Speaking Volumes

Chipotle has been hot - and that is no reference to the sauce - the stock (CMG) has been on fire. Over the last year the stock has increased 62% (from 241 to 390).

But if you are the least bit "technically" inclined, you've probably mastered a simple concept of what it means when volumes expand or contract. Simply, expanding volumes favor the existing trend, and contracting volumes are signs of a reversal. The latter condition is playing out in remarkable fashion.

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As February 2012 ends - here are some volume statistics on Chipotle (CMG):

Since 3/1/2011 (1 year) the daily volume has averaged 829,000 shares
The first half of February 2012, as the stock rose from 367 to 378, daily volume averaged 600,000
The second half of February 2012, the stock rose from 378 to 390, daily volume averaged 400,000; with the last five days of the month all being less than 400,000 shares.

The above graph is the Golden-125 charted for Price and Volume. The Golden-125 employs eight moving averages that have 28 relationships with each other. As the shorter term averages exceed the longer term averages it calculates a progressive point system; longer averages garner more points than shorter averages. The point system results in a score from zero to 125. Zero means every shorter moving average is less than every average of longer duration. Conversely, 125 points means that every shorter moving average exceeds the longer moving averages.

It is clear that in December 2008 that the dropping prices ended when volumes hit zero. Everyone had rushed to the exits, and there were no more sellers to be found. Now the contrasting condition is in effect; the buyers are "in". Volumes are drying up, predicting a price reversal.

The last such sell-off is evidenced on 11/11/2011. Volume hit zero with the CMG price at 332. Two weeks later on 11/25/2011, with volumes spiking, the price dropped 10% to 301.

Watch for heavy volumes starting to occur on down days. Get your bets placed if this makes sense to you; I have established a long put on the January 2013 options with a strike price of 375.

Junior has been misbehaving

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All measurements are set as an index = 43.80 at 12/31/2004 (GLD price)

When investing in gold, one has several options. Everything from collectible coins, bullion, stocks, and ETF's are on the menu.

I track, and own, three dinstinct categories.

GLD is an ETF that holds gold bullion. For me, it is the best way to own gold without having to figure out how to handle and store it. It also tracks well to the price of gold. There are a few indices that track gold stocks; I prefer the GOX index. It is comprised of the major gold producers, like Newmont and Barrick. The Juniors - the explorers and developers - are the most difficult to track, so I made my own index. I use 10 junior stocks, then advance an index based on the median price change each month. My results mirror everything I have read lately, in that junior gold miners are lagging.

I started my comparison at the end of 2004 when gold was in the $430 range. Since then staying as close to bullion has been the best way to go; a CAGR of 21.6%. Major gold producers have been challenged by high energy costs, political risk and their own price hedging stumbles. Despite those drags, one would think the price of the base commodity could not be any more favorable and these majors should be well leveraged to the price of gold. If your costs are $700 per ounce and gold travels from $1200 to $1400 - it's not just a 17% (2/12) gain for them - it is a 40% gain to the bottom line ($700, versus $500).

The juniors, who are very important for the major producers to expand their finite capacity, just have not delivered. One of the most frustrating aspects to owning the juniors is the way their management always hypes their opportunities and never acknowledges risks until they experience them. The management all speak effortlessly in terms of probable reserves, but usually contradict themselves when they project their long term cash needs - as they continually issue more shares to advance exploration and production. Those "probables" always seem to undeliver in the present, but always look so good in the future. Meanwhile machinery failure, environmentalists, nationalists, you name it, detracts from current results.

Despite their lagging performance, juniors are returning an average 6.2% over the six-plus years I have tracked them. That compares very favorably to the 1.8% CAGR on the Dow Jones in that same time frame.

Some of the underperformance can be laid at the feet of the majors. Eventually these giants will buy the juniors to expand capacity - but they always wait until they get expensive before they start buying. It is as if they don't like a bargain. Most likely they just move in herds and only start buying when inflation in the price points to the fact that if they don't buy now, it's going to cost them more in the near term future.

The juniors are the only group here that have not come back to their pre-credit-crisis high. For that reason alone, I like them here - I just try not to listen to their management.

It's a Horse Race

Here is the 12-year battle between the DJIA 1982 bull and the Jim Rogers Commodity Index of 1999. The DJIA was at 4,000 in February 1995 which is the equivalent time on the DOW to June 2011 on the Commodity Bull.

A Quick Statistical Analysis

Today the market was up and the VIX was down - a normal occurance. The VIX, a measure of market volatility, is typically inversely correlated to market direction. Periods of high volatility occur in declining markets - markets don't melt-up.

