Investors Have Nowhere to Run, Nowhere to Hide

Thursday, 28 Jul 2011 08:18 AM

By Jacob Wolinsky

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Although many people expect the end of the world to coincide with the end of the Mayan Calendar, which occurs on 12/21/2012, it looks like Armageddon could be coming a lot sooner.

Unless an agreement is reached shortly, on Aug. 2, 2011, the U.S. government could default on its debt and will likely lose its AAA rating, as Standard & Poor’s and Moody’s have warned.

So what assets are safe? Possibly nothing.

Many institutions, such as pension funds, are required to hold bonds that have an AAA rating. If U.S. debt is downgraded from its current AAA status, this would cause a massive forced sell-off in Treasury bonds and the yields would go up dramatically.

This would have a ripple effect that would cause all types of domestic bonds to drop and would spread to U.S. equity markets.

Just holding cash in the bank might not be a good idea because the dollar could become worthless as people lose faith in the credibility of our currency.

There are other currencies to consider, such as the Canadian dollar, Swiss Franc and those of other strong economies. However, these currencies have had a huge run-up lately and nearly every country in the world, especially Canada, is highly dependent on the United States for trade (The United States accounted for 73 percent of Canadian exports and 63 percent of imports in 2009).

Foreign debt would also be dangerous as countries like China would also likely see an economic collapse as the whole global economy is so dependent on the United States.

Real estate wouldn’t be a good asset because it is highly illiquid and as yields on government bonds go up so will mortgage rates – that would destroy the already weak housing market.

There are some more sophisticated instruments that individuals can use, such as buying put options on various asset classes, which rise in value as the asset falls. However, these instruments have become far more expensive during the past few weeks. Additionally, the instruments are sold mostly by banks, which would be heavily affected by any default as they hold all these asset classes that could decline. If the banks collapsed, they wouldn’t be able to pay out the investors.

What about commodities? Regular commodities will see a tremendous decrease in price as demand would fall for items like steel because China is the main buyer of commodities.

The speculative commodities such as gold might be the only safe class.

However, they too have had a massive run-up in the past few years and especially in the past few weeks. Additionally, an investor buying the gold ETF where the physical gold is held in some bank in Switzerland might not be so fortunate if the entire financial system breaks down.

Physical gold could be a good bet, but it too could have a huge decline if the economy of Australia, where much gold is mined, collapses as a result of the worldwide contagion.

What should investors do?

The retail investor should realize there could be a good buying opportunity if the stock market collapses. Besides that, there is little once can do to prepare for Aug. 2.

However, one can hope that our politicians will get their act together shortly and the end of the world will be postponed — at least until 12/21/2012.

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