While there’s no really bad time to kick underperforming stock positions out of your portfolio, some times are actually better than others.
The good news is, if you’re sitting on losing positions, now may be a great time to exit them.
It’s great because stocks are near all-time highs. That makes it easier to see which stocks in your portfolio haven’t participated in the long run-up we’ve had.
It’s also a good time because some investing themes that saw big gains are fading, some are dead in the water, and others are just starting to take shape.
So let’s get to work…
Why You Shouldn’t Be Afraid to Get Rid of Losing Stocks
The length of time you hold a position doesn’t matter, as long as it’s working for you. That is, if the price of the stock you own has been rising steadily, or if it pays a good, secure dividend.
Hold onto those positions.
But if your investments are not working for you after giving them a reasonable period of time to do what you expect them to do, chances are they’re not all of a sudden going to explode higher and prove you right.
Too many investors fall in love with their positions. They think the stocks in their portfolio that were once expected to be the next big thing, or that were once high-fliers, will eventually start moving up or will come back after they fall out of favor.
Because there’s no way of knowing whether a “dead in the water” stock will all of a sudden take off, or whether a fallen angel will ever rise again, you’re almost always better off getting rid of those stocks and replacing them with more promising prospects.
But hold on right there.
I know what you’re thinking. In fact, I know why most investors don’t sell those positions that they think will come back to life. They’re afraid to sell them because they’re afraid they’ll take losses on the positions and then watch them skyrocket to all-time highs.
I say, good luck with that. It could happen. But if it doesn’t, you’re left with a big loser. Not only will you not make money on those positions, you won’t have a chance to make money in other opportunities because you didn’t “take the risk.”
That’s how most investors look at selling loser positions – they actually think that selling them is taking a risk!
You can break that bad habit by telling yourself losers hold onto losing positions and winners buy winning positions. So sell your losing position and if it starts to act like a winner again, buy it back.
I don’t like to sit on losers too long. I hate the feeling of being wrong, but I hate losing money more. So I’ll sell my losers, cry for a second, and move on.
After I sell them, I look at them as if they’re new positions I’m interested in. If they act like I want and expect them to start acting, I’ll buy them back.
That’s how you deal emotionally with losers you’re afraid to sell. You look at them like new positions after you sell them. That way you can tell yourself you won’t miss out on them bouncing back to the moon because you’ll get back in when they start moving.
You have to sell losers because that’s the only way to free your mind… and your capital.
Sometimes you’ll want to sell because the stock isn’t performing, sometimes because the investment theme you bought into isn’t working, and sometimes you’ll want to sell because there are better opportunities right in front of you.
Here’s what I mean…
A Few Ways to Handle a Bad Position
Recently, we were sitting on a few underperforming positions in my Capital Wave Forecast service.
One position was a gold stock. We got into gold because we saw geopolitical risks all around us, and because central banks have been printing money like crazy, which devalues currencies and over time is a positive for gold prices.
But gold hasn’t performed as we expected it to. So I had my subscribers put down a stop-loss to sell our gold position if the stock made a new low. Our stop was hit and we’re out of the position.
That’s an example of playing a theme. If it doesn’t work, take your loss and get out. Could we continue to hold the position under the belief that gold will eventually rise? Sure we could. But I was wrong about gold. It hasn’t been acting like it should. So it was time to move on.
If gold firms up and its prospects look good, there are plenty of beaten-down gold positions we’ll get into to ride back up. But that isn’t happening, so why tie up capital?
We also bought a big drug manufacturer. The play there was to ride the coattails of a lot of big hedge funds that were taking massive positions and were agitating to get the company to sell itself for a nice fat premium. But that hasn’t happened, and the stock has slipped a little from where we bought it.
This is a different example of taking a position that may not pan out. So what if it doesn’t? We’ll get out with a small loss and jump on another trade, or put that capital to work in a fat dividend-yielding stock.
On this position, however, we didn’t just sell out and move on. We’re still in it, but I don’t want to own it if it keeps going down.
Bottom Line: Getting Out on Your Terms
Here’s how to exit a position when you don’t want to just pull the plug immediately.
We picked a spot where we wanted to get out with a loss that wouldn’t kill us but still give us a chance to see if the company could be put into play to be sold. We have a stop-loss order down to sell out stock at that “we’re done” price.
In the meantime, if the stock starts to rise, which it has been slowly doing, we’ll raise our stop and lessen our loss as the position goes our way. If it turns into a winner, great. If it doesn’t and we get taken out, so what? It’s a small loss and was worth the risk based on what the reward might be.
That’s how you should get out of all your losers now.
Because we’re coming into the end of the year and we might get a rally into the New Year, it’s a great time to go through your losers and put down a stop to sell them a buck or two below where they are now. If you get stopped out, say goodbye and get ready to get into better positions.
If we rally higher from here, keep moving your stop-loss orders higher as the stock goes higher. Don’t stick your stop-loss order right under the stock – give it a little room to wiggle. You never know, maybe it will get back to breakeven or even turn into a winner.
But because it hasn’t happened so far, it’s not too likely it will turn out that way.
In the meantime, you’re cleaning house, getting rid of losers, and making way for winners.
About those winners… I’ve got a bunch of hot new positions teed-up for my newsletter subscribers. I’ll tell you about some of them after we get into them.
Stay tuned. And don’t be afraid to dump the losers.
On Varney & Co. today, Shah takes on current events, turmoil overseas, and what he’s not buying right now.
Get Shah’s perspective on whether the U.S. is still the safest place to put your money, plus an update on his prediction that the market is set to go down 20%. Find out where he thinks the price of oil is headed, and how that number will affect the Dow… How the turmoil in Europe might affect the Fed’s next move…. What he thinks about the potential “retail ice age,” and how he really feels about Target.
The U.S. Securities and Exchange Commission proposes, enacts, and enforces America’s securities laws and regulates the nation’s stock and options exchanges.
