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Once again gold is on the rise with increased speculation of more stimulus from the Federal Reserve. Gold is trading over $1,700 an ounce and closing in on $1,800, currently at a 10 month high. With comments from the President of the Chicago branch of the Federal Reserve, Charles Evans, that the Fed can still do more to bolster the economy is increasing speculation on inflation. The Federal Reserve has three tools at its disposal to affect the money supply and assist in the growth of the economy. The Federal Reserve can lower interest rates, decrease required reserves by banks, or what is famously now called quantitative easing or as some refer to it as printing money. The Fed cannot lower interest any lower that it already has so that option is off the table. Banks are already flushed with cash and the supply to lend out is not the problem. The Federal Reserve is now attempting to entice lenders to lend their capital instead of holding government debt. The Federal Reserve had announced last month a third round of quantitative easing worth about $40 Billion a month. President Evans did not mention exactly what they would do but the only weapon left in the arsenal for the Fed is quantitative easing. Quantitative easing is also described as printing money and printing money creates inflation or the devalue of the dollar. So what are investors supposed to do with the expectations of continued quantitative easing and the threat of inflation, BUY GOLD! It is not only the United States that is taking measures to stimulate its economy, the European Central Bank is doing the exact same thing and the European Union is a larger economy than the United States. Japan, the fourth largest economy in the world is attempting to stimulate their economy with stimulus measures. We know have the European Union, United States, and Japan all flooding the market with cheap capital and lowering interest rates with bond buying programs. So where does this leave gold?

Gold is considered a safe haven for investors and a hedge against inflation. So what commodity strategy are investors choosing? Investors have a number of different strategies including the purchase of gold bars or coins, ETF’s, gold related stocks, or for direct and liquid exposure the futures market. The futures market is a great way to take advantage of the price of gold, especially if you don’t have hundreds of thousands of dollars. An investor needs to choose a futures strategy that is consistent with their risk parameters. If an investor is looking to become a millionaire off less than $100,000 then they need to purchase outright futures, no messing around with options here. The risk however is extreme. The investor could potentially lose more than they originally put into the account but should be using stop loss orders to prevent that.

If hedge funds are reducing their long positions in the futures market it is a sign that speculators no longer see the rise in demand or we will see a decrease in demand for commodities. One reason is due to the looming fiscal cliff. If no agreement is made between Obama and Boehner that can pass the Senate and the House while increasing taxes and cutting spending we will see a downturn in the economy. Some predict a 1,000 point drop in the stock market, but even if that is not true we are all confident we will see a shrinking economy if a deal is not met. It simple, if a deal is not done we will see a worsening economy which means lower demand for goods and lower commodity prices. This is simple economics, if you drastically increase taxes on all income brackets and huge spending cuts especially to defense it will damage the economy.

Net long positions in 18 different commodities decreased by 11 percent according to the Commodity Futures Trading Commission for the month ending December 11th, 2012. The biggest losers were sugar wheat and crude oil and with no deal in sight or time to draft legislature there will be some market drops after the New Year. We will probably see a deal in January but it will not stop the fact that we will have no deal come January 1st. There is also no trick up Ben Bernanke’s sleeves to prevent an economic downturn if fiscal policy is not enacted. The Federal Reserve has no tools available to counter tax increases and spending cuts. Analysts on Wall Street also believe the economy will come to a near stalling speed because monetary policy by the Federal Reserve will become less effective. Emerging economies such as China and Brazil have kept commodity prices steady over the last few years and any indication of growth in the U.S and stabilization of debtor nations in Europe has spiked growth in demand. We will likely see demand stall in growth but not crash due to world demand stabilizing these commodity prices, especially oil and copper.

The futures strategy being used by commodity trading companies or hedge funds is to reduce the outlook for growth in demand due to U.S fiscal issues. They may change their Commodity Strategy and stick to more predictable commodity classes. There could be a play in choosing oil as a commodity strategy and trading options as a futures strategy for some commodity trading companies. They could speculate on how much oil will fall and have a safety net if it doesn’t fall at all. They can do this by selling put options. Oil is currently about $87 a barrel, so they could sell a put option around $80 if they assume that is the lowest it will go if we go over the fiscal cliff. The trader would collect a premium and is only at risk if oil falls below $80 a barrel before expiration. The trader keeps the premium if oil stays above $80 during the life span of the option which could be weeks or months. So if oil doesn’t fall at all or remains steady due to world demand the trader profits. This is a good strategy for uncertainty in one market but confidence in the world market to hold a price floor.

For investors who have no idea on how to trade futures but have a stock and bond portfolio it is a great time to seek out diversification opportunities. If the fiscal cliff arrives and we see a drop in the stock market they could see a good chunk of their portfolio disappear. By having some exposure to the futures market they could potentially have some profit in their portfolio. Managed futures were profitably as an asset class in recent stock market declines including the tech bubble, 9/11, and the 2008 collapse. Managed futures are aware of the fiscal cliff situation and are going to place trades for their customers that will hopefully profit from the economic downturn.

The Republican Party is holding strong against Team Obama on dealing with the fiscal cliff. The fiscal cliff refers to automatic spending cuts and tax hikes that will take place on Dec ember 31st if congress does not reach a deal with President Obama. According to the congressional budget office the automatic spending cuts and tax hikes would send the U.S economy back into a recession at some point in 2013. So why are lawmakers playing chicken with the economy?

