Archive for January, 2007

Horse Sense

Al Ries and Jack Trout summed it beautifully. To become successful in life, you need horse sense to ride a winner. When to get on a sector horse and when to get off is a sense not every body has. Identifying outperformers from underperformers needs home work.

For example, sector risk is the greatest contributor to price fluctuation in a stock, it is very important to determine sector relative strength. Relative strength is a ratio line, a tool so simple and effective that it generally gets overlooked. “How can something so simple work?”. The beauty of Relative strength is that it can keep you invested in strong stocks for a long time, allowing you to participate in the gains. If the sector or stock continues to have positive RS for years on end, while broad market moves up, this would mean higher returns for the sector or stock under study. Relative strength allows you to let your profits run.

And on the other hand if the indicator is negative, it allows you to get off a horse not running the race and to move to one that is. Given that market goes up two thirds of the time and down one thirds of the time, going to 100 per cent cash by selling all your positions is a huge bet. A more sensible approach is to weed out the poor RS performers and sell those stocks to raise the cash level in your portfolio. The charts on the right are the RS chart of CNXIT (Tech Index) against rest of the sectors in India. CNXIT has clearly underperformed Auto, Capital Goods and Oil sector in India. The ratio stands clearly below 1 and technically we don’t see the ratio coming above Parity soon. This means continued underperformance. Then we have CNXIT vs. BSE BANK. The ratio line rules near 1. This is in sync with CNXIT vs. Sensex RS, which moved up after the Jun 06 dip. But the bounce back on the RS is hardly encouraging. This leaves us with FMCG, Health Care and Public Sector. Even here CNXIT seems to have hit if not significant atleast intermediate resistance.

Now, if this is too simple a portrayal for us to convince you to reduce your Technology allocations. Then it’s our horse against yours. Let the best one win.


The legend of Cornucopia

Amalthea raised Zeus on the milk of a goat and in turn Zeus gave her the goat’s horn, the horn of plenty, which had the power to give to the person in possession of it whatever he or she wished for. This is the legend of cornucopia.

Despite what contemporary mindsets might be, for us at [bold]Or-phe-us[/bold] real wealth is still linked with milk, food, corn and maize. To just give you a reality check. Did you know that from 1995 - 2005 CORN gave an average minus 3% return annually? And 6 out of the last 10 years were negative. But 2006 just inverted the scale, as the decade average moved up from minus 3 to plus 3. CORN was up 57% in 2006. What happened?

Analysts might blame it on ALTERNATIVE ENERGY, ETHANOL and the how there is not enough CORN in this world. And about the CORN-ETHANOL conversion ratio of 2.7 gallons per bushel etc. But for us the rounding bottom pattern (right) accumulation got over in 2006 and currently CORN is undergoing the 3 primary wave move up, which should take it atleast 23% up from current levels.

We don’t have the horn of plenty for you, but just to make sure you don’t miss the bus we have studied CORN.L (Exchange Traded Commodity) traded at London Stock Exchange along with the local MCX and NCX spot and futures marked with key FIB levels. May your wish come true.


The Prosperity Index

Daniel Kahneman, Father of behavioral finance has clearly illustrated in his life long and Nobel Prize winning work that a majority of us humans are loss averse. Even if it means making a wrong choice. If we plug his work on the Elliott fractal then we can assume that all down ending C waves will have very few people digging into stock fishing. There will be more panic, as extreme negativity involving mass psychology would mean “stay away”. Capital conservation is not a strategy for a top, it’s always been an investment strategy for the bottom. This is why Humphrey Neil said, masses generally go wrong on a turn. But as technicians, we understand that timing is the name of the game.

The prosperity index espouses the same principle of wrong choices at an extreme. We highlighted the prosperity index on 13 Nov 06 in our WAVES.METALS report. Also known as the Gold-Silver ratio, the ratio lows come near prosperity highs. As illustrated, we as a society are heading into the most prosper times of the last 25 years. And conventional wisdom and conventional research foresees prosperity as a straight line, which means the bounty and loot shoot continue. But unfortunately, life and everything in nature, like stock market is cyclical. After high prosperity it’s time for the swing to the other extreme. The ratio is near 1 and has always returned back from these levels for a quarter century. Whether the Index will turn again remains to be seen.

