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.

September Performance

Index	Sep %	YTD %
S&P 500 TR	8.92	3.89
MSCI EAFE	9.49	-1.25
上海 Shanghai	0.64	-18.96
Fund
Entertain.Trends	2.09	14.77
Green Dragon	-1.82	5.33
Best of Funds	-4.72	-3.89
Pharma & Dogs	3.93	10.28
China Fund	2.01	-1.11
SoftwareSecurity	330	14.24
Yield to Me	2.61	5.29
Catch a Falling Knife	-10.02	-18.60

A big up month for the markets and a big drop for the U.S. dollar worked against several portfolios. Defensiveness continues to hamstring the returns, but overall they're still doing well relative to the market.

August Performance

Index	Aug %	YTD %
S&P 500 TR	-4.51	-4.62
MSCI EAFE	-3.34	-9.81
上海 Shanghai	0.05	-19.48
Fund
Entertain.Trends	1.83	12.42
Green Dragon	2.79	7.27
Best of Funds	3.84	0.87
Pharma & Dogs	1.04	6.11
China Fund	1.24	-3.07
SoftwareSecurity	3.62	10.59
Yield to Me	1.04	2.61
Catch a Falling Knife	7.90	-9.53

The euro went lower and gold and gold miners went higher, as did silver. Another winner from the portfolios are heavy weightings in iShares Barclays 20+ Year Treasuries (TLT), most funds have had very large chunks in this ETF for many months, more than a year for many. The buyout of McAfee (MFE) helped boost the Software Security Fund.

I long for the day when I can exit positions such as TLT and fully invest in target sectors, but for now I think this remains the best strategy.

July Performance

Index	July%	YTD %
S&P 500 TR	7.01	-0.11
MSCI EAFE	9.41	-6.70
上海 Shanghai	9.97	-19.52
Fund
Entertain.Trends	0.54	9.42
Green Dragon	-1.30	3.94
Best of Funds	-5.64	-4.53
Pharma & Dogs	0.33	4.53
China Fund	-0.37	-5.14
SoftwareSecurity	1.47	5.89
Yield to Me	1.89	1.21
Catch a Falling Knife	-7.64	-15.80

Rising euro and falling gold and gold miners clobbered the Best of Funds portfolio.

June Performance

Index	June%	YTD %
S&P 500 TR	-5.23	-6.65
MSCI EAFE	-1.16	-14.72
上海 Shanghai	-7.48	-26.82
Fund
Entertain.Trends	0.01	8.84
Green Dragon	1.54	5.30
Best of Funds	0.19	1.18
Pharma & Dogs	1.09	4.18
China Fund	-2.77	-5.50
SoftwareSecurity	-0.23	4.35
Yield to Me	0.13	-0.67
Catch a Falling Knife	11.13	-8.84

Another bearish month and another decent performance from my model portfolios. These have mainly been on autopilot this year, turnover has been low for all but the "Best of Funds" portfolio, but that's the one I most actively adjust. Turnover was almost 10% last month as I went in and out of gold miners and short ETFs, and turnover was 300% in the past year. Turnover has been high in general in the past year, however, due to playing the short-side with inverse ETFs.

Right now, my single largest position is ProShares UltraShort Euro (EUO). I have a monster position in "Best of Funds", but it is a smaller position across almost all the portfolios. At the moment, it is my highest risk-to-reward trade, given my high expectation for continued euro weakness in the long-run. Generally it does not pay to hold a leveraged or inverse ETF due to the negative effects from compounding the daily value reset, but the (generally) low volatility of currency movements results in a much smaller performance drift. Also, this compounding works in the investors favor when the position is moving consistently in the investor's direction.

May Performance

Index	May %	YTD %
S&P 500 TR	-7.99	-1.50
MSCI EAFE	-12.06	-13.72
上海 Shanghai	-9.70	-20.90
Fund
Entertain. Trends	1.12	8.83
Green Dragon	1.25	3.70
Best of Funds	2.95	0.97
Pharma & Dogs	-3.49	3.06
China Fund	-2.96	-2.80
Software Security	-0.39	4.59
Yield to Me	-3.53	-0.79
Catch a Falling Knife	12.01	-17.99

My decidedly bearish positioning for most of these portfolios paid off in May. We're off to a bearish start in June, but the only trend I'm confident about is the weak euro. A one-month drop in Chinese manufacturing is a single data point, not a trend, but manufacturing does lead the economy. If China's manufacturing is weaker, the rest of the global economy will follow.

