Gold To See New Highs?

I have always been a bear on Gold, and like so many traders, always viewed the yellow metal as some kind of a bubble. But I have been proven wrong so many times in the past few years on this that I have lost count. Apart from human population, perhaps the yellow metal is the only thing which has been following an upward trajectory for a long period now (may be Apple shares as well, but thats a whole different level of madness). 

As I think more over it, fundamentals aside, the demand for Gold has been rising. Earlier it was just from India, but now China has also joined the race and is expected to surpass India to become world's largest gold consumer. Everything thats being valued and demanded by Asians should keep moving up, and Oil is one prime example. So, may be, the prices have been right (as they always are), and Gold bull run is here to stay. We may see higher and higher prices on Gold in coming days. 

I would start adding a little gold to my portfolio, and see how it performs over the next few quarters. I'm hoping it would outperform the bonds over the next five years period (bonds being a nominal return asset). 

Trading View: August 13

Markets haven't really been moving as per my views in the past few weeks - they have been exceptionally strong. FIIs continue to pump money into the Indian markets, making it the most stable markets even on global-down days. Downside volatility has almost disappeared from Nifty, and markets just seem to be inching up. 


There are plenty of red flags, but for the moment its more like 'ignorance is bliss' once again. The results haven't really been exceptional - with only banks and autos surprising on the upside. Rest all have been a drag on the markets at best. Telecom is almost wiped out completely out of the rally, and so is Real Estate. IT and Metals, which led to the first leg of the rally from 5000 to 5300 levels seems to have gone quiet taking recessionary global cues. Now, for the next leg up, we need pure domestic sectors, and this is where banks and autos fit the bill. Indian banks are primarily a domestic story, with negligible global operations and exposure. And so is the auto sector - with most of the supply being absorbed by local demand. Only Hyundai exports a decent chunk of its production, but thats not listed in India anyways. Other domestic stories are FMCG, and Infrastructure. If we do have a next leg up, I would be betting on Infrastructure more than anything else. 

I'm not particularly bullish over the short term, though over the longer horizon I do believe that as a whole the India story is intact, at least for the next 3-4 years. We do have a case of over-heating and excessive inflation, but these are not big issues to worry about. 

Technical Analysis 105: Important Tools - II

Earlier posts of Technical Analysis:

• Technical Analysis 101
• Technical Analysis 102
• Technical Analysis 103: Trends and Channels
• Technical Analysis 104: Important Tools – I

There are numerous other tools which are used in Technical Analysis – (a) Oscillators, (b) Stochastics, (c) RSI, (d) Moving Average Convergence Divergence, and (e) Bollinger Bands, just to name a few. However, I do not think I would be able to follow so many of the tools, and have identified two additional tools which I believe I could track:

1. Relative Strength Indicator (RSI): Very simply put, it measures the relative strength of the overall market, and has readings between 0 and 100. Usually, it is computed as

RSI = 100 - {100 / (1 + RS)},
where RS = Average of N period’s up moves / Average of N period’s down moves

RSI would be more than 50 if the average up moves are greater than the down moves, and would reach 100 (theoretically) when all days are up-days. Usually N is taken as 13 or 14. An RSI value above 70 is considered signs of an over-bought market, and RSI value below 30 indicates oversold markets. However, one should also look at the price charts in addition. If the prices are forming a double top, whereas the RSI isn’t, then it may be a bearish signal. Similarly, in situation when RSI is making a double top, and prices aren’t,we might see an up-move in prices.

2. Bollinger Bands: These are bands placed 1.5 to 2 standard deviations up and below a simple moving average line. For example, if we are looking at a 20 DMA line, then its Bollinger band would be 2 sigma up and below the 20 DMA line. Usually, the prices would remain within the band, however, the breakout is a strong bullish/bearish signal. If a breakout happens on the upside, its a bullish sign. And only when it returns back to the band, its a sign of reversal.

