Selling Long Positions, Going Short and Buying Gold

Today’s market is just plain ugly, and I am beginning to have serious worries about the economy flipping into a recession. In fact, the more I listen to companies guidance (Caterpillar (CAT), Union Pacific (UNP), etc). In fact, I am willing to bet that the U.S. is already slipping into recession, but we have yet to actually see it in the numbers. The way that both the stock and bond market have acted in the last few sessions is telling me to beware, so I have sold sizable amounts of long positions, increased my short positions, and taken up sizable new positions in gold miners. The rate cut thesis has continued to work over the last few days (with my portfolio being green despite the market), but Friday’s selling has me worried that we are going to see a bit of margin selling and other panic selling, and therefore, I have to exit some positions simply based on the fact that selling breeds more selling. I don’t see this being over in a day.

Therefore, I have closed positions in the following stocks:

China Agritech (CAGC.OB) at $4.75
ShengaTech (SDTH) at $7.83
China Education Alliance (CEUA.OB) at $3.57
AeroVironment (AVAV) at $23.87
Biogen Idec (BIIB) at $80.02 (I was a bit hesitant to let this go, but with credit market turmoil, it probably lessens the number of people who can afford to buy it).

I have also sold 60% of my position in Annaly Capital Management (NLY) at $16.52, even though I do believe it will benefit from a Fed rate cut. Quite simply, I don’t want to see my nice gains evaporate if we get forced selling, and I also want to free up capital for what I believe are the opportunities going forward.

I have also increased my leverage to the downside, tripling my position in BC at $20.46. Read the archives for my thoughts here.

Finally, let’s get down to where I am really putting my money–gold. I think we are on the verge of an incredible bull market for gold, based on the fact that the Fed has to cut rates in order to assure the sanctity of the banks. The banks need low short rates or we may well see WaMu or Countrywide or someone else actually fail as losses continue to pile, and the Fed cannot let that happen. This confirms once and for all that the dollar is no longer fit to be the world’s reserve currency, and therefore, it will continue to fall as people look toward the euro and gold to take its place.

In addition, the dollar is going to be further plagued by the weakening economy. As I see it, the Fed has to cut on Oct 31st because a banking crisis is the nuclear apocalypse of economics. However, what people don’t realize is that the Fed is powerless to stop a recession because the drop in short term rates will not act to lower long term rates as well (and the 10 year is all that matters to save housing). As we say during the most recent capital flows data, Japan, the rest of Asia, and the Middle East all were net sellers of Treasuries last quarter, which was one of the key reasons why yields spiked so much. If the Fed cuts again, you can bet that the demand for Treasuries abroad will continue to decline, and therefore, long term interest rates are going to be pushed higher. While that may be good for the banks’ solvency, it will hurt housing and the rest of the economy. Therefore, a rate cut isn’t going to do much to prevent a recession (other than preventing a depression by ensuring the banks health). The weakness in the U.S. economy is going to continue to drive rates in the U.S. and Europe in opposite directions, which will lead to more dollar weakness and a surge in gold.

The result of all of this policy will be that the euro probably goes to $1.50, gold goes almost immediately to $1000, and oil will probably spike short term above $100 (due to dollar weakness). While oil will then probably correct back down because of U.S. economic weakness, there is no reason to believe that the euro or gold will weaken after a rate cut. To the contrary, we could see gold assume leadership of the economic system, and that could push gold higher than anyone is currently willing to admit.

However, it’s not all bad (just kidding)…the coming dollar devaluation will finally force China to revalue their currency in order to fight inflation. In fact, it is not against the realm of possibilities that Hank Paulson and Ben Bernanke are waging war on the dollar in order to force this revaluation. Honestly, they’ve exhausted every other path in trying to convince the Chinese to revalue, so maybe they’ve resorted to forcing China’s hand. Given that Chinese inflation is already running at 6.5 percent, and they simply cannot afford to pay $100 for oil from an inflation standpoint. Therefore, China will revalue the yuan below 7 yuan in the next 6 months to try to stem the tide of inflation and cheapen the cost of oil in terms of yuan, which may very well rock the Chinese stock market in a way we have not yet seen. Of course, the U.S. will have to pay for its war on the dollar with higher interest rates as China refuses to continue to finance the U.S. government deficit, but as long as the dollar war is waged with secrecy, the adjustment should be slow (but still painful).

With my rant over the dollar out of the way, now on to where I’m putting my money. I am making a very big and broad bet on gold, and spreading my money across the sector in several different miners. Readers of the blog know that I like junior miners, but we have to be a bit more conservative here and pick companies with near term production prospects or current producers in order to ensure that we capture the move higher in gold. Therefore, here are my new buys from Friday:

Barrick Gold (ABX) – moderate position at $41.43
Yamana Gold (AUY) – small position at $13.99
Eldorado Gold (EGO) – small position at $6.74
Vista Gold (VGZ) – large position at $5.15

VGZ is largest position, and it is also the most speculative as it is still awaiting the go ahead for production of its mine in Mexico. However, this stock has huge upside potential, and my bet on gold is not designed to be a small one. I also continue to hold U.S Gold Corporation (UXG) as another speculative miner, so my bet on gold is very large indeed.

