How to Trade Fear and Uncertainty

by Michael Shulman | August 10, 2011 2:02 pm

We are experiencing three events that have fed each other, and this interaction has turned each event into a crisis. And while each crisis is contributing to uncertainty and sharp market declines in their own way, they have one thing in common: They are underpinning fear and uncertainty.

Europe: The European debt crisis is going to last a long time, but daily changes in the European bond markets and daily conclusions by analysts who can do second-grade math understand that Europe does isn’t undergoing a liquidity crisis that is manageable, but rather a solvency crisis that is not.

Europe’s crisis has made a three-fold contribution to the market selloff – headlines on political decisiveness triggering selling, margin calls on bondholders triggering selling, and math that says this is going to last a long time, keeping buyers out of the market.

The U.S. Debt Crisis: The political theater leading up to the fake debt crisis solution now on the table led to the downgrade of U.S. debt by S&P, and this, in turn, served as a trigger for the market’s big selloff. The decline itself may accelerate the ultimately fruitless discussion about fixing the deficit and debt issue and that will lead (maybe) to automatic spending cuts and the messiest presidential election in memory.

So Uncle Sam’s politicians have contributed three things to the crisis: the short-term trigger of the debt downgrade; six months of uncertainty with a messy political debate; and a year or more, depending on who wins, of more uncertainty about fiscal and tax policy.

The Double-Dip Recession: I have been predicting a double dip since I thought the official end of the last recession was only on paper. We are essentially in one now — forget the statistics that will be revised anyway. Roughly one in four Americans would work or would work more if there was a job available.

At the current rate of defaults and foreclosures, it will take another five or six years to clear the housing mess, stabilize prices and kick off a material increase in home building. Fiscal stimulus is ending and we are entering a period of contraction at all levels of government. And the growing certainty about a double dip is keeping many investors out of the market — and chasing others away at the same time, as they’re uncertain about the impact of a slowdown on corporate profits and market multiples.

What do these three crises have in common? Where do they intersect? Fear and uncertainty – and that is the trade of the day, the week, the month, the quarter and perhaps all of 2012.

How to play uncertainty and fear

You do it the old-fashioned way – precious metals. I am in gold, silver and cash. Oh, and the gold miners. The ETFs here are SPDR Gold Shares (NYSE:GLD[1]), the iShares Silver Trust (NYSE:SLV[2]), and the Market Vectors Gold Miners (NYSE:GDX[3]). I have been recommending this for subscribers for a long time. And there are two ways to play it. If you want to protect capital – always my priority – and want consistent returns, either buy the ETFs and sell covered calls or sell puts. If you want to speculate, you buy those calls. I do both – I have pots of capital for each focus, monthly cash and income or speculation.

When does this trade end? The inflation adjusted previous high for gold is roughly $2.400 – a 30% increase from here. The miners will follow as will silver.

If these numbers don’t do it for you, ask yourself the question: Does the next week, month quarter and year look more or less uncertain than the past week, month quarter or year? The answer says it all.

 

 

Endnotes:
  1. GLD: http://studio-5.financialcontent.com/investplace/quote?Symbol=GLD
  2. SLV: http://studio-5.financialcontent.com/investplace/quote?Symbol=SLV
  3. GDX: http://studio-5.financialcontent.com/investplace/quote?Symbol=GDX

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