The Great Divergence

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 |  Includes: CDE, GDXJ, MUX, PAAS, RBYCF
by: Paul Nathan

Rarely has there been so great a divergence between the fundamentals and the technicals as today. Many chart patterns are breaking out to higher levels as gold, silver, a host of commodities, food stocks, homebuilders and tech stocks move impressively higher--all in the face of terrible economic figures.

The GDP has fallen from 4% to 1.5%, profits are falling, inventories are rising, investment is dwindling, and exports are evaporating. Much of Europe is in recession, some of it in depression. Even mighty Germany looks to join England soon as it slides into recession. China's stock market is in a vicious bear market, possibly indicating greater problems ahead. If China falls so will many emerging markets. Commodity nations such as Australia, Mexico, and others will be pulled down as inventories are dumped onto markets. Just when inflation is feared, major deflationary forces could emerge as nations dump excess inventories on markets all over the world.

Yet despite all of this commodity and stock markets have rallied. Investors seem to believe that the central banks of the world will step in and prevent deflation and depression from taking hold of the world economy. And well they might. But monetary policy can only do so much. It can fight inflation and deflation, create liquidity to alleviate financial stress, and even temporarily stimulate economies; but it cannot create prosperity or employment. If central banks could accomplish these things they would. But almost every central bank in the world has failed when attempting to do so.

While central banks can be effective lenders of last resort they are impotent when it comes to preventing recessions or creating prosperity. They know this. Several important meetings will be held soon and many decisions, statements, and speeches will be delivered. The markets will be extremely attentive and sensitive to any hint of policy changes coming from these meetings.

Taking that into account along with the run we have had in many stocks (some stocks up as much as 50 to 100% since May), it's time to reevaluate the risk/reward potential from here. The charts could be right and we could see the fundamentals improve dramatically in the future. Or the fundamentals could get worse and create a wave of selling due to a dramatic disappointment by optimistic investors.

I went "all in" on resource stocks when they were at their near lows. And now I have decided to sell out my leveraged trading positions (CDE and GDXJ) and have even trimmed some of my core positions (MUX and RBY) back a bit. I also have a close stop under PAAS. I can always get back in if warranted, but at this point my play is to lock in profits on what has been a pretty decent run. Hopefully this all amounts to no more than an academic exercise and the rally continues.

With central bankers making statements this weekend and meeting in Europe and at the Fed next week, I feel it is time to get a little cautious.

Disclosure: I am long RBY, PAAS, MUX. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.