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May 31, 2006

No Basis for a Party

Traders put on their party hats and started buying stocks... and just about everything else... during the early hours of trading today. They expected the punch bowl to be spiked by the release of the FOMC's meeting notes. The last two such releases got everyone believing the Fed was about done with rate hikes. Those attitudes set up a great trading opportunity, which I outlined before the last Fed meeting. I continue to believe that the last thing the Fed wants is for people to think they will let inflation get out of hand, though once they are threatened with just a hint of deflation, they will unleash the hounds and let inflation run rampant.

Not only did the meeting notes fail to hint at an end to rate hikes, they revealed the Committee actually considered a 50 basis point hike. Those people calling for a rally simply on the premise of expectations for a halting Fed have been dead wrong. That game is over, and I don't think we will see widespread anticipation for a shift in policy until more serious damage has been done to stocks and commodities.

That said, the news flattened this morning's rally, and we witnessed half-percent reversals in most equity indices. Metals were clobbered as FOMC minutes-driven speculation unwound and sent gold down $12 and silver down a half buck. Interestingly, traders of mining shares ignored the downdrafts and bought, sending the miners to more than 1% gains. Pan American Silver gained nearly 3%, and it's recent action has finally drawn me back into the options game. Since option premiums are so high due to the recent volatility, I chose to be a seller instead of a buyer.

Please do not think I am contradicting my statement two paragraphs ago that we will see more damage to commodities. I still believe so, and if I did not, I would be buying silver in addition to selling PAAS puts. I sold the puts simply because the premium was large enough for me to be comfortable with the risk of being put the stock, which, in fact, I would be happy to own at the net purchase price provided by the option. In addition, if I am wrong and metals do indeed shoot up from here, at least I will have something to show for being wrong.

Apart from the metals bashing, an interesting aspect of today's session was that stocks did not sell off sharply in the last hour. On the contrary, they rallied quite nicely. That bulls finally showed some spine during the hour of truth may be a clue that more buying lies directly ahead. How the market opens tomorrow will be of utmost interest.

Disclosure: Short PAAS Puts


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