On the short term, the anticipated triangle resistances ahead for Gold, Silver, MCX – Gold Near, HUI – Gold Bugs, NEM Newmont Mining Corp, GFI Gold Fields Limited and XAU – Gold and Silver Index are still running at 640, 13.2, 9300, 340, 47.4, 18 and 144 respectively came in visibly and clearly. A break for Gold here will push us to our alternate interpretation of a Gold flat up to 690 and maybe to a new high with a first target to psychological 700. If prices move above 690, we will get two signals. One it’s time for Gold (tangible asset) to move to 1000 and second that the prosperity Index has turned from an extreme and it’s time to conserve capital in the paper assets (non tangible) that you might be holding.


THE PROSPERITY INDEX

Daniel Kahneman, Father of behavioral finance has clearly illustrated in his life long and Nobel Prize winning work that a majority of us humans are loss averse. Even if it means making a wrong choice. If we plug his work on the Elliott fractal then we can assume that all down ending C waves will have very few people digging into stock fishing. There will be more panic, as extreme negativity involving mass psychology would mean “stay away”. Capital conservation is not a strategy for a top, it’s always been an investment strategy for the bottom. This is why Humphrey Neil said, masses generally go wrong on a turn. But as technicians, we understand that timing is the name of the game.

The prosperity index espouses the same principle of wrong choices at an extreme. We highlighted the prosperity index on 13 Nov 06 in our WAVES.METALS report. Also known as the Gold-Silver ratio, the ratio lows come near prosperity highs. As illustrated, we as a society are heading into the most prosper times of the last 25 years. And conventional wisdom and conventional research foresees prosperity as a straight line, which means the bounty and loot shoot continue. But unfortunately, life and everything in nature, like stock market is cyclical. After high prosperity it’s time for the swing to the other extreme. The ratio is near 1 and has always returned back from these levels for a quarter century. Whether the Index will turn again remains to be seen.

On the short term, the anticipated triangle resistances ahead for Gold, Silver, MCX – Gold Near, HUI – Gold Bugs, NEM Newmont Mining Corp, GFI Gold Fields Limited and XAU – Gold and Silver Index are still running at 640, 13.2, 9300, 340, 47.4, 18 and 144 respectively came in visibly and clearly. A break for Gold here will push us to our alternate interpretation of a Gold flat up to 690 and maybe to a new high with a first target to psychological 700. If prices move above 690, we will get two signals. One it’s time for Gold (tangible asset) to move to 1000 and second that the prosperity Index has turned from an extreme and it’s time to conserve capital in the paper assets (non tangible) that you might be holding.


Westernisation of Asian diet

Adam Smith would have been so happy to see thriving Mac burgers next to Andheri station in Mumbai. The vision of capitalism lived much beyond his imagination. But what might shock him though is how consumerism overwhelmed the invisible hand. And how sustained income, urbanization and growth pushed Asia to drop an inferior good rice and move to wheat. Westernization of the Asian diet is a demand factor, which does not find mention in leading grain think tanks around the world.

Rather the United States Department of agriculture came out with its alarm bell on wheat on 16 Oct 06, 6 Nov 06 we covered wheat last time here and 7 Nov NCX FEB wheat futures topped at 1144 and fell 13% by the end of 2006. Some might call it another lucky coincidence, we call it inverted incidence. If everybody knows of the crisis, the asset class will surprise. And that’s what wheat did. It surprised by a fall when conventional wisdom suggested a rise.

The news of the crisis came more than half a decade late. For us, the bull market for wheat started in 1999, more than 7 years back. Now the asset is forming a multi month corrective form. This means that all this hue and cry about the grain might actually push wheat further down before the crop really starts to re-exert its multi year bull trend. The chart on the right seems the first leg down of wheat on NCDEX FEB Wheat. All upsides should be capped by 0.382 FIB at 1050 - 1060 levels.

And about ASIAN diet preferences, when preferences become a habit, then is when it hits the most. Who said, moving back to an inferior good is easy.


Waking up to Gung Ho

An asset or currency that wakes up from years of inaction is an opportunity. And Market psychology that goes gung ho is scary. We at Or-phe-us differentiate between the two clearly. We are alert when an asset is ready to move out of inaction and we are careful when market psychology gets going. For us waking up of market psychology is a sign of extremity and time to exit.

