Trade of the Year 2010
Research for Online Investors

This article originally appeared in MarketWatch on 3/30 & 3/31

Last year we called crude oil the ‘Trade of the Year’; we recapped the performance of the trade on 12/31/09 when we recorded a 79% gain on the year. What do we think will be the Trade of the Year for 2010?

There are so many areas to choose from.  Should we look for a contrarian play, like health care?  A Blue Chip, like Apple, that is taking over the world or large macro trends?  An argument can be made for each one of these, but I don’t think these will hold the biggest gains.  Let me explain.

The U.S. has spent money for the last eighteen months we do not have, ON A SCALE NEVER SEEN BEFORE.  Last year’s budget required borrowing 49 cents out of every dollar spent.  Congress just passed a health care bill that will raise taxes and balloon spending in the future.  Social Security is now paying out more than it brings in.  Seniors are taking earlier retirement because of high unemployment.

Federal tax receipts are a little over $1 trillion per year, every dollar spent over this amount has to be borrowed. A few years ago, the treasury started selling more short term notes, which reduced interest expenses. The yield on short term notes is almost always less than borrowing long term. This helped keep the budget deficit as low as possible at the time, but now is coming back to haunt us.

This debt must be rolled over, or refunded, and will create a tidal wave of debt that must be sold into the fixed income market. In addition to the $1 trillion the government needs to fund current annual expenditures, the government has to start replacing the little I.O.U.'s in the Social Security fund.  We estimate over $3 trillion is going to rollover (refund) in the next two years.

Earlier this year, Treasury had its first $100 billion week.  We sold more treasuries in one week than we used to sell in one year.  There are more of these weeks scheduled.

Added together, over the next two years the Treasury will have to borrow at least $5 trillion dollars. This amount does not include off-budget items that are likely to move on-budget. How much more money will Fannie Mae and Freddy Mac need? Case-Shiller reported last week lower prices on homes in the March. The FDIC is closing banks every week. The FDIC collected advance insurance fees from banks last year to handle all the bank closings, and they are closer to insolvent than ever before.  The FDIC can borrow money from the Treasury, but where does that come from? More Treasuries to sell!  These three entities could easily require another $500 billion in the next year or two.

Within three years, interest expense will be our largest budget item.

In fiscal year 2009 the U.S. paid $187 billion in interest on the national debt, with $1 trillion in tax receipts. This year the estimate is $383 billion in interest expense. We have added more money on the debt, and interest rates are starting to push higher.  The national debt ceiling now stands at $12.39 trillion. If interest rates rise to 5% in the next year on a mixed maturity basis, the interest payments in 2011 could be as high as $619.5 billion, again on one trillion in federal revenue, or 61.9% of cash flow!  It all depends on how much additional must be borrowed to replace the I.O.U.'s in Social Security, and additional borrowing for off-budget items.

CNN reported on March 20 that the congressional budget office projected deficits “averaging almost $1 trillion every year for the next 10 years.” In three years our debt will be more than $15 trillion. Tax receipts may increase by 3% per year, as the economy recovers placing them at almost $1.1 trillion. Interest rates will continue higher as we sell more and more debt. At a 6% mixed maturity basis, annual interest expense in the Federal Budget will be $900 billion. Do you see a trend here?  These projections anticipate a slow trend higher in interest rates, as we borrow more and more. What happens if the market gets spooked? Greece debt is priced over 7% interest on April 6th for 10 year notes.

The U.S. deficit is increasing our national debt to levels that are unsustainable.  The U.S. will not be able to sell all the debt required to fund the continuing operation of the government on its present course without interest rates dramatically rising.  Interest charges to service the national debt will consume an ever increasing share of the national budget.  Interest on the national debt could reach 100% of inflation adjusted tax receipts within a few years.

If this doesn’t scare you, I have not explained it sufficiently or clearly enough for you to understand.  The U.S. government is going broke, and it is irreversible with the present attitude in Washington.

The most obvious answer some will have is the government must raise taxes.   Some have suggested that the democrats are prepared to introduce legislation to collect a Value Added Tax (VAT).  This would mimic Europe, but can you imagine dropping the income tax?  I cannot either, so we will have both.

We wrote about taxes and the amount of money government can take out of the economy.  You can read our article from February 1, 2010, New Budget, Death Spiral.  The U.S. government tax receipts have averaged 17.9% of GDP over the last 60 years.  The president’s 2011 budget raises spending to 26% of GDP.  This did not include the new health care overhaul bill, which will increase taxes by $1 trillion over the next 10 years.

The attractiveness of the VAT is it lets the democrats raise a tax that will be passed through to people that make less than $200,000  President Obama can act as if he didn’t break a campaign promise of raising taxes on ‘working families.’

The essential truth, it does not matter how the government collects taxes, whether through income, VAT, sales, licenses or tariffs. The more the government takes, the slower the economy grows. This is why stating taxes as a percent of GDP is revealing.

It follows that government can only raise taxes so high as a percent of GDP before all economic growth is cut off and the economy will start to contract on confiscatory tax rates. Again, the U.S. is driving down a fiscal road that ends with the bridge out.

Bernanke testified before congress that the “Federal Reserve will not monetize the national debt.”  I doubt it.  The pressure will become enormous for the Federal Reserve to enter the markets and buy Treasuries, as they did last year.

By that time, it will be too late.  The genie will be out of the bottle.  When bond vigilantes have turned away, demanding higher rates, they will be slow to come back to the table when the game is rigged.

The only way out of the corner, the one answer politicians and central bankers all understand…is inflation.  Inflation on a massive scale.  Inflation is the only way out of the spending commitments the government has made.  It is the only way to increase revenues.  It is the one magic pill they can make us eat without throwing up.  It doesn’t even have to be hyperinflation, because 10% per year compounded will cover up all the stimulus and interference in the free market.

How do we profit?  What do we do?  John Paulson, hedge fund manager, famously made $15 billion for his investors and $3.7 billion for himself by shorting mortgage backed securities and the banks that owned them.  He saw the future, and acted.  He is buying gold, and in November of 2009 started a gold fund.

Our trade of the year, Silver.  If you like gold, you will love silver.  Most trading days, if gold goes up one percent silver goes up one and a half. We like silver for this reason.  You can buy SLV, the etf that holds silver in vaults to back up the shares.   If you want to lever up your return, buy Ultra Silver (AGQ), it moves twice the daily movement of SLV.  We normally would not recommend an Ultra etf for a holding for more than a few days.   Over a year time period, AGQ will not return double the gains of SLV, but its percentage gain will be greater.

If you would rather buy a company than an ETF, buy Freeport-McMoRan Copper and Gold (FCX).  FCX mines copper and gold.   FCX is just as good as silver; copper is used in almost every electronic gizmo known to man.  Copper is used in home construction, and kitchen utensils.  Many have called it “Dr. Copper” because it reacts directly to economic activity and inflation.

The key to our recommendation is to buy a commodity or commodity company that will increase because of inflation in U.S. dollars.  Crude oil, and oil companies, also fit this description.  We believe the biggest gains will be in Silver, because it is a precious/industrial metal that will benefit from fear and greed.

When do you buy?  The easy answer is now, but I believe there will be an opportunity before May 21 to buy SLV for less than $16.00 per share, that is less than it traded for on 12/31/09.

How much will they be worth by 12/31/10?

You should also consider buying silver and taking possession.  We do not have any relationship with any suppliers, but like the folks at Colorado Gold.  If you do business with them tell them we recommended them.  It won’t get you a discount, but I like doing business with people that are genuine and honest, and want them to know it.

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