Max caution alert: exit or hedge all market risk

This is one of those times where markets are stretched to the limit and any further upside will be minimal in relation to the extreme risk entailed. Sentiment has been dollar-bearish and risk-bullish for so long that a violent reversal is all but guaranteed. This is not to say that the absolute top is in, but that at the very least, another episode like last April-June is coming up.

Watch for a sharp sell-off in stocks, commodities and the EUR-CAD-AUD complex. Even gold and silver are vulnerable, especially silver. We could be near a secular top in silver, where the recent superspike has all but gauranteed an unhappy ending to what has been a fantastic technical and fundamental play for the last decade. Gold is much more reasonably valued and should continue to outperform risk assets because the monetary authorities are so reckless, but there is just too much froth in silver to hope for even that.

The rally since early 2009 has been not just another dead cat bounce in the bear market from 2007 (like I thought it would be), but another full-blown reflation and risk binge like the 2003-2007 cyclical bull. The secular bear since 2000 is still here, and valuations and technicals suggest that another cyclical bear phase is imminent. There is no telling how long it will take or how it will play out, but the only prudent move at times like this is to take all market risk off the table. Bears still standing should think about going fully short. Anyone holding stocks should sell or get fully hedged. History shows that the expected 10-year return on stocks from conditions like this is under 3.5%, and such a positive figure is often only acheived after a major drawdown and rebound. See John Hussman’s excellent research on the topic of expected returns from various valuation levels:

Want to know what a secular bear looks like? Check out 1966-1982: a series of crashes and rallies that resulted in a 75% inflation-adjusted loss. In the absense of 70s-style inflation, this time the nominal loss should be closer to the real loss. Think Japan 1989-who knows?

The headlines this time around should have less to do with US housing, though that bear is still raging. We’re likely to hear much more about European sovereign debt, where haircuts and defaults need to happen, and Canadian, Australian and Chinese real estate. When the China construction bubble pops it will remove a major fundamental pillar from the commodities market.

There is no safe haven but cash, and cash is all the better since everyone has feared it for so long. If I had to build a bulletproof portfolio that I was not allowed to touch for five years, it would be something like this: 20% gold bullion, 25% US T-bills, 25% US 10-year notes, 25% Swiss Francs (as much as I hate to buy francs at $1.13) and 5% deep out-of-the-money 2013 SPX puts (automatic cash settlement).

There will be a great value opportunity in stocks before long (the tell will be dividend yields over 5% on blue chips). It’s just a matter of having the cash when it comes, so that you aren’t like the guy who said in 1932 that he’d be buying if he hadn’t lost everything in the crash.


PS – For those of you who think QE3,4,5,6 will save the markets, I’ll counter that it doesn’t matter, not on any time frame that counts. Risk appetite and private credit are what matter the most, and the Fed can’t print that. At 3AM, spiking the punchbowl doesn’t work anymore.

Or I can put it this way: the Fed has increased the monetary base from 850 billion to 2500 billion since 2007. Have your bank balance, salary and monthly bills increased 200%? If not, why should stock and commodity prices? Not even Lloyd Blankfein is 200% richer than four years ago.

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34 thoughts on “Max caution alert: exit or hedge all market risk

  1. Gold looks vulnerable to $1000/oz here when the music finally stops for risk–GDX is having trouble getting past its Dec 2010 top and if you look at a chart of silver and gold, it looks like gold is just getting dragged along somewhat unwillingly.

    Would it not be better to wait for a correction to get the 20% portion of gold in the defensive portfolio? If you agree, where would you be looking to add?

    Also, with all the pure hatred for US bonds, in light of the Kabuki debt limit farce, might it be better to take that percentage up on weakness between now and July–when USA CONgress-critters are likely to vote to continue to get paid?

    Why are Swiss francs better than USA dollars in the coming bear market?

    I like the point about the dividend yields. In history of the market the S&P 500 dividend has gotten above 6% at the bottom of bear markets. We were not that close in Winter 2009.

    Thanks for you commentaries and please continue to post!!

  2. Sure, the timing now is not ideal on CHF and gold (all-time highs in each on hugely bullish sentiment), so you’d probably get an opportunity to enter much lower. 10-year yields are pretty attractive right now though. I wouldn’t bet on further bond weakness this year.

