Hedgephone’s Macro Market Outlook for June 12, 2011

        So far this year, our long gold and short IWM pairs trade has held up quite well… At this point, we are looking at Silver here for an interim buy signal but we realize that the metal could get hurt if additional stimulus measures are not undertaken. Keep in mind, that silver moves in parabolic moves up and down. For example, Silver lost 50% of it’s value in 2008 and when the 1970′s Hunt Brother bubble popped the entire %1,800 gain was pretty much erased in about one year. I am not bearish on Silver, however, as I think we have seen a near term correction in the longer term bull market. The reason I am bullish Silver is the quadrillion of derivatives contracts outstanding and the massive budget and entitlement deficits in the U.S. — the Fed is already levered to the hilt and all of the leverage in the system is quite bearish for the dollar and therefore bullish for commodities in general and specifically bullish for Silver which has been in a 100 year bear market and was viewed as money for thousands of years, with a relatively stable mid-evil 16-1 peg to the price of gold. Today, Silver is much less abundant than it was 200 years ago yet the ratio of silver to gold in price is around 40-1. Additionally, with China’s 400% increase in Silver demand due to increases in RFID, Solar Panel manufacturing, biocides, etc… Silver appears to have much more favorable non-investment related supply and demand characteristics than Gold and most other commodities. The fact that Silver has traditionally been viewed as money has likely not been priced into the commodity at all as of yet.

       What is driving the fall in silver? Likely the fact that Silver has historically seen massive run-ups followed by massive collapses in price. In 2006 for example the metal was just $10 per troy ounce whereas today the metal is 360% more expensive — clearly a monster parabolic run has been seen over the past few years, but on an inflation adjusted basis this increase still puts the metal 400% from the highs of the late 1970′s while the supply of Silver is far lower and demand far higher than it was back in the days of the Hunt Brothers.

       Another reason that silver has been under pressure lately is the current crash in equity prices — the Dow is now below $12,000 while the S&P 500 is now down 7% from the year to date highs. Is this the start of a new bear market for equities? The real question is what will happen to the U.S. Dollar — if the U.S. has entered into a new era of monetary collapse, stocks are not a good short because fundamentally shorting stocks is not only a bearish bet on U.S. businesses and equity valuations but also an expression of bullishness on the U.S. Dollar as equities have been a good inflation hedge in some cases during hyperinflation such as in Wiemar Germany where stocks kept up with around 30% of the increases in the price of Gold — IE gold and silver are likely much better investments than equities during hyperinflation but betting against equities has not always worked during the collapse of central planning regimes and currencies throughout history.

       The case for a long Gold and Silver and short Equities position is also quite clearly logical if viewed in the context of other periods of currency collapse in several countries throughout history.

       At hedgephone.com we are students of history, and we have studied currency collapses in several nations and the affect on various asset classes in each case. For example, when the Soviet union collapsed and the Ruble was devalued, Russian stocks and currencies both plummeted at the same time. It was better to stay long Gold and short stocks during the collapse of Russia because Russian equities dropped some 80% during that period of time. In Latin America several currency collapses also confirm a long Gold and short Equity position makes sense. During the currency collapse of Mexico and Argentina the stock markets in these countries were decimated in both real and inflation adjusted terms, meaning a long Gold, foreign currency, and short stock position was the best play on collapse of currency. When Mexico’s Peso was devalued in the 1980′s Real Estate was not a good place to hide because you could not collect higher rents — rents remained exactly the same while costs went up dramatically for things like lumber, cement, paint, etc… Stocks, likewise, did not receive a Wiemar effect as did Germany’s stock market in the 1930′s.

       All in all, we are in a very weak position economically but at the same time the trends behind the long Gold and short Equity trade remain in place — with that said, at some point we have to convert paper profits into cold, hard cash. In my view, the logical trade is to convert that cash into a more stable currency. Many of the commodity based currencies such as the Australian and Canadian currencies look much more stable than the U.S. Dollar but at the same time if the global economy crashes these commodity based currencies will face additional headwinds. All in all, it seems to me that most paper currencies suffer from the same risks and headwinds over the next five years. The hard part about investing in this environment is that nothing is completely safe — if we let the deflationary forces behind a weakening GDP and economy take hold, holding

gold and silver may be more risk than one can stomach. I feel a good mix of currencies both domestic and foreign as well as a good mix of physical silver and gold held in your own bank vault or private safe beats treasuries as the yields are so low that opportunity costs make a 1% yield simply too low to make any sense. Owning a diversified basket of currencies in nations with surpluses and also physical gold, silver, and farmland seems to be the best policy for investing going forward.

       Likewise, residential real estate and high yielding cash flow positive farmland seem to be better investments today than stocks and are a good diversification tool for investors holding as mix of cash, gold, silver, foreign currencies, long and short equity positions, etc… Real estate in south Florida, for example, seems to be quite reasonably priced. I am currently in S. Florida looking at properties which should yield a 15% cash on cash return and an even higher return when a mortgage at 4.5% is taken out against properties which have declined some 75% from their highs in 2007. When markets crash 75%, we start to get interested in longer term investments here at Hedgephone.com and residential real estate is starting to look quite attractive to us in S. Florida at present prices. Property taxes, hurricane insurance, tourism, etc… are all factors that need to be investigated but the discount to rental cash flow seems more than enticing at present valuations for many homes. Yes, the overhang of mortgage paper and supply is a worry on a nominal basis, but if you are worried about inflation a mortgaged property which is free cash flow positive is a good way to mitigate your risks. Additionally, rents are unlikely to fall by 40% which is essentially the level needed to put your investments at a longer term risk. I am not suggesting investors should rush out and buy real estate, but I am suggesting that the longer term picture seems to be better for Real Estate than stocks and could possibly be better for Real Estate than Gold. Currently, Gold is in a bull market while real estate is in a bear market but longer term these trends could reverse if fiscal discipline is implemented in Washington. All in all, we feel wide diversification is prudent and that shorting overvalued tech bubble equities is a better hedge and a more conservative investment approach than owning U.S. treasuries at 2.5%.