then moved that out to every 150 point rise.

TLT: In a March-style liquidity event, everything sells off including bonds. Then the federal reserve comes in with big purchases of the only things they are allowed to purchase and treasuries skyrocket. Look at the behaviour of TLT in March and you’ll see what I mean, and why I consider this an effective hedge. However, this isn’t the entire reason I’m into the space.

Back around early November, Rauol Pal mentioned something about a decent play in March TLT calls and Steven Van Metre. I started following twitter @MetreSteven and his Youtube channel The Market Says a Blue Wave of Inflation is Coming! – YouTube

You should really look at what Steven is saying if you’re interested in this space, but what catches me is the idea of massive speculative short positions in US long bonds, building up like a coiled spring since August while the Federal Reserve is actively buying every month. This could lead to a big short squeeze and it acts as a hedge in case of a major risk-off event. I started getting into this with a couple March 2021 calls back in November, then started going out the time curve with each batch I added – June, August, January, etc.

How I think about options in general:

Options have intrinsic value plus duration/risk value. I like to stick with something that seems to have a good shot at positive intrinsic value, which means I generally buy in-the-money options. I find this an interesting part in the curve because if the trades go my way, the intrinsic value is rising dollar-for-dollar with the stock. Consider this:

  • You have 1 call option with giving you the right to buy 100 shares at $20, the stock moves from $21 to $22, intrinsic value went up $100. Your gain went up a bit less because of the lower risk premium, but that intrinsic value puts in a solid floor which starts to make the slope of gains increase closer and closer to a dollar-for-dollar level.
  • When you are out-of-the money and it trades against you, intrinsic value is still zero but duration/risk doesn’t go away. The dollar value of the option tends to go down at a shallower slope, which is closer to a $0.50 loss per dollar decline.

Look at any options table, especially for longer durations, and you’ll see what I mean. The reason that the slope of losses shallows out is because the option has value until it expires, and anyone looking to hedge outside risk would easily take double the put options to go a bit further out of the money. The pricing makes sense if you think about it, but I really like to be in the sweet spot of the curve where I capture more of the money from a 20% gain and lose less of it from a 20% loss.

As for duration, I often look at the difference month to month and pick one that seems like it has a good chance of hitting a positive intrinsic value. For TLT, I see a test of the 165 resistance level as a fairly likely outcome so I like to make sure that my strike + premium is significantly less than that. For example, Jan 2022 150 strike, cost of $10/share, so my intrinsic value covers my entire cost if TLT hits $160. I really don’t like to hold options when they get too much less than 3 months because the duration/risk value starts to drop fairly quickly.

On the flip side, when options seem crazy expensive I like to covered calls around 1-month because they still have significant value but can quickly decline to zero. For example, I wanted to go long CWH around late October but the options were really expensive – it was trading at just over $28 and 1-month 30-strike calls were selling for $3.40 (perhaps because it was over the election). I jumped right in with 600 shares, sold the covered calls, and ended up with a solid 20% gain in one month

Final note:

I am really nervous about a market correction – and I admit I have been for a while. I think of the crazy Dave Portnoy’s sign “stocks only go up” and picture my own sign “gold is in a bull market.” Gold has been extremely strong in January in past years, and I’m thinking of de-levering my portfolio at the end of the month if I get that up-move I’m looking for. I would do this the same way I did after June – by selling off all of my call options, buying the underlying shares, and then beginning to sell covered calls on them. Still, the idea of a big risk-off event in February/March haunts me a bit especially with my aggressive position in calls right now, so I am very likely to add to my hedges in the near term … particularly long TLT because I really like that story. Good luck and happy trading!

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Christmas, New Years, and Crypto Madness

My brother came up with his 4 kids between Christmas and New Years. During that time I took a few more days off work and went Kayaking, hiking a number of places, playing board games, and all that sort of thing. It was both fun and exhausting. Needless to say, taking a couple of hours to focus on a blog post was simply impossible.

Markets had a quiet melt-up back to the highs. The only trading I did there was picking up a couple of June calls in TLT as I expect another down leg in long term US treasuries. The federal reserve can no longer purchase commercial bonds without an act of congress, the senate is very skeptical about further stimulus, and the real economy is still feeling the pains of pandemic lockdowns as this winter wave ravages the US and Europe. In this environment I expect the federal reserve to want to take some action, and suppressing long interest rates through purchases of long-dated US treasuries is one of the few tools they have. Add to that the enormous speculative positions on rising interest rates and there can be a decent run on long-dated US treasuries.

The real moves this holiday season came in crypto currencies. Here’s a chart I picked up from Twitter:

Source: Northstar @Northst18363337 – he has great charts on cryptocurrencies, precious metals, and commodities

The chart above points to the next major high between $150k to $300k on Bitcoin. The dollar axis is logrithmic rather than linear, and he points out pullbacks of 25-40% on the last leg up. I’d say thats a decent target for potential upside, but I’m still a bit cautious.

One thing that has me worried, pointed out by @SamanthaLaDuc is that 2% of accounts control 95% of all the bitcoin and that the concentration of ownership has been rising. The biggest bitcoin trust, GBTC, holds a bit over 3% of the bitcoin, so it is not the bitcoin “whale” she is worried about. The problem is that the liquidity of bitcoin, the dollar amount of a trade that significantly affects the price, is much lower than many would think. This could easily be a pump-and-dump move where the big bitcoin holders are trying to corner the market to push it higher and then start selling when it hits their target.

