As we all know, Federal Reserve Governor Ben Bernanke said:
with the implication that the Federal Reserve will do whatever it takes, including the production of US dollars, to avoid deflation. Now it is certainly possible that some of this money could go into equities resulting in painful short squeezes for the bears. So a bear could reasonably ask the question: would it be better to just go with gold and gold investments instead of shorting the market? A look at the $HUI around the time of the Bear Market rally shows that bears would have been better off with mining stocks than with shorting tech and other stocks.
Of course the nimble trader can make money shorting short-term tops and covering on short-term bottoms but I think that most bears would prefer not to be daytraders.
One other possibility is that a bear could buy foreign currencies to protect against a decline in the US Dollar. One particular vehicle that I find attractive is the Prudent Bear Safe Harbor fund which invests in short-term government paper, foreign and domestic and maintains an exposure to the price of gold. The Prudent Bear Safe Harbor fund has done quite well this year though the $HUI has done considerably better. But the $HUI has been more volatile as well.
One could take a look at the potential risks and rewards in the two main choices that we've outlined. Shorting equities entails unlimited risk with the potential reward 100% or the price of the stock should the stock go to $0.
If you subscribe to the belief that the Federal Reserve will run the printing presses full throttle and that gold has a bright future, at least in US dollar terms, then the potential is unlimited and the downside risk is your entire investment. We're exaggerating a bit here but you get the idea. To illustrate, I'll provide a chart of the price of gold vs the Argentinian Peso to illustrate a currency under extreme inflation.
As you can see, gold has done well against the Argentine Peso over the last year. The Argentine Merval Index actually has risen from about 325 to about 390 year-to-date so shorting the market would have resulted in losses.
There's overall less risk with gold investments given the Federal Reserve's concern with deflation than there is with shorting and better potential returns if history is a guide. One can, of course, do both with some shorts and some gold to take advantage of technical opportunities in the equity markets. But I've generally found it easier to be heavier in gold mining stocks and gold equivalents like the Central Fund of Canada along with a few small shorts than trying to short intermediate market tops.
I, like most bears, believe that there will be a major selloff but I don't have a real idea as to when this will happen.
Disclaimer: this is not investment advice and you should do your own due diligence in deploying your capital. I do not know if we're at a near-term top or if we're about to launch into outer space. My strategy is to accumulate here and there, preferably when prices decline.
December 18, 2002