Will Gold’s trap remain intact?

Gold is up from since I mentioned that it looked bearish after the false breakout. However, the gold market still looks bearish, as long as it continues to stay below $1200.

You’ll see on the GLD daily chart above that 120 (~$1200/oz) is a critical resistance. If there was a true bull trap last week, gold needs to stay below that level to prevent all those traders from breaking even. I think this might happen because volume shrunk during the rally this week. Nevertheless, I will exit my gold short if the highs from last week are broken.

The stock market is now in a downtrend

Today was an important day in my opinion. We finally made a lower low and broke the 15 month uptrend.

You can see in the chart above that since March, 2009, SPX made a clear series of higher lows and higher highs, thus defining an uptrend. Then we had the crash on May 6th, which stopped just shy of the previous trend low on Feb 5th; uptrend still intact. After a rally which made a lower high, however, the market has now resumed selling off, breaking the series of higher lows.

One might compare this decline to that of August 2007, in which we had two sharp down-legs with extreme bearish sentiment. But notice that back then, the market stopped short of making a lower low, and the uptrend continued for another couple months.

Now that the downtrend has been confirmed, my strategy will be to short rallies against 1180.

Gold is looking ugly

Gold was all over the news last week as it was raging to new highs. I now think that it may be near the end of it’s uptrend, and I’m shorting KGC (Kinross Gold) as a proxy for gold, with an order to exit if GLD makes a new high.

My first chart shows yearly candles for gold. Notice that we’ve had 10 straight years of higher prices in gold. Gold is the “no-lose” investment today. Even if gold eventually does hit $2,000/oz as many people expect, I think we need an intermediate term correction that creates a down-year candle to shake some people out. Even the massive inflation in the 1970’s only lasted for 4 years. Furthermore, we are seeing the weakest inflation in 44 years, even with the trillions and trillions of dollars that governments are printing. This implies massive deflationary forces which could spell weakness for gold.

 

The next chart shows weekly bars for the past 11 years. From an Elliot Wave perspective, notice that 5-waves have completed. Often times, commodities will have a massive rush as the trend ends, but my thesis is that perhaps we will see an intermediate correction before we get this massive rush. A correction could take gold to the Wave-4 low of $700. There is clear RSI and MACD divergence, but these have yet to be confirmed.

The daily chart above shows a very interesting phenomenon that occurred last week as the media was excessively bullish on gold. Notice that price broke out above the previous high and stayed above there for several days, enough to convince people that it was a real breakout. Then today it gapped lower, trapping all the bulls badly. If this false breakout is significant, we should not see a new high, and thus I am placing my stop at that level.

One other interesting chart which shows the excessiveness of gold’s rally is the weekly candles of gold priced in euros. Notice the clear parabolic nature of that rally. Once again, no matter how badly the press portrays the situation, parabolas are unsustainable. Either gold will tank, or the euro will rally, or both.

Finally, take a look at the daily chart for KGC. Most gold stocks have slightly underperformed gold, but not nearly to the extent that KGC has. Its relative strength to GDX (a gold stocks index) has been weakening ever since gold bottomed in 2008. Since gold stocks tend to leverage moves in gold, I see KGC as a good stock to short; if gold drops, KGC should drop harder than most gold stocks, and if gold rallies, KGC may continue to underperform, thus lowering my risk.

It’ll be interesting to monitor what gold does in the near future. It’s obviously too early to call a long-term top in gold, but I’ll try to catch a rising knife at this point. If gold makes a new high, I’ll know that I’m wrong on the short-term.

Taking a Bet with NEP

Back in Jan, 2010, when NEP was rising exponentially, I made several posts clearly explaining that price would soon top, and that it would start a downtrend and poor returns going forward. I think NEP’s intrinsic value is between $9.70 and $13 (using 24% or 15% discount rate, respectively) so today I’m taking a risk and purchasing some shares into the recent downtrend, with a stop @ 4.77.

You can see on the 3y daily chart above that there is a very long-term trendline which has supported price action ever since it broke higher with the news that it was uplisted to AMEX. By going long here, I’m betting that the trend will continue, and that NEP’s management will get its s*hit together and correct the company’s financial statements! Regardless of what happens, though, if price breaks below the trendline and goes below 4.75, I’ll take a loss and stop myself out, as this would indicate a longer-term trend reversal.

