Oil shaman gourds and Paradoxes

T. Boone Pickens was out yesterday shaking his oil shaman gourds. In the past, whichever position he has espoused in that ritualistic shaking, the market has made a U-turn. Specifically, in the past, he has stated that we'd see higher prices prior to lower. We got lower. Granted, my n= (sample size of observations) is not very large. But yesterday, T. Boone stated that he was short oil. My expectation, then, is that it will go up!

I say that half kiddingly. As this market has gone down, we've seen it as a sector by sector smackdown. Do you remember the first sector to top and then fall? I believe that it was REIT's. Gary K and Doug Kass were the first two folks that I heard warn of these sectors topping, then of course falling. That event was almost a year ago.

Watching this market both crest and fall has been a privilege for me. While I've no insights or experience regarding this process, I know that I will be served well in the future by having watched, and more importantly, THOUGHT, about this process. I'm less concerned with my thinking being right in as much as I'm concerned about whether I'm thinking about the right things.

If I were on an elevator, and someone asked me, "Leisa, what do you think is the most important thing that an individual investor should know?". I would give this answer: "Every individual investor should have a basic understanding of the economic cycle and the sectors which do well or poorly in the phases of those cycles." I would then point them to George Dagnino's blog and ask them to print out and read his brief article on same.

I've referenced this graphic and George's commentary several times on this blog. I continue to believe it to be the single most important article on the web. If you click on the graphic, you will be transported to the article. I hope that you'll take a moment to print it out and read it. If you have an investment in a terrific company that is in a sector that has peaked the probability of your losing money is quite high. I think that buy and hold is so widely touted in that it is the easiest methodology to communicate to the masses--that means you and me. For this to be a singular strategy without some periodic rebalancing makes no sense to me.

In my view, why would I want to buy (commit new money) a good company in a peaking sector only to lose 15-30% when it moves down? The Hirsch brothers have a simple mantra: Always sell half on a double. I've followed this advice religiously, with never a regret. It allows one to generate 'new' money within a low turnover portfolio. It protects past profits and commits 'new' money to sectors/stocks that have a higher probability of doing well. But everyone has to find an investing modality that makes sense to them. This is my modality.

Models serve to give our thinking structure. It does not mean that the models are infallible; but rather, it means that models give our critical thinking process particular points of traction. What are we analyzing? We are analyzing whether or not current observations converge with divergence with the model. In general, points of divergence between empirical (what we observe) data and models is the genesis of all progressive thought. The model of the Earth being the center of the universe worked until Copernicus posited an alternative theory.

You're probably wondering if I have some point to make. I do, and it relates to commodities. Commodities decline in an economic slowdown. We have a point of divergence between commodities rising v. data that our economy in addition to the European economy (as well as some Asian economies) are slowing.

I know the arguments that Jim Rogers and others make that we are in a supra-cycle for commodities. I don't disagree. But even within supra-cycles there are relative points of decline, and there is volatility. I'm trying to understand if the current strength in the non-ag commodities is due to traders goosing the last golden egg of the economic cycle, or if this strength is due to something different.

I believe that relative to where we were a year ago, the demand for commodities has declined. Even China's growth is slowing down a bit, albeit it is in high gear. I also must wonder if many were short commodities as it is the natural place to be in a slowing economic cycle and the recent increase in iron ore prices took many by surprise.

I believe that the world economy is slowing. But I also believe that there are a few paradoxes.

Paradox 1: Resolution of the USD direction. If the USD strengthens against other currencies, then I believe that commodities will fall. The USD likely will not strengthen due to our resolving our economic issues, but rather because our markets and systems (despite the flaws) are more transparent and better regulated than other markets.

Paradox 2: Specter of Stagflation. That despite a slowing in the global economy, the strain on commodities will keep prices high. This becomes the dreaded stagflation. There seems to be an even mix of proponents and opponents to this view. I've not formed an opinion, but I'm watching it.

Paradox 3 (perhaps a Past Paradox!): Liquidity/carry trades. With the Yen strengthening against other currencies combined with its contribution to the carry trade, we've probably seen the effect of this unwinding already. It's been dramatic. But I think that with the reduction of this carry trade effect, there is less cross current noise. I think that this is a past Paradox (meaning markets going up due to the effect of carry trade though future economic picture also showed some slowing.

Paradox 3.1: Fed liquidity. Despite the Fed's lowering of interest rates and increasing liquidity, it is still not enough to create incremental liquidity (meaning liquidity that makes its way into YOUR hands rather than staying within the boundaries of financial institutions with severely impaired capitalization issues). I've mentioned this paradox several times over the last few months. It flies in the face of the aphorism of don't fight the Fed. Nevertheless, there is credible evidential matter that traditionally created liquidity pales in comparison to the synthetic liquidity created by the credit markets. I believe this Paradox to be one of the single most important things to watch. I believe that the amount of liquidity needed to shore balance sheets of credit market players is huge--and the Fed cannot provide all of that. Additionally, one has to consider the effect of tightening lending standards.

Paradox 4: If the magnitude of the credit debacle is as great as they say (and I believe that it is and more), where are the dead bodies? We are not out of the woods until you see more dead bodies. I think that there will be a floater or two that will surprise us. If there are no dead bodies, then IN RETROSPECT, we will know that the issue was never as deep and wide as believed. I do not believe that to be the case.

These are a few of my favorite things to keep in mind as events unfold.

I sold my HERO calls for a 50% gain. Looked like this area was getting a bit weaker--and it was a good decision with the information that I had available. I still like this stock, and I'll look to re-enter.