Devil's Advocate

I visited a former colleague yesterday, and presented the weak dollar/strong commodities thesis to him, with some agreement. As many of you know, this huge rally has been great for our account values, but it has made me increasingly nervous. I've asked for counterarguments against these plays, and was looking to poll some of you in our email threads last night. After a long day, I was too tired to post, so I will do so today:

1) Despite success in our holdings so far, what could derail the current rallies in commodities? Hubris is not a virtue when markets turn south.

2) Are our pivot event-driven microcap biotech stocks immune to an overall market downturn, or are we merely decline-resistant?

Well, today's actions confirms my suspicions--even if precious metals are a hedge against inflation (as are other hard assets), when the market tanks, it takes almost every sector with it (unless you are short the indices). If individuals, hedge funds and in hard times--institutional investors have to raise cash, they will sell any asset class, whether it's a gold ETF, REIT, or just regular old equities.

Having said that, nothing goes straight up (I know I have been redundant here), and corrections are healthy. The pertinent question is this a correction, or the start of another demand destruction decline?

On equities, I'm still of the opinion that we have been blessed with a strong rally since March 6, enclosed within a secular bear market. I still see too much debt within the consumer, corporations, real estate, as well as public sectors. Foreclosures and unemployment are rising, this time infecting borrowers with good credit, not just sub-prime borrowers. Commercial real estate defaults are exploding. And with 70% of our nation's GDP consumer-based, all these entities are in the de-levering mode--of course, with the exception of our nation's exploding balance sheet. And if consumers and businesses aren't opening their wallets, every attempt by the economy to recover will fail.

So where does that leave commodities? I suspect a bifurcation between commodity prices and equities overall. Even tho the world will consume less energy due to industrial and consumer demand destruction, inflation is still the boogey-man, mainly because the US Treasury has printed too many dollars. The pivot point is when those dollars start circulating through the economy, creating a multiplier effect. Currently, banks are hoarding dollars in order to recapitalize their toxic balance sheets. When and if commercial bank lending resumes, the Fed will be powerless to turn off the spigot, igniting inflation. It will be too little, too late. It is political suicide to raise interest rates and reign in money supply while citizens are losing jobs and their homes.

Will I be proven right? Nobody knows, but so far, the market agrees with me, as history has shown with 100% accuracy central banks are always late in closing the discount window. And with the economy on such shaky ground, I predict they will be late again in tightening monetary policy.

Conclusions? Commodities remain in a secular bull market--one that started in 2001, and one that corrected immensely in 2008, due to the financial crisis. In other words, we will experience a correction, and gold may correct 10% perhaps. But eventually, inflation will take root, as central banks worldwide attempt to stimulate their respective economies. Besides, inflation reduces the debt burden. In a perverse situation, central banks now want to INDUCE inflation, instead of trying to manage it. And as long as the Fed is intent on trillion dollar deficits, the US Treasury will continue to issue trillions of dollars of paper. Savers will be destroyed, and debtors rewarded. With the US government the biggest debtor in the world, guess who benefits from inflation?

As for the stock market, this bear market rally will also experience corrections, and could even go higher with the S&P 500 touching 1100. But don't count on us reaching our all-time highs. I don't see that in the cards, and if we do, it would be the short of our lifetime.

Having said that, I would appreciate counter-arguments. Sometimes losing money is more instructive, and despite our recent gains, my anxiety level is heightened. I even sold some of my winners earlier this week, and bought a few SPY puts last week. Turns out I may have been early with the puts, but better early than late.