Technical Analysis 104: Important Tools - I

Earlier posts of Technical Analysis:

• Technical Analysis 101
• Technical Analysis 102
• Technical Analysis 103: Trends and Channels

In this post, and the next one, I would discuss about some of most commonly used tools (indicators) in Technical Analysis:

1. Moving Averages: Perhaps the most important points on any price charts are the moving averages – and they can used both for short term as well as long term analysis. Usually, there are multiple ways of calculating the MA, but most commonly used is the Simple Moving Average, and hence I would be using this one.
The important moving averages which should always be kept in mind for the important securities are:

1. 5 DMA
2. 10 DMA
3. 20 DMA
4. 50 DMA
5. 100 DMA
6. 200 DMA

These are important levels on the charts, and act as strong support and resistance levels. In addition to the home markets, they should also be followed for the regional as well global markets. I would be following the levels on Nifty, Sensex (home markets), Hang Seng, Shanghai composite, Kospi, Nikkei (regional markets), S&P, Dow, DAX, and FTSE (global markets) – on a daily basis.

2. Relative Strength: In a trend, there are sectors which perform well, and there are sectors which are laggards. Its always profitable to identify the sectors (and within the sector, the stocks) which have the strongest relative strength, as well as those with the weakest relative strength. This coupled with the general market trend could result into good stock picking early in the cycles.
I would be following the sectors of the home market, and track their performance vis-a-vis Nifty on a weekly basis, and report on Friday.

3. Volume and Open Interest: There is great information hidden in the market volume, as well as open interest data. Very few people in the market are able to make sense of these, and due to added complexity due to options data, it becomes quite complicated to make any sense. However, would try to capture the data and their sense on a weekly basis – how have markets moved, volume during the week, and how has open interest changed. Would start with Nifty on this, and as I become more comfortable, might add a couple of other indices or stocks.

Cement Sector 101

Cement sector is one of the promising sectors in any growing economy, and it’s the same in India as well. However, most of the analysts believe there would an over-capacity in the sector in the coming years, and hence are quite bearish on it.
Overall capacity is 180 Million Ton, and another 90 MT is in the pipeline (to be added over the next 5 years)
Important Factor:

• Overall Capacity: This is again a purely volumes game, and the players are ranked as per capacity. There is as such no pricing power with any of the players, and is a relatively commodity business (except may be some premium or white cement segment).

• Geography: There are two broad regions – North and South, and both have slightly different dynamics. Currently, all the infrastructure push is in the northern region, and hence the prices here are at a premium. Given the bulky nature of cement, usually its quite difficult and cost-ineffective to transport the same within regions.

• Growth Rates: The industry growth rate is directly linked with the GDP growth rate, and more specifically, very closely with the Infrastructure growth. Currently, the cement demand growth is close to 12%.

• Operating Efficiency: The industry operates at a high utilization rate of 85%, though going forward due to high capacity addition in 2010, this is expected to come down to 80%.

• Coal Prices: Usually, coals are an important input to the process, and constitute a good amount of the total cost of materials. Roughly, a 1% rise in coal prices would lead to 35 bps fall in earnings.

• Freight Cost: Cost of transportation is also an important cost as cement is a bulky good. And that indirectly would depend upon the oil prices.

 
Some of the big companies in the sector are as follows:
 

• ACC: Currently trading at a market price of 900, the stock might be a good buy at lower levels (700). The EPS is estimated at INR 75-80 in 2009, though there may slight reduction in 2010 and 2011. High presence in the Northern markets, with a total capacity at 26 MT. It is the largest player in the Indian markets, and has a large presence in Eastern as well as Northern markets.

• Ambuja Cement: Current market price of 100, and target price of 85. EPS is INR 7-8, whereas the capacity is ~24 MT. It’s a big player in north and western region, and usually is one of most richly valued stock in the sector.