    CHF is not necessarily better than USD. I just added it for some non-dollar cash. Could as easily be CAD I suppose, though again this is an awful time to be trading out of dollars.

  3. Oh, the attraction of CHF is that Switzerland is the most stable country in the world, and though the CHF has been purely paper since 1999, the central bank is pretty conservative as far as they go, as is the voter base.

  4. Yikes–CAD–no thanks–they still have a RE bubble like AUD and China. Swisses sound rock solid compared to Canucks :) !!

  5. Yeah, as bad as the dollar is, there’s nothing better. Now that gold is pricey and silver is a clear bubble, the buck is the safe haven at the moment.

  6. Indeed Silver has gone parabolic and many are pointing to an eventual correction … when? Gold has spiked as well but on average, if gold moves 1%, then silver will move 1.2731%. So a coorection of Gold back to $1100 will mean a much wider correction in Silver.

    Some interesting info: On October 1, 2011 the extremely relaxed lending guidelines for the FHA, Fannie Mae, and Freddie Mac will begin tightening.

    In higher priced cities the maximum loan amount for Fannie Mae and Freddie Mac jumbo loans will fall from $729,750 to $625,500.

    In lower priced markets that are currently dominated by FHA insured loans, the maximum limits will also be falling. For example, in Minneapolis the FHA loan limit will fall from $365,000 to around $275,000.

    This means a lower supply of buyers (lower demand) on the market.

    This lower demand will coincide with a surging supply of homes as shadow inventory continues to enter the market.

    (Lower demand) + (Higher supply of homes) = (Home price declines)

    Unless………the government steps in to relax lending standards further as prices once again begin to plunge. This is a very likely scenario.

    As the United States continues to provide 97% (or more) of the mortgages to home buyers who cannot afford them at these prices, the government will continue to take massive loan losses, which in turn will be paid for with higher budget deficits. Higher deficits will reduce the demand for US dollars from both foreign and domestic investors. In addition, the Federal Reserve will have to increase the money supply to fill the void. Let’s take another look at the updated economics cause and effect example:

    (Less demand for US dollars) + (Higher supply of US dollars) = (Lower Value for US dollar)

    Cause and effect.

    Then one step further:

    (Lower Dollar Value) = (Higher Gold and Silver Priced In Dollars)

    If asset market buoyancy indeed was an intended goal of the Federal Reserve’s monetary actions, well … they got it; but will it restore confidence enough to improve the lending situation?

    If it does not, would a third round of quantitative easing do the trick? Dallas Fed President Fisher, for one, has noted on several occasions now that banks have sufficient liquidity, and they just need to get the money out into the real economy; there’s nothing more the Federal Reserve can do. Maybe Bernanke will hint at the same on Wednesday. But that may be a long shot … since quantitative easing expectations have been a major drag on the US dollar; and a weaker dollar is
    certainly welcomed at this stage of economic recovery as it makes US exports more competitive.

    But you have to wonder whether Fed intervention is setting the US up for longer-term economic evils in order to alleviate the near-term pain.

    The fate of the US dollar is in the hands of the Federal Reserve this week. Their direction is widely understood, but maybe they’ll surprise with a change in tack.

  7. The Fed controls nothing except short term interest rates. Debt limits are a Kabuki exercise of political BS.

    QE is the new name of the Greenspan/Bernanke put–we saw how well that worked all through the current century. When the current bubble bursts, the US dollar will surge as it has in 2000, 2008 and 2010. It is called unwinding of the carry trade.

    Our RE bubble has popped–next up the other half of the world including Canada, Australia, Brazil. China, among others.

  8. Mongol$ up, Sgp$strong, but S’por is island w/ no water,
    resources, fuel, must import all. Jim. Rodd-
    gers moved to SP, Mac Faber to Thai., nice views but
    all will suffer in fuel, resources shortages?
    . s e e F o ..F 0..A…4 1 1 on ‘hyper inflation…’ only
    AU will shine and vips know that w/ us$6 t in pvt. hands.”