Or… that’s what it’s supposed to do.
In practice, the SEC proposes and enacts overly complicated rules with loopholes big enough to drive dump trucks through, then selectively enforces those rules and regulations. It fosters competition among exchanges and “dark pools” and lets their private operators manipulate customers.
But right now, the SEC has a big opportunity to level the playing field for investors like you. One firm has proposed a “tiny” solution to the huge problem that high-frequency trading (HFT) poses to individual investors, challenging the way every other stock exchange does business.
But Wall Street’s heavy hitters – especially the “Flash Boys” – are lining up to voice their opposition, demanding that the SEC continue to allow them to profit by front-running millions of trades per day.
Will the SEC allow this company to revolutionize how stock exchanges are run… or will it once again side with the big banks, hedge funds, and HFT companies?
We’re about to find out…
A New Exchange Could Be the SEC’s Worst Nightmare
As if eleven SEC regulated stock exchanges in the U.S. weren’t enough (and that doesn’t include dozens of privately-run dark pools) yet another company has filed an application with the SEC for registration as a National Securities Exchange.
The company is Investors Exchange LLC (IEX)… and it’s the SEC’s worst nightmare.
That’s because IEX is challenging the way the SEC has allowed every other stock exchange to conduct business.
Which is the wrong way (I’ll tell you why) – but an incredibly profitable way for the exchanges, for discount brokerage houses, and for the mega profitable HFT desks at big banks, hedge funds, and listed HFT companies.
(Yep, you got that right. High-frequency trading is so profitable stand-alone HFT trading companies have listed their shares for trading on national exchanges. Kind of ironic.)
IEX, which as a private company started executing customer orders in 2013, was prominently featured in Michael Lewis’ bestselling 2014 book “Flash Boys: A Wall Street Revolt.”
In the book, Brad Katsuyama, who founded IEX, is David going against the Goliaths of the HFT universe, all of whom have been coddled (I’m holding back the words I really want to use) by the SEC.
Katsuyama says HFT shops have an unfair advantage over everyone else because they have faster access to all related trading data.
He’s absolutely right.
This Tiny “Speed Bump” Is a Huge Threat to the “Flash Boys”
IEX doesn’t use high-speed access to trade on behalf of its customers or itself. In fact, its business model does the opposite – it actually slows down orders coming into the IEX platform, as well as the data going out.
By slowing down orders by 350 microseconds (a microsecond is one millionth of a second), IEX levels the playing field on its exchange platform so that super-fast HFT machines can’t front-run everyone else’s orders on its platform.
This causes a huge problem for HFT players, who are able to game the system because of their ability to read data and act on it faster than everyone else.
If IEX can level the playing field, it will draw a lot of business away from other exchanges and dark pools that let HFT shops read all their incoming data and trade against it.
Now, the SEC has to decide whether to “sanctify” IEX by letting it become a National Securities Exchange, and in so doing threaten the profitability of high-frequency trading.
David vs. HFT Goliath
Of course all the big HFT shops have lined up against IEX with its annoying little “speed bump.”
Citadel LLC is a huge alternative asset manager (or hedge fund complex), a big HFT player, and the firm that executes trading orders coming from Charles Schwab and TD Ameritrade, to name just two of its discount brokerages clients.
The company wrote a 12-page “comment” letter to the SEC challenging IEX’s application.
While the Citadel letter makes several good points, every negative they point to can easily be overcome, and probably will have to be. While that’s more of a reflection of IEX’s less-than-thoroughly fleshed-out application, most of what’s in the Citadel letter is just plain nonsense.
The main premise of Citadel’s letter is this: IEX’s application should be denied because by intentionally delaying the flow of orders and trading data via its “IEX access delay” (its “speed bump”), IEX is breaking the SEC’s NMS (National Market System) rules 600, 610, and 611.
And Citadel is right.
But here’s the thing…
The SEC allows all kinds of wolves into the henhouses it’s supposed to protect because it makes everyone a lot of money, even if it disadvantages a lot of big investors and technically undermines capital markets, trading platforms, and the entire system.
On account of the fact that there are so many competing venues where trading orders can be executed, exchanges and other platform providers began to offer rebates on execution charges and pay to have orders directed to them, in order to win business.
All of which the SEC allows.
That works out well for discount brokerages, which don’t have their own execution desks and ship their orders out to be executed. Middlemen pay discount brokerages for their order flow (which lowers customer brokerage fees) so they can “see” their customers’ orders and direct them to where they get paid to send them.
And the SEC is fine with that.
The problem is all those orders are sent all over the place, and before they even get to where they’re going they can be intercepted by super-fast HFT computers that have the ability to know what the orders are (which means they know how those orders will affect prices) and can trade ahead of them, trade against them, or get out of the way if they have their own orders in transit that would be disadvantaged by trades about to be processed.
In other words, there’s a “latency” problem. Not all players get order information or execution data at the same time.
Everyone who doesn’t have access to those computers (like you and me) has that latency problem. But it’s our problem because the SEC let HFT shops put their servers next to exchange servers and let them front-run everyone’s orders on account of being able to see them before they get to where they’re going.
In short, HFT traders have this advantage because other market participants have latency problems, which the HFT computers created. And now HFT players are saying IEX will disadvantage them by intentionally delaying data because it creates a similar latency problem for them.
Yeah, it’s that crazy out there.
The craziest thing is the SEC has let all this happen because it makes money for so many of the players it regulates, all of whom who spend a fortune lobbying Congress to make sure the SEC serves their profitability rather than the public interest.
If the suits at the SEC kill IEX’s application, we’ll know exactly who their masters are.
Sure enough, next week the company’s going public on the Nasdaq under the symbol MTCH, at an upper valuation of $433 million.
Is MTCH marriage material?
