December 2011

Go here to read all about it.

Back in the heady days of 2007, the US Congress established mandates for the amount of cellulosic ethanol and other biofuels to be used in the nation’s transportation fuel supply. Cellulosic ethanol and fuels based on algae are made from non-edible biomass, and thus avoid the criticism of replacing food with fuel. The Congressional mandates were very aggressive, calling for 100 million gallons of cellulosic ethanol by 2009, 250 million gallons by 2010, and 500 million gallons by 2013. By 2022, US transportation fuel is supposed to include 16 billion gallons of cellulosic ethanol.

In 2010, the mandate was lowered for that year to 6.5 million gallons and for 2012, the mandate set by the US Environmental Protection Agency has been set at 8.5 million gallons. Companies like Codexis Inc. (NASDAQ: CDXS), Amyris Inc. (NASDAQ: AMRS), Gevo Inc. (NASDAQ: GEVO), Solazyme Inc. (NASDAQ: SZYM) and Kior Corp. (NASDAQ: KIOR) have so far failed to reach production levels anywhere near mandated levels. Traditional corn-ethanol makers like Archer Daniels Midland Co. (NYSE: ADM), Valero Energy Corp. (NYSE: VLO), and Pacific Ethanol Inc. (NASDAQ: PEIX) continue to supply the vast majority of non-petroleum based fuels.

Refiners are required either to use cellulosic ethanol or to pay $1.20/gallon for the privilege of not using it. Because so little is available, refiners end up paying for something they can’t buy at any price.

Most biofuels makers have turned to producing specialty chemicals for the cosmetics and pharmaceuticals industries in order to make some revenue. Truth be told, a gallon of a cosmetic component is far more costly than a gallon of cellulosic ethanol, so these companies continue to work on developing substitute chemicals. The payback from these is more certain and nearer in time than is trying to scale up manufacturing of biofuels and facing uncertain political and distribution issues.

To show how hard things have been, the share price of many pure-play stocks pretty much sums it all up:

Codexis trades at $5.53 and its 52-week trading range is $3.91 to $12.24.
Amyris trades at $11.16 and its 52-week trading range is $9.90 to $33.99.
Gevo trades at $5.59 and its 52-week trading range is $5.18 to $26.36.
Solazyme trades at $11.27 and its 52-week trading range is $7.68 to $27.47.
KiOR trades at $9.31 and its 52-week trading range is $8.88 to $23.85.

And this is a negative?

I think not. If CDXS can produce, they can sell. It is only a matter of expanding production, backed by Royal Dutch Shell, capital is not the issue. This is a great little stock that has great potential and a government subsidy.

Now this chart goes to the ‘type of market’. In a stable volatile market, which to date we have had, you expect a reversion. However, we are near a breakout point, where the market would change to a trending volatile market. We have had since the September lows a series of higher highs, higher lows, which is a trending market, contained within a wide range, which is our stable volatile market.

Technical analysis confirms this via a trendline study across two timeframes, resulting in a symmetrical triangle. Which way will it resolve? You go with the current trend until proven wrong. All the faster, or shorter timeframes also fail to confirm the end of the current trend: you sit it out. It is volatile, that means that price will reverse against your position, that simply is a fact of financial markets, don’t sweat it.

In gambling, the risk of ruin refers to the likelihood that you bust out and lose all, prior to possibly winning, because you were actually gambling with a positive expectancy. For example using the simple die roll. If I were to offer you $2 for every $1 bet if the numbers 4, 5, 6 were to come up, you would have a positive expectancy bet.

The problem, or question however is: how much would you actually bet? Bet too much, say 100% of your available funds, and there is still a 50% chance that you go bust as a 1, 2 or 3 could come up. Even reducing the bet could result in a total loss as a lower probability of a long run of 1, 2, and 3 emerges.

The problem then with any allocation into a system that trades stocks, has this same problem. How, assuming a positive expectancy system, do you allocate funds? There is no perfect answer, however the methodology that I will follow in the newsletter that is obviously purely optional, it is primarily written on the signal, will be a fairly conservative methodology.

