Saturday, March 24, 2012

Some kind of Monster...

Ok.  A quick moment to talk about energy.  We are not going to get into the fundamentals of things too much, we are just going to look at the charts.  We already know the QE and inflation side of things.  Dollar goes down, things priced in dollars go up.  As for the aspect of a growing world population, or the extent of the supply of crude on earth,  or the costs to produce it, or alternative energy, or it's ability to be economical on some timeline, or anything else of the like, we are going to leave out right now and just look at what the charts tell us.

Technical analysis is one of those things, people either love it or hate it.  No one ever seems to think its just "ok".   Which ever side of the fence you fall on, just think about this:  In 2010, 70% of all the trades done on a given day on the NYSE were done by computer programs.  Computers that are emotionless, and think and analyze hundreds of different scenarios on thousands of different stocks, in a matter of mere seconds.    Those computers aren't analyzing PE ratio's when they buy stocks,  they're analyzing support and resistance points, moving averages, oscillator crossovers, etc... Technicals.  Charts.  Let's face it, we humans got a major handicap.  But knowing ahead of time what they're looking for is a big help.  Look, sometimes technicals run for a while with no fundamentals behind them, so you never buy something only because you "like the chart", you will get burned.  (Netflix?)  But fundamentals never run without the technicals. It's impossible when you think about it.  If the fundamentals are there for a bull market eventually it will translate into a pretty damn good looking chart. Personally, I don't like dead money.  So when I am reading up on say a stock that I like, the first thing I do is look at the chart.  They could have so much great stuff going for them when analyzing the balance sheet and assets of the company, but if it's not translating on the chart, I guarantee that you will probably be sitting on stagnant money for longer than you would like to.

Quick story and 2 charts of why I do things the way I do  (I assure you there is a method to my madness, even if I am the only one who might understand it.):  I know a man who has been an avid gold bug, long before most of us.  A real Original Gangster.  As the national debt skyrocketed to insane levels he was purchasing gold over the course of about 10 years, starting in the mid to late 90's at prices in between $250-400/oz.  He has probably averaged about $300 for all the oz's he owns, so obviously, he has made a few dollars off that idea since then.  Problem was, his money was tied up for a decade in an investment that was not performing.  He was buying into a bear market.  The end of a bear market mind you, but there is a difference between a bear market end and a bull market beginning, and often a limbo in between.  Below is the weekly gold chart dating back to 1995.  The red box surrounding the gold price is where my friend purchased his gold over the course of a decade.  The blue box is where I would have purchased my gold.  By about 2002 gold had bottomed and began trending higher.  In the time from then till 2006 you could purchase gold for an avg of about $400/oz, meaning you paid about about $100 more for each oz than my friend, but you didn't tie up your money for nearly as long.  You waited for confirmation from the chart that this market was beginning to go somewhere and began to see returns on your money much quicker than my friend.  At current price you would have made over $1200 in profit for each ounce you owned, while my friend made $1300 per oz.  Seems negligible now doesn't it?

So now as we look at this and realize that the 6 years of dead money is a much bigger deal than the extra $100 in profit we missed out on, this begs the question, what should you have done with you're money in 1996 as you waited for bull market confirmation in gold?  Well, below is one idea.

In 1996 the Dow was at about 5,000.  It was trending upwards and  monthly MACD had just crossed over, which is very bullish for a long term time frame.  By about 1999 to 2001 the Dow began trending downwards and MACD rolled over giving a pretty clear sell signal at least for the time being.  No worries, because you just doubled your money over that 5 years while my friend's money just sat there.  More than doubled it if you had everything on dividend reinvest.  Now you have a lot more money to pour into that gold market which is now starting to bottom and trend up.  Meaning, the more money you now have kinda makes the extra $100 in profit you missed REALLY negligible as you can now buy much more gold than my friend.  Point is, technicals are important.  Hide your head in the sand if you like, the world will trade around you.  Your only hurting yourself.

Ok, now I have digressed greatly.  It makes sense to me at least, I will tie this back in at the end, we will see if you can follow my schizophrenic thought process.

The following is the Weekly chart for West Texas Intermediate Crude... Have you clicked it yet?  I'll wait for you to stop hyperventilating.  We can see what looks like a text book MONSTER inverse head and shoulders on crude oil.  You hear these terms everyday, so lets go over the psychology of its significance for a minute.  In May of 2011 Crude bears knocked price from the lofty 115 mark down to about 90 only a month and a half later.  Some bears cashed out on their profits, and some bulls came in to buy the pullback rallying Crude back to 100 before the bears came out again and pushed things all the way down to 75.  After a couple of months of deliberating between the 75 level and the 90 level, bulls came in strong and crude trended back up, pushing through resistance at 90, (the support point of the left shoulder) and finally 100 a few months later (forming the right shoulder).  So now here we sit.  The bulls have had a good run from 75, pushing crude up about 50% from that point, and the bears made some nice profits on the way down when that lasted.  Now price sits near the neckline that was the level prompting bears to get in short.  This is the level from a bulls perspective that they previously lost money at and may look to sell at.  If the sentiment is overly bearish at this point, prompting bears to come in short again and bulls to cash out for fear of lost profits, this chart formation will fail and send prices lower.  If bulls refuse to let go of their long positions, and bears, feeling beaten are forced to cover, price will break out above the neckline area.  But how high?  There is a formula for that.  Take the neckline break out point which sits at about 110-115.  Then take the depth of the head which bottomed at 75 (you can go buy closing prices to be more conservative on your targets, no one ever went broke doing that.)  Then calculate the difference.  (we will use 75 and 110)  The difference here being 35.  Add that to the break out point (neckline) at 110.  You have a target of about 145 that will probably materialize in the same time frame it took for the formation to be built.  ( so a year long chart pattern would target 145 by about spring next year)  Now are you hyperventilating?  People have been speculating for quite some time what would happen if crude went back to it's all time high.  It would obviously be bad for consumers, but now with gas prices rising, concerns in the middle east, and a technical formation on the crude chart that has a break out target of, oh yeah, EXACTLY what the all time high of crude oil was, I am beginning to fear that the possibility of such an event is much higher than just "speculation".  Coincidence maybe?  That the target of this formation is the all time high for crude?  Sure you can go that route of thinking.  I suppose it was also a complete coincidence that as MF Global went down in flames, 1.2 billion dollars of client money coincidentally disappeared. We now know that to not be the case.  My view on coincidences, they don't exist.  If it seems like a pure coincidence, it's probably only because you have yet to find the link between the two.