Maybe, but I’ve got a better way to play the company’s IPO right now…
The Dating Business Is Booming
As you know, what thrills me about this Social Disruptor is the dating business.
Match Group has a portfolio of 45 brands, including Match.com, Tinder, OKCupid, OurTime, BlackPeopleMeet, Meetic and PlentyOfFish.
That’s a lot of reach.
In fact, Match Group boasts 59 million active monthly users (including 4.7 million paid subscribers). Their dating services introduce people in 38 languages across an astounding 190 countries. I love that.
They’re profitable and they’re growing their top and bottom lines.
In 2014 Match Group made $148.4 million on $888 million in revenue. They’ve increased revenue and net profits handsomely over the past three years.
But I’m just not sure the company won’t have entanglements with its overlords at IAC (more on that in just a minute). I’m not sure their properties couldn’t or wouldn’t get hacked, or that some negative publicity from a hack (think AshleyMadison.com) wouldn’t hit the stock hard.
My interest in the Match Group will be fairly high if the stock comes out on the lower end of its price range and doesn’t get ahead of itself right out of the gate.
If the stock soars on its debut, and the market isn’t marching higher to new highs, I definitely won’t chase the stock.
But while I think the Match Group’s IPO is a smart move, there are a few issues that give me pause.
The Question of Independence Is Crucial
First of all, Match Group won’t be completely independent.
InterActiveCorp will still own 86% of the new company after some 33.3 million shares are sold to the public. That number could rise to 38.3 million shares if underwriters pick up an additional 5 million shares, which they’ll do if investors drive the stock price up.
Since IAC will own all the company’s “B” shares, which have 10 votes per share, at the end of the day they’ll have 98% of all voting rights. So don’t think that any outsider, any activist, any shareholders, or any executive is going to have a free run at the company.
Owning stock in a supposedly independent company that’s anything but independent doesn’t thrill me. That’s especially true when the overlord of the property is Barry Diller, who moves around companies like he’s playing corporate chess.
Of course he’s got plenty of incentive to grow earnings and profitability at the Match Group. After all, the Match Group contributes almost 33% of IAC’s revenues. I’m just not sure there won’t be some gaming going on when it comes to deals and loans between Match and IAC.
The IPO price has tentatively been set between $12 and $14. But with the roadshow for institutional investors beginning shortly, that price range can change depending on how receptive money managers are to the dating game.
At $12 a share, the company will raise $400 million. At $14 it will raise $466 million. And if all the shares head out the door at $14, the company will take in $536 million.
So, what’s Match going to do with all that cash?
Give it right back to IAC to pare down some of the $1.2 billion the company spent on acquisitions since 2009. So much for working capital.
That doesn’t thrill me, either.
Here’s How to Play This Social Disruptor
To me, the stock is worth a look on account of their vast array of properties and their ability to sell ads across all their platforms, increasingly via mobile, which is key.
But I’m not planning on getting married to the stock. I’ll take profits if I get in and get a nice move and the stock slips back, for whatever reason.
In other words, it’s a trading stock for me until I see how it handles a few quarters as a standalone company.
The better way to play Match Group is to buy IAC. After all, they will own 86% of Match.
I like buying IAC right here around $66. I’d average down and buy more at $60 if it gets there, because there’s “support” there.
If the stock breaks below $60, it could go to $55 to $50 in a hurry. So I’d get out of my shares at $58 and see what happens next.
On the plus side, if Match takes off and IAC’s other properties continue their growth trajectory – which collectively has been underwhelming, but moving higher nonetheless – I can see IAC getting back up to $80.
Shah showed up after hours on Fox Business to discuss two huge stocks reporting earnings – Facebook and Tesla.
Even though he thinks it’s too expensive, Shah still likes Facebook and says it has much higher to go from here on the strength of their efforts to monetize mobile. As for TSLA, Shah’s still short the stock, and says that the numbers just don’t add up.
Host Charles Payne also asked Shah about a possible Fed rate hike… will they really raise rates in December?
So here we are, heading back to 18,000 on the Dow Jones Industrial Average after dipping below the 15,500 mark back in August, a 2,500 point move up.
If you’ve been in the market all along, if you got out of the market on the selloff, if you got back in anywhere going back up, or if you’ve been on the sidelines all this time, there’s a good chance you’re wondering how to trade the market at these levels.
I’m going to tell you.
That’s right. I don’t do this often, but today I’m going to show you how I’m going to trade it and why. You can follow along for free.
If I’m wrong, we lose a little money. As a professional trader and hedge fund manager for many, many years, I’ve put on lots of trades that didn’t go my way. We’ll plan to get out of the trade with a small loss and get back in the trade again or switch gears and go long.
If I’m right, you’ll make a boatload of dough and post a nice comment here.
Here’s my thinking…
Cheap Money Brought Markets All the Way Back
Markets have been riding zero interest rate policies and quantitative easing for years and are duly inflated. Everyone knows that.
What we don’t know is how this game is going to end.
We don’t know what the “free-market” level of stocks should be because free markets have been hijacked by central banks acting like central planners.
But that hasn’t mattered because more and more QE and “stimulus” programs flooded market players with more and more liquidity, meaning more cheap money to play with.
And since economic growth has been a questionable route, most of that money went into short-term positions in financial markets. They’re short-term positions not because the investors who’ve been chasing stocks higher are necessarily short-term traders, they’re short-term investments because they can be liquidated on a dime.
We saw what happened back in the summer of 2013 with the “taper tantrum,” when then Fed Chairman Ben Bernanke hinted the Fed was considering winding down asset purchases.
All hell broke loose and markets tumbled.
Lots of stuff happened between then and this past summer, but not a lot of it mattered. Markets kept being fed their baby formula and kept getting fatter.
That is, until this past August…
Stocks fell globally, and very quickly, because the Fed was talking about raising rates and all of a sudden China decided it would devalue its currency.
