Reflation and How to Exploit It

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"One way is to use options. . .and take positions that would profit from a massive drop in Treasury prices or a near doubling in gold prices."

The most talked-about investing strategy these days isn't stuffing money in a mattress, it's the reflation trade - the bet that the world economy will rebound, driving up interest rates and commodities prices.

Even though the economy continues to struggle, investors are looking ahead to time when the massive rescue efforts by central banks and governments gain traction.

They are focused on raw materials and commodity-related stocks that would benefit from the surge in infrastructure spending. They are looking to exploit potential bottlenecks in production that could lift prices and corporate earnings. Some are layering on insurance against a spike in inflation should central banks lose control of their stimulus efforts.

One way is to use options where an investor is able to use relatively small amounts of money and take positions that would profit from a massive drop in Treasury prices or a near doubling in gold prices. While in the short run such trades may not work, "it's a long-term move," said Shawn Rubin, an adviser at Smith Barney in New York. "You want to buy insurance when it's cheap."

Until a few weeks ago, investors weren't even thinking about preparing for a recovery, hoarding cash and U.S. Treasury bonds and defensive stocks that would perform better than most in a recession. And the longer the economy takes to rebound, the longer it will take for the so-called reflation trade to pay off. In the meantime, investors with those bets run the risk of big losses.

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