Let us explain. Yen is moving sideways for the last 22 years and has touched near 120 levels for more than 10 times in the respective period. This means on average every 2 years. This is a huge currency inaction compared to dollar. This we consider a multi year potentially rewarding opportunity. And on the other hand we have the emerging Eastern and Central European currencies like Hungarian Forint, Romanian Ron, Bulgarian Lev and emerging Indian Rupee, which are some how directly or indirectly the talk of the town. If not long term, short term, we do have some gung ho lurking around.

Market forces as we explained last time slowly find their way to define the value of the asset. All other parameters like the charisma of central bankers etc. is make believe. The C&E European currency story is going on for half a decade now. And with Bloomberg announcing that Romanian Ron was the strongest currency of the World in 2006, everybody knows the secret now. This is what forced us to get down to our workings again to reassess whether dollar will eventually break down this year or is there a surprise cooking for atleast the first half of 2007.

The USD/YEN ratio line (right) broke the 22 year trend suggesting YEN is ready to move out of inaction and head to potentially below 80 (33% strengthening) for many years. However, before it does that we might see some final bit of dollar surprise strengthening. Technically many factors still favor dollar strengthening in the short term, whether this takes an intermediate strengthening remains to be seen. But if we add the gung ho factor, dollar might just wake up against it.


TRIANGE TRIANGLE EVERYWHERE

If you would replace triangle with water, the statement will become life defining. But what if we tell you the simple Euclidean geometric form not only defines the molecular form of H2O but also the demand and supply cycles of environment that might push the now inexpensive natural asset into a high return exponential trajectory. By the way, water stocks have outperformed OIL futures in the last 2 years.

Technicians like geometricians stand by the triangle. We at Orpheus give it high weightage whenever we churn out a forecast. For us triangles are every where, in water, sugar, coffee, oil, forex, Sensex, HZNC and in GOLD.

The current form in GOLD seems to support a TRIANGLE with five legs. We illustrated the Gold triangle to you as early as Oct 06 as an alternate count. We said that if the triangle comes to being there will be a lot sideways action. As after the form comes to fore, prices oscillate till the form completes. Based on triangle estimations we highlighted a key turn level for GOLD at 640, as early as Nov 06. As thing stands today the triangle form continues and Gold still stands below the resistance set by the simple polygon.

For us this simplicity is the key to forecasting. The anticipated triangle resistances ahead for Gold, Silver, MCX – Gold Near, HUI – Gold Bugs, NEM Newmont Mining Corp, GFI Gold Fields Limited and XAU – Gold and Silver Index are still running at 640, 13.2, 9300, 340, 47.4, 18 and 144 respectively. All levels stand firm.

The Triangle completion is followed by another leg up i.e. a leg up from sub 600 levels to near 1000 levels. The back up count still expects a move up to 690 in an expanded flat. Lets see it’s the triangle or the flat.


OIL on the edge

After the confusion at 60, we threw in the towel for the alternate count looking at prices lower than 17 Nov low. This was still easy, as Nov – Dec move up was a counter trend move, which had to end and push prices lower. Now we are almost $ 10 down from 60.

Last few months we have been mentioning of a little something which OIL had left behind when it moved up in Dec 06. It was the test of psychological 50, which was not just a psychological level but also a confluence of many price objectives. We mentioned two degree of price objectives. First kind justified an upmove near 54-55 viz double top (slide 5), multi year supports and resistance reversal points, moving average penetration and retest (slide 3).

The second degree price objectives were the little something that OIL left behind. The second degree price objectives were the previous 4 wave (slide2), normal scale channels with price objectives as the width of the channel and the log scale channel (illustrated – slide 4 and 5).

Now OIL has achieved the second degree price objectives and also some FIB objectives with C=0.618*A for the ZIG ZAG internal ratio. What happens beyond current levels, is nothing short of falling over the edge for OIL. We at Or-phe-us are ENERGY BULLS and remain long term positive on OIL with future targets above $100. A clear break here does put us back on work to chalk out the counts again. At this stage we see psychological 50 and short term support come in. Beyond 50 we will have to review. We have enclosed support zones and a historical check on what we anticipated and how prices panned out.

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INDIA OUTLOOK 2007

 The Indian economic cycle is heading to the late expansion stage. Theoretically there are five stages viz. early expansion, middle expansion, late expansion, early contraction and late contraction. The very fact that we are heading to the late expansion stage suggests that we are still away from a top and 2007 might see a new high above 14000 before the real slowdown starts.

