Portfolio Annihilation Coming Next Week

I got killed today on my gold trades and it looks like it was a big mistake to up positions in them on weakness a few days back. I am so happy that I managed to resist that trap again this morning as it took a lot of discipline from me. This is my first real "trading" loss of the year. And although it is still unrealized I have a good feeling that I could lose "a lot" more money from here if I do not make some changes over the coming week.

I have another problem as well though - because I still believe in the underlying funamentals of all the trades I have on. I am suffering from what is called, "smartest kid in the class syndrome." Grant you, I have never, ever been the smartest kid in the class - not in elementary, not in junior high, not in high school, not in college, and certainly not in law school. This syndrome has a lot more to do with false confidence in statistics or fundamentals and trying to apply them to a real life investing/trading situation. This can be extremely risky for investors and is death for anyone who fashions themselves - a "trader," because you may average down in a position while concentrating on your numbers or belief that is probably wrong. The stock price movement is what counts. Take Enron for example or better yet Refco (more recent) - you could point to all these statistics about your company that looked OK on paper, but the bottom line is that investors were seeing through what was going on and began to sell the stocks well before the actual numbers caught up. That is also certainly the case today with the homebuilders and energy sectors of the market.

My goal in the below rant is to get some of this out of my system so that I can see my portfolio for what it really is next week and try to distinguish hope from fear over Monday and Tuesday and try to just look at the price action to make the correct call - hold or dump remaining positions at whatever prices I can get.

The biggest hit I have taken in connection with the syndrome is my belief in the weakness of the US economy and political situation at the current juncture. I see several factors affecting the economy negatively - inflation, rising interest rates, huge debt, problems with derivatives and counterparty risk in the financial markets, slowing housing. In this environment I would expect to see 1) the financials sell off and 2) gold prices rise. In fact, and this is probably the scariest thing of this whole post - I actually "got" the numbers I was lookin for. I tied my expectations for most of my portfolio today's CPI number. I convinced myself that any number above 1.0% in the total inflation amount and I would make a killing both in gold and the financials short as it would signal that inflation was out of control and also that interest rates were going up. When I read the 1.2% number early this morning - I was sure that I had done it.

Unfortunately for me, I did not anticipate the correct result of investors. Investors sold gold off hard on the news and actually bid the market up, choosing to ignore the overall inflation number and focus on the core number which was only up 0.1% - this number excludes food and energy. I have posted a few charts from the BLS so that everyone can take a look:

Here is the monthly trend:
Here is the yearly trend:


The distinction that I like to make when analyzing the inflation report - is not between the "core rate" and the overall rate of inflation. I like to look at what are the prices of the mandatory items v. the discretionary items. To me apparel which is the only item in the list that is down meaningfully at all over the past months/years, is a discretionary item. Sure - I buy new clothes a few times a year, but it is not a must item that would get me. On the other hand - food and energy - these are two consumables that I buy every day of the year. I have to drive to work, I have to eat breakfast, lunch, and dinner - and I am always looking to earn more $$$ so that I can handle the costs/purchases of these items.

I also consider recreation to be a discretionary item. It is also one of the items in the list that isn't up that much. I am not going to try and conjure up some new statistic on my own - but I do believe in my own heart that I got the number side of things right. Now below I will discuss some additional tidbits.

I also had a working hedge relationship for a week or so in the price reactions of the XLF v. the Gold stocks. Whenever gold would take off it would increase those options, and whenever XLF would go up it would decrease those options and vice versus. It was a give and take which was working. This relationship broke down today as although interest rates rose across the board (predictably killing gold), the financials actually increased in price decoupling - at least today.

The action is not done yet though. I still have approximately $3K of capital committed to options contracts which expire next Friday - 10/21. I am slightly in the money on one of them - as there is absolutely no time premium left in it (that is the XLF puts). I am out of the money in RGLD and it will require an upward move of at least 8% next week. Now if gold recovers and challenges $480 - I am confident that trade will turn out great. That is a huge assumption though - for all I know gold could collapse and head back to $430 next week because inflation at least as it is considered by the investing public and wallstreet is dead in the water.

Here is the final portfolio snapshot going into the weekend which should serve as a sobering reminder of how not to BET. This was definitely putting everything on RED and I am taking it up the kazoo as a result.

Snapshot:

The above closing prices are what was posted to my account but I believe that XLF is probably closer to $0.80 right now and RGLD closer to 0 - which would tak me down an additional $1,500 - puting actual portfolio value around $9,400...............YEEEEOUCH.


Regards,

BG