Over the past twelve months, many economists and investment professionals (along with the occasional politician such as Ron Paul, and more recently Gary Johnson) have been warning Americans that a severe dollar collapse was likely given the U.S. government's view that the economy was in severe dire straights, just as it was in the Great Depression. Fed Officials and most politicians also warn that the only way to fix these problems (in their myopic and incorrect view) is to simply print more money and heap more and more layers onto our already spiraling national debt. Those who argue that the debt increases are actually beneficial must either be hard asset bulls or live in a world where food and fuel are not an important part of their daily budgets (ie. the super-rich and their well-lobbied political string puppets).
The Quantitative Easing argument hinges on several "truths," which are used to manipulate the populace into believing that the only way out of our current stagflation dilemma (let's call a spade a spade here) is "growth" and even more inflation. In fact, many times our leaders have proclaimed that we as a nation need to "Grow our way out of this" current economic malaise. In the 1930s money printing (quantitative easing) helped to relieve the economic stress caused by the stock market crash and the credit collapse that sent many depositors into mass panic and to mile long lines to withdraw their savings in a bank run. Today, we have just the opposite problem, massive inflation and too much debt, and are trying to cure that problem by adding fuel to the fire -- intentionally creating more inflation.
Today's problems are significantly different than those of the Great Depression. Over the past fifteen years, our leaders have decided that we were in a constant state of recession and kept interest rates as low as possible to spur economic growth. Each administration successively borrowed more and more money to expand the economy with the view that future administrations could simply pay that debt back via a growing nominal GDP. The thinking goes that with inflation and economic expansion the debt would be reduced as the buying power needed to pay that debt back would be significantly boosted in nominal terms with a rising economy and a booming stock market, which would also help their political ambitions. In other words, with inflation the thinking goes, the debt in real terms would be significantly reduced while the leverage would actually help the economy to grow over time.
The short-term "print, borrow, and spend" mindset created by four year election cycles works wonders for politicians looking to get re-elected as it paints such leaders as "visionary" innovators who are looking to make America a better place despite a tide of rising prices, which is easy to blame on outside supply and demand factors or other countries. By playing this economic blame game (after all, economics is a confusing, subjective subject, right?) and by claiming that inflation was a supply and demand problem and not a symptom of too much debt and money supply expansion, politicians have slowly out bluffed the American public into forgetting that an ounce of gold cost just $200 an ounce a few years back or that gasoline was selling for $1.50 a gallon just eight years ago while the stock market has barely budged over the same period of time. By the "reality standard" we have all become a little bit poorer unless we became gold bugs very early on like Jim Rogers.
As long as the stock market goes up, politicians get re-elected -- this is the mantra followed by many in office, and the ultimate boost to stock prices is more money printing and more deficit spending. This catch 22 of inflation and deficit spending was precisely why the founding fathers required that our nation was to have a currency based on gold and silver (a commodity, which governments cannot just print at will). It is of no coincidence that a well known crook, Richard Nixon, would be the "leader" who eventually took us off this constitutionally required currency standard and moved us toward what we have today -- a system based on "hope" and fantasy. Could the boom of the 1980s and 1990s be followed by a hangover far worse than anyone has previously imagined (anyone, that is, other than our forefathers and many astute economists who understand inflationary pressures)?
Flash forward to the economic collapse of 2008. Our so-called leaders cried out that if we don't bail out our failing financial institutions, ie the too big to fail banks who recklessly gambled with their customers' funds, the country would spiral into a state of anarchy and martial law would be declared in America to prevent chaos. This fear-laden, strong arm tactic used to simply flood the economy with more debt and more spending (along with more freshly printed U.S. Dollars) had the effect of postponing the long overdue de-leveraging process, which our country so desperately needs to move forward. The end result was that stock markets and GDP growth could resume their short term upward climb and the proverbial can could be kicked down the road a bit longer toward the ultimate day of reckoning.
