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Because of excessive margin buying (borrowing money to buy stocks) in the stock market by investors we will classify as large hedge funds and professional traders, day traders etc., through instruments such as ETFs, etc., margin calls (where you have to pony up more cash or your broker starts selling your positions) were triggered for many last week. This is the fastest way to the poor house. I tried it back in 1987 and have refrained from using it again as I got hit with a margin call at the ripe old age of 23 and it took out 30% of my nest egg at the time. Well now we have billion dollar hedge funds using leverage to buy stocks, gold, silver and commodities and they are getting margin calls in excessive amounts. So all this leverage is hitting the commodity markets as hedge funds are so underwater in their stock portfolios that they are forced to sell their commodity holdings, where gold is/was a major position along with silver and oil, among others.

Most of the selling occurred in Silver, Oil and Gold ETF’s such as:

IShares Silver Trust (NYSEARCA:SLV) = down -22.43% for the week

SPDR Gold Shares (NYSEARCA:GLD) = down -9.22% for the week

United States Oil Fund (NYSEARCA:USO) = down -8.93% for the week

Because they were able to leverage so much, you hear rumors of hedge funds buying oil tankers full of oil, parking those ships two miles out of ports and then waiting for oil prices to go up and then bringing them to market at a large profit, because they borrowed the money to buy the oil. Unfortunately once one big hedge fund starts losing money and is forced to sell that oil, the price of oil comes down if dozens of others do so as well, all at the same time.

Also, everyone and their mother jumped on the gold and silver bandwagon too, especially small investors who bought gold and silver with every dime they could scrape up. This created a bubble that has now burst. I bought Freeport McMoran Copper and Gold (NYSE:FCX) as a hedge on a market downturn as gold since 2008 has gone up every time the markets went down, but that pattern is now broken and I sold out all my commodity based firms such as Core Laboratories (NYSE:CLB) and Exxon Mobil (NYSE:XOM) and went to 74% cash in my average client portfolio.

Why is gold going down so much? The reason is that these investors (gamblers) are getting margin calls and are selling their most liquid holdings such as gold and silver ETFs. This selling pressure has nothing to do with the commodity itself; the downturn was forced by people selling because they HAD to, not because they wanted to. Therefore panic on the downside was the result as this forced-selling pressure started a snowball effect, just as the panic on the upside that we saw in gold and silver this year caused prices to skyrocket artificially.

With banks, techs and now commodities imploding you have the markets going down. It is amazing that Microsoft (NASDAQ:MSFT), already beaten down and announcing a 25% increase in its dividend, went down -7.60% last week, so as you can see when people start selling their Index ETFs everyone goes down. Microsoft went down as it is a very liquid stock and easy to sell but when the average daily volume of SPDR DJIA (NYSEARCA:DIA) is 11 million shares or Power Shares (NASDAQ:QQQ) Trust is 82 million shares, it’s not hard to see that ETF selling can really hurt your stock if it has a major weighting in an ETF.

I am mainly in cash in my portfolios and do not own banks, techs and commodities and waiting on the sidelines with the majority of our assets at ZERO RISK because cash does not go down. Besides the cash and one short ETF, Advisor Shares (NYSEARCA:HDGE) that I wrote an article about earlier in the year, I am remaining in Multi-Nationals like:

  • McDonald's (MCD
  • Yum Brands (YUM
  • Colgate Palmolive (NYSE:CL)
  • Coca-Cola (NYSE:KO)
  • Nu-Skin Enterprises (NYSE:NUS)

just in case there is a massive rally to the upside. The rest is in cash if the markets continue to go down.

I was planning to make further equity investments but the move by the Federal Reserve was a complete disaster and it has resulted in forcing me to go to the sidelines and wait. The mistake of the Federal Reserve cost the global markets almost $1 trillion in market losses in just two days and I still have no clue why Bernanke would do something so STUPID. I tried to explain it in an article last week for those interested.

Nevertheless we cannot control what mistakes government officials make or the excessive leverage that is taken on by billion dollar hedge funds, but what we can do is take advantage of it by limiting our downside by using the most under rated instrument of cash, which has allowed me to go down 1/5th as much as the NYSE Index this quarter. Again these losses are on paper, while the losses for the hedge funds are permanent as they were forced to actually sell. When this panic sell-off finally stops my stocks are the ones that investors will probably run to first as they are also the ones that people run to now for what is called a flight to quality. I am salivating and have a large list of stocks ready to buy and every day that list keeps getting cheaper and cheaper.

If you are in the market for a car with a $30,000 MSRP and every day you drive by the dealer and see that the dealer keeps dropping the price $1000 a day, the smart move is to wait until he stops dropping the price and starts raising it. By waiting you may get the car for $20,000, so why not sit on the sidelines? When you are only 26% invested, a market crash like the one we are experiencing this quarter is a wonderful thing as you end up buying stocks for 2/3rd’s of what you originally planned on. How can that be a bad thing? This is why “Cash is King” when markets are imploding and God help those who are fully invested in Index Funds or Pension Funds who are invested with highly leveraged hedge funds. This quarterly statement coming up will be quite an education.

Why is the car dealer dropping his price? First because he has a huge inventory and no buyers (like commodities now) and still owes money on those cars, which he borrowed money to buy (hedge funds), so he needs to sell them. So his misfortune is our good fortune. I know it sounds mean and cruel, but we did not force him to over-leverage and to buy high and now be forced to sell lower. We did not force recent gold and silver buyers to buy at all-time highs, but they did and unfortunately they will now pay dearly for doing so.

In the Army the luckiest soldiers are not the ones on the front lines, but the ones "in the rear with the gear." While those fully invested are on the front lines and are getting hit hard and taking casualties, those in cash are in the rear with the gear and have limited risk of getting killed as the army we are fighting (government) has to clean out the infantry first before it gets to us.

I hope this all makes sense as I have tried to explain a very complicated situation in layman's terms. I may continue to go down 1/5th to 1/6th as much as the markets, but the stocks I am waiting to buy are going down 5/6th as much, so if you do the math, when everything reverses I should go up 10/6ths as much as others because our losses are minimal and are on paper. You only really lose when you sell, so when the market reverses my holdings should be the first out of the gate and they are run by elite managers.

Hope that helps explain what happened last week.

Disclosure: I am long CL, HDGE, YUM, KO, NUS, MCD.

Disclaimer: Always remember that these are the results of our research based on the methodology that I have outlined above and in other articles previously published. This research is provided as an educational tool and should not be considered investment advice, but just the results of our research. There are many ways to analyze a stock and you should never blindly follow anyone’s work without doing your own due diligence or by seeking the help of an investment advisor, if you so need one. As Registered Investment Advisors, we see it as our responsibility to advise the following: We take our research seriously, we do our best to get it right, and we “eat our own cooking,” but we could be wrong. Please note, investments involve risk and unless otherwise stated, are not guaranteed. Past performance cannot be used as an indicator to determine future results. Strategies mentioned may not be suitable for everyone. We do not know your personal financial situation, so the information contained in this communiqué represents the opinions of Peter “Mycroft” Psaras, and should not be construed as personalized investment advice. Information expressed does not take into account your specific situation or objectives, and is not intended as recommendations appropriate for you. Before acting on any information mentioned, it is recommended to seek advice from a qualified tax or investment adviser to determine whether it is suitable for your specific situation.

Source: Why The Markets Went Down Last Week