Playing the China Hoax, Part II

Add FXP Calls. Plus, an Early Look at SPRWA

PLAY: Buy the FXP September 9 Calls (O:FXP 10I9.00) at market, good for the week. Place a protective stop limit at $0.50 and implement our scaled-selling technique as your position achieves gains of 50% (and greater).

ADVANCE LOOK AT NEXT WEEK’S PLAY: Buy the SPRWA January 17.50 Calls (O:SPWRA 11A17.50) at market, good for the week. Place a protective stop limit at $1.90 and implement our scaled-selling technique as your position achieves gains of 50% (and greater).

Dear Bottarelli Research Member,

Thanks to federal debt and poor planning, Warren Buffett’s longtime Berkshire Hathaway business partner, Charlie Munger, just wrote a new editorial column for Slate.com. In the article, Munger says that the U.S. economic empire is crumbling right before our eyes – which he attributes to Wall Street’s reckless love affair with gambling. Not only that, but as you’ll see below, comments this week from Fed Chairman Ben Bernanke and FDIC Chairwoman Shelia Bair have each supported Munger’s thesis. But amazingly, Wall Street continues to shrug off these growing threats.

We’ll start with Federal Reserve Board Chairman Ben Bernanke, who told lawmakers on Wednesday that the U.S. economic recovery is not yet on a sustainable path. Therefore, he said that near-zero interest rates are still needed. Said Bernanke, “as the impetus provided by the inventory cycle is temporary, and as the fiscal support for economic growth likely will diminish later this year, a sustained recovery will depend on continued growth in private-sector final demand for goods and services.”

Let me translate that for you…

In non-Fed speak, Bernanke is basically saying, “when the Fed and the Treasury stop pumping money into the system, I’m not sure what’ll happen.” Therefore, the Fed has chosen to keep rates near zero simply because they have no clue how strong the recovery will be without their external stimulants.

Given this situation, we’re once again presented with a unique play opportunity. Specifically, we’ll revisit our LEAPS alert from January 25^th titled, “Playing A China Hoax.” Then, I’ll give you an early look at next week’s LEAPS pick, which gets you positioned for a bottom in one of the world’s top solar companies. Due to upcoming travel plans, I will be out of the office on Thursday and Friday of next week. Therefore, I’ll offer you an advanced look at next week’s LEAPS play today. As you’ll see, negative news has absolutely hammered the entire solar sector, offering you an attractive price unlike anything you’ve ever seen before. So on that note, let’s begin!

If you recall our January 25^th LEAPS alert, then you know we discussed a man named Jim Chanos. As a quick refresher, Chanos is a billionaire American investor and president of Kynikos Associates, a New York City investment company focused on short selling.

Chanos’ philosophy is simple…

He finds an overvalued stock, and then commits a large amount of money to a short-position, which he is willing to hold for a long period of time.

Chanos’ claim to fame came when he uncovered the Enron fraud in 2002, and made himself millions betting on its collapse. For example, during the time Chanos was short Enron, shares fell from $90.00 in August of 2000 to a low of $1.00 in January of 2001.

This background is relevant because Jim Chanos is now betting on the collapse of Chinese stocks.

By closely examining the economic growth numbers that China is reporting, Chanos believes that the Chinese miracle growth story “is getting harder and harder to believe.” As a result, he feels that the coming collapse of China could be just as bad for the global market as the U.S. housing crash.

According to Chanos, China is now experiencing over-capacity in nearly every economic sector. But instead of admitting their slowdown, China is “saving face” by covering up their slowdown by reporting faulty statistics. For example, to support car sales growth, state-run companies are buying huge numbers of cars and simply putting them into storage. This explains a recent up-tick in Chinese car sales and a recent down-tick in Chinese gasoline consumption. Something doesn’t add up.

On the same hand, the Chinese government is also cooking their economic numbers to show 8% growth in gross domestic product. But in reality, China can’t keep growing while the rest of the world is suffering a crippling financial crisis. So, to cover this up, China’s government is buying up durable goods (such washers, dryers, TVs, and so forth) and stuffing them in empty warehouses. When the truth about these faulty statistics becomes exposed, Chinese stocks will suffer. This sets up a very lucrative opportunity to get positioned in a little-known asset called the UltraShort FTSE/Xinhua China25 Proshares (FXP – NYSE).

The FXP is a special asset that moves at a rate of twice the inverse of the FTSE/Xinhua China 25 index. In other words, if the top 25 companies in China fall 3%, the FXI gains 6%. This double-leveraged position, combined with the power of options, offers you the very best way to play a Chinese hangover. It’s the cheapest yet most lucrative way to play a continued Chinese sell-off.