April Performance

Index	Apr %	YTD %
S&P 500 TR	1.58	7.05
MSCI EAFE	-2.10	-1.88
上海 Shanghai	-7.67	-12.41
Fund
Entertain. Trends	3.07	7.63
Green Dragon	1.24	2.42
Best of Funds	1.69	-1.93
Pharma & Dogs	1.36	6.79
China Fund	0.28	0.16
Software Security	2.30	5.00
Yield to Me	-0.06	2.84
Catch a Falling Knife	-10.64	-26.78

March Performance

Index	Mar %	YTD %
S&P 500 TR	6.03	5.39
MSCI EAFE	5.81	0.22
上海 Shanghai	3.13	-3.96
Fund
Entertain. Trends	2.18	4.43
Green Dragon	-0.22	1.17
Best of Funds	-3.45	-3.56
Pharma & Dogs	2.96	5.35
China Fund	-1.28	-0.12
Software Security	2.37	2.63
Yield to Me	2.21	2.91
Catch a Falling Knife	-14.46	-18.06

Last month I asked: Will shorts begin to pay off, finally?

The answer is no, they did not.

February Performance

Index	Feb %	YTD %
S&P 500 TR	3.10	-0.61
MSCI EAFE	-0.88	-5.28
上海 Shanghai	2.10	-6.9
Fund
Entertain. Trends	3.34	2.21
Green Dragon	0.35	1.40
Best of Funds	-2.15	-0.10
Pharma & Dogs	1.25	2.33
China Fund	1.48	1.18
Software Security	2.22	0.26
Yield to Me	1.47	1.30
Catch a Falling Knife	-11.67	-4.28

Will shorts begin to pay off, finally?

Defensive & Short ETFs

I have these funds in my "Best of Funds" portfolio on Marketocracy. Holdings skew defensive, rather than short.

ProShares UltraShort MSCI Brazil (BZQ)
ProShares UltraShort China 25 (FXP)
ProShares UltraShort Euro (EUO)
ProShares UltraShort MSCI Europe (EPV)
PowerShares DB U.S. Dollar Bullish (UUP)
iShares Barclays Short Treasury Bond (SHV) - this is short-term Treasuries, not an inverse ETF.

I also have a large cash position, some precious metals, and inverse ETFs on the major U.S. indexes.

The portfolio is underperforming the market by about 2% today, but YTD through yesterday, it was up more than 3% compared to -5% returns for the S&P 500 and Dow.

As I wrote last month, I think there has been a sentiment shift in the market and I expect "Best of Funds" to do much better this year.

January Performance

Index	Jan %	YTD %
S&P 500 TR	-3.60	-3.60
MSCI EAFE	-4.44	-4.44
上海 Shanghai	-8.78	-8.78
Fund
Entertain. Trends	-1.08	-1.08
Green Dragon	1.05	1.05
Best of Funds	2.16	2.16
Pharma & Dogs	1.07	1.07
China Fund	-0.29	-0.29
Software Security	-1.90	-1.90
Yield to Me	-0.16	-0.16
Catch a Falling Knife	8.36	8.36

It's been awhile since I hit some outperformance. Large cash and bond positions, plus long U.S. dollar, short euro, and inverse ETFs helped deliver a good month. Greece and China dominated the news in the second half of January and they may be the key to what the market does in February.

December Performance

Index	Dec. %	YTD %
S&P 500 TR	1.93	26.46
MSCI EAFE	1.36	27.75
上海 Shanghai	2.56	79.98
Fund
Entertain. Trends	-0.09	23.46
Green Dragon	-0.09	26.79
Best of Funds	-2.81	-1.35
Pharma & Dogs	-1.26	6.91
China Fund	1.49	11.86
Software Security	1.84	32.88
Yield to Me	0.04	21.73
Catch a Falling Knife	-13.74	-49.81

SINOX	m100	S&P 500	DJIA	Nasdaq

Above is a 1 year chart of my China fund. Below is the two year chart.

SINOX m100 S&P 500 DJIA Nasdaq

Bearishness didn't pay off this year, and the fund is about level with the U.S. market and missed the huge rebound in Chinese stocks this year. Below is the steady under performance of the Best of Funds since about June. Of course, bearishness paid off in the previous year and the two year chart shows it.

MRC	m100	S&P 500	DJIA	Nasdaq

MRC	m100	S&P 500	DJIA	Nasdaq

Finally, here's a two year chart of the Green Dragon fund, clearly showing when I turned bearish on this year's rally around the time of August-September of this year. I had been invested in some mining shares such as Teck (TCK), among others, which went on to higher ground as my fund flat-lined and lost some value.

GDF	m100	S&P 500	DJIA	Nasdaq

This year is going to be just as challenging, with a potential dollar rally already in the works and a new $4 trillion bailout for the banks courtesy of Barney Frank. They'll need it, since the government's actions of the past year have only postponed the inevitable. The question is whether this year sees a setback, or whether, as with the housing bubble, the government and Federal Reserve manage to delay it for several years.