What a week it was!

October 6th, 2008  by Antony Ganzitti

Closing Data

	Current	Change	%
Dow Jones	10325.38	-157.47	-1.5022
NASDAQ	1947.39	-29.33	-1.4838
S & P 500	1099.23	-15.05	-1.3506
FTSE 100	4980.3	110	2.2586
All Ords	4,703	-71.3	-1.5
SPI Futures	4680	-95	-1.9895
Nikkei	10938.14	-216.62	-1.942
Oil	93.91	0.04	0.0426
Gold	833.2	-11.1	-1.3147
Silver	11.325	0.205	1.8435
Copper	269	6.25	2.3787
Lead	1702	28	1.6726
Zinc	1581	19	1.2164
Aluminum	2295.25	39.25	1.7398
Nickel	14925	-145	-0.9622
Tin	17020	300	1.7943

What a week it was!  The Dow Jones Industrial Average (DJIA) plunging 777 points, then jumping 485, all to finish the week on its lows and at levels not seen since late 2005.  The previous market downturn lasted from January 2000 and went on for 34 months, with a 4553 point swing.  The current downturn is 13 months and we are presently 3874 points from the high.

Friday night the House of Representatives finally passed the bailout bill and President Bush signed it.  But here comes the hard part, putting the plan in motion and restoring market confidence.  Market participants are obviously of the assumption that this is no quick-fix and the problems facing the US economy are more deeply rooted.  This is a structural and somewhat ‘once in a generation’ type situation we are being faced with.  And in the information age that we live in with global economies all linked together, we are already starting to see this flow onto other economies.  Euro-zone members are rushing at bailout proposals to try to alleviate the problems facing many of their prime lending and banking corporations.  Money market conditions are still tight, and lending has been very restrictive, and no matter how many US dollars or Euros have been pumped into the system by central banks confidence is still low.

What does all of this mean??  Well the price action from last week is of great importance for those studying price action.  A 7% fall in a price index especially after such a controlled and orderly correction alerts the analyst to what would typically be deemed ‘capitulation’.  (See Market Fox last Friday for a description).  Well we did capitulate and the typical outcome from a capitulation is generally a strong rebound with little weakness.  This did not occur, as the market was unable to sustain a rally and in fact breached the lows of an important price bar.  There is obvious pressures still built up in the DJIA, and until we see otherwise the focus is still lower.  Using an equivalent low from the 2000 market downturn gives us a technical price target of 9645.

The ASX/SP200 (XJO) on the other hand has started to ease itself away from the performance of the DJIA.  Although obviously still trending lower, we have so far showed some initial bullish activity, twice off the 4550 level on the XJO.  This doesn’t mean we are out of the woods, but it shows there is some buyer support returning.  Thru 4550 however and we could easily target a major price zone in the 4200/4300 region.

This isn’t meant to sound alarmist, this is what technical analysts digest from charting.  We still have a valid sell signal in place from the 2nd of September where the XJO sold off from previous resistance around 5150 which was mentioned in the Market Fox.  So until we see a signal that tells us otherwise or we get an internationally significant fundamental or climactic event (think Government default, world war, currency collapse) the trend is still down.

This is why we have continually stressed the importance of deleveraging portfolios and accumulating only solid blue chip companies, and selling call options which give attractive premium.  One sector to note domestically which has shown some interesting activity has been the banks.  It looks like the majority have put in some decent lows and buyer support has slowly returned.  Any weakness has seen signs of buying.  Dividend season next month for ANZ, NAB, WBC and SGB may mean that fund managers and arbitrageurs have been active.

The RIO-BHP article from last week is also something that deserves another mention.  Cale McCulloch noted the significance of the present ratio of BHP to RIO, which as of Friday was at 2.92.  This was below 2.80 earlier in the week and represents an interesting opportunity.  Below is a chart which graphs this ratio and we can see some solid bullish activity off the lows.  Hedge funds, traders, investors and arbitrageurs are able to sell the present ratio of BHP shares which is 2.92 and convert into 1 single RIO share.  Obviously you need more than a few shares, but it is definitely worth consideration, considering the BHP offer for RIO is officially at 3.4, with RIO directors still maintaining their stance of a higher offer.

Picture the example, imagine you have 2920 BHP shares.

Sell 2920 BHP @ $30.42 = $88,826.40
Buy 1000 RIO @ $88.91 = $88,910

If this ratio moves back to 3.4 using the current BHP price, RIO shares should trade at $103.43, and you make a profit of $14,520 (103430 – 88910), not inclusive of brokerage.  It seems too good to be true but this is arbitrage, and if the deal is going to go ahead, which just last week the ACCC competition watchdog said it did not oppose, this is practically ‘free’ money for investors.  If the deal goes ahead at a higher ratio than 3.4 as presently being demanded you make even more.

And the good thing at the end of the day, YOU GET YOUR BHP SHARES BACK.

You may be asking that if this is arbitrage why hasn’t the market factored this in and shouldn’t we be trading at a higher level???  Not necessarily.  Such a trade is usually done on volume, by traders shorting BHP and buying RIO.  Credit conditions are tight and so traders haven’t been able to gain access to the liquidity that they have previously been used to.  Another reason, funds need to hold BHP as part of their mandate, and unless they are a ‘special situations’ or an ‘events’ type hedge fund such trades are not usually in their investment strategy.  The discount also takes into account the interest and borrowing costs of setting up such a trade, and the timeframe expected from now until the deal actually goes ahead and RIO shares are converted into BHP.

Ok, a couple more charts.

ORG Origin Energy.  A bearish monthly candlestick bar has appeared on the chart as per below.  Many are still long the stock from between $6 - $8 and now may be a time to consider locking in profits.  An interesting thing to note from this chart is the combination of technical and fundamental analysis.  Last month when ORG announced a proposed $8 billion deal with Conoco Philips, the price jumped to a high of $19.99 before profit takers stepped in.  Market cycles often change at such ‘defining’ or ‘climactic’ events.

WOR Worley Parsons is another stock which has been under pressure.  The monthly chart below depicts a seriously ‘top heavy’ bias.  We have been happy selling this one over the last few months as many are long the stock from below $10.  Consolidation at best for this stock and any strength is an opportunity to offload.  Technically we could see $22-$24 at some stage.

Well done the broker who spotted a neat little spec stock last week which was ripe for a run, IPR Ipernica.  Some clients got in early at 11 cent levels, however when Friday came the stock closed at 14c after a high of 14.5c.  A neat 27% move.  Chart-wise the stock was due for a momentum kick and initial short-term resistance is located at 15c, then 18/20c.

Contact your Freeman Fox Stockbroker on 07 3031 9960 or 1800 003 369 Ext 7.

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