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The Secret Signal That Kept Us Out of the Steel Crash

By Ian Davis
Monday, September 15, 2008

The stock market is full of tells you can use to make extra money and protect your cash.
 
In poker, a "tell" is an unconscious act that tips off your opponent. For example, many players' hands will shake when they get great cards. Anyone thinking about bluffing might notice the tremor and decide that folding is the better option.
 
A similar stock-market tell – and one of my favorites – is the "blow-off top."
 
A blow-off top is a period of wild appreciation at the end of a bull markets. During the blow-off top, naysayers and worriers finally give up and join the party. This extra wave of buying leads to spectacular gains. But soon, no one is left to buy. The smallest amount of selling can lead to a wholesale exodus.
 
Take China for example...
 
In the four years between August 2003 and August 2007, China was in a raging bull market, growing by an average compound rate of about 2.4% per month (33.2% annualized).
 
Like many bull markets, the party ended in a blow-off top. Chinese stock prices rose 81.8% in just two and a half months.
 
It was a good tell. In the following three months, Chinese stock prices were almost cut in half, falling 37.3% from their high.
 
Steel's tell came nine months later.
 
In April, steel prices saw a blow-off top. Between mid-March and mid-April steel prices went parabolic, climbing from $299 to $454 per ton: an unbelievable 51% gain in a single month.
 
So on April 28, I waived a cautionary flag: "I believe the trend has developed from steady, linear growth... to unsustainable, exponential growth."
 
As you can see from the following chart, the tell couldn't have come at a better time.
 
Steel Blows Its Top 
 
 
The price of steel is down 28% from its high and shows no signs of strengthening.
 
I thought steelmakers would make great short candidates once steel's uptrend collapsed. During the blow-off top, the situation couldn't have been better for U.S. steel producers. They were benefiting from high steel prices. And they were benefiting from a cheap U.S. dollar, which gave them a competitive advantage when they shipped steel overseas.
 
But as I wrote, "Things might look rosy now, but let's not forget... steel is a cyclical commodity business. It's prone to big booms and busts."
 
Since then, steel's collapsed, and the dollar is up 14% against the euro. Nucor Corporation, the largest U.S.-based steel producer, is down 45% since it peaked in mid-May. Steel Dynamics, the other company I mentioned in April, is down 43% since June.
 
So the next time you think you're looking at a blow-off top, see if you can find a company with everything lining up perfectly in its favor. The more going right for a company today, the more that could go wrong tomorrow.
 
Good investing,
 
Ian Davis




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Market Notes
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Crude oil sinks below $100 for the first time since April.
Market Watch
Symbol Price
Change
52-Wk
S&P 500 1223.12 -0.1% +10.6%
Oil 38.22 -0.2% -0.3%
Gold 139.11 +0.8% +22.3%
Silver 29.51 +3.2% +62.6%
US-Dollar 79.17 -1.3% +4.3%
Euro 1.33 -0.8% -10.4%
Volatility 18.02 +0.1% -15.2%
Gold Stocks 590.99 +1.6% +25.5%
10-Year Yield 2.94 -2.7% -15.5%

World ETFs
Symbol Price
Change
52-Wk
USA 122.76 -0.1% +10.6%
Canada 30.56 +0.2% +18.0%
Russia 21.98 +0.2% +17.2%
India 37.92 +0.2% +19.4%
Israel 16.76 +0.4% +10.4%
Japan 10.69 +0.5% +7.0%
Singapore 13.71 -0.2% +18.1%
Taiwan 14.92 +1.0% +20.2%
S. Korea 57.19 -0.2% +21.5%
S. Africa 72.26 +0.5% +29.7%
China 43.84 -1.3% -3.3%
Lat.America 53.21 +0.1% +9.2%

Sector ETFs
Symbol Price
Change
52-Wk
Oil Service 137.74 +0.1% +20.2%
Big Pharma 63.99 -0.2% -3.2%
Internet 72.58 +0.7% +25.0%
Semis 16.18 -0.3% +26.4%
Utilities 31.19 -0.3% +1.8%
Defense 18.47 -0.3% +8.9%
Nanotech 10.08 +0.5% +1.3%
Alt. Energy 10.24 +1.6% -2.0%
Water 18.62 +0.7% +13.8%
Insurance 16.08 -0.4% +19.0%
Biotech 20.56 +0.1% +26.6%
Retail 19.59 -0.6% +26.6%
Software 24.65 -0.6% +22.7%
Big Tech 53.85 0.0% +22.1%
Construction 13.20 +0.8% +14.8%
Media 13.73 +0.7% +24.7%
Consumer Svcs 67.38 0.0% +23.4%
Financials 55.01 -0.1% +5.7%
Health Care 63.90 -0.6% +1.2%
Industrials 63.51 -0.1% +19.3%
Basic Mat 74.64 +0.4% +27.8%
Real Estate 55.35 +0.1% +21.8%
Transportation 91.39 -0.4% +23.9%
Telecom 22.65 +0.3% +16.8%