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The long and short of selling in May

Gold, stocks, technical trends and insider trading all cry “go away,” says this Canadian analyst. Are you ready for a bit of short selling?

Are the bulls on to something? Does the post-March rally in the stock markets mean the worst is behind us?

Well, let’s just take it easy, says one Canadian expert. Yes, stocks do bottom a good six months or so before the economy stops contracting, says Mr. Louis Paquette in Emerging Growth Stocks.

Yes, the pace of economic contraction has eased, and indexes like the S&P 500 have rallied by 28 per cent and more.

But this expert remains skeptical. This isn’t a typical “inventory” recession. “It’s the bursting of the largest credit bubble in the history of mankind that was two decades in the making. And I believe it will take much longer than a few months to resolve.”

From his vantage point in Vancouver, Mr. Paquette believes that the timeworn advice “sell in May and go away” still has legs, even in a market that has turned many of our assumptions upside down.

He offers a series of brief observations on gold, stocks, technical trends and the signals we’re getting from insider trading.

He concludes with a few words on short selling in this market “for those who consider themselves sophisticated enough to keep a close eye on their short position.”

Reversal of fortune

We start with gold, which appears to have put in its seasonal high already. It has hit what the technical analysts call a “double top” around $1,000 an ounce (that is, it has peaked twice at that level, which usually means a reversal of fortune, from bullish to bearish).

Mr. Paquette is convinced that gold will break through $1,000 an ounce again and probably go several hundred dollars higher, but it’s not likely to happen until after it has trudged through the summer doldrums.

Stocks have played a bit of a trick on us as well. They were cheap back in March, this analyst admits, but no more.

There are no longer undervalued, “but merely fairly valued after rallying. And during bear markets we only want to hold out for and buy at extreme lows in investor sentiment and valuations.”

In short, whether or not you sell in May, this is not a buyer’s market, in this analyst’s opinion.

Running for the exits

The technical charts offer no great cause for optimism, either. The key market indexes are running into major downward trends. The S&P 500 appears to be “rolling over” after its big move up.

The index could be on its way back down by 50 per cent or more, Mr. Paquette tell us.

And the Moving Average Convergence/Divergence (MACD), the most popular of all price trend indicators, is just about ready to flash a sell signal, says the analyst. “Combine this with the lousy seasonality and I believe there is good reason to be cautious.”

The news doesn’t get any better when we look at insider trading.

“Insiders are running for the exits!” exclaims Mr. Paquette. In just a few weeks, the ratio of sellers to buyers has shifted from bullish to bearish. A seller-buyer ratio of 12:1 is bullish. Readings over 20:1 are bearish.

As this issue of Emerging Growth Stocks went to press, the ratio was near 40:1! “What do these insiders know that we don’t?”

Short-selling instruments

“Short selling is certainly not for everybody,” says Mr. Paquette. But if you are willing to keep a hawk eye on your investments, this market offers some juicy opportunities for short sellers, he states.

The way to go is the exchange-traded fund. Specifically, the leveraged Horizon Beta Pro funds that track commodity indexes. A leveraged fund that’s long on the underlying index means that when the index rises one per cent, the fund goes up two per cent. For an inverse fund, if the index falls one per cent, the value of the fund rises two per cent.

And of course, your losses are double if the index goes against you.

These funds suffer from “time decay,” Mr. Paquette tells us. That is, if you track them over a period of months, the returns don’t add up to a perfect two-to-one ratio. In his view, this makes them better short-selling instruments than long-term holdings.

Falling over time

In this market, chances are that both long and inverse funds will fall over time. He points to the gold indexes — Horizons BetaPro S&P/TSX Global Gold Bull Plus ETF (TSX-HGU) and Horizons BetaPro S&P/TSX Global Gold Bear Plus ETF (TSX-HGD).

Both are way down from their highs, so you could have shorted both the long fund — and the inverse fund! The erratic performance of gold would have netted you gains on both.

Look at oil, he says. The price of crude has pushed past its February high. Yet the leveraged inverse fund on oil Horizons BetaPro NYMEX Crude Oil Bear Plus ETF (TSX-HOD) has collapsed by more than half, from over $45 to below $20.

But the bear market for crude may be ending. So where to go next? How about natural gas? The inverse fund for this beaten-down commodity is Horizons BetaPro NYMEX Natural Gas Bear ETF (TSX-HND).

Some have said that natural gas will never recover, Mr. Paquette says. “As a contrarian, I wonder if that negative sentiment is a sign of a bottom. If gas does stop declining the inverse ETF will collapse just like the crude oil ETF has.”

So you short the fund that shorts the price of natural gas. It’s not a simple proposition, and many investors will give this strategy a wide berth. But some venturesome investors will do very nicely on the shorting side of the equation.

But whether you sell in May, or short sell in May, or just hold everything, this analyst believes we have to wait a little longer before the good times roll.