Our trade of the decade

published 28 March 2012

Bill is away until 17 April. So in his absence, we're bringing you some of his most insightful, caustic and witty observations from the last 14 years. This piece was first published on 4 January 2010.

Well, that was it for 2009. Whew!

Another great year for gold. But it wasn't a bad year for stocks either. The NASDAQ rose 45%. The Dow went up about 20%.

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As we guessed back at the beginning of the year, stocks bounced. What we didn't guess was that they would bounce so much for so long. All over the world, stocks went up and continued to go up. A bounce is inevitable, following a stock-market drop. And it's impossible to say how big a bounce it will be or how long it will go on.

But a kiss is still a kiss and a bounce is still a bounce. No kiss lasts forever. Neither does a bounce. Looking ahead, we have to anticipate that it will come to an end, probably in 2010.

If you've profited from the 2009 run up in stocks... bravo! Now, sell them. Yes, the bounce could continue. But it's not worth the risk.

And how 'bout the gold market! Gold has risen every year of the decade. It was the surest, safest place for you money by far.

Does that mean gold will go up in 2009? Does that mean we will stick with our Trade of the Decade' for another ten years? Not to brag, but our trade was a big success. Even we were surprised by how well it did.

As long-suffering Daily Reckoning readers will recall, we announced our Trade of the Decade' in 2000: Sell Stocks; buy gold.

"It turned out to be a good plan," observes colleague, Merryn Somerset Webb, in a recent Financial Times story. "In 2000, you could buy an ounce of gold for $280 (the average price over the year). Now, it will cost you about $1,100. At the time, Bonner saw what most others did not. He saw the US not as an economy carefully and cleverly managed by then Federal Reserve chairman Alan Greenspan and his passion for low interest rates, but as a massive credit bubble waiting to burst.

"He also saw the massive and growing national debt, the trade and budget deficits, and fast growth in the money supply as factors that would naturally debase the dollar over the long term. He also saw the credit bubble as global rather than peculiar to America. So it made sense to him to hold the only non-paper currency there is gold."

So what's next? What's the trade of the coming decade? Well, your editor has decided not to double-down on the identical trade. Gold will remain in our core holdings, but not in our Trade of the Decade for the nextten years. Why? Because we think the US economy is going the way of Japan.

Japan went into a slump in 1990. It has come out and gone back in, and come out again, and gone back in again. In terms of the amount of wealth destroyed at least, on paper it was the worst disaster in human history. The value of real estate went down 87% in some cities. Stocks fell from a high of 39,000 on the Nikkei Dow down to the 7,000 range in 2009, their lowest point in 27 years.

Why such a bad performance? As we keep saying, if you really want to make a mess of things you need taxpayer support. The Japanese put more taxpayer money into the effort to prevent the correction than any nation theretofore ever had. The result: the correction was stalled, delayed, and stretched out over more than two decades.

And now, US economists are looking at Japan, not with alarm, but with admiration. They are beginning to believe that the Japanese model is the way to go, because it prevented widespread unemployment and a deeper slump.

Here's our best guess:

Now that the US economy is caught in the same sort of de-leveraging process that gripped Japan, the same sort of 'remedies' will inevitably be employed, leading to the same results, more or less.

We'll skip the details for now. You'll hear plenty of them in the days, weeks, and months ahead promise!

Instead, we'll turn to our 'Trade of the Decade' for the nextten years. There are, of course, two sides to this trade, the long side and the short side. We had no trouble finding things to put on the short side. In a de-leveraging period almost everything goes down. We could have stuck with US stocks, for example. They'll probably continue to come down, just as they did in Japan.

But who knows? US stocks just had their worst decade since the '30s. What are the odds that they'll have another bad decade? We don't know. But what we look for in our Trade of the Decade, for the sell side, is something that has just had its best decade ever, something that has been going up for so long people think it will go up forever, something that everyone wants.

What does that describe? Well, the thing that comes closest is US Treasury debt. Yields have been going down (meaning, the price of debt is going up) since 1983. And now, despite a supply that seems to be going off the charts, demand for Treasury bonds, notes and bills has never been stronger. What's more, if our analysis of the US economy is correct, the supply of Treasury debt is going to continue to rocket upward for many years. Deficits of $1 trillion to $2 trillion per year are going to become commonplace.

How long will it be before the market in Treasury debt crashes? How long will it be before hyperinflation, or a debt default sends investors running for cover? We don't know, but it seems a likely bet that it will happen sometime in the nextten years.

So, on our sell side, we'll put US Treasury debt.

How about the buy side? Ah... that is something we've struggled with. While there are many things that seem likely to go down, there aren't many that seem destined to go up. Let's see, what has been beaten down, dissed, battered, and abused for the last 20 years or more? What is it that people don't want? What is it that they expect to go down, possibly forever?

Of course... Japanese stocks!

So there is our 'Trade of the Decade':

Sell US Treasury debt / buy Japanese stocks.

Crazy, right?

Maybe not. Treasury debt has been going up for the last 27 years. Japanese stocks have been going down for the last 20 years.

Does this mean we're giving up on gold? Not at all. We're sticking with gold. Aurus eternis, or something like that. The yellow metal is what you buy when you think the financial authorities are making a mess of things. We have little doubt about it. So we'll continue to buy and hold gold until the financial system blows up.

But gold at $1,100 an ounce is fully priced. It is not cheap. It's been going up for the last ten years! At this level, it is insurance against a monetary catastrophe and a speculation on when and how the blow-up will finally come. It is definitely worth having. And holding. And using to protect your wealth.

But the 'Trade of the Decade' is a way of making money by buying/selling two opposing assets that are at extraordinary valuations. It is not a speculation on what MIGHT happen. It is merely a bet on the phenomenon known as "regression to the mean". Things that are out-of-whack tend to go back into whack.

If we're right, over the nextten years, the most popular investment of 2009 Treasury debt will go out of fashion. The least popular investment of 2009, on the other hand Japanese stocks will surprise everyone by finally showing signs of life.

In any event, the trade is fairly low risk. What are the odds that US Treasury debt will go up? What are the odds that Japanese stocks will go down? Of course, we don't know. Things that are out-of-whack can get farther out-of-whack. But we count on time to sort it out. And hope we live long enough to be able to say, "we told you so".

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