SET Monthly Issue November 2009

| November 17, 2009

November 2009


At this point it’s clear – the recession’s over.

We’re in the midst of a ‘V’ shaped recovery.  But there are still skeptics who contend it is all smoke and mirrors.  They think the recovery will fail and the stock market will crash again.

The scenario many bears are clinging to is shaped more like a ‘W’.  Outside of major policy blunders from Washington, I don’t think this scenario repeats itself.

Remember, the markets were braced for Armageddon due to bank and business failures last fall.

Could it get that bad again?

I don’t think so.  So I’m putting any ‘W’ talk out of the equation.

Now the question becomes, how far can the market go?  Does the ‘V’ pattern have legs?

I know it does.

Right now the expected growth rates are still low for 2010 and even ’11.  An upside surprise in GDP, sector, and company growth is still possible.

If growth is better than expected, the ‘V’ could carry the markets a long way. Possibly all the way back to the highs we saw in October of ’07.

When we see strong economic growth, the big concern will be the Fed.  How will they handle stimulus and interest rate hikes?

Two key measures the Fed’s watching are the unemployment rate and inflation expectations.

As far as the unemployment rate goes, there are really three pieces to the puzzle.

First are the initial jobless claims.  This number is the first to show signs of improvement.  The good news is it’s been falling steadily for months.

Next to show improvement will be the payroll numbers.  This is simply the total number of people on the private and public sectors payroll.

And the last part to start turning positive is the unemployment rate.  This number has historically peaked about six months after the recession ends.  By that metric, we should see the unemployment rate peak sometime in the first quarter of 2010.

Once unemployment starts falling, the Fed will begin raising the interest rate.

That’s a good thing.  If they don’t raise rates, it’s because the economy is still too fragile.  (If they aren’t raising rates by mid to late 2010, we have much bigger issues.)

Now, the market won’t like rising interest rates.  We’ll see some minor pullbacks as interest rates rise.  But any negative investor reaction should be short lived as attention will quickly turn back to the improving fundamentals.

The reality is, even if the Fed fast tracks rates up to 2%, interest rates will still be historically low.  A level that’s still very pro-growth.  That means a battle with inflation.

The Fed will try to strike a balance between keeping inflation in check and not smothering the economy.  But because we’re starting at an effective interest rate near 0%, I think inflation will be a major issue to contend with.

Inflation combined with an already weak dollar is a recipe for big gains in everybody’s favorite safe haven… gold.


There’s a new kid in town.  Van Eck Global Advisors has added a new gold miner ETF to their lineup.  It’s the Market Vectors Junior Gold Miners ETF (GDXJ).

GDXJ is the little brother to their wildly successful Market Vectors Gold Miners ETF(GDX).  And just like its big brother, a company must generate at least 50% of their revenue from gold or silver mining.  The only difference is the junior miners are much smaller companies.

These small cap companies are a bit riskier.  But in times when gold prices are rocketing higher – like they are now – smaller companies tend to outperform the large cap mining stocks.

Macro/Economic Trend:  Bye, Bye King Dollar

As I said earlier, gold’s primarily a hedge against uncertainty and inflation.  But that’s not the biggest reason gold has shot up 27% this year.

No, the biggest driver of the price of gold is the US Dollar’s exchange rate.

Commodities like gold are traded in US Dollars.  A commodity price and the US Dollar have an inverse relationship.  Simply put, when the US Dollar is rising, commodity prices tend to fall.  And when the US Dollar is falling, commodity prices tend to rise.

Now there are other influences that throw this relationship out of whack.

In the last half of ’08 and beginning of ’09, the dollar was rising and so was the price of gold.  But that was because we were in the midst of an economic meltdown. Investors were flocking to gold and the US Dollar as safe havens.  But with everything else being equal, gold and the US Dollar will move in opposite directions.

Right now the US Dollar is falling.  I think it will continue to fall.  At least until the Fed moves to raise interest rates.  And we already established earlier that probably won’t happen for another six months or more.  (That’s plenty of time for us to squeeze a nice profit from the gold miners!)

The price for an ounce of gold has stampeded its way higher over the last month to around $1,100 an ounce.

At these prices, the big miners are very profitable.  With excess cash burning a hole in their pocket, many of the junior miners will become takeover targets.  And when they offer a big premium to the junior miner’s stock price, GDXJ will be the beneficiary.

Fundamentals:  A closer look at GDXJ

GDXJ holds 38 small to mid-size companies engaged in the acquisition, production, and exploration of gold.

The junior miners give us “exposure to early-stage ventures”.  Many of these miners won’t become productive and profitable for many years.  But that’s not going to stop them from rocketing higher right along with the price of gold.

The expense ratio is 0.6%.

The top five holdings and percentage weight for GDXJ are –

Company Name Ticker % Weight
Coeur d’Alene Mines CDE 6.6%
New Gold NGD 5.6%
Silver Standard Resources SSRI 5.4%
Hecla Mining HL 5.2%
Gammon Gold GRS 4.7%

Technicals:  The charts lead the way

GDXJ’s so new it lacks the history to do any meaningful technical analysis on the ETF itself.  Instead, let’s look at the underlying index and the metal itself.

