I never seem to have enough time until now... now I have too much. Couldn't life spread spread this out a little? Please?
Anyhow... I started writing and my first topic got a bit long so look out for part two later tonight. I will be writing about a book that has really opened my eyes to the history of depressions. No conspiracies, no big bankers... just the real observations of a guy who lived through it and kept a journal. It doesn't sound too riveting, but trust me, the parallels to today are flat out scary. Stay tuned.
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The (in/de)flation trade
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I think some of the reason that people disagree about inflation vs. deflation (as a scenario for our economic future that is) is that they are picturing different parts of the economy. People point to housing and say there's a deflationary blow-off while people look at the Federal Reserve in the U.S. and say the opposite. Who is correct? I try not to equivocate too much when writing this blog, but it now seems obvious to me that we are going to
see both in our future. Necessarily, they must occur in different asset classes at any given time. As such, the small investor is left to ask the simple question... What do I do?
Up until a month ago, I was certainly biased towards an inflationary scenario. My portfolio reflects this. However, even before I was acutely aware of my new 'flationary* views, I was already taking steps to address this by raising cash. The primary way that one defends against deflation is to hold the one thing that goes up in value (currency).
(* 'flation=(in/de)flation i.e. both at the same time)
But how do you defend against both? I present a simple strategy that involves two investing accounts. One is a margin account, the other is a cash account.
Before I go on, however, I should point out that while I will be employing this strategy in a small way to start, it still contains risk. This sort of risk is something that I am aware of and can analytically quantify by both traditional and modern (fat tail methods). As I am just a squid floating around in the ocean, I am obviously not a good source of direct financial advice. But if you find the idea compelling, research it before doing anything and seek out professional help if desired. I envision that this is the way that a speculator such as myself would protect themselves.
In the margin account goes a super conservative portfolio of blue-chip dividend paying equities. Basically your Dow-Jones 'Dividend Titans' members. With these stocks as collateral, it is then possible to purchase small amounts of physical bullion funds (Central Fund of Canada, Sprott Physical Silver for example) in the same account and have the dividends from the blue-chips pay the interest and a small amount of principal each month. After time, the dividend stream will have paid off the margin loan. Knowing how much margin to use will depend on the dividend streams, but personally, I would use nothing over 20% of the value of the collateral and even that can be risky.
In the cash account goes your spare cash, all the junior mining companies, and riskier inflation sensitive commodity plays. These go in cash accounts since securities in margin accounts can be lent out to short sellers. For large companies this is no problem... for JM's this can be a death knell. The spare cash component should be roughly the same size or larger than the margin loan from the other account. Note, the real idea behind this trade is separating the cash and margin debt... put simply it gives you flexibility to respond to 'flation.
So why bother?
Inflationary Scenario...
-Commodity stocks will do well.
-Bullion will do well.
-The margin debt will inflate away.
Deflationary Scenario...
-Bullion will fall but only in a big way if it was part of an inflationary 'blow-off' (something like $10 000-20 000 Au would likely signal this... you'll need to time the top a little)
-The real value of the loan will go up, but so will the real value of the dividends that cover it. If the companies you choose really are high quality, they might slow dividend growth, but not suspend. Such companies do exist... you just have to find them.
-The cash is now key. Deflations never last for ever. You will need to be careful about timing, but stocks will be much lower in this scenario and those with cash will
have the opportunity of a lifetime.
SNAFU Scenario...
-Transfer cash to margin account and pay off the loan
Anyhow, the major risk I see with this idea comes from the timing involved in the deflation scenario. Since I don't plan on doing this in a big way to start, the margin loan will be paid off faster and I will have bought gold. Hardly a hugh risk in my opinion.
Lastly, I just want to suggest that this is still a nascent idea and needs some work. Like many trading ideas, there are always kinks that get ironed out during the execution. As such I don't think this is for everyone. If you are uncomfortable with the idea of margin, for example, don't do this!
Anyways... good luck and happy hunting. Comments are always welcome.
A.
(As of today I own no positions in any of the stocks mentioned.)
