There are a few times every decade where I believe you can easily spot oversold conditions in the stock market. The uncertainty over the currency markets, the direction of the Fed and geo-political terrorist concerns have caused many investors to take losses and watch from the sidelines. The oversold condition of the market has created a few splendid purchasing opportunities.
Since I primarily watch technology and gold stocks, I have come up with what I believe will be a highly profitable strategy in the short-term (1-3 months).
In technology, I watch several semiconductor stocks and currently none appear to be a better value to me than United Microelectronics Corporation (NYSE:UMC). UMC is the world’s second largest outsourced semiconductor fabricator. Global demand for outsourced semiconductor services is growing. Sales and margins are up at UMC, yet the stock is down and appears to be marching toward its 52 week low of $2.68. Looking at UMC’s June sales we can see that sales have improved 32.94% compared to the same month a year earlier. I don’t see sales dropping at all as we approach the holiday season. In fact, I expect demand to reach record levels as the consumer electronics industry gets ready to launch a bevy of new technologies.
2006 heralds the introduction of the new High Definition DVD formats, HD-DVD and Blu-ray. Investors should take note that standard definition DVD was the most successful consumer electronics technology category of all time. DVD technology sales far eclipsed that of VHS, Walkmans, MP3 Players and everything else before DVD.
It’s an exciting time for outsourced semiconductor companies like UMC that rely on electronics companies placing orders for new chips. UMC also receives higher margins on newer electronics that require smaller process technologies to fit more microprocessor connections into smaller areas. Looking at the max chart for UMC, we can see that the stock is trading near late 2002-early 2003 levels. During this drop in the semiconductor industry, the consumer electronics industry was experiencing an inventory glut amidst softening demand, so fewer orders were placed with outsourced semiconductor fabricators.
The landscape for the consumer electronics industry is vastly different today than it was in 2002-2005 period. Prospects couldn’t be any better for UMC and other outsourced semiconductor fabricators. The stock price is not reflecting the strong current and future potential for growth.
My only concern is a macro view of the global stock markets. A crash, driven by currency worries and fears over rising crude oil prices, is a distinct possibility that should not be ignored. I believe the coming earnings week will be overshadowed by the conflicts in the Middle East. I expect the markets to be driven by news coming out of the Lebanon conflict instead of earnings announcements. If you are of the mind that the market will rapidly revert back to a normal state as the Middle East conflicts pass over or as investors price in results of the conflict, then I suggest buying into the oversold condition of the market.
I would play this short-term strategy:
1. Buy gold mining stocks in the next 1-2 weeks if gold trades above $700. This would signal a positive psychological entrenchment in the mind of investors that the Middle East conflicts aren’t going to blow over anytime soon. I am actually giving readers a conservative approach. I have already started accumulating a gold position. My top two picks Yamana Gold, Inc. (NYSE:AUY) and Tanzanian Royalty Exploration Corp. (TRE) now represent 1/2 of my portfolio.
2. Sell gold and take your profits as the Middle East conflicts ease and crude oil prices drop.
3. Buy UMC and other beaten-down tech stocks like my number 2 choice, eBay, Inc. (NASDAQ:EBAY).
If UMC drops below $2.50 or EBAY drops below $24, I would consider either a tremendous value. I have my sights set on buying UMC in the $2.60-$2.80 range. I believe this simple strategy will lead to extraordinarily high returns in the next 3-6 months. The only thing the strategy is predicated on is the market returning to flat or slightly bullish growth toward the end of the year. If the Middle East conflicts persist, holding onto gold stocks as a hedge is most likely the best way to go.
I would not be surprised if gold were to jump up above $800, almost entirely driven by the escalating Middle East conflicts and crude oil supply fears. In either case, whether the conflicts persist or not, I am continuing to recommend holding 50% of your portfolio as cash if you have available investment capital or you have the possibility of cashing out without much loss.
These certainly are uncertain times. There are chances of huge profitability if you play into the oversold conditions, but safety and preservation of capital should always come first.