Buy puts on the yuan?

From John Mauldin's Thoughts From the Frontline: Changing the rules in the Middle of the Game

“We saw today that 80% of Chinese construction firms say developers are now behind on payments (late cash flow), and that consequently land purchases are already 42% down y/y (slowing local authority cash flow). We also heard that pricing controls means that utility companies no longer have the cash flow to afford vital imports. Q3 corporate cash flow was down 27%.

“China's trade surplus is annualizing this year at USD152bn, FDI [Foreign Direct Investing] @ USD114bn yet its FX reserve increase is USD472bn. The attached chart [below] shows Chinese external borrowings which unfortunately were last updated at the end of last year, but the data would infer these have continued to soar.

“I am being told that European banks are now starting to shrink their foreign loan books to meet domestic needs, with Mexico, Brazil and China all big losers. With China now saying they may run a full-year trade deficit next year, and with them unable to afford to import vital coal and other resources without either suffering domestic inflation or without selling its FX reserves, it may now well be time to consider some sort of puts on the yuan. In fact the only reason perhaps not to is that India may collapse first, reducing the competition for coal and giving China a little more breathing room.

Using a fund such as ProShares Ultra Short China (FXP) may be the best route for retail investors to directly short a decline in the renminbi, although there will be numerous knock-on effects and funds such as PowerShares DB Base Metals Double Short ETN (BOM) should also do well. Direxion Daily Emrg Mkts Bear 3X Shares (EDZ) would also likely be a winner.

I haven't discussed my Marketocracy portfolios in awhile, but I have these types of ETFs in my China fund, which is up about 2% this year. The gains were mainly from a large gold position, which was the largest holding; it's now a very small position. The aim of the fund is to be a play on China, holding either Chinese stocks (always some), but also commodities and currencies related to China. Chinese are heavy gold buyers, hence the gold position. Europe is the largest export market, so ProShares UltraShort Euro (EUO) or PowerShares DB U.S. Dollar Index Bullish Fund (UUP) get added during crisis periods. The largest position is currently FXP, with short funds totaling about 33% of assets, which works out to effectively 70% short exposure based on leverage. Cash is near the mutual fund regulated limit of 35%, with short term bonds upping that to about 40%. My timing has been bad with the short funds, but I'm still of a mind to increase short positions if the market rallies. If timing remains an issue, I'll just move to cash equivalent assets and ETFs such as UUP to ride out the storm.

Nice down move today, but will it reverse again?

I haven't had time to do a post on my Marketocracy portfolio performance last month, but I did add some inverse ETFs to a couple portfolios today. The Best of Funds was a bad performer since March because its been defensive most of the way, but it has outperformed over the past two weeks.

Although I recently added a small holding in China Rare Earth and had previously made a small purchase of CBM Asia Development (TCF.V), a coalbed methane exploration company with operations in Indonesia, my main positions are 20+ Year Treasury (TLT) and, for the moment, Double Short Oil (DTO).

I have some puts on Starbucks (SBUX) which I bought way too early. Going forward, I'll make use of puts, currency futures, and inverse ETFs.

I've been burned several times by market reversals, however, and I may quickly reverse all my bearish positions if the market moves higher with conviction.

August Performance

Index	August %	YTD %
S&P 500 TR	3.61	14.97
MSCI EAFE	5.16	21.14
上海 Shanghai	-21.80	46.51
Fund
Entertain. Trends	0.31	20.96
Green Dragon	-0.25	28.84
Best of Funds	-2.64	5.20
Pharma & Dogs	-1.04	5.89
China Fund	-0.85	11.28
Software Security	-2.37	25.43
Yield to Me	-0.81	11.52
Catch a Falling Knife	-5.54	-46.74

I went heavily bearish in my Best of Funds, with large positions in TLT, UUP, FXY, plus multiple positions in inverse ETFs such as FXP, SRS, SKF, EEV, QID, DTO, etc. It started paying off at the end of August, but I'm ready to reverse if the market climbs higher.

China Fund also has a large neutral position plus bearish with heavy FXP exposure.

Other portfolios have raised cash or moved to more defensive holdings.

Out of Double Short Oil, Double Short Real Estate

In the Best of Funds portfolio, I closed out PowerShares DB Crude Oil Double Short (DTO) and ProShares Ultra Short Real Estate (SRS). I don't think the trades are wrong fundamentally, but I was down about 30 percent and 20 percent, showing the timing risk of leveraged funds. The failed trades cost about $13,000, or $0.13 on the shares, which closed at $14.42 yesterday. That makes for a loss of about 0.9 percent for the fund.

I'm still in several other short funds, which have losses clustered around 10 percent.

Shorts Killed Again....Updated

I went short on oil in my Best of Funds fund, and it crimped returns in the past month. Since adding PowerShares DB Crude Oil Double Short ETN (DTO) it is down 17 percent; it fell 11 percent yesterday.

Oil prices are up in recent days, to about $60 a barrel. I'm staying short because I do not believe there will be an economic recovery. If I am wrong, and prices do continue to rise, then we have an inflationary situation, in which case I am well-hedged in other commodities and precious metals.

Update: I posted this in the morning, but we've got a nice reversal today. The Best of Funds portfolio is invested for just this type of market. Though the hedges (such as short gold, versus gold miners) and large cash position have hurt returns (I don't sense a full on short opportunity yet), the fund is up 1.60 percent as of about 2:30pm, versus a 2.36 percent drop in the S&P 500, a difference of almost 4 percent.