November 2007

Given the stock market's remarkable surge the last couple of days, anyone reading only the headlines might get the impression that all our economic troubles were behind us ' the mortgage crisis, falling home prices, dark clouds of recession, the sickly dollar, etcetera. Alas, all of those problems are still very much with us and growing, even if Wall Street's wildly exuberant behavior would seem to suggest strongly otherwise. But what's a headline writer supposed to do? Probably no parabolic stock-market rally in history has ever been properly described as having resulted from a massive short-squeeze. And yet, that is precisely what caused shares to explode yesterday against the most depressing economic backdrop since Americans queued for blocks to buy gasoline in the early 1970s. (Click on chart to enlarge) What triggered the buying panic was a dovish speech by the Fed's vice-chairman, who acknowledged that the credit markets have deteriorated dramatically since the last round of easing. Now, we doubt there is anyone on earth who is so stupid as to believe that another rate cut, even a big one, is going to transform a rapidly deflating $13 trillion economy into a booming one ' and, make no mistake, it will take no less than the rekindling of a full-blown housing boom to merely nudge consumer spending up to levels that would allow us, yet one more time, to dodge the bullet of recession-or-worse. Why the Frenzy? So if no one actually believes easing will accomplish much ' other than, perhaps, to accelerate the dollar's destruction ' then why were buyers whipped into a frenzy yesterday on the NYSE? The answer is that they were buying simply because they recognized that none of their OPM-churning colleagues would be able to suppress the buying reflex in the face of a

Think there's a chance the Dow Industrials will be trading at least one percent lower a couple of months from now? So do we. Now suppose someone was willing to give you 5-to-1 odds that it won't happen ' that the Dow will be at current levels or higher come late January. Would you take that bet? Of course you would. Now, you're probably wondering who besides Abby Cohen or Larry Kudlow would take the other side of such an idiotic bet. Probably no one. But you could still get 5-to-1 odds by buying put spreads based on the prices reflected in the table below. It shows bid/asked quotes for January put options on the Diamonds as of yesterday's close. The Diamonds, a trading vehicle that mimics the price action in the Dow Industrial Average, were trading for 129.32, about a tenth of the value of the actual cash Dow index. Here's how you could have placed your bet. With the Diamonds at 129.32, the DIA January 129-128 put spread was offered for 0.60. This means you could have bought a 129 put on the offer for 4.35 and shorted an offsetting 128 put on the bid for 3.75. Your net cash outlay would have been 0.60, or $60 per spread. Now let's roll the calendar forward to January 21, when the options expire. With DIA trading 128 or lower ' a drop of one percent from current levels -- your $1 vertical put spread would be worth 1.00 ($100). Your profit would be $40, but that would be no great shakes considering you risked $60 to begin with. Improving Your Odds But suppose you were able to buy the put spread at a better price. Look at how even a slightly better entry will enhance your odds. You would want to

The stock market's lazy drift lower turned ugly in the final hour yesterday, demonstrating once again that the Santa factor is no match this year for investors' unusually severe jitters. The Yuletide effect should have been working at full-strength, given that weekend shopping reports were quite upbeat. (We're not sure whether to believe these reports ourselves, since, although the local mall looked crowded, retailers at the higher end appeared to be deserted.) Shopping estimates aside, the pundits attributed the selloff to credit market woes -- which is like attributing snow to cold weather. The most disturbing fact concerning these 'woes' is that there is no logical end to them. Granted, things always look darkest before the dawn. But in this case, we think that the financial and economic troubles that have surfaced so far are going to look like relative rays of sunshine compared to what's coming. Still worse is that the problems seem to be growing deeper and more menacing each day, notwithstanding the fact that Bernanke, Paulson et al. remain officially unconcerned about whether recent credit easing will suffice to turn things around. Ohio Lawsuit Since you are not going to hear this from either one of those guys -- nor from CNBC, at least for a while -- let us mention the Ohio lawsuit now making its way toward the U.S. Supreme Court. It seems that Deutsche Bank tried to foreclose on 14 homes in Cleveland when the residents living in them failed to make timely mortgage payments. Unfortunately for the bank, it could not produce documents showing it had legal title to the properties. Such are the complexities nowadays of a financial system that long ago decoupled from the actual risks of lending. We are going to be hearing quite a bit more about this story in