That caused a major panic. If the Fed raises rates, the dollar should appreciate. And a rising dollar in the face of a falling Chinese yuan would mean other emerging markets countries would have to depreciate their currencies to compete for exports with China… or the markets would do it for them. The panic concerned how, with depreciating currencies, foreign borrowers would pay back U.S. dollar-denominated loans to the tune of almost $9 trillion.
Oops. The Chinese backed down instantly, the Fed backed down instantly, the ECB suggested more QE to come, the Bank of Japan choked, China had to lower interest rates and reserve ratios again.
It was a mess.
Here’s What’s Pushing Markets Higher Now
That is until investors said, wait a minute, we know how to dance to this tune. And here we are back up where we left off in August.
But I’m not buying it.
Yes, I know I’m going against the tape (and I rarely do that), and I’m going against the Fed (they may not raise rates in December, next year or ever, just kidding), and investors are all giddy about the big bounce and we’re coming into the end of the year when money managers desperately try to take the averages up to make their awful years look better. I know all that.
But, what if the Fed does raise rates?
What if all the profits that have been made look like they’re going to evaporate?
Markets could fall, and quickly.
Yes, we’re back up here at 18,000, but that’s the headline story.
But here’s the truth: the major indexes are being driven by a handful of “hot” stocks.
Those big percentage gainers – Amazon, Facebook, Microsoft, Google – are giant companies whose mathematical impact on capitalization-weighted indexes belies what’s going on under the surface.
But where’s the “breadth?”
Fifty-two percent of stocks that make up the S&P 500 are trading below their 200-day moving averages.
Big stocks, as measured by the S&P 500 (keeping in mind their narrow leadership mentioned above), are up 13% from their August lows. But the Russell 2000 Small-Cap Index is up a mere 5%.
In the bounce after the 2011 dip, more than 90% of stocks traded quickly above their 50-day moving averages. This rally’s only pushed 79% above their 50-day moving averages.
A lot of the “buying” looks to me like high-frequency traders taking out small offers on successively higher prices as fast as they can, to push socks up in gap fashion.
Commodities have to hold up, too. Oil (WTI) has to stay above $45 and get above $50.
Copper has to stay above $2.30/lb. and not break below $2.20/lb.
And that still-giant elephant in the room, China, has to firm up. The Shanghai Composite took a few hits again recently. If it heads back towards 3000, or heaven forbid, breaks 3000, rallies everywhere will reverse and we’ll be back in correction mode in no time.
We’re on a knife edge, and any number of these “negatives” could scare markets.
That’s why at 18,000 I’m willing to put on a downside position that will make a lot of money if we can’t hold 18,000 and slip backwards.
Here’s what to do…
Take a Small Risk at a Major Pivot Point
Because 18,000 is a pivot point, meaning a point that we were at before, a psychological point, a point where investors have to decide to get back in, get more in, or take profits, it’s a pivot point, a fulcrum point, a point where we can go either way.
I like taking a small risk at pivot points. I look at the big picture and I get all the headline bluster, but I also see that not everything is on solid ground.
That’s why I’m buying the ProShares Short QQQ ETF (NYSEArca:PSQ).
If the Nasdaq Composite, which is what the QQQ ETF follows goes down, and I’m choosing the Nasdaq because it has performed the best lately and if stocks turn tail, investors here have the most to lose, then PSQ, which is an inverse ETF (meaning it goes up if the Nasdaq goes down) will rise in price.
So here’s what we’ll do…
Buy PSQ at $51.75 or lower.
If I’m wrong and stocks rally, I’d sell PSQ at $49.16 for only a 5% loss.
If I’m right, I expect to make maybe 20% on the trade.
Risking 5% to make 20% is a worthwhile risk/reward play for me.
And if I’m right and I see markets weaken, this will only be one trade I’ll have on. I’ll put a lot more leveraged trades on if we start heading down from here.
Both U.S. and overseas stocks have been rallying since their ugly August sell-off.
But, if the prices on two key commodities tank, expect stock prices to follow.
Oil and copper hold the keys to the future of stock prices.
A Blueprint for Disaster
Generally, stock valuations are a function of earnings and interest rates.
How much a company has earned historically, what its earnings are today and what its future earnings prospects are – relative to its share price – are key valuation ingredients.
Interest rates also are crucial determinants of valuations in both individual stocks and the overall market.
And with good reason.
There are many interest rate-influenced factors that can influence the valuations of individual stocks and the broad market. There’s the interest rate a company pays on its debt, what its dividend yield is relative to its peer firms, and the overall market and what competition bonds and other fixed-income investments pose.
Sometimes, however, interest rates and earnings just don’t matter. That’s because stocks and markets can get hijacked by outside forces, like commodity prices.
Investors who don’t understand that forces like the prices of oil and copper – which may not be raw inputs or have anything whatsoever to do with a company’s business – can move stocks better learn quickly what to watch and why.
Or they’ll get blindsided quickly.
Right now, the price of oil is extremely important – even critical – to the markets.
While falling oil and gasoline prices are considered good for consumers and economic growth in the long term, there’s another side to this story. In the short run, if oil prices were to drop back to their recent lows, stock prices would immediately start to skid.
And if oil downright collapses, stock markets all around the world will tank.
With declining oil prices, it’s what’s playing out behind the scenes that matters most.
Let me show you…
When oil falls, it’s from lack of demand, oversupply or both.
And right now, it’s both.
When oil demand starts growing at a slower rate, it’s a sign that economic growth itself is slowing.
That’s happening now.
According to a brand-new report from the International Energy Agency, global demand growth is expected to slow from its five-year high of 1.8 million barrels a day this year to 1.2 million next year – which the IEA says is “closer towards its long-term trend as previous price support is likely to wane.”
Recent reductions in global growth forecasts are having an impact, the IEA report says.
