Are ETF Investors Only Making Money on Paper?

Fiat money is money that a government has declared to be legal tender. It has no intrinsic value since it is not backed by actual “stuff,” like a precious metal.

Hard money typically describes currency that is made of or backed by hard assets like gold, silver or platinum. A government that uses hard money is backing the value of the currency by a tangible, durable material that is expected to retain relative value over time.

Many a hard money advocate believes that the U.S. dollar is not only weakening, but will someday collapse. Post-credit crisis, the doomsday dollar prognostication can no longer be dismissed as “preposterous.”

Personally, I don’t believe we are headed for hyperinflation nor the complete demise of the U.S. dollar; rather, the gradual movement away from the dollar as the world’s reserve currency seems more likely. (That’s scary enough!) Moreover, we should expect above-norm inflation with a Federal Reserve that’ll be late to act aggressively.

It follows that we have to invest dollars in ways that’ll maintain purchasing power or increase purchasing power. (Easier said than done!)

For instance, if the nominal gains on the S&P 500 SPDR Trust (SPY) are roughly 18.5% through 10/6/09 close, an all-stock portfolio is actually flat in real money terms (a.k.a. gold). That’s because the SPDR Gold Trust (GLD) is also up about 18.5% on the year.

Gold bugs might even choose to exacerbate your pain. The all-S&P 500 portfolio may have lost 37.0% in nominal dollar value in 2008, but it lost more than that in real money (gold) value. In 2008, gold gained 7.3%.

Over the last decade? Gold is up nearly 250% while the S&P 500 SPDR Trust (SPY) with dividends reinvested is basically flat. In real money terms, then, stock investors have lost approximately 70%! Ouch!

The question that non-goldies might ask is, “Why should I care how many ounces of gold my S&P 500 SPDR Trust (SPY) shares can buy?” After all, the local Albertson’s is still taking George Washingtons.

Yes, but it may require $10 for the carton of milk or, more aptly, $20 for that 6-pack of beer. And you may find yourself becoming a vegetarian by price, not by choice.

Granted, I don’t see it happening. I see the Fed coming late to the table, but when they come, they’ll genuinely defend the dollar (no ”wink wink”) and they’ll raise interest rates aggressively. Former Fed Chairman Volcker is in the Fed’s ear… so one should expect an aggressive rate hike campaign down the path.

As an investor, it may be paramount to prepare for the shift from deflation to inflation… ahead of the Fed. ProShares Ultrashort 7-10 Treasuries (PST) and Proshares UltraShort 20+ Treasuries should be a consideration for rising interest rates. Foreign equities from regions of the world where the currency is safer, particularly China, make sense for many stock investors as well. Consider the PowerShares Dragon Halter China Fund (PGJ).

Full Disclosure: Gary Gordon, MS, CFP is the president of Pacific Park Financial, Inc., a Registered Investment Adviser with the SEC. The company may hold positions in the ETFs, mutual funds and/or index funds mentioned above.

Comments

[roy piper:]

Solid article.

I do have SEVERE doubts about the Fed raising rates, fo two reasons.

1. If our massive deficit is revalued at higher rates, it is completely unaffordable.
2. The Fed has a history do doing the will of the President. Given the admission that everything and every union is too big to fail, I doubt that suddenly the government would be willing to just turn on a dime and send the US back into recession just to keep inflation at bay.

Also, rates could go up EVEN IF the economy tanks. If foreign nations stop buying out debt until they are properly paid for the obvious risks, rates would have to go up even if we had deflation. We are not in our own control anymore.

Oct 07 06:15 PM

[Analyste de...:]

Volcker was "used" by Obama, and has no clout whatsoever - look at Larry Summers and the Greenspan protege for hints what's to come. Little Timmy might jaw-bone a strong Dollar, but will he tell you the TRUE inflation rate?

Over the last 20 years, an investor needed avg annual returns > +8.2% to beat the real inflation rate. Over the last 30 years, s/he needed avg annual returns > +9.1% to beat the real inflation rate. How did s/he manage, by the numbers?

For an investor nearing retirement, select the DJ Portfolio 2010 Index (w/ a glide-path & asset-allocated returns) from 1983, apply the REAL inflation rate and and subtract 112bps (avg) expense ratio. Factoring real costs & loss, the long-tem 20-Year retirement saver is underwater -30% > -36% (-2%/ann.) God bless those contributions, there's no other gain!

Looking back over the past 125 years, these negative long-term inflation adjust returns are without precedent, worse than the mid 1980s, worse than the early 1920s. The Rolling 20 Year Ret wasn't so bad in Great Depression.

Going forward, just to break even the long-term investor needs a 5 Yr Annualized > +8.25% over inflation. fwiw, that kind of phenomenal return occurred just 4 TIMES in the last 45 years. Only in the low-inflation 1950s do we see rolling 5 Yr. Ann > +10% inflation-adjusted returns. (That implies something akin to a 1950s US economy, starting next year. Don't bet on it.)

It's more likely the real inflation rate will skyrocket in 2010 or 2011. So who would bet long term inflation-adjusted returns will suddenly turn positive with severe inflation? When in US history has that ever happened?

Oct 07 11:03 PM

[jrainspe:]

I really think people need to look up, read and truly understand the meaning of the word intrinsic. Don't get me wrong, I am invested in gold and making money, but it is still the bigger fool theory. The only intrinsic value of gold is that it is pretty and it lasts a long time, maintaining its beauty. It has no other intrinsic value. It is such a soft metal that it cannot be used as a structural component and even jewelry is alloyed to some extent to make it more scratch proof and less malleable. It does have some uses in electronics, but other than those, it has no "intrinsic" value. It is the value that people attribute to it that makes it worthwhile as an investment.

Just imagine, if you were sitting on top of all the gold in the world, but nobody else cared anything about it as an investment or as a means of exchange. No one would trade you anything for your gold. Where is the "intrinsic" value of the gold, i.e. the value that an object has "in itself" or "for its own sake", as an intrinsic property.

Other than decoration, gold has really very little intrinsic value.

Oct 08 02:51 AM