Trader’s Narrative

The worst thing an indicator can do is not to be consistently wrong but to have no edge whatsoever. This is because if it is consistently wrong or almost always wrong, then it can be used as a contrarian indicator. Jim Cramer would be a good example. If on the other hand the indicator is more or less right on the money, then it is a leading indicator. A good example would be the OEX options market.

The TickerSense blogger sentiment poll is useless as a sentiment indicator because it has no edge, it is just random data. Noise. To this useless sentiment indicator, we can add another one: Citigroup’s Panic/Euphoria Model.

This is an proprietary aggregate measure of sentiment from the quants at Citigroup and is published weekly by Barron’s in their sentiment section. If anyone had any doubts as to the value of this indicator from Citigroup, this most recent market upheaval has given them a definitive answer.

Citisnooze
As we suffered one of the sharpest drops in stock market history, as volatility spiked to record highs, as sentiment measured by traditional investor surveys reached epic pessimism, as breadth redlined, the Citigroup’s Panic/Euphoria Model yawned and continued napping:

I’m not sure what goes into the calculation of this number and frankly, I don’t care. Whatever recipe Citigroup Investment Research is using, it is garbage. What I can’t understand is how anyone can continue to come in in the mornings and crunch numbers for this indicator when it is completely separate from reality. Why is a reputable publication like Barron’s legitimizing this drivel by disseminating it every week?

Tweaking Garbage
Although the make up of the indicator is secret, there are some hints that Citigroup has tweaked it in. You can see that in the chart below (from April 28th 2008), the low in March 2008 does not coincide exactly with the same trough in the most recent iteration of the graph above. The low in March was deeper (more “panicky”) and it registered closer to the end of the month while in the most recent data, it is shallower and occurs mid-month.

The problem with tweaking garbage is that even if Citigroup corrects it, the data won’t be historically comparable. Just like TickerSense, the best thing to do is to acknowledge reality and discontinue it.

When a widely popular site like icanhascheeseburger.com puts this up, it’s safe to say that not only has the concept reached everyone, but that “recession” has seeped into the very depths of our collective psyches:

Source: icanhascheesburger.com

Of course, as a contrarian indicator, the fact that we are in a recession may in fact be a condition of the new bull market.

Although I’ve previously touched on the predictive quality of the IPO market, I wanted to bring it up again because what last year was a slow trickle has now dried up to an outright drought.

So far in the first quarter of 2008 we’ve had only 12 IPOs: 5 in January, 4 in February and 3 in March. The last one being the high profile initial public offering of Visa (V). It added an enormous $18 billion to the quarterly value number, leaving less than a billion for the other 11 IPOs.

Visa has also provided the best IPO performance this year with a 50% rise from its $44/share offer price. BioHeat (BHRT) has been the worst performer, with a return of -24%.

Although this lack of activity can be interpreted by some as being negative because it means less business for Wall Street, less money for companies that are growing, and less opportunity for investors to fund new enterprises, in actuality it is a sign of good things to come.

To understand why, we’d have to put on our contrarian goggles: a drought of IPOs mean that there is a total lack of ‘froth’ in the market; it means that VC’s are holding off selling their equity because they know that it won’t get a bid; it means that most investors are in a retrenchment mode and are in no mood to put new money in unproven companies, instead preferring to hold more conservative securities.

When you restrict the supply of something, demand being equal or growing, prices go up. Economics 101. So as public companies continue to buy up their shares and private ones refuse to go public, the ‘float’ of equity decreases… pushing up average aggregate share prices.

Also, historically periods of IPO drought have not meant that new companies do not grow or find funding. Instead they have denoted incredibly opportune times to invest in the stock market.

As the maxim goes, “Be bold when others are fearful and fearful when others are bold.” And right now it doesn’t take a genius to see that with a lack of IPO filings, nervous companies pulling their filings and an empty roster of secondary offerings… that fear is rampant on Wall Street.

I remember learning the predictive power of IPO trends during the height of the bubble. It was one of the most powerful arguments that convinced me we were indeed in a bubble and would soon see a bear market correction.

But right now its message is the opposite. Just as it was in early 2003.

Here are some IPO resources:

• Hoovers IPO Central
• Marketwatch IPO Overview
• CNN Money IPO
• Yahoo! Finance IPOs
• MSN Money IPO Center
• IPO Home by Renaissance Capital the managers of the IPO Mutual Fund

Amid all the wailing and gnashing of teeth, we had a successful IPO: Visa (V) went public yesterday and made history.

