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Mercenary Trader ( was created by traders, for traders. We are aggressive swing traders who routinely combine fundamentals, technicals and sentiment with deep awareness of global macro and rigorous analysis of individual equities. See all of our content, including free... More
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  • Global Macro Notes: Long Gold Stocks, Short Retail
    In April of this year, I penned a think-piece titled “Keynesian Psychology With Austrian Tails,” detailing the latest upgrade in my philosophical growth path as a trader.

    The gist of the piece was that, while the Austrian school offers the more true and correct view of economic reality in the longer term, Keynesian psychology — “the triumph of hope over experience” — can and does dominate the short term.

    The net result, in terms of market action and consistently repetitive cycles, is drawn out Keynesian ramp-ups followed by infrequent yet inescapable “Austrian tails,” in which the hope-jaggers face a violent comeuppance.

    The bulls are thus in danger of being “rocked like a hurricane” — because the scorpion sting in the “Austrian tail” is upon us.

    This is bad news for some, but good news for others. We are well-positioned for what’s next via two aggressively juxtaposed themes: long gold stocks / short retail.

    As I write this note, the GDP revision number is just hitting the premarket — gold and S&P futures both up a little, meaningless thus far — and the talking heads are already turning to the big Ben Bernanke speech from Jackson Hole.

    Hedging Bernanke

    Speaking of Bernanke and Jackson Hole, does anyone else find it sadly amusing that investors are so transfixed by what one man has to say?

    In his masterwork “On Human Nature,” sociobiologist Edward O. Wilson explains how the shamans of old functioned as the cohesive glue of society. Back then, the local witch doctor was judge, jury, and sherriff all rolled into one, enabling tribal societies to function before any of those roles had become formalized.

    These days, the Chairman of the Fed is our modern shaman — the financial witch doctor for the global marketplace, giving the masses a vessel to put faith in (and a false sense of hope that someone is in control).

    As far as the Great Shaman Bernanke’s impact on the market is concerned, here is our encapsulated view:

    • The U.S. economy is slipping into a classic liquidity trap.
    • This is, in part, a result of the U.S. economy being strip mined.
    • The Federal Reserve has neither the will nor the way to get us out.
    • Instead, “QE lite” measures will keep us limping along at best.
    • A necessary deleveraging trend will continue apace.
    • Stimulative monetary policy will amount to pushing on a string.
    • This environment is poison for “old normal” discretionary retail names.
    • In contrast, it is a highly constructive backdrop for gold stocks.

    Why favor gold stocks here? Because, in addition to an excellent track record in the Depression (early years 1929-1935), gold stocks are the logical beneficiary of “pushing on a string” monetary debasement efforts that fail to revive the real economy.

    As all paper currencies get debased — and especially if fiat currency debasement is coordinated on a global scale — “gold in the ground” starts looking more and more attractive as a long-term store of value.

    Recent action in the Market Vectors Gold Miners ETF (NYSEARCA:GDX) gives a good example of how the swing trading process works. We are currently aggressively long GDX as a core position, along with a number of other individual gold stocks, some of which were added to on strength this week.

    In last week’s notes the GDX position was highlighted, along with an outlay of our long gold stock / short retail thesis.

    Since that time, however, GDX made a “fakeout move” to the downside that took us out at breakeven… and then recovered nicely, giving us the opportunity for reentry.

    As a matter of discipline and habit, the Mercenary method requires moving the risk point to breakeven as soon as it becomes feasible, as a means of reducing volatility and risk by requiring a position to “act right” from the get-go.

    When a position throws a “headfake” — as often happens in a competitive market environment — we are not hesitant to step aside with the main aim of reducing risk, knowing we can always get back in (and do get back in!) as price reconfirms.

    In the case of GDX, the reentry point was 41 cents worse than the initial, but this is of little consequence. For the swing trader, the benefits of consistently reducing risk will always outweigh the trade-off of a slightly worse “getting back in” price if thematic conviction is maintained.

    On the retail side, our exposure is similarly balanced between a sizable short position in XRT and a number of complementary individual equity shorts. The vast majority of these positions (including our XRT short) have been locked in at breakeven, giving us a “free ride” on further downside.

