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June 6, 2006


Equities struggled for definition today, undergoing see-saw action that took the indices out slightly in the red. With the exception of a positive open, though, stocks spent the entire day under water. Once again, the most weakness was seen in homebuilding shares. The GSEs, Fannie Mae and Freddie Mac, also slumped heavily after being downgraded by Credit Suisse.

Home builders appear to have turned into the easy target for wannabe-tough traders to beat up on. The group lost another 3% today, taking Building Materials Holding along with them. BMHC, one of my best shorts of the year, has slipped another 8% since I covered. That's the price one pays for staying within a zone of comfort with regard to capital protection. The homeys are a long way from the capitulative sell-off that would mark the end of their decline. Therefore, I expect to be short BMHC again, but I don't know whether the trade will occur at higher or lower prices from here. What I do know is that the trade won't occur unless the situation gives me an apparent advantage.

My attention has also been turning more and more toward retailers. I've been writing since last summer about a macro theme in which the U.S. economy enters a heavy consumer recession on the heels of a housing slowdown. The first creaks of the downturn in housing were heard last summer, and housing-related shares began a precipitous decline early this year. It would be a natural progression to see consumer stocks follow the homeys into the abyss. As always, timing the breakdown will be difficult. Over the last two years these stocks, like the homeys, cracked sharply only to recover. However, I suspect the throw-over in this descending wedge pattern (see chart) may eventually prove to be a bull trap and that we are more likely to see the support line violated before descending resistance is punctured again.

stock chart

In one of the more perverse displays of speculative fervor of late, Google shares rallied 4% behind news that the company would begin testing an online spreadsheet application. The news is little more than brazen showmanship against Microsoft, which dominates the market with its Excel product, and I fail to see how the Google's product adds much value to its business. What the reaction in Google shares reveals to us, perhaps, is that the market gods are ready for another quick foray northward. Given the last-hour recovery in equities, a buy-the-momentum rally early tomorrow would not be surprising.

Finally, today's post simply wouldn't be complete without a discussion of the bashing suffered by metals. Gold was hit for nearly 3% and silver for 5%. Regular readers should not be the least bit surprised by the action since I've been writing about my expectations for the metals to get hit harder than most others anticipate. I do not have a target price. I am simply looking for signs of a mini capitulation. It is interesting to note, though, that the last time silver went parabolic (in early 2004), the low point occurred only four weeks after the peak, but the metals did not set a new high for 20 months. I'm not suggesting the same will happen with this cycle. In fact, metals will probably find new highs more quickly this time since we are likely to see the dollar spiraling instead of rallying. I bring up the history only to make the point that metals could make an interim low very shortly, but then require patience before outsized gains are realized. I think those outsized gains will come once Mr. Bernanke morphs into his evil alter-ego, Dr. Deflation.

Disclosure: Short FRE; Long GOOG Puts


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