Swatek (< 20)

Capital Preservation and Investment Risk

June 30, 2008 – Comments (0) | RELATED TICKERS: FXY , FXE , FXB

Let's start by saying that I'm not normally in the very conservative camp regarding investments. My real money portfolio return since September is over 43%. All of this was with ETFs (that's my lazy way of managing individual company stock risk and playing both long and short), plus a selection of airlines to represent the airline index which doesn't have an ETF (yes, I made some money on airlines this year). These are indeed the best of times to be a good trader. They could also be dangerous times. The following reflects my more prudent side that has very recently become dominant in the current market situation.

This message is for your real money investments, which should be different than any game. Yes, the growing preponderance of the rumblings sound very bearish, approaching bullishly so according to some. But, what if some portion of a much worst case for the financial system happens? How will your investments hold up? Will it merely hurt or be a disaster for your net worth? VIX and the bullish % are not yet very close to extremes. This could allow the current direction to continue quite a bit further in an orderly fashion, before the panic phase that usually just precedes a significant equity bottom (and maybe not the last or lowest this cycle)...

Enough recognition of the growing demand destruction may soon drive down commodities and associated stocks (possibly not recovering for years). The downside for commodities will probably be just as steep, and maybe even steeper, possibly without a second peak. That could drive what looks like a panic for the equity markets. More so if a high profile financial institution(s) follows the Bear about the same time (perfect storm). How nimble are you? Really? That may become the most important risk question on commodity related funds, if they represent a direct investment in the commodity or company stock. If a fund invests in futures or derivative, the next paragraph may apply to them too and could become even more important.

Be sure to read the prospectus' risk section of short funds, especially the counterparty risk part regarding the derivative swaps these are based on. Long funds also often invest in futures and derivatives that have associated risks. These may end up being the times that this part of prospectus are written for. Don't hang on too long to derivative and futures based investments, if there is a serious financial system meltdown. Be sure you know what a fund really invests in and its associated risks. Some of them will really surprise you. Are you hyper-nimble? or able to foresee a stop in trading for futures or freeze-up in derivative trading? How would your portfolio look if the worst case happened? Simply painful, or a disaster? Think about it and proportion accordingly.

The increasingly popular GLD at these heights is becoming more risky, especially if you can't baby-sit your investments (I travel a lot, often on short notice). It has a significant possible downside, if good Fed/gov't decisions start being made, or are widely perceived as such (currently looking unlikely). I’m not implying GLD is a bad investment, especially near term. It should simply be proportioned according to your nimbleness and investment risk tolerance.

I'm only recommending FXY (Japanese Yen) for new investments by fellow non-nimble types, until the next good bottom is in place, for capital preservation. FXF (Swiss Franc) is almost as good for upside, but could suffer a lot if UBS follows the Bear and the Swiss central bank doesn’t get any help from the neighbors (unwilling) or from the USA (increasingly unable). FXE (Euro) and FXB (British Pound) have made more of a move up and seem likely to not have as far to run as FXY. However, they could be relatively safe ways to provide some foreign currency diversification. Japan will likely stay with the US on rate increases, or may even lead, considering their current 0.5% rate, which would give FXY a nice boost. There's a good chance you'll make some decent money while preserving capital in these, with a relatively acceptable worst case downside risk, especially if you're not the nimble type.

At the bottom (or what looks like one), legging-in will be prudent, in case you're wrong. Will be posting different recommendations then, depending upon the prior moves and situation. Still studying for that day, and planning to have plenty to invest in what may become opportunities of a lifetime.

Cheers