If you recall, we originally entered the FXP September 9 Calls on January 25^th for $2.00, and quickly sold them for $2.60, good for a 30.00% gainer. As I write, these calls have once again dipped below our original $2.00 entry price. Currently trading between $1.60 and $1.80 per contract, it’s time to play this same game once again. Get positioned now!

PLAY: Buy the FXP September 9 Calls (O:FXP 10I9.00) at market, good for the week. Place a protective stop limit at $0.50 and implement our scaled-selling technique as your position achieves gains of 50% (and greater).

ADVANCE LOOK AT NEXT WEEK’S LEAPS PICK: Next up, I’m going to offer you an early look at the LEAPS pick for next week, which is a “bottom-feeding” opportunity in shares of SunPower Corporation (SPWRA – NASDAQ).

Spun off from Cypress Semiconductor on September 22^nd 2008, SunPower manufactures and sells solar cells, solar panels, and inverters – all of which convert sunlight to electricity. With residential and commercial customers in Germany, Italy, Portugal, South Korea, Spain, and the United States, SunPower is truly one of the top solar companies in the entire world.

SunPower also offers power system technologies, which includes development, engineering, construction management, monitoring, and maintenance services for their commercial, governmental, and utility clients.

Now, when it comes to the solar stocks, the latest news has absolutely hammer-jacked the entire sector. For example, this past Tuesday, First Solar (FSLR – NASDAQ) posted a 48% revenue jump to $641.3 million, which was higher-than-expected, but shares fell 6% as their outlook disappointed and profit margins narrowed.

This was certainly a negative for the solar group. But the real sector-wide weakness came when Germany planned to cut their solar subsidies. This is significant because Germany is the world’s largest market for renewable solar power. With fears that demand from the world’s largest market for renewable power could drop notably lower, analysts have hit solar stocks with a slew of downgrades (most recently from Barclays on February 22^nd). This has put a storm cloud over the entire solar sector. But despite all this negativity, there have been some very recent signs that indicate that the sun is coming out once again.

You see, it now appears that the German subsidy cuts, which originally triggered the selling pressure, may not be as large as previously expected. German Chancellor Angela Merkel drafted plans to cut subsidies for solar parks by -15%, which is less than the -25% that was originally proposed in January. That’s why the intense selling pressure might have gotten over-done. In fact, if you look at SPRWA’s valuation ratios, you’ll see that the weakness has now made the shares quite attractive.

SPWRA’s income statement shows revenues of $1.38 billion, which amounts to $15.64 in revenue per share. Considering the fact that SPWRA shares now trade for $18.64, that’s a great value. Not only that, but their balance sheet shows $472 million in cash, which gives them a book value per share of $13.97. Combine their revenue per share and their book value per share, and adding longer-dated calls at these depressed levels looks like a smart play. If we witness any sort of recovery between now and January of 2011, owning these calls will handsomely pay off. As I mentioned, this will be the featured pick in next week’s LEAPS alert. But considering the timing of this position, I wanted to give you the play now so that you can get positioned before we witness any strong bounce.

PLAY: Buy the SPRWA January 17.50 Calls (O:SPWRA 11A17.50) at market, good for the week. Place a protective stop limit at $1.90 and implement our scaled-selling technique as your position achieves gains of 50% (and greater).

UPDATES

UUP June 23 Calls (O:UUP 10F23.00): Renewed fears of a sovereign downgrade in Greece once again pushed investors into the U.S. dollar. While it’s not the prettiest currency out there, it’s certainly “a lot less ugly” than the alternatives. If the 50-day moving average can hold as a support level, the upside is just beginning. Hold.

CCJ September 28 Calls (O:CCJ 10I28.00) & BG July 60 Calls (O:BG 10G60.00): While the commodity sector remains volatile, both CCJ and BG are holding onto their strong support levels. Hold.

