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Currencies and commodities anyone?

I have always believed that direct investments in currencies and commodities, while risky are also a hedge against economic and market downturns. That said, I certainly don't think we mid-rangers should dive into the Foreign Exchange Market [FOREX] or the commodities markets (CME Group; formerly Chicago Mercantile Exchange) to get our clocks cleaned - our government is doing a good enough job of that.

In a way, the Protected Principal Retirement portfolio already has indirect exposure to both currencies and commodities through foreign stocks (which may pay dividends in foreign currencies) and through investments in MLPs, CEFs and Royalty Trusts (oil, natural gas and natural gas liquids). What we will discuss in this article are a few techniques that will provide a more direct exposure to these asset classes.

Currencies

There are several vehicles available for currency investment. I have already referred to FOREX, there is at least one closed-end fund Nuveen Multi-Currency Fund (JGT) that affords this type of exposure, there are mutual funds, ETFs/ETNs (single currency, multi-currency, inverse, leveraged etc.) and probably other vehicles that I have not mentioned (or even thought of).

Since our portfolio's present allocation to currencies and commodities stands at five percent, by necessity we need to keep investments in these asset classes as simple as possible.

For a few years now I have read, watched and listened to Axel Merk - President and Chief Investment Officer of Merk Investments LLC - manager of mutual funds that specialize in currency investments. In 2010 Merk authored Sustainable Wealth, a book that addresses how we can retain what we have worked so hard for in times of economic crises. I highly recommend this book to concerned investors of all demographic groups. I do not receive any stipend for recommending the book.

The Merk family of currency funds is small, and consists of four funds: the Merk Absolute Return Currency Fund (MABFX), the Merk Asian Currency Fund (MEAFX), the Merk Hard Currency Fund (MERKX), and the newest fund, the Merk Currency Enhanced U.S. Currency Fund (MUSFX). All funds are no-load funds, and the expense ratio for the first three is 1.30 percent, and is 1.38 percent for MUSFX. None of the funds pay what I would consider a substantial dividend.

While MABFX has as its objective generating a profit regardless of the direction of the U.S. dollar, the other three seek to profit in a rise of non-dollar currencies against the U.S. dollar. Therefore, I consider an investment in one, or more of these funds to be something of an insurance policy. None of the Merk funds have been an outstanding performer thus far in 2012, and I do not expect a stellar performance unless, and until our economy (and the value of the U.S. dollar) hit the skids - possibly in 2013?

While the Protected Principal Retirement portfolio currently holds none of these funds, MERKX was a position in 2011. I am somewhat intrigued by the MUSFX investment strategy (it uses currency overlays while providing exposure to the S&P 500 stock index), but until I have a better understanding as to how it works I will stick with MERKX.

The Nuveen Multi-Currency Short-Term Government Income Fund invests half of its funds into short-term international government securities that are denominated in non-U.S. currencies. This closed-end fund sells at an 11.9 percent discount to net asset value, uses a managed distribution policy, and pays $.2975 dividend per quarter (a 9.24 percent yield). The price return year-to-date is 11.6 percent. It is worth noting that the quarterly dividend was reduced slightly this past quarter.

For those desiring a direct investment in the currency of a specific country, Guggenheim Investments offers the opportunity to invest in one, or more of eight country (region) currencies (Australia, Great Britain, Canada, China, Euro, Japan, Sweden and Switzerland) via an Exchange Traded Product (ETP). Their website (and appropriate investment information) can be found at currencyshares.com.

As far as year-to-date performance of the Currency Shares products, an investment in the Australian dollar has returned 4.58 percent and in the Swedish krona has returned 3.80 percent.

I believe that an equal allocation between the Merk funds and JGT would provide an adequate level of diversification within the currency asset class.

Commodities

As with currency investments there are a wide range of commodity opportunities - again, many of which I know very little about. I have limited my commodity exposures in the past to a few closed-end funds, a few mutual funds and the Jim Rogers Exchange Traded Notes (ETNs).

There are about half a dozen closed-end commodity funds presently trading. These include the Sprott Physical Gold and the Sprott Physical Silver funds - which I will not discuss herein since I do not wish to take physical delivery of either silver or gold at this time. Besides, both trade at a premium to net asset value.

The Central Gold Trust (GTU) has, as it's objective replicating the price of gold bullion, and the Central Fund of Canada (CEF) affords the opportunity to invest in both gold and silver without the delivery option.

In a prior article we covered Gamco Global Natural Resources and Income Trust (GGN) as an exposure to commodities. Gamco has recently trimmed its monthly dividend from $.14 to $.12, an expected move on their part. This cut did not have a serious ramification on the price, and the net asset value is beginning to increase post-cut. GGN gives a wide range of exposure to metals and energy commodities and we continue to hold it in the portfolio.

This leaves the Blackrock Resources and Commodity Fund (BCX) as a viable alternative for inclusion in our portfolio. The fund trades at a seven percent discount to its net asset value and yields 9.9 percent as of yesterday's (Tuesdays) closing price. A good portion of the quarterly distribution is considered return of capital, which might cause some a little heartburn. In addition, the majority of "commodity" investments are in the common stocks of chemical companies and MLPs.

There are a number of commodity mutual funds available - the two that I am most familiar with are PIMCO funds: PIMCO Commodity Real Return Strategy D (PCRDX), and PIMCO Commodities Plus Strategy D (PCLDX). Both of these fund were high yield funds until recent dividend cuts or omissions reduced yields significantly.

Jim Rogers is considered by many to be one of the foremost experts in the commodities field. He presently sponsors several ETNs, each of which focuses on a specific sector of the commodity markets, or on a broad market basket of commodities. I actively follow four of them: Elements Rogers International Commodity Agriculture (RJA); Elements Rogers International Commodity (RJI); Elements Rogers International Commodity Energy (RJN); and Elements Rogers International Commodity Metals (RJZ). All of these funds are a part of the Swedish Export Credit Corporation fund family. In the past, the Protected Principal Retirement portfolio has held a small position in RJA.

Information on RJA and other Elements ETNs can be found (here).

If you believe what Rogers espouses, then you believe that we are in a 20 year commodities bull market. Perhaps it will be 20 years, perhaps less, but I do believe that agricultural commodities are dwindling - evidence the drought being suffered in our own Midwest. Therefore, my interest RJA as a mid-ranger outweighs my interest in Rogers other ETNs.

RJA has been trading since the latter part of 2007 and caught the brunt of the market downturn in 2008. It traded sideways until mid- 2010, peaked in early 2011 and is presently beginning what appears to be a new uptrend. RJA does not pay a dividend and sports an expense ratio of 0.75 percent, lower than average for this category of fund. It has returned just over 11 percent year-to-date. I will consider re-adding RJA to the portfolio on a price drop to the low-nines or lower.

Conclusion

I have tried to point out the broad spectrum of available currency and commodity investment vehicles and the potential pitfalls and rewards of just a few. There is a lot of work involved in this area prior to stepping up and making purchases, and I urge you to take the time, as positions in both of these asset classes can be quite rewarding - but they are definitely not buy-and-hold as are some of our other portfolio investments.

Source: Protected Principal Retirement Strategy: Retiring Without A Million-Dollar Nest Egg - Part X