We at Or-phe-us still see the immediate preferred direction sideways to down with a potential upward breakout probably after first quarter. The Sentiment Theorist highlighted broad market non confirmations in Nov 06, which still stand firm. As barring Sensex, BSE BANK, CNXIT and BSE Capital Goods Index, rest all the Indices (Health Care, Small Cap, Mid Cap, BSE OIL, BSE FMCG, BSE PSU, BSE AUTO) are still below May 06 lows. Historically, such non confirmations do not guarantee that markets may turn down or remain sideways, but if you look at it from the Intermarket perspectives and add in a few technical aspects, we have enough reasons to validate our case.

Capital Goods sector has exhibited a clear leadership since 2004 with average returns over the last three years near 80%. This was the only sector to churn up more than 100% ever in a year. Capital Goods or Industrial sector growth mark the best run of the economic cycle. Materials and Energy sector should assume leadership from current levels. And the effects should be visible starting first quarter.

Materials and Energy: Though we are still negative on ZINC and other base metals on the intermediate term, materials sector is a mixed bag and steel and aluminium still seem to have upside left. Integrated Aluminium companies are still trended up. On the Energy front, we do not see OIL falling substantially below $50. After OIL hits base, the respective sectors should assume leadership. Till then we can see some negativity in both the Energy and materials sector. Energy is also a late expansion sector and seems in sync with our preferred wave count on market.

BSE BANK was the next best performer after capital goods sector. Credit expansion is the highest in late expansion stage. This boosts banking profitability on one side and makes banking sector very vulnerable to corrections. We are near our price targets on the sector and sector components and recommend pre budget reductions on the sector.

Technology: Despite the noise that Infosys and Indian Tech gets abroad, the sector has underperformed every other sector in 2006. The underperformance should continue. Technology is a Middle expansion sector and does not do well in late expansion sectors (current). We still believe the technology sector prices should correct sizeably from current levels. We will not be surprised if Technology gives a negative return for 2007.

The automobile sector should see negative surprises. The index and its constituent stocks should decline further from here. This push and pull of various sectors should result in the sideways to net negative movement we are expecting till the first quarter of 2007. In conclusion, banks and technology alone cannot sustain the markets at current levels. And with the capital goods story being more than three years old, we need smart sector allocations as we head into late expansion. Energy and materials should start ticking from this quarter. Let’s be conservative in 2007.


The Quirky Human

Although he never took an economics course, Princeton psychologist [bold]Daniel Kahneman[/bold] received the Nobel Prize in economic sciences in 2002. Kahneman’s life-long work integrated psychological research and economic science. His work showed economists how people don’t always make reasoned choices. Kahneman calls it “The Quirkiness of Human Judgment”.

[bold]“Sell high and buy low”[/bold] sums this mood partially. No body wants to buy at a market bottom, everybody wants to buy at a top. The quirky human does not reason, is impatient, and herds. We at [bold]Or-phe-us[/bold] are taking Kahneman’s hypothesis further. We say that not only the majority of us behave like dumb sheep (irrationally), our behavior as a group is a fractal. This means that whether we are talking about intra day traders, weekly traders, monthly or yearly investors, as a group our behavior has a form, a form defined by [/bold]Fibonacci[/bold] sequence. And talk about anything, climate, politics, gay marriages or coffee the decisions to vote or not, buy or sell are polarized by a pattern and the Fibonacci sequence.

For example, Coffee is undergoing an accumulation pattern for the last 8 years (a Fibonacci number). And has retraced nearly 61.8% (Fibonacci Golden Ratio) of the previous fall. In the coming months it should find support at the 8 year resistance and push up to a new high above 180 in a five wave impulse form.

We remain SOFT (Coffee, Sugar, Cocoa) BULLS. We initiated our coverage on Coffee on 3 Oct 2006. The SOFT just like SUGAR ended its multi decade SUPECYCLE bear IV wave in Jul 02. The commodity is in a multi year bull market. Currently, the soft seems to be moving in a IV primary circle. And is now churning up the final (E) intermediate wave of the triangle back to sub 100 levels. After this move down the thrust up to 180 should begin. And after it breaks out, the news will arrive, maybe 13 months late (like it did in case of Euro-RON) that Coffee was one of the best performing commodity of 2007. And you know, what will happen then? Everybody will “Buy”. Quirky, isn’t it?