The Current Market Turmoil Must Mean Short Sellers Are Running Out of Ideas…Right? Part I

Having spent most of my time in the last 12 months playing the short side of my book (particularly in the China Reverse Merger space), rather than the long side, I can tell you that ‘risk off’ may appear to be ‘bad news’ to bottoms-up short sellers, as all risk assets are selling off. Unless we face market-wide panic and reach 2009 levels (which is possible), I doubt it. To the contrary, I see plenty of opportunities for the following reasons:

(A) It Still Pays To Commit (White Collar) Crime- Ask Sam Antar, former CFO of “Crazy Eddie” who said earlier this year:

“Now, crime is easy and much more profitable. We have Republicans like Bachmann and Issa who are making the world safer for criminals,”said Antar, who famously devised the “Panama Pump” embezzlement scheme. “Bachmann wants to repeal Dodd-Frank, so I won’t have to worry about whistleblowers turning me in for a reward. And Issa wants to gut the SEC, so I won’t have to contend with them investigating me for securities fraud.”

(B) Speculation/Risk are Alive and Well - So long as Ben Bernanke (or similar), easy money, QE, the possibility of QE, incentives to trade rather than invest,  etc. are alive and well, risk-taking and bubble-nomics reigneth supreme.

(C) Valuations are Less Rich…but Still Rich - If you can sell part a stake of your business for 20X..30X…40X…80X P/E ratios, are you going to stay pat? The gap in valuations between top-line growth-oriented companies and non growth-oriented companies is jaw-breaking.

With all the above said, I have a few sectors in mind, that are likely to offer asymmetric returns long term (on the short side), when there is a crash. I will start with gold:

GOLD - I believe gold has moved past its initial stages within the current boom cycle, and are exhibiting signs of a bubble. The innovators have largely left the building (those who screamed buy in the early to mid 2000s), the imitators are thriving (The bottoms-up value investors turned macro investors, for example, Paulson, Einhorn, and those who bought the dip in 2008/2009, have made good returns), and the idiots/frauds have entered the scene and are looking like geniuses (GLD day traders, Central Banks).

IMPLICATION: There likely are and will be fraudulent gold/silver mining concerns, pump & dump schemes, that will seek to benefit from the emerging euphoria; there will be ways to profit asymmetrically on the short side, in time. I believe this will happen, independent of general financial market conditions (unless we have a long lasting spell of asset deflation, and gold corrects 40%-50% and remains at those lower levels).

WHAT TO LOOK FOR: A few of the things to keep an eye out for:

• Growth in the # of publicly-traded gold/silver related companies (IPOs, reverse mergers)
• The innovators and imitators to be out most or completely of their gold and gold mining shares
• Hyperbolic moves upward, correction, and increased volatility in gold prices; more Central Bank purchases, and possibly adoption on the retail level
• Major share price appreciation in questionable silver/gold concerns, without corresponding improvement in fundamentals.
• Insider activity of the majors; strategic activity (such as M&A, LBOs, etc.)..
• Signs of uneconomic use of capital, both on the business side, and on the financial mgmt side (idiotic buybacks/dividends, taking on too much debt)
• Restoration of sound fiscal and monetary policies; change in political adminstrations and/or appointments are key triggers

WHAT TO DO NOW: I believe the above thesis will likely take several years to play out; I am early. But I’d rather be early, learn the ins and outs now, and eventually initiate a position while the thesis remains contentious. Here is what to do now:

• DO NOT ‘short and hold’, even with long-dated options at this point; the ‘fundamentals’ and sentiment are still largely in favor of going long, and the positive feedback loop remains in high gear
• Learn the space, the business economics of mining, etc. now..become an expert. Keep an active pulse on gold price and gold miners’ capital market developments.
• For the more enterprising folks…trade gold, with tight rules. If you have a solid track record trading momentum-oriented stocks, etc., you probably have a competitive advantage.

I plan on updating the gold analysis, in time, and also continue with ‘Part II’ that examines another sector potentially ripening for short sellers.