Not Out Of The Woods: Long Metals, Short Financials
PLAY: Buy the WFC January 2009 30 Puts (WFC MF) at market, good for the day. Place a protective stop limit at $1.90 and implement our scaled-selling technique to lock in portions of your profits as these calls achieve 50% returns (and greater).
PLAY: Buy the PCU January 2010 25 Calls (YPV AE) at market, good for the day. Place a protective stop limit at $2.30 and implement our scaled-selling technique to lock in portions of your profits as these calls achieve 50% returns (and greater).
Dear Bottarelli Research Member,
Two major themes emerged this week, and today’s LEAPS alert will help you profit off both of them.
The first major theme was Inflation.
Despite what Ben Bernanke said on Friday, inflation does not appear to be slowing down anytime soon.
The second major theme was the second (or even third) round of Financial Sector Weakness.
Despite the news from Lehman Brothers (LEH – NYSE) on Friday, which triggered a temporary upside move in the financials, the sector is certainly not out of the woods.
Starting with the financial weakness, former IMF chief Gary Duncan warned this week that the credit crunch may take out yet another “large” U.S. bank within the next few months.
At the same time, Professor Kenneth Rogoff (a leading academic economist) added his own ominous warning saying, “We’re not just going to see mid-sized banks go under in the next few months, we’re going to see a whopper – one of the big investment banks or big banks.”
Following up on this point, the recent issue of Barron’s said, “This (financial) mess is still a long way from a happy ending.”
With warnings like this coming from many of the world’s most experienced andrespected economists, I want to use the recent financial bounce to establish a new short position. And we’ll establish this new short position in one of two companies I’ve identified as the “whopper” that could be next in line to fall. These two companies are Wachovia Corporation (WB – NYSE) and Wells Fargo (WFC – NYSE).
Wachovia has gotten over its head in the auction-rate securities blowup, and now they have become the subject of an investigation by New York Attorney General Andrew Cuomo. There is a possibility that Wachovia (who has been accused of “burning” clients with their auction-rate products) will be ordered to make these customers whole again.
Between Credit Suisse, Wachovia, and Bank of America, a total of $220 billion of these auction-rate instruments remain outstanding. Therefore, it goes without saying that a payback could severely threaten WB’s financial sustainability.
At the same time, WB also got heavily involved in “Alt-A” mortgages, which is a fancy way of describing loans that came without proper income verification. USA Today recently reported that delinquencies and foreclosures are up sharply for Alt-A mortgages, further weakening WB’s position.
As you can see from the WB chart below, clear resistance at the 50-day moving average signals a re-test of the lows under $10.00.
Another troubled financial company is Wells Fargo (WFC – NYSE).The fact that Warren Buffett owns WFC stock has, in many respects, kept the shares semi-insulated from the recent financial sell-off. Case in point, WFC currently trades at 12 times ‘08 earnings estimates and 2.7 times tangible book. The remaining financial sector trades at less than two times book.
NOW HERE’S THE THING: If you look at WFC’s current financial position, it’s easy to see why their premium multiple will soon evaporate.
First off, Wells Fargo is heavily exposed to the real estate problems in California, where delinquencies and losses are sharply on the rise. Not only that, but 16% of their financial portfolio consists of Home-Equity Lines of Credit (HELOC), many of which originated at the top of a real-estate bubble. The threat here is quite substantial.
You see, HELOCs sit on top of first mortgages. That means if a home goes into foreclosure, the first mortgage holder can get most of their money back. But the home-equity line, which originated second, absorbs all of the loss.
In other words, delinquencies can entirely wipe out home-equity lines of credit. Therefore, WFC is at considerable risk of losing out on 100% of any HELOCs that go into delinquency. That’s not a good position to be in. Combine this threat with the un-winding of the “Buffett Premium,” and I think WFC puts are the play. So as the first order of business, let’s get positioned to profit off the next down-leg in the financial sector. We’ll accomplish this using January 2009 puts on WFC.
PLAY #1: Buy the WFC January 2009 30 Puts (WFC MF) at market, good for the day. Place a protective stop limit at $1.90 and implement our scaled-selling technique to lock in portions of your profits as these calls achieve 50% returns (and greater).
Next up, we’ll get positioned to profit off rising inflation.
According to the August 18th issue of BusinessWeek, “growing evidence suggests American consumers, businesspeople, and political leaders should all be bracing for double-digit inflation, probably as early as 2009.”
