Trader’s Narrative

We know what the US market is doing, shrugging off every single negative news and floating higher almost effortlessly. But what about the emerging markets?

One of the strongest emerging markets before the recent bear market was Brazil and it has come roaring back with a vengeance. If you think the recent gains, whether a bear market or the real thing, are impressive, then consider Brazil’s gains.

Similar to almost all world markets, the Bovespa started the last bull market in late 2002 and went almost non-stop until late May 2008. As a sign of the impressive relative strength, it shrugged off any signs of a top in October 2007 and went sideways as other markets around the world weakened and fell. Then in early May it surged to new highs, to then reverse and form a top.

Using simple Weinstein stage analysis, it was easy to see the trouble signs. But even after such a strong showing the index still fell 60%. It reached its low in October and in the following months, every single low was higher than the previous one.

While the US market struggled, falling lower still in March, Brazil was already trading 19% higher than its October 2008 low. As of today, it has made an astonishing 70% gain from the extreme low of last year.

I don’t know enough about the fundamentals to make a case but I imagine it would refer to the fact that the Brazilian banks were, for the most part, left unscathed by the financial mess that enveloped US and European banks. And also the turbo boost provided by Brazil’s commodity wealth can’t be ignored. They produce everything from soybeans to precious metals.

But all that can be encapsulated in the relative strength of BOVESPA to the S&P 500 index. It has already surpassed the previous high it set in 2008.

There are a few ETFs for the country:

• iSHARES Brazil ETF (EWZ)
• WisdomTree Dreyfus Brazilian Real Fund (BZF)

As well, there are many ADR’s like:

• Petrobras (PBR)
• Itau (ITU)
• Banco Bradesco (BBD)
• Brasil Telecom (BRP)
• Brasil Telecom (BTM)

While continued heady gains are improbable in the short term, a pull back would bring prices back to the 150 day moving average (in red) which is slowly flattening out. This would then provide a platform from which it can realistically challenge the previous highs.

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Almost a year ago I asked rhetorically, is the REIT bull market over? My own take on it at the time was that what we were seeing was yet another correction and not a top, as it actually turned out to be - in hindsight.

So where did I go wrong?

For starters, unlike the Canadian REITs (which I was also wrong on by the way) the US REIT index had an ominous head and shoulder formation. I downplayed this because of its “obviousness”.

But the head and shoulder pattern completed and price broke through the neckline. This same level corresponded to the bull market trendline. So because of this multiple significance it was important what price did near this level.

Back when I wrote about US REITs last, the breadth in the sector was really bad with only 20% or so above their 50 day moving average. This is a short term metric however and does not provide signposts for a longer term outlook. The REIT index did snap back sharply into June 2007. But from then on it was on a continuous and relentless decline.

The next rally created a lower high and the subsequent reaction a lower low. REITs were now in a clearly new market condition. As you can see from the chart, a bull market means that price stays well above its long term moving average. It only sporadically comes back to meet or pierce the 200 day moving average. The previous time that the REIT Index was “under water” this long was prior to the final base building in 2002-2003.

Trend Change or Correction
It is extremely difficult to pinpoint a major change in trend - at least I almost always find it extremely challenging. I have enough trouble with short to medium term inflection points. So I prefer to assume that there isn’t a major trend in store unless I’m proven wrong.

I prefer this not only because of the difficulty in separating a major trend change from a normal run of the mill correction but because the former only happens once in a blue moon while the latter occurs much more frequently. So I’m more than happy to take my chances because probability is on my side.

Powerless Fed
My other mistake was in attributing too much power to the Fed. I correctly thought they would soon start to lower interest rates. But my mistake was in thinking that this would be able to halt or reverse any weakness in the housing market. The rot in this sector was beyond the imagination of even the most die hard shorts.

What Now?
The only positive “spin” I can put on the abysmal REIT performance is that unlike most investments in the stock market, REITs are specifically built to be income vehicles. So while your holdings may be underwater, as an investor you are continuing to earn monthly or quarterly income from holding them. And depending on the particular REIT in question this can be a substantial amount. But this is only consolation for the long term investors, not the nimble short term traders.

Until we see the REIT Index (DJR) or the REIT iShares (IYR) or similar proxy carve out higher highs and higher lows, I can’t say it has flipped into bull mode. The disadvantage is that while by that time we may be confident, the inflection point will be far gone and with it, a good chunk of price performance.

Wall Street has a knack of bringing new financial products online just as the demand for them is at its zenith. In Wall St. parlance: when the ducks are quacking, feed them.

I’ve already mentioned several examples of this: Don’t Buy What Wall St. Sells

Here’s another:

On May 4th 2007, the iShares FTSE NAREIT Mortgage REITs Index Fund (REM) started trading around $50.