Gold broke through the longtime resistance at $1,000 an ounce in October on high volume.  Since then, it’s tacked on another 10%.  The high volume of shares being purchased in the gold ETFs tells me this trend has a lot of staying power.

And now that gold is at all-time highs, there’s no overhead selling pressure.  Simply put, there aren’t investors who were ‘trapped’ at a previous high.  We’ll often see selling pressure from people looking to breakeven once an ETF reclaims the old high. Right now we don’t have any of that!

GDXJ is set up to mirror the Market Vectors Junior Gold Miners Index (MVGDXJ).
The index has been tracked back to 2003.  Its initial value was 1,000.  The chart below shows what the index has done since then.


You can see the index has rallied along with the price of gold this year.  But it’s still well off the highs set back in ’07.

The GDXJ ETF and the index it’s based on should continue its longer term uptrend.  And I’m expecting it to outpace the rise in the metal itself.

Trade Alert

Buy:  Market Vectors Junior Gold Miners ETF (GDXJ) up to $28.00
Recent Price:  $26.50
Price Target:  $35.00
Stop Loss:  $20.00

Remember:  GDXJ is going to be volatile.  It’s really a leveraged play on rising gold prices.  That means the junior gold miners will increase faster when gold prices go up. But will also fall more when gold prices fall.  I’m giving the stop loss plenty of room so a short term pullback in gold prices doesn’t whipsaw us out of the trade.


Consumer Discretionary (+4.09%)

The important holiday shopping season’s just around the corner.  All signs are pointing toward stable to slightly better sales than last year.  Just last week, American Express said credit card spending is increasing.  That’s a good indication the wealthier consumers are beginning to open their wallets.

One key difference between this year and last for the retailers is inventory.  Last year, inventories were much bigger than they are now.  Retailers were forced to slash prices just to clear their shelves.  This compressed margins and hurt the bottom line. This year’s leaner inventories will prevent a repeat of the mall-wide fire sales we witnessed last year.  That’s great news for retailers.

Consumer Staples (+1.90%)

This slow and steady defensive sector looked pretty good this month.  That because the markets pulled back 6.5% at one point.  Now the markets are moving higher once again and the staples should lag the rest of the market.

This sector’s not going to participate in the big moves higher the way cyclical companies do.  They’re just not sensitive enough to the economy.  I expect they’ll continue to climb higher with the rest of the market.  But the gains will be much smaller.

Energy (-0.37%)

Oil’s recent run to $80 per barrel makes energy the top sector on my board.  Don’t expect prices to head lower anytime soon.  More than likely they’ll hold steady at these levels for awhile.  The wild card is the economic growth rate.  If economic growth is faster than expected, oil prices will begin to rise in anticipation of higher demand down the road.

Financials (-2.63%)

The financial companies made their bed – now they have to sleep in it.  Like sharks circling a wounded fish, regulators are circling the financial industry.  And that means regulations are only going to get worse.  What do you expect when greed and carelessness brings the economy to the brink of disaster?

New regulations on everything from credit cards to derivatives are going to make it harder for banks to make money.  But that’s not their biggest problem.  The regional and community banks are still facing huge unrealized losses from residential and commercial real estate loans.

Healthcare (+2.87%)

The political debate on healthcare reform is still the dominate force in the sector. What will the final bill look like?  It’s about as clear as mud right now.  However, the House of Representatives did finally pass a bill.  Now it’s in the Senate’s hands.

With everything else being equal, healthcare stocks look like the best value in the market.  But with the winds of change swirling, there’s no way to tell which way new legislation will push stock prices.  I’m staying away for now.

Industrials (+3.95%)

As I mentioned earlier, the value of the US Dollar is falling.  And it should continue to fall until the Fed moves to raise interest rates.  A weak US Dollar is great for the US manufacturers.  A weak dollar makes US products more price competitive and all of the foreign sales more valuable.

The weak dollar and signs of economic recovery has manufacturing company executives feeling positive about their outlook.  The ISM manufacturing index hit the highest level since April 2006.  That’s a great sign that the entire industry should continue to rocket higher.

Technology (+4.83%)

The best thing to hit the tech world in years is the release of Microsoft’s (MSFT) Windows 7.  It’s no secret Microsoft’s last operating system, Windows Vista, was a bug filled flop.  Many companies decided to forego upgrading and are running on software that’s five years old.  An eternity in the tech world.

As companies upgrade to the new operating system, they’ll likely upgrade their hardware too.  This could finally be the trigger to reverse last year’s virtual business tech spending freeze.

Materials (+1.97%)

A weak US Dollar is helping push commodities like silver and gold to new highs.  I think the outlook for the entire sector is great.  But the best place to be right now is precious metals.  We’re adding the Market Vectors Junior Gold Miners (GDXJ) this month… see above for more details.

Utilities (+0.27%)

The utilities continue to do what they do.  And it’s not very impressive.  The gains are modest when the market rallies.  The more cyclical sectors continue to outpace them as the global economic growth story unfolds.  A trend I expect to continue going forward.

Utilities will benefit from economic growth, just not on the same scale more economically sensitive sectors will.

In my opinion, this sector will continue to lag the cyclical industries as investors look for growth opportunities.

Portfolio Changes

  • This month we’re buying GDXJ…
  • Move XRT, XME, and MOO to ‘Hold’


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