Yes, I am taking on a big risk by betting so heavily on gold, but given the economic and market outlook, I think that gold is the best risk adjusted opportunity right now. I still have significant leverage available, so I have flexibility to navigate this market.

Comments

[irondoor91]

I'm not so sure that I agree with your $1000 price for gold, but I do agree on the potential for gold in light of the dollar decline and the notion that the soverign funds may step up their buying of gold in lieu of dollar denominated assets. It is also a hedge against the continued rise of the dollar-denominated oil price. I own EGO,IAG,KGC,HMY,SWC & LMC. Some getting slammed today, but perhaps a good entry point for your purchases.

Gold seems to be a reasonable place to wait out the increasingly unreadable noise coming from around the financial world. I'll certainly take the $1000 if it comes and wish you the best in your investment.

[Franco]

Mr Kelly, what are your thoughts on Iamgold (IAG) as a gold play?

[Matt Callow]

Be very careful. I too believe that Gold will exceed $1000 in the near future. I also believe this market is due for a massive correction due to the current global economic picture, the US economic picture, the plunging dollar, the credit crisis, the housing crisis, and the high amount of margin currently being utilized in the stock market. Friday was a mere foreshadow of what is to come. Due to the trading curbs in place now, this sell off will be several days like Friday, not one massive drop like 20 years ago. These days will not be consecutive, but 6-18 months from now, we'll be talking about the slow and steady market sell off.
So what happens to mining stocks when gold is going up and the stock market goes down? As one small example, ABX fell 19% on Black Monday, October 19th 1987, while the Dow fell 23%. The next day, the Dow gained 6% while ABX continued to fall another 23%. The bottom line is, don't fool yourself. Even Gold Miners will get nailed if the market sells off.
Here's how I plan to play the rising gold/falling market problem. I plan to be long GLD the Gold ETF. It is based in bullion, not stocks and should track well with the price of gold. Although it will not pay off as much as owning mining stocks in a RISING market, the risk is MUCH less if we do indeed have a falling market.

[razormd]

Funny but I don't think I ever met a rich economist...in fact, wasn't it a bunch of economists that founded good old "Long Term Capital Management"?...HA... term" until they went broke a six years later!...pardon me if I seek advice elsewhere.

[biodieselmama]

You should take a look at Sino Gold. This is an australian company with that has built the largest gold mine in China.
I bought shares at 3.25 over a year ago and just took partial profits at 6.50. The mine was opened in March and just reached opporational capacity. They already have targeted the next mine project and have several exploration sites in drilling. GoldFields is a partner. There is tremendous up side to this stock even from 6.50 where it is now. This trades over the counter as SIOGF. www.sinogold.com.au/ne...

[biodieselmama]

You should take a look at Sino Gold. This is an australian company with that has built the largest gold mine in China.
I bought shares at 3.25 over a year ago and just took partial profits at 6.50. The mine was opened in March and just reached opporational capacity. They already have targeted the next mine project and have several exploration sites in drilling. GoldFields is a partner. There is tremendous up side to this stock even from 6.50 where it is now. This trades over the counter as SIOGF. www.sinogold.com.au/ne...

[biodieselmama]

You should take a look at Sino Gold. This is an australian company with that has built the largest gold mine in China.
I bought shares at 3.25 over a year ago and just took partial profits at 6.50. The mine was opened in March and just reached opporational capacity. They already have targeted the next mine project and have several exploration sites in drilling. GoldFields is a partner. There is tremendous up side to this stock even from 6.50 where it is now. This trades over the counter as SIOGF. www.sinogold.com.au/ne...

[Brian Croner]

I question the value of gold. I think it's already saturated with investment capital and isn't a good investment. There's way too many US Dollars in the monetary supply. There's nowhere for the money to go. That's why Google is overpriced and overcapitalized despite the risks with hiring so many workers and having only one good income source. Gold, at best, is a bet. Gold is lustrous and just sits there, and the currency problem is worldwide. Ethanol got overcapitalized. Amazon.com actually increased their net income by almost double and their stock tumbled.

One thing you can do with US Dollars is light your cigar easier. Take a note that displays a single digit, such as a 1 or a 2 or a 5, and then roll it up lengthwise. Get out your lighter or match and commence the flame. Ignite one end of your rolled up paper note and observe the blaze strengthen. Apply the larger blaze to the end of your cigar for a more robust ignition. Then make sure to extinguish the blaze so you don't start a fire. If you wish, you may take your partially burnt notes and send them to the US Department of Treasury for a replacement of fresh new notes. If you mess up and burn the whole note to a crisp, relax, because even if it's a $5 bill, it's in US Dollars, and therefore less than enough to pay for gas to get back from the cigar shop.

[goldielox]

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