Man Is His Own Worst Enemy

By: Captain Hook | Mon, Jun 16, 2008
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The following is an excerpt from commentary that originally appeared at Treasure Chests for the benefit of subscribers on Thursday, May 22, 2008.

Below is information that may have benefited you over the past few weeks. But make no mistake about it; messages contained below are not past their usefulness. So, read carefully, where it is our sincere wish one might take something of value away with you here today.

Man is his own worst enemy - this truism has proven itself over and over in history - and is doing so once again in our handling of economy. As you undoubtedly know the consumer is on the ropes and in need of relief due to excessive credit. True to form however, and consistent with our title today, just when this is happening, commodity prices have lit-up, and are showing no signs of retreat, especially energy prices. This has created a very big problem for central planners they can actually identify within their incompetence, that being, in order to tackle the effects of inflation, they will genuinely (a few choice words in the Fed Minutes won't do the trick) need to show fiscal restraint, or crude oil will go to $200, the dollar will break 70, and it's hyperinflation here we come.

Of course with the economy looking so perilous, the orthodox view is commodities are bound to feel the weight of water soon, with prices to follow lower. As you know, this view has proven to be expensive up until now, with the big question being why? Other than the fall of the dollar ($), which doesn't seem to matter much now anyway when it comes to crude, why are commodity prices rising given future prospects in the economy appear bleak, along with True Money Supply (TMS) growth rates suggestive future prospects are not good? Some hypothesize it's the lagged inflation between the mid-90's and 2003 that is causing prices to rise now. And of course in previous similar instances, history has proven this to be the case.

In speaking specifically about crude now however, and its unrelenting rise into increasingly deteriorating economic fundamentals, I can tell you categorically it's more than the above, or peak oil, or growing demand out of Asia. And please, don't get me wrong, these positive factors / fundamentals will definitely continue to play important roles in pricing crude. Further to this, it should be understood that the price of liquid oil, our most vital commodity that becomes increasingly scarce every day, will need to rise in order to cut the population off from access to it. And that is what is happening right now due to a combination of all factors mentioned above, and more, that being a speculative mania. Again, man is his own worst enemy.

Taking this a step further, because conventional world wars that wipe out sufficient numbers to fix this problem are not palatable given the supposed sophistication level of people today, oil is being priced up to accomplish the same end via an economic war of multidimensional complexity. For the 'haves', this is not a war defined by geography, but by investing acumen, at least for the time being. That is to say, while armed conflict over access to increasingly scarce resources may not appear likely at this moment, this may change, as times get tougher. A desperate man has little to lose.

It's important then to understand that failure to adapt to this condition could prove fatal financially, which again, is the whole idea as it pertains to the masses. And I'm sure most will agree the current run-up in crude prices is accomplishing this, with increasing large percentages of the world's population being cut off from not only energy in a direct sense, but also, all that cheap energy provides. (i.e. food, water, employment, etc.) Moreover, it's important to understand that this is a condition that won't go away anytime soon, even when economies are buckling.

But are economies really buckling from the weight of a rapidly rising crude price? Sure, stocks have turned lower and gold higher, but how can we be sure these are not just temporary conditions? What's more, why does crude keep rising if this is the case? Is demand destruction defunct, as opined the other day? No, demand destruction is not defunct, but neither is speculation - speculation that if crude / commodities are topping out, then it makes a great deal of sense to short oil (and its related equities), along with precious metals, and go long the stock market.

And this is exactly what stock market speculators are doing these days, as reflected in open interest put / call ratios on US indexes falling hard. As you will see below, speculators are now bullish on the S&P 500 (SPX), bearish on oil stocks, as measured by the Amex Oil Index (XOI), and increasingly short gold stocks as well. After all, if commodity prices are to fall because they are overbought, gold prices are surely to do the same to reflect this condition, or so the orthodox thinker would believe. So, speculators are betting that way these days, where generally investing has become more like a trip to the casino than anything else.

Here are the open interest put / call charts for the above, showing a surge in optimism reflected in plunging SPX values, displayed first: (See Figure 1)

Figure 1

pThe XOI is second, showing speculators are the most bearish on energy shares in two years based on this measure: (See Figure 2)

Figure 2

pThe third is the Spiders Energy Select Sector ETF (XLE:AMEX). I am showing this because as opposed to the XOI, investors are getting increasingly bullish over here. The other thing you should know is as opposed to the XOI, XLE has a large open interest, which is better reflective of sentiment. This of course does not mean energy shares will fall apart however, because I went in and looked at the options configuration on XLE, and a floor has been set at 85 until the July contracts expire, so prices should remain buoyant until then. Here's the chart: (See Figure 3)

Figure 3

And the Philadelphia Gold And Silver Index is fourth, where as per our insights above, speculators are becoming increasingly bearish, which is fuelling the squeeze in precious metals shares. The best structure for your portfolio right now is to be increasingly long precious metals at the expense of energy given the Gold / Crude Oil Ratio is setting historic lows: (See Figure 4)

Figure 4

So, as you can see above, betting conditions are shaped around the view commodities are topping, which necessarily means stocks should rise to crazed speculators. And this mindset is defining inter-market price action. That is to say while fundamentals definitely play a role in the markets, like a falling $, speculative betting practices are an equally big factor in driving price action these days, with the mania de jour being in crude oil, and it's related equities. As discussed the other day though, it's important to understand that although the crude market will need to correct a manic move higher at some point, because of inelastic bullish fundamentals, it's always difficult to discuss oil in terms of it being in a 'bubble'. Thus, while there may be a mania in the pricing mechanism right now, oil is essential to our survival and increasingly scarce, which makes pricing inelastic. This is the point the market is proving right now, along with pricing a bunch of people out of the survival game.

Unfortunately we cannot carry on past this point, as the remainder of this analysis is reserved for our subscribers. Of course if the above is the kind of analysis you are looking for this is easily remedied by visiting our newly improved web site to discover more about how our service can help you in not only this regard, but also in achieving your financial goals. For your information, our newly reconstructed site includes such improvements as automated subscriptions, improvements to trend identifying / professionally annotated charts, to the more detailed quote pages exclusively designed for independent investors who like to stay on top of things. Here, in addition to improving our advisory service, our aim is to also provide a resource center, one where you have access to well presented 'key' information concerning the markets we cover.

On top of this, and in relation to identifying value based opportunities in the energy, base metals, and precious metals sectors, all of which should benefit handsomely as increasing numbers of investors recognize their present investments are not keeping pace with actual inflation, we are currently covering 69 stocks (and growing) within our portfolios. This is yet another good reason to drop by and check us out.

And if you have any questions, comments, or criticisms regarding the above, please feel free to drop us a line. We very much enjoy hearing from you on these matters.

Good investing in 2008 all.

Special Note: All chart panels above were provided courtesy of Schaeffer Research.



Captain Hook

Author: Captain Hook

Captain Hook

Treasure Chests is a market timing service specializing in value-based position trading in the precious metals and equity markets with an orientation geared to identifying intermediate-term swing trading opportunities. Specific opportunities are identified utilizing a combination of fundamental, technical, and inter-market analysis. This style of investing has proven very successful for wealthy and sophisticated investors, as it reduces risk and enhances returns when the methodology is applied effectively. Those interested in discovering more about how the strategies described above can enhance your wealth should visit our web site at Treasure Chests.

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