Monday, March 15, 2010

DBC -- Our Top Pick for The General Liquidity Challenge

Early this morning I introduced a new blog feature called The General Liquidity Challenge. To briefly recap, the Challenge is pick one of the ETFs in the General Liquidity Index as a long or short trade when the GLI's SSO Histogram gives a buy or sell signal for the entire index.

As mentioned in the introductory post, the histogram gave us a sell signal on Friday, so I chose DBC, the commodity index ETF, as our short trade for the Challenge.

I said we were going to use this morning's opening price as our entry point for DBC. Well, the fund opened the day at $23.38, 14¢ below Friday's close of 23.52. DBC closed the day at 23.24, so our short position was up .6% from our entry price in the model portfolio. (And I emphasize that the Challenge is a model portfolio, I didn't actually place the trade in a real account.)

Had I declared the entry point at Friday's close then the gain for the day would have been 1.2% instead of just .6%, but I am using the using the next open price as entry point for the challenge to make it as realistic as possible.

I picked DBC as the short this time because to me it looks like commodities have the highest probability of dropping over the next week or three. Not that I am very bullish on most of the other markets either, but looking at the charts of all the markets, I see commodities as in a more middle of the road position than most of the other markets, and the commodity indexes have been trying to roll over for a couple weeks now. (I mentioned this briefly about a week ago. click here.)

There will necessarily be other ETFs in the GLI that out-perform DBC to the downside, if only because one or more of the more narrowly focused commodity ETFs in the index will have to out-do a broad basket like DBC. Or a broader panic could develop in the near-term and some of the higher-beta stock ETFs could start to dive much faster than the commodities.

All kinds of possiblities, but since I'm kinda ho-hum about the markets right now and don't have any crazy visions confronting me, I am playing down out-lying possiblities and basing this trade primary on a probability.

My view of commodities has changed little since the indexes first shot up about 10 months ago. My view at the time was that the price advances would prove to be just a counter-trend rally within a much larger bear market in (most) commodities that began in 2008. I still think that, it is just that prices stayed elevated much longer than I initially anticipated.

But I think I am actually more bearish on commodities now than I was 10 months ago. The very fact that prices have remained elevated for so long is going to make the next downturn a real doozy. Sustained overpricing has led to a whole new round of overproduction. Add this new supply overhang to the structural distortions of the commodities bubble that are not even remotely resolved and the renewed bear-market that confronts the sector should make you shudder.

But, the question, as usual, is one of timing. Is the crash directly in front of us or another six months or even a year away? Beat's me, actually. That's why I like the idea of trading on the GLI histogram signals.

The next Trend & Value Letter will feature price analysis of some of the major commodities. I am going to start working on it tonight, but it might not be done for a couple days.