Month: February 2013

By The Sizemore Letter

Question: How do you know ahead of time when a garden-variety correction is about to turn into a bear market rout?

Answer:  You don’t.

I would love to tell you that there is a tried and true way to make that distinction ahead of time, but there isn’t.  At best, you can look at past scenarios that were similar and handicap the odds to the best of your ability.

With that said, look at the recent performance of the iShares MSCI Spain ETF (NYSE:$EWP). The Spain ETF is down nearly 10% from its January highs and is in negative territory for the year.  Given the bad press coming out of Spain these days (a corruption scandal is threatening to tank to government that implemented the reforms that appeased the bond market last year), it is understandable if you fear that Spanish stocks are in the early stages of another bear market tumble.

iShares MSCI Spain (NYSE:EWP)

But if this is the case, then the six-month rally in EWP would be one of the shortest on record.  When the Spanish market rallies, it rallies hard.

More importantly, Spanish stocks are cheap at barely 11 times earnings, and sentiment towards them remains horrid.  With European Central Bank President Mario Draghi suggesting this week that the euro is priced too high (implying that further monetary easing may be in the cards), my bet is that Spanish stocks are simply taking a short break before taking the next leg up.

Action to take: Buy EWP at market.  Use a 10% stop loss.

Disclosures: Sizemore Capital is long EWP. This post first appeared on TraderPlanet.

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The post When Spanish Stocks Rally, They Rally Hard appeared first on Sizemore Insights.

The Canadian dollar extends its weakness before the US dollar today after sliding below parity last Friday. The unexpected drop in employment in January added to concern that the world’s 11th-largest economy is slowing.

The Loonie dove off to beneath parity as Statistics Canada reported employment fell in January for the first time in six months. The drop by 21,900 jobs, following December’s revised gain of 39,800, weighed on risk demand as economists just estimated a weaker gain of 4,500 jobs for the period. Though the unemployment rate decreased to 7.0 percent from 7.1 percent, this was just enough to stagger the downward spiral of the Loonie’s price valuation. The jobless rate, which happens to be the lowest since December 2008’s 6.8 percent, was a result of fewer people looking for work.

Looking back at last Friday’s statement from Matthew Perrier, director of foreign exchange at the Bank of Montreal, the Loonie has indeed waned. “If we see a little giveback of the strong employment gains of the last two months, we’ll probably see Canada [dollar] weaken off” says Perrier.

Moreover, Canada had its ninth straight monthly trade deficit, while housing starts fell to the lowest since the end of the 2009 recession. Manufacturing sales fell in December, data this week is anticipated to show. Oil, Canada’s biggest export, fell for the first time in nine weeks, and investors erased bets that interest rates could rise this year.

“The sentiment for the Canadian economy has been shifting, and something like the jobs data sends a signal that we’re in more of a precarious situation today than we thought,” says Aaron Fennell, a futures specialist at Bank of Nova Scotia’s ScotiaMcLeod in Toronto.

The Loonie could well be in for more wanes in the ensuing exchanges, suggesting a buy position for the USDCAD. It would be wise to look out for probable technical corrections on the currency pair’s movement, as the price index indicates that the pair is already overbought.

For more news, analysis, technical charts and candlestick analysis, visit AlgosysFx Forex Trading Solutions.

London Gold Market Report
from Ben Traynor
BullionVault
Monday 11 February 2013, 06:45 EST

U.S. DOLLAR gold prices fell to a one-week low Monday morning in London, dropping to $1660 per ounce, as dealers in Asia reported quiet trading, with China celebrating the Lunar New Year holiday.

“We are neutral [on gold] until the current consolidation resolves itself,” says the latest technical analysis report from bullion bank Scotia Mocatta.

Silver fell to $31.27 an ounce – its lowest level in nearly two weeks – while stocks were broadly flat and commodities edged lower as the Dollar strengthened.

Over in India, traditionally the world’s biggest source of private gold demand, “not many deals are happening as the Rupee depreciated on opening and gold is holding steady,” one dealer in Mumbai told newswire Reuters this morning.

