The Risk Aversion Trade

A good fight should be like a small play…but played seriously. When the opponent expands, l contract. When he contracts, l expand. And when there is an opportunity… l do not hit…it hits all by itself.
-Bruce Lee

The stock market–still fighting its formidable economic opponent–is showing signs of exhaustion after its rally from the March lows (666 on the S&P). Since the lows, It has landed some powerful punches and earned considerable gains, but lately we have seen some days of intense selling and the market has developed yet undetected “internal injuries.”

As robust as the rally has been in terms of percent gains, it has actually been bid up—bolstered—by only a very few contributors. Indicators suggest that this minority will soon be throwing in their towels, leaving the market on very unsteady legs.

On the whole, the scorecard is not looking favorable for further market gains. In fact, one might speculate (this judge is) that after this grueling bout, the market is headed down several weight classes. In the S&P 500 specifically, the next support will be below the 666 print from March.

Equities are not the only asset class headed lower. Many commodity markets have taken defensive jumps in anticipation of inflation. No, the inflation has not yet reared its unsightly head–it is still wading amidst the muck of the banks’ clogged liquidity–but it will spill over and saturate consumers soon enough. Until then, we sit high and dry in deflation.

With Treasuries and the Dollar (USD) on one side of the fiscal teeter-totter and equities and commodities on the other, we can expect some raucous fun during the inversely proportional interplay. As the dollar kicks up, all dollar denominated assets (commodities) as well as many currencies will be forced down. Some judicious shorts on the downswing will pave the way to gains: my favorites in commodity land are oil and soybeans; in currencies, the euro and the pound.

Lastly, we come to precious metals, specifically gold and silver. Long term, I am very bullish on precious metals; however, if the dollar strengthens (as I think it will), gold and silver will fall. Therefore, I am temporarily eliminating my gold positions. But when the liquidity that is stopped up in the banks resumes its flow to the consumer, the resultant inflation will buff these precious metals to an impressive sheen. I will own them again when they are shiny.

Like a fighter before the championship match, I recognize an immense opportunity and steel myself for the challenge. Fortunes are going to be made and lost…all I need to do is step out of my corner and let it “hit all by itself.”