At the same time demand is easing, oil supplies keep increasing. The U.S. Energy Information Administration’s newest outlook – released this month – says “global… production continues to outpace consumption, leading to strong inventory builds throughout the forecast period.”
Global oil inventory builds in this year’s second quarter averaged 2.3 million barrels per day, compared with increases of 1.8 million barrels a day back in the first three months of the year.
Slowing economic growth, as evidenced by slowing demand growth for oil, isn’t good for stocks.
What’s worse, if the price of oil tanks, the banks that have huge loans out to energy companies will get hit.
And hit hard.
More than $500 billion worth of “junk bonds” issued by energy companies that have been bought by mutual funds and exchange-traded funds (ETFs) will get clobbered. Falling oil prices will rekindle deflation. And perhaps most frighteningly, collapsing oil prices could destabilize oil-producing countries in the Mideast – most notably Saudi Arabia.
West Texas Intermediate (WTI), the U.S. oil benchmark, is trading around $43.50. If WTI falls below $38 – thereby breaching its recent cyclical lows – there’s no telling where the bottom is.
The lower oil goes, the more selling it ignites. Lower prices cause futures prices to fall as energy players rush to hedge inventories and future production, which puts more pressure on spot prices.
Big drops in the stock prices of energy companies will take down the rest of the market.
And then there’s copper.
The End of Days
Everyone knows that markets went into a panic sell-off mode back in August.
But here’s what they missed: the reason investors panicked in the first place.
In an almost humorous “Eureka!” moment, China had to instantly backtrack a day after announcing it wanted to devalue the yuan by 2% against the U.S.dollar.
Emerging markets tanked instantly, Asian stocks free-fell, European stocks tumbled and U.S. stocks freaked out.
What wasn’t funny was that Beijing momentarily forgot that – in spite of its slowing economy and its hope to help revive exports by lowering the country’s currency – there’s an almost $2 trillion game being played in China having to do with copper, interest rates and the value of the yuan relative to the U.S. dollar.
Almost instantly, investors and speculators in the Chinese copper “carry trade” began to unwind the bet that the Bank for International Settlements estimates is somewhere between $1.2 trillion and $2 trillion. I’m going with the $2 trillion figure because the BIS is notoriously conservative in its estimates of leveraged positions.
The copper carry trade works like this.
Chinese and other investors and speculators get loans in U.S. dollars, because U.S interest rates are so low, and buy copper that they warehouse in China. Chinese lenders then make loans in yuan, using warehoused copper as collateral. The “investors” then park their borrowed money in higher-yielding Chinese fixed-income securities, sometimes in stocks, and most of the time buy more copper to warehouse and borrow more against.
You see where this is going?
If China’s currency falls in value, it will take more yuan to pay back the U.S. dollar-denominated loans that carry-trade investors and speculators took out in the first place. If China ratchets down internal interest rates to stimulate growth – which it did Friday – the rate of return that carry-trade speculators get on their Chinese investments gets cut back.
And that makes the carry trade less profitable – and riskier.
Then there’s the final nail in the coffin of this $2 trillion monster…
The price of copper.
If the price of copper starts falling, the value of the collateral all these trades are based on also drops. Not only will there be margin calls, there’s fear globally (for those who understand what’s really going on in China) that some unknown amount of warehoused copper has been pledged as collateral several times over for different loans.
Right now, copper is trading around $2.38 a pound. If it falls below $2.20 to $2.25 per pound – where it has some technical support – the decline will likely set in motion a cascade of selling as carry-trade speculators start unwinding their trades because they’re getting margin calls.
A copper sell-off will trigger the unwinding of the massive copper carry trade and put extraordinary pressure on other commodities, on emerging markets that export them, on Australia whose economy is driven by commodity exports and on global markets that will see panic rush of “risk-off” selling.
Watch the stock market all you want. But if you want to know if a Category 6 hurricane is about to blow over you, watch the price of oil and copper.
You’ve been warned….
P.S.I encourage you all to likeand followme on Facebook and Twitter. Once you’re there, we’ll work together to uncover Wall Street’s latest debaucheries – and then we’ll bank some sky-high profits.
Thanks to the connections I made during my days as a trader and hedge-fund manager, I’ve enjoyed meals at some of the world’s finest restaurants.
Needless to say, I’ve enjoyed this immensely.
But I’m also smart enough to know that there are times when simple fare is the best fare.
Today I’m going to show you seven different ways to cash in on the looming “Glencore Moment.”
And I’m going to do so by applying some semi-sophisticated trading strategies to some of the simplest fare in today’s markets – exchange-traded funds.
But don’t let that simplicity serve as a turnoff.
The profits you’ll pull down will be as zesty as any you’ll achieve anywhere – especially given the substantially reduced levels of risk posed by my ETF strategies.
And if you do as I say, you’ll be writing to me to relate your easily financed haute cuisine forays.
Let’s take a look…
Trades to Tackle
In my last few visits with you, I’ve talked extensively about the financial plight of Glencore PLC (LON: GLEN). I’m going to continue that talk today – but give you some trades to accompany my analysis.
Going forward, the two key factors to watch are 1) the company’s stock price and 2) whether it can sell assets fast enough to stave off a ratings downgrade.
If the stock falls back to its September lows, it’s time to get defensive. Or if there’s any meaningful ratings slide, get short.
Commodities prices have to be watched closely. If copper falls steeply from current lows of $2.35 a pound, a cascade of selling from unwinding the Chinese carry trade would have immediate global repercussions. By the way, copper traded as low as 60 cents a pound back in 2004. So a drop from $2.35 could be steep – and play out as fast as a lightning strike.
Emerging markets will sell off. And so will China.
Commodity-based stocks and ETFs will get creamed.
And financial stocks will get hit because bad loans will start sprouting like weeds. Billions of dollars of leveraged, commodity-backed loans and junk bonds have been packaged and warehoused by yield-hungry banks, high-yield mutual funds and ETFs.