Extremely light volume allowed DaBoyz to plump up stocks during the traditionally brain-dead-but-buoyant post-Thanksgiving Friday. The short-squeeze added 182 points to the DJIA, recouping exactly half of the losses sustained earlier in the holiday-shortened week. However, we were wholly unpersuaded of the rally's sincerity, and found ourselves bidding for some December 129 Diamond puts a minute before the final bell. Alas, there were no sellers of these puts sufficiently despairing to dump them into the thieving hands of market makers who had thoughtfully advertised a fire-sale bid of 2.95. It would seem that even on so-called Black Friday, brazen opportunism has its limits. (Click on chart to enlarge) We should confess that our futile attempt to buy put options ahead of the weekend was more emotional than rational, since, as you can see in the chart above, the Diamonds created a bullish impulse leg in the final minutes of the session. This they did by slightly exceeding a 129.64 peak that had marked the intraday high on Wednesday. This small but not inconsequential feat is properly interpreted by the disciplined trader as bullish for the very near-term, even if in our heart of hearts we decided to give it a sneering thumbs-down. One reason we were feeling conflicted was that the dollar had touched a new post-War low earlier in the day. While this seems to have registered only dimly on Wall Street if at all, it was reason enough for us to infer that the world's financial problems are not likely to melt away between now and Monday morning. (Note: Since the Dollar Index's nascent rally on Friday holds potentially very important implications for stocks, energy resources and precious metals in particular, you should consider Monday's Touts as a must-read.) A Red Herring Speaking of global financial problems, the gathering debt contraction is almost palpable

December Gold turned sharply higher yesterday, trampolining $25 from an overnight low that lay within just four ticks of our downside target, a Hidden Pivot. Subscribers will recall that we were expecting the correction to go a bit further last week when the futures were hovering around $793, down $55 from a high of $848. Here is the advisory exactly as it went out intraday via the Bulletin Launcher and the chat room: 'It's now possible (and logical) to project downside to at least 772.90 for this correction. If there is going to be a struggle between bulls and bears over the next 2-3 days, though, it will be near the CD midpoint, 796.10. The struggle we alluded to did occur, but only for a relative moment last Friday, when the December contract was briefly quoted as high as 798.40. But it was downhill thereafter -- until yesterday's dramatic turn -- and although the actual low at 773.40 was a few ticks above our target, it was close enough that several subscribers evidently caught the bottom for a lovely ride. 'I entered one contract at 773.60 last night, a dime above the low,' wrote one longtime Rick's Picks subscriber, Phil D. 'Nice work, but I'm still not sure I expect much from gold at this point so keep us posted on all pivots for both entry and exit.' And so we did. With the futures trading yesterday near 795, we put out a bulletin suggesting that profits be taken on half of any long positions at that time. We also recommended a trailing stop above 798.40 and furnished a minimum rally target at 802.80. That last number, a Hidden Pivot resistance, was slightly exceeded in the final minutes of the regular session when the futures pushed to an intraday high

Yesterday being the Monday before Thanksgiving, we arose with expectations of the Dow opening a hundred points higher on a gap, then tacking on another hundred points as bears struggled to extricate themselves from the trap. Lo, the Indoos plummeted from the opening bell and were down as much as 300 points by mid-day. An apparent contributing factor was a downgrade of Citi shares by some bean counter at Goldman Sachs. The intrepid analyst spooked the Street with a prediction that Citi's rapidly metastasizing losses may hit $15 billion over the next two quarters. We're pretty sure that that estimate, too, will fall far short of the damages yet to be told.  Perhaps by then Citi will not be getting all of the attention, since there must be at least a few more other very large banks with problems of a similar magnitude. Good thing investors evidently were not thinking about those other banks yesterday, for if they had been it's possible the Dow would have fallen by 1,000 points rather a mere 218. And how unThanksgiving-like would that have been? We still expect a strong rally this week, but maybe we're just being paranoid? We hold short positions in two stocks at the moment, including some put options in Citi that we partially hedged yesterday by buying some shares near the lows. This 'backspread' position will automatically make us shorter if the stock continues to fall, or longer if it rallies, since that is the way backspreads work. The tradeoff is that the options are getting whittled away by time decay. The Little S.O.B. We can live with that as long as Citi continues to plummet, but we will also look forward to shorting the little sonofabitch whenever it embarks on one of those doomed-but-fleetingly-credible rallies that make bear markets such great sport. It is hardly a

