3 Contrarian Plays on a Potential Rally

 |  Includes: C, GLD, ORCL, SLV, VXX
by: Bio Insights

Treasury yields at 2.4%, a 635 point drop on the Dow, gold hit $1,700/oz., ominous and downward charts on the front page of CNN with subtitles like "sell now and ask questions later." The classic signs of panic. Clearly you should sell, right? Even news agencies are telling us to.

The U.S. government will go to QE3 if it really has to. While things don't look peachy right now, I think many people are blowing the negative news out of proportion. If you haven't sold already, why would you do it now? The damage has been done. As ugly and red as it is now, and as much as you might be hurting, it would be like pulling a barbed arrow straight out of a wound.

If you, like me, don't believe on an impending crash of the U.S. government, and some sort of apocalyptic scenario where gold is the only currency and banks cease to exist, it might be time to consider a contrarian play or two that has the ability to net a huge return.

As already elaborated on in this article, fixed-income is probably one of the worst ideas right now since everyone has already rushed to it. Ten-year Treasuries at 2.4% is a terrible yield and inflation would make the bond quite useless. Besides, if U.S. government debt is supposedly so "unsafe" that S&P had to downgrade it, why buy it?

There are many equities that are worth buying with the current low prices, but since people are so very risk-averse at the moment taking risks will yield much bigger benefits than normal. Here are some risky ideas that could reap huge benefits upon a market rally.

1) Shorting the VXX

A.k.a. the iPath S&P 500 VIX Short Term Futures ETN ((NYSEARCA:VXX)), or the "fear index." Any time fear grips the market, this thing surges. It is a very volatile ETN, which is quite leveraged. On Aug. 8, 2011, while the Dow fell 5.6% at the end of the day, this index almost breached a 15% gain.

But what goes up must come down, or so they say. If the Dow rebounds into autumn, especially at a smooth and steady rate, VXX should suffer greatly. Holding a short position in the VXX may be one of the best plays you can make this year, but naturally has its risks. If some disaster strikes and the market tanks yet again, the short position will be hit hard.

2) Buying Heaps of Heavily Damaged "Offensive" Stocks

For the most part, all the defensive and/or high dividend stocks have fallen a lot less than their lower dividend and riskier counterparts. By drop I mean Citigroup (NYSE:C) for instance, which fell off a cliff on Aug. 8, dropping 16.42% and trading at about 50% below the average analyst's target, or Oracle (NASDAQ:ORCL) which dropped 8.22% and now trades 44% below the average target despite its incredible earnings growth, and I supposed these can be considered the opposite of defensive stocks - offensive. Since the S&P has a few less of the famous and supposedly safe companies, it only makes sense that it fell a little more than the Dow.

The rationale seems to be that fund managers and major players have simply labeled certain shares as "risky," and in this environment they're only going to hold the safest most defensive stocks. Whatever happened to fundamentals? Many of the best value plays are not the safe haven dividend stocks but the risky ones that people are currently scared of.

3) Shorting Gold/Silver

Although there have been fundamental reasons for their rise over the years, the sentiment towards precious metals seems all too familiar to sentiment towards real estate half a decade ago. This is a rather controversial debate, but at least for the medium or short term, precious metals will not have much reason to continue their climb if the stock market recovers in due time. Their intrinsic value is very hard to define and since the confidence is so high in these metals it seems possible that there can be some drastic price drops if people change their attitude. No commodity is invincible to basic economics.

I won't list all of the ETFs for each metal, but here are my favorite two:

  • GLD - SPDR ETF for gold.
  • SLV - iShares ETF for silver.

If outright shorting of the metals isn't to your liking, it's advisable to at least consider scaling down your positions since the metals are doing so well in midst of the chaos.

Disclosure: I am long ORCL.