In fact, if you follow the Consumer Price Index, you know that the inflation rate averaged 2.6% a year from 1992 through 2007. But since January, this figure has doubled, reaching an annual rate of 5.6% in July. By 2009, this monthly figure could hit double digits, which would triple 2007’s inflation rate of 2.85%. This is a substantial increase.
It’s easy to see the effects of inflation. After all, just look at the recent increases of commodities:
- Oil has quadrupled in five years.
- Coal has tripled in 12 months.
- Copper has increased 350% over five years.
- Corn prices gained 76% in one year.
- Wheat doubled from July of 2006.
When you see price increases like these, it’s clear that the Federal Reserve is under tremendous pressure to curb inflation. This paints a strong picture for metals.
But in a strange anomaly, metals prices have been very weak recently.
Why the selling pressure, you ask?
The way I see it, investors think that a slowdown in the U.S. economy will slow down the rest of the world. And in turn, this will reduce the demand for metals.
Not only do I disagree with this assessment, but I take the completely opposite viewpoint. In sharp contrast, I feel that the current state of the U.S. economy will paint a very bullish picture for metals going forward. Inflation fears (combined with global demand strength) will actually help metals bounce from their current lows and rally in the months leading into 2009. As a result, I’d like to establish an upside call position in shares of Southern Copper (PCU – NYSE).
As I’ve mentioned in my daily options alerts this week, PCU produces and sells the entire spectrum of metals, including copper, molybdenum, zinc, silver, lead, and gold.
They’re one of the only companies currently trading at a $20.8 billion market cap that also comes with a 23% revenue growth rate (over the last 3 years) and a dividend yield of 9.6%. That’s an awfully strong company to own, especially in a market like this.
Combine these statistics with my bullishness for metals (sparked by inflation) and the case for upside gains in PCU looks crystal clear. Therefore, let’s add January 2010 calls to our LEAPS ledger now!
PLAY #2: Buy the PCU January 2010 25 Calls (YPV AE) at market, good for the day. Place a protective stop limit at $2.30 and implement our scaled-selling technique to lock in portions of your profits as these calls achieve 50% returns (and greater).
STRATEGY NOTE: The combination of WFC puts and PCU calls properly positions you in the best way possible to profit off the current market conditions. So be sure to buy both positions on Monday!
UPDATES
Barrick Gold January 2010 40 Calls (WRX AH): Talk about great timing! A strong bounce this week helped our position gain 28%. Hold for more upside.
United States Natural Gas Fund January 40 Calls (UNG AN): Another great timing call, as the bottom in natural gas prices appear to have been set. Therefore, maintain this position for more upside.
JA Solar Holdings January 15 Calls (QJP AC): Our third consecutive “good timing” entry handed us a 37.25% return on half of our position this week. Powerful news out of solar names like STP and SPWR continue to paint a strong picture for the solar industry going forward. Therefore, hold the remaining half of your JASO calls for more upside.
UltraShort Dow30 ProShares October 65 Calls (DXD JM) & CBOE Volatility Index VIX October 25 Calls (VIX JE): These two positions continue to offer us a buffer against a dramatic downside market move, so maintain each position for this protection.
Valero Energy January 35 Calls (VLO AG): As another “recovery” play, a break above VLO’s 50-day moving average could set a powerful upside trend in motion. Hold.
Salesforce.com November 55 Puts (CRM WK): After a crushing downside move on Thursday, shares of CRM are finally behaving the way that I expected when we entered these puts on July 14th. We locked in half of our profits at the 20% profit level, so hold the remainder for more gains.
Overseas Shipholding Group January 95 Calls (OSG AS): I continue to feel that OSG is at the bottom of its recent trend. Therefore, I fully expect to see a powerful bounce in the coming weeks. Hold.
America Movil January 2009 70 Calls (AMX AN), Petroleo Brasileiro January 90 Calls (PMJ AR) & Entergy January 140 Calls (ODF AH): Do I smell a comeback!? Between Wednesday and Thursday, all three of these positions made impressive upside advances — and I’m hoping this could be the beginning stages of a recovery leading into Q4. It’s remarkable just how quickly an options position can come back, so maintain these three plays for an extended recovery.
Sincerely,
© 2012 CSR Group, LLC. All rights reserved. Published in USA.
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