by Michael Shulman 04/24/08
There's a black cloud over the commodities market and, hiding behind that black cloud, is a rainbow with a pot of gold at the end for those of us who are situated on the short side of the market. (That is, we're buying put options and profiting when stocks are going down.)
I know, I know: Wheat is up 600% a bushel. Oil touched an inflation-adjusted, all-time high and seems like it's setting up residence above $100 a barrel. Gold is on a straight tear up. I can hear you now: "There's no way to play the short side of the commodities sector, Shulman."
ALL MAY BE WELL … EVENTUALLY
Longer term, there's every reason to believe that commodity prices will be high and perhaps go even higher. You might have heard a lot about growing infrastructure and demand in areas like "Chindia" (i.e., China and India) and other developing nations.
With this boom will come increased need for food products, building materials and energy sources. As these areas become more industrial, it is only natural that more jobs will be generated, thus leading to a rising standard of living. Thus, even more commodity consumption.
OK, so that's the big-picture outlook. But with a slowing economy in the U.S. and its carryover into the global community, not to mention the fact that the big-money players (i.e., institutions, hedge funds) are piling into commodities and inflating the prices with their speculative buying, what does it mean for us in the short term and, more specifically, on the short side?
BUBBLE, BUBBLE, TOIL AND TROUBLE?
Just like the economy seems to be taking a rest, commodities are likely going to pull back before they can keep going up, up and away. The bubble is building. In some commodities, there's a classic parabolic bubble, which is a short-side investor's dream.
Perhaps gold can run to $1,600, as "Mad" man Jim Cramer thinks -- but will wheat stay at $25? Will a fertilizer and feed producer, which is on my "short" list of companies that are going to get hit when the commodities bubble starts letting out air, manage to stay in the stratosphere? Will platinum keep shooting skyward?
What the smart short-side investors do is to identify the commodities that are driven by economic reality -- with the exception of gold -- and look for places to establish short-side plays for the commodities or companies taking a free ride with the run-up in prices. There are plenty, but there are also some rules to follow:
- Rule 1: Don't get ahead of it. It's better to miss the beginning than get run over by being too early.
- Rule 2: Focus on those commodities most tied to economic reality.
- Rule 3: Avoid commodities that are potentially driven by geopolitical events.
- Rule 4: See rule No. 1.
So, how do you profit while commodities are poised for a pullback? There are two main areas I'm investigating right now.
The first is agricultural commodities. There ain't no way wheat is staying at $25 (up from four bucks last year) or a company we're riding in my ChangeWave Shorts service is going to remain at $160 (up from $60 just one year ago!).
There are several Exchange-Traded Funds (ETFs) and several overbought companies in this sector, so I am looking at them carefully right now. I also have a close eye on precious metals other than gold -- namely, platinum and silver. This segment can also be played by a mixture of ETFs and individual companies.
But for every opportunity, there is a sinkhole, and I can tell you where I will not be looking.
Sinkhole 1: Gold. Avoid playing the short side of gold at all costs. It is tied to the U.S. dollar and geopolitical issues -- and just possibly to the people who built bomb shelters in the '60s and their offspring who created hideaways in preparation for Y2K.
Sinkhole 2: Oil. The fundamentals (which serve as our road map in my ChangeWave Shorts service) show that oil prices will rise, because they are also tied to the dollar and geopolitical events. Stay far, far away.
Remember, you can play the short-side of individual stocks, sectors and, soon, commodities. So, anything like gold and oil that tied to the U.S. dollar -- and other factors beyond the segment that can change on a dime and decimate a play -- will be kept away from my "short" list.
What is a Short Stock or Option Position?
Did you know there are several ways you can go short? Well, if you didn't you're not alone. I'll help you count the ways to go short.
Do you think a stock is about to go up? You can buy call options or sell put options, as both indicate that you're making a bullish bet. But how you get from Point A to B is quite different.
Live Well, Thanks to Dying Companies
If you don't want to buy a company's products or services, you shouldn't buy its stocks.
What to Know When Making a Short Trade
Do you know what the trading issues are when shorting a stock? Don't get blindsided with shorting.
Going long, buying puts, selling shorts -- all of these can be confusing at first. But there's hope!