Ready for another "coincidence"?  Below is the Brent chart.  It is similar to crude, but different.  On the brent chart we can see what looks like a cup and handle forming.  Cup and handles and inverse head and shoulder formations are extremely similar, and can often be mistaken for each other.  For example, the above Crude chart could be painted with one big round bottom as well and we could call that a cup and handle.  The Brent chart however is not a head and shoulders.  Kinda like in geometry, a square is always a rectangle but a rectangle doesn't necessarily have to be a square.  Well, this head and shoulders on crude, could be a cup and handle, but the Brent chart is not a head and shoulders.  Now that I've officially confused you, it doesn't matter.  The psychology behind the two formations are virtually identical anyway.  This brent chart shows a break out point at 125 and a depth of the cup of 100.  The difference between the two is 25. Add that to the break out point of 125 and you get a target of 150, also just about the all time high for brent.   Let's also keep in mind the DEPTH of these formations.  If they were to pan out they would call for the price of crude to rise about 50% higher than it currently is.  I don't know about you but my wallet is already black and blue.

So how's those coincidences working?  We got rising gas prices, a falling dollar, an anemic recovery (at best) and two long term charts for both brent and crude BOTH foreshadowing a run to all time highs in the same time frame.  I'm finding a lack of reasons to argue a test of all time highs won't occur.  The real problem is, that if this were to occur it will not be a parabolic run to simply "tap" our target price and then run away as it did in 2008.  No, it will most likely stay in a range with a low of the breakout and a high of the target price for quite some time.  So when you hear people say "Can the American economy handle $4/gallon gas?" realize that they are asking the wrong questions.  You could survive naked in Siberia ya know.  If we were only talking about a few minutes.  Can the American economy handle $4-5/gallon gas?  Sure, for the month of April maybe, but on average for the next year or so?  Now you have a whole different monster.

Let's change gears a bit and look at Nat Gas, which has done nothing but free fall.  This energy source, which is a viable alternative to crude has had price kept under a lot of pressure do to the enormous supply of it.  Tying  back into the "dead money" concept, this is not a market I would be getting long here.  Calls for Nat Gas to fall to $1-$1.50 in my opinion are just plain ridiculous but I wouldn't be surprised to see it trade under $2, and stay dormant for quite a while before moving higher, especially if it continues to not be utilized to even a fraction of it's ability.  When you account for currency devaluation, Nat Gas is probably cheaper than it ever has been in history.

Not to get too political, as that is not the point of this, but I want people to realize how quickly technology can advance.  In the year 2000, chances are you had a cell phone that looked like a paper weight, may or may not have transmitted harmful radio waves that will give you massive brain tumors, and sounded something like this. (there was supposed to be a link here that played that annoying "Nokia Tune" but oh well) In 12 short years, your cellphone ringtone is now Katy Perry's new single that was just released 15 min ago, which plays when your friends you haven't seen in a decade post pictures on Facebook they took from their cell phones of the restaurant they're at and how good the chicken francaise is, while you calculate your taxes from it and email them to your accountant all while on the train ride home from work.  This isn't isolated to today either.  In 1885 Karl Benz patented his Moterwagen, a 4 stroke cycle gasoline engine on a platform with 4 wheels essentially.  It was a revolution and since then the world has used this model as the main source of transportation on the ground, replacing horses.  17 short years later, the Wright Brothers took a similar engine idea, added a propeller and wings and we were flying with the birds.  (An additional 17 years after that and flying ace Manfred von Richthofen, AKA the Red Baron had utilized the airplane in combat to shoot down more enemy planes than anyone else had at that point (80) turning what was a crude idea in 1902 and officially solidifying flying and piloting as a science and artform and future mode of transportation.)  Somebody born at the end of the civil war could have lived long enough to sell their horse they used to get around for most of their life for a car in their 40's and could have traveled in later life across the country in an airplane.  What a concept!

Nat Gas is not an indefinite solution to our energy problems, but it is a better alternative to what we have.  I am not knocking anyone's beliefs on alternative energy, you might be a big fan of solar or wind, and that's great.  I have no idea what we will be using for energy 50 years from now, but what I do know is that it will be abundant enough to be cheap for consumers, but still able to produce profit for the energy producer.  Currently, no alternative yet fits the bill, that's the fact of the situation and why nothing has yet worked.  Maybe we will use Solar, maybe Wind, most likely something none of us have even thought of yet.  The point is to be patient, it will happen when its ready.  In the mean time giving consumers a choice helps everybody, and will certainly help keep this energy situation we have from turning into some kind of monster.

-Jonathan M Mergott

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