Not only was it a resounding success for the investment bankers in a very difficult time, it was also the biggest IPO ever at $18 billion. And it managed to jump +30% from its $44 per share pricing.

But perhaps it was because of the financial and credit market turmoil that Visa did so well. Unlike many financial companies it carries no consumer debt but instead relies on small commissions on transactions.

Leadership
Each bull market has its leaders. A few years ago, Google (GOOG) and Baidu (BIDU) debuted on the stock exchange and quickly became the darling of momentum investors. Now they both lie broken, not only below their long term moving averages but also with the sword of Democles” (overhead resistance) hanging persistently above price.

So, if we are in the painful process of putting in another bottom here, as I’ve endlessly argued for the past little while, it is wise to look for the next leadership that will breath new life into the “new” bull market.

If Visa does as well as its competitor, MasterCard (MA), I’ll be a happy camper.

IPO Market? What IPO Market?
So far this year, we’ve had only 22 IPOS. Last year, by this time, we had 47. That is a greater than 50% drop off in activity.

If you’ll recall, the IPO market has predictive abilities.

The other way that the IPO market can help us time the market, or at least understand where we are in terms of market cycles, is by being a contrarian indicator of sorts. A bountiful harvest of IPOs has almost always preceded dramatic and sustained market downturns while a barren IPO market has historically meant the opposite.

Time to ‘fess up. I’ve been horribly, horribly wrong on gold. So much so that now I’m afraid of being labeled a contrarian indicator!

So let’s see, in December I thought I saw a tentative double top in gold… which didn’t materialize. Instead, gold paused by trading sideways for a month and then continued blazing higher and higher:

To be fair, a double top formation is only triggered when the neckline (the dotted line on the graph above) is pierced. Since that didn’t happen, we didn’t officially have a double top, at least according to the widely accepted definition within technical analysis.

That doesn’t absolve me as I’ve been skeptical of a continuing gold bull market. And I’ve been wrong, wrong, wrong. Gold’s climb has been unrelenting. Just today it closed at $949.20 on the Merc, taking it within a nugget’s throw of $1000.

But while the price of the commodity is 12% above the swing high in November 2007, gold stocks - as measured by the Gold Bugs Index - are barely peeking above those levels. So if you’ve owned any gold equity, instead of the metal itself, you’ve lost out on a lot of money.

The k-Ratio
The discrepancy can be seen in the k-Ratio which shows a slightly downtrending chart (in the short term):

Since the k-ratio has entered a channel, the easiest strategy is to buy gold stocks only when it approaches the “floor” and to sell them when it hits the “ceiling”. I’m hesitant to venture into any trades with a longer time frame since I’ve been clearly off my game on this sector.

I think my mistake was that I used the k-ratio’s valuation message to mean that gold’s trend couldn’t continue. Boy have I been schooled. The valuation is still high - historically - but that doesn’t mean that a trend can’t continue. The k-ratio is an amazing tool but it is really useful in giving you the really big picture. For anything more granular it falls apart.

Seasonal Pattern
Surprisingly, the rise we’ve seen in the price of gold has been against the headwinds of seasonal patterns. Historically, the period of time from the end a year to the end of March of the next year has been a very bad time to be long gold. It is exceptions to such seasonality “rules” that remind you that the market doesn’t have to follow any dictates, no matter how well founded.

In case you’re wondering, the best time in the calendar to go long gold is at the end of August and into October. Traditionally, this short time frame has provided the biggest boost to the price of gold. But right now the summer is way too far away for me to use it to place any bets.

Sector Breadth
Finally, as an attempt to peer into the fog of future prices, lets do a quick review of the current breadth in the gold sector.

Almost 86% of the gold stocks that comprise the sector are trading above their 200 moving average. Since this is a strong bull market, the percent of stocks above their long term moving averages has been consistently high with only a few short blips lower.

In January it even reached the rare maximum: 100% - around the time that the Gold Bugs Index (HUI) topped out at ~480. This statistic tells me that if I want to go long gold stocks for an intermediate time frame trade, this isn’t it. Not even close.

Thanks to today’s strong close, 100% of the gold stocks in the sector are trading above their 10 day moving average. At the beginning of the month, that number was less than 10% - so again, this is not a good time to go long, even for a short swing trade.

The best combination of breadth is strong long term (200 day average) and weak short term (10 and 50 day moving average). A good example was in mid December 2007 when there were only 10% trading above their 50 day MA and 5% above their 10 day MA with a very high 60% above their 200 day MA.

I’m keeping a wary eye on this sector until it presents a similar setup and will post about it.