    We are also long dollars and short high-yield debt, for reasons well articulated by Mike McD.

    Swing is the Thing

    As a side note, there has been a lot of chatter lately about how tough these markets have been. Many short-term traders have found themselves vexed by the seemingly irrational action. The aim of the Mercenary method is to sidestep most of this “churn concern” via a few key factors:

    • The development of high conviction “top down” related themes.
    • A willingness to reduce risk quickly by moving positions to breakeven.
    • An equal willingness to risk small profits in pursuit of large profits.

    Think of it like starting a lawn mower. When positions are established and the market falls back, it is like yanking the lawnmower cord and having nothing happen.

    This can be a frustrating experience, obviously. (Who hasn’t cursed at a lawnmower in their day?)

    But here is the thing. If pulling the cord doesn’t cost you anything, then having a “non-start” is fine. Because you get the chance to pull again — and again — and even yet again if need be, with no real cost to your capital base. And then, once the lawnmower roars to life, that’s when things really start rocking and rolling.

    The swing trading metaphor here is in respect to being stopped out at breakeven. It’s ok to be stopped at breakeven, multiple times if need be, if the net result of your actions is the ability to have a suitably large position in place when a real move occurs.

    That is the way to generate large returns with large sums of capital. And that is what we are constantly looking for — high conviction themes with lots of “runway,” in which a solid position established on a low-risk basis can result in exceptional profits from the ensuing breakout trend.

    Three other quick notes of consideration:

    Bring Me That Horizon,


    Tags: GDX, XRT, Macro
    Aug 27 11:44 AM | Link | Comment!
  • Assured Guaranty: Deep Value, Improving Prognosis
    As the market begins to show strength and both investors and traders begin putting capital back to work, I'm finding opportunity on two different fronts.

    1) Speculative positions which are heavily leveraged toward an economic rebound can get juiced higher quickly as institutional managers scramble to add beta to their portfolio.

    2) Value equities which have healthy long-term businesses but have become depressed after falling out of favor can also show tremendous short-term performance along with the potential to become longer-term core investments.

    As swing traders, we often focus on the more speculative positions that are quick to move (higher or lower) when market dynamics change.  But today I want to take a closer look at a stock that is trading at an exceptional value due to institutional investor's aversion to the industry this company operates in.

    Financial Insurers

    The names MBIA Inc. (NYSE:MBI) or Ambac Financial Group (ABK) bring back some pretty ugly memories for the LOLO (Leveraged Outright Long Only) investors - most of whom took a bath when these insurers hit the skids.

    The business model seemed pretty sound.  Just like any other insurance companies, financial insurers took in a regular premium to insure investors against losses.  In this case, the potential losses were from investments - usually fixed income products - and to a large degree these companies insured what we now know to be very risky Mortgage Backed Securities.

    To make a long (and painful) story short, stocks like AIG, MBI and ABK were trashed when the securities they insured took on water and the companies were saddled with huge losses.  In order to pay the claims, these companies had to raise additional capital and still don't have the balance sheet strength to underwrite new insurance business.

    But one company in the business managed to survive with its business intact - and today looks like an attractive trading and investment opportunity...

    Assured Guaranty - A Cut Above the Competition

    When competitors like AIG were making a mint collecting premiums for insuring toxic waste, Assured Guaranty (NYSE:AGO) was ridiculed for passing up the easy profits.  Management simply wouldn't play the mortgage insurance game because they believed the premiums charged by the industry didn't match with the risk insurers were taking...  Of course we know how the story ended.

    And so when most in the industry were teetering on the verge of bankruptcy, Assured Guaranty had plenty of capital to take advantage of the situation.  Ironically, AGO entered the mortgage insurance market at the bottom of the cycle, purchasing a struggling competitor and emerging as the only major insurer actually underwriting new business.

    At this point, the risks in mortgage securities are well known.  And since AGO is basically setting the price at which it is willing to take on risk, the company is being well compensated for its risk - and appears to have plenty of capital set aside for potential losses.

