June 2005

We had bids in below the market Friday for some QQQ calls, but perhaps we shouldn't be too disappointed about not getting filled. The July 37s were trading for 2.00 apiece earlier this month and for 1.40 as recently as Thursday, but as the index tumbled yesterday toward an abysmal close, the July 37s came within 0.05 of our stingy 45-cent bid. When stocks are falling hard on a Friday, call premium can evaporate with frightening speed, especially for those who own them. And yes, you're right, it can be a helluva a lot easier to make money being short options than trying to scoop them up at bargain prices in hopes they'll double before time decay wins the game, as it very often does. However, because of the punitive margin requirements governing naked-short positions held by retail customers, I never, ever recommend option strategies that would leave subscribers net-short contracts. Instead, we look for our edge at swing points, attempting to buy puts at rally tops, calls at swing lows. Ideally, those who hold puts and calls will be at the point of despair when the stock is topping or bottoming, and they will sell us options not at fair value, but at distress prices. (Click to enlarge) A Winner in Gold Speaking of swing points, we had a fine winner in Comex August gold, which danced on our hidden pivots Friday (see chart above) with the precision of an Astaire soft-shoe. Here are the instructions I put out the night before, for those of you would like to retrace the steps for practice: 'August Comex Gold is accelerating toward a 447.70 rally target first broached here more than a week ago, when the futures were trading below 437. The target has a 60 percent chance of being reached

Investors supposedly were spooked by rising oil prices yesterday, but a glance at the chart below could make one wonder why they weren't just as spooked last Friday and on Monday, when crude quotes first brushed against the $60 threshold. Wall Street denizens must have missed the previous day's interview of Andrea Mitchell, aka Mrs. Alan Greenspan, on Imus in the Morning. 'No one expected $60 oil to have no impact on the economy,' the NBC reporter told Gotham's number one shock jock, presumably voicing sentiments shared by her husband. 'It's a demand shock and not a supply shock, and people are happy to pay and keep going.' Reading between the lines, one could plausibly infer that the Fed is not as worried about rising gas prices as the average motorist. Not that the prospect of paying $2.50 for a gallon of regular this summer has kept me awake. The effect on my household has been muted so far and comes down to this: 'Honey, why don't you take the little car?' But I have to admit, if gas prices in the U.S. were to rise to levels comparable to Germany's ' about $6 a gallon now, I am told ' I might not be so blas�. 'Honey, if you're only going to Safeway, could you please take the Schwinn?' Even in Boulder... No way to preserve peace in the household for sure -- even here in Boulder, where those who ride bikes to work are viewed as local heroes. Some serious biking goes on hereabouts, for sure, and if you drive anything bigger than a Subaru Outback you're considered a fat cat. Fortunately, for trips into town, I've got an eight-year-old Nissan compact that puts out about as much torque as an arthritic hamster's treadmill. Just the car for

I majored in English literature, one reason why my trading system is light on such quantitative tools as regression analysis and chaos theory. Even so, I'm unaware of any other system that consistently yields swing points more precise than the hidden pivots I serve up here each day. The propietary method I use is idiosyncratic to the extent it employs mainly pattern-recognition skills and other right-brain tricks to interpret stock charts. I've considered automating my forecasts and trading by way of a rules-based system but have been told by my friend Mike Barna that the end result would probably not improve on the laboriously achieved results I'm already getting. Mike is arguably one of the world's most skillful and successful trading-system developers. He and his partner John Ehlers have developed and marketed numerous commercial systems that continue to dominate FuturesTruth magazine's 'Top 40' rankings. One of those systems, R-Mesa, is an index futures-killer whose capabilities have evolved to the point where Mike and John no longer sell it but instead partner with institutional clients for a percentage of trading profits. No Holy Grail Mike has been hard at work lately developing a very powerful system that he says will encompass and supersede thousands of other trading systems he has developed over the years. Still, he does not claim to have found the Holy Grail, for even the most profitable systems need to evolve as market conditions change, as do the hand-wrought strategies that I bring to you each day in Rick's Picks. At some point, I hope to be able to offer you algorithmically generated trades. Their main advantage would be to greatly expand the number of issues I can track and trade. For now, though, other format changes are in store that will emphasize detailed and specific trading advice over

