One Investment Strategy for Q1 2011: Cash, Baby, All the Way

Despite my oft-avowed amateur-market-observer status, readers often ask me for advice or opinions on where to put their capital. This is not advice (please read the HUGE GIANT BIG FAT DISCLAIMER below), it is a disclosure of my own personal opinion, what we might call "one investment strategy of many possible investment strategies" for the first quarter of 2011: cash, baby, cash all the way.

Why am I in cash? Because I don't trust the parallel rallies, and I am extremely skeptical of the various "stories" which are driving the rallies. Why am I skeptical? Because everybody and their sister has bought into the stories, and a one-sided trade is rarely the winning one.

Yes, it's my contrarian nature: when everyone is a believer in a "story" that is too good to be true, then I become skeptical. This often gets me in trouble. When everyone was buying GM at $50, I was shorting it. When everyone was buying Fannie Mae at $60, I was shorting it (via puts). Both GM and FNM were obviously, painfully insolvent, but it took practically forever for reality to intrude on the fantasy/narrative that each firm was a "solid blue chip" investment with numerous analyst recommendations. In the meantime, I lost money treading water for quarter after quarter.

So even though the market is clearly top-heavy, the short-side trade may yet be ground down by the Fed's prop-job and the Wall Street/Central State partnership's desperate desire to use a rising stock market as a propaganda proxy for the "recovery."

(Hey, just borrow and squander roughly 13% of GDP, year after year after year (roughly 45% of the entire Federal budget), and you might stimulate a modest "recovery," too.)

So let's examine each of the "stories" driving the rallies.

1. The global recovery is solid, and Central State stimulus and quantitative easing will keep growth rising and interest rates low. This narrative drives capital into "risk assets," i.e. stock markets, commodities, FX carry trades, Chinese real estate, junk bonds, etc.

I'm not really sure where to even begin in throwing cold water on this "global recovery story." So 9 million jobs have vanished in the U.S., and a few hundred thousand jobs added in the past year is supposed to be "growth"? We're borrowing $2 trillion a year and blowing it on propping up the status quo, and this is all the job growth we get? That's beyond pathetic.

Mish has done stellar work dismantling the jobs propaganda, and here is my own modest analysis: What the rising stock market doesn't say about jobs.

Does anyone actually believe the Euroland debt crisis is "resolved"? To believe the "global recovery" story, you have to believe the Eurozone debt crisis is all fine now, fixed, done, history.

By all means, go ahead and risk your capital believing this story; I'll pass.

2. The rapid growth of China and India means commodity prices will spiral higher basically forever, so buy gold, silver, copper, cement, iron ore, tar sands, etc., it's only going higher--and soon.

The basic premise here is sound, but the story really boils down to this: China can expand its money supply by 55% every few months forever, without consequences. If you believe that, you need to actually get some on-the-ground intelligence from China. My contacts on the ground are reporting the official 5% inflation rate is an absurd joke--prices of some food items are doubling or even tripling.

And so a funny thing happens on the way to the projections of skyrocketing commodity prices: inflation eats everyone alive below the top 5% in China and India. When people can't afford to eat the way they have become accustomed to due to skyrocketing prices, then they get rather testy and irritated at the Powers That Be, and massive civil unrest is the inevitable outcome.

The Chinese authorities have aimed a toy popgun at the tsunami of inflation (their pipsqueak .25% rate increase) and I suppose the water receding has caused them to chortle in great self-satisfaction. But then the water receding is just the tsunami's warning signal, and the little popgun will soon be revealed as utterly inadequate to stem the inflation which is ravaging the common people's budgets in both India and China. You can't double your money supply and prop up a housing bubble (flats that cost 40 times gross income, is that sustainable? Believe it if you want, I'll pass, thank you) without unexpected and uncontrollable consequences.

Don't read the headlines and the propaganda, talk to real workers in these economies.

So what happens when money supply is throttled, the building boom goes bust, and development-dependent local government revenues collapse? Demand falls, and the commodity bubble pops. A huge amount of the "demand" for commodities was Chinese stockpiling, not true organic demand. Once they stop building empty malls and cities, demand doesn't decline--it craters.

3. Central Bank printing will drive inflation globally, which will drive up all tangible assets. Again, this is a sound idea but I get nervous when everyone is all-in on one side of a trade, and there are very few who haven't bought into this story.

But the market rarely rewards the 90% on one side of a lopsided trade. Usually it hands the 90% a big fat unexpected loss.

Look, $12 trillion has vanished in wealth in the U.S. alone. So the Fed (put on a funny hat, wave a dead chicken at the rising tide and shout, "recede, tides, for we speak for the mighty Federal Reserve!") prints $2 trillion and that's supposed to unleash a mighty wave of reflation?

