This piece follows a previous article, in which I warned against shorting equities -- despite the fact that I believe the stock market is going to fall dramatically, at least in real terms (which I'll again expand upon later). As usual, my cautious outlook prompted a flurry of emails from readers asking what they should be doing with their money in order to prepare for the impending firestorm of rising prices that will derive from the inflationary printing and unprecedented credit-easing governments worldwide are foisting on their citizens.
It's important to note that, although I refer to "the" collapse of the dollar and Treasuries, these events are not going to happen in one minute, or one day, or even one week. Indeed, since I started writing about this scenario in December, the government has done so much to try to reverse the course of this trend, and yet the cracks have widened, and the dollar and Treasuries continue their inexorable march downward. Even though I don't believe, however, there will be any particular event that will trigger the collapse, I do believe it will accelerate with time -- ultimately exploding in a quick, catastrophic climax.
I am forever an analyst, but I am no longer an adviser or manager, and I want to encourage anyone investing money to do a prodigious amount of research before committing funds to anything – especially in this environment. Having said that, the best and safest place to start discussing my own opinions about capital allocation is to reiterate what you shouldn't be investing in: stocks, Treasuries, and dollars. As I said in my last article, although the stock market may trade sideways or even go higher from here, once the consequences of the unparalleled governmental printing spree and credit-easing of the last few years finally do hit the economy, earnings and dividends growth -- which are the main drivers of stocks – will never be able to keep pace with the inevitable and substantial inflationary price increases in the general economy.
This highlights what I consider to be the most dangerous part of this environment: your portfolio will appear to be going higher, but in real terms, you'll be losing money – on a scale greater than, I believe, even that of the 1929 to 1932 collapse. The only thing I can imagine worse than watching the market fall the 90% or so that it did 80 years ago is watching a stock market rise in a period in which it is vastly underperforming inflationary price explosions. The drop from 1929 to 1932 may have been painful, but at least it was an honest market.
So where do you go to survive, or even to outperform?
SHORTING THE DOLLAR INDEX?
The dollar index is merely a gauge of the dollar against a handful of the rest of the world's major currencies – leading to a general misperception that I call "currency relativity." Unfortunately, the fact is that every other central bank on earth is employing the same quantitative easing principles as the U.S., and so their currencies are equally doomed. If you short the dollar index, you are merely taking a position that the dollar is going to be weak relative to other major currencies, and that probably isn't going to be the case; they're all trapped in the same burning house.
On a related note, you may want to pay attention to the fact that Treasuries and gold seem to be decoupling from their heretofore nearly direct inverse relationship with equities. What does this mean? Mainly, in my eyes, it decries the old notion that, just because the stock market goes down, people will run to Treasuries as a safe haven; apparently the so-called "risk-free" rate of return isn't so risk-free anymore. Likewise, it would seem that, just because the stock market is going up, people aren't necessarily dumping gold. And this lends credence to my theory that investors not only expect inflationary pressures to drive stocks higher in nominal terms (but not real terms), but also that, in order to really survive rising prices, gold is one of the best places to be.
Have we hit the bottom, and are prices going to rebound from here? My best guess is that, again in nominal terms, we are near a "bottom," but as with the stock market, what does that mean? Yes, housing prices might rebound, but will those prices outperform inflationary pressure in the entire economy? Probably not. I will say this, however: when rates and prices are shooting skyward, having a personal residence with a relatively low interest-rate fixed-rate mortgage is a great position to be in – assuming you have a job, and you are going to be able to keep it. First, there's the tax deduction on the mortgage interest. But more importantly, a fixed-rate is just that: fixed. Even as all other prices and rates move higher, the mortgage payment doesn't – making it a progressively smaller part of a household budget.
To illustrate the way fixed-rate mortgages work with inflationary trends, think about the house your parents or grandparents bought for $20,000 several decades ago. Their monthly payment remained fixed at around $200 per month for thirty years, and yet their wages undoubtedly increased dramatically in that time. At the beginning, $200 was likely a hefty part of their budget, but toward the end, it was probably insignificant. Now, imagine how much that effect would be amplified by a hyper-inflationary economy – which, unfortunately, our government has all but guaranteed in the coming years. Remember, we all have to live somewhere, and if part of your cost of domicile is going toward equity, and the interest you're paying is fixed -- in an environment of rising rates and prices -- well, I guess it doesn't get much better than that. The alternative is to rent -- and leases escalate with inflationary surges.