“I don’t think there are many other influences in the market, certainly in the Asian market anyway, beyond currencies right now,” says Nick Trevethan, Singapore-based senior metals strategist at ANZ.

“I think it’s very much going to be the case of watching the Dollar Index.”

The US Dollar Index, which measures the Dollar’s strength against a basket of other currencies, rose to a one-month high this morning, while the Euro hovered near two-week lows.

Since the start of February, the Euro has fallen more than 2%, though it remains 2.9% up on its low from the first week of January. Major stock markets are also up on the year so far, with the S&P 500 up more than 6%.

“Gold’s correlation with the Euro-Dollar has been hovering close to zero recently, a stark contrast to the stable, strongly positive relationship experienced for most of last year,” says a note from UBS.

“The relationship between gold and equities has similarly eased…this suggests that gold’s safe-haven properties are currently considered more dominant, and as such gold is considerably lagging the move in equities as its defensive characteristics become redundant in a more optimistic view of the world.”

European Central Bank Executive Board member Joerg Asmussen has rejected calls from France for a Euro exchange rate target.

“The core of the problem lies inside the country and not in the foreign exchange rate,” Asmussen told German newspaper Handelsblatt over the weekend.

“I am glad that the French government has made increasing competitiveness into its central topic.”

Elsewhere in Europe, uninsured depositors in Cyprus could be forced to take losses along with holders of the country’s sovereign debt as part of a proposed rescue package, the Financial Times reports.

The FT cites a confidential memorandum prepared ahead of today’s meeting of Eurozone finance ministers, who have set themselves a deadline of next month to agree a rescue plan for Cyprus.

Under the plan, which does not currently have any official backing, Cyprus’s bailout would be reduced from €16.7 billion to €5.5 billion by imposing losses on bond holders and foreign depositors.

Earlier this month, several German politicians expressed concern at the idea of bailing out Cyprus without introducing more effective anti-money laundering controls.

Over in Greece, the government cut tax receipts and public investments last month in response to falling tax revenues in order to meet budget targets, Athens announced Monday.

Russia meantime has added more gold to its official reserves than any other nation over the past ten years, according to International Monetary Fund data cited by news agency Bloomberg this morning.

The Swiss France remains overvalued against the Euro, Swiss National Bank governing board member Fritz Zurbruegg says in an interview published by the Aargauer Zeitung Monday.

The SNB has pegged the exchange rate at SFr1.20 per Euro since September 2011, promising to print currency in whatever quantity needed to maintain the peg.

“[The peg] remains the appropriate instrument for achieving price stability in Switzerland for the foreseeable future,” says Zurbruegg.

“If necessary we are ready to take further steps.”

The so-called speculative net long position of Comex gold futures and options traders rose in the week ended last Tuesday, having hit its lowest reported level for six months the previous week, data published Friday by the Commodity Futures Trading Commission show.

The spec net long measures the number of bullish minus bearish contracts held by traders classified as noncommercial, such as hedge funds.

Ben Traynor
BullionVault

Gold value calculator   |   Buy gold online at live prices

Editor of Gold News, the analysis and investment research site from world-leading gold ownership service BullionVault, Ben Traynor was formerly editor of the Fleet Street Letter, the UK’s longest-running investment letter. A Cambridge economics graduate, he is a professional writer and editor with a specialist interest in monetary economics. Ben can be found on Google+

(c) BullionVault 2013

Please Note: This article is to inform your thinking, not lead it. Only you can decide the best place for your money, and any decision you make will put your money at risk. Information or data included here may have already been overtaken by events – and must be verified elsewhere – should you choose to act on it.

By www.CentralBankNews.info Here’s today’s Central Bank News link list, click through if you missed the previous link list. The list comprises news about central banks that is not covered by Central Bank News. The list is updated during the day with the latest developments so readers don’t miss any important news.

By MoneyMorning.com.au

If you had to guess which country has stacked the most gold in its central bank in the last ten years – who would you pick?