It then promptly lost half of its value in the next few months (at its lowest point):

I pleaded the same case when Blackstone (BX), the private equity outfit went public in late June:

I’m not saying that these firms are bad investments. On the contrary, they create a lot of value. But buying here and now at these prices? I’m not sure that’s wise.

Seeing as how it is their job to know when to sell what, it makes perfect sense that they would flip their shares to the public when they knew they would get the highest price for them. Blackstone fell from a high of $38 to a recent low of $22.

Now that all things related to mortgages are avoided like the plague, it would take a smart contrarian to buy the mortgage ETF here.

While the Chinese stock market is white hot, non-Chinese are not allowed to participate. The only thing we can do is the next best thing: proxies in the form of ADRs or neighboring Asian markets like Hong Kong and Singapore.

Meanwhile, Li Ka-shing, Asia’s richest man said that the Chinese stock market “must be a bubble” and that he was worried about it. But I have a nagging feeling this mania will only get crazier (before it eventually bursts).

Reports of grandmothers investing and trading are trickling in already but we still have to see a truly spectacular zoom higher. I wouldn’t even be surprised if the wide eyed new investors in China would view Li Ka-shing’s from a conspiratorial point of view (”he wants to jawbone the market lower so he can buy more”).

If you want to play this volatile market, either long or short here are your options as an outsider:

ETFs
There are also two Exchange Traded Funds: iShares FTSE/Xinhua China 25 Index Fund (FXI) and the Powershares Golden Dragon Halter USX China Portfolio (PGJ). Who names these things?

The relevant Asian market ETFs are: Singapore iShares (EWS) and the Hong Kong iShares (EWH). Whether the Chinese market continues its meteoric rise or crashes, these are the ETFs which will be most effected.

Chinese ADRs
Here is an alphabetical list of Chinese ADRs trading on US exchanges.

Here’s a trading opportunity you don’t see every day!

On March 31st 2007 Uranium Participation Corp. (U) had a NAV of $12.38, while it traded for $16.00 on the Toronto Stock Exchange. After a spike up to a high of $18.76, it is now back to $16 a share (all amounts Canadian). That represents a premium of approximately 23% to the underlying commodity.

Since Uranium Participation represents actual uranium (the commodity), I’ll be going short the Uranium Participation Units and long the upcoming NYMEX UxC Uranium futures to arb out this premium. My only risk will be currency exposure between the US and Canadian dollar but since this should be a short term trade, that’s acceptable to me.

As of April 13th 2007, the short position of U on Toronto Stock Exchange, was 2,479,300 shares. This was a reduction from the 3,416,000 sold short on March 30th, 2007. I wish the exchanges would release this info with less time lag!

This trade is a great example of a non-directional trade. Although both positions are in uranium, the actual price of uranium doesn’t have to move for the position to be profitable. All that has to happen is a collapse of the NAV premium in Uranium Participation Units (U) to reflect the real uranium prices on the NYMEX.

By the way, this happened before when Central Fund of Canada Limited (CEF.A) - a closed-end fund in Canada investing in gold and silver - had its premium collapse after the introduction of the streetTRACKS Gold Trust ETF (GLD) and the iShares Silver Trust ETF (SIL).

Watch Out!
Historically, the introduction of a new contract has usually meant an intermediate high in prices. But since this is non-directional, it won’t affect me. If you’re long uranium or uranium stocks though, we could be in for a rough patch as this is a reliable contrarian indicator.

The other dark cloud on the horizon is that according to inflation adjusted prices, we are almost at the previous high (~$115/lb) last seen in the late 1970’s. After a parabolic move up within a few short years, I won’t blame anyone for being nervous to see prices at previous resistance levels.

Cheatsheet for the upcoming NYMEX UxC Uranium futures contract:

• U₃O₈ (yellowcake) is concentrated uranium oxide produced from uranium ore and is the most actively traded uranium-related commodity. Its primary use is as fuel for nuclear reactors.
• NYMEX UxC Uranium U₃O₈ futures will be launched at 6:00 pm May 6, 2007 (Sunday) for the trade date of May 7, 2007 (Monday).
• Contract symbol will be UX
• Contract size is 250 pounds of uranium U₃O₈ (currently spot price: $113/lb.)
• Minimum tick size is $0.05
• It will be a financially settled contract with each month settling on the corresponding spot month-end U₃O₈ price published by The Ux Consulting Company.
• Trading hours are 6:00 PM through 5:15 PM, New York time, Sunday thru Friday, with a 45 minute break each day between 5:15 PM and 6:00 PM.
• Initially, 36 consecutive months will be listed. The first listed month will be June 2007.