Will Gold Stocks And ETFs Save Us In The Coming Market Crash?

by: Peter F. Way, CFA


Just when may that be, by the way?

How bad is it expected to get?

What have these capital lifesavers done for us in the past?

What might be used as an alternative?

It could be any time now

Or any time last year. If we bought these things back then, we would be way behind the market. On a six-month basis, we're about even, using the biggest ETF or stock. So when we decide to act can make a big difference. Suppose the market just keeps on chugging and isn't really overpriced yet - at least not as much as it's going to get?

Who knows when, or how bad it might get? Just looking at the past has been quite misleading most of the time. What do the market pros say?

We look at the way market-makers [MMs] hedge the firm capital risk exposures that have to be taken every day in order to provide liquidity for big-money funds' desired trades. Certainly the smart money must have concerns with markets at these levels. How do the MMs read their clients' actions and comments?

There must be some activity on the ETF front from that quarter. Let's see what volume trades in precious metals ETFs suggest.

A quick explanation of the less-obvious numbered columns: (5) is the % change between (4) and (2). (12) tells, out of the total number of forecast days available, that sample number of those days with Range Indexes like the present. The Range Index (7) is the percentage of the forecast range (2 to 3) that lies below the forecast day market price (4). Using the prior sample in (12) to follow a standard, simple time-efficient holding discipline, (8) indicates the percentage of them that were profitable, (9) the average net gain on all such holdings, (10) tells how long on average the samples were held, and (11) the rate created by (9) and (10). (13) measures the credibility of (5) given (9), and (14) compares (5) to (6).

Please invest the time and effort it may take to understand the dose that is inflicted by all of those ( )s in the prior paragraph. The data does provide a useful way to compare some not-so-simple, but realistic, investment considerations.

For example, the critical starting point in each is the benefit being offered by each forecast in (5), largest for DUST, smallest for DBP. Past experiences of (9) say UGL's l +14.5% is most credible of the group, and those of AGQ is the least believable. But none of these current forecasts has been supported by actual market performance in months following similar forecasts made in the past.

And the biggest gains achieved for prior forecasts like the past have been for Direxion Daily Gold Miners Bear 3x Shares (NYSEARCA:DUST) which is a highly leveraged inverse ETF, built to go up a lot when gold stocks are going down. That doesn't sound very encouraging to the problem at hand.

Maybe ETFs aren't the right vehicle to look at for investment action in gold. After all, they only have about $60 billion in AUM, when the market caps of precious metal stocks are over $160 billion. Let's see what forecasts they have there:

Well, that's hardly much better. Here are 25 stocks and the MMs see a better-than +20% gain for them, on average, with some as big as +46% and +36%. Uh-oh! The actual results in months following prior forecasts like these are a minor net loss of about -1%. Guess that's just the cost of doing business while waiting to collect on the market hedge.

But many of these forecasts have been score-kept over quite random months during the last 5 years, as suggested in (12) so it must be an ongoing problem. And let's look at how often such forecasts made any money. The Win-ODDS in (8) shows a little worse than a coin-flip on an average basis, and only 3 stocks were well enough understood by these market pros to make money two out of every three times. Take a look at this article, where they have been batting 7 hits out of every 8, for double-digit gains in less than two months at a triple-digit annual rate.

That tells me something meaningful about the level of guesswork that is persistently proffered on this subject. Nobody really knows, but many folks are fairly skilled at frightening others.

The best-informed guessers in the investment business are up against the reality of risk exposures pictured here:

(used with permission)

This map shows the tradeoffs between the experienced risks (6) in the table above, and what might be likely enough to happen (5) so that a MM who had to be short the stock to fill a client order would pay out, in order to be protected, part of what could be a trade spread profit.

All those possible upsides are confronted by actual price drawdowns experienced in the past of -12% and more (over there on the left, in the red scale). That is what may need to be expected if these are the hedges being sought.

Is it worth your time?

More importantly than the emotional wrench of seeing an investment that far under water, is the distress of not knowing when it might get better. Until it does, the time spent in this kind of unproductive, possibly expensive, hedge can never be recovered. It's gone forever, invested in a wish-we-had-spent-it-more-productively effort.

Why not make the best defense from a good offense. When there are market pros who can guide investors to profitable investments in time periods that are short enough to keep a good lookout for the development of trouble, short of its real entrapment, then that strikes us as a much better strategy. Don't hide fearfully, compete.

Check out the article linked to above. Which way would you rather invest your time?

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.