Just when you think things couldn't get any duller� This time, though, technical signs are mildly disquieting, perhaps warning that we should be on our guard. But against what? I refer you to the chart below, which shows that the DJIA's funereal rally over the last two weeks has left stochastic tracks that look even more somber than the mournfully ascending price bars that created them. This is a bearish divergence relative to vital signs generated in late May, and although it would take only a modest three-day rally to cure the condition, it could just as easily turn hellish if even a wee bit of softness creeps in over the next two days. (Click on chart to enlarge) No matter how this divergence is resolved, though, there's no getting around the fact that buyers seem to be losing enthusiasm with each uptick in the average to marginal new highs. Ordinarily, I'd say let's buy some QQQ puts just in case. But we've died with them before, and besides, technically speaking, the QQQs don't look so bad. My hunch is that neither buyers of puts nor calls will make money this summer, even if a punitive whoop or a swoon for a day or two temporarily pins naked option sellers by the ears. More immediately, perhaps serendipity will bring us opportunity during today's real-time Q&A session. In any event, I will look to you, valued subscribers, for fresh inspiration. &&& Time Out for Repairs I'm having a torn ligament in my wrist surgically repaired on Thursday, so there will be no Friday edition of Rick's Picks. If I'm not too doped up I'll try to put out a tradable recommendation intraday.

With summer narcolepsy beginning to infuse Wall Street like embalming ether, we'll turn our attention once again to the far more interesting topic of the housing bubble. The bubble surely exists, no matter what anyone says to the contrary, but one wonders whether its inevitable collapse is being delayed by anticipation itself. Anyone not from Mars will have noticed by now that the mainstream press has been devoting more and more ink to the subject. Just last week, USA Today splashed its money page with a feature on how owners of high-priced real estate can 'cash out' before the crash. And the staid Economist, rarely given to sensationalism, believes 'the whole world economy is at risk�the biggest increase in wealth in history was largely an illusion.' True enough, as any economist who hasn't forgotten what he learned in college could tell you. But one suspects that it could take a while, and some genuinely hard times, for the illusion to lose its power over an American middle class with so many material blessings to count. For the time being, though, with mortgage rates down near 5.5%, and 0% balance-transfer offers arriving in the mail regularly, it seems unlikely that the economy is going to run out of gas in a mere month or two. To be sure, we have probably seen a peak in discretionary spending, as well as in GDP growth. However, the real damage will come when consumers drastically curtail buying out of fear the economy is sinking. Not right now, though. With money still relatively loose, and the dollar's buying power waxing in global markets, the economy-chilling kind of fear will probably remain in remission at least till autumn. No Illusions Regardless, we shouldn't allow ourselves to fall sway to the illusion that the Fed has tight control

It was morning in America on Friday for the home-builders, whose shares all gapped higher after a creative analyst at Smith Barney came up with a hitherto unsuspected reason why we should still be bullish on the housing sector. According to the analyst, Stephen Kim, home builders could handle a downturn in the housing market because sales of existing homes would bear the brunt of the decline. We're not buying it, not one bit, but even so, we got a piece of the action when six home builders on Smith Barney's short list took flight Friday. We just happened to be long some June 60 Beazer Homes calls that I'd already declared brain dead, kaput. They cost us just 0.15, and you could have bought all you wanted for 0.05 in the days before they expired. But before going to their reward on Friday, the calls traded as high as 0.95, more than six time what we paid for them. Without a doubt, we have housing-stock bears to thank for our good fortune, since the rally was a picture-perfect short squeeze the whole way -- far more powerful than occurs when it is mere wishy-washy bulls who are doing the buying. Not that shorts would be much consoled to hear this, but they hardly acted like the proverbial greater fools. For each and every reason some retail analyst can come up with to buy the likes of KB Homes, Hovnanian, Meritage, Ryland, Pulte and Beazer, there are at least three even better reasons to fade the rallies in these stocks, especially extreme rallies such as Friday's. And so we did, buying some August 35 puts in D.R. Horton a nickel off their intraday lows. The puts had gained 25% by day's end -- perhaps because Horton, alas, did not make