If the capital-market “canaries in the coal mines” I’ve detailed here start choking, you’ll want to bet on falling copper prices, falling commodity prices, falling emerging-market economies and falling stock prices.
To cash in on copper’s plunge, I like buying out-of-the-money puts with at least three months to expiration on the iShares MSCI Chile Capped Investable Market Index Fund(NYSE: ECH). I also like shorting ECH – even if I have to pay out part of the dividend while I’m short. Timing is an issue with buying puts: They give you more leverage but can expire worthless if time runs out before the stock takes its hit.
To manage my risk, I’d cover my short above $38.50 for no more than a 10% loss if the trade doesn’t pan out.
As I explained in my last report, the price of copper is a key to the future health of Glencore.
And that means it’s a key to our trade.
Wait until you see the price of copper break below $2.25 per pound, before you buy your puts or short stock. Copper accounts for half of all Chile’s exports. The country is a mining powerhouse, so falling commodities prices will act as a kick in the teeth for the Chilean economy.
Indeed, the emerging markets in general will take it on the chin from falling commodities prices if Glencore implodes. They’ll all see crucial capital flee their shores in favor of the safety of the U.S. dollar – thereby boosting the cost of their dollar-denominated loans and pole-axing their currencies.
To profit from tumbling emerging markets, I like to buy puts on – or outright short – the iShares MSCI Emerging Markets ETF (NYSE: EEM). I also like to bet against China by shorting or buying puts on the large-cap fund – the iShares FTSE Xinhua China 25 Index ETF (NYSE: FXI).
Follow the same trade game plan here that I laid out above for playing ECH.
For U.S. stocks, I’d buy the February 2016 $30 Calls on the ProShares Short Dow30 ETF (DOG) – a so-called “inverse” ETF – and try to pay only 25 cents each for them.
Anyone can buy an inverse ETF like DOG to “short” the Dow Jones Industrial Average. Because you’re not actually “shorting” a security – meaning you don’t need a “margin account” – this is a trade you can make in your IRA.
I like buying calls on DOG because it gives me a lot more leverage and the potential for a gain of several hundred percent if the market explodes and drives that trade in our favor.
U.S. and global stock markets always sell off when a substantial threat – like Glencore imploding or copper prices crashing – reveals just how “correlated” (interlinked) the world’s financial markets are and how risk-averse investors become when they’re confronted with monumental unknowns.
Stay tuned: I’ll show you more strategies – and more trades – that will protect your wealth and help you profit when the bottom drops out of this market.
I see plenty of chances for us to cash in – thanks to the “Glencore Moment”… and beyond.
It’s the biggest commodities-trading player on Earth.
And it’s in big trouble.
I’m speaking, of course, about Glencore PLC.
Its near-term prospects are bleak.
And thanks to its size and market influence, the ripple effects of any problems will be widespread.
For instance, if the company can’t pare its debt load fast enough, if it can’t sell assets to raise cash fast enough, if ratings agencies knock its thin investment grade rating down to junk, if commodities prices keep falling, Glencore could implode – violently.
The disruption caused by a Glencore meltdown would be global: The company’s implosion would affect commodities markets, debt markets, derivatives markets, emerging markets and, of course, U.S. and global stock markets.
As someone who’s closely watched the company for many years (I even wrote the story of Glencore’s infamous founder for Forbes magazine several years back), I’m as well positioned as anyone to tell you what’s really happening.
Here’s the truth about how close the company is to the edge of the cliff, how markets would be affected by a Glencore “credit event,” the signals that will tell you a crash is imminent – and how to protect yourself and profit from this company’s extreme difficulties.
Let’s start with the “players” who set these potentially calamitous events in motion…
Lighting the Fuse
Ivan Glasenberg, Glencore’s hard-charging CEO, got his start under the company’s infamous founder, Marc Rich – the man I told you about in our last talk. From a coal marketer in the 1980s, Glasenberg eventually became a worldwide director, and ultimately was a partner on the management team that bought Rich out in 1994.
Glasenberg became a billionaire in 2011, raising a whopping $10 billion by taking Glencore public. His 8.4% stake in the company alone was worth nearly $10 billion.
But running the world’s most powerful commodities trading company – and being a multibillionaire – wasn’t enough for Glasenberg.
In 2013, almost at the height of the commodities super-cycle, he bought the 66% of publicly traded mining giant Xstrata PLC that Glencore didn’t already own. That $30 billion, all-stock deal – coupled with subsequent mining purchases – transformed Glencore into a global mining powerhouse… a strategy designed to augment the firm’s hyper-lucrative trading operations.
Today, Glencore controls about 50% of the world’s copper production, 60% of zinc production and 45% of lead production. Besides huge nickel, coal and oil-and-gas operations across the globe, Glencore has massive agricultural holdings and a monster ag-trading operation.
The company’s problems began when its huge hard-asset commodities positions started taking hits last year as prices plummeted in the wake of slowing growth in China.
As China slows, so go commodities prices.
Copper, which rose to a 26-year high of almost $4.50 a pound in 2011, now trades at $3.69 a pound – an 18% drop. Zinc, which was as high as $1.20 a pound in 2010, now trades at 81 cents a pound – a 33% drop. Thermal coal, which spiked to almost $83 a ton in 2010, now fetches $42.13 a ton – a hefty 50% plunge.
Oil is down more than 50% since 2011.
And aluminum prices have dropped almost as much – a full 43%.
The bottom line: Every single major commodity that Glencore owns and trades is in a bear market.
Bloomberg’s Commodity Index of 22 raw materials fell 17% in 2014. And most of the commodities in the index are down another 2% to 6% already this year.
Goldman Sachs Group Inc. (NYSE: GS) recently said it expects to slash its three-year forecasts by an additional 10% to 20%.
Debt … That Four-Letter Word
That free fall in commodity prices is a huge problem itself. But that’s exacerbating an even bigger problem facing Glencore.