Today was the fifth day in a row, or every day this week, that the market increased. The DOW ended last week at 11955 and finished today at 12583. Conversely, the VIX fell each day this week, ending last week at 21.10 and closing today at 15.87.

While observing this toward the end of close, with the VIX at 15.39, I was inclined to buy some call options on the VIX. But having a rule that I don't invest in options unless I can calculate an edge, I pulled up my spreadsheet on closing VIX prices since 1990 to do some statistical analysis.

With a check of the option tables, I saw that I could buy a November 17 option for $5.20.

That means that sometime between now and November, the VIX must hit 22.20 for me to break even on that option. There are 94 trading days remaining until the November 15, 2011 expiry date.

I took my spreadsheet of daily closing prices and wrote the formula, where "B" is the column of prices:

=max(b2..b94)/ b1 -1

For every price point I looked forward across the range of 93 days-forward and found an average expected maximum price. Over 20-plus years that figure averages 42.8%.

Using my current price of 15.39, that resulted in a max price of 21.98. That would make the November 17 option worth 4.98 intrinsically - so paying $5.20 looked like a bad tradeoff.

However, since I'm buying the option for the reason that the VIX has fallen five successive days, I put that logic in the spreadsheet; only calculating the max value if the price had fallen five consecutive days. Interestingly, there were 70 times that occured in 20 years.

The result was 48.0%. That increased my max price expected from 21.98 to 22.77. That made the option's intrinsic value go from 4.98 to 5.77. Now a $5.20 entry price is looking at a 10% return; more if you consider that if it happens before expiry date, there will still be some time premium in the price of the option.

And with that analysis, I clicked a few keys in my Optionsxpress account and became the owner of 10 contracts.

There was still another hour left in the trading day, so I was anxious that my price may not be favorable. Recall that all my analysis was done on closing prices and I extended the price at 2:41 p.m. when it was 15.39. I was then lucky to have the VIX strengthen to 15.87 at the close. That means my analysis of 48% increase on closing price after 5 days of decline now calculated to 23.35, or an intrinsic option value of $6.35.

All of this analysis, with spreadsheets ready-to-go, takes less than 15 minutes. But it gives a nice documentated case as to why one should or should not take a position.

Yield on the 10-Year Treasury

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The graph above is the 10-Year U.S. Treasury Bond Yield from 1965 to 2000.

On the left Y-axis is the percent-change of the current yield from the 144-week moving average of the yield. It is a technical measure that I watch closely.

The right Y-axis is the yield. It clearly shows that interest rates are exceedingly low with a perspective of a 45-year history.

Fundamentals

The easy-money environment that has existed since the 1980's has changed in one basic regard; the money from the Federal Reserve to Banks is still easy while money from the banks to business and consumers is anything but easy. However while individuals and small business are learning to live within their means - the U.S. Government and Investment Banks are on a spending spree. Banks are demonstrating they can make money as long as it starts as risk-free money (no, or little cost). The Government cannot stand the thought of assets, like homes, reaching fair market value, so stimulus money is a favorite means to prime the money pump into the general economy.

Ultimately, the long-date Treasuries are the means which cash flow runs through the Goevernment. If buyers line-up and bid these securities prices up, then the rates remain low. Once buyers demand a higher return, sensing risk on these securities, then the ask price stumbles until buyers can be encouraged to find their risk-reward tradeoff.

Technical

For the last twenty years the yield has been dropping with the yield in a boundary of +/- 20% of its long-term moving average. The downside has taken a few trips below -20%, but the upside has been regularly capped at +20%.

With this latest bounce off lows, again, the yield is coming from near -20% - however this time I believe the boundary will be violated on the upside. I foresee several run-ups in yield (generated by a buyer's strike on Treasuries) with a quick ride to 4,5 and then 6+ percent yields.

Profiting directly from yields (drop in price) is not easy. It is possible to short Treasuries. ETF's like IEF, TLT and TLH are easier to short. TNX is the symbol for yield, and it has traded options - but they seem to always be pricey, with an unattractive bid-ask spread.

As treasuries become cheap - hard assets will become expensive. The indirect way to profit is to own commodities like gold and silver.

A contrary opinion to rates rising is another credit-related crisis with massive deflation ensuing. While possible, rejection of the expensive U.S. Treasury seems more likely at this point.

The Second Half of the Commodity Bull

This is a frequent post topic, but it is intended to correlate with the importance of the topic.

