Sitting on the Fence
With Our Experts

Q: I see from Jay's Recent Transactions that you sold all your Yen and XLE (Energy Select Sector SPDR ETF) and USERX (US Global Gold Shares ETF) and then used part of that to buy GDX (Market Vector Gold Miners ETF).  Was this planned?

A: Not until I heard Rogers on 2-12.

I'm going to begin with currencies.  There has been a decided shift in Rogers' thinking and actions on currencies since the forced selling crash. He said that and he's decided to not sell all his dollars yet. He expects high inflation at some time, but he doesn't know when, because we are seeing massive forced liquidation that is keeping the dollar strong (see Letter 34 - Uncertainty and the Dollar Short Squeeze). Clearly he is expressing uncertainty, making statements like "expect wild gyrations and chaos in all the currency markets." This communicates to me greater risk. I have no business trying to invest in markets this sophisticated and chaotic. And I have no hope of keeping up with what he is doing on a day to day basis. He doesn't even know what he's likely to do next week or next month. I'm moving out of the other currencies, and plan to hold safe dollar deposits until I sense (or Rogers or Maybury tell us) velocity is turning up and it's time to reduce our dollar holdings. I may hold my Swiss Francs a while longer, but will likely convert my RMB to dollars, because Rogers has even expressed doubt about its intermediate future. Again, I'm over my head in these markets. Why take the risk? My gold and silver are increasing nicely and have exceeded my target allocations, but I do not plan to cut them back because I consider them the best and safest "currencies" in the world. I am comfortable holding them as alternatives to the US dollar, and consider them part of my cash. (See Holding Gold As Cash.)

Next, let me discuss stocks. Rogers has made a decided shift in his attitude toward stocks. He is holding tenaciously to his thesis of a twenty year secular bear market in stocks (beginning in 1999), and a con-current secular bull market in commodities. This is the major determinant behind his strategy. But within the secular stock bear, he has been willing to hold several stock investments which he considered undervalued, but which he fully hedged with other stock short positions which he considers over valued, leaving himself in a "market neutral" position relative to the overall stock market. However, just recently he has sold some or all of his stock positions (I have no way of knowing the specifics), and has even added some new short positions. When asked what he was shorting, he answered, "IBM, GE, JP Morgan...you know, same old companies." It is now possible he may be net short in stocks, but I have no way of knowing. My conviction from this is that he has definitely modified his posture toward stocks, and beyond any doubt in my mind, it is time for me to become more cautious toward stocks. What does that mean? I'm already only 15.7% in stocks (as of 1-31-09). The transactions we're discussing reduce that to 12.9%. Next week, I plan to take about 1% of my portfolio and buy "insurance" against a down market on that 12.9%. If I had as much as 20% to 40% in stocks today, I would make a partial reduction in stocks now, then wait to see if a rally develops. If it does, I'd sell more. All our experts feel the probability of another selling wave has increased.

I was confused when Maybury put out his forecast of alternating runaway deflation and runaway inflation (giving it a 95% probability). When does it change from deflation to inflation? Which are we in, etc.? In Bulletin 11, he has clarified it. He said in part, "Fear is contagious. At any time, Obama could trigger off a new plunge in velocity, and a further deflationary drop in the investment markets. This makes investing a 50-50 risk. Everything is up to one man...if he awakens one morning and decides to stop the end-of-the-world rhetoric and go to the-tide-has-turned, velocity could soar, and along with it non-dollar assets...50-50 is too much risk for me, so I'm staying on the sidelines." Remember, except for gold, silver and platinum, Maybury's crown jewels list is all stocks. Now we're all on the same page. Follow the above regarding reducing stocks. Move in small measured steps.

Q: Why did you sell all USERX in the first place?

A: To reduce stocks overall, but increase GDX, since GDX is outperforming USERX 2 to 1 since the November bottom. Look at the charts - incredible. GDX had a 52-week high of $56.87 but went down 72% to $15.83 in October; since then it has risen 125% to $35.68. USERX had a 52-week high of $19.93 but went down 64% to 7.08 in October; since then it has risen only 59% to $11.24.

Q: So are you saying the last four months has simply been a preview of what you expect over the next few years from these two funds?

A: I would put it this way. USERX is an old fund. GDX has been recently established giving emphasis to the larger blue-chip gold mines. In the early phases of a bull market, the large blue-chip mines greatly out perform the smaller mines. The last four months confirm the good job the manager has done in selecting the mines. I am expecting a monster bull market in the mining shares over the next four years, irrespective of the overall stock marker performance. We are only at the beginning, but it could be a little ahead of itself. It will be volatile. USERX will also do well over the four years, but I prefer GDX, and plan to add more.

Q: What are your actual and target allocations for gold and silver mining stocks now?

A: No further increase in silver mining (6.8%), but eventually up to 10% (from 6.1%) in gold mining, mainly GDX.

Now let's move to a discussion of Physicals. It is clear that Rogers has not changed his thinking at all on the 20-year secular commodity bull market. Quite the opposite, he declares that commodity fundamentals have improved markedly during this deflationary crash, and will continue to become even stronger over the next few years. He cites the fifty-year low world food supply, the world-wide shortage of farmers and new plantings. The world shortage of fertilizer, and financing for new crops and new mines. Mine closures are increasing, and he expects it to be 10 to 15 years before any significant new mines go into production. World oil reserves are declining at 6.7% per year. 
Unlike some of our other experts, Rogers emphasizes buying the actual commodities rather than stocks of companies that produce them. And he points out (as does Maybury) that this asset class that was "hated" and at bargain prices in 1999 has again become "hated," an event which probably does not happen more than once per century on average, giving us a second chance to buy within 10 years. Therefore Rogers has been adding to his commodities consistently over the past weeks using his own Commodity ETNs, in the following order of priority: (1) agricultural products (RJA), (2) energy (RJN), and (3) the full Rogers Index (RJI). He is also adding consistently to his gold.

SUMMARY: Taking the best available from our experts at the present time, here are the key points as I see them, and interpret them:

• A substantial allocation to US dollars (minimum 30%), and gold and silver (minimum 30%) are a must now, at least until velocity turns up and non-dollar assets go into a strong bull market. I believe we have access to some of the best advice available for timing this event, although nothing is guaranteed.
• Minimum exposure to stocks is a must. I would say 15% to 20% as an absolute maximum. See the discussion on stocks above for suggestions on changing your position. One other point on stocks: the only stocks I hold now are gold and silver mining shares, with emphasis on the blue-chip larger companies. I consider the mining shares an exception to the secular bear stock market, and I expect my mining share portfolio to multiply by 3 to 15 times over the next 4 years. Again, I could be wrong on this forecast.
• Finally, the remainder of your portfolio after cash, gold and silver and stocks, should be in physical commodities. For simplicity I suggest you follow Rogers' priorities: RJA, RJN and RJI. For those desiring less risk and more safety, increase your cash, gold and silver following your own convictions.

 
The contents above were taken from an e-mail exchange between Ted Spaeth (Q's) and Jay O'Keefe (A's).