Hedge Fund | Madness, And The Delusions Of Wall Street Hedge Fund Managers

How to (calmly) make 160% as Washington and Wall Street go stark raving mad.

"All the secret signs say it's a bottom. From here, things just start looking better and better."

"No, it's going to get worse - a lot worse - and then bottom out."

"No you're wrong: It's the end of the friggin' world! You should invest in guns, gold, canned food and a life raft."

Each of these disparate - indeed completely contradictory - opinions has been foisted on us over the past couple of days, each from supposedly unimpeachable sources like the U.S. Federal Reserve, New York's Conference Board and well-placed sources at several hedge funds.

I don't blame you a bit if you're a tad confused. I follow this stuff for a living, and some days, I can't make heads or tails of what these guys are trying to say.

It's almost as if they all have gone stark raving mad.

Remember "Bad?"

Let me see if I can sort it all for you. The Fed says that we are in the soup about as deep as we ever have been. They've asked us to tear up all their old statements and projections.

You'd better start with the one about how the economy is only in a short mild recession (the prediction that replaced: "We are only in a flat stretch"), since it is already so obviously wrong. In a few more weeks, we will have notched up five full quarters of declining GDP, a feat we haven't managed since 1991.

Now the Fed is calling for diminished (if not diminishing) output till 2011.

Depth-wise, they were calling for the economy to fall off some 0.2% in 2009. Unless, of course, it grew 1.1%. They weren't quite sure, you know.

Now they are a tad more certain. Unfortunately, it's to the downside, a 0.5% loss for 2009.

Well, Now We've Got "Worse"

Remember back in the good old days of late 2008, when they thought unemployment might hit 7.1%? A month or so later, it's already at 7.6%.

But now the Fed warns we may look back on even that figure with warm nostalgia. Now they are warning we may hit 8.8% before the year is out.

But maybe, if we are really, really lucky, and say our prayers every night, we may see the figure whittled back down to 7.5% in 2011.

Interestingly, they place a great deal of faith in 2011, now. Not only is unemployment supposed to return to a level that was previously predicted as the maximum high, but the economy is supposed to grow as much as 5% that year.

Unless, of course, they are forced by cold hard facts to change their minds again.

"This Time We Really Mean It!'

Not to worry, says Fed Chairman Bernanke, because this time we are going to "pull out all the stops" to get things going again. In remarks before an incredulous audience at the National Press Club, Bernanke admitted that: "Recent economic statistics have been dismal, with many economies, including ours, having fallen into recession."

But there is good news, Bernanke assures us: "In the United States, the Federal Reserve has done, and will continue to do, everything possible within the limits of its authority to assist in restoring our nation to financial stability and economic prosperity as quickly as possible."

He's not lying, you know. The Fed has been playing with what it describes as "aggressive new tools." These tools are so "aggressive," the Fed's balance sheet has more than doubled $900 billion last September to somewhere around $2 trillion today.

Bernanke is completely complacent as to the exceptional dangers he has taken on: "The credit risk with our nontraditional policies is exceptionally low," because as soon as we get things straightened out these programs can be quickly reversed "to avoid risks of future inflation."

Yeah, I shudder too when I hear that, but let's move on for a moment.

Some "Good News?"

The latest out of the NY Conference Board: The economists there are done totting up the figures for January, and note that their Index of Leading Indicators actually rose 0.4%, the second positive reading in two months and an actual doubling of December's 0.2% increase!

The Board's Ken Goldstein claims that this means the recession's "intensity" will ease over the next few months. The problem is, the Board wasn't piecing together this index back in the 1930s, which is the last time the data looked anywhere near this grim. So their conclusions may be just a tad skewed.

Indeed, when I broke open the report and dug into the numbers, I found that the primary item pushing the index higher was the marked increase in cash in circulation. Yeah, I'll bet that is pushing the index higher, seeing as how M3 doubled over the past few months - a feat never seen before in modern history.

Or Not!

Which brings us around to the inevitable result of that doubling: Remember all those assurances from Bernanke et al. that inflation was dead? Yeah, well, you need to tear up that prediction too.

Seems that inflation in January posted its biggest spike in six months. Wholesale prices rose 0.8%, four times December's 0.2% increase. This unsettling increase was led by a 3.7% surge in energy prices.

But don't let anyone kid you that this was only "volatile non core." First of all, we saw the ugly truth behind that myth back in 2006 and 2007, when energy prices percolated into the mainstream economy with devastating effects.

Beyond that, core prices also picked up a robust 0.4%. And all of this is already edging into consumer prices, which were up 0.3% in January.

It's Baaaack (and I Am Loving It!)

Yeah, that's right, folks. For all the talk of "potential deflation," it's inflation that is rearing its ugly head again, just as we predicted here in TD.

Also rising like a phoenix from its own ashes, we saw gold shining through to a robust $1000 an ounce for the first time in nearly a year. This spike has pushed WOW reader's position in Gold SPDR (GLD: NYSE) calls to $14.20 for gains of 85% over some six weeks. We are still watching this position with great interest and expect gains to reach as high as 160% in the near future.

In fact, we rate gold's risk so low right now, we are recommending additional calls against senior miners as well. We anticipate Washington's lunacy to hand us an easy double on this position as well.

I'd like to claim remarkable prescience here, but really it was a no-brainer. Every wiseguy on the Street knows you simply can't double dollars in circulation with impunity.

Yeah, the market might appear to rise. Heck, that's exactly what happened from 2003 to 2007. But it turned out to be a mirage that evaporated the moment we looked at it too closely.

So they are all doing exactly what you should be doing: grabbing a piece of something solid as fast as you can.

Now That's Just Crazy Talk

Which brings us to that last thought at the beginning of the article - the one about guns, gold and bottled water. Back in the dark days of December 2008, back when we thought the world was falling apart (as compared to now, when things look just dandy), New York hedge fund managers like Gene Lange began to get just a tad spooked as to how the whole story might end.

Lange told Timothy Sohn of New York Magazine that in December, he and his friends began stocking up on guns, food water diapers and other necessities. Lange's compound over the river in New Jersey is replete with a biometric ammo safe and a military surplus diesel-powered off-road vehicle.

He is even contemplating stashing a motorized lifeboat somewhere on the edge of the Hudson, so he can get off the island if things go all "I am Legend" on us.

These guys are nuts, right? Completely out of their tree.

Seriously, that's just never going to happen. We've weathered storms like this before without seeing our grand cities turn into cannibalistic jungles. Soup lines? Maybe. House parties even? Possibly.

But Donner Parties? Naaah.

Still, it tells you a lot about the intellectual capacities of the idiots who happily led us into this mess, and are pretty much still madly swinging the levers of power back and forth.

Crazy, just crazy.