  9. Mongol$ up, Sgp$strong, but S’por is island w/ no water,
    resources, fuel, must import all. Jim. Rodd-
    gers moved to SP, Mac Faber to Thai., nice views but
    all will suffer in fuel, resources shortages?
    . s e e F o ..F 0..A…4 1 1 on ‘hyper inflation…’ only
    AU will shine and vips know that w/ us$6 t in pvt. hands.”

  10. Based on

    there are 367,300,000 shares of SLV. Today around 3 PM volume was at about 160,000,000–that far exceeds any trading volume for a day–in November 2010 there was a day when 149 million shares traded.

    The last two trading days April 20, 21 traded around 190 million shares. So it is likely we have close to a 100% turnover in the last three trading days.

    Pretty amazing. Wonder who were the dumpsters and the dumpstees? (LOL)

  11. Wow. BTW, I’ve been wondering why the PM stocks haven’t performed as well as the metals this time around, as compared to the late 70s-1980 run. I think it may be due to two factors: 1) there has been a huge number of new companies created in Vancouver, Toronto, London and Sydney; 2) easy access to bullion through the ETFs – in the old days you needed a futures account, and few people bothered.

    The miners have been a big let-down for most investors so far, with some stunning exceptions of course.

  12. Hi all–it’s Uncle Bucky, here–also know as the US dollar. I first of all want to thank Mike for his kind words. He didn’t have to do that , since about 95% of the population think my death is imminent. Of course most of that comes from various websites including such things as “Dollar Death Spiral” or I’d say from the tone of these sites, R.I.P. is assured for me there, although it would be a stretch to say it had anything to do with peace.

    My obituary covers the web these days and so it goes. Traders and bankers use and abuse me as I am sold short on margin so that the “evil speculators” as our fearless leader has remarked can buy anything that is going vertical on margin.

    It has happened in most risk assets these days, especially in things like cotton and silver. While I am on “death’s door”, there isn’t much I can do but go along for the ride. What was that old song–”I’m your vehicle baby, I’ll take you anyplace you want to go.” LOL

    But you know, silly season lasts only so long. My friends the commercial traders have been hedging ole Uncle Bucky through the futures exchange and they have built up a net long position. But lately they have been dumping my long contracts, meaning they are preparing to hedge the other way and unwind the carry trade.

    You can see it on my chart (hehe, you would think I was in the hospital):

    The green line down at the bottom, that tracks the commercial hedgers position is the risk market’s pulse and like in mid 2008 and early 2010, they are starting to look sick as the green line approaches the zero line.

    At any rate, with all the bubbles in the world, chief of which are the continuing real estate ones, its only a matter of time before investors will have a better attitude when it comes to Uncle Bucky. It may not be as strong a love as the early 80s when I was in all my glory and short term interest rates were above 15% in the USA, but it doesn’t take as much to brighten the spirits of an ole man, err currency. Around 100 should do the trick this time around–by then nobody will want to touch risk and the kind feller here will get some bargains.

    Take care and see you at the top–100 or bust.

    Your pal,
    Uncle Bucky

  13. Hmmm!!! Another obit to add to the crescendo. It is nothing new really and there are no websites that takes a charitable view of me, except perhaps the Bureau Of Public Debt one. Those kind folks track the performance of my brother, US treasury debt. They are perhaps the most honest of any public agency in the world, tracking USA debt to the penny 24/7.

    I must say my brother has certainly been forging ahead lately amid the catcalls and raspberries of the bond king and other so called media gurus (some of whom have forsaken their native land to escape before the coming “collapse” of yours truly).

    It is somewhat stunning to see US t-bonds forge ahead in an environment of total hatred, almost as deep a loathing as there is for me. Sometimes it signals a sea change that is not being picked up by herds of investors who are throwing themselves at what continues to go up. We will just wait and see, but investors in treasuries are sometimes the first to get it before the crowd does. Time will tell.

    Looks like I have just put in another 3 year low–cousin Ben will be speaking today. Rock-a-by my children, rock-a-by!!


    I have recently come across this blog and highly recommend it if you would like to expand your economic understanding past banksta and propaganda.

    Today I read where one very well know blogger (Mish) decided to cash in his silver and put the proceeds into gold. I also got a call from my boss who said that someone he met on his travels told him to do the same.

