My Dream Short Turned Nightmare (2009)

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In 2007, I started reading the Daily Reckoning.

At that time, the founder of Agora (our parent company), Bill Bonner, was still running the DR.

It was absolutely fascinating. All my questions about what was happening with real estate, gold, silver, and the economy were answered.

Most importantly, Bill taught me about the Federal Reserve and its subversive effects on our currency. And how the Fed creates and pops bubbles with its reckless monetary policy.

I bought my first precious metals around that time. Silver was trading around $11/oz, and gold was $842.

I quickly became convinced we were in for a world of hurt.

In 2007, I heavily shorted banks and REITs.

The timing was beautiful. Within a few months, banks and REITs were tanking. I added to my shorts.

For a while, the trade worked brilliantly. I was a genius, for a short time. My account value rose more than 40%. I recall feeling triumphant at Thanksgiving in 2008, because my account was at all-time highs while stocks were plummeting.

Then the massive $700 billion bailout happened. Huge direct cash injections, and endless loans via the Fed’s “discount window”. Helicopter money, indeed. At least for Wall Street.

Never mind that, I thought. The bailouts and Fed actions were futile. These banks and real estate stocks were going to zero.

So I held onto those shorts as markets rebounded, convinced doomsday was inevitable.

I missed my window, and ended up closing those shorts for a sizable loss. At one point, I could have closed many of my shorts at a 70%+ gain. But greed took over. That last 30% was my downfall.

Lessons Learned

I do have a bit of short exposure currently. I have puts or inverse ETFs betting against the S&P 500, Walmart, and the Russell 2000.

It’s not a big part of my portfolio, though. These days I prefer to hedge with gold, silver, oil, and cheap high-dividend stocks.

If you know what you’re doing, or have guidance from experts like the folks here at Paradigm, having some shorts during times like these can make sense. Portfolio insurance.

But don’t go too far with it. Or make the same mistake I did back in 2009, and expect stocks to go to zero. IF we do get a stock market crash (I sincerely hope we don’t), eventually the Fed will step in with enough force to stop the bleeding.

In the 2007-2009 period, it took a few rounds of bailouts and rate cuts to reverse the crash. But eventually it did stop.

These days the purpose of puts and shorts, for me at least, is not to make a huge profit. It’s to help preserve wealth in case a major crash happens.

Most people shouldn’t bother with shorts/puts. It’s very tricky to get the timing right.

But if you insist, here are some things to consider.

Inverse ETFs, Puts, and Shorts

Today there are many different options for investors who want to hedge with downside protection. All carry risk, however, and should not be taken lightly.

ETFs which are leveraged to downside in the market are popular but perilous. A few examples include:

• SDS – negative 2x the daily performance of the S&P 500
• SRTY – negative 2x the daily performance of the Russell 2000

It’s important to note that they aim for 2x inverse performance, but don’t always achieve it.

These ETFs can be useful tools at times, but timing is very difficult. Additionally, there are hidden tax risks in these products.

These funds use derivatives to gain short exposure to the market. They rebalance frequently, and distribute proceeds to holders. This has tax implications. Sometimes you’ll have to pay taxes even if the funds lose value.

Be sure you’re aware of these risks, and talk to a tax professional if you’re unsure about anything.

And these leveraged inverse ETFs are not meant to be held for extended periods. I use them occasionally to hedge for a month or two, no longer.

Additionally, I strictly avoid the 3x leveraged ETFs. Too volatile to hold over any sustained period of time.

Put options can also be a good hedging tool, but you need to know what you’re doing. I recommend following our experts here at Paradigm, especially Jim Rickards and Dan Amoss. They’re putting out excellent research (no pun intended).

Shorting stocks isn’t very common these days. Most people these days prefer to use put options, because your losses are contained to the price you pay for the contract. With shorts, potential losses are unlimited (the stock can keep rising indefinitely).

Overall, shorting is not for most people. There are better, less risky ways to hedge. If you do decide to buy puts, I strongly recommend following trustworthy experts like Jim and Dan.

Stocks Still Bubbly

Software and other previously hot sectors have been hit hard over recent weeks, but overall, markets have held up remarkably well.

Valuations remain stretched. Stocks are pricey.

With major supply disruptions coming due to the war with Iran, things could go south from here. Oil is likely to remain elevated for some time to come, and there will be disruptions to critical items such as petrochemicals, fertilizers, pesticides, and herbicides.

Also, consumers will be pulling back on spending.

If this war drags on, the situation could get ugly. So if you’re looking to reduce exposure to stocks, it’s not too late.

There’s nothing wrong with having a substantial cash position in this environment. That’s a hedge in its own way. It gives you optionality to buy lower.

And of course, we continue to like oil. Exxon Mobil (XOM) and Petrobras (PBR, PBR.A) are still my favorite ways to play it.

Miners have sold off hard in recent days, but as we discussed yesterday, this is likely hedge and quant funds exiting their positions.

Volatility will remain high, but I still love gold, silver, and miners as long-term hedges.

Buckle up. I suspect it’s about to get crazy out there.

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