I’m talking about the company’s massive debt load.
Glencore has almost $50.48 billion in gross debt (excluding cash and marketable securities). Even its net debt load is nearly $30 billion.
In other words, Glencore’s debt load is five times its cash flow (as measured by a closely watched metric known as EBITDA – or the money the company has after expenses but before taxes and “paper” charges like depreciation and amortization).
But the immediate concern isn’t the company’s total debt load, which management has promised to slash by a third through as much as $10 billion in asset sales.
It’s Glencore’s short-term debt that’s become the company’s financial Achilles’ heel.
Thanks to its $18 billion “trading book,” Glencore’s trading operations typically account for about 75% of the company’s total earnings.
But the short-term debt that finances that huge trading book has to get “rolled over” (refinanced) every 30 to 45 days.
And that’s the slice of Glencore’s finances that’s really pushing the firm toward the brink.
Because of the market’s fear over Glencore’s potential insolvency, continually rolling over that hefty amount of short-term debt is becoming a problem.
If Glencore’s trading desk – the “engine” of its profits – sputters or stalls because the company can’t serially refinance those short-term loans, the firm’s revenue guidance will keep getting cut.
Thanks to the bear market in commodities, that’s already been happening.
At $1.1 billion, total trading revenue in the first half of this year was 29% lower than it was in the first six months of last year.
In the first six months of 2014, Glencore posted a profit of $1.72 billion. In the first half of this year – when Wall Street was anticipating a diminished profit of $728 million – the company actually reported a $676 million loss.
On top of all that, the company’s equity cushion got hammered as its stock price fell as much as 85%.
On Sept. 28 alone, shares of Glencore PLC (LON: GLEN) experienced a single-day plunge of 29%. That plummet – exacerbating earlier declines – meant shareholders had lost nearly $52 billion since the company’s initial public offering.
But buyers took heart from Glasenberg’s Sept. 29 assertion that Glencore had “no solvency issues” and was taking immediate remedial action.
Besides promising to cut net debt by a third, the company axed its dividend and raised a quick $2.5 billion by selling stock. Investors took note that Glasenberg and company insiders bought 22% of the $2.5 billion stock offering. And since the frightful selloff, Glencore’s shares have rebounded.
On Oct. 5, for instance, Glencore shares (HKG: 0805) trading in Hong Kong skyrocketed as much as 70% and ended the day up 18%. So the shares have rebounded a bit from their lows. But they are still down nearly 60% over the past year.
Unfortunately, the trouble is far from over for Glencore.
In addition to the major challenge Glencore faces in financing its huge trading book, there are big concerns about the firm’s credit rating.
If the ratings agencies – Standard & Poor’s, Moody’s and Fitch, for instance – slash Glencore’s credit rating to “junk” status, all sorts of debt covenants get triggered and the company has to post more margin on its $19 billion in derivatives liabilities.
That derivatives challenge is a big one. Back in September, “credit-default swaps” (CDS) associated with Glencore’s debt rose to the point where it cost more than $1 million to insure $10 million of the company’s borrowings against default for five years. That price implies a chance of actual default of greater than 50%.
CDS prices have fallen over the past weeks and now trade at around $600,000. Still, that’s a big bet on a potential ratings cut that could trigger a “credit event” in some of Glencore’s debt covenants, meaning the firm could end up in technical default.
And any cascade of unexpected, negative events could bring the company to its knees.
One such event would be the unwinding of the Chinese copper “carry trade.”
For years, Chinese speculators, and others, have been buying copper, warehousing it and borrowing in dollars (because U.S. interest rates are so low) against their copper collateral. Then they’ve been speculating in higher-yielding Chinese fixed-income securities, Chinese real estate and Chinese stocks.
That’s called a “carry trade.” Cheap financing is used to carry higher-yielding positions.
To bolster a slowing economy, Beijing has been lowering interest rates, which narrows the spread between U.S. interest rates and those in China. That dampens the carry trade and puts pressure on the Chinese yuan (which makes paying back dollar-denominated loans more expensive) – even as the U.S. Federal Reserve is talking about raising U.S. rates. More importantly, it’s also happening as the price of copper – the collateral backing Chinese carry-trade loans – keeps falling.
In other words, if a massive carry-trade unwinding takes place because the value of copper collateral collapses, Glencore, with all its copper holdings and derivatives bets, including its own carry trades, is toast.
Global panic over falling commodities prices, especially copper, will immediately impact emerging markets – because so many of them depend on commodity exports. That will ignite a situation known as “capital flight” – causing the dollar to strengthen as investors pile into the greenback in a flight-to-quality move.
A strengthening dollar will trigger even lower commodity prices, because most commodities are priced in dollars, a situation known in finance as a “negative-feedback loop.”
Such a massive negative-feedback loop could be touched off by Glencore imploding – or by a steep drop in the price of copper, which would trigger Glencore’s collapse.
In its own documents, Glencore says its $6.5 billion in EBITDA drops by $1.2 billion for every 10% drop in the price of copper. That gives you some indication as to how important the price of copper is in the Glencore saga.
The price of copper is also a key to the intriguing trades I’m going to outline for you – in my next report.
The story of the man who started Glencore PLC – and why he fled the United States (and needed and got a presidential pardon) – is a crazy one.
But it pales compared to the ongoing story of Glencore itself – how this Swiss firm grew from one of the most powerful private commodities company in the world to the globe’s most powerful publicly traded commodities companies… and how relentless growth in pursuit of staggering personal wealth drove Glencore’s existence and global markets to the edge of an abyss.
It’s a story I know well: As a trader, I followed the company closely for years. And I actually chronicled the Glencore saga for Forbes several years back.
So no one is better-positioned to bring this tale to you.
That’s why you should listen when I say that if Glencore can’t survive over the next few months the company’s collapse could splatter the markets in a manner that’s every bit as gruesome as the Lehman Brothers collapse of 2008.