So what do I do? Well, I’m really not a hod’ler. At the end of the year I reduced my holdings by 30%. Yesterday I reduced a little bit more so that the money I put into bitcoin back in October has all been removed. That leaves me with 2/3 of a bitcoin for upside. My current plan is to sell it down a little bit at a time for every $10k milestone upward and probably sell it all if bitcoin touches $100k.

I’ve been a little bit more cautious with Etherium. It hasn’t moved nearly as much as bitcoin, but it has been trickling up. I held 10 Ether below the $500 mark, and I ended up selling 6 of them off at a bit over $700. Northstar has his chart for that pointing to $1400 as the next top, but I’ll probably get out completely between $1000 and $1200. Etherium has a great story and I expect it to last but what can I say, I’m a trader.

Ripple has been another fascinating one to watch. It has similarities with Etherium and has been out for 5 years or so. The 2017 peak was at $3.50, it had a low around $0.15 in March, and it had a recent peak of around $0.75 in December. After an SEC investigation started, it collapsed to around $0.22 today. I actually decided to buy some after the crash, just before Christmas. It went up 30% overnight and I immediately thought “dead-cat bounce” and sold it. This kind of downside potential is possible in all the cryptocurrencies. Ripple could easily survive as the number 4 crypto asset, but who knows.

The future of Cryptocurrencies and regulation is a major topic for anyone interested in the space. Here’s the way I see it …

  1. Regulation should not be seen as the endgame for crypto, but as a necessary stepping stone for broader acceptance.
  2. Cryptocurrencies which survive will have to register as securities (like stocks) or commodities (like Gold) and be taxed and regulated as such.
  3. Many cryptocurrencies offer banking functions over a new platform, such as overseas money transfers with lower fees than banks for example. I believe that this alternative to the current Swift banking system will survive in some form, but it will be regulated much more like commercial banking including transparency of account holders and transactions to allow governments to clamp down on tax evasion and money laundering. The ideals of anonymous transactions will disappear.
  4. Consolidation in this space will be brutal, with many cryptocurrencies going to zero. Bitcoin and Etherium are big enough and different enough to survive. A few others may survive as well, but they will enter a brutal struggle for relevance to see if they can either displace Etherium or at least lock in a meaningful market share.
  5. I haven’t decided about re-entering XRP. Ripple has a 5 year history with a lot of dedicated users, and I could easily see a company like Facebook (which tried to create it’s own Cryptocurrency in the past but was stopped by regulators), Paypal, or another big player deciding to take it on if the price is right.

I’m not going to list my holdings today, as they haven’t changed much anyway. My main plan is the same … I think we’re going to see decent gains for Gold and Silver in the next few years and I’m mainly positioned there – with call options in the miners as well as underlying stock. I also see a substantial risk of a significant market correction and I plan to hold a significant position in puts, mainly in the Russell 2000. The market is more fragile than many think so it’s good to have a solid hedge. I am also looking at running some covered call positions where options seem expensive … a current candidate is CCJ (Cameco). I was long CCJ options when it was in the $9 range but sold half when it hit $11 and the rest when it hit the high $13’s. If I can buy around $13/share and sell 1-month at-the-money covered calls for $1.30 I’ll do it. A 10% gain in a month is great and I still think that one is more likely to go up than down.

Good luck and happy new year!

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The Store of Value Trade vs The Reflation Trade

As you can see above, the current market narrative is certainly all about the reflation trade, not the store of value trade. While both gold and copper miners are up on the year, gold miners are still consolidating below a peak in early August, while copper miners are at the highs. Gold miners are up about 24% on the year vs copper miners up 44%.

Part of this can be seen as a deep value trade, as both indexes are still down over 50% since 2011, but part of this is also a disagreement on the nature of the inflation that we are going to see from record central bank balance sheet expansion worldwide. I’ve made no secret that I’m firmly on the store of value side … I see way too much money chasing a shrinking stream of investment opportunities, with valuations that make as much sense as negative interest rates.

Milton Friedman famously said “inflation is always and everywhere a monetary phenomenon.” This phrase has long been oversimplified with unrecognized implicit assumptions and interpreted as hyperinflation is coming because the federal reserve balance sheet went up again. Any serious investor should know that predicting the outcomes isn’t quite that easy.

The size of the federal reserve balance sheet has been rising substantially over the past 12 years. How did assets respond:

  • Between September and December 2008, the balance sheet more than doubled:
    • S&P 500: Intermediate bottom November 2008, bottom in March 2009, and didn’t recover to former highs until 2013.
    • Copper miners: Bottomed in November, had a higher bottom in March, and peaked out in early 2011.
    • Gold miners bottomed in November, had a higher bottom in March, and peaked out in late 2011.
  • Between Oct 2010 and Jan 2015, the balance sheet nearly doubled:
    • S&P 500: After a false start from Oct 2010-Oct 2011, it nearly doubled by 2015
    • Copper miners: Up 50% from 2010-2011 to a glorious peak, then collapsed to a third of that peak by 2015.
    • Gold miners: Up nearly 50% from 2010-2011 to a glorious peak, then collapsed to a third of that peak by 2015.
  • Between 2015 and 2018, the balance sheet stabilized. Then it went down 20% by Aug 2019.
    • S&P 500: Rough & flat from eary 2015-late 2016, then shot up 40% by Jan 2018, then rougher and flat thru Aug 2019.
    • Copper miners: Hard bottom in 2016 down 85% from the peak, more than tripled thru Jan 2018, then down by half in late 2019
    • Gold miners: Hard bottom in 2016 down over 80% from the peak, up 2.4 times thru Jan 2018, then down by a third in late 2019
  • In September 2019, the fed sharply reversed course. Then the pandemic it and the balance sheet doubled from it’s 2019 low. Aside from the pandemic lows that all 3 asset classes hit in March, we have:
    • S&P 500: Up 25% from Aug 2019 at new all-time highs
    • Copper miners: Up 87% from Aug 2019, still less than half the 2011 peak
    • Gold miners: Up 39% from Nov 2019, still nearly half the 2011 peak

What conclusions can we make here? The answer isn’t as simple as you’d think. These asset classes all have long-term cycles to consider. Stocks seemed to respond the best to the Federal Reserve’s quantitative easing this last decade, but they also had an enormous prior consolidation with a peak in 2000 that was barely exceeded in 2007 finally broken through in 2013. Gold and copper did terrible in the 1990’s, shot up like a rocket from 2000 to 2011, then did terrible in the following decade.