Gold quotes rose sharply yesterday, supported by heavy fund buying that included a million-ounce purchase by one player. I'd told you to expect a rally to at least 436.80, which is precisely where the August Comex contract topped before taking a 90-minute breather. A subsequent two-dollar retracement left the futures sufficiently recharged for a further push to 438.50, portending still higher prices over the next 5-7 days. If so, you can use the 447.80 target disseminated via bulletin as your minimum upside objective. I also provided a 'Hallelujah, brother!' target well above this objective if it is breached decisively. The exact number, a hidden pivot, is given in the Intraday Notes section of Friday's edition, so check it out if you want something to feel good about. There are other reasons as well why gold bugs should take encouragement from yesterday's surge. For one, the rally dramatically exceeded a hidden pivot that had been two weeks in coming. Although it was not a major pivot, neither was it an insignificant one, and the fact that it gave way in a mere two hours came as a bit of a surprise. What this suggests is that buying interest is unlikely to peter out soon, even at moderately higher prices. No less bullish was the speed with which the 436.80 target was achieved. I had expected the ascent to take from four to six days, but it took only one. And here's one more thing to consider, perhaps the most bullish factor of all: June's rally from lows near $416 has occurred at a time when news concerning inflation has been relatively benign. All of which gives us good reason to be optimistic. But I would caution against getting too revved up, since we've been disappointed more than a few times before.

My recent comments on deflation have prompted some interesting responses. Here's one from Gary Tanashian, proprietor of www.biiwii.com ('Not bullish or bearish, just dealing in what is!'). 'I couldn't agree more with most of the ideas put forth, and I am one of those inflationists. I think those of us talking about inflation or hyperinflation, at least those who bother to think out the details, know that the whole argument revolves around how we get to our final destination, which is of course a deflationary reckoning of levels of excess layered one over the other for decades. [Those 'levels of excess' include a derivatives market valued at over $200 trillion ' an outlandish sum when you consider that global GDP amounts to less than $40 trillion per year. RA] 'In my view, the inflation game is played against the deflationary impulse or need to correct. It is the Fed and other forces pushing on a string, and one day they will find the string simply goes limp and all the inflated chickens will then come home to roost. [I agree, of course. Credit cannot expand unless there's an asset that can be used as collateral, and we've pretty much exhausted the big one: real estate.] The 'Good' Deflation 'I am a friend of [a well-known guru whom you also know], so you may guess where some of my influence comes from. But also, I am a manufacturing guy, and I have witnessed productivity first hand in the form of automation and other progress through technology and ideas. The crux of the way I see things is that deflation (at least in capital flowing to the US manufacturing sector) has been a good thing, driving progress and productivity; but it has been perverted in recent years/decades to the point where it

Monday's edition featured the thoughts of fellow deflationist Mike "Mish" Shedlock, who believes as I do that this world is far too deeply in hock to avoid a debt deflation. Mish covered a lot of ground in explaining why this is so, but I'd like to add my two-cents' worth, since he left a few things unsaid that could affect all investors ' even financial geniuses like George Soros and Warren Buffett. Speaking of whom, both supposedly have been positioned to profit from a weak dollar -- a strategy that has not worked out very well this year, to put it mildly. In the last quarter, Buffett took a reported $310 million hit on a $21 billion short-dollar position. That's chump change by his standards, but to paraphrase the late Sen. Everett Dirksen, a hundred million here, a hundred million there, and pretty soon you're talking real money. Even worse for Buffett, the dollar's rise has steepened considerably since. Given his propensity to take the long view, we shouldn't be surprised to learn at some point that he increased the size of his bet since it was last estimated. But what do we make of the fact that world's second richest man, known mainly as an equities investor, has gone outside of his bailiwick to mix it up in the currency game? And how do we regard this legendary contrarian's aggressive shorting of the dollar at a time when nearly everyone else hates it as much as he does? False Bottoms Well, I've always said that when deflation finally arrived it would be tough for investors merely to survive, much less prosper. But I had assumed all along that the big fortunes would be lost on the way down because bargain hunters were unable to imagine how much lower prices were yet to fall. We saw this happen during