Underway...

Long TLT
So Our Man in NYC (“OM”, or “Our Man” depending on my mood, laziness, etc) feels like a recalcitrant school boy writing this post, given the broad unpopularity of his position. Furthermore, Our Man understands the reasoning behind the popular Short TLT (or Long TBT) position being posited by many; that the US government deficits are unsustainable and the willingness of creditors to continue financing them (especially of a dollar that’s likely to decline in value) is not infinite.

Then why take the other side of this trade? The reasoning is simple; OM doesn’t like equities, no make that really doesn’t like equities…in that he has no idea how they can rationally price in an implied 4%+ GDP growth for 2010! Furthermore, OM suspects that now the spigots of government financing have finally started to slow (how we miss you “Cash for Clunkers”) that the probability favours some kind of macro disappointment being around the corner.

Disappointment you say? Yes, sireee…OM still thinks there’s a chance of your good ole fashioned double dip, ISM going back under 50, what Q4 GDP isn’t 3%+, oh my god! Furthermore, he suspects that such disappointment will be greeted with a “what, you mean we can’t take a big bounce recovery for granted in 2010 and price things on 2011-12 are almost here and they’ll be like 2007 numbers, with its whopping margins”, kind of reception from the equity players.

How to play such a disappointment?
- Short SPY? Keynes did say “the market can stay irrational longer than you can stay solvent”, and Keynes is all the rage these days! Besides, OM remembers his carefree youth…and even then the shortcuts he used to take home from school across the train tracks weren’t advisable!
- L SPY puts? While issues could rear their heads before the back-end of 2009, it’s more likely to come to the fore in mid-Q1 to mid-Q2 2010. Besides, negative carry trades are no really not that fun and it’s an arrow OM would like to retain in his quiver, in case things the technicals look more interesting.

And that led OM to L TLT?
Well, it’s clearly imperfect, but it’s not a long-term holding…it’s more of a flight to quality play, in the medium-term. Rightly, or wrongly, OM’s thinking is that if there’s any proper correction in the equity markets then it’s likely that the behavioural instinct of investors will kick in and they’ll run to Treasury bonds, irrespective of fears about long-term solvency. Furthermore, who knows…maybe that puny yield will mean OM can get Mrs. OM a shiny iPhone for Christmas!


Long GLD
If he had to choose a side, OM would leap (quite theatrically, of course) into the deflationist view of the world thus this may not seem like a natural holding (given the barbaric relic’s alleged inflation hedging properties). However, GLD is OM’s play on the bad Fed/governance and weak currency. In OM’s humble view the credit crisis bears some resemblance to various financial crises before, and GLD is OMs hedge in-case of the "sudden stop" (as in, the shock devaluation/currency crisis that various Asia currencies saw in 97, etc). The single biggest cause of a sudden stop is likely to be either a default by the US government or an unwillingness of creditors (primarily China and Japan) to lend to the US (in all probability, leading to the US defaulting!), hence OM hopes the GLD offers some hedge to his TLT position in case things go south.

Why GLD?
1). Gold stocks have leverage to the gold price though OM is concerned this wouldn’t be as clear this time and wouldn’t help in the case of a sudden-stop (i.e. when their costs in ZAR or AUD, etc, go up sharply in USD terms), thus the preference for the hard asset.
2). GLD holds physical gold and is the 5th or 6th largest holder of gold in the world (just ahead of the Swiss Central Bank, woo hoo!).
3). There isn't much physical Gold in the world (you could pretty much fill 1 oil tanker, or a few swimming pools, with all the gold in the world).

Positioning (as at 10/19):
PA: L GLD – 54.4%; L Long-Term Treasuries – 41.5% (because of pre-existing positions, Treasury bonds are held in slightly smaller size)
Kaching: L GLD – 46.5%, L TLT 47.7%