Here’s a summary of my thoughts on it:

  • S&P 500: I don’t this asset class after a decade-long run to new highs. I just feel like a consolidation is more likely than a continuation after this run. Add to that an environment where incomes have gone nowhere for decades, small companies are forced to shut down and starved of cash while the big companies have been given practically limitless access to capital, and the trend of globalization has been reversing. I think we’re about to start a new cycle both politically and economically.
  • Base commodities: I still don’t see how these can do well if demand is low. I want to see huge cities build annually in China like around 2010, or tanks and planes being built like crazy. Instead we see planes sitting idle, massive unemployment, and governments that are too worrried about the cost of throwing more rice to the peasants to consider any major infrastructure projects. That being said, I will be watching commodities like a hawk because a sharp downturn in copper is often followed by a sharp downturn in gold a few months later.
  • Precious metals: I see everything lining up for the short term here. A solid period of consolidation below the highs, a good time seasonally, and world trade starting to ease into more currencies than just the US dollar. Add to that a huge supply of money looking for investments through stocks and bonds that are priced at all time highs despite an extremely weak economic backdrop.
  • Commodities including precious metals do not behave like stocks, so be careful! The S&P 500 has a continual passive bid from people’s 401k’s which gives it a much more steady climb in bull markets. Commodities and precious metals don’t have this endless and impartial bid to buy, and they are much smaller markets by valuation. Because of this, they behave in fits and starts with much wilder swings.

This past week has been really great for me because of my heavy allocation to gold miners and silver, as well as my significant allocation to bitcoin and etherium. Silver seems to be breaking out nicely, while gold is weaker but I expect it to follow. At the same time, I have been getting more and more nervous about how sustainable this stock market rally really is. I dumped the CRM which I bought the week prior for a small loss … I just didn’t have conviction on the trade. I looked down from the sky-high tech valuations and got spooked. BDX had some nice gains so I sold my positions there as well. CCJ shot way up and I looked at why … Uranium went up in value because Cameco had to temporarily shut down a mine due to a covid outbreak. I sold my position there for a nice gain as I couldn’t wrap my head around why a stock would go up because the underlying company had a covid outbreak. I’m still invested 100% and then some … aside from reducing margin leverage considerably, I bought an IWM put and invested the rest toward my gold miner plays.

Here’s where I’m sitting:

  • 32.9% Gold Miner Stocks (Large)
  • 19.1% Gold Miner Calls (Large)
  • 17.0% Gold Miner Stocks (Jr)
  • 6.0% Gold Miner Calls (Jr)
  • 3.2% SLV
  • 10.5% SLV Calls
  • 0.9% TLT Calls (20+ year US treasuries)
  • 8.7% IWM Puts (Russell 2000)
  • 1.8% EEM Puts (Emerging markets + China)

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Making Sense of the Market as the Risks Pile on

As you can see from the charts above, my simple strategy of investing long gold miners hedged by puts in IWM (the Russell 2000 index) has been struggling.

I find this environment we’re in as absolutely astounding. To think that a repeated series of worldwide business shutdowns, one of which we’re in here in California, combined with low & expiring fiscal stimulus and the most divisive politics I’ve ever seen would actually lead to a skyrocketing Russell 2000 which is up 15% on the year.

The recent IPO’s were absolutely phenomenal. Airbnb, which never made a profit and his hurt by the pandemic, is worth twice as much as Marriot. Doordash, which doesnt make money either and which is likely to have less use after vaccines are available and restaurants are open, is worth almost double the YUM brands chains, greatly dwarfing the valuations of Denny’s and Cracker Barrel.

Influence of Passive Funds

What can explain this? Obviously not fundamental analysis of any shape or form. The best I’ve heard is the phenomenon of the great shift to passive investing as explained by Mike Green. Here he’s speaking about it with Danielle Dimartino Booth: The Rise & Fall of Passive Investing w/Mike Green – YouTube

The gist of it is this … passive indexation and rules-based funds have become such a dominant player of the system that they have changed the way the market functions. People investing for retirement in their 401k’s have money that is automatically allocated to these funds every paycheck. Part of it goes into stock funds, and part of it into bond funds, often with a 60%/40% balance. The rules are simple – when the funds have money coming in, they immediately buy everything as weighted in the index at the current market price. Similarly with selling. This money is periodically rebalanced – typically monthly or quarterly – to maintain that 60%/40% stock to bond ratio. Simple, right? Here’s how it works…

In January and February, news was out about covid-19, though many thought it was contained in Wuhan. There were also signs such as an inverted yield curve and low manufacturing numbers – yet the market was going strong. This was because the federal reserve had been intervening in the bond markets since the fall causing bond prices to rise, which caused the big funds to sell bonds and purchase stocks.

