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One Decision Per Decade: Three Choices

by John Rubino on December 29, 2009 · 3 comments

A few years ago the trust department of a major bank decided that it would be good to know where its profits were coming from. So they had their accountants run the numbers and found that, notwithstanding their army of highly-paid stock pickers, more than 75% of their investment profits came from sector choices.

In other words, when they picked the right category (i.e., oil, technology, retail), most of what they bought outperformed typical assets from less-successful categories. This makes intuitive sense and is easy to verify from recent memory: Most tech stocks beat most grocery store stocks in the 1990s and vice verse (big-time) in 2000 and 2001, while most precious metal miners have outperformed banks since 2007.

So there it is. If we want to quintuple our money in the coming decade, all we have to do is find the next sector with a sustained 45-degree arc. Which of course is a lot harder than it sounds, since the choice is probably not obvious at the start of the run or everyone would already have piled in (making it the past decade’s big winner). But right now there are three good candidates:

Gold and silver. We’re destroying the world’s paper currencies, so capital will continue to pour into the only kinds of money that out-of-control governments can’t create. Precious metals are already way up (which appears to violate the “not obvious” rule for one-decision assets) but the dollar’s destruction is ongoing, so this might be one of those rare two-decade decisions.

Ways to play include digital gold currencies and storage services like GoldMoney and BullionVault, and high-quality mining stocks and the ETFs that own them (GDX and GDXJ). “Paper metals” like the bullion ETFs and futures contracts that depend on some exchange being able to deliver physical metal are not good bets in what promises to be a chaotic, panicked market.

Short Treasury bonds. See the above. If we’re destroying the dollar, then instruments that pay a fixed number of dollars each year are a really bad idea. Yet 20-and 30-year Treasuries are priced for continued low inflation. If the market is wrong, Treasuries are the short of a lifetime. Bet against them with TBT,  an ETF created for this purpose. Or, if your broker allows it, short a bullish T-bond ETF like TMF, which makes these souped-up funds’ much-publicized tracking errors work in your favor.

Short U.S. stocks. The S&P 500 is up 65% from its mid-crash low. That’s a helluva run even in normal times. And these times aren’t normal: From Dubai to Greece to Spain, the number of potential sovereign defaults is high and growing. Several major U.S. states are bankrupt, with no solution in sight. And the U.S. government is running suicidal deficits and passing new entitlements as fast as it can round up the votes. This is not a bull market environment.

Then why the recent pop? First, after the worst bear market since the Depression a relief rally is to be expected. See this chart of the Dow in 1930 and note the similarity.

Second, the governments of the world have printing presses, and when the financial system imploded they responded by shoveling tens of trillions of dollars into the banks. This stopped the bleeding and is now inducing some banks to start lending again. Here’s an email excerpt from a reader with an inside view of the mortgage business:

I consult with a large independent mortgage banker. Last year, around June, they were faced with the enviable problem of having warehouse lines that were inadequate to finance the growing demand for FHA refi’s. They needed to raise capital to get larger lines. But two months later a funny thing happened. The warehouse lenders raised their lines substantially with no further capital. I would call this stealth lending. A place where no one is looking, more credit gets pumped in. You don’t see it in the credit card market or in business, but those freshly minted dollars that appear on the Fed’s balance sheet are finding their way into the money supply.

So if we follow the logic that the new money is quietly making its way into the money supply, in areas that the Fed and Treasury want them to, then we realize that the increased monetary base has not really been “sterilized” but rather is being slowly leaked out.

The result: stability in the financial sector and a lot of newly created cash chasing houses and stocks. And an economy that appears to be growing but is really just borrowing.

Anyhow, assuming stocks run out of steam for technical and/or fundamental reasons, there are lots of ways to profit from a downturn, from bearish ETFs and mutual funds, to shorting individual large-cap stocks.

But here’s where it gets tricky, because these three virtual sure-thing outcomes — gold up, bonds and stocks down — might be mutually exclusive. If the dollar tanks, gold will soar and T-bonds will fall. But stocks might rise in nominal if not real terms, just because the dollar is falling faster than corporate valuations. So shorting the market would be a losing bet.

If the financial implosion overwhelms the printing presses and we slip into a 1930s style depression, then stocks will tank, gold might tread water, and T-bonds will soar as cash is crowned king.

In other words, only two of these three strategies will are likely to work at any given time, and it’s not clear which two or in what order. What to do? One logical response is to try all three and hope that two pan out. Or we can accept that the world is now on Internet time and what used to take a decade now takes a couple of years, and adjust our expectations. For example:  Short stocks today and ride them down to their 2008 lows. Then load up on gold and short bonds in anticipation of even more central bank money printing. Then, when interest rates start to go parabolic, short stocks again. It’s less restful than a single decision but if it works it might compress three big decades into one.

  • Del

    The military industrial complex is also forecast to continue booming. Private security firms and the military tactical gear market is still growing in leaps and bounds. http://www.TacticalWarfighterGear.com

    Investing in companies like TWG look to be a good bet for the immediate future at least. I agree with the author though that gold and silver are still at the top of the list.

  • http://renli.wordpress.com Oliver Richman

    Nice work, John! I nominated this for article of the year.

  • Hannan

    To the previous poster: while your rationale might be sound, the ethics are debatable.


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