    Municipal Bond Risk

    Since AGO was not very involved in the mortgage security market, the company developed a specialty insuring Municipal Bonds - which has recently become a concern for investors.  Of course we know that states like Illinois and California are in deep trouble and may have a significantly hard time meeting their obligations.

    If states or other municipalities begin defaulting on their debt, AGO will likely have to step up and fulfill the obligations. Investors have liquidated positions due to this risk, pushing the stock down nearly 50% from the April high to the low point less than 2 months later.  Clearly the risks have been considered and at this point it looks like the fear has likely been overdone.

    Recent comments out of Washington indicate that there will likely be federal assistance for struggling states, and at the same time, many of the municipal obligations insured by AGO are misunderstood by the investing public...

    There are a number of municipal bonds insured by AGO which are characterized as "revenue bonds."  These bonds are used for very specific purposes such as building water treatment plants, and the bonds are backed by the water and sewer revenue from the municipality.  Of course this revenue stream is not immune to economic ebbs and flows, but at the same time citizens are more likely to pay their water or electric bill to keep the lights on - even if it means defaulting on the mortgage.

    AGO's risk with these bonds does not appear to be nearly as dangerous as traders believe, and now that we are seeing signs of a recovery - however weak that recovery may be - that risk is becoming less of an issue.

    Compelling Value and Attractive Trade

    Analysts (who you remember are pre-disposed to be overly conservative in this industry) are forecasting earnings for AGO of $2.76 per share this year and $3.89 for 2011.  Based just on this year's expected earnings, the stock is currently trading at less than six times earnings.  If you use 2011 earnings as a baseline, the stock becomes even less expensive at just over four times earnings.

    There is a significant argument to be made both for increased earnings estimates as well as multiple expansion.

    Of course, as Mercenary Traders we are looking for evidence of positive price action before committing our capital.
    AGO has participated in the July rally - gaining 18% during the month and tacking on additional gains so far in August.

    The stock is now above the 50 EMA and appears to be gaining institutional support.  The company announces earnings Thursday after the close and will host their conference call on Friday morning.  I'm expecting management to offer more evidence of their risk management skills and may look to use any volatility around the earnings report to work into a long position.

    Initially, I will want to use the price action to take a shorter-term swing trade position.  However with AGO representing a deep value and if the business dynamics continue to be healthy,
    I would consider maintaining a longer-term position, establishing more of an investment approach while still managing risk carefully.

    Disclosure: no positions
    Aug 03 11:57 AM | Link | Comment!
  • View From The Turret: Bulls Take the Offense
    Welcome to a brand new month of trading!

    As institutional managers enter a new reporting period and search for ways to generate alpha, it appears the bulls are taking the offense at least for the time being.

    While economic reports have been uncovering disturbing declines in growth and poor employment trends, investors are choosing instead to focus on corporate earnings which have been relatively stable.  As Jack mentioned in the Weekender, weak economic reports may still be supporting confidence in the bull camp because of the influence the data will have on policy decisions.

    Regardless of the reasoning, the price action appears to favor rising prices and while I am still keeping a bit of short exposure on in under-performing sectors and specific stocks, Jack and I are working on building out more long exposure this week.

    The key for our trading will be picking the right entry spots where we can reasonably manage risk while still shooting for outsized returns.  There are a few key sectors which are already showing evidence of attracting capital flows, and we will be buying strength rather than trying to pick bottoms in negatively trending issues.

    So let's take a look at some of the sectors and individual stocks that are setting up for attractive trades this week.

    Agriculture Revitalized...

    Over the last few weeks we have seen a sharp increase in the agriculture space.  The bullish story isn't new by any stretch of the imagination.  World population growth and a relatively fixed supply of farmland makes for a long-term positive backdrop.  Of course, stocks in this sector can fall in and out of favor based on short-term capital flows, inventory reports, political shifts and plenty of other variables.

    Last week we took a position in Potash Corp. (NYSE:POT) as it broke out of a short-term consolidation and ramped through the 200 EMA.  Industry pricing appears to be on the rebound and that is good news for profit margins as well as the volume that POT is able to move on a quarterly basis.