Then came the panic in late February through late March when Covid outbreaks and lockdowns started happening in Europe and then the US. A lot of active managers sold and there were very few buyers, so prices plunged. Bond yields spiked (prices fell), so passive funds were not directed to rebalance them into stocks. In late March, the federal reserve intervened massively, even creating funds to support corporate bonds and junk bonds. Bond yields went way down (values of bond portfolios went way up), and passive funds starting selling bonds to buy stocks.

When passive funds buy stocks however, they purchase them as weighted in the index. The market caps of the biggest companies in both the S&P 500 and the NASDAQ were dominated by tech giants including Apple, Amazon, Alphabet (Google), Facebook & Microsoft, so blind demand for shares in these companies was extremely high. In addition, many of these companies had stock buyback programs which reduced the number of shares in the face of relentless demand. These stocks skyrocketed and became an even bigger weight in the indexes – which meant that passive funds had to allocate even more money to them – and the top 5 stocks went up even more. Combine this with the stimulus checks leading to a record number of new investors flooding to the most talked about names and we had a rally of truly epic proportions.

After these enormous tech stocks hit a certain level of valuation, they began to stall out. More of the big fund managers began looking for other vehicles to invest in, figuring that they’d broaden out away from the biggest stocks into smaller market funds like IWM (the Russell 2000) and emerging market funds. Announcements of the first major vaccine by Pfizer caused this rotation trade to accelerate, and money plowed into other parts of the market.

Where did I go wrong?

My primary assumption was that the economic damage from the pandemic, distancing, and lockdowns was tremendous and should cause earnings to fall which will cause the stock market to fall. This was incorrect, because the stock market continued to rise despite falling earnings, causing P/E ratios to go up by nearly 70%. Earnings simply don’t matter anymore because the main steady supply of money into the investment markets ignores them.

My secondary assumption was that it would take an enormous supply of money from the federal reserve to keep the markets up, which would lead to lower interest rates overall because they primarily purchase bonds, and this would encourage large funds to look toward precious metals as a way to diversify risks from the high prices of stocks and bonds.

This secondary assumption worked for a while as Berkshire and others started looking at gold miners back in May and June. However, these markets behave quite differently from regular stock markets for a number of reasons – a major one being that they don’t get regular money from the largest passive 401k funds.

What’s different about Gold?

The market has large active funds with their own strategies combined with massive futures trading and hedging by the market makers (bullion banks). Certain options & futures expirations are key, particularly the one on November 25th just before thanksgiving. When investors are long, the market makers have to take the other side, and they are heavily incentivized to hammer the price down before these key expiration dates. These operations are routine, and it tends to make the precious metals markets move in seasonal patterns with sharp spikes (like last July) followed by lengthy corrections. These patterns are made more extreme by the seasonal buying of physical gold, both for Jewelry and for festivals like Diwali in India.

Take a look at these charts from the last major bull market in gold:

You can see that even in a bull market, you get these sharp jumps followed by extended downward consolidations which last for months. You have to be prepared for this so that you aren’t shaken off at the wrong times.

What am I doing now?

Here is my current portfolio:

  • 31.6% Gold Miner Stocks (Large)
  • 16.1% Gold Miner Calls (Large)
  • 13.1% Gold Miner Stocks (Jr)
  • 4.1% Gold Miner Calls (Jr)
  • 2.9% SLV
  • 8.7% SLV Calls
  • 3.1% CCJ Calls (Uranium)
  • 6.6% BDX Calls (Healthcare-needles and such)
  • 3.3% CRM Calls (Salesforce / Business Tech + Bitcoin)
  • 1.2% TLT Calls (20+ year US treasuries)
  • 7.3% IWM Puts (Russell 2000)
  • 1.9% EEM Puts (Emerging markets + China)

In early November, I stopped selling covered calls on my precious metals stocks. The week of Thanksgiving, I sold a lot of the gold miner and SLV shares, replacing them with call options. This allowed me to increase my upside exposure significantly. I skipped buying IWM puts when the Russell beat 1900, because I figured that I had more than enough for downside hedging and I would be better off keeping more upside exposure.

I bought a call in CRM yesterday for two reasons … Thomas Thornton mentioned buying it in Realvision on Thursday , saying it was hitting a 13 Demark indicator count and getting ready to move to the upside. They are poised to grow with cloud computing as well as cryptocurrencies and blockchain. I am also very bullish on Bitcoin as it is getting increasing interest from larger investors, but I don’t have much money to plow into bitcoin without selling a lot of gold and silver positions. I have been buying Etherium in recent weeks, getting myself to 8 Ether with a goal of an even 10 – but I have been ignoring bitcoin because I already have 1 and adding here won’t increase that much.

As for precious metals, I plan to continue to increase exposure by selling the shares and replacing them with calls if they continue lower. I expect that gold and silver will have a phenomenal January and February just like last year, but I am also aware that precious metals can easily consolidate downward for a number of months, so I am sticking with January 2023 calls which will allow me time to wait this thing out.

There is always a significant risk that we see another March-style deleveraging event which makes stocks, bonds, and gold all sell off together, but I also expect that Powell at the Fed with Yellen as treasury secretary will do their best to keep these markets inflated.

Last note … the total negative yielding bonds hit a record $18 Trillion valuation recently. This trend is accelerating, not reversing. At the same time, foreign trade has been steadily increasing in currencies outside the US dollar. If these trends can’t make precious metals shoot higher within the next 25 months, then I really need to re-think everything I’ve learned about investing. That being said, I will probably wait to see if precious metals get hammered prior to the Dec 29 expiration, and then go longer if they do. Goodbye and good luck.

