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John Paulson

|Includes: DRV, GLD, GLL, iShares MBS ETF (MBB), SRS, VMBS

When it comes to risk, Warren Buffett is famous for saying "It is better to be approximately right than precisely wrong" and in 2007 and 2008 hedge fund manager John Paulson was approximately right with a personal gain of 6 billion dollars and a profit for his clients of $20 billion. The bonanza dwarfed George Soros' billion dollar gain in 1992 when Soros wagered against the British pound. Paulson's bet on the collapse of the housing market propelled him from mid-tier hedge fund manager to king of the jungle on Wall Street and is the subject of a new book The Greatest Trade Ever by Gregory Zuckerman. In The Greatest Trade Ever, Zuckerman goes into great detail of how Paulson accumulated huge positions in Credit Default Swaps enabling him to make large bets with minimum risk in the real estate market. Unfortunately, as retail investors, we can't do the same. It's an area of finance that is reserved for the players with tens of millions of dollars.

However, retail investors do have options as to how to bet against the real estate market with ETFs. No, you won't get the kind of results that John Paulson did, but you can pick up a significant amount of money if you believe there is still another leg to drop in both the commercial real estate and retail housing markets. The most notable would be to bet against mortgage backed securities. After all, 23% of mortgages nationally are now underwater, meaning that the price of the house is worth less than the mortgage. The probability of an increase in defaults still a high percentage wager. There are currently two mortgage backed security ETFs that you can short, the iShares Barclays MBS Fixed (NYSEARCA:MBB) and newcomer Vanguard Mortgage-Backed Securities Index Fund (NASDAQ:VMBS). I wouldn't recommend shorting these ETFs because for one, you would need to have a margin account with your broker and two, this play may not be that liquid. Instead, I would opt for a simpler tactic by purchasing either the ProShares UltraShort Real Estate (NYSEARCA:SRS), which is 200% the inverse of the Dow Jones U.S. Real Estate Index, or, the Direxion Daily Real Estate 3x Bears Shares (NYSEARCA:DRV), which is 300% the inverse of the MSCI REIT Index.

When Gregory Zuckerman isn't writing books, he is the scribe for the Wall Street Journal's 'Heard on the Street' column and last week updated the John Paulson saga. It seems that Mr. Paulson believes the high energy gold trade of late still has a lot of mileage left on it and is starting a new hedge fund dedicated to the precious metal. In fact, Paulson is investing between $200 and $250 million of his own money in the new fund that launches January 1st. I couldn't disagree more with Paulson on his new investment. I think gold has run it's race and if it's not at the finish line, then it is certainly on the home stretch. The SPDR Gold Shares (NYSEARCA:GLD) currently fetch $115 on the open market up from $41.50 in January of 2005. That's a triple for an asset that didn't move for 15 years. The mass media has recently picked up on the gold frenzy and we are being bombarded with stories about the price of gold on TV and in newspapers and magazines. To me that is a contrary indicator. I would stay away from gold or short it using ProShares UltraShort Gold ETF (NYSEARCA:GLL) which is 200% the inverse of the price of gold.

I am not suggesting I get into a pissing match with John Paulson concerning his investment decisions, I just don't see eye to eye with him on his new endeavor. It seems as if he is trying to chase performance here when spent the last few years as an outlier. Whether he is right or wrong on his bullion bet is of little consequence because he's worth about $6 billion and losing ten or 20 or even 50 million dollars would be a drop in the bucket to him. If you have been following this blog, it will be of no surprise to you to know that The Ithaca Experiment portfolio is on life support. I still believe that asset prices are divorced from fundamentals and that the market is due for a major correction. In a psychological victory, the portfolio has been treading water for three weeks now with a meager gain of $400. At least it's not going down, but with December looming and the traditional Santa Claus rally on the horizon, we may be in for rough sledding.