The Global Guru: Goldman Sachs’ Top Trades for 2013 — And How You Can Bet Against Them

Every year at this time, market pundits venture their predictions for the coming year. Among the more anticipated ones is from investment bank Goldman Sachs, which recently offered its seven top trades for 2013.

If there is a common thread through Goldman Sachs’ trades for next year, it’s that risk is “back on.”

If Goldman Sachs is right, we all should have a pretty good 2013.

The operative word here, though, is “if.” Looking at them today, Goldman’s forecasts look reasonable. But perhaps that is their biggest weakness, aside from the fact that Goldman’s predictions are often embarrassingly wrong.

Consider Goldman’s top trades for 2012. Here are the top four: (1) short European high-yield credit (2) short German government debt (3) go long Euro/Swiss Franc (EUR/CHF) and (4) go long Canadian equities (S&P TSX) versus Japanese equities (Nikkei).

Aside from being fairly obscure trades targeted at sophisticated institutional investors, the real trouble with these predictions is that they essentially were just plain wrong. In fact, if you did nothing else than follow Goldman Sachs’ recommendations for 2012, you would have made less money than your average hedge fund. And hedge funds already are having a lousy 2012, thank you very much.

With that caveat, below are Goldman Sachs’ top seven predictions for 2013, with two twists.

First, where I can, I’ve tried to recommend how, if at all, you can play them in your own personal portfolio.

Second, I’ve also tried to highlight how you can bet precisely the opposite way — as that may actually offer you more profitable results.

1. Go Long the “Wavefront GDP” Growth Basket
Target: 10% return

Goldman’s proprietary “Wavefront GDP Growth” basket consists of long positions in cyclical stocks from the materials, industrials and consumer discretionary sectors and short positions in more defensive stocks from sectors such as consumer staples and healthcare. It is essentially a bullish call on the U.S. stock market with a couple of sectors over and underweight.

How You Can Play This:
Buy Materials Select Sector SPDR Fund (XLB)
Buy Industrial Select Sector SPDR Fund (XLI)
Buy Consumer Discretionary Select Sector SPDR Fund (XLY)
Short Consumer Staples Select Sector SPDR (XLP)
Short Health Care Select Sector SPDR (XLV)

How You Can Do the Opposite:
Just reverse the “long” and “short” recommendations above.

2. Go Long in the Current Account “FX Current”
Target: 4% return

“FX Current” is a proprietary Goldman basket that takes long positions in the currencies of countries running current account surpluses. These countries face currency depreciation risks which, in turn, increase the value of currencies running surpluses.

How You Can Play This:
This is a complex trade with, frankly, little upside without substantial leverage. I’m sure you could replicate some of this through the bevy of currency exchange-traded funds (ETFs) now available. But frankly, it’s not worth the effort.

3. Go Long Large Cap U.S. Banks
Target: 20% return

Goldman recommends that you invest in the KBW Bank Index (ticker BKX), comprised of 24 of the biggest U.S. banks. So why bet on the hated banks? The housing market is improving, partly because of the U.S. government’s mortgage-backed securities purchase program. This, in turn, will benefit U.S. banks which have lagged improvements seen in other housing-related stocks over the last several months.

How You Can Play This:
Buy SPDR S&P Bank ETF (KBE)

How You Can Do the Opposite:
Short SPDR S&P Bank ETF (KBE) or, more indirectly, buy ProShares Short Financials (SEF)

Note that SEF is based on a broader financial index than banks alone.

4. Go Long Spanish Sovereign Bonds
Target: 8% return

Invest in five-year Spanish government debt with a target yield of 3.5%. Spanish bonds are undervalued relative to German bonds. European policymakers have shown that bank creditors will take the losses on Spanish banks’ legacy assets rather than the Spanish government. Investors in search of yield in a liquid government bond market supported by the European Central Bank should make Spanish bonds popular in 2013.

How You Can Play This:
Buy iShares Barclays Spain Treasury Bond (IESP)
Note: This bond fund is listed in London and may not be available at all U.S. brokerages.

How You Can Do the Opposite:
You can try to short IESP, though that strategy may be difficult to pursue in practice.

5. Buy the Commodity Carry Basket (Crude, Corn and Copper)
Target: 12% over the next six months

Goldman expects crude oil to rise thanks to Iranian sanctions, low crude oil inventory and limited production from the Organization of the Petroleum Exporting Countries (OPEC). A pick-up in Chinese property sales and robust growth in Chinese construction completions will drive demand for copper through 2013. Goldman also issued a “strong conviction” that corn prices are too low and will rise.

How You Can Play This:
Buy United States Oil Fund LP (USO)
Buy Teucrium Corn (CORN)
Buy iPath Dow Jones-UBS Total Return ETN (JJC)

How You Can Do the Opposite:
Buy United States Short Oil (DNO)

You are unlikely to be able to short copper and corn with ETFs.

6. Go Long Risk on High Yield Credit Default Swaps
Target: 4.9% return

Goldman recommends that you short the CDX HY Series 19 credit default swap index, targeting a tightening of the spread to 450 basis points.

So, how’s that for an obscure trade?

Translated, this is another way of saying junk bonds offer attractive relative value in a world of quantitative easing, and are likely to rise. Defaults should stay low as investors pour into high-yield bonds, forcing down the cost to service debt and thus lowering the chances of them being unable to keep up with payments.

How You Can You Play This (Indirectly):
Buy SPDR Barclays High Yield Bond (JNK)

How You Can Do the Opposite:
Buy ProShares Short High Yield (SJB)

7. Go Short the Aussie Dollar against the Norwegian Krone
Target: 15.2%

Go short the Aussie dollar and long the Norwegian krone. The Australian dollar has remained strong, despite tumbling commodities prices and slower growth in China. Goldman Sachs predicts Australia’s central bank will be forced to cut rates over the next 12 months. In contrast, Norway is a relative safe-haven in Europe. The krone will appreciate, as Norway’s economy is expected to grow 3.1% next year.

How You Can Play This:
Short CurrencyShares Australian Dollar Trust (FXA)

Buy CurrencyShares Swedish Krona Trust (FXS)
There is no Norwegian currency ETF available for U.S. investors but, from a 30,000-foot view, the bullish case for Sweden is very broadly similar to Norway.

How You Can Do the Opposite:
Buy CurrencyShares Australian Dollar Trust (FXA)
Short CurrencyShares Swedish Krona Trust (FXS)

To read my e-letter from last week, please click here.

Sincerely,

Nicholas A. Vardy
Editor, The Global Guru