                Republicans and Democrats both think they have the right solution and both want different things when it comes to the fiscal situation. Republicans want spending cuts and real reform to entitlement programs which are 2/3rds of the expenditures. The democrats want spending to stay the same but want tax hikes on the top income brackets, more than $250,000 a year. Most Republicans signed a pledge by Grover Norquist which states that they will never raise taxes. Democrats cannot see spending cut because their base of voters is the free loaders. Neither party has control of all three branches so a deal will have to be cut to prevent another recession.

                Republicans have proposed no tax hikes but limitations on deductions at $50,000 maximum. They have stated this as a tax hike and would like democrats to come forward with real entitlement reform. The problem is that they have not done it. This situation is on President Obama, if a deal is not struck and we end up in another recession it will be at his feet. There is no blaming the former President anymore. The President has no real plan to cut spending and we are 28 days away from the deadline. My thought is that a deal will get done between Speaker Boehner and President Obama but the lead up will be full of speculation and wining by both sides. Obama is all about his image so being remembered as horrible President is something he will want to prevent. If the country slips into another recession he will be known as the President who could not only create poor economic policies and grow the economy but as the President who sent us backwards. No one will remember who killed Bin Laden the Mr. President. The United States has an annual budget of roughly 3 Trillion dollars, raising taxes to $160 billion a year is not going to fix our spending problem. We all know entitlements are only going to get worse and Obama care is going to cost aver $100 Billion a year where is this money going to come from. You can only tax people so much; it gets to the point where it could really push the U.S economy backwards. Not only are Americans having federal income taxes increase but State and local governments are going broke, does the federal government have any money to give them? Hell no they are going to have to raise taxes.

                If you have money in the stock market now is the time to review your portfolio and see if you are fully diversified. Make sure you have exposure to a multitude of markets and asset classes. You may want to look into managed futures.  Managed futures are futures trading accounts managed by professional money managers called CTA’s or commodity trading advisors. CTA’s are commodity trading companies that allow average investors the ability to access the futures market. The commodity trading companies trade a specific futures strategy or commodity strategy. A futures strategy would be the type of trade they place. They could buy and sell futures contracts, options or both. They could also buy and sell a futures contract and options on futures at the same time at different prices which is called a spread. A commodity strategy would be trading done in a specific market. Some traders at CTA’s have specific markets they are specialized in that they trade. These markets could be Agriculture which includes livestock and grains, energy, currencies, interest rates, stock indices, or softs (coffee, cocoa, and frozen OJ).

The Fiscal Cliff is a term used to describe the laws set to take place on Dec 31, 2012 that will include tax increases and cuts to government spending including defense. So what is the big problem with spending cuts and some tax increases, isn’t that the solution to lowering the national debt? By allowing tax cuts to expire and initiating spending cuts to 1,000 government programs including defense will most likely put the staggering U.S economy back into a recession.  By extending tax cuts and spending we will increase to our debt in the short term. With the U.S debt at more the $16 Trillion it is time to start thinking of how to reduce the debt so we don’t have our own European Debt crisis. Ben Bernanke has warned that going over the fiscal cliff will be devastating to the U.S. economy. The CBO estimates that going over the Fiscal Cliff will reduce the 2013 deficit by $560 billion, but would reduce the GDP by 4% which would be negative growth and a recession. The CBO predicts we would also lose about 2 million jobs.

What should investors do to protect their portfolios in the event we slip into another recession? I do not think we will go into another recession because the U.S congress knows better. There may have to be some compromise on both sides of the aisle meaning some spending cuts and some tax increases. Investors need to be prepared for either situation. By going over the fiscal cliff and going into another recession we are going to see a decline in the stock market. This could be the second major stock market decline in 4 years. One way investors can diversify is by diversifying or betting on a commodity that will go up as the stock market goes down. Investors could hedge their portfolio by purchasing put options on the S&P 500 or they could purchase gold, a commodity strategy.  This futures strategy is limited risk and protects a portfolio against catastrophic loses. Many mutual fund managers purchase options on S&P 500 futures on a quarterly basis to hedge the stock portfolio from a decline in value.

Investors could also diversify into an alternative asset class that is non-correlated to the stock and bond markets. Alternative asset classes include hedge funds, private equity, and managed futures. They are non-correlated because they either trade a market that is not affected by the same factors or they have the ability to go long and short. They also have the ability to trade option strategies which can be profitable in any market. Managed futures are an investment vehicle that allows average investors to get direct exposure to the futures market without having to actually trade the futures themselves. Through commodity trading companies or CTA’s investors can choose a commodity strategy or futures strategy that suites their risk parameters. These commodity trading companies give investors exposure to liquid markets and do not have access to customer funds. Managed futures can use more than one futures strategy or commodity strategy in their trading. By having exposure to the futures market an investor can create a portfolio with exposure to a non -correlated market. What this means is that if the stock market has a downturn and your mutual funds experience a drawdown that may not necessarily happen with your managed futures account. Your managed futures account may actually be profitable and therefore reduce the overall drawdown of your entire portfolio.