How to profit from another episode of the global financial crisis

Five weeks into a US stock market sell-off and the bears are starting to be taken more seriously, and not only for equities.

This week in London veteran banker and scion of the greatest banking dynasty Lord Rothschild warned that time may be up for the commodities boom too.

Bond kings

Is the best safe haven for investors now bonds? The Rothschilds made their money as sovereign bond traders in the nineteenth century. But with US treasuries now paying a yield under three per cent the bond market also looks near a top, and many are concerned about US debt levels and the sustainability of such low rates.

When rates go up then bond prices will fall, and from current heights a major crash is perfectly possible. So where can investors put their money for safety and gain?

Always after a major financial market crisis there is somebody who emerges as the man who shorted the markets and made a fortune. In 2008 it was John Paulson and his bet against subprime US housing, said to have netted $20 billion as the best trade in history.

The ArabianMoney newsletter (sign-up here) has been discussing leveraged short ETFs that achieve similar shorting strategies. Now could be the time to buy these instruments which obviously do not work well if markets go up rather than down.

However, we have noticed that the fear of holding these instruments over time is somewhat unfounded. Sure there are losses but there is a residual amount left to benefit from a movement in the other direction, and movements to the upside can be substantially better than to the downside.

We also like the daily resetting process. A traditional short cannot do more than double your money. One that resets daily does not have an upper limit. A long, smooth sell-off of the asset class represented by this kind of ETF would be very profitable.

Then again we still like gold and to a lesser extent silver in a sell-off. What seems to be happening globally is that government controlled banks are buying up bonds, and private investors are putting their money into precious metals instead.

Precious metals

If there is a crisis in the bond market money will flood into the relatively tight precious metals markets. It is certainly most likely that a big sell-off in stocks would cast gold and silver lower for a month or two, but that would only be a buying opportunity.

We think that would be true for many commodities. Lord Rothschild and George Soros may have been sellers recently but they might be the biggest buyers in a downturn, having the funds available from selling early.

Private investors are also keeping funds in cash, particularly the Swiss franc. If asset prices dive then cash is always king for a period and should interest rates be forced up then cash is clearly more valuable than when deposit accounts pay almost nothing.

ArabianMoney would go to cash, precious metals and short ETFs to protect against a market sell-off which is already happening and could get substantially worse before it bottoms out.