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 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 ultra-short financials ETF 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 ETF GDX.
3) Energy and 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 Russia 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 (PBR) on Friday at $50. Long-term, they are 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.
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