FSO Editorials: 3 Rules for Bear Market Success by Robert B. Gordon 03/16/2004

3 Rules for Bear Market Success
Patience * Patience * Patience
by Robert B. Gordon, Sc. D.
March 16, 2004

Recently on CNBC, an unfamiliar guest commentator stated with confidence that we are now in the second year of a new bull market - a totally wrong assessment. We are now in the fifth year and very early stages of an Elliott Grand Supercycle Wave IV that may require the full 21st century to complete. And to make the forecast even harder to imagine, Robert Prechter has published one possible prediction in which the DOW will show several huge price swings from below 1,000 to above 12,000. It is not just a wild guess since Wave II of the same Grand Supercycle exhibited a long "trading range" price cycle lasting for 62 years from 1722 to 1784 in London. So, our youngest readers should plan to reread this prediction 50 years from now. This type of market could be very profitable for Elliott Wave users, while being totally confusing to nearly everyone else.

My personal introduction to the long Elliott wave history and predictions came in 1995 when I was 80 years old and read Prechter's great book At the Crest of the Tidal Wave. It changed my whole outlook on investing. Once you get the true picture of the dominance of natural waves over the less important news headlines, your investing skills will be greatly improved. My firm hope is that many of my readers will become students of Elliott’s great work and will use it to plot a safe course thru the troubled times ahead.

More than 99% of American investors know nothing about Ralph Elliott’s discovery of the Elliott Wave Principle 70 years ago. There is absolutely nothing I can do to reach these unfortunate individuals. But my readers can do something about their immediate circle of friends and relatives. Please print copies of this article with its stark warning of the many serious problems that lie ahead.

Let’s list some reasons why this bear market will take so much time to defeat. The first and most important issue is that only a tiny minority of people know about and expect it. The Depression after the 1929 Crash lasted only 10 years before it was halted by World War II. But, the great stock market crash in Japan in 1989 is now 14 years old and still shows no end in sight. Their government has tried many things to cure their depression, but with little success. Their inability to break out of their problem presents a big warning to the rest of the world.

The developed countries in Europe and Asia are now so closely tied economically with the United States that all the major stock markets will drop in unison in one huge and devastating bear market. Once the shock of this news sinks in, every reader should take all possible actions to assure their survival.

There is no better way than owning one or more of the numerous available short funds to build profits in a major bear market, but the timing of this position is critical to it success. We have decided to emphasize the increasing importance of using short funds to the success of a bear market portfolio. In order to do this successfully, investors must learn how to open and close short positions.

Mutual funds love to publish the results of successful dollar-cost-averaging programs. Their examples use a bathtub or u-shaped price curve that starts high, drops to a low point and then returns to the original price level. Think how wonderful the gains would be if the u-shaped curve was 50 years long. A 20 year old, investing over 50 years of low prices, would retire very happy if he took the money out at the high of the price range.

Now, let's suppose our young investor had the wisdom to buy natural resources such as oil and gas whose supplies are shrinking, or prime timberland or precious metals. Please understand that we are not recommending any 50-year program to anyone. Our crystal ball is very cloudy after 20 years. But, if Prechter’s vision of a huge trading range market turns out to be correct, there may be a number of favorable 20-year cycles for accumulation of capital.

At some point in the future, real estate prices for farm land or houses might become very attractive and create huge buying opportunities. But please remember the real estate bubble is still growing as we write, so the bargains are still far into the distant future. The very best advice anyone can give to our youth right now is to develop a strong urge to build assets by systematically spending less than you earn. The savings have to be readily available in order to take advantage of future bargains.

I recently wrote about the Pimco Real Return Fund and thought it was unique. It is not since I now have found three other identical funds, 3 of which have 5-star Morningstar ratings. They all have beautiful price charts over the past 4 years with annualized gains in the 10 to 11% per year. This group of bond funds stands out from all other Treasury bonds.

If and when interest rates rise, these TIP bond funds may need to be protected by a fund that is short bonds such as RYJUX.

The three originators of the original portfolio did a brilliant job and I am sure it will continue to do so for quite a while. It can surely be improved in a number of ways, but I am only going to suggest 3 changes that will provide a more modern coverage of the world's safest assets.

By reducing the original portfolio to just 50% of the new one, we make room for 5 relatively new funds, 3 of which are great new additions to the mutual fund industry. They are David Tice’s Prudent Bear and Prudent Global Income funds and John Huffman’s hedged Strategic Growth fund which are allocated a total of 36.5% of the new portfolio. Then we have replaced part of the Natural Resource category with a rapidly growing Global Resource fund PSPFX and replaced part of the original precious metal bullion with stock of closed end fund CEF to take advantage of future swings in its market price vs. the net asset value.

So the breakdown between the old one fund portfolio and the new 6 fund portfolio is shown below:

Six Fund Portfolio
Asset Class	Permanent Portfolio	New Portfolio
Gold Bullion	20.0%	15.0%
Silver Bullion	5.0%	6.0%
Swiss Francs	10.0%	5.0%
Foreign Government Bonds	0.0%	10.0%*
Real Estate & Natural Resources	15.0%	12.5%
U. S. Treasurys	35.0%	17.5%
Aggressive Growth Stocks	15.0%	7.5%
Hedged Stocks	0.0%	14.0%*
Managed Short Fund	0.0%	12.5%*
Total	100%	100%
* also holds gold

50.0% Permanent Portfolio
8.5% CEF (Closed end AMEX)
10.0% PSAFX Global Income
5.0% PSPFX Global Resource
14.0% HSGFX Hedged stocks
12.5% BEARX Managed Short
100% Total

We are pleased with the new portfolio which has cut the aggressive growth stocks in half and protected the remainder with the short fund. With the shaky position of the U.S. dollar we feel good about adding the Global Income fund. Fortunately during the bear market rally in the past year, the Prudent Bear fund was able to have a profitable year.

Our readers are free to do anything they wish with the information presented above. Our freedoms are constantly being reduced, but at least for a while we can build our own fund of funds anyway we wish.

It may occur to some of our veteran readers that the above portfolio might be a good portfolio for the very long term either thru dollar cost averaging, a lump sum purchase or a combination of both.

In view of the fact that David Tice is free at any time he chooses to liquidate his short positions and turn bullish, I do not feel this modest short position should be traded as suggested earlier in this essay. However, I do remind all readers to perform periodic rebalancing steps when the asset percentages show the need. This new portfolio has some fairly aggressive, volatile assets that will provide periodic profit opportunities that should be taken when available. After a few years of experience you will be able to pick a good time to do it.

THREE YEAR PERFORMANCE OF NEW PORTFOLIO
Asset Class	Annual Return 3/12/2001 - 3/12/2004	Weighted Percent Return
Stable Assets
Permanent Portfolio	13.29%	6.64%
Foreign Government Bonds	13.95%	1.39%
Hedged Growth Fund	15.08%	2.11%
Total		10.14%
Volatile Assets
Gold/Silver Fund	21.46%	0.97%
Natural Resources	28.87%	1.44%
Managed Short Fund	11.18%	1.40%
Total		3.81%
GRAND TOTAL		13.95%

The 50% addition from the five new funds increased the total portfolio return by 7.31% vs. 6.64% from half of the old PRPFX. But this small increase in returns over the past 3 years does not measure the potential gains that will come in the future from the five funds that we added. We expect to get significant returns and diversification from the new hedged growth and managed short fund assets.

We will be pleased to receive your comments on the enlarged Permanent Portfolio. By adding some outstanding new funds, we believe we have corrected a few weaknesses and reduced the possibility of there being a down year such as occurred several times with the original asset mix. Your comments will be appreciated.