Wednesday, February 24, 2010

Going defensive

I know that I should never ever try to time the market. Yet, at the moment it looks like the stock markets can run out of steam at any point of time. There are just too many things that can go wrong and spark a large scale sell-off. Therefore, I am seriously considering alternatives to my current positions.

Naturally, any good alternative needs to involve minimum downside and as much potential upside as possible.

I don’t like shorting stocks because you have basically limited gain prospect (100% if stock goes to zero), but unlimited risk (if stock rises). Naturally you can play with “stop loss” or such parameters with brokers, but still, at best, it is a short term bet. And I don’t like short term bets either because I don't have the time required to follow those and because essentially short term bets are the extreme case of trying to time the market.

Future of U.S dollar does not look that good. Neither does that of euro. Therefore it could be a good idea to take a position in Chinese Yuan. NYSE: CYB is one option for such position. However, this particular ETF has 0.45% expense ratio and what is essentially seems to be is a position in U.S. dollar with potential upside from appreciation of Yuan vs. dollar.

Going short U.S treasuries seems to be a popular trade. NYSE: TBT offers leveraged (200%) exposure to inverse of 20 year treasury index via an ETF. At some point of time this can be a spectacular trade. However, as they say “markets can stay irrational longer than you can stay solvent”. Also, it has 0.95% expense ratio and because it effectively multiplies daily changes in index by factor of minus two, volatility will hurt the performance badly. So essentially this is a short term bet, like most leveraged ETFs are.

OK, then what. Gold is at the moment the best defensive position outside stock market that I can think of.

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