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Long Silver. Short Treasuries. A Trend I Like For Awhile.

I had a good week in the markets this week. Treasuries were brutalized, while precious metals, especially silver, did well. I have been gradually pushing more portfolio in favor of commodities, especially silver, and betting against treasuries for a couple months now.

I believe politics and government will affect the economy significantly. With our current economic crisis and the people’s belief that the government must “do something,” I think we’ll see a lot of intervention.

During the fall crash, it was primarily a deflationary moment. While gold did decently as a safe haven, most commodities crashed along with the stock market. The dollar and treasuries roared. People bought dollars to deleverage their debt (which was primarily in dollars) and bought US treasuries as a safe haven investment (which also increased the value of the dollar). I believe these actions were misguided and the opposite will be the case in the future.

America is a society drowning in debt, and the signs point the society will become more deeply in debt. Government debt is approaching 100% of GDP. This in of itself is not terrible; however, the deficit itself is about 20% of GDP this fiscal year and I think it will likely stay as high as 10% of GDP. Even though the government will likely do less stimulus programs in the future, the unfunded liabilities of medicare and social security will take their toll.

Besides government debt, people and corporations are drowning in debt too. The US government debt had been primarily bought by foreigners, particularly China, since the US people didn’t have the money to loan to the government. However, China will likely not be so quick to give a blank check to the US government. Not only are their exports suffering (thus less money to lend), there is more US government debt than ever and China is wisening up to this potential calamity.

I dont’ think we will see amazing economic growth anytime soon, which the Obama administration seems to happily assume. Our politicians are attempting to transform America into a social welfare state, similar to European countries, where growth there is 1-2% in good years (not 3-4% as Obama expects, and this makes a big difference over time). The stimulus package mainly went to entitlements, not investments. Corporations face a higher corporate effective tax (as Obama has said he will close loopholes). Small businesses (people making $250k+) will face higher taxes soon. More regulations are coming. Environmental regulations will likely increase energy costs.

The outlook for growth is pretty abysmal, but the outlook for debt increasing is crystal clear. People like their entitlements, particularly social security and medicare. Politicians are slow to change the system that does anything but expand these entitlements. The sluggish growth will be a continued drain on tax revenues, so less revenue will come into the government, but more and more demands for entitlements and social welfare programs will continue. Our debt will balloon.

What’s the best way out of debt if you can’t default? How can you magically make the debt worth less? Inflation of course. With more US debt being issued, the yields will likely rise on the debt (hence my short position on treasuries). People won’t be willing to loan to the US at 4%, they may want 8% (or as high as 12%, like it was during the early 80′s). That will of course kill all lending to business and consumers, so the Fed will be pressured to buy more debt to lower yields. This will trigger inflation.

I like silver as the best hedge against inflation since I think it is more attractively priced compared to gold. The gold/silver ratio is still in the high 60′s, something that I think is a bit absurd since silver provides many of the investment advantages of gold. However, silver is ‘cheaper’ so I think the jewelry market for silver won’t get hit as badly as gold…people simply can’t afford gold jewelry compared to silver. Also, silver has many industrial uses much like copper. If you look at the early 80′s gold/silver boom, the ratio fell closer to 30 at the peak.

The deficits we are running and our debtload as a percentage of GDP are unheard of in peacetime. The last time our government was borrowing at such a massive rate was WWII, and prices nearly doubled between 1941-1950. Since our whole society is in debt, the easiest way out of this dilemma is a period of moderate inflation, which will allow for the debts to be wiped away and hopefully positive restructuring to be done for the future. The process will be painful. Cash holdings will drop in value and holders of fixed-income debt (particularly treasuries) will get slaughtered. Holders of commodities, especially precious metals, should make out like bandits though :) .

Note: Author is long SLV, SSRI, GLD, USO. Short TLT.

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