First, I’ll relate how Glencore came into existence.
Then, I’ll detail how the company could easily implode.
Finally, I’ll let you know what to look for so you’ll know Glencore’s brakes have failed and it’s heading over the cliff, taking global markets with it.
Plus, I’ll show you some ways you can make some big money on this potentially horrific crash…
The Brassy Bandit
Everyone loves a good story, and the story of Glencore starts with Marc Rich (born Marcel David Reich), the most colorful, controversial, crooked and fabulously wealthy commodities trader the world has ever known.
In the winter of 1974, Rich jetted to the Swiss Alps – not to ski, but to “accidentally” bump into the CEO of Philipp Brothers, at that time the world’s biggest commodities-trading house.
Rich was an oil trader with Philipp. And he was determined to get a huge bonus for the extraordinarily profitable trading he engaged in on behalf of the company. After bumping into his boss on the slopes – and feigning surprise at the “chance” meeting – Rich boldly asked for a $1 million bonus.
Retorted his boss: “Phillip Brothers has never paid a million dollar bonus to anyone – and never will.”
Rich found the nearest telephone and put a call through to Pincus “Pinky” Green – his right-hand man at Philipp’s New York offices.
“Take everything out of the office now,” Rich told Green.
Marc Rich + Co. – later Marc Rich AG – was launched the very next day. Rich had one goal: to crush his former employer – and former boss.
As you’ll see, Rich succeeded – by becoming the most powerful privately held commodities trading house in the world.
Meanwhile, Philipp Brothers – now renamed Phibro Corp. – rallied back and acquired Wall Street’s then-most successful trading house, Salomon Brothers, to form Phibro-Salomon Inc. “Phibro” was dropped from the name, and Salomon Brothers was later acquired by Travelers Group, which merged in 1999 with Citicorp to become Citigroup Inc. (NYSE: C).
Ironically, Andrew J. Hall, the head of Citi’s Phibro unit, demanded a $100 million bonus from his bosses in 2009 for the division’s contribution of $2 billion to Citi’s pretax revenues. He didn’t get it.
The Arab oil embargoof 1973-1974 spawned an array of oil-pricing regulations in the U.S. market. One of those regulations drew a distinction between oil drawn from old wells and the “black gold” pulled from new ones.
Because Washington wanted to spark an expansion in oil and gas exploration, production from new wells commanded much higher prices.
Now his own boss, Rich seized the opportunity. He infamously “daisy chained” millions of barrels of oil from old wells out to sea in tankers and then, through a dizzying maze of transfers, on-shored the oil as “new oil” and sold it at prices allegedly marked up four times. He reportedly netted $100 million in the scheme.
But oil wasn’t the only commodity Rich + Co. was trading. The company was trading everything – and almost “cornered” several markets.
Rich was becoming fabulously rich and partnered with his friend, Denver oil billionaire Marvin Davis, known as “Mr. Wildcatter,” to buy 20th Century Fox. (Rich later sold his 50% stake to Rupert Murdoch for $250 million. Murdoch would end up buying out Marvin Davis, who died in 2004, reputedly broke.)
In the meantime, Rich’s oil trading was getting out of control. Not only was the master manipulator daisy-chaining (artificially bolstering) oil, but he later bought massive quantities of crude from Ayatollah Khomeini’s Iran while that country was holding U.S. citizens hostage in Tehran. Much of that oil was subsequently sold to apartheid-era South Africa.
In 1983, Rich was indicted on 65 federal charges – including racketeering, tax evasion, conspiracy, fraud and trading with the enemy (Iran).
He faced 300 years in prison.
The day the indictments were handed up, the “King of Commodities” abandoned his lavish Fifth Avenue offices – in favor of Switzerland, where he believed he’d be safe from extradition.
Incidentally, infamous arbitrageur Ivan Boesky moved into Rich’s abandoned New York offices. And in keeping with $100 million profits and $100 million bonus requests, Boesky paid a $100 million (cash) fine after being convicted for insider trading in 1987. He also served two years of a 3.5-year sentence in prison.
Comfortably ensconced in Switzerland, instead of slowing down, Rich amped up his trading. With “Pinky” still serving as his right hand, Rich exerted absolute control inside his company – and flexed his muscles out in the marketplace.
Rich eventually retired in 1994 after a management-led buyout of his interests spawned Glencore.
Although Rich was born in Antwerp, Belgium, he was raised in New York – and it was the United States that he loved.
But he never dared to return.
Not even after his ex-wife – songwriter Denise Rich – gave more than a million bucks to Democrat Party causes, including $450,000 for the Clinton Presidential Library. Not even after he was pardoned by Bill Clinton – in the president’s final hours in office.
In June 2013, Rich – a man who’d escaped the Holocaust with his family, and who was known as “El Matador” for his swashbuckling style – passed away at age 78 from a stroke.
The legend of Marc Rich will be told and retold – and will undoubtedly grow.
After all, there are stories about his backing Israel’s Mossad and how that intelligence service protected him – about his close contacts with Henry Kissinger, the King of Spain, Israeli power politicians and the Mafia.
But even after Rich was out of the picture, Glencore kept on growing.
Under CEOIvan Glasenberg, who engineered the buyout of Rich and took Glencore public in 2011, the company would leverage itself up to the point it’s reached today.
The company’s debt load – compounded exponentially by the price collapse of all the commodities the firm controls and trades – endangers not only the company, but the global financial markets, too.
It’s no exaggeration to say that the “Lehman Moment” of 2008 could be reprised as a “Glencore Moment.”
That’s why – in my next report – I’ll show you just how bad things really are at Glencore.
I’ll tell you what to watch to determine if Glencore is headed over the cliff – and likely to take global markets with it.
And I’ll show you a few moves to make to protect yourself and profit if Glencore ends up on the rocks.