    Intrepid Potash (NYSE:IPI) is a smaller and potentially more nimble competitor.  The company will be reporting earnings Thursday before the market opens.  At this point, analysts have pegged POT as the leader with more subdued growth expected for IPI.

    However, if IPI manages to impress with stronger growth and more importantly positive guidance,  the stock could retake the 200 EMA and become much more attractive.

    Besides the fertilizer companies, seed manufacturer Monsanto Co. (NYSE:MON) is looking interesting having rallied nearly 30% off the lows and now sitting in a minor consolidation pattern.  The company operates with an August fiscal year end so it will be some time before we receive a full accounting from management.  But industry trends could certainly drive this stock higher.

    One area of concern is valuation
    .  Monsanto is currently trading at 23x this year's expected earnings.  That's not cheap for an agriculture stock, but considering the cross currents in emerging markets, expectations for next year's earnings could fluctuate significantly if China or India were to increase their seed demand even by a small percentage.

    Solar Pullback May Attract Buyers

    Last week I mentioned that the solar sector had hit a speed bump as First Solar Inc. (NASDAQ:FSLR) and MEMC Electornic Materials (WFR) disappointed investors.  But while these two names were certainly a drag on the sector, several stocks in this industry appear to be experiencing a healthy pullback.

    There was an interesting piece of news on Friday as Bloomberg reported new developments in Spain's stimulus program.  Nothing is final yet, but it appears that some of the solar stimulus cuts may not be as severe as previously expected - benefiting companies with existing plants already operating under existing government agreements.

    ReneSola Ltd. (NYSE:SOL)
    met resistance near $8.00 and has pulled back slightly to the 20 EMA.  That could prove to be a short-term support area and I wouldn't be surprised to see SOL break through $8.00 this week before reporting earnings next Monday morning.

    At this point the stock is trading with a single-digit earnings multiple and could see multiple expansion if industry developments help to boost demand.

    I already mentioned Trina Solar (NYSE:TSL) in last week's piece as an attractive value with an improving technical picture.

    More speculative traders may want to consider LDK Solar (NYSE:LDK) which is still in the early stages of a turnaround.  Risk is a bit higher in this name due to a heavy debt load.  But the company is coming out of a horrible 2009 and if it is able to turn earnings around as analysts expect, the resulting rise in its stock price could be tremendous.

    LDK strikes me as an asymmetric trade opportunity with the potential for a large triple digit percentage move higher over the next few months.  Of course the risk is that the company will stagger under the debt load and investors could lose 20% to 30% in very short order. If I get involved with LDK, my position size will take the risk into account, and I would likely consider scaling into the position as fundamental data improves.

    Still Potential for Weakness

    The market indices have turned more constructive and this morning the futures are indicating a higher open.  But that doesn't mean we are out of the woods.  In fact, Jack and I have talked about how a late summer rally could set the table for an exceptional short opportunity heading into the fall months.

    With that said, I'm still keeping my short list handy and even maintaining short exposure in particularly weak names.

    MGM Resorts International (NYSE:MGM)
    can't seem to get out of its own way, and a recent rally on relatively light volume has simply touched the negative trend line.  With a debt to equity ratio greater than 300%, it is difficult to see how traders will develop much confidence in this name, and I'm inclined to consider shooting for more short profits in this name after closing out my position earlier in July.

    Retail names remain on my watch list as well - with particular attention towards the middle class outlets.  A widening gaps between those who are thriving in the current environment and those who are under pressure could result in more business for discount chains but less spending for mid-range discretionary purchases.

    There are  a number of consumer patterns I want to research further, but changes in consumer patterns could provide a number of trade opportunities from both the short and the long side of the trading ledger.

    Hit em hard this week and don't forget that there is only one side to the market.  It's not the bull side, not the bear side, but the right side.

    As they say, "bears get slaughtered, bulls get slaughtered, but Mercenaries eat well

    Ok, that's a paraphrase but you get the point...  Good trading!

    Disclosure: positions in stocks mentioned
    Aug 02 10:16 AM | Link | Comment!
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