Last spring I went all cash and sold all resource stocks. Over the summer I slowly rebuilt some of those positions and by fall I was again 100% committed. Come December I was buying on margin. During this period of almost a year I became more bullish while the populace at large became as pessimistic as I've ever seen them. At one point 66% believed we were going into a recession or depression. Meanwhile the market kept climbing. And since there was simply no evidence for a downturn I took a bullish stance and bought.
But that all changed recently. I became cautious, even as I added to positions. In a Market Update sent to my subscribers on March 3rd, I suggested they "watch Freeport-McMoRan Copper & Gold Inc. (FCX), the one stock that indicated world growth." Since I wrote that I've sold FCX due to its lack of follow through. FCX should be going up, but as of late it has turned and is going down, which I take as an indication that world growth could be slowing more than expected. Teck Resources Limited (TCK), one of the largest resource companies in the world, is also falling. Last week I cautioned my subscribers that if Coeur d'Alene Mines Corporation (CDE) should fall back and break its previous day's low it would be reason enough to exit--which I did.
Why am I so concerned? Because resource stocks should be making higher highs with the market. Resource stocks are leaders, not laggards. If anything, the past decade at least has seen gold and other commodities such as copper, lead the overall market both higher and lower. So what's going on?
One scenario that could explain resource stocks diverging from the stock market, as they have been recently, is a return to the disinflationary/recessionary bias we came out of last year. We may have just peaked in growth and inflation and we could be looking at the beginning of a long decline back to the zero growth level in GDP, and deflationary/recessionary fears.
Housing prices could take another leg down as they have been doing better than expected lately. A recession in Europe could kill exports from China and to a lesser degree from the US. China continuing to slow further would likely take Asia with it and make Japan the next "problem child." Few are looking in that direction. But increased taxation, gas prices, and austerity measures around the world, could reassert a recessionary bias on world growth. If this happens we will return to a bear market in stocks. Are resource stocks signaling this turn?
I published a thesis of sorts on my overall interpretation of world market conditions which I call, A World of L. In this L-shaped world, I envision a 0 to 2% growth rate for as far as the eye can see. Last year we went from .4% growth to 3% GDP last quarter. It's not much of a stretch to assume we might be ready to revert back toward zero to maintain that average.
If this is in fact the scenario we face, how do we play it? My first move was to sell half my position in resources stocks, locking in profits. I've also bought ETF's as a downside hedge. (TZA) and many other inverse ETF's such as (DZZ) and (ZSL) are near their recent lows.
I hope I am wrong about this scenario, but if I'm not, it would explain a lot of unanswered questions about the market. I doubt that even one in a hundred investors is looking at the possibility of an imminent downturn in the economy, let alone a full-blown economic recession. The stock market certainly isn't anticipating this. Either way, I've placed close stops under my short positions in case this is only a bump in the road.