Sunday, December 21, 2008

Themes for 2009 - Part 1 ('08 Review)

That was just one year? Really? Fannie and Freddie, AIG, Lehman, Bear Stearns, Merrill Lynch all went belly up or were bailed out in one form or another. The entire auto industry collapsed. Unemployment began to skyrocket. We learned the US was in recession for the whole year. Foreign markets collapsed. Commodity markets collapsed. Oil fell 73%. Shipping rates fell 90%. Central banks cut rates to 0%. Governments bailed out private corporations, sent tax rebates to consumers, went into massive budgetary deficit. Iceland became insolvent. We learned of the largest ponzi scheme in history. Russia invaded Georgia. Civil unrest in Tibet. Political unrest in Pakistan. Terrorist attacks in India. Obama elected president.

A year is long time.

Indeed, another year has passed and it is once again time to evaluate my performance over the previous year and start making rough sketches for the next. I typically go through this process on a bi-annual basis as I find it helps me “turn the page” on the past and look toward the future. This is why I began writing in the first place. I found that without writing my opinions down, I was liable to unconsciously change them to suit whatever was emotionally less painful. It is common knowledge that learning from past mistakes is the ticket to future success. But a prerequisite to that is for a person to be able to recognize and admit those previous failures. This goes for traders, investors, or anything for that matter. Publishing my thoughts gives me an inescapable glimpse of my past thought process.

At this time last year I wrote a 6 part series outlining my thoughts on what would happen in 2008. Some of it was laughable. Much of it turned out to be fairly prescient. Let's take a look.

Summary of themes for 2008

- US economy is either currently in a recession now (Q4 ‘07) or will be in one early in 2008.
- the Canadian economy will follow
- Emerging markets will experience slowdowns as the US consumer is pinched
- The credit crisis will continue to intensify as more homeowners go underwater on their mortgages
- Commercial Real Estate declines, credit card defaults, and bank runs will be major stories in 2008
- Municipalities and States will be going bankrupt and require federal bailouts
- this situation will be a catalyst for the precious metals complex and could push gold past $1000
- there will be a time for both large declines and large gains for the US Dollar - likely in that order
- the Federal Reserve will be seen at some point in 2008 as ‘an emperor without clothes’
- US stocks will decline as lower interest rates fail to revive the credit markets
- energy and food prices will continue their upward climb due to supply concerns

Nearly all of this transpired according to plan. Some of it unravelled mid-year. However, if I were to only show you that, I would not be fully honest. Some of my opinions from last year were false. I did not foresee the precipitous drop in commodity prices, and I thought junior mining companies (TSX-Venture especially) would hold up far better than they did. To be fair, I was not a raging bull on commodities. I was expecting lower prices. But to say I was not surprised by the CRB index falling by 40% y/y would be a lie. Here are a few quotes from last year's preview:

“I also believe silver is in a good spot to benefit from another leg up in the precious metals. The gold to silver ratio is at a historically high ratio (55.6), and if people begin to buy physical bullion as I think they will, this ratio will decline.”

“I believe oil prices, over the long term, will continue to rise. In the short term oil could pullback on concerns of recession in the US, but I don’t think the drop would be too far. I foresee oil trading in a range between $80-120 in 2008.”

(in regard to the CDN Dollar charts) “They are telling me that a bottom has been put in and the currency is now poised to challenge or surpass previous highs.”

Commodities were something that I had been bullish on for years. Therefore, I had attributed their rapid assent in price as a logical development. So while I rightfully felt that the debt bubble would come unglued at some point in '08, I wrongfully assumed that what was logically high in price would relatively outperform what wasn't. Gold behaved in this manner. Nothing else did. I was not able to make the distinction between the commodity bull market and the commodity bubble. As a result, I left some profits on the table, wasted more of my profits trying to “catch the falling knife” and in the meantime, I missed one of the better shorting opportunities we've seen in decades. I will try and learn from this experience and will hopefully not allow it to happen again. Where else could it manifest?

One area I have my eye on is the US Treasury market. I have been bullish on treasuries for a couple years now. The move over the last few weeks has been stunning. The US Fed has announced that they may start buying these securities as part of their Quantitative Easing programs. Are treasury traders and investors using the same logic as they were for oil in July? Are they using the Fed's intervention threat as justification for believing “prices can't go down?” Just the same as we were hearing “oil can't go down because of peak oil.” Will we all look back at the seemingly bizarre recent occurrence of the US Dollar falling/Treasuries rising as a very obvious hint of irrational exuberance?

What would that mean for the inflation/deflation debate? I've been firmly on the side of deflation. Would a sell-off in treasuries be signalling that the deflation trade is reaching it's end? I've also been very bearish on equities for years now. With stocks down 40% from their highs, am I overstaying my welcome on the dark side?

It all boils down to one question. Do the trends of 2008 continue, accelerate or reverse in 2009? In the subsequent parts of this series, I will attempt to attack that question.

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