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Yosemite and Lockdowns

I’m writing from Yosemite right now, so I’ll keep this post relatively short. My mother and I just got back to the Ahwahnee hotel after a morning hike to mirror lake.

There was a notice at our door, saying that due to a lockdown order from Gavin Newsome, they are locking down the park starting Monday morning. I suppose it’s lucky timing for us because we planned to check out then anyway.

The park has been semi-restricted all year so it isn’t very crowded (amazing for Yosemite). They are big on masks and distancing of course, but on the trails most people (including us) will put on masks when passing someone by and then take it off again when we’re alone.

The only trading I did this week was buying two more calls in TLT because yields spiked up again. I honestly don’t understand the inflation trade. We got terrible jobs numbers of Friday, so I guess the theory says that increases the odds of stimulus which may then cause higher yields and inflation in energy and base commodities.

But if employment is horrible and lockdowns are permanently shuttering small businesses then where does demand come from? Even if they do another round of $1200 checks to everyone, most of it will be used to help with basics like food, rent, and paying down debt and the rest will likely be thrown into the stock market. Any money given to states would temporarily stave off layoffs due to budget constraints rather than start infrastructure projects. The Federal Reserve will likely buy more treasuries or bring up yield curve control without actually doing it yet.

While I was hiking, one thing that occurred to me was that I should probably stick with my strategy of precious metals investing over the next few years. This is partly because I still believe it’s in the early stages of a bull market, but it’s also partly because I feel like I’m getting to know more about what to expect. I suspected the pullback after June, selling off any long call positions and selling covered calls on all my miners. I knew that Gold would be hammered prior to the November options expiration and I got a lot longer there. I wasn’t surprised when it was hammered past key support levels to trigger stops. I am still fairly confident that it will have a great Dec and Jan with a likely pullback in Feb and Mar. You start to get a feel for some of these things when you trade a market for a while.

With other assets – tech stocks for example – you have gamma hedging cycles from options, periods of heavy passive fund investment flows, algorithmic traders trying to hit stop losses or force short squeezes, and many other complexities that are tough to get a handle on. Crypto has crazy cycles and I don’t feel comfortable trading it at all … I’m literally just sticking with the two biggest ones and hodl’ing what I have with a penchant to buy a bit more if it corrects down hard, and that’s it.

Anyways, I suggest you think about sticking with a sector if you really want to get into trading. When you diversify, think of assets that you’re willing to sit on for a few years without worrying about the prices and consider a simple re-balancing strategy that allows you to mechanically reposition to keep a consistent sector weighting. Trying to pick the right moments to jump into and out of a stock will give you trouble in an unfamiliar sector.

Good luck and happy trading!

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Thanksgiving trading: Big moves in a short week

It’s certainly been a busy week for the markets. These are the charts I’m most involved with.

I put in some horizontal lines that seem to show significant support. As you can see, both gold miners and silver have been consolidating downward since September while Bitcoin and the Russell 2000 jumped to new highs.

My biggest position is long gold miners (mainly the top 4 holdings of GDX rather than the ETF itself), with a significant #2 spot in SLV, so my portfolio is also consolidating to the downside you could say. There is some nuance behind it of course. I was long a lot of call options in gold miners and SLV in July. In August, after the top, I sold all of the calls & bought the underlying shares, and then I sold 1-month covered calls on them for 2 months in a row, the last one ending Oct 30 & Nov 6. Then I started selling the underlying shares and replacing them with Jan 2023 calls on dips as a way of increasing exposure.

Added to that, I had some luck with my OSTK and CWH trades from a month ago … I was amazed that out of the money 1-month covered calls were selling for 13% premiums, so I bought a bunch of the underlying shares and sold calls on them. Both had some wild rides, and their covered calls expired worthless, and both had significant bumps before I was able to sell the underlying shares the following Monday. All of this was re-directed towards my gold and silver trades, so now I’m long enough to be nervous.

Some reasons behind this crazy trade:

  1. Gold in particular has a way of pulling back on the expiration of significant options expirations. A big one was on Nov 24, I was waiting for it, and I bought into it significantly both on the 23rd and 24th.
  2. December and January tend to be very good for precious metals. Stockcharts.com allows you to check the seasonality on anything, take a look: GLD | Seasonality | Free Charts | StockCharts.com
  3. There is a major re-flationary trade going on right now with base metals, energy, and value stocks soaring. I see this in two ways:
    1. If global liquidity is increasing fast enough to cause significant inflation with a weak underlying economy and record low interest rates, then there’s no way it will leave precious metals behind.
    2. If there is a deflationary shock, which would cause a selloff in all assets including precious metals, it will hit the broader economy and the debt-laden Russell 2000 companies hard. My significant put positions in IWM will ensure I have plenty of money available to invest in this outcome. I would also expect a counter-reaction by the federal reserve and other central banks, which would be good for precious metals.

In other words, I see my chances of success as high, so I have an aggressive position.

In case you need more convincing of my points above on seasonality and behavior of precious metals during important expirations, look at this chart from last year:

Here are my current positions:

  • 31.9% Gold miners, large
  • 16.1% Calls in large gold miners (Jan 2023)
  • 13.3% EQX (a junior gold miner)
  • 3.2% Calls in SAND (Gold streamer)
  • 9.8% SLV shares (ETF for physical Silver)
  • 6.8% Calls in SLV (Jan 2023)
  • 8.3% Puts in IWM (Jan 2022-Jan 2023 puts, short Russell 2000)
  • 1.9% Puts in EEM (Jan 2022 puts, short emerging markets + China)
  • 0.5% Calls in TLT (Mar 2021)
  • 3.0% Calls in CCJ (US uranium miner)
  • 5.2% Calls in BDX (US producer of medical needles and such)

Note that even though I’m significantly long, I can continue to add to the long side until all of my underlying shares in gold miners and SLV are sold and converted into long call positions. This is intentional … I am convinced that Gold moves higher but I am not convinced that anyone can pick an absolute bottom. If gold continues to turn against me, I want to be able to add to the long side – and if my IWM hedge continues to outperform, I still plan to add 1 put for every 100 points it moves higher. I am also sticking with very long duration options – the Jan 2023 ones currently – so that I can be wrong for a while and still survive financially.