Would it be India, the world’s biggest importer of gold?

Or maybe China, the biggest force in the modern gold market?

Nice try, but you’d be wrong with either guess.

The unexpected winner has accumulated a formidable stash – and just in time for the huge coming move in gold…

The answer is in fact, Russia.

For the last ten years, Russia has been busily converting its oil revenue into gold. According to the IMF (International Monetary Fund), the Russian central bank has now stacked 570 tonnes of gold in its basement. This has seen the total jump by 147% in a decade, from just 388 tonnes, to 958 tonnes.

To put that in context, the world’s biggest national government stash is the US holding of 8,134 tonnes.

So the Russians may have had a busy decade but they still have a way to go. Still – Russia is hot on the heels of China’s official holdings, which had 1,054 tonnes at last count. I say ‘last count’ because it’s coming up to four years since China updated the market. So they almost certainly have far more than 1,054 tonnes by now.

You only need to look at how much gold is pouring into China. Chinese gold imports from Hong Kong have soared in recent years from just a few tonnes a month in early 2011, to the interstellar pace of 114 tonnes in December of 2012.

This finished off a huge 2012 for Chinese gold imports, with a total of 834 tonnes going from Hong Kong to China – almost twice the figure for 2011.

Some of it will have gone to the central bank, but a large portion will go to the Chinese public. And as the Chinese get wealthier, they buy more gold.

The same is also true for India. The two countries buy around 40% of the annual (mined and recycled) gold supply between them, so it’s no surprise that as China and India have seen strong economic growth, the gold price has moved up in line with them.

So the recent bounce in Chinese economic growth is one reason to be more bullish on gold. I think this is one of a few key factors behind the market getting much more positive recently, after a very slow 18 months for gold.

For Diggers & Drillers readers, I’ve already tipped the five best gold stocks on the market to leverage the coming move in gold.

The institutional research on gold is really getting going now. For example, ANZ Research just called gold one of its top four hard commodity picks for 2013. They suggest buying gold as ‘dollar weakness and strong demand create [a] positive atmosphere’. In case you’re wondering, their other three picks are copper, palladium and brent crude oil.

We’ve also heard from JPMorgan calling for gold to surge very soon and for it to hit $1,800 by June. The reasons are that the Middle East is becoming more unstable, and that production is crashing in key supplier South Africa due to the country’s unstable mining industry.

But there’s one much bigger reason to buy gold now, which I’ll tell you about in a moment.

First I’ll show you why I think the timing for Aussie investors to buy gold looks particularly good.

When buying in Australia you need to factor in the Australian dollar. Thankfully it looks like the Aussie is finally on its way down, which would give the Aussie gold price a lift. This five year gold chart shows the Aussie gold price making its way up in fits and starts.

Aussie Dollar Gold – Buy on the Dips…Like Now

You can see that the best time to buy gold is when the Aussie gold price has dipped below the 200-day moving average (red line). And the good news for you is that we’re pretty much in one of those dips right now.

Take another look at the chart above. If you could have timed your gold purchases over the last five years, don’t you wish you’d bought during the periods I’ve circled in green? Well if you buy gold soon, you should be able to do exactly that.

For my money, the main reason to buy gold and gold stocks, sooner rather than later, is the imminent effect of the Fed’s new pace of asset purchases. It is now buying $85 billion a month via QE3+4, and this has had an electrifying effect in the past. The current program now includes $45 billion in Treasuries, which should add some kick.

This chart below illustrates this beautifully. Over the last twelve years, as the Fed expanded its balance sheet (red line), both with QE programs and other asset purchases, the gold price (green line) has tracked it very closely. As the Fed trashed the dollar, the value of gold has become relatively higher.

Quantitative Easing Sends Gold Higher Like Clockwork

The important point here is that the blue line shows what will happen to the Fed’s balance sheet this year as it purchases another $85 billion in assets each month. You can see it started turning up a few months ago, but the gold price has yet to catch on yet.

If the relationship holds as firmly as it has in the past, then gold should start tracking up very soon indeed.