• Ultratech Cement: It’s the 2^nd largest cement company in India, and is being controlled by Aditya Birla group. Overall capacity of 23 MT, with presence in southern and western markets. Again, target buying level would be INR 800.

• Grasim: This is also one of the largest companies in the sector, with an overall capacity of 25 MT. However, this is not a pure-play cement company, and has textile exposure as well. Again, this too is controlled by Aditya Birla group (along with UTCEM), and there are plans of merger between Grasim Cement and Ultratech.

• India Cement: Has a good presence in south india, and buy target at INR 100. Current capacity is 14 MT, however, its present mostly in the southern region where there is substantial capacity addition plans. Also, they are the owners of the Chennai Super Kings, and a small part of their valuation comes from the IPL revenues as well (around INR 20-25 per share).

Automobiles Sector: 102

Earlier Post: Automobiles Sector Basics: 101

Automobiles are again a relatively simpler sector, and the most important data to look forward to are monthly sales numbers, margins, sequential growth, dealer inventory (short term), demographics, penetration levels (long term).
A very brief look into each of the companies, and their monthly sales numbers:

• Maruti: Sold 100,000 cars in Dec 2009, highest ever. Expected per month run rate is 70,000 to 90,000 going forward. The big growth driver is from the exports, which now account for close to 15% of the overall sales for Maruti. However, there are concerns with new global players eyeing the market in 2010, with some new models.

• M&M: There are two separate divisions – (a) Automotive consisting of 3 and 4 wheelers, and (b) Tractors. Overall monthly numbers were 36,000 in the month of Dec 2009, and the about 1/3^rd is from Tractors. M&M has seen a very high volume growth over the past one year, and that should explain some of the gains in the stock price.

• Tata Motors: Tata Motors too caters to too very distinct segments – (a) Commercial Vehicles, and (b) Passenger vehicles. The overall sales numbers in Dec 2009 were 51,000, and bulk of the sales is in the domestic market (with less than 5% exports). Also, the recently introduced Manza and Magic are receiving tremendous response.

• Hero Honda: The Company is reporting rise in the vehicle sales month after month, and the current run rate stands very close to 400,000 units per month. Also, the company plans to introduce 3 new products/variants in the next 2 months. The company is currently operating very close to its total capacity, and hence a great uptick from these numbers is unlikely.

• Bajaj Auto: Bajaj is fast catching up with Hero Honda, and has a good presence in the premium bike segments. The monthly sales numbers currently stands at 250,000, and these are mostly from bikes.

• TVS Motors: A relatively smaller player in the sector, with monthly sales of 110,000 units (mostly bikes and other 2-wheelers)

Technical Analysis 101

I have started reading a bit about Technical Analysis once again, and here I would note down all the important points so that I do not have to get back at the bulky books again and again for future reference.

Introduction

Technical Analysis is the study of patterns – price, volume or any other variable. And it is based on a few fundamental principals:

1. Everything is discounted and reflected in the market prices: All the knowledge about the specifics of the company and sector has been captured by the prices, and any movement is purely based on supply and demand of its stocks. Here, it implicitly differentiates between the underlying company (real world) and its stock. The stock price moves purely as a function of its demand and supply. In other words, Price is King.
2. Prices move in trends and trends persist: It means here that there is a trend in motion due to interplay between demand and supply. And once the trend is set, it continues for some time unless there is a clear reversal. It assumes here that not all people react at the same time, and hence once there is buying in a stock, it would go on for some time. As they say, ‘Trend is your Friend’.
3. Market Action is Repetitive: Certain patterns appear time and again on the charts, and it means that people behave in the same way as they have in the past. People react similarly in similar situations, and this can lead to identify major tops and bottoms.

Basics of Charting

The most important indicators are related to price, volume and open interest. While tracking prices, one should keep in mind that there are usually 4 prices which are important – Open, Close, High and Low (for each period). In terms of volume and open interest, they are usually read in conjunction with the price action, and independently do not signify anything.