The methodology will run two strategies in one. This is to allow for an adaption to all market environments: the stable market and the trending market. The system incorporates a weekly component that ‘times’ the market, which only constitutes 5% of total funds, and a longer term method that seeks to compound both the capital gains, and the total number of shares held.

The shorter, faster, pure timing method, will, in the correct market, hold ‘short’ positions. The longer term method will always remain ‘long’. The % positions will obviously alter over time as the portfolio grows.

The signals are weekly for the timing component, although as the current newsletter indicates that this is currently a ‘hold’ already existing long positions. Remember this is not a daytrading system, it is a ‘weekly’ system.

The longer term system is simply a ‘buy’. This is how you would stand:
Total Cash $1,000,000. 00
Allocated $500,000 ……50%
Swing component 10% of the 50% allocated
Cash 500,000.00 ………50%

The Swing system was triggered long at the bottom of the market in September. That long signal has not yet been rescinded. It remains long, thus the ‘hold’ recommendation. If there comes a ‘sell’ signal, the swing component, in this case the 10% or 400 shares of SPY will be sold, but not sold ‘short’, simply the position closed, and moved to cash.

The longer term system will remain long. Should the market decline, and seriously decline, this constant position will enter a drawdown. Drawdowns are not pleasant, but they are a reality of system based trading. They are a necessary component.

In a serious decline, there may come a ‘sell short’ signal. This ‘short’ position will be bought with the swing 10%. You can hold it as an inverse ETF, leveraged if you wish, or PUTS. You are now both long and short.

In a reversal, where a buy signal is issued, depending on the ‘trend’ of the market, you may then close the swing short and initiate a swing long, or go to cash, looking for a re-entry ‘short’. In the longer term position, you may increase the total holding from the cash that exists held in the portfolio. It sounds a bit convoluted, but actually it’s fairly straightforward.

As I said earlier, this is purely optional. The newsletter is produced simply for the signal. The method that I follow is purely optional, and you can follow along via the link and the various updates and commentaries that will appear on the blog as we go. It will be very transparent, and all will become clear after a week or two. Essentially the methodology is trying to reduce and eliminate the ‘risk of ruin’ through correct position sizing cognizant of a positive expectancy system.

Of course you need a subscription to the PPT first. So you need to add the price of a PPT subscription to those prices. I have no idea how much value this service adds, there is no record of results anywhere that I am aware of.

When designing a methodology, you need to consider the type of market, or markets, that it can succeed in, and the type of market it might fail in. Markets change. Can your system or methodology adapt to that change?

The four types of market: [i] stable and quiet [ii] stable and volatile [iii] trending and quiet [iv] trending and volatile.

The current market is a type [iii] or stable and volatile. This is a tough market to trade and make money. There is a lot of drawdown, or giving back of profits, while the range is explored. Market ‘timing’ is tough in this type of market, it calls for far greater precision than in trending markets. So much so, that unless you are day-trading, the effort at timing is likely to cost you far more than you will gain.

Had I been writing the newsletter, the market bottom in September would have triggered a ‘long’ signal that has remained in place right through today. For verification you can look through all the market calls made on the blog, they have all been stay long. There have been pullbacks, but they have been part of the range.

The market may be getting ready to change; going from a stable volatile, to a trending volatile. Will your methodology or style or system adapt? With what risk? How managed? These and other questions will be addressed.

More buy the dip.

Kristin had her art exhibition here in Whangarei a couple of weeks ago. The gallery was a new one, opened only about a month or so ago. Attendance was good, especially as this was a student exhibition, probably about 300 tuned up all told. There were also quite a few sales amongst the various artists exhibiting. I have just included a small selection of the photos that were exhibited.

Does it mean anything?

Lars Pennington says:
December 27, 2011 at 11:36 am
You sire are full of shit. May I see your audited returns? Of course I cannot

The Fly says:
December 27, 2011 at 11:47 am
My returns are none of you concern, frankly. You should pay homage to the fact that I’ve allowed you to dwell here for so long. But no more!.
Sir, you are banned.

flippe-floppe-flye, my main man.

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