What I see is the dollar arbitrage that is the foundation of U.S. wealth has, in combination with unprecedented money/credit expansion in China, led to rampant inflation in China and India--what others call "exporting inflation." I don't think that is really accurate, however, because the Chinese Central Bank doubling its money supply and injecting trillions of RMB (yuan) into malinvestments such as millions of luxury flats and excess capacity in everything is a key driver of the coming implosion of credit (and thus of investment) in China.

Meanwhile, the BRIC nations and other developing-world economies are supposedly "decoupled" from flailing developed-world economies, a "story" which has sent their stock markets soaring. Plopping down a Starbucks or three on the tony coasts of South America is proof that the growth there has nothing to do with credit bubbles elsewhere--it's all organic and sustainable.

Go ahead and believe that story--I'll pass. What I see is trillions of dollars in hot money seeking a quick-buck return, and capital sloshing into every watering hole in the world which promises a risky but potentially quick return.

Yes, costs of essentials (the FEW resources of food, energy and water) are rising in the U.S. due to the global frenzy caused by massive credit expansion and the trusty gaming of the U.S. dollar, and local taxes are skyrocketing as insolvent local governments desperately try to meet impossible demands to fund unaffordable pensions and benefits to public workers.

But other than the bogus Fed-induced stock rally, U.S. assets are rolling over or deflating: housing is Example 1, and bonds are Example 2 as rates are rising (rates = the rising tide, the Fed = silly guys in funny hats waving dead chickens at the rising water).

That everyone believes gold and silver have no downside makes me skeptical. If you are a buy-and-forget investor in precious metals, fine, but the market likes to destroy some wealth when the trade gets lopsided. The time to buy anything, gold and silver included, is after everyone who believed there was no possible downside has their head handed to them on a platter.

Maybe that will never ever happen to gold and silver, and if so I will miss out on the next stupendous precious metals rally in Q1 2011.

Ditto the "don't fight the Fed" stock market rally scheduled for Q1 2011. It will soar to the stars without me.

Ditto the Q1 rally in oil, farmland, pork bellies, coffee, sugar, quatloos, 'roo innards, sand, bat quano, swampland in coastal China, Chinese IPOs and all the other tangibles slated to head to the moon in Q1.

Some very smart people note that very few Americans own any silver or gold. True. But then 80% of Americans have no capital to speak of, as many have negative equity and little to no cash or other assets. Of the top 20%, many have the vast majority of their capital in their homes or 401K Corporate America retirement plans, which often have limited choices for investing.

Most Americans don't own any gold or silver to speak of because they have no cash assets to speak of, either (a closet full of spiffy Nike footwear doesn't count).

Lastly, I don't trust rallies that correlate to every other rally. Gold, the S&P 500, emerging-market stocks, oil, copper, sugar, 'roo innards and bat quano are all rallying in parallel: in effect, there is only one trade here: for everything and against the U.S. dollar.

But weirdly, given the near-universal predictions of its collapse to near-zero, the dollar keeps rising.

This doesn't seem all that mystifying to me, because one key feature of a reserve currency is the potentially stupendous demand for it when debt has to be repaid in cash. Printing up a couple trillion just isn't the big deal everyone seems to think it is. They seem to forget that there is $52 trillion in assets in the U.S. and roughly $160 trillion in the global economy. A couple trillion dollars is chump change.

That's how you get a supply imbalance--demand for dollars can actually exceed supply, and then the price of the commodity in question (USD) rises.

The fact that virtually nobody sees this as likely makes it very likely to me. But then that's my contrarian nature, which should be heavily discounted. I don't trust rallies which are correlated to practically every other asset class, and I don't trust "stories" that everyone has already bought into. I think the global markets in all asset classes are unsettled, murky, and heavily gamed/ manipulated.

I see being in cash as a viable investment strategy, and being in the hated and loathed U.S. dollar as where I want to be, precisely because it is so widely viewed as doomed.

This is not advice, it is merely a disclosure of an amateur's opinions. Cash may yet be king, and his reign may last a lot longer than many think possible. When one asset class in a highly correlated group rolls over, then maybe the entire group rolls over with it. Maybe not, but the possibility of losing 25% in being wrong makes me cautious.

I don't know what will happen, but I can sleep being in cash in Q1 2011. If I miss all the spectacular rallies that everyone sees as sure things, so be it. I prefer to let things settle out before making any bets or predictions.

For another perspective on 2011, I recommend Jesse's A Handwave Forecast for 2011.

The crush of work and events has caused me to fall behind my email once again, so please allow me to thank everyone who sent their holiday greetings and best wishes to me: thank you for your kind thoughts.

New recipes on What's for Dinner at Your House?--Elsewhere Cafe Muffins, and Louisa's Vegetarian Baked Beans

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