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"Inflation is taxation without legislation."
-- Milton Friedman

I have been running a private investment advisory newsletter in which I pick a "Top Ten" Portfolio for four years now. In 2008, I did not issue a "Top Ten" portfolio based on the fact that I thought it would be a very difficult year to invest. As we now know, that may have been the understatement of the century. But things are getting interesting and I believe that after the washout that was 2008 there will be more opportunities in 2009.

The investment landscape has changed dramatically in the last 12 months. The investment banking industry has been obliterated. Fannie Mae (FNM), the largest mortgage buyer on the planet, has been taken over by the U.S. government. The federal government has expanded its balance sheet to over $1 Trillion (the truth is, nobody knows by exactly how much) and is taking large stakes in private businesses. We're becoming "Francified" as the country moves toward large-scale socialization of industry.

Nearly all asset classes were destroyed in 2008: Equities, corporate bonds, municipal bonds, real estate, oil, industrial commodities. Almost everything was down 40-60%. I guess we can take solace in the fact that we weren't Iceland, where the stock market declined 95%! There were really only two places to hide: 1) Gold, of which I have been a big fan (and still am), which ended the year up 5% 2) Treasury bonds, which mounted their largest rally in history, up anywhere between 10-20% depending on which flavor you were in. 2009 will certainly throw a few curveballs.

Where does it all lead? Unfortunately, Americans aren't very good at making baguettes, so the "Francification" isn't a good look for us. As the government takes on more and more liabilities of the private enterprise, prints up money, and seeks to bail out the economy by the creation of new public debt, this could lead to the largest inflationary bubble of our lifetime.

I believe we will see a "divergence in asset classes." As the government prints more money, expands its balance sheet, and becomes the public dumpster of all toxic assets that caused the collapse in the market, savvy investors are likely to run for the cover of assets that would hold their value in an inflationary environment as global governments begin a mad race to "print the most money." In just the last month, we have seen data that indicates that we are diverging away from the fear of deflation and moving back toward inflation. How's that? True, CPI is still going down, but that is a lagging indicator and mostly linked to the collapse of energy prices. M1 and various reconstructed forms of "M3"—the Broad Money Supply – are leading indicators, and they show that money supply is beginning to explode. This will lead to inflation down the road.

I believe the "stuff" trade will be back on, as people protect themselves against the coming inflation. As Jim Rogers, the commodities investor and founder of the Quantum fund has pointed out, commodities do not have "impaired" fundamentals. That is, the fundamentals for many commodities, especially agricultural commodities, remain incredibly strong (for example, wheat stocks are at their lowest point in history while global demand for food hits new highs). Financial assets, including government balance sheets, are, in fact, impaired. Nobody knows where the federal government balance sheet will end up after this process, nor what it will be valued at. Therefore: Capital will flow to more easily valued stuff: Corn, Wheat, Gold, and high-quality, and, hopefully, dividend paying stocks with stable businesses.

In 2009, you might not be able to buy a new Escalade on bank credit, but you will need to eat and buy food. And those with capital will need to find places to earn a return, which I believe will be the themes below.

Some themes and potential winning trades I see in 2009:

  • Shorting Treasury bonds – possibly one of the best trading opportunities in a long time.
  • Precious metals and agricultural commodities are likely to outperform.
  • Energy will return, along with the precious metals and grains. It is interesting that major diversified oil companies such as Chevron (NYSE:CVX) has stabilized ahead of crude oil, and we think that is a favorable sign for energy stocks.
  • The stock market could see a benefit from the return to liquidity, and for that reason it would not surprise me to see the market rally for the next 2-3 months. It is a good time to test the equity waters with some high- quality dividend-producing stocks, if only because they are a decent hedge against inflation and the dividend "pays you to wait." But take it slow and easy! Dollar-cost averaging rules, and have a long time horizon.
  • High-quality corporate bonds are also interesting. Individual corporate bonds take a lot of work to understand and I am no expert, therefore I am going to stick with some reputable funds, including the BlackRock Income Opportunity Trust. However, any stock market rally should be seen skeptically and sold accordingly. I doubt that a new bull market can emerge in 2009 because of issues with corporate profits.

Below is my "Top Ten" portfolio for 2009. This year, our portfolio "goes to 11" because we like to add another unit of diversification to our approach. A more complete explanation is posted on my blog at www.futuresfanatic.com. Here it is:

Top Ten Portfolio 2009 – The "Macro Portfolio"

1) Gold – Either iShares Gold (NYSEARCA:GLD) , gold futures, or physical bars and coins.

2) Silver – Either iShares Silver (NYSEARCA:SLV), silver futures, or physical silver.

3) DBA – Powershares Agriculture ETF

4) BNA – Blackrock Income Opportunity Trust

5) BPT – BP Prudhoe Trust

6) CVX – Chevron

7) BMY – Bristol Myers

8) MCD – McDonald's

9) BDX – Becton Dickinson

10) GILD – Gilead Sciences

11) TBT – Double Short Treasury Bonds (Note: you are selling bonds short when buying this ETF)

Disclosure: I am invested in all of these themes.

Source: The 'Reflation' Top Ten Portfolio