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Here, once again, is the comparison of the current Commodity Bull with the last great Equity Bull, measured by the Dow Jones Industrial Average (DJIA). Jim Rogers started an index to track Commodity prices starting in July 1998. His call about that being the next great bull market has been "right on". The two indices start on this graph the last time they were at 1,000 but did not retrace below that mark. That occured in March 1999 on the Commodity Index and November 1982 on the DJIA.

The "X axis" is shown in current Commodity Index dates with the DJIA occuring 16 years and 3 months earlier. The end points are March 2010 for the Commodity Index and November 1993 for the DJIA. It's important to recognize that November 1993 is one year into Clinton's first term and one year past the 1992 recession that caused Bush I to lose the election. Currently we sit about one year past the great Credit Crisis of 2008-2009. Regardless of the economic recovery path in the U.S., the Commodity Index is much more likely to be influenced by continuing development of the emerging economies of China, India and Brazil.

The November 1993 DJIA sits at 3,700 with a quick trip to 10,000 in store during the next six years. It is very conceivable that the Commodity Index will not fall behind this pace, and may even exceed that pace. At the current end points the DJIA has compounded at 12.6% from its origin, while the Commodity Index is running at a rate of return of 11.2%.

The one important difference is the volatility one will experience by being a Commodity investor. Note the difference in the 1987 crash on the DJIA and the 2009 Credit Crisis impact on the Commodity Index (and they are scaled correctly on this log-graph).

Here is another look at annual returns, plotted every month on a rolling basis for the Commodity Index. It is the right place to be, but not for the faint of heart investor.

Annual returns can regularly exceed 40%, but correspondingly, the falls can be equally as breathtaking.

Relative Value - on which side of the equation?

Gold and Oil have a long-term relationship. It is marked by volatility, but it lives within a range. Gold's per-ounce price runs from a 10 to 30 mulitple of Oil's per-barrell price.

This chart from IncredibleCharts.com shows the thirty-plus year history of the gold-to-oil ratio.

As this chart ends in 2005, the next chart uses the ETF's for each commodity.

Since the gold ETF, GLD, has a 1:10 ratio to the per-ounce price, that makes the relevant range of 10:30 reduced to 1:3.

That's exactly what the range has traveled in a New-York-minute. While almost all commodities have fallen like a stone, gold has held up.

Commodities have been giving an indication of deflation during the financial crisis unwinding of massive leverage. Common sense tells a different story, seeing the Fed and US Government ready to move trillions in place to prevent a financial collapse. Caught in-between is the once weak dollar which rallied in the face of the unwinding. Now as the dollar is weakening again, that leaves the question whether gold will resume its role as a hedge to the dollar and inflation.

Regardless, the gold-to-oil ratio is historically high. Will oil or gold be the stronger relative mover to shrink the ratio. Not knowing the answer, I think buying GLL, the ultrashort gold ETF, and long USO is the best combination.

Commodities - Shocked Back to Reality

The graph shows the 1982 Dow Jones Index (blue) and the 1999 Rogers Raw Materials Index (orange).

Jim Rogers identified the impending bull market shift from equities to commodities back in 1998. He set up his own index beginning then, set to 1,000.

The indices are plotted along the current time line of the Rogers Index. The Dow Jones index is 16 years and 3 months behind the Current Time Line. The October 2008 Rogers Index aligns with June 1992 on the Dow Jones Index.

The Rogers Index fell from 5,718 to 3,138 from June 2008 to October 2008. In June 2008 the Rogers Index was advancing at a Compounded Annual Growth Rate (CAGR) of 20.5%. The dramatic 45% sell-off reduced the CAGR to 12.5%. The Dow Jones Index had a CAGR of 15.3% from 1982-2000.

So while the Commodity sell-off was dramatic enough to erase three years of gains, it is still not far off the two-decade return that equities produced. Commodities are known for volatility - and the second-half of their bull market should have some more twists and turns in the road.

Today's Market Falls in Line

Looking at this post back in July, the May 2007 to May 2008 projection was a very good outlook.

http://marketrhymes.blogspot.com/2007/07/caught-speeding.html

The post looked at the decade of returns following a record setting decade. The mother of all decades was the May 1988 to May 1998 period, cruising at a Compounded Annual Growth Rate (CAGR) of 16.7%. The post compared the three prior record-setting decades and subsequent decade returns. They all showed a dramatic drop off at the end of the subsequent decade.

Using the 1968-1969 returns, the last year of the subsequent decade returns, I placed a projected DOW to predict how the last year of the current subsequent decade would look. Placing this morning's low in the current week, one can see that the projection has been a great guidepost.


One can only conclude from this point some sideways consolidation and then a nice burst back to 13,000+; only to find a spring sell-off waiting after that rebound.