In general, however, the reason I believe housing won't outperform inflation is that credit is all but gone; no matter what any of the pundits say on CNBC, the stark reality is that people can't get loans. It doesn't take much to recognize that if the consumer can't borrow, then he can't buy a house. And if that condition has become the status quo – and I believe it has – then what will drive the housing market?
People call me a gold bug. I'm going on the record here -- I am not a gold bug. I am, however, a huge fan of commodities right now -- and gold is hovering near the top of my list. Gold has almost no industrial value, but I follow it anyway, because it is nearly a perfect metric for the anticipation of future inflationary price-increases. Why? Gold has a psychological component that it shares with almost no other thing on earth -- it literally packs eons of historical consistency and value; people have always been passionate about gold, and it has unfailingly been the ultimate measure of economic and financial stability. As such, when people are frightened, they fly to the one thing that embodies that stability in order to protect wealth, and this means that gold will react to inflation faster and more accurately than just about anything else.
Further, its overall popularity means it is more liquid than other scarce metals and stones. All of these variables come together to convince me that, when the bottom falls out of the dollar and Treasuries, not only will gold keep up with prices, but it will outperform as people flock to its empirical safety. Remember: during a panic, everything tends to overshoot intrinsic value, to the upside and to the downside. Gold's universal nature will undoubtedly put it at the head of the pack, all but guaranteeing an above-average rate of return – at least until everything stabilizes. Unfortunately, however, I think we are sitting on the cusp of a colossal crisis, the likes of which we've never seen. At this point, economic stabilization seems like little more than a distant dream.
For many of the same reasons I like gold, I also like oil and agriculture. Let's face it -- getting a loan these days is almost impossible for anyone, and farmers and oil-producers are no exceptions to this troubling rule. Yes, I understand a slowing economy means slowing demand for commodities. But demand for food and oil will not simply cease; 2 billion Chinese and Indians may not be buying at the Gap (NYSE:GPS) this season, but they aren't about to stop driving and eating. So -- unlike gold -- oil and agriculture do have practical aspects to their demand that ensure more than a mere "safe store of wealth." As currencies falter, prices of oil and agriculture will keep pace; the fact that producers in these industries can't borrow should limit supply in a world in which demand probably won't fall all that significantly – relative to everything else. All this will almost certainly equate to better-than-average performance.
Shorting long-term Treasuries at this moment may be my favorite investment of all time. I love how the Fed commits to buying $300 billion worth of 10- to 30-year Treasuries in order to keep down the long end of the yield curve, and yet those rates go up anyway. This is just more evidence that the United States government is rapidly losing its ability to manipulate the economy, as well as further testimony that now is the time to bet against the Fed, and to bet against it big. I know, I know, I'm a doomsday prophet and a conspiracy theorist. Believe me, I've heard it all. Try to remember, though -- if you can see through that fog of skepticism and doubt -- that people were also ridiculed for predicting the failures of the Roman, British, and Soviet empires. And yes, you are correct -- anyone can make a general prediction, but timing is everything.
Let me be clear on this point, however: I am not making a vague prediction; I am predicting, specifically, that the dollar is going to weaken to the point of collapse – along with many other global currencies, and that it's going to happen sometime in the next two years (probably sooner). Try to bear in mind that the U.S. has committed itself to almost $13 trillion just to battle this financial crisis alone, and that figure is 50% more than the government has spent on every single project, war, or undertaking since the country's inception, in real dollars -- combined.
Despite what you may or may not believe about my prediction, shorting long-end Treasuries continues to be a no-lose proposition. If by some miracle, the Fed manages to pull some proverbial rabbit out of its hat and fix this incomprehensible mess, then part of its solution, ipso facto, will necessarily be raising rates to maintain the integrity of the dollar. On the other hand, if my prediction is correct and the dollar fails, well, Treasuries are going to follow it all the way down. Yields have been hovering near all-time lows for months. There's no place to go but up.
HOW DO YOU GET INVOLVED?
The obvious and inevitable question is: what vehicles offer the easiest and most practical way to participate in some of these moves? Until recently, the only way the average investor could profit from such events was to use futures contracts or to take physical positions, both of which are cumbersome, complicated, and involve a great deal of maintenance. Fortunately, however, times have changed. In recent years, many companies have introduced exchange traded funds (ETFs), some of which even offer two- or three-times leverage. There are a lot of them out there, and I again encourage you to do thorough research before diving headfirst into any investment vehicle. In my own portfolio, I am using some of these ETFs, which I have disclosed below.
Disclosures: Paco is long TBT, UGL, and DXO. He also holds U.S. dollars by necessity, pending the advent of private gold-backed currencies.