Investment Guidance

A Great Time for the Contrarian: Put Oil, Natural Gas & Silver on Your Radar Screens

The recent stock market selloff was due to the U.S. Federal Reserve saying that the domestic economy faces some serious challenges over the next year. The central bank didn’t take much in the way of new policy action, because there isn’t much left their toolbox. Interest rates can’t go much lower; therefore, the economy is on its own.

I pretty much have the expectation that the U.S. economy is likely to produce little to no growth in gross domestic product (GDP) in the next two quarters. Investors, who already sold stocks after reducing their expectations for the future, have now had to do the same thing again.

Given the earnings picture, I still view the stock market as very fairly valued at this time. Commodities (precious metals in particular) are now experiencing a well-deserved price correction and this makes for an opportune time to be considering new positions in resources.

One of the few industry sectors to be generating any material growth in revenue and earnings is resource-related, and now is a great time for contrarians to step up to the plate.

It’s really quite amazing for the spot price of oil to be trading below $80.00 a barrel. The spot price of oil continues to be the barometer for financial markets and speculators are betting that the global economy will be in a greater rut than previously expected. But with this reality, a lot of growing oil and gas companies are cheaply valued…and I think investors can be buying right now. I also like the longer-run prospects for silver, which hasn’t traded commensurately with gold.

Investor sentiment is likely to improve when third-quarter earnings season begins. The financials usually report early on, so there could be a shaky start. One of the things that non-resource corporations are doing is sitting on their cash. Big companies are acting just like stock market investors—they’re afraid to make new investments, because the outlook is so uncertain.

All in all, it’s a tough time to be an investor in anything. Investment risk is very high for everything but cash. One of the big issues that has to be addressed before corporations and investors feel confident about making new investments is the sovereign debt issue in Europe. Financial markets need to see a concrete plan to get out of the current mess and a timetable for the execution of such a strategy. Only with certainty will all the money sitting on the sidelines be put to work.

At this time, a lot of well-managed, large-cap companies are seeing their share prices now well off their highs. It happened very fast. Yields have gone up and the opportunities for long-term investors are getting much more attractive. We’re in a wait-and-see market, with little expectation for capital gains.

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The stock market sold off last Thursday. Even gold could not avoid the collapse, as the October gold futures plummeted to $1,700. We have the debt crisis in Europe, with Greece facing a default situation unless its austerity program is accepted by lenders. Moody’s downgraded eight Greek banks after several Italian banks were also downgraded.

Watch the S&P 500 as it nears a critical support level of 1,125 and the four-week low at 1,114. A break could send the index down to below 1,100.

Small-caps are getting hammered, with the Russell 2000 down over 26% from its high and now technically in a bear market.

Watch over the next few days to see if oversold buying emerges.

There is nowhere to hide. Even gold and metal plays are being dumped despite gold being a safe-haven play. Investors are clearly dumping everything.

This could be an opportunity to buy on weakness; but, without a firm base, there could be additional downside moves.

Watching your asset value decline is not great, but you can minimize the effect.

I continue to recommend using put options or buying short-based exchange-traded funds (ETFs) to offset the weakness. It’s easy and cost-effective as a defensive hedge.

Don’t be put off by options. They are a great risk-management tool that is more than often overlooked by the retail investor or trader, but used often by the pro traders and institutions. The SPY index option that tracks the S&P 500 is a top trader on the CBOE.

You can buy puts for stocks and sectors.

Take a look at your holdings and break them down according to the sector, whether they’re technology, industrial, small-cap, large-cap, etc.

The second step is to take a look at the various indices that closely reflect your holdings.

If you are heavily weighted in technology, you can buy put options on the PowerShares ETFs (NASDAQ/QQQ), a heavily traded ETF in technology.

Or let’s say you have benefited from the run-up in gold and silver to record historical highs, a strategy may be to buy put options on the Philadelphia Gold & Silver Sector (NASDAQ/XAU), which tracks 16 major gold stocks and silver stocks.

To play the near-term downside weakness in small-caps, you could buy the ETF ProShares UltraShort Russell 2000 (NYSE/TWM).

Alternatively, if you hold a large position in several stocks, you can buy put options on these individual stocks and help protect against a major downside move.

Be careful and remember that maintaining your capital will allow you to trade longer-term.

With the upside limited at this point, you may also want to write some covered call options to generate premium income and reduce the average cost base of your positions. But be careful, as an oversold rebound could take out your position at the call strike price. Make sure you are comfortable with the upper strike price of your covered call. Make sure it’s above the key resistance of the stock.

By George Leong, B.Comm.

The fact that consumer spending has not tanked in spite of unemployment being at over nine percent and expected to stay around this level through 2012, and continued weakness in housing is encouraging.

When consumers are cautious, they tend to hold back on any major purchases, such as homes, vehicles, furniture, appliances, and travel, to list a few. This will impact spending and gross domestic product (GDP) growth and the ability of companies to expand their businesses and hire. This is my concern, and I feel that continued nervousness among consumers will impact GDP.

Consumer Confidence in August was another disappointment, with a dismal reading of 44.5, the lowest reading since March 2009. The reading was well below the estimate of 52.0 and the revised 59.2 in July.

To give you an idea of how bad the readings are, economists feel that a reading of 90 indicates a healthy economy, something that has not happened since December 2007 when the recession began. It looks like it will be some time until the confidence reading heads back towards the pre-recession readings of 90. In my economic analysis, the situation is not good.

The impact of lower confidence has been felt in spending.

The headline Retail Sales reading for August showed no growth, below the consensus estimate of 0.2% and the downward revised 0.3% in July. Excluding the auto portion, Retail Sales increased a mere 0.1%, again short of the consensus estimate of 0.3% and the downward revised 0.3% in July.

At this juncture, I’m selective with retail stocks. My investment advice, my best stock advice, to you would be to stick with the leading discount bellwether retail stocks. We are also seeing buying in higher-end goods, such as Tiffany & Co. (NYSE/TIF).

In the large-cap area, the top stocks include Wal-Mart Stores, Inc. (NYSE/WMT), Target Corporation (NYSE/TGT), and Costco Wholesale Corporation (NASDAQ/COST).

On the smaller end, I’ve previously highlighted small-cap PriceSmart, Inc. (NASDAQ/PSMT), an operator of 28 warehouse clubs in 11 countries in Central America and the Caribbean. PSMT has been on a tear on the chart, advancing over 155% over the past 52-weeks versus a mere 7.51% for the S&P 500. The stock is now pricey. The profits have been made in the stock.

An interesting discounter is large-cap Dollar General Corporation (NYSE/DG), which operated a staggering 9,300 stores across 35 states. Dollar has reasonable valuation trading at 14.27X its FY13 earnings per share and a price/earnings to growth ratio of 0.97. Dollar General has above-average longer-term price appreciation potential for investors.

My favorites in the retail space continue to be the discounters and big-box stores. The big-box stores are now selling a broad range of electronics and are adding to their product line. This will offer consumers a one-stop place for shopping and make more money for these companies. Just take a look at the impact on Best Buy Co., Inc. (NYSE/BBY) from the discounters aggressively moving into the electronics area. Even supermarkets are selling TVs now. Best Buy may need to redefine itself.