by David Sterman
Investing in stocks in 2011? Sadly, that's not where the action has been. For the most part, the biggest gains for the year have been reaped in precious metals, energy and agriculture. Plain old equities are on track for a forgettable year after posting stunning gains in the prior two years.
A quick look at the top 20 exchange-traded funds (ETFs) reveals a healthy dose of silver-focused funds at the top of the list. (I've culled four or five from the table below to give a look at some other top ETFs as well.)
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Why silver at the top of this list?
The main appeal of the lustrous metal has been for its seeming utility to hedge against runaway inflation and a sharp drop in the U.S. dollar. To be sure, Washington's leaders inspire less confidence with each passing week, leading many to conclude our fiscal mess will end with a bang. Precious metals have a whiff of Armageddon about them right now, though it's not clear our current crises will end up as many suspect.
Runaway inflation? It just seems so unlikely when the world is awash in so much excess liquidity, a key reason why central banks can offer rock-bottom yields and still find ample demand among bond buyers.
The challenge for silver in particular (when compared with gold) is even more prosaic. Back in April, I laid out the demand part of the equation for silver prices, noting that "the speculative end of the market is creating real pressure on the industrial end of the market." Since then silver prices have surged even higher-- to nearly $48 in late April, and then plunged to $32 just a few weeks later. Now it's back up near $40 again. Yet there is a key distinction between early April and today. Back then, the global economy was building a head of steam, but it has been steadily losing steam since then. This should spell rising concerns for industrial demand. The recent spike is due more to the speculative inflation-hedge buying, which makes the precious metal too risky to pursue right now.
Energy and services
Other asset classes besides silver have also been on the move. Oil prices have been firm for much of the year, and energy producers (both oil and gas) have been putting up some pretty impressive profits. This has helped the Direxion Daily Energy Bull (3X) (NYSE: ERX) fund post a solid 28% gain. The fund invests in energy stocks found in the Russell 1000 Energy Index. Note the term "3X" in the fund's name. This means the fund deploys three-to-one leverage, magnifying what would have otherwise been a 9% gain for the year. Of course, the converse would also be in effect if stocks in energy companies begin to slump.
Yet this seems less and less likely. After all, the global economy is in sorry shape, but that has yet to meaningfully dent oil prices or the profits generated at energy exploration firms. So if you think that the global economy will eventually get back on its feet, then you have to assume energy prices may strengthen (at least until they rise so high that they choke off economic activity -- which some believe to be at the $140 to $150 per barrel of oil threshold).
Even if energy prices don't rise higher, companies providing equipment and services for energy exploration are set to keep flourishing. This is because it's taking more and more work to extract every last drop out of energy fields that have been tapped. Companies like Schlumberger (NYSE: SLB) and Halliburton (NYSE: HAL) have noted extremely strong industry dynamics in their recent conference calls. This should set the stage for further impressive gains for the iShares Dow Jones U.S. Oil Equipment Index Fund (NYSE: IEZ), which is already up 18% this year.
The Direxion Daily Real Estate (3X) (NYSE: DRN) fund and the ProShares Ultra Dow (3X) (Nasdaq: UDOW) fund also employ lots of leverage, so if you're really bullish on the real estate sector in particular, or the broader market in general, then these funds should hold great appeal.
Yet we also know some recent top-performing funds won't likely generate a repeat performance in coming quarters. Take corn as an example. A series of unusual weather events, coupled with a robust export market, have lit a fire under corn prices, sending the Teucrium Corn ETF (Nasdaq: CORN) up nearly 20% this year. Yet surging corn prices have led agricultural economists to predict a record planting season in 2012. This may coincide with a drop in demand for corn-based ethanol as the fuel source steadily loses favor.
More broadly, today's hot agricultural commodity is tomorrow's laggard simply because farmers chase high prices and plant what is selling well. Indeed, the time may be right to short the corn ETF because the fall planting season may surprise on the upside, according to some economists.
We can extrapolate a few broader themes from these quarterly results...
First, stocks are lagging right now, which is why very few unlevered stock-focused ETFs are doing well thus far in 2011. Second, silver-focused funds are doing very well right now, but may be on the cusp of a bubble. For that matter, agricultural commodity price outperformance tends to rotate, so corn may be the star of the first half of 2011, but soybeans, wheat or other foodstuffs may outperform in the next period. Lastly, the dynamics in the energy sector are defying the global economic showdown, and look set to stay aloft for quite some time to come.
That last part is what needs to be paid attention. Energy looks like the best bet of this high-flying group, so it may be time to reevaluate the portion of your portfolio devoted to the sector. Taking a flier on one of the big energy or services stocks is one way to go, but a position in an energy fund, like the ones I mentioned earlier, may be the best bet.
Disclosure: Neither David Sterman nor StreetAuthority, LLC hold positions in any securities mentioned in this article.