When our bird flu correspondent, Erich Simon, is not immersed in the potentially world-ending details of the pandemic, he sometimes likes to tote up the ways in which gold bugs could eventually profit from the behind-the-scenes maneuvering of bankers and their Friends in (very) High Places. Some might think Erich paranoid for ascribing so much power to one firm in particular, Goldman Sachs. But even if Goldie does not in fact run the world, there can be little doubt that they have the kind of incestuous ties to big government that most lobbyists would kill for. By Erich's reckoning, bullion investments are not likely to disappoint over the long run. More immediately, though, he sees a cap on the price of gold that will be lifted only when Goldman et al. are 'over the hump' of the financial system's present duress. Here's Erich: 'I mentioned to you earlier that Bernanke shows his hand when he stutters. During his recent appearance before a joint Congressional panel, I was somewhat surprised by which subjects caused him to stutter and which did not. I was also pleased that his stuttering may be telegraphing some bargain-hunting opportunities ahead in gold. 'According to Bernanke there are 450,000 mortgages resetting every quarter extending through the end of next year. No surprise there. Many of these are doomed to foreclosure. On this point Bernanke's voice was all a-stutter. He then went on to speak about 'growth' in the domestic economy, and on this point his voice went beyond a stutter. It shook. The deflationary implication is now obvious. Curiously, on the subject of our huge trade deficit, his voice did not stutter. And when Ron Paul admonished the Fed Chairman about the dollar's collapse, Bernanke literally wiped his nose with his index finger. The look in his eye was

Someone mentioned in the Rick's Picks chat room that our old friend Jon Najarian ' 'Dr J' to all of Chicago ' estimated that bears had covered only 25 percent of their short positions at Tuesday's giddy highs. If so, we can expect the markets to remain vulnerable to the kind of take-no-prisoners short-squeeze that occurred that day. Face it, no one is so stupid ' not even Larry Kudlow ' to be buying stocks at these levels simply because he 'likes' the market. The country is in incipient recession, the banks have only barely begun to acknowledge their CDO losses, and the whole debt pyramid is trembling because the players are clueless as to the ultimate value of hundreds of trillions of dollars worth of highly leveraged securities. Under the circumstances, only a bear caught in a short-squeeze could find a compelling reason to buy shares. (Click on image to enlarge) In the meantime, when discussing our financial woes, the usual experts have acknowledged only the tip of the iceberg ' i.e., that it is impossible to know for certain how much a mountain of soggy subprime paper is worth. But surely even these bozos know that nearly all debt paper has been similarly encumbered by leveraging schemes so esoteric as to verge on the metaphysical. We suspect that even Joe Investor's lowly passbook account has been multiplied in ways that would make it impossible to determine what might remain of it after the inevitable meltdown occurs. Follow the money trail and you might discover that Joe's paltry savings have been pledged 20 times over by some Master of the Universe who makes his living selling synthetic put options on Bolivian reverse floaters. Epochal Con-Game Putting aside the unsettling implications of this epochal con-game, we can be fairly certain

In the past week, Rick's Picks has been monitoring the put options of a stock that looks extremely vulnerable to an economic downturn. Because we are convinced the U.S. has already entered a recession, our goal has been to accumulate puts in this stock, and perhaps others in its group. Yesterday the stock took a dive near the end of the session, but the puts actually decreased in value. How can this be? someone in the chat room asked. In all too many instances such anomalies can be traced back to some sleazy brokerage firm that is front-running its own customers. For instance, if the firm has a customer who is trying to unload a million shares of XYZ stock, it might try to sell calls or buy puts ahead of the transaction. Sometimes the broker will do something even shadier, briefly bidding up the price of XYZ so that, with the million-share offer hidden from view, the stock looks stronger than it actually is. Then, with XYZ artificially pumped up, the broker will short a ton of calls, or buy a ton of puts, or both. That's how money is made on Wall Street, folks. (Click on table to enlarge) But in the instance yesterday that some chat-room regulars found so baffling, there may have been no such skullduggery involved. The options in question were out-of-the-money puts with a strike price of 70. Notice in the upper right-hand corner of the table that the open interest in these puts is 24,628 contracts. That is far more than all of the other strikes combined, except for the 80 strike, in which there are 24,935 contracts currently in play. Notice as well that puts at the 70 and 80 strikes traded almost identical volume on Tuesday -- a little more than