This essay is based on the Premium Update posted October 9th, 2009
Although some investors argue that it is deflation that is in the cards, not inflation, I believe that one should at least one step just in case the massive amount of capital that has been pumped into the sliding economy causes a deterioration in the value of the currency. This step is making sure that one's portfolio has at least one asset that will retain value should dollar's value drop significantly.
There are several options to go, and the few of the most popular are: the emerging markets, precious metals (today I would like to focus on ETF's / ETN's / mutual funds) and TIPS (Treasury Inflation Protected Securities).
Speaking of the latter, I would like to point your attention to the fact that purchasing TIPS makes sense only if you believe that the inflation numbers are correctly representing the situation in the economy. Since I have a hard time believing this (as the way the inflation is measured has been changing and is currently -- politely speaking -- suspicious), and I think many of my Readers share my doubts about the reliability of the official inflation statistics, I can't recommend purchasing TIPS.
This leaves us with the emerging markets and precious metals. The emerging markets provide an interesting way to diversify you stock holdings, but given the level of globalization in the financial markets, it is likely that any serious plunge in the US would translate into a similar development on the emerging markets as well. Therefore, as far as long-term investments are concerned, I still believe that a well-diversivied precious metals portfolio is the best way to go. Like I mentioned a few paragraphs earlier, today I would like to focus on the indirect way of owning PMs, as it is often preferred due to the convenience it involves.
I personally think the ETF's and ETN's are indeed a convenient way to trade any market. However, as far as long-term holdings are concerned (which mean that you would put a lot of money into particular fund and keep it there for a long time), I believe the default risk involved is much more important factor than it is the case with speculation. Since ETF's / ETN's "add another layer" to the risk pyramid (and by that I mean that there is one more entity between you and the place where your money is), I prefer owning stocks and especially metals directly.
However, since ETFs, ETNs, and precious metals mutual funds might still be preferable way of being in the precious metals market for many investors, I have prepared a list of the most interesting funds that you might be interested in.
Exchange Traded Funds / Exchange Traded Notes:
- DBP - based on UBS Bloomberg CMCI Gold Total Return index. In short, this ETF's performance is a weighted average of gold's and silver's gains with the following weights: 80% gold and 20% silver
- DBS - based on the Deutsche Bank Liquid Commodity Index - Optimum Yield Silver Excess Return™ - it tracks the price of silver
- DGL - Deutsche Bank Liquid Commodity Index - Optimum Yield Gold Excess Return™ - it tracks the price of gold
- DGZ - 100% anti-gold, moves in the opposite direction to gold. Purchase if you want to profit on gold's decline (not recommended for most investors, as this means taking positions against the main trend)
- DZZ, GLL - like above, but these funds involve double leverage. In other words, if gold gains 1%, this fund loses 2%.
- GDX - 100% precious metals stocks, based on the GDM Index
- GLD, IAU - price of these funds reflects the value of gold owned by each trust
- XGD.TO - It replicates, the performance of the S&P®/TSX® Global Gold Index, so it offers considerable exposure to Canadian gold stocks.
- PMPIX - aims to track performance of the Dow Jones Precious Metals Index (PM stocks) with the 1.5x leverage factor. It uses at least 80% of its capital to purchase equity securities contained in the index. In other words - it is in a way similar to GDX, but it involves more leverage.
- FSAGX - Fidelity Select Gold invests at least 80% in gold and gold securities - it is actively
- USAGX - USAA Precious Metals and Minerals is very similar to the above fund (at least 80% in gold and gold securities). Additionally, the remainder (capital not invested in PMs) may be used to purchase other natural resource stocks
- TGLDX - Similar to FSAGX, but not more than 20% of this funds total assets may be invested directly in bullion / metals themselves. Therefore, this is fund is more of a proxy for PM stocks, than FSAGX is.
- UNWPX - Again, this fund invests at least 80% in companies principally engaged in the exploration for, or mining and processing of precious minerals such as gold, silver, platinum group, palladium and diamonds. The difference here is that it invests at least 40% of assets in securities of companies that are economically tied to at least three countries other than the U.S. Therefore, it offers a considerable geographical diversification.
In the Premium version of this essay I additionally comment on the recently introduced fund that provides you with a convenient way of owning gold in Switzerland .
While the decision as to what investment vehicle one should use is one of the most important that an investor must make, the "when?" and "at what price?" questions are vital as well. In this essay I will provide you with an analysis of the GDX ETF, which serves as a proxy for the precious metals stock sector (chart courtesy of http://stockcharts.com)
The situation in the PM stocks is similar to the situation on the silver market. We are relatively far from the previous highs, but given the recent volatility and strength of the market, it is likely that we will soon test (and then take out) both of them.
The first resistance level that I think has a high probability of stopping the current decline is at the $52.5 level. It proved to stop rallies in November 2007, April 2008, and finally in July 2008, just before the big plunge. Either way, unless anything unordinary happens, I believe that the currently rally has a big chance of taking PM stocks to the $52-$53 area, which would most likely correspond to the 70 level in the RSI.
Summing up, there are many ways to protect yourself from rising inflation / decrease in the value of the U.S. Dollar, but not all of them are really useful. One of the best ways is putting at least a part of your assets into precious metals. There are several ways to do it, and there is nothing like holding the metal in your physical possession, but if the choice is between owning them through a fund or not owning them at all, I would certainly go with the former option.
PM stocks are one of the ways to leverage your assets, and although they have on average not broken into new highs yet, it seems that it will take place sooner or later, probably before the end of this year. Since price of no asset goes straight up or down, PM stocks will need to take a breather - most likely the first stop will be made near the $52.5 level in the GDX ETF.
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Thank you for reading. Have a great and profitable week!