Happy Thanksgiving Weekend!

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Another Crazy Week in the Markets

I’ll start with some charts:

Both the S&P 500 and the Russell 2000 are flirting near all-time highs. They really seem to be oblivious to a world of rising covid cases in both the US and Europe, both of which are lacking stimulus measures for different political reasons. The president tried to replace Fed Chair Powell with a hawk who promotes a gold standard, but lost by 1 vote (2 if you count McConnell’s last minute switch). The treasury secretary asked the Federal Reserve to end its emergency lending facilities. Our top defense leaders have all been fired and replaced. The secretary of state is officially recognizing Jewish settlements as our troops are being pulled out of the middle east and the president discusses a strike on Iran – it’s almost as if he’s trying to start a war.

The markets are in the biggest frenzy I’ve ever seen – nothing can make them go down. There’s a bull case for this too … if unemployment is rising due to a combination of people refusing to go out and local lockdown measures, and there is little to no fiscal stimulus coming, then the federal reserve will once again buy up the treasury market in force. This will cause money allocated for investments to move out the risk curve, flooding into the stock market among other things. This is primarily why I’m interested in stores of value such as precious metals – anyone looking to diversify from the stock market who doesn’t feel comfortable betting on debt with extremely low yields will continue to find these alternatives more compelling.

Gold has been relentlessly consolidating downward this week, along with the miners and silver. I strongly believe that this is a consolidation move on a strong upward trend, and it will break higher at some point. As such I’ve actually been levering up my positions. I increased my margin a bit, but I’ve also been selling the underlying shares and purchasing Jan 2023 in-the-money calls. This allows me to gain the upside of around 3x the number of shares while keeping a positive intrinsic value after a very small gain and leaving plenty of time for the move to play out. I’ll purchase my junior miner, EQX, with any extra money not used in these calls. Using this strategy, I can keep increasing exposure to the space even if prices consolidate downward throughout year-end.

Other interesting plays … I purchased a March 2021 call in TLT on Monday – expecting yields to fall as the federal reserve tries to stimulate the economy by purchasing government debt. I also purchased another Jan 2023 put in IWM when the Russell 2000 went over 1800. The funny thing with these trades is I wasn’t sure if they executed until today. I can’t focus on the markets while I’m working all day, and options contracts tend to have large bid-ask spreads. When I want to buy one, I’ll put in a purchase order barely above ask. If it doesn’t execute, I’ll go up a bit more, perhaps getting to halfway between the original bid and ask, then just leaving it there and concentrating on work. Needless to say, I’m glad both trades went through as I’m ahead on them at the moment.

My covered calls in CWH and OSTK both expired worthless on Friday. I’m leaning toward selling both on Monday. If sold at closing prices, those trades would net me about 12% on CWH and about 4% on OSTK as the options premium more than compensated for losses in share value.

Here’s where my positioning ended up:

  • 31.0% Gold miners, large
  • 6.7% Calls in large gold miners (Jan 2023)
  • 12.6% EQX (a junior gold miner)
  • 3.2% Calls in SAND (Gold streamer)
  • 12.6% SLV shares (ETF for physical Silver)
  • 3.5% Calls in SLV (Jan 2023)
  • 8.6% Puts in IWM (Jan 2022-Jan 2023 puts, short Russell 2000)
  • 2.0% Puts in EEM (Jan 2022 puts, short emerging markets + China)
  • 0.5% Calls in TLT (Mar 2021)
  • 2.7% Calls in CCJ (Jan 2022-Jan 2023 calls in US uranium miner)
  • 1.9% Calls in BDX (Jan 2022 calls in US producer of medical needles and such)
  • 10.8% CWH
  • 3.9% OSTK

Many of the changes in relative weights have to do with the volatility of the underlying – such as OSTK, which has been quite volatile.

Both Bitcoin and Etherium have been fun to watch with their enormous recent gains. Looking at the chart above, I still can’t believe I managed to pick some up in that Sept-early Nov window. I’m still in the HODL crowd though, being more afraid that after selling my holdings I’d never be able to get back in than I am about riding through a significant downside correction. The bullish case for both over the next few years is extremely compelling.

I am still quite worried about a liquidity event like we saw in mid March. That is why I have a significant amount of money in puts right now – as such an event would pull all assets down including Gold, Silver and Bitcoin. If such an event happens, I will purchase a lot of bitcoin on the pullback, but if it doesn’t I want to make sure that my long positions in precious metals more than compensate for my losses from those short positions. Good luck with your strategies, and happy trading!

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End-of-Covid trade dominates the week

15 minutes before market open on Monday, November 9, Pfizer initiated a press release saying that preliminary results showed it’s vaccine to be more than 90% effective.

Suddenly, the market dynamic shifted violently into the End of Covid Reflation Trade. The Russell 2000 value index surged along with airlines, cruise lines, concert booking sites, and others that would benefit from a quick return to normal. Stay-at-home stocks like Zoom, Amazon, Shopify and FedEx were crushed.

