View From The Turret: Shifting Conditions

After a beautiful long weekend on the slopes at Northstar, it’s time to step back into the turret for a shortened week of trading.

US equity markets were closed for President’s Day on Monday, but that didn’t stop globex traders from handicapping new pockets of social unrest in the Middle East.  Libyans have taken to the street – and faced brutal violence – in an effort to overthrow Gadhafi’s regime.

The renewed violence and uncertainty is once again shifting the “risk-on, risk-off” market sentiment.  Futures on oil and gold moved sharply higher on Monday with April crude oil futures hitting $96.60 per barrel, and gold futures back above $1400 per ounce.

Heightened levels of fear will certainly shape the trading environment this week.  Up to this point, US markets could largely be categorized as optimistic with a hint of complacency.  It’s difficult to know if the Middle East unrest will be enough of a catalyst to send the market significantly lower.  But considering the fact that the Middle East seems to be unwiding rather than blowing over, the risk is significant.

In the last few weeks, the majority of our profits have been booked on the bullish side.  Our gross exposure has been trimmed significantly as risks are certainly in place.  But at the same time, we have found opportunity to ride the trends in a few select long positions with tight risk points.

Stepping back into the flow this week, it’s likely that a number of our pending short positions will hit their trigger points.  As is the case with most of our trades, price action has to confirm before our bearish positions are executed.  With any negative follow through this week, we could quickly shift the balance of our exposure and begin generating profits as prices drop.

Below, are a few of the key setups we’re tracking this week…


Oil Sands – Stability and Proximity

The potential for disruption of oil supplies from the Middle East has crude prices hitting new recovery highs.  While the unrest causes concern for investors of large-cap oil developers with significant exposure in less politically stable areas, the environment is great for companies with significant exposure to Canadian oil sands.

As noted in our Strategic Intelligence Report, Canadian oil sands rival Saudi Arabia in terms of reserve magnitude, and higher oil prices make the process of mining these sands more economically competitive.  More importantly, Canada enjoys one of the most stable political environments, and the US is directly tied in to Canadian production through a robust series of pipelines, refineries, and storage facilities

In late January, we took a long position in Canadian Natural Resources (CNQ).  From the Mercenary Live Feed, on 1/31:

…we have CNQ, an oil sands related name, which saw a surge on Friday and is naturally positioned to benefit from a renewed hunt for mainstream oil alternatives…

Two weeks later, Mercenary portfolios took half profits off the table as CNQ broke to a new recovery high.  This week, the remaining shares should continue to see additional profits as alternative sources of oil become more valuable in comparison to supplies that face political risk.

In addition to CNQ, Gulfport Energy Corp (GPOR) is another name with significant exposure to oil sands.  GPOR stands to benefit not only from higher oil prices, but also from a ramp in production as oil sands projects are moving from development stages to full-on production.

As of the last report, the company has 32% of its production for this year hedged at roughly $87.00 per barrel.  But that still leaves more than two-thirds of this year’s production free to trade at premium oil prices.  I imagine management will also use today’s prices to hedge additional exposure at even higher levels.

After spiking higher in late January, the stock has consolidated a bit – giving bullish traders a minor inflection point between $26 and $27 on the chart.  If GPOR breaks to a new all-time high this week, it would likely catch the attention of major energy traders.  With a market cap of $1.2 billion, there is enough liquidity for large funds to justify a significant position.  But at the same time, the firm is small enough that a large inflow of capital could continue to push the stock sharply higher over the next several months.

Emerging Markets: Back to Risk-Off

On the bearish side of the ledger, we have been tracking a number of emerging market ETFs that will be vulnerable if commodity prices continue to climb.

The Guggenhiem China Small Cap (HAO) topped out in November, and has been developing a very bearish pattern.  A series of continual lower highs and lower lows has attracted trend-follower traders.  If the Chinese economy faces significantly higher energy prices, small-cap companies will have a hard time hedging out these costs.

Inflation is already a significant problem for the global growth champion, and the addition of an oil shock to already out of control food and housing costs could be very tough to deal with.

Shorting any weakness in HAO looks like an attractive trade, because we can use a tight risk point above last week’s high.  If that resistance area is broken, we will be out of the trade without too much damage.  However, if HAO reconfirms its bearish trend this week, the profit potential is much higher than the capital we will have at risk.

In addition to a couple of China ETFs, we also have pending shorts set up for Malaysia and Mexico.  As traders begin to migrate back to the “risk-off” side, these growth areas will likely see capital outflows and could breach support levels.

The potential short trades could pick up momentum quickly as investors have been chasing beta – embracing volatility in an effort to keep up with rising markets.  If higher levels of risk forces fund managers to take capital out of volatile emerging market positions, these areas could be hit hard – and very quickly.

Solar Offers a Mixed Perspective

It will be very interesting to see how solar stocks react to heightened Middle East tensions…

One one hand, the industry is an obvious alternative to traditional fossil fuel energy sources.  As oil prices climb, solar energy becomes more competitive – leading to more long-term investment in the sector.

But the solar industry has been traditionally viewed as a growth industry – vulnerable to economic shocks.  Typically, a broad market correction will hit solar names, even if long-term profit dynamics still look attractive.

We have a number of profitable solar positions in play, with tightened risk points and half profits already taken in some instances.  Today’s action will be a key test as to whether these names can hold up under difficult conditions.  If the industry remains strong, we will likely be adding more exposure, with the opportunity to add vertical exposure to names already on the books, or horizontal exposure into additional candidates.

JinkoSolar Holdings (JKS) could be particularly interesting as the Chinese manufacturer is trading at the top of a consolidation pattern.  A breakout above last-week’s high would be a strong move considering the environment.  Taking a long position would also be helpful as a counterbalance to our pending China ETF shorts in play.

The stock is currently trading at about six times earnings – quite a low price for a company that has been showing significant earnings and sales growth over the last four quarters.  JKS has access to plenty of capital to fund growth, and its easy to make an argument for a much higher stock price in the context of a bullish energy market.

LDK Solar (LDK) is on the cusp of breaking to a new recovery high after gapping higher in early January.  The stock has a single digit earnings multiple which could catch the attention of value investors looking for energy exposure.  At the same time, growth investors have plenty of rationale for picking up a position, considering year-over-year revenue growth of 148% and 140% in the last two quarters.

On a daily chart, the stock may look a bit extended, but the weekly pattern shows a much longer basing period that could lead to a much larger breakout this year.  This is a trade that would require a bit more room in terms of a risk envelope, but over a period of several weeks, we could see the value and growth metrics converge and lead to great risk-adjusted returns.

Goldman in Transition?

Goldman Sachs (GS) has been a dominant force, due to strong proprietary trading and an extremely profitable investment banking platform (oh, and a few billion from Uncle Sam too…)  But is the global economic uncertainty catching up to the industry titan?

While other major investment banks are hitting new recovery highs, GS has been hitting overhead resistance.  A recent high-profile article in Bloomberg Magazine discussed how the company is falling behind its competitors when it comes to investment management for wealthy clients.  This kind of publicity can have a significant effect on customer confidence and could actually cause the issue to become worse as clients jump-ship.

We’re considering a short position if the stock breaks below the 20 and 50 EMA, and this week’s turbulence could be just the right catalyst to send the stock below key support areas.

Despite the short duration, this week should have plenty of action and profit potential.  Jack and I are shaking off the sore ski / snowboard muscles and we’re ready to carve up some new profits as the conditions continue to shift.

Trade ’em well!


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