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Global Macro Notes: Long Gold Stocks, Short Retail

|Includes: VanEck Vectors Gold Miners ETF (GDX), XRT

In April of this year, I penned a think-piece titled “Keynesian Psychology With Austrian Tails,” detailing the latest upgrade in my philosophical growth path as a trader.

The gist of the piece was that, while the Austrian school offers the more true and correct view of economic reality in the longer term, Keynesian psychology — “the triumph of hope over experience” — can and does dominate the short term.

The net result, in terms of market action and consistently repetitive cycles, is drawn out Keynesian ramp-ups followed by infrequent yet inescapable “Austrian tails,” in which the hope-jaggers face a violent comeuppance.

The bulls are thus in danger of being “rocked like a hurricane” — because the scorpion sting in the “Austrian tail” is upon us.

This is bad news for some, but good news for others. We are well-positioned for what’s next via two aggressively juxtaposed themes: long gold stocks / short retail.

As I write this note, the GDP revision number is just hitting the premarket — gold and S&P futures both up a little, meaningless thus far — and the talking heads are already turning to the big Ben Bernanke speech from Jackson Hole.

Hedging Bernanke

Speaking of Bernanke and Jackson Hole, does anyone else find it sadly amusing that investors are so transfixed by what one man has to say?

In his masterwork “On Human Nature,” sociobiologist Edward O. Wilson explains how the shamans of old functioned as the cohesive glue of society. Back then, the local witch doctor was judge, jury, and sherriff all rolled into one, enabling tribal societies to function before any of those roles had become formalized.

These days, the Chairman of the Fed is our modern shaman — the financial witch doctor for the global marketplace, giving the masses a vessel to put faith in (and a false sense of hope that someone is in control).

As far as the Great Shaman Bernanke’s impact on the market is concerned, here is our encapsulated view:

  • The U.S. economy is slipping into a classic liquidity trap.
  • This is, in part, a result of the U.S. economy being strip mined.
  • The Federal Reserve has neither the will nor the way to get us out.
  • Instead, “QE lite” measures will keep us limping along at best.
  • A necessary deleveraging trend will continue apace.
  • Stimulative monetary policy will amount to pushing on a string.
  • This environment is poison for “old normal” discretionary retail names.
  • In contrast, it is a highly constructive backdrop for gold stocks.

Why favor gold stocks here? Because, in addition to an excellent track record in the Depression (early years 1929-1935), gold stocks are the logical beneficiary of “pushing on a string” monetary debasement efforts that fail to revive the real economy.

As all paper currencies get debased — and especially if fiat currency debasement is coordinated on a global scale — “gold in the ground” starts looking more and more attractive as a long-term store of value.

Recent action in the Market Vectors Gold Miners ETF (NYSEARCA:GDX) gives a good example of how the swing trading process works. We are currently aggressively long GDX as a core position, along with a number of other individual gold stocks, some of which were added to on strength this week.

In last week’s notes the GDX position was highlighted, along with an outlay of our long gold stock / short retail thesis.

Since that time, however, GDX made a “fakeout move” to the downside that took us out at breakeven… and then recovered nicely, giving us the opportunity for reentry.

As a matter of discipline and habit, the Mercenary method requires moving the risk point to breakeven as soon as it becomes feasible, as a means of reducing volatility and risk by requiring a position to “act right” from the get-go.

When a position throws a “headfake” — as often happens in a competitive market environment — we are not hesitant to step aside with the main aim of reducing risk, knowing we can always get back in (and do get back in!) as price reconfirms.

In the case of GDX, the reentry point was 41 cents worse than the initial, but this is of little consequence. For the swing trader, the benefits of consistently reducing risk will always outweigh the trade-off of a slightly worse “getting back in” price if thematic conviction is maintained.

On the retail side, our exposure is similarly balanced between a sizable short position in XRT and a number of complementary individual equity shorts. The vast majority of these positions (including our XRT short) have been locked in at breakeven, giving us a “free ride” on further downside.

We are also long dollars and short high-yield debt, for reasons well articulated by Mike McD.

Swing is the Thing

As a side note, there has been a lot of chatter lately about how tough these markets have been. Many short-term traders have found themselves vexed by the seemingly irrational action. The aim of the Mercenary method is to sidestep most of this “churn concern” via a few key factors:

  • The development of high conviction “top down” related themes.
  • A willingness to reduce risk quickly by moving positions to breakeven.
  • An equal willingness to risk small profits in pursuit of large profits.

Think of it like starting a lawn mower. When positions are established and the market falls back, it is like yanking the lawnmower cord and having nothing happen.

This can be a frustrating experience, obviously. (Who hasn’t cursed at a lawnmower in their day?)

But here is the thing. If pulling the cord doesn’t cost you anything, then having a “non-start” is fine. Because you get the chance to pull again — and again — and even yet again if need be, with no real cost to your capital base. And then, once the lawnmower roars to life, that’s when things really start rocking and rolling.

The swing trading metaphor here is in respect to being stopped out at breakeven. It’s ok to be stopped at breakeven, multiple times if need be, if the net result of your actions is the ability to have a suitably large position in place when a real move occurs.

That is the way to generate large returns with large sums of capital. And that is what we are constantly looking for — high conviction themes with lots of “runway,” in which a solid position established on a low-risk basis can result in exceptional profits from the ensuing breakout trend.

Three other quick notes of consideration:

Bring Me That Horizon,