MTB April 70 Puts (O:MTB 10P70.00) & SRS July 9 Calls (O:SRS 10G9.00): Given this week’s news, I’m still not sure who is buying shares of real estate companies or banks with high exposure to commercial real estate (like M&T Bank). Check out the latest statistics, and you’ll see what I mean…

• According to the National Association of Realtors, they don’t expect any meaningful recovery in commercial real estate before 2011.
• According to First American CoreLogic, 24% of all residential properties with mortgages (which amounts to 11.3 million homes) were “underwater” at the end of 2009. By “underwater,” I mean the homes are now worth less than the value of their mortgages. That’s up from 10.7 million properties at the end of Q3 2009 and 8.3 million properties at the end of 2008. Not only that, but 2.3 million additional properties are approaching negative equity, which means the difference between the value of the loan and the value of the property is less than 5%. In Nevada, a shocking 70% of home mortgages are underwater. In Arizona, the number is 51%, followed by Florida at 48%, Michigan at 39%, and California at 35%.
• According to the Federal Deposit Insurance Corporation (FDIC), the number of distressed banks in the U.S. rose to 702 in the fourth quarter, which marks the highest level in 16 years. This means that 10% of FDIC-insured banks are now on the “troubled” list. Considering increasing losses in commercial real estate, analysts expect even more failures throughout 2010. FDIC Chairwoman Sheila Bair said, “This year, the losses are going to be heavily driven by commercial real estate, we’ve known for some time and we have been projecting that. The pace is probably going to pick up this year and for the total year it will exceed where we were last year.” In response to these comments, a congressional watchdog group reported that a wave of commercial real estate loan failures could threaten the U.S. financial system. As a worst-case scenario, hundreds of additional community- and mid-sized banks could face insolvency.

When you consider all of this news (which has just surfaced within the past week!), I cannot fathom how anyone can invest in assets exposed to these tremendous threats. But as you can see below, shares of MTB have once again moved up to their 200-day moving average. I continue to feel like this is a strong level of resistance. Therefore, let’s use this pop to our advantage, and add to our April puts now!

PLAY: Buy more MTB April 70 Puts (O:MTB 10P70.00) at market, good for the day.

TIF May 40 Puts (O:TIF 10Q40.00): I admit, I’m a little surprised with TIF’s recent strength. But a quick look at the chart indicates that it could be forming a head-and-shoulders pattern. Let’s see if this formation can play out. Hold.

EEV June 13 Calls (O:EEV 10F13.00): If China sneezes (as indicated in the above commentary) then emerging markets around the world will quickly catch pneumonia. Plus, ballooning deficits, salary freezes, and troubled banks continue so spark worries in any nation with financial troubles. It sure looks like a good idea to remain protected. Hold.

GDXJ August 21 Calls (O:GDXJ 10H21.00): On Thursday, Newmont Mining reported a truly blockbuster earnings report. The Denver mining giant earned $558 million ($1.13 per share) compared with $4 million ($0.01 per share) during the same period last year. This blew away the $0.79 per share estimate by analysts at Thomson Reuters. Revenues for the three months ended December 31^st increased 90% to $2.52 billion, which also handedly beat Wall Street’s estimate of $2.02 billion. This could mark the beginning of the next upward push in the gold sector. I fully expect the junior miners to follow NEM’s lead and report equally powerful earnings. Hold.

TM July 75 Puts (TM 10S75.00): Responding to a “crisis of confidence,” Akio Toyoda took the hot seat in Washington on Wednesday and testified before Congress. As expected, he took full responsibility for the massive recall. Bottom-feeders tried to push TM shares up, but this won’t last long. I still expect shares to tap $60.00. Hold.

AXP July 38 Puts (AXP 10S38.00): From a chart perspective, the 200-day moving average continues to act as a resistance level. Hold.

GME July 20 Puts (O:GME 10S20.00): On Thursday morning, shares of video-game retailer GameStop (GME – NYSE) got clobbered on the shock news of CFO Catherine Smith’s unexpected resignation. This sudden news means that GME has lost two CFOs in the last six months. Obviously, this does not sit well with investors. After all, the chief financial officer is typically the first person to truly recognize that a firm is in bad shape. In the case of GME, they now have two CFOs who have come to the same troubling conclusion. As a result, GME shares fell 8% on Thursday, which helped us to sell half of our puts for a 55% return. With our bearish thesis coming true, maintain the second half of your position for more gains. Sold half, hold remainder.

BBH July 105 Calls (O: BBH 10G105.00): From a weekly perspective, the upside trend remains in play. Hold.

SQM April 40 Calls (O:SQM 10D40.00) & DBA January 2011 25 Calls (O:DBA 11A25.00): Continued volatility in the commodity sector is forcing us to remain patient with these two positions. But sooner or later, the pendulum will swing back our way. Hold.

TBT June 49 Calls (O:TBT 10F49.00): Comments from the Fed continue to keep the Treasury bubble inflated. How long can it last before inflation comes calling with a sharp pin? Hold.

Sincerely,