This would make now a good time to buy gold. It would also make now a very good time to buy gold stocks, but that is a story for tomorrow’s Money Morning…

Dr Alex Cowie
Editor, Diggers & Drillers
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From the Port Phillip Publishing Library

Special Report: How to Hunt Down 2013′s Biggest Stock Market Winners

Daily Reckoning: It’s All Fake

Money Morning: The U-Shaped Portfolio

Pursuit of Happiness: Exchange Traded Options: A Way to Boost Your Retirement Income

Diggers and Drillers:
Five Reasons Why Gold Stocks Are Set to Rebound

By MoneyMorning.com.au

It’s amazing that no one is talking about this.

‘China’s demand is robust’ they’ll say. ‘China may overtake India as the top gold consumer’ they’ll add. ‘Exports rise year over year’ the chatter continues.

But no one, and I mean no one, in the mainstream is calling a spade a spade. China is hoarding gold at a rate never seen before – like modern day conquistadors. Only today, unlike in the time of the conquistadors, the blood trail is tough to follow, as are the shipfuls of gold.

It’s an egregious rake, though. And while the mainstream media fails to cover this huge story, we’ll do our best to figure out just how much gold China is holding…

It all Comes Down to a Little Chinese Maths

Remember, the last ‘official’ announcement detailing China’s gold holdings was in 2009 – ringing in a total of 1,054 tonnes. Compared to their previous official holding, announced six years prior, the new total represented a dramatic 75% increase in Chinese gold holdings.

Much time has passed since the latest official announcement – and China’s gold holdings have surely risen higher. Indeed, a year ago, when we touched base on this topic, we ascertained that China was likely holding 3,300 tonnes of gold – that’s about three times the current ‘official’ holdings.

Flash forward to today and the strategic Middle Kingdom is surely holding even more gold.

Just take a look at their import patterns over the last 12 months…

As you can see, imports via Hong Kong have been off the charts lately. Indeed, last year set a record for imports to mainland china.

But that’s only part of the story. This morning I took the time to add up all the imports along with production stats to give us a clear idea of just how much gold China is holding behind the curtain.

Starting at the time of China’s last official announcement, we’d need to add another 2,873 tonnes to China’s ‘official’ holdings, just to account for imports and domestic production alone. That would put China’s current ‘known’ holdings at 3,927 – well above Germany as the second largest gold holding nation in the world.

And do you think Germany’s ears are starting to burn? You betcha! Why do you think we saw that news earlier this year that Germany is auditing its gold holdings and repatriating some of its gold held out of country? It’s all about the Chinese math!

But here’s the kicker.

When you start adding up the stealthy, hard-to-track sources of gold – black market gold from Africa and South America (and maybe Iran) exports, global gold mining from semi-national Chinese firms or buyouts, and the idea that China is urging their own citizens to hoard gold – you’ll notice that China’s gold hoard is closer to 7,000 tonnes, or more!

Take a look:

By my calculations China could be sitting on more than 7,000 tonnes of gold, today. A lot of which comes from ‘stealthy’ acquisitions that the mainstream won’t dare talk about: stealthy exporting, potential nationalization of the citizens gold, and gold transfers from mining buyouts, just to name a few.

Think of it this way. Right now the U.S. is tightening sanctions on Iranian oil exports.

There’s a huge thrust by the U.S. to curb monetary flows into Iran – so the U.S. has more than a few eggheads figuring this out, too. But even with all of the press coverage and government collaboration, do you really think Iranian oil exports are grinding to a halt?

I don’t. Sure the ‘official’ exports are heading lower – but on the back end of that there is a massive amount of Iranian oil hitting the market.

China’s Hungry for Gold

Now let’s switch back to our discussion on China. There aren’t any sanctions on China’s gold imports, nor do we have any government agencies or global-collaborations attempting to stop China’s gold moves.

That said, if Iran can export oil when we don’t want them to, just imagine what kind of show China is putting on behind the scenes without a peep from the U.S. government! The amount of under-the-radar gold coming from Africa and South America has the potential to be enormous.

