Matthew J Goldseth's  Instablog

So…my last market prediction was a bit too cautious.  We’ve had quite a rally since I expressed some remaining bear sentiment in mid April…can’t always be right!  I’ve been slowly conceding the bear mentality, but remaining cautious with covered calls as a hedge just in case!  However, last week, I took some gains and the stocks I held are no longer covered. Today was a further confirmation of optimism as markets surged on strong volume and the S&P pierced the 200 day moving avrage for the first time in over a year.

I’ve been looking at new investment opportunities for a couple weeks and had a deep watch list ready for the next correction….which never came.  So as I slowly ceded my apprehension, I also slowly reduced my watchist top those companies with stellar fundamentals, great market position and strong growth prospects.

Petroleo Brasileiro S.A. (PBR)
$40 oil was a joke, but it is now showing real strength in its recent rally past $60.  The U.S. economy seems to be bottoming out and with the China/India demand for oil unlikely to fade, I’m feeling more comfortable with the long term prospects of oil investments.  I’ve been watching Petrobras for months and I’m admittedly disappointed that I didn’t trust my gut sooner as I’ve missed out on some of the huge rally, but I believe it is still well valued for a long term investment.  I bought the $30 July calls and if I get a sustained rally over the next week, I’ll sell $45-50 calls and wait until July to decide if this is a trade or long term position.

Diamond Offshore Drilling, Inc. (DO)
I’ve also liked the drillers and invested some serious time in researching 3 companies over the last couple weeks.  Transocean is the 800 lb gorilla and perhaps the “safest’ best in the industry.  Noble (NE) is a smaller player with a majority focus on jackups while Diamond Offshore (DO) primarily focuses on deepwater.  In the end I went with Diamond Offshore due to their focus on deepwater, the strong backlog, relatively low capex costs (newbuilds are about done) and a demonstrated willingness to pay special dividends.  With these advantages and customers like Petrobras and Royal Dutch Shell, I expect continued strong cash flow which could lead to additional special dividends to compliment the growth potential.  I purchased $80 options for July and I intend to exercise these before any potenial dividend announced.  I was encouraged by today’s action…the stock gapped up almost 6% on high volume, setting up the right side of this base and possibly preparing to setup a minor handle before taking off…I’m looking to sell $100 calls to hedge my position on the follow through and trade movement in the handle before exercising my options.

Fluor Corp. (FLR)
This is an infrastructure play and I also studied Foster Wheeler choosing Fluor in the end due to better diversification, with over half of revenues in the oil/gas industry, 15% industrial/infrastruct... Gloabl Services 12%, Power 9% and Government 6%. Admittedly no expert in this inustry, I was looking for a large company with gegraphic diversification, strong cas flow, stong backlog with new growth potential and some exposure to alternative energy projects to balance exposure to oil and gas.

Diana Shipping Inc. (DSX)
I traded Navious Maritime earlier this year and took gains looking for a smaller, more nimble fleet less dependent upon debt.   I’m also very interested in Nordic American Tanker Shipping Ltd, but I have plenty of oil exposure so I went with the dry bulk shipper.  Shipping rates (BDI) are bottoming, DSX has low debt compared to other shippers, they have a great history of rolling over time charters and has a historically strong dividend.  I purchased an in the mone call and plan to exercise and sell calls to hedge once the rally putters out.

Pontificating on the market’s current impressive rally, some experts are calling it the start of a new bull market while others maintain it’s just a bear market rally. Bull, bear…I don’t care, I just won’t be a pig! Time to lock in some gains.

Coming off an extended holiday weekend (market closed on Good Friday) into a week that includes tax day, the deadline for 2008 IRA contributions, Goldman Sachs earnings and options expiration, I expected Monday to be a key trading day. At the end of the day, the market did finish higher and was buzzing with optimism as the Wells Fargo and Goldman Sachs results seemed to fuel speculation that the stimulus was beginning to take effect. I suppose there is some merit to that perspective, but I think that view is fixated upon the short term while ignoring other long-term issues yet unresolved. Furthermore, I was disappointed with the technicals, so in the end, I’m preparing for a correction.

Taking a look at the chart below, this rally showed signs of weakness with the March 23 attempt to set up support of the 50 day moving average. While this run continued with higher closes on ten of the next fifteen trading days, the volume seemed to dry up as we approached the longer term trend. For fans of candlestick charting, April 13th’s trading may have been the confirmation I needed. While not a classic doji or spinning top, it illustrates the indecision in the market…and more importantly, a lack of conviction.

In my opinion, this rally simply reflects that many great companies with solid fundamentals were oversold, undervalued and ripe for the picking. Many traders and investors decided to jump in at these prices, but with a 25%+ gain off the bottom, I would also expect plenty of profit taking! This profit taking combined with the general market indecision may provide another test of the bottom or set up a sideways channeling pattern.

That considered, I think it would be wise to take profits here or start hedging with covered calls or put positions if you haven’t already.

My recent purchase, Yanzhou Coal Mining Company Limited (YZC), is up over 25% already, so I’m just looking to hedge at 10-$12.50 as the stock tests $10. Navious Maritime (NM) is more of a trade candidate than an investment, so given the huge run in the last 2 days, I may sell near $3.00 and revisit my next shipping move with NAT or DSX. Frontier Oil (FTO) is trading under the strike price, so hopefully they’ll expire and I’ll sell another round for May. After gold’s retreat from $1000 last month, I closed my Yumana Gold (AUY) hedge for a 50% gain. This stock IS my hedge against stocks, so I’ll leave it that way unless gold runs up again. With the great performance of CHK, JOYG and RIO, my short calls are now in the money, so if we have a nice correction, I may buy them for a gain back rather than risk getting called out, but until then, I’m going to let them ride. I closed my loser position in E-Research Technology (ERES). Being down almost 35% at one point, I was happy to get out with a 12% loss!

Bottom line…its time to lock in some of these gains even if at the risk of missing some upside. Nobody ever got poor taking profits!

(Disclosure:  My managed fund is long CHK, RIO, JOYG, FTO, AUY, YZC.  I also own NM in a roth account)