Bet on chaos…and thrive.

As the global financial landscape dramatically changes over the next several months ahead of new government regulation and partial or full nationalization of the banking industry, investors will have to look to alternative investment strategies to produce absolute returns. It is highly likely that some of the most important changes to existing securities laws and regulations since the Great Depression are forthcoming.

Stocks, despite offering great values at these busted levels, won’t secure a retirement over the next few years. Asset allocation will be a key determining factor. Investors will have to look to alternative sources of capital gains that can thrive amid total market chaos. That means placing a portion of your assets into investments that can appreciate even when the markets are in a virtual nosedive.

Chaos to the Rescue!

Last December I introduced a new crisis investing portfolio in The Sovereign Individual called the Chaos Portfolio.

While virtually everything has plunged over the last several days amid total panic, the TSI Chaos Portfolio has surged. In October, this equally-weighted strategy has rocketed 16% compared to a crushing 25% loss for the S&P 500 Index. Year-to-date, the TSI Chaos Portfolio has soared a cumulative 34%, including dividends, compared to a mind-blowing 43% crash for the S&P 500 Index.

To be sure, many of my stock recommendations have plummeted in value this year as stop-losses are triggered like a pinball machine; the only strategy thriving in this mess is literally one based on total chaos.

What makes the Chaos Portfolio thrive is, well, chaos. A near complete breakdown of the financial system is exactly what makes this strategy excel. It’s easy to trade, cost-effective and any investor can participate even with a small initial investment.

Total Crash

The events now unfolding in the United States and overseas are the most significant financial developments since the 1930s. Investors have been crushed. Institutional portfolios have been mauled and retirement accounts lay in near ruins following huge double-digit losses. This is the worst bear market since the 1973-1974 Nixon years and, in some cases, on par with the Great Crash of 1929. The losses are truly horrific.

Global markets are roiling. Despite numerous government efforts to introduce market backstops and massive injections of liquidity to grease clogged credit markets, we’re still in a freefall. I expect coordinated government intervention to eventually arrest – if only temporarily – the bloodletting now infecting global asset values.

Sell on Strength, not in a Panic

A massive short-term up-crash or spectacular market rally is highly likely at this point.

History strongly suggests at least a 20-40% rally lies ahead following a hugely oversold period for common stocks. Even in the midst of protracted bear markets, stocks can muster huge rallies. This occurred on numerous occasions since 1929 with stocks surging from 1934 to 1936 before declining again. Stocks also posted an intermittent 40% gain in the 1968 to 1972 period while also recording impressive annual returns in the post-1974 period before finally bottoming in 1982.

Yesterday’s up-crash was no surprise as governments work overtime to reassure investors and inject additional doses of liquidity into inter-bank lending markets. Confidence will return to capital markets, if only for a while.

Many companies with strong balance-sheets and strong cash-flows have been trashed. In fact, U.S. blue-chip stocks harbour more than $650 billion dollars in cash right now and, in some cases, are probably more solvent than most governments and municipalities.

For investors with a five year investment horizon or more, this is exactly the time to start cherry-picking some of the best names in the United States. I would still avoid the financials. But many superb companies with strong global brands and no need to secure short-term financing are selling at five-year lows. Many stocks also pay high dividends.

What to do Now

Regardless of your age or tolerance for risk, investors should be at least 50% in cash or cash equivalents now. Make sure your funds are safe or deposited in banks that are FDIC-protected. Cash is vital because it will allow you to buy hugely distressed assets in stocks and credit markets over the next 12-24 months.

Alternatively, short-term Treasury bonds are a good safe-haven from the carnage and uncertainty affecting the global financial system. If you buy a money-market fund then make sure it’s a “government” or Treasury” designated product.

For stocks, don’t panic. The worst possible thing an investor can do in this dangerous environment is panic.

If you own stocks that you’d like to sell -- then take advantage of this rally. But again, if you have at least a five year investment horizon then start nibbling at select blue-chips now. The time to buy these great distressed companies is when prices are at a multi-year low, not when stocks trade near or at all-time highs.

Don’t forget about gold. I suspect global central banks have been suppressing the price of gold in this panic. Gold supplies are razor thin and most investors can’t access coins or bars in the United States or Europe. Global gold production in 2008 is basically flat with no new mine production expected until at least mid-2009. I can’t believe gold isn’t trading north of $1,500 right now; yet before this crisis is finally laid to rest, I think gold prices will fetch more than $2,000 an ounce.

However, I expect gold prices to decline following any concerted policy announcement from the G-7 industrialized countries to arrest the ongoing crisis; that’s when I plan on adding to my gold positions.

Gold should represent at least 10% of your portfolio. Any intermittent stock market rally accompanied by a relaxation of credit stress should be viewed as an opportunity to buy gold and other chaos-related investments that can thrive when uncertainty rules.

A big bear market stock market rally is highly likely. As it progresses, sell into strength and buy into chaos. I expect chaos insurance-related investments to become much cheaper over the next several days as this bear market rally intensifies.