Such a tactic is fine, if you are already wealthy or if you are in a hard asset business, because more money printing and more debt simply lead to higher levels of inflation and higher prices for any asset priced in Dollars. Such a result is viewed by many economists and many wealthy citizens as a positive since they view inflation as a way to cure the debt, which is now worth less on a purchasing power adjusted basis than it would have been if we decided to cure the illness we face by paying off our bills and leaving monetary policy alone. The major problem with an "inflation is good" approach is that it does not take into account the fact that natural resources are not in infinite supply and furthermore that this type of manipulation does not promote a free market in which all players have to play by the same rules. In fact, over 400 banks will fail before the crisis is over and those institutions that were bailed out will necessarily become even more large and onerous. In effect, by failing to cure the nation's problems at the root, the big banks essentially hold Americans hostage because they are now "too bigger to fail" and we are basically living in a fiat currency world where the Fed's twelve member banks are our financial overlords whether the populace likes it or not.
What is fairly clear to me is that the Fed will not tolerate the needed deflation or the breakup of its member banks (and because the member banks actually own the Fed it is even more unlikely that the nation will do the right thing and break this banking cartel up in any significant fashion). Therefore, as investors we must view the game for how it is obviously played -- inflationary forces will persist against the backdrop of a relatively overvalued and overbought stock market until a massive correction is allowed to happen and a real de-leveraging begins. Here are 18 ways to play the inflation side of the money printing and debt expansion trade. In my next article I will delve deeper into the 12 member banks and how "saving" them has helped create the latest waft of inflationary malaise. I will also explain how to hedge against another asset price collapse if we are to reign in the printing presses after QE2 ends in June.
SGG -- Long SGG and long PEP in Similar amounts -- This is a trade I first recommended early last fall and one that has worked quite well over that time period. SGG is the Sugar ETF and Pepsi investors have to wonder if higher sugar prices will hurt the value of their common stock. By owning both, investors have a more defensive approach to investing in both the commodity, which offers no yield and the stock, which is seen as vulnerable to any rise in the price of sugar.
PEP -- Long PEP and SGG in similar amounts -- Pepsi common stock is fairly cheap at just 14X forward earnings and 10X EV/EBITDA. Pepsi is not a value play on assets; however, as the balance sheet has little to offer as far as margin of safety is concerned. Conservative income investors should consider selling the front month out of the money call options at, say, the $67.50 strike price to add a bit of downside protection and/or income to their PEP holdings.
FCX --Short FCX December 2012 $55 Put Options -- Freeport has been on a tear lately and is up almost 25% since a recent low in the $48 range just one month ago. Investors looking to add copper exposure and a Dollar hedge should sell the $55 puts here for added margin of safety and should wait a bit before entering the name given the large recent run up in FCX shares. At a forward PE or around 9X, investors are not overpaying for this name, in my opinion, on a valuation adjusted basis.
NEM -- Short NEM December 2012 $50 Put Options -- Newmont is both a relatively cheap stock and a company that is extremely leveraged to the price of gold. NEM shares have underperformed recently which makes their appeal even more palpable to the prudent value investor. Selling the At the Money Leap put Options is a more conservative way of entering the stock than buying shares directly and also ties up less capital.
VALE -- Long VALE with covered calls sold against the stock -- Vale is an iron ore and metals miner in Brazil, which is markedly cheap and could be a great hedge for investors who are concerned about the value of the U.S. Dollar going forward. Selling the front month calls against this position seems to be a conservative way to play the name, which trades for around 7X analysts projected forward earnings.
PBR -- Long PBR common and short the monthly calls against the stock -- Petrobras has become more confusing since the government's large investment into the company, but on a reserve basis the stock may be even cheaper than ever before. Investors may want to consider covered calls on this position.
