Stock Market Correction

Stock Market Correction: Wading into Gold
by Justice Litle
The Rude Awakening
Wall Street, New York
Thursday, April 13, 2006

Justice Litle discusses the possible consequences of a US Stock Market Correction.

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Wading into Gold
By Justice Litle

If a stock market correction is coming soon in the U.S.,
one Outstanding Investments subscriber recently inquired,
will foreign stocks also suffer badly? And how will the
stocks of natural resource companies fare?

I cannot know the unknowable, of course. But I can hazard a
couple of guesses and offer a couple of suggestions.

First off: I too believe there is a correction coming — and
potentially much more than a correction. While nothing is
guaranteed, we could be lining up for a 1987-style market
crash, with all that entails (though a crash is not
guaranteed, either). If we see such an event, I doubt
foreign stocks will be spared in the short term.

Here and now, the bulls are practically baying at the moon.
Everything seems to be going up and up (except government
inflation numbers). Bears have gotten trampled. There is
talk of global slowdown, but the reality hasn't taken hold
just yet. Copper, otherwise known as "Dr. Copper" or "the
metal with a Ph.D. in economics," is rolling along at
historic highs. Steel stocks, sensitive to industrial
demand, are carving out new highs too. Liquidity channelers
like Goldman Sachs are at the absolute peak of their
earnings cycle — making more in the most recent quarter
than in the entire 2002.

Stock Market Correction: Protectionism Rising

Ominous signs are also building: Protectionist sentiment is
on the rise, even more so in Europe than in the United
States. The housing bubble hasn't popped, but it is clearly
hissing. The consumer-spending gas gauge is moving closer
to "E," even before adjustable-rate mortgages begin
adjusting much higher. Long bonds are breaking down. The
Middle East situation is fraying badly at the edges (and
Middle Eastern stock markets have already crashed, by the
way). Emerging markets in general look vulnerable.

The bulls are still in control, but the bears aren't
vanquished yet: At some point, the credit-driven liquidity
boom has to end, and it will likely end badly. Still, it
could be six days, six weeks or six months before things
come apart at the seams. Our markets could be even higher
at that point — much higher. And who knows how energy and
metals will respond to stepped-up global turmoil? Depending
on the circumstances, it could help as much as hurt, even
with the walls falling down all around.

So what do we do in these turbulent times?

First, work from a long-term thesis. Second, work out a
plan and stick to it.

Stock Market Correction: All Roads Lead to Inflation

The thesis regarding precious metals — which we have
reiterated many times over the past year — can be summed up
in one phrase: All roads lead to inflation. If the
government continues to fudge the statistics and run the
printing presses, gold and silver will continue to rise in
secular bull market fashion. Alternatively, if liquidity
dries up and a deflationary spiral sets in, the Fed will
eventually be forced to "inflate or die," pulling out all
the stops to avoid a Great Depression scenario.

The thesis regarding energy and infrastructure is a bit
more complex, but still fairly simple. Between the
ramifications of Peak Oil and the long-term implications of
developing world growth, we are in the early stages of an
energy bull market that could last another 5–15 years or
more. Furthermore, we have barely begun to address the
world's 21st-century infrastructure needs. There are many
years' worth of work to be done.

So if one is mostly on the sidelines, better to jump in now
or wait?

The problem with waiting is you don't know how far things
will go before the big downdraft comes. It might be a long
way off yet. And it might be smaller than you expect when
it comes. No two ways about it, the ride is going to be
wild at times. So don't plunge in all at once. I suggest
putting cash to work a little bit at a time.

The investor's key trait is patience, defined by some as
"the art of waiting without tiring of waiting." This
includes waiting out the pains of corrections, resisting
the urge to cut and run when the chips are down. A good
investor can handle a sharp setback, because he or she is
focused on long-term objectives.

The trader's key trait, on the other hand, is flexibility.
If you want to use tight stops and take profits on run-ups,
that's excellent — as long as you are willing to monitor
things closely, make consistent decisions and re-establish
positions at the appropriate time. The trader has more
active responsibility than the investor, and willingly
embraces that responsibility.

It is not a question of which mentality is better, but
rather which mentality better suits you personally.

Many portfolio managers scale into their long-term
holdings, rather than loading up the boat at once. They
also prefer buying into short-term weakness, if possible.
For investors as well as traders, options can be an
effective tool for mitigating short-to-intermediate-term
downside risk.

Stock Market Correction: Hedging Tools

Because options pack so much leverage into a small space,
they are excellent hedging vehicles — one of the things
they were designed for. For example, an outlay of 1–3% of
portfolio equity in something like XLE or OIH puts could
help offset the downside risk of a much larger basket of
oil stock positions. But there are no easy fixes when it
comes to portfolio mechanics, and no one can make the hard
decisions of how much to buy and sell except you. That is
why you rarely hear this stuff talked about in newsletters
or the financial press.

Already this year, most oil and metals stocks have
subjected investors to gut-wrenching volatility. Expect
more of the same. The energy and metals markets are likely
to get even wilder, making a solid plan that much more
critical. I expect the bull market in gold, silver, oil and
most other natural resources to last another five to
fifteen years, but I also expect harrowing price drops
along the way.

In other words, think of the resource stock sector as
shallow pool: "No Diving or Jumping." Wade into the water
slowly and enjoy the refreshing long-term gains.

[Joel's Note: Trading and investing in commodities can be
hugely rewarding – if executed with vigilance and prudence.
You may remember a couple of days back we brought you an
article by Justice Litle's Outstanding Investment's
partner, Kevin Kerr. With a solid grasp on these two
virtues, and an uncanny knack for predicting market moves,
Kevin has recently squirreled away astounding profits on
both silver and gold. Without giving away exact details, I
can say that the silver gains were flirting with the 400%
mark.

Given his incredibly keen sense for cashing in on
commodities, I issued an investment alert to Rude readers
on Tuesday afternoon. You can check it out below but, as I
said in the original alert, you will have to be nimble.
Constant talk of capping Kevin's service means that I can't
guarantee you a position will be open for too long.

The next alert is on the way. If you want to get in on it
and join the winner's circle, I suggest you read on right
here:

Let the Profiteering Begin!
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