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indymacYou know the economy is in bad shape when one of the world’s largest investment banