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WHAT TO DO NEXT Part 2
In the last issue, I advocated steering clear of most stocks, investment real estate and any bond below investment grade. I also recommended buying the Japanese yen. I hope this advice helped you. When Part 1 of this CT was released Aug. 6, the Dow Jones Industrial Average was trading on either side of 13,500. The Japanese yen futures were trading on either side of 8,500. Since that issue, the yen has traded as high as 9,000 and the Dow nearly 1,000 points lower. On Friday, after the big news of the discount rate cut, the Dow closed at 13,079, with the yen at 8,806. It was a wild week, but with the Dow closing up 230 points on Friday, many stock investors went home feeling as if the worst was over. However, the fact is since the last issue of CT just two weeks ago, the Dow is still a lot lower. As of Friday’s close, it lost 500 points in those two weeks but has recovered about half its loss from the lows. OK, that’s the history. But what now? This is Part 2 of a special Commodities Trends presenting five viable, tradeable alternatives to stocks for these volatile times. Note that this issue is longer than most that I send out to you, but I believe it’s important if you're concerned about your financial health. In the last issue, I discussed my first two alternatives--buy six-month Treasury bills and buy the yen; and in this issue, I plan to present Nos. 3 through 5. These are alternatives I personally have invested in, trade in or am looking to diversify into. You won’t be reading about some of these alternatives in the mainstream financial press. The objective is to help you ultimately prosper in today’s world fraught with risk and uncertainty. The Federal Reserve's lowered discount rate may stabilize the market temporarily. In addition to the rate cut, the Central Banks of the world are printing excess money at breakneck speed. Sure, interest rates have come up in recent years, but they're really just back to what can historically be considered normal levels. The subprime mess will get worse, in my opinion, and a half-point or whole-point cut in rates won't solve this problem. The real problem has to do with derivative positions that were developed because of Alan Greenspan’s historically low rates. Although this may all lead to a continuing real estate deflation, in my opinion, it also will create commodity inflation in certain sectors much like during the 1970s. The Fed until now had indicated it was worried about inflation (and, therefore, was raising rates). But now Bernanke is saying, "To hell with inflation. There are bigger problems out there." My advice this week remains to steer clear of most stocks, investment real estate and any bond below investment grade. T-Bills still make sense. At this time, I'd place a stop on any yen purchases to assure a nice profit on that trade. And I present three other financial alternatives to stocks for these volatile times. First, let me explain once again (this section is a reproduction of Part 1 from Aug. 6) why I believe the stock market in general still looks to be risky right now: You might have noticed the plethora of IPOs, mergers, acquisitions, junk bond and other financing issues, new hedge funds and deals of all sorts in recent months. This type of mania often takes place just prior stock market crashes. It occurred just before the stock market crash if 1987 and then again right before the dot-com mania in 1999-2000. It occurred before the Japan crash in the early 1990s, the Southeast Asia crash in teh late '90s and, yes, even prior to the Great Depression of the early '30s. It’s the smart money’s way of cashing in and cashing out. I’ve observed this phenomena before, and believe I understand the reason so many smart people have been looking to cash in and cash out right now. The reason is the liquidity that fuels a bull stock market is fast drying up, and this could create a big problem not just in stocks, but also in a variety of financial markets. The liquidity problem was created by the Fed’s (Greenspan’s) easy money policy, and has recently come to a head with the subprime loan problems. At first, I didn’t fully understand what a contagious problem this was. Originally, I thought--like most investors--that the subprime problem only affected some naive home buyers and a few hedge funds. However, now I'm beginning to understand how this problem is a monster that is spreading and snowballing with implications for the entire stock market. Here’s why: We already know foreclosures are skyrocketing. The worst has yet to come. Before the end of this year, over $200 billion in subprime adjustable mortgages will adjust upward from the low teaser rates. Many subprime borrowers will see their monthly payments increase by 30, 40, and even 50 percent. And it's a fact that many more of them will default. How do I know this? Because it’s already happened on the billions of subprime debt that has already adjusted in the first half of this year. This is why two Bear Stearns hedge funds are in collapse and American Home Mortgage recently declared bankruptcy. With housing prices falling, these borrowers who though they could always sell their homes are finding out they have negative equity, cannot refinance and can’t sell. This problem hasn't been fixed yet. Here's the question this all hinges on: How many more are out there? I fear many more. Certain of these entities and hedge funds are getting singed and the investing public may not even have a clue. Many of the banks are getting burned as well. The yields on high risk money are going up, and this is the heart of the problem. The mergers, acquisitions, public offerings and deals of all varieties and sizes have one common denominator: They're fueled by cheap money. And because of the subprime problem, cheap money is fast becoming a relic of the past. It’s all related. As home equity evaporates, delinquencies go up, foreclosures go up, home equity loans go down, with consumer spending behind it. As the economy weakens, we buy less from China. Liquidity from China starts to dry up, affecting the global economy and even energy consumption fades. Oil money, which also fuels hedge funds and deal making, is less plentiful. There are other hedge funds on the wrong side of some of these positions, and other hedge fund collapses. More risk, more leverage. Cheap money is what got deals done. Cheap money is fueled by liquidity. Less liquidity means money is dearer and becomes more expensive, and this is definitely not a recipe for stock market success. And the US government has few options. Overextended with a costly foreign war, and trillions in debt, one of the only ways out is money printing. This ultimately creates inflation, causing rates to rise even further, thus exacerbating these problems. Stock market crashes generally are preceded by periods of prosperity, are seldom predicted. They're created by periods of easy money that turn into periods of tight money ultimately leading to money printing and inflation. You get the picture. This is the reason I personally have substantially lightened up on stocks (only holding those I consider very long term) and junk bonds. The bad loan practices and problems created by excess leverage won't go away with a few interest rate cuts. And this brings us to the meat of the matter. Here are Nos. 1 and 2 from the last issue, plus Nos. 3 through 5: Five Financial Alternatives (to Stocks) for These Volatile Times Financial Alternative No. 1: Buy Six-Month US Treasury Bills Six-month Treasury Bills are risk-free and, as we go to press, are yielding 4.18 percent. Note this is down from the 4.88 percent you could have locked in when our last issue came out before the discount rate cut. However, it's still not a bad place to park a major portion of your funds while you safely wait out a market shakeout. (You can check out current Treasury and other key rates here.) Financial Alternative No. 2: Buy Japanese Yen The yen has had a big move up since our last issue, and I'd use a stop to assure profits on this one. Now we get into three new alternatives. These are all based on my premise that a variety of hedge funds have been selling everything they own to raise cash for margin calls. In the mix, there are value markets with bullish supply/demand fundamentals that got swept down with the bad. Financial Alternative No.3: Buy Cotton December Cotton
Certain commodities with bullish, longer-term fundamentals have suffered in recent weeks because of the subprime liquidation. Cotton is one of them. It's not a financial instrument and has no subprime exposure other than hedge fund liquidation. It's one of those commodities many funds were long and were selling to raise cash for margin calls generated from other areas. American farmers planted only 13 million acres of cotton this year because they favored other crops; this is the lowest planted acreage in 20 years. Prices responded earlier this year by moving from less than 50 cents per pound to more than 65 cents per pound. However, in recent weeks, prices collapsed by about 10 cents per pound because of hedge fund and other margin call liquidation. December cotton closed at 57.5 cents per pound on Friday, Aug. 17. A 60 cents-per-pound December call option is currently trading at less than 2 cents per pound. This is a cost of less than $1,000 and the maximum risk should cotton prices fail to rise back above 60 cents in the coming 80 days. A move back to 68 cents (achievable in my estimation) would return approximately $2,000 net profit for every $1,000 invested. Sure, commodities are risky, but the stock market has also proven itself quite risky in the past several weeks. Cotton appears to have stronger supply/demand fundamentals than many stocks do right now. Financial Alternative No. 4: Buy Soybeans November Soybeans
Last week soybean prices dropped more than 50 cents per bushel and are now down more than $1 per bushel from the July highs. The sellers once again were hedge funds liquidating all varieties of assets to raise cash for margin calls. The buyers were end users. The end users know the projected carryover supply (at the end of this crop year next summer) will be very tight at approximately 200 million bushels. The longer-term price outlook for the soybean market remains bullish; China isn't going to stop buying soybeans from us. As soon as the market shows technical evidence of a turnaround, which I expect to see as early as this week, I plan to flash a new buy signal to my Futures Market Forecaster subscribers. There are numerous ways to get involved in the soybean market, and if you require more information and have a serious interest, feel free to e-mail me directly at geo@commodity.com. Financial Alternative No. 5: (Selectively) Short Dow Futures or S&P 500 Futures The purpose of the Dow and S&P 500 futures, and the reason the government allows them to exist, isn't for speculation but for hedging purposes. Speculators are essential to the process as they take the other side of the trade, but hedging is the purpose. By selectively shorting stock index futures in a down market, profits on the short futures will offset (hedge) paper losses on a stock portfolio. The advantage of doing this as opposed to selling quality stocks is that you can hold the stocks for the long pull and still collect dividends without being concerned about tax consequences on that side of the equation. The key is to use this tool when the trend is down and selectively be out of the short futures when the trend of the market appears to be up. The specifics and mechanics of how to do this are well beyond the scope of a free newsletter. However, if you have a substantial portfolio, it's something you may wish to study in greater depth. If you'd like to contact me with specific questions, please e-mail me at info@commodity.com. I wish you good luck and good trading during these volatile times.
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