Indeed, Wall Street (and the rest of the world) has started to fear the worst when it comes to the damage inflicted by a poisonous cocktail of automatic spending cuts to crucial sectors such as defense, and automatic tax increases. The combination of these two events could take a $600 billion-plus bite out of GDP, so it's no surprise that traders, investors and really anyone with skin in the economic game is so worried about a potentially disastrous outcome.
Resolving this issue will likely be a game of brinksmanship on both sides; however, time is of the essence. Some semblance of a solution to avoid the automatic cuts and tax increases must be worked out by Dec. 31, or the country could be staring down the barrel of a recession.
Now, as they so often due, commodities traders already have begun to foreshadow a coming recession. If we look at the action in Wednesday's trade, we see that gold and grains moved higher, and were basically the best performers in the commodity pits. Conversely, we saw a big sell-off in energy and base metals.
Traditionally, commodities such as gold and grains are not driven by economic growth. The flipside here is that commodities such as energy and base metals are very much fueled by economic growth. The thesis here is that if the fiscal cliff fails to get resolved in time, or even if there is some patchwork, kicking the can down the road like last year, then the economy is in for some very choppy waters.
For traders looking to profit from this thesis, you can do so with several exchange-traded funds (ETFs) poised to profit from the circumstances. You want to be long commodities that are economically insensitive and short commodities that are economically sensitive.
On the long side, there are funds such as the SPDR Gold Shares (NYSE: GLD), which is pegged to the spot price of gold, and the PowerShares DB Agriculture (NYSE: DBA), a basket of commodities such as cattle, coffee, corn, sugar, lean hogs and wheat.
On the short side, you have funds such as United States Short Oil (NYSE: DNO), an ETF pegged to deliver the inverse of West Texas Crude Oil prices, and the PowerShares DB Base Metals Short ETN (NYSE: BOS), a fund designed to deliver the inverse of a basket of base metals that include aluminum, copper and zinc.
Here's a breakdown of the trades as I see them:
SPDR Gold Shares
-- Buy GLD at the market price
-- Set stop-loss at $153.17
-- Set initial price target at $183.14 for a potential 10% gain in three months
PowerShares DB Agriculture
-- Buy DBA at the market price
-- Set stop-loss at $26.50
-- Set initial price target at $31.69 for a potential 10% gain in two months
United States Short Oil
-- Buy DNO at the market price
-- Set stop-loss at $37.56
-- Set initial price target at $44.91 for a potential 10% gain in two months
PowerShares DB Base Metals Short ETN
-- Buy BOS at the market price
-- Set stop-loss at $19.93
-- Set initial price target at $23.82 for a potential 10% gain in two months
According to my friend and colleague, Tom Essaye of The 7:00's Report, "The market is pricing in the expectation that fiscal cliff negotiations will drag on, and reduce economic activity, just the way the debt ceiling debate in the summer of 2011 did."
If Tom is right, and he almost always is, then these pair trades could make you a tidy recession/fiscal cliff profit in the weeks to come.