Why Sadar Biglari's proposed compensation package from BH is a fair deal for investors

After being invested in Steak and Shake (SNS) last year from $5.80 to $9, I've continued paying attention to them. Today the company has changed its name to Biglari Holdings (BH ) and trades at $320 (They reverse split 20-1, so its $16 when compared to my shares).

I noticed that their stock price has dropped from as high as $418 in early April, and wanted to see why. Apparently one big reason is because of the new proposed compensation package for the CEO, Sadar Biglari. Here is the gist of it:

1. Biglari is selling his other company, Biglari Capital, to BH for $1. Biglari Capital is the general partner of The Lion Fund, L.P., a Delaware limited partnership that operates as a private investment fund. The Lion Fund manages about $50mil, and Biglari Capital was paid 25% of any returns over a 5% annual hurdle with "high water mark" stipulations.

2. In return, Biglari would now be paid an incentive bonus based on the increase in Book Value of BH. Again there will be a 5% annual hurdle before any bonus is paid out, at which point his bonus would be 25% of the gain in excess of 5%. There is also a "high water mark," stipulation in place. Finally, Biglari would be required to use 30% of bonus money (at least 50% after taxes) to purchase BH shares within the next 120 days after issuance.

Thus far, investors have been screaming bloody murder on the message boards and even well respected (by me at the very least) NFI has sent a letter to BH against this package. However I feel that this package is quite fair and that investors will actually end up quite satisfied with their returns if Biglari makes a lot of bonus money. Let me go over my logic:

There are three main ways BH book value will go up:

1. Profits from Operations

2. Increase in the value of company investments

3. Purchase of other companies through issuance of stock

The first two ways are clearly beneficial for investors as in the long run the stock price will follow if the company's value increases in those ways. The third way is where investors could be hurt, because new stock being issued to purchase another company would potentially dilute current investors, yet possibly create a situation where Biglari could receive a bonus. However, I believe that Biglari will only use stock to purchase other companies when they represent a good long term value because he holds a lot of BH stock and the value of his shares would fall by more then his potential bonus.

Here's what BH's book value has been the last 5 years:



Now lets look at how investors might benefit long term vs how much Biglari will benefit. In the chart below I've assumed that Biglari delivers earnings of 10% of Book Value each year, giving him a bonus of 12.5% of the increase in Book Value.


As you can see, investors do quite well for themselves, pocketing 8.75% yearly gains, while Biglari receives a yearly bonus in the $3-4mil range. I feel like many CEOs at publicly traded companies make quite a bit more whether or not they deliver long term performance figures that would be as solid as these.

I think it is clear that Sadar's long term plan is to emulate Buffet and Berkshire Hathaway. He will take cash from Steak and Shake and other future acquisitions and plow it into investment opportunities which he feels will yield higher then 10% returns. I bet that in a few years the bulk of the yearly Book Value increase will be due to the increase in the value of investments owned by the company. At that point, one could consider BH to be a hedge fund, and Biglari's bonus to be his management fee. Personally, his fee structure is much more appealing that the typically 2%+20% of profits.

Disclosure: Don't own any BH at the moment, but seriously considering buying some right now.

Closed out EUR/USD Short Trade

If you look at my last post about EUR/USD, you can see that I favored the collapse scenario for the EURO. We certainly got a nice swoon! My target on this trade has been 1.27 for a while, and since we got that price today, I decided to take profits and sit out for at least a couple weeks. I believe we could see additional downside, but 2,300 pips in 6 months is fine for me.

 

On the daily chart above, notice that price easily pierced the weekly trendline dating back to 2002! I believe that the congestion around 1.35 was where all the buying pressure from that trendline was absorbed. Once the buying power was absorbed, there was nothing to hold up the EUR when it actually reached the line, and it was able to easily collapse (probably tricking many a retail trader who bought there for an ‘easy profit’).

Regardless, if the EUR/USD bounces from here, it appears that there could be one more wave down to follow. I would love to see price break through the 2008/09 lows before starting a sustained uptrend, just to create the bearish sentiment required for an uptrend.

Exited ABX short @ 42.65

As you know, I’ve been short ABX from around $47.20. I recently got stopped out of my short position since the Gold market has been exceptionally strong. I closed out the trade @ 42.65 for a small profit, according to my trade plan.