Frankly, name any country in Africa – with gold in the ground – and I bet you there are Chinese nationals on the ground digging or, at minimum, setting the ground work for black-market trade agreements.

On that end, you could fit enough bullion into a dingy to shift the global market for gold. But I’ll be the first to tell you the Chinese aren’t showing up to Africa’s gold-holding nations in a dingy – instead, they’re stopping by with cargo ships. Lots of em.

Ha, and here’s another little anecdote for you…

A few years back I sold my old car. In the process I had a lot of ‘colorful’ characters show up at my house. They’d try to lowball me or pose a ‘trade’ for my car (man, the kind of people that you find on the internet these days!) But when it was all said and done I ended up selling my beat-up, 13-year old car to the highest bidder. He was happy to pay for it, too.

After we did some paperwork I asked him if it was for him or his family, he casually said ‘nope’.

‘I’ll be shipping this car via cargo ship to Africa, there’s a huge market for old cars there and this is one of the top selling models’ he said. Forget selling the old car to a high-schooler, my car was headed overseas!

What’s this got to do with the whole China gold debate?

Well, believe it or not the developing world in Africa wants to keep developing. Whether they get old cars from the U.S. or cheap goods from China they are willing to pay good money (or good gold) for imports.

And China is at no lack for tradable merchandise – just check your local dollar store.

I’m shaking my head as I type right now. Just imagine a cargo ship filled with what’s essentially five, dollar stores-worth of merchandise – plastic soccer balls, wanna-be Barbie dolls, cheap tool sets, you name it.

When that ship shows up on the shores of an emerging African nation and empties its cargo (to the happy locals), there’s NO WAY that boat is going back to China empty. More and more I bet it’s filled up with local resources that China craves – one of which is surely GOLD.

Ignore China’s Poker Face

So you see, China is getting far more gold than it’s leading on – I bet there are thousands of tonnes that are unaccounted for. Heck, officially China says it hasn’t added an ounce of gold to its holdings for almost four years! That’s laughable. And it’s also profitable to those that see the writing on the wall.

So add it all up. China is the world’s leading gold producer and also the world’s leading gold importer. And surprisingly their official gold holdings haven’t risen an ounce in over three years.

It’s like the annoying guy at the poker table that hides his casino chips in his lap, waiting to pounce. But unlike a game of poker, the stakes are much higher in the global currency market.

Better start studying your Chinese math. After all, how much gold you have?

Matt Insley
Contributing Writer, Money Morning

From the Archives…

Two Questions to Ask Before You Buy Another Stock
8-02-2013 – Kris Sayce

Are These 5 Blue-Chip Stocks Still a Good Buy?
7-02-2013 – Kris Sayce

Don’t be Long and Wrong on this Stock Market Rally
6-02-2013 – Kris Sayce

Perceptions of Beauty and Stock Valuations
5-02-2013 – Satyajit Das

This Share Market Rally Has Angered Some Investors
4-02-2013 – Kris Sayce

GBPUSD broke above the upper line of the price channel on 4-hour chart, suggesting that lengthier consolidation of the downtrend from 1.6339 is underway. Range trading between 1.5630 and 1.5900 would likely be seen in a couple of days. Key resistance is at 1.5900, as long as this level holds, the downtrend could be expected to resume, and another fall to 1.5500 area is still possible. However, a break above 1.5900 resistance will indicate that the downward movement from 1.6339 had completed at 1.5630 already, then the following upward move could bring price back to 1.6500 zone.

Forex Signals

Re-emergent house flippers are set to flop.

By Elliott Wave International

In 2005, a mania for residential real estate reached such a fever pitch that a series of cable television shows became entirely devoted to house “flipping.”

Flipping involves buying a worse-for-wear house, making the minimum repairs necessary, then turning right around and selling it – ideally for a fast and handsome profit.

Two years before the housing bust became painfully obvious to U.S. homeowners, EWI’s publications warned subscribers that the housing market had reached extremes and was about to bust.