Steak n Shake - Situational Analysis

Recently I was accumulating Gander Mountain (GMTN), a retail play that caters to the outdoorsmen. This was violating the "invest in what you know" rule, since I'm an avid indoorsman. Somehow I was ahead a few dollars on GMTN, and when a weekend edition of the Economist had an article on how the number of hunters are rapidly declining in the U.S., I had sell tickets entered that next Monday morning.

Realizing that I was lucky, rather than good, I made a conscious decision to get back to familiar ground. I have a Yahoo portfolio of twenty-five restaurant stocks that I like to keep an eye on. No sooner had I scanned the news headlines when I saw the name of Sadar Biglari next to an old favorite stock of mine, Steak n Shake (SNS).

I had owned Steak n Shake soon after they brought Peter Dunn aboard as CEO in 2003. He had good credentials as a large company food executive and he immediately put together a multi-point operational plan to address SNS shortcomings. Some of the points of attack were:

* Get consistent products at each of the stores (there were stories of the curly fries being made differently at many of the sites)

* Reduce employee turnover, which was exceedingly high

* Develop bench strength at the store management level to prepare for the next round of expansion

* Keep innovating new menu selections to drive traffic (the new product when I visited Indiana in 2004 was side-by-side shakes, featuring two flavors of ice cream sitting side by side)

The company performance and stock price started improving very nicely. I think I bought around $9 and took profits around $14, missing some of the double that occurred in 2004 from the 2003 prices.

I made another round trip in equity in 2005, but I basically broke even when my motivation for selling came on the news of weak same-store-sales.

Meanwhile I had invested in the northeast low-end restaurant chain, Friendlys. First, I bought their bonds at $.60 on the dollar and when I started seeing some gains on that position, I hedged by shorting the stock. Then along came Sadar Biglari. Someone I never heard of until he filed a 13D (disclosing a position of greater than 5% ownership). He killed my short and made me a bunch of money on my bonds. Biglari was a young gun who made his name by taking a position in Western Sizzler restaurants and pitching a campaign that the board room had fallen asleep allowing the company to underperform for too long. He fought for board seats (2) and basically won the war he waged which included billboards to state his case. He is now the CEO.

Some of his investment firepower comes from a hedge fund that he runs, and he now has the cash flow of Western Sizzler to direct, much like a Buffett or Lampert. Biglari is smaller scale; but the guy is barely 30 years old. It seems he made his initial wad by starting an ISP while still in college.

He used many of the same tactics from Sizzler's experience at Friendlys, though he never won his way on the board. He did remain active as the company reviewed its options and he ultimately agreed with the company's steps to be taken out by private equity.

He now had two notches in his gun belt, and when I saw a filing of a 13D for his position in SNS, I was quick to get on board. I didn't even realize that Dunn was gone as I took my new position. True to his pattern, billboards are up around Indianapolis (SNS headquarters) and letters are being written demanding seats on the board.

My shares purchased on November 6 @ $13.69 were not treated kindly and soon were under $11. At the beginning of December it was announced that Biglari upped his ownership to just under 10%, or 2.7 million shares, of SNS. I wanted to buy more but the weakness of the stock froze me into a "wait and see" mode. I remained that way for the entire month and only over the New Year's Holiday did I look at the internet for some new information on SNS.
The new information came in the form of a Motley Fool interview: http://www.fool.com/investing/general/2007/12/27/a-special-situation-at-steak-n-shake.aspx

Here a value fund manager gives Biglari credit for being a catalyst for him to purchase SNS stock. Read the link and make your own assessment and read my summarization of the key points that I take away:

Opportunities: Company-owned assets could recapitalize SNS by selling franchises; Biglari has the board in the "review options and take action" mode. Biglari is two-for-two in extracting a value-premium from a restaurant stock. Lower-end dining may be the last segment impacted from the stretched consumer pocketbook.

Risks: Steak n Shake has always been at an awkward price point with higher prices than fast food, but the quality of the food is inconsistent with wait-staffed dining. Management can't explain their poor same-store results. This is not where a health-conscious consumer eats; this risk is mitigated by the chain's 400 stores being in the Midwest and Southeast where obesity is the highest in the country. Food inflation likely to get worse, with an unknown capacity for passing cost increases through prices.

Finally, it is interesting to note that Biglari's 2.7 million share ownership is less than the short-interest in the stock by about 1 million shares - establishing an interesting tug-of-war on the future stock price.

I'm surprised that the December 27 Motley Fool article did not generate any additional volume or price action to the stock. That may be a statement to the Fool's declining influence on investing, but never-the-less tread careful with this situation.