10 Long Hedges for a Net Short Position on the Market

by: Hedgephone

Over the past year I have argued that stocks are overvalued, but the fall in the dollar and the incredibly massive printing scheme of Ben Bernanke could push overvalued markets to new nominal highs versus our flawed currency. I have also argued that Silver and other hard assets would outperform stocks, which has also happened, although not to the degree I had previously imagined.

So what is in store for the remainder of 2011? I think it is safe to say that stock markets will sell off at some point, while oil and commodities could continue to spike higher if a QE3 program is undertaken. I would position myself long commodities through an RJI type vehicle with a 7% below the market stop loss order (or buy call options that are 7% in the money) and would buy put options on the Russell 2000, which I view as 50-60% overvalued.

What is clear is that the economy stinks while stocks are skyrocketing-- clearly a disconnect in the markets. One way investors can make money in today's environment is to buy farmland and real estate that is cash flow positive. In other words, buying rental properties in South Florida seems interesting, as many homeowners walk away from their underwater properties and prices for real estate can be had for less than 7X cash flow earnings from rental payments. Farming seems like a no brainer as an inflation hedge for both food and for farm prices in general.

There are not too many public farming companies, but there are a few stocks that can hedge investors against inflation while providing a long hedge for your short positions in the Russell 2000 and in the overvalued pockets of the market. I do not recommend REITS at all, but I do recommend actual property at this point, where a cash flow stream can be earned.

Here are 10 stocks that make good hedges on the long side for a net short position on the stock market:

Potash (NYSE:POT) is likely a good way to hedge your risks of inflation. I like the name personally because well known value guru Mohnish Pabrai holds a large, concentrated position in the stock and clearly believes the company to be undervalued. POT offers options investors interesting opportunities in the put selling arena as the option premiums for POT are quite large. Selling an at the money January 2012 put seems like a good way to buy the stock at a much cheaper price.

Bunge (NYSE:BG) is a farming and commodities operation located in South America which provides investors with a dual hedge against a collapsing dollar. BG is not as cheap as it once was when I first discovered it, however the stock is trading below book value-- for a PE under 12X-- and has a large position in the global commodities boom. Investors should consider selling the January 2012 $70 put options instead of buying the stock.

Mosaic (NYSE:MOS), like Potash, is a good play on the commodity cycle and as a hedge against future inflation. Although the end of QE2 is being priced into the market and crushing commodity stocks right now, the future will likely see more money printing by central banks globally, which should provide a bid for the stock over time.

Union Pacific (NYSE:UNP) is a large holding of value guru David Williams and has a reasonable price to free cash flow ratio. After Buffett wisely purchased Burlington Northern, Union Pacific is a good investment for the long term if M&A activity continues in the space.

Another cheap Williams pick is ACE, which sells for less than 8X earnings and a little under book value. ACE can be bought using leap call options (I prefer the January 2012 in the money calls) and investors can further protect their investment by selling at the money front month calls as a hedge. If the market tanks, you can only lose a fixed amount of money that represents a much smaller amount of capital at risk.

Coca Cola (NYSE:KO) is running a bit lately and is slowly getting out of my buy price target zone, but the stock is still reasonable at current levels. I will continue beating the Leap Calendar Call spread drum for my readers as long as the stock remains below $70 per share. KO is one of the best managed businesses on Earth. As the company grows in emerging markets, I expect earnings and cash flows to grow at a nice rate over time.

John B. Sanfilippo & Son, Inc. (NASDAQ:JBSS), the maker of Fischer Nuts, is a cheap stock at current prices. This peanut champ gets hurt with higher commodity prices, but I feel it has some pricing power after its large restructuring in recent years. At a price around half of tangible book value, JBSS appears to be a good value.

Another half price stock that trades for nearly 50% of tangible book is Kansas City Life (NASDAQ:KCLI). I like this stock as part of a larger hedged portfolio of below book value names, but would caution investors that small cap value tends to lack liquidity, and often times sells off hard in market corrections. Because of this, look to add capital to these type of stocks during corrections in a dollar cost averaging strategy.

National Western (NASDAQ:NWLI) is cheap and getting cheaper. At 45% of tangible book, the stock looks interesting, but when you add the fact that the company is also dirt cheap on a PE basis, NWLI looks like a good place to invest over the longer term.

Presidential Life (NASDAQ:PLFE) is another dirt cheap insurer trading below tangible book value. The stock, like KCLI, is a holding of ABC Funds and is a long term type investment that should be sold after a 50% gain or after holding it for two years if you believe in Ben Graham's methodology for low price to book investing.

For the short side of your book, I suggest shorting the IWM or buying longer dated IWM put options for a hedge.

Disclosure: I am long MOS, NWLI, KO, ACE.

Additional disclosure: I am short IWM