    This sort of thing is crowding, but more importantly, I can’t really understand the legend of gold. Don’t get me wrong, I am a long time gold bug, but what we are seeing now is exactly what I remember in the early eighties–mania that will end badly.

    I’ve read all the arguments for PMs. I’d say investors in the depression (1930s–not the one we are in) had it a lot better on the PM front. Then, a company like Homestake was virtually a monopoly, paid rich dividends and the price of its commodity was fixed at a stable high rate (for the time) by the US government.

    These days you have wide eyed cats talking about hyper-inflation when upwards of 20% of the population is unemployed and can’t make ends meet regardless of the consumer price level. How hyper-inflation or any long term price surge is going to happen is beyond me. Government default and collapse are political hocus pocus that remind me of a tornado warning where the commentator has you jumping in a ditch one moment and then tells you in the next breath that the threat is over and we now return you to your regularly scheduled program.

    There is no support for the current level of PMs or any other commodities–no government is supporting them, other than possibly buying them and that can stop at any time if economic conditions get dodgy, especially in over half the world that still have ongoing RE booms. The only support is some imaginary line on a chart and everybody is looking at the same chart on their charting software, so we know how that will probably work out.

    Like the article points out–capitalism has regressed into a version of short term bubbles that harm the general population, enrich the bankstas and political class and then are destined to pop. Lets hope when this one does, we can break away from this madness and start thinking about how we can make the work better instead of listening to some sociopath fed-head tell us that inflation is transitory and deficits must be cut while he funds his fellow bankstas to loot us and ultimately crash us again.

  15. Nice charts. The last one shows how tight an inverse relationship exists between commodities and the dollar. Result of a massive carry trade of course.

  16. Mike:

    What is the most cost effective way to go long the US dollar? Not asking you to recommend the US dollar, just looking for any alternatives other than UUP–for use in an USA IRA (short of just being in a money market fund).


  17. That’s a tough question. I prefer to just buy the futures contract, but in an IRA I don’t know what I’d buy besides UUP since derivatives and shorting are out of the question.

    UUP is not bad though – it could easily move up 10-20% in a few months, which is not bad if everything else falls at least as much.

  18. I might also think about adding a touch of TLT (20+ year Treasuries) or TLH (10-20 year) for extra oomph, though I’m less bullish on bonds than the buck on a longer time frame because we must be fairly close to a secular top there, and I’m not comfortable chasing the last few points of a move.

    On the other hand, it’s a great time to just relax and sit in cash.

  19. Been looking around and can’t really find any alternative to UUP–started averaging in yesterday after Benron yapped the day before.



    If you look at late 1999 and early 2000–that is what makes me a bit nervous about t-bombs. Sometimes you have to have dollar strength before you have t-bomb strength–and who is to know if there is some carry trade on them. That is a confusing chart–but t-bombs took some big drops late 1999-early 2000 and in 1987 . Funny, I don’t know what 1987 would have in comon with today!!! :)

  21. Well, the relationship of the dollar with the risk trade is also new. These things come and go.

    Bonds did drop in the 1987 crash, but the bond crash in late 1999 happened before stocks started to fall in Q2 2000.

  22. The last 2 Signficant US bond market rallies have been lead by dollar strength.

    3/17/2008 UUP 22.79 and TLT 97.18
    10/27/2008 UUP 26.50 and TLT 92.83
    but then by 12/15/2008 UUP 24.74 and TLT 122.26

    11/23/2009 UUP 22.26 and TLT 96.40 (in Spring ’10 TLT was around 87)
    6/1/2010 UUP 25.77 and TLT 97.79
    but then by 8/16/2010 UUP 24.13 and TLT 106.04

    It’s like the carry unwinds out of anti dollar currencies and risk and later rotates into treasuries.

    The TLT performance in 2008 was especially chart and techie defying . While TLT showed strength in mid-2008, it then showed a period of lower highs and lows in fall 2008 to shake many investors out (during the dollar strength) before it zoomed in November and December.

  23. The dollar and Yen are “safe havens” because they are the lowest yielding currencies. At the other extreme are the Australian dollar, Brazilian Real, etc.

    Treasuries are safe as long as the U.S. economy remains weak (= no Fed hike).

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