Bears turn to bonds, gold and shorting stocks

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With global financial markets in a scary crisis mode, bears are once again ruling the day.

Their advice: to keep portfolios safe in hard times, try some combination of government bonds, shorting stocks and grabbing gold.

Bears don't agree on the right mix of those investment vehicles, but they say such an eclectic selection of assets is the right course during an unsettled time when a country like Greece might implode at any moment, or the Dow Jones Industrial Average might unexpectedly swoon nearly 1,000 points, as it did Thursday afternoon before recovering some of its losses.

In this kind of environment, forget most stocks, advises Gary Shilling, the eponymous head of A. Gary Shilling & Co., an economic consulting firm based in Springfield, N.J.

Mr. Shilling is a bearish prognosticator who thinks the economy is on the cusp of deflation, or falling consumer prices, and in response is buying U.S. government bonds. For extra zing in portfolios that can handle some risk, he advises selling stock markets short, and shorting some commodities, such as copper, whose price will be vulnerable if the economy tanks.

Selling copper futures, he says, "is one of my favourites."

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Mr. Shilling holds an extremely negative view on the stock market. He thinks we're in the midst of a long-term decline that actually started back in 2000, with the bursting of the tech bubble.

In his view, the rise in share prices of nearly 70 per cent from the panic lows of March, 2009, has merely been a blip in the longer term bear market cycle he thinks is under way. "We may be finding that this rally in a secular bear market is ending," Mr. Shilling says of the recent market action.

The uptrend from the lows of a year ago has been "so dramatic and so extensive that if you don't get a straight up economy in this country and indeed the world, you're going to get disillusionment and disappointment," he predicts. Mr. Shilling's call to buy government bonds is based on a view that weak economic conditions will help cause deflation of about 3 per cent a year, which in turn will make the securities extremely attractive.

Long term, 30-year U.S. Treasury bonds currently yield around 4 per cent. If the interest rate on them falls to 3 per cent over the next couple of years, as Mr. Shilling thinks it could, investors will make a return of about 25 per cent, including both capital gains on their bonds and interest. Those buying Treasuries in the form of zero coupon bonds will do even better, gaining 35 per cent.

Ian Gordon president of Longwave Analytics, an economic forecasting group based in British Columbia, thinks the global economy shows all the signs of being in the early stages of a 1930s style depression. He frets that the Dow could crash, and in his own investment account is buying gold and shorting stocks through exchange-traded funds.

While many bears think stocks will fall, Mr. Gordon thinks the decline will be super-sized, and extremely profitable for investors like him who are shorting equities.

"I'm on record as forecasting a Dow of 1,000 and I'm still comfortable with that kind of prediction," he said on Thursday, when the index closed at 10,520.

Many bears like bullion, which has also been putting on a nice move, rallying above $1,200 (U.S.) an ounce as panicked investors flee to the perceived safety of the yellow metal.

"People turn to gold as they did in the '30s because they don't trust paper money," Mr. Gordon says of the reason for the upward trend in the price of bullion.

Those on the bearish side often don't agree on merits of government debt. Mr. Gordon, for instance, thinks the prices of U.S. government bonds will fall and their interest rates will go up as the economy trips into a severe downturn and governments have trouble handling their debts. However, he hasn't sold them short, although he thinks that is a good trade.

Mr. Shilling, by contrast, is more of an agnostic on gold. While he recognizes that many investors see it as a safe harbour in times of trouble, he says the bullion market isn't big enough to become an alternative currency for fretful investors worried by the global market downturn. He thinks the flows of skittish money are just so huge they have no choice but to gravitate into U.S. dollars and Treasuries, bolstering their prices.

He recognizes, however, that the United States, with its large budget deficit, isn't perfect, it's just that it's a better bet than Europe and its euro right now. "I think that the argument for the U.S. is not that we're doing anything right. It's just we're the best of a bad lot," he says.