Important Chart Patterns

1. Reversal Patterns
   • Head and Shoulders Pattern
   • Ascending and Descending Triangles
   • Rectangles
   • Double and Triple Tops/Bottoms
   • Rising and Falling Wedges
2. Consolidation Patterns
   • Flags
   • Pennants (Triangles)
   • Symmetric Triangles
   • Head and Shoulders Continuation Patterns
3. Gaps
   • Breakaway Gap
   • Runaway Gap
   • Exhaustion Gap
   • Island Reversal

Exit Point

Why do all the trading literature concentrate so much on entering a trade? The successful exit strategy is as important as entry. And that would many a times make the difference between a profitable trade and an unprofitable one.

More on this later, when I finish some of the Technical Analysis books that I have got.

Why there is no word called ‘Bear-sh*t

To start with, let me put the disclaimer first:

I have a very strong belief that most of the asset classes in the world always trade at a premium over their fundamental value – defining fundamental value as what people would earn if they indeed keep the asset till perpetuity. I have a term for it as well – the ADR phenomenon. It goes like this – any ADR can anytime be converted into the underlying stock, and hence the value of an ADR will seldom fall below whatever an investor can earn by buying the ADR and then immediately converting that into stock. So, ADRs most of the time trade at a premium to the intrinsic price of the underlying share. The price of the stock here is the ‘Opportunity Value’ of the ADR – which could be derived any time the investor wants to. The same rational goes for the stocks or any other asset class – they always trade at a premium over what people can earn by holding them to perpetuity (their “Opportunity Value’). Only in times of deep recessions and market crashes do they trade below their values. So, more than 80%-90% of the times there is a bubble in the market.

Now building on my belief about the perpetual asset bubble in the world, any rational person would most of the time expect the market to correct (looking deeper into the terminology here – market falls are called ‘correction’, while the rise in markets are given terms like ‘bubbles’, ‘frenzy’, and ‘euphoria’). So, there is an inherent bias in the market where more people always believe that markets should fall. Whether they expect the fall to happen immediately or later is where the opinion differs, but they are all united in their belief that they are over-valued. There seems to be slight sophistication in thinking ‘Bearish’ – anyone who thinks markets would keep on rising is termed a naive retail speculator, whereas anyone who can substantiate a market fall is an ‘Economist’ or a ‘Trader’. So much are the professionals in the field biased against the bulls that they have named the ultimate description of crap as ‘Bull-sh*t’.

So, little wonder that all the ‘E’s and ‘T’s of the world are united in terming the latest rally as overdone, and are predicting another crash to happen ‘any moment’. No one likes a rising market – anyone can make money there. The dumbest of people end up making the most mullah in a bull market – as they don’t have the slightest of fear about a market fall. If one was born in US in the last 1970s, and discovered their senses in mid-1980s, then he/she saw was an ever rising market. How on earth would someone explain him/her that markets could fall as well. They were living in a ‘fool’s paradise’. NNT also warned against the bull markets, and bought deep OTM options – in the full knowledge that markets one day would fall big, and he would make a killing. He did make it, but that came after years of painfully watching the market move up, and seeing all his options expiring worthless (he did get all his money back, but that was from the sale of his books, rather than from the markets). No one ever loses everything in the market – either you make money, or you learn.

In the end, everyone is right about it – but seems that if you do not think about it too much, you are right on more occasions than the rational thinkers. You might lose everything you made in just one bad year, but then, its the same with the other side as well. So next time an expert warns you against a crash, just tell him that you would rather lose money in a couple of crashes, than being worried about it for all your life. And for all the ‘bears’ in the world, there is one simple answer - ‘Ignorance is Bliss’.

The Best Aspect Of Trading

The best part about trading is that you just need to be good at something. One can spend all their lifetime trading just one stock, or one sector, and make good amount of money.