RJI -- Long the Rogers International Raw Materials Index Fund (ETN) -- The Rogers Funds have proven to be fantastic hedges against rising inflation and the falling value of the U.S. Currency. Investors long this basket of Raw Materials should understand that this is an ETN and not a typical index fund. The fund carries a particularly low expense ratio, however, and is optimal for those who are less worried about a second financial crisis than they are about rising inflation.
RJA -- Long the Index Fund (ETN) -- The Rogers Agricultural Index is a good way to bet on rising food prices. Like RJI this fund offers a low expense ratio and can help investors capitalize on the trend of rising commodity prices.
DJP-OLD -- Long the Index Fund -- This diversified commodity index fund is based on futures contracts and is a good way to add diversified commodity exposure to a portfolio of stocks and bonds.
UUP -- Short the US Dollar Index -- The U.S. Dollar has broken long term support and the bottom does not appear to be anywhere in sight. Shorting the UUP is essentially a bet against the Greenback, as sad as this trade is it should help investors hedge their risks of Uncle Sam printing even more cash in the future.
PSLV -- Long the Sprott Physical Silver Fund -- This physical silver fund is held in vaults in Canada and may provide protection from the possibility that the U.S. Government will elect to confiscate precious metals at sometime in the future as they did during the Great Depression.
SGOL -- Long the Swiss Physical Gold Fund -- This index fund is based on physical gold stored in a vault in Switzerland, which gives investors a dual hedge against the price of gold rising and the value of their paper Dollars falling.
GLD -- Long GLD calls -- gold continues to shine brightly at a time when just about nothing else works to the same degree. Frustrated value investors may want to add gold exposure through GLD calls and can view the position as an insurance policy against a crumbling U.S. Dollar.
RSX -- Long the Russia ETF -- the Russian economy is uniquely positioned to benefit from rising energy costs and inflation. Investors worried about nationalization or corruption should focus on index fund investing in the country because a shotgun approach carries less risk than betting on individual companies in the region. The low PE in Russia should provide investors with a wide enough margin of safety to make money on their position over time.
CVX -- Long the stock and short the front month call options -- Chevron has moved mightily of late but the stock still represents a good value if oil prices continue to remain at lofty levels. Investors in the stock may want to sell front month call options against their positions to add additional margin of safety and income.
GCC -- Long the Greenhaven Continuous Commodity Index Fund -- The Greenhaven Continuous Commodity Index Fund is a useful way to hedge your dollar risk in a basket of evenly weighted commodity futures, which also looks to protect capital from Contango (the risk created from the difference in price of front month and back month futures contracts).
DAL -- Short out of the money call options -- Airlines tend to be negatively affected by rising fuel costs as well as the consumer's inability to pay for expensive flights and travel as gasoline and food prices eat into a larger and larger chunk of their discretionary budgets. The same pressures could also hurt travel agencies and companies such as OPEN, TZOO, PCLN, etc...
IWM -- Long Leap Calendar Put Spread -- Small businesses with little foreign exposure suffer the most from inflation's wrath on economic activity and consumer spending patterns. As gasoline, rent, food prices, and other raw materials costs skyrocket small businesses with little to no overseas revenues suffer the most. Buy the January 2012 $90 put options and sell the May 2011 $80 put options to hedge your risks that another stock and commodity market downdraft hits the markets sometime this year.
Finally, investors and citizens in general may want to ask for some divine inspiration these days as times are more trying than ever for Americans and citizens of the world in general. What ever your faith, creed, or beliefs are it is clear that we should all hope that the forces of good can defeat the forces of evil in a time of rampant poverty and suffering. Good luck out there and remember to stay diversified and humble. Keep in mind that real assets have had a remarkable run and that there will always be corrections along the way. Also, remember that much of the rise in asset prices comes from Quantitative Easing and that once this is taken away, a severe correction could ensue, which I will discuss in my next article.
Disclosure: I am long FCX, PEP, RJA, SGOL, GLD, PSLV, PBR, RSX. I am long IWM calendar put spread, and long the Rojers International Raw Materials Index through the Private fund. I am short OPEN and OPEN call options