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Contrarian Trading Tips: Gold, the Dollar, Energy and Financials

by: Jason Hamlin August 11, 2008 | about stocks: FXE / GDX / OIL / PBR / SKF / UDN / USO / UUP    
Jason Hamlin

Jason Hamlin

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In the short-term, sentiment and emotion rule the markets more than fundamentals. This type of trading pushes stock prices to extremes, whether the extreme is overbought or oversold. As a contrarian investor, I like to trade against these extremes and invest in the opposite direction of the herd. The wild action in markets, the dollar, gold and financials over the past few weeks leaves the door open for a few contrarian trades that I will be looking to make as trading opens this week.

1) Financials and UltraShort Financials ProShares ETF (SKF) - The SEC is lifting its emergency ban of naked short-selling on 19 U.S. financial stocks. I believe this will swing sentiment and add a fresh round of downward pressure on financial stocks. The ruling certainly had the desired effect, as financial stocks rallied and the SKF lost nearly 50% of its value in just over a week. Is the rally justified? Are the bulk of write-downs over? No way. Financial stocks will get hammered again, more banks will collapse and SKF will again push towards $200.

Contrarian play #1: Pick up SKF around $115 with a price target of $155 in the coming weeks.

2) The U.S. Dollar and Gold - The dollar posted a surprise rally in the past week, after European central banks signaled that they would not raise rates. The story goes that the move is bearish for the Euro and therefore bullish for the dollar. The dollar bulls have been looking for any reason for a rally. A dollar run from 71.50 to 76 in a matter of days, solely on this news and in the face of declining wages and the highest inflation figures in a quarter of a century? Gold, which has an inverse relationship with the dollar, lost $100 alongside the dollar run.

All of this while a new war rages at the border of Russia, which could easily widen and become much more dangerous. We also have reports of a massive U.S. naval armada heading for Iran. The dollar is now incredibly overbought and gold is extremely oversold and resting on key support at $850. The massive debt, economic ills, negative real interest rates, deficit spending and aggressive foreign policy of the United States has not changed. There is no fundamental reason for a dollar rally of this magnitude and it will not last. This is likely the last buying opportunity for gold under $900.

Contrarian Play #2: Sell the U.S. dollar and purchase gold and silver stocks. Buy producers or near-term producers. If you don’t want to pick individual stocks, consider the gold stocks Market Vectors Gold Miners ETF (GDX).

3) Energy and Petroleo Brasileiro S.A.Petrobras (PBR) - Oil was undoubtedly overbought around $150 and the correction was necessary. But I don’t think we go much lower from here, especially not with the above-sited war raging between Georgia and Russian and signs of an intensification of the stand off with Iran. Peak oil is not a theory, it is a verifiable fact. Argue with this notion all that you want, but production had peaked and has been declining ever since this peak. That is the very definition of Peak Oil.

Higher prices did dampen demand somewhat, but not nearly as much as could have been expected. The economies of China, India and other developing nations will continue to increase their demand for oil and supplies will continue to decline. A cursory understanding of economics points towards higher oil prices.

Contrarian Play #3 - Buy the sell-off in energy stocks. I purchased shares of Petroleo Brazileiro or Petrobas on Friday at $50. Long-term, it is one of the best energy plays within one of the strongest and fastest growing economies in the world. Short-term, this stock should rally. I took a small position and will continue to purchase on any additional weakness.

Contrarian investing, commodity investing and short selling are not for the faint of heart. Investors are always concerned with “catching a falling knife” and most investors will lose large amounts of money trying to call tops and bottoms. It takes discipline and is difficult to buy when everyone else is selling, but I believe buying low and selling high is the objective. And you don’t need to go “all in” with these plays. Consider averaging in by taking small positions at these levels and adding to your positions as things play out.

Disclosure: The author owns PBR.

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This article has 16 comments:

  •  
    Aug 11 04:38 AM
    Excellent article supported with simple logic and clear charts. Worth considering.
    Reply
  •  
    Aug 11 05:42 AM
    brave man, consistent, good luck
    Reply
  •  
    Aug 11 05:51 AM
    Nearly every commentary I have read today is suggesting the same strategy so perhaps the real contrarian would buy the $ and sell Gold and Energy.
    Aly-Khan Satchu
    rich.co.ke
    Reply
  •  
    Aug 11 07:08 AM
    I've been shorting oil thru DUG since early July. Making a fortune and adding more positions as oil prices fall. I still think oil has a long way to fall, perhaps below $100, then I'll turn bullish again. There have always been these blips of war, just more "under the microscope" now with everybody watching oil price.
    Reply
  •  
    Aug 11 07:15 AM
    I like the calls on SKF, oil below $100, and gold if it drifts a little lower could be setting up the buy of the next decade. I do not subscribe to the peak oil notion, but rather to the peak "willingness to drill" notion. We've got a lot of resources undeveloped, the scarcity, as always, lies in our lack of will. Great article and insight.

    One question, assuming oil does go below $100 and gold below $800, might we see some consolidation as temporarily overleveraged firms start to suffer? Where the better capitalized will come in and grab them if only for the mineral/drilling rights?
    Reply
  •  
    Aug 11 07:22 AM
    "but I believe buying low and selling high is the objective"

    that would be the first mistake. trying to outsmart the market is the mark of a novice or a fool--a well-capitalized and lucky fool, perhaps, but still.

