A happy and prosperous New Year to all our dear readers and fans – may 2015 mark for you and your loved ones a year of feasts and plenty, health and happiness, and remember, too, at this time next week we’ll review our midyear predictions and award one all-expenses-paid, one-way ticket for two to Atlantis, courtesy Malaysia Airlines.
Try this, then…
Before we dig into the meat of this 1st letter of the New Year, we’re going to conduct a very simple poll, and we urge one and all to participate.
It consists of one question, and it goes like this –
Six months from now, do you expect the Dow to be
higher or lower than it is now?
We’ll tally the numbers to determine just how optimistic you are as a group, and then report back to you on, say, the 4th of July to see how you did.
Feel free to add a word or two on why you feel the way you do – e.g., “Higher, the Fed” or “Higher, economic expansion” or “Lower, Obamacare” or “Lower, Republicans/Democrats”, etc.
Just please keep it brief.
And now we hit the bid.
We’re going to start today’s letter with the curious and the bizarre, two qualities that – unbeknownst to most – regularly lead to ginormous profits.
Consider the following –
The price of oil has been in a freefall for the better part of six months. Over that time it has lost half its value.
In light of that, one would expect those companies involved in the oil trade to also be experiencing losses – and indeed they have, though not to the same degree as the commodity itself.
Nothing weird and wacky yet.
Where things get strange is in the recent action of the drillers and marketers, whose collective behavior against oil’s ongoing decline has been… that’s right, to climb steeply!
No joke. Take a look at the chart below that matches just the last three months trade of the United States Oil Fund (NYSE:USO) against the Select Sector SPDR Energy ETF (NYSE:XLE).
So what is this!?
As the chart shows, the connection between the two issues broke in mid-October and the two have increasingly drifted apart ever since.
And we’re left wondering whether the drillers still have to pay the piper, or crude is set to bounce? Who’s the leader and who the laggard? Who, in other words (besides McAbby), is the PROPHET!?
We say it doesn’t matter who’s what here, though we certainly have our opinion (that the oil companies lead the commodity). Why? Because either way, we can win by matching the two in a pairs trade.
By betting that the gap between the two will close meaningfully sometime in the next quarter (it generally doesn’t take the market more than three months to catch on to oddities like this).
If we had our druthers (and your money), we’d buy three month CALLs on USO and sell the same number on XLE. We’d also search the tables with a magnifying glass to find offsetting prices, so the trade costs us next to nothing when we launch.
From the Shocking to the Miraculous
We move now to a pairing that we stumbled across after choking on our Wendy’s Triple Baconator this morning.
We couldn’t believe it. There, side by side on the Wall Street Journal’s classroom edition, were long term charts of Facebook (NASDAQ:FB) and the Market Vectors Gold Miner ETF (NYSE:GDX), screaming at us to trade, trade, trade.
But how, we asked the greasy mess before us. How to trade it? After all, we’re only human. We’re not made from three 100% fresh, never frozen North American beef, 1/4 lb. patties topped with fresh-cooked Applewood Smoked Bacon in between a premium warm, toasted bun, like you.
The answer was not long in coming.
Look here –
This is Facebook’s full history charted against the Miners. And what does it show? That FB is the anti-gold!
What the hell has come over you, McAbby?
Say what you will. I’ve been through a Solemn Exorcism – you haven’t. And I ain’t going back.
Now its just money.
The trade that emerges from the chart is to be long short-term FB CALLs and to pay for them with short-term GDX CALLs.
Close the trade at the first sign of FB popping higher.
And many happy returns!
Matt McAbby, Senior Analyst, Normandy Research