To many people following the markets, this trend change is somewhat surreal. It seems absolutely crazy to me that the Russell 2000 index is sitting above the all-time highs reached before the pandemic.

Stimulus in the US ran out already, and there is none on the immediate horizon. Europe is still a long way from any meaningful agreement for a Eurozone stimulus package. Case numbers are exploding in the US and Europe, followed by regional restrictions and lockdowns in both areas. Banks are preparing for record credit writedowns as lending conditions remain tight. On top of that, the vaccine still has another month of trials, requires 2 shots 3 weeks apart to work, and must be stored at -94F, so it will be difficult to spread it widely. Insider selling is at record highs, and the CEO of Pfizer sold 60% of his shares after the big press release.

I understand that the major central banks have all done a lot of quantitative easing, which means more money chasing fewer investable assets. That is why my main trade is positive exposure to precious metals. My hedge has been puts in IWM because I figured that the Russell 2000 small caps will get the least benefit from central bank easing and the most downside exposure to a rough economy. Needless to say, this week has been brutal for my holdings as IWM soared while gold miners and silver retreated.

I am very nervous about a coming correction in the markets, but there are a couple of things I keep reminding myself of:

  1. The excess liquidity provided by central banks around the world means that asset prices are set to rise. My puts in IWM are just a HEDGE so that I have money to invest IF everything tanks. They are not meant to make me rich directly. My last put was purchased at a Russell above 1700 so my next shouldn’t be until it’s above 1800 – If I keep them 100 points apart they’ll do their job without overwhelming my portfolio.
  2. Real money is made by investing in long-term bull markets. The best way to do that is to buy the dips. I am convinced that store-of-value trades such as precious metals are in a long-term bull market, so I’ve been buying the dips. During the rallies you want to keep exposure to avoid being left behind, but you also want to reduce your leverage so that you have money for the next dip.

Bitcoin and Ethereum: These are the only two crypto trades I’m interested in. Bitcoin is the Gold of the space – the ultimate store of value. Ethereum is the Silver which has some store of value components with exposure to other areas as well. Etherium lacks the hard cap on supply that Bitcoin has, but it is building into a network of smart contracts, lending, and other services to compete with banks and the swift-payment system used by Visa and Mastercard. I am way ahead on both, as my positions were accumulated mainly between September and October, but I didn’t buy as much as I wanted and I have no interest in selling them until I see how the next two years play out. Maybe I’ll buy more on significant dips, maybe those dips won’t come to the levels I’m looking for. Regardless, I see no point in recording them with my trades below.

Gold miners and Silver: I increased my holdings a decent amount this week, mainly by purchasing more EQX, but also by purchasing some Jan 2023 calls in SLV. I dipped into margin a bit to buy these dips. If they continue to consolidate lower, I will increase my leverage both buy buying more on margin and buy selling the underlying shares to replace with Jan 2023 calls. I don’t plan on being max long before it rallies, I simply plan to get a little bit longer each week if it continues to pull back.

Here’s where my holdings landed:

  • 42.4% Gold miners, large
  • 10.2% EQX (a junior gold miner)
  • 3.2% Calls in SAND (Gold streamer)
  • 14.0% SLV shares (ETF for physical Silver)
  • 1.1% Calls in SLV (Jan 2023)
  • 8.7% Puts in IWM (Jan 2022-Jan 2023 puts, short Russell 2000)
  • 2.0% Puts in EEM (Jan 2022 puts, short emerging markets + China)
  • 2.5% Calls in CCJ (Jan 2022-Jan 2023 calls in US uranium miner)
  • 2.5% Calls in BDX (Jan 2022 calls in US producer of medical needles and such)
  • 10.1% CWH with covered calls sold on it
  • 3.3% OSTK with covered calls sold on it

Note that a lot of the allocation changes are just relative prices jumping around. For example, CWH (Camping World Holdings) and OSTK (Overstock.com) were both hammered on the vaccine announcement – but CWH recovered a bit during the week while OSTK did not. My covered calls on these expire Nov 20, and I have don’t plan on messing with them ahead of that. Afterwards who knows.

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Knife juggling or mountain climbing?

The Russell 2000 soared on the open today as gold miners collapsed. I guess I’m stubborn, but I still don’t trust it.

I never felt so lucky to have a bunch of my gold miners called away yesterday at options expiration. I just bought by list – going with underlying shares rather than call options – and even dipped in the margin a bit. That NEM that was called at $67 on Friday now trades at $62.50, wow!

Stabilize your footholds & don’t look down!

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Positioning for upside while highlighting and hedging those risks

It’s been a crazy week. Frustrating in the sense that my views of the market didn’t pan out, yet good in the sense that my Ameritrade portfolio climbed nearly 5%. Covid cases erupted in the western world, lockdowns imposed in parts of Europe. Stocks went up. The stock market narratives went from a Trump win being good to a blue wave being good – with a danger scenario of a disputed election resulting in divided government. The danger scenario happened and stocks went up.

I suppose the lesson here is that you need to think about what’s driving risk assets higher and what are the risks of them crashing lower and have plans for both scenarios. My big portfolio is gold miner stocks, figuring that if central bank liquidity is driving markets and interest rates are crazy low, that is great for precious metals. Low input costs such as oil is another tailwind. If we hit a liquidity event like in March though, these will drop along with everything else. My preferred hedge at the moment is long-dated puts in IWM (Russell 2000), because these companies are hit the hardest by economic slowdowns and they benefit the least from central bank policy. Back in April and May I thought these kind of bets would make me money. Now I just think that these kind of bets will allow me to buy low if a liquidity event happens.