I am trying to understand a few of the stocks, and form views on them. Would be starting with a very small set (2 or 3). Over time, would increase the set to include about top 10 names in the market.

Short-selling and Efficient markets

I have pondered over this question for some time now - 'Does short-selling make a market more efficient?' Or, to put it differently, 'Is short-selling a pre-requisite for efficient markets?' Here are my views on the same.

To answer the above question, we must first define 'market efficiency'. In my opinion, an efficient market is one where price discovery is solely based on the intersection of demand and supply functions. And any new information or event affects either or both of these functions, and hence results in the change in price. But as a whole, price is always arrived at by the demand function of the consumers and the supply function of producers.

In stock markets, the demand and supply functions are slightly complicated. The supply function is simpler to understand. During an IPO, its the standard supply function as in case of a manufacturing firm - higher the price, more the supply. As the valuations become richer, promoters supply more and more shares in the market. And as time passes, in a secondary market, the supply comes from prior period consumers (which were the demand function earlier). However, the supply side is still limited by the total amount of stock outstanding, and hence, has its upper-bound. It can always be estimated as coming from a single large firm with limited production - higher the price offered, more the supply.

Demand function, on the other hand, can come from anyone in the market place, and it has no upper-bound. However, it has a non-zero lower bound. So, there is always a positive demand, as well as a positive supply in a perfectly functioning markets. And it doesn't need 'short-selling' to function efficiently. In the worst scenario, there is no demand for the stocks, and hence, there is no trade in the market.

Now if short-selling is allowed, the supply function becomes as independent as the demand function. Everyone can become a supplier (that is, can sell the stock), and the upper bound on supply function disappears. Or, to look at it differently, now there is a possibility of a negative demand, and hence, must be matched by a positive demand. In falling markets where there is no positive demand, a negative demand if not met, can make a stock price nosedive towards zero. It will keep falling as long as it is matched by some positive demand. Hence, it can lead to quicker falls and higher volatility during the times of uncertainty.

Its a choice between a dry market with no trading (zero demand) or a highly volatile market with falling prices (negative unmet demand). And am not sure why the latter is better than the former.

Trading is an Art?

I have often heard people saying that trading is an art, and not a pure science. Well, based on my little experiences, I can certainly say for sure its not an art. Whether its a science or not, I would take another year or so to make a view on.

When I say Art here, I mean a field where individual choices are different, and there is no way to judge two different entities. Two paintings or two works of music can both be good, and they might be incomparable to each other. Similarly, one can argue that even in trading there are different techniques used by different traders, and no one of them can be said to be superior to the other. Agreed to this, however, isn't it always about the output more than about the process?

Whatever be the technique employed by different traders, over a sufficiently long period of time, its a common measure that is used to judge who was better amongst them. Again, this measure can be flawed over the short term where luck and chance play a big role, and that is the reason why I have said over a sufficiently long time - around 10-12 years.

In my humble views, trading is much closer to science. All the successful traders have always been hardworking people, who keep a closer look at anything and everything happening in the world. I have seen/heard good traders working on the weekends to catch-up on the events of the past week, and get up to date with the world. They must study not just their own asset classes, but also what is happening in the other asset classes. At the minimum, one's view on interest rates and foreign exchange is a must, irrespective of the assets one trade. In the recent times, Commodities have acquired much more significance than in the past, and may truly end up becoming another big asset class. Its more a result of unrelenting efforts by the investment banks and hedge funds to bring it to prominence, and this is the first time we have had an oil shock after the derivatives got popular. It may have far reaching results a to how traders keep track of the world.

I'm yet to develop my own methods of trading, and that has more to do with the fact that I have not been able to zero down on the final asset class/securities that I would be trading. I have to make a choice between Equities and FX at the broader level, and between delta trading and volatility trading at the securities level. At the moment, I'm more inclined towards FX and Delta trading, and will be able to make a final decision by first half of 2009.