    Russia invading Georgia is def a big deal for oil and gold, you may get a bounce to get out of underwater long positions, but dollar strength is real.
    Reply
  •  
    Aug 11 11:06 AM
    Dollar Strength is "real"?
    Based on what? $5 trillion in mortgages of Fannie and Freddie that the Govt (you and I) will have to "backstop". Or maybe the "mirage" that Trichet will lower rates in the near future. Of course he just raised rates last month so that does not make him look very credible or smart does it? Or maybe it's the incredibly strong US economy that will raise the USD. You mean the economy that is growing 1/5 the rate of China and India? Or maybe the USD will stengthen over the possibility of higher US interest rates? Never mind the "inconvenient truth" that raising rates this year would more than likely shove us into a real Great Depression with massive foreclosures and bankrupticies. Bill Gross (one of the smartest guys in the room) has publicly asked the question why would anyone in their right mind even contemplate a tightening cycle in one of the worst asset deflationary periods in US history? Bernanke may be a little slow but he's not that dumb. This USD move higher is a complete "mirage". Like building a house on a foundation of sand. There is nothing of any value to support a move higher in the USD.

    Yank
    Reply
  •  
    Aug 11 11:54 AM
    "Peak Oil" from conventional oil sources? Yes. But unconventional oil from sources such as Tar Sands(not just in Canada) and "heavy" oil deposits, also well dispersed,will mean that we have seen the last of cheap oil. I see no close -in technological breakthrough in bio-fuels. Until the latter happens, we are going to have to pay the dear price for petroleum to run a modern economy.
    Reply
  •  
    Aug 11 12:17 PM
    As I write this, it isn't on the Kitco chart yet, but gold had just taken another Yosemite Falls drop of nearly $20, breaking through the $835 level. (it is now at $836.60) My guess is that the bullion banks won't quit driving gold down until gold is at least down to $780. I'd hold off on buy gold yet.
    Reply
  •  
    Aug 11 12:22 PM
    Wow, gold is now down another $5 to $830.50 - I'd say hold off a while longer in buying gold - the wild ride - er, slide - continues.
    Reply
  •  
    Aug 11 02:47 PM
    So gold has dipped to below 820 and could go further. It is a major blow-off but if you have the stones and the cash - preferably debased U.S. Dollars you might want to pick up a few dozen bullion bars in a week or so. Why? I can't see the fundamentals changing for the US$ can you? Also, no matter what, when the gold you hold is truly oversold, it'l break and in its wake, will leave all except the bold! Happy trading - er take a deep breath and enjoy the fun. If you're reading this, you probably won't starve.
    Reply
  •  
    Aug 12 02:22 AM
    Attention fiat currency lovers: gold is worthless. Please sell me yours. Do not hesitate to get short regardless of price; you will be able to cover at zero. I am stupid and will happily give you good solid patriotic American currency for your useless metal. No need to feel bad; I like being a sucker. Do I hear $600? $275? Surely you will rush to get short even at $51, just above the face value of a gold eagle coin minted in the good old US of A by our beloved Treasury Department. Takers? Takers? I'm buying!
    Reply
  •  
    Aug 12 09:58 AM
    Very nice article. caveats on both sides of the argument. no one can catch the bottom perfectly, so recognizing the beginning of opportunity is better than having missed it, even if you're somewhat early. Most people reading this are short term minded, and want to make a Buck weekly. True investing is much longer than this. Great article!
    Reply
  •  
    Aug 13 07:35 AM
    LINK: massive U.S. naval armada heading for Iran.

    Err... the reporter on this blog has completely fictitious title. I have lived in Canada for over 40 years and we ain't got no Lord Lieutenant, eh?

    Over and oot.
    Reply
  •  
    Aug 13 01:01 PM
    Not a single recommendation is actually contrarian, every single one is just a trend following bet on the first half of the year trends continuing, ignoring the last month and a half.
    Reply
  •  
    Aug 13 04:24 PM
    I too was playing oil until last week. I sold my Ultra Short Oil - DUG last week for a tidy profit (but could have waited a little more before I sold). I have always enjoyed all these "were running out of Oil" stories for years. As someone who lives in the Oil Patch, I can remember the "peak oil" theory being brandished in 1982 like it was the gospel....until Oil crashed to $8 a barrel in the late 80's. Everyone forgets the obvious - that all markets will seek an equilibrium in which supply and demand forces will equal.

    Obviously oil at $140 caused too much demand destruction as gasoline useage was off 3.5%. The market is going to see if it can stablize at current levels. If demand continues to dwindle, it will go down one more knotch down to the $85 level. Oil makes more long term sense at $85. Some old gas guzzling habits may reappear at that level, but not here at $115. This is just a correction to a good downward move. I intend to buy back into DUG when it corrects down to $34 and enjoy the last of a very profitable ride.

    All you Oil bulls can keep chanting your dogma - China, Peak Oil, Middle East wars, etc...., but you cannot ignore simple economics. The US is the biggest user of Oil in the world. If we continue reducing our oil needs (through conservation and demand destruction), Oil has nowhere to go but down. The average US resident uses about the same amount of Oil as about 100 Chinese. If we are not resuming our oil intensive lifestyle because the price is too high, lookout. Gee, I guess getting that economics degree actually had some value - I got to make some good money off some dogma spouting Oil bulls who believe every article they read in Time magazine.
    Reply
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