There’s no mistaking it now: Extreme psychology … has taken up residence in real estate. …

A significant percentage of the population does not know that a return to earth is implicit in [real estate’s] pole-vault to record heights.

The Elliott Wave Financial Forecast, July 2005

That issue published around the time the S&P Supercomposite Homebuilding Index peaked.

The index bottomed in late 2008. Since then, the index moved sideways into late 2011 and in 2012 staged a modest rebound. Take a look at this chart from the November Financial Forecast (wave labels removed):

The outburst of over-the-top enthusiasm for home buying turned out to be a great sell signal. The Homebuilding Index lost more than 85% over the next 40 months. The rise from its November 2008 low appears to be a … countertrend rally. … Near-term excitement has definitely risen.

Financial Forecast, November 2012

As you might expect, the rebound is accompanied by a rise in expectations for a real estate recovery.

The head of the world’s largest asset management firm sees more than just higher home prices ahead; he sees a return to 2005 levels.

As the inventory of unsold U.S. homes drops to a more manageable level, the U.S. housing industry is inching closer to a complete rebound, [said] BlackRock CEO.

CNBC, Oct. 4

By looking at the chart, you can see how much farther prices have to climb before achieving a “complete rebound.”

What’s more, home flippers have returned.

Property Flippers Are Back as Housing’s Middle Men

Yahoo Finance, Oct. 15

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By Warren Seah

A stop loss order will automatically close a trade at a set level in order to prevent further losses. If a buy order has been placed, then the stop level is set at a price that is lower than the buying price. On the other hand, if a sell order was triggered, then the stop will be placed above the selling price.

A general rule is that the exit strategy must coordinate with a trader’s entries and his overall trading system. For trending system, it is required that the trader set a bigger stop loss level which allows more room for the trade to breathe. If it is a contrarian system or breakout system, a small stop loss should be set so that trade will exit immediately if it is a bad trade. Thereby, traders’ loss will be limited in such forex trading system.

There are a variety of stops that one can incorporate into a system.

1. Initial Stop This is the first stop set at the beginning of the trade. This stop is identified prior to entering the market. It is used to calculate the position size of the position at which to trade and this is also the largest loss a trader will take in the current trade.

2. Trailing Stop Develops as the market moves. This stop enables the trader to lock in profit as the market moves in the favor. Trailing stop ensures that the stop loss follows the price movements closely as the trend develops. This is to prevent any sudden market movements from taking out profits should the trend starts to reverse.

3. Two Bar Trailing Stop This is used in a trend if the market seems to be losing momentum and a reversal is anticipated.

4. Moving Average Trailing Stop Moving average indicator is most common used for trailing stop loss.

5. Average True Range Trailing Stop Also called ATR indicator. This indicator is mostly used by turtle traders or trend following traders to determine market volatility and place their stop loss away from volatitily and protecting their profits at the same time.

6. Parabolic SAR Trailing Stop Another indicator widely used for placing your stop loss.

6. Channel Trailing Stop Also a commonly used trailing stop technique for turtle traders or trend following traders.

Is Your Stop Loss Selection Based on Market Dynamics?

It means that have you taken in to account market conditions that will tell you how much room you need to give the trade to breathe so that your trade will not be exited due to market noises and repeatedly stop out? There is no perfect stop loss strategy but the most ideal stop loss strategy has to be discovered and worked out by the trader via back testing and forward testing.

About the Author

Warren Seah

Forex Trailer is a fully independent software EA which manages traders’ positions in the foreign exchange market. Forex Trailer ensures they are closely monitored to close for optimum profits. It works by managing the trader’s stop loss level or take profit levels and thereby locking in profits for the trader.

Download Your Stop Loss EA Now

By The Sizemore Letter

In the opening lines of What’s Behind the Numbers?, co-authors John Del Vecchio and Tom Jacobs offer to “help you find where the investing bodies are buried so you don’t join them.”  These are appropriate words to begin a book on the detective work of finding financial chicanery.

