Times of Uncertainty Mean Risk Hedges
Christopher Laird, October 1st, 2009
Page 1
I can't think of a better way to describe the last 2 years than as times of great uncertainty. Not only did we have two near catastrophic banking failures worldwide, but we also have the ever present Iran Israel nuclear contention. The USD held reasonably well during this period, although it's weaker. In any case, gold has held up amazingly well over the period of the last two years too, in fact is at highs. What else is except US T bonds?
Pimco's Bill Gross just said the longer term of the US T yield curve is flattening and that suggests markets expect deflation to be an ongoing concern. He moved to 44% US T exposure as a result for his total return fund. Since that is often considered gold bearish what does this mean going forward? It is hard to hedge USD risk and gold risk at the same time. But we think there is a very good hedge strategy that can accomplish both reasonably well, which hedges many of the risks out there, and still leaves a very strong gold upside if it occurs later when the USD inevitably falls in value. This strategy is a long term strategy, so it's worth looking into.
Uncertainly at a high
Well, for one thing, the dilemma of wither gold and the USD is being driven by uncertainty. In fact, the USD held up quite well during the last 2 years deleveraging - in the sense that it was around 70 on the US Dollar index USDX at its low about 1.5 yrs ago, and started climbing during the flight to liquidity (cash). US treasury bonds are at record low yields indicating that flight to cash is still very much in place. Money market funds are sitting on something like $2 trillion in cash at the moment (they also lost the US emergency guarantee recently). It is not safe just to sit in USD if you think there is deflation building because the USD is having major credibility problems. The GBP is in a lot of trouble too, and other central banks are still flooding out liquidity and lowering interest rates to just about 0. So what is a safe strategy?
And, as we said gold is at a high again around $1000, compared to later 08 where it dropped to near $700 after the Summer 08 commodity bubble crash. The other commodities are nowhere near their highs, even though copper has rallied a good bit, but the CRB commodity basket index is still near its lows. Gold recovered but commodities did not.
So what are some of the major uncertainties out there for the next 6 months? And how can we preserve our gains so far in this rather toppy stock market? Is there an ‘uncertainty strategy' that can account for stock risk, commodity risk, USD risk, bank risk at the same time? And of course war risk? Or are we locked into an ‘either - or' situation where its either USD or Gold hedging as if these are mutually exclusive?
Major sources of uncertainty affecting the world
- USD risk - (affects all USD denominated investments from T bills to CDs to cash to US stocks)
- Stock risk - (worldwide) world stocks rallied a great deal with a deteriorating economy.
- Deflation risk - Deleveraging worldwide causes flight to cash, stock selling and falling prices, wages and production
- Commodity risk - Tied to economic demand
- Gold stock ‘risk' - Inverse to the USD and other currencies and affected initially in stock sell offs due to flight to liquidity
- Financial system risk - Ever threatening world bank holiday and currency collapses
- War risk - A huge wild card that can immediately affect gold, oil, and the USD and war commodities