I’ve highlighted what’s called a megaphone crash pattern in the S&P 500. You can’t look at a chart like this and assume that it will always go up. This chart illustrates that while there are powerful forces driving the market higher, there is also an inherent fragility to the pricing system.

There are several narratives I follow which highlight this fragility:

  1. Massive central bank liquidity papering over a backdrop of insolvencies and real economic damage. This pushes the problem into the future while making it bigger by driving debt levels ever higher. The higher debt levels get, the greater the underlying demand becomes for currency such as US Dollars to service them.
  2. Passive investing strategies have driven momentum investing to a whole new level. These strategies increasingly pushing investors to concentrate ever more money into a small number of large stocks at any price – ironically in the name of diversification. These cash-rich tech stocks tend to have large stock buyback programs, reducing the number of shares in a backdrop of relentless demand for those shares from enormous funds such as SPY and QQQ. As these share prices go up, the market cap of these companies grows relatively higher, and market-cap weighted funds like SPY and QQQ must allocate even more money to those stocks. This poses a problem when cash flows reverse, as the same forces pushing the big gainers higher reverse to push the big losers lower. A relatively small amount of “buy the dip” investors are the only real backstop preventing a larger market drawdown when this happens.
  3. The options market has grown larger than the stock market for the first time. This has strange effects, as market-makers dynamically hedge their risk in selling these options by essentially chasing the trend. If an options dealer has exposure to say $100 million of TSLA calls expiring in 1 month, and the share price jumps 10% putting them “in-the-money”, they have to purchase a lot of shares to make sure they can hand them over for the strike price when the options expire – pulling the market higher. If the share price then drops 10% below the strike price, these dealers have to sell a lot of shares to reduce the risk of losing money on the underlying stock – pushing markets even lower. Essentially this is another force which magnifies market moves to the upside as well as the downside.
  4. At the same time, extremely low interest rates push investors out the risk curve, and drive more funds to use “leverage”, or borrowed money, to enhance investment returns (CALPERS recently started doing this). This leads to an environment where dollar demand can become extremely large if asset prices fall as a firm like CALPERS must sell anything it holds to reduce its leverage. The simple version: it borrows money to buy stocks, the stocks fall in value, then it is required to sell stocks to pay back that some of that debt. When this happens, large entities that need those dollars will sell anything they can, typically dumping whatever went down the least. This causes everything to lose value together including gold, bitcoin, growth stocks, value stocks, utilities, and bonds.

The forces I describe above are very real and somewhat scary. I bought a couple more IWM puts this week, this time expiring in Jan 2023.

Here’s where my portfolio ended up:

  • 8.5% Unallocated cash
  • 9% Bitcoin
  • 1.5% Etherium
  • 28% Gold miners, large (covered calls expire Oct 30 or Nov 6)
  • 8.5% EQX (a junior gold miner)
  • 3.6% Calls in SAND (Gold streamer)
  • 13.5% SLV shares (ETF for physical Silver)
  • 8.1% Puts in IWM (Jan 2022 & Jun 2022 puts, short Russell 2000)
  • 2.1% Puts in EEM (Jan 2022 puts, short emerging markets + China)
  • 2.2% Calls in CCJ (Jan 2022 & 2023 calls in US uranium miner)
  • 2.1% Calls in BDX (Jan 2022 calls in US producer of medical needles and such)
  • 9.3% CWH with covered calls sold on it
  • 3.6% OSTK with covered calls sold on it

With all of the risks I described above, I have to keep telling myself – the bull market in precious metals is very real. The IWM puts are only there to make sure I have money to allocate there if a real buying opportunity – aka a market correction – emerges. If markets correct downwards for reasons I outlined above, the response from central banks will be enormous and precious metals will soar back up.

I lost my holdings in NEM as the covered calls expired in-the-money yesterday. Overall it was well worth it, as I sold the calls for $2.50/share and they ended up only $1.25/share over the strike price. That is the only reason my gold miner allocation plummeted and my cash soared. I did purchase more EQX though.

I have been thinking a good deal about how best to rebuild my exposure though. Covered calls are out because I expect that the consolidation in gold and silver is coming to an end, and I want that upside. I could buy call options … I tend to prefer long duration and in-the-money, like the Jan 2023 $55 strike calls in NEM which have an intrinsic value gain above $75/share. I could also buy the underlying stock and sit on it for a bit. I’ll probably do some of both. As for which miners to focus on, I simply pick the top 4 holdings of GDX which is GOLD, FNV, NEM & WPM. It’s like buying the FANG stocks instead of bothering with SPY or QQQ – that is where most of the money will concentrate and I have no management fees.

Note on Bitcoin and Etherium: I’m going to remove my allocations there in future posts. This does not mean selling them. The reason is this … when I manage my Ameritrade account, I can calculate that I have a 4.5% gain this week – but that doesn’t include anything in my Coinbase account or any of the physical gold and silver I have stored. I’m going to start treating both the Bitcoin and Etherium as I do physical gold and silver – a side holding rather than a trading asset. These are unique assets which I can hold for years without touching.

Crypto investors have a term for those following this approach called HODLers, from a mis-spelled “hold” call which became affectionately known as “hold on for dear life.” I effectively consider myself a member of the HODL community as Bitcoin soars. Unless I desperately need the money, the one thing that will lead me to liquidate these holdings is the appearance of high real interest rates like you saw in the early 1980’s.

Mind those downside risks, but don’t overallocate to hedges – if the market goes up through the end of the year and you lose money overall, then you’re doing it wrong. Good luck and happy trading!

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