Numbers covers the art of short selling—a lonely endeavor that requires thick skin.  By definition, you aim to win when others lose. This means that when you’re right, you’re hated; and when you’re wrong, you are shown no sympathy.    In Del Veccio and Jacobs’ words, short selling is considered “un-American at best and criminally manipulative at worst.”

Moreover, shorting stocks requires taking an unsentimental approach to investing and—perhaps most importantly—keeping the ego in check.   Very few investors have the disposition to be successful short sellers;  John Del Vecchio is one of them.

Del Vecchio is the co-manager of the Active Bear ETF (NYSE:$HDGE) and the creator of the Del Vecchio Earnings Quality Index that drives the Forensic Accounting ETF (NYSE:$FLAG).  Tom Jacobs is the portfolio manager of Motley Fool Special Ops and a specialist in small-cap value opportunities.  In Numbers, Del Vecchio and Jacobs reveal some of the tricks of their trade and expose some of the myths that tend to get novice short sellers in trouble.

To start, overvaluation is not a sufficient reason to initiate a short position.  A stock that is irrationally expensive can always get more expensive.  Likewise, while it is tempting to short a fad stock—think of Crocs (Nasdaq:$CROX), the maker of colorful rubber clog shoes—fad stocks can stay trendy for longer than you think.  The same is true of questionable business models—think Netflix (Nasdaq:$NFLX).

And what about the stocks of companies engaging in fraud?  Well, maybe.  But good luck finding them ahead of time.  Remember, if management is engaged in something illegal, they’re not likely to mention it in the footnotes of their financial statements.

What is missing in each of these cases is the catalyst.  What is the sign that the jig is up—and that the stock is due for a tumble?

Some traders rely on contrarian indicators, gauges of investor sentiment towards a stock, or simply the feeling in their gut.  But Del Vecchio and Jacobs take a more rigorous approach.

The key is aggressive accounting and specifically aggressive revenue recognition and inventory management:  “The time to sell or short is not when you think a business model can’t survive.  The time is when the numbers suggest that management is covering up poor performance.”

And how might you know when this is the case?  Del Vecchio and Jacobs spend most of the book telling you, but I’ll give two examples that I found to be particularly insightful.

The first is a metric called Days Sales Outstanding (DSO), which measures accounts receivable in proportion to sales.   An unusual increase in DSO can mean that future sales and being pulled forward by looser payment terms or special financing.

This hurts future profitability in two ways.  The most obvious is that sales that might have happened in the following quarter have now already happened.  But  worse, those sales might have come with more favorable pricing had the company not been in such a hurry to book revenues.  In order to keep Wall Street happy for another quarter, management makes the eventual day of reckoning worse.

A second, similar metric is Days Sales in Inventory (DSI), which measures inventory build-up.  You don’t need to be a CPA to see why this metric is important.  Inventory build-up suggests that the company’s products are not selling as briskly as forecast.  It also means that discounts will probably be needed move the merchandise, which will lower profit margins.

All inventory is not equal, of course.  A build-up of raw materials inventory may mean that demand is stronger than ever.  It is the build-up of finished goods that should be a major red flag.

What’s Behind the Numbers? is full of little tricks like these, explained in simple terms that non-CPAs can understand.  Before you attempt to short another stock, read and re-read this book, particularly the chapters on aggressive revenue recognition and aggressive inventory management.

I’ll leave you with two final nuggets of wisdom from Del Vecchio and Jacobs.

First, don’t be too eager to jump into a short position.  As the authors point out, “You make as much money shorting a stock that falls from $70 to $5 (93 percent) as one that falls from $100 to $5 (95 percent).”  Getting into a trade too early will turn a would-be profitable short into a frustrating loss.

Second, watch out for crowded trades.  Don’t short a stock if the short interest is too high as a percentage of the float.  This puts you at risk of being short-squeezed as your fellow sellers all scramble to buy at the same time and send the share price to the moon.

If you are a serious investor, pick up a copy of What’s Behind the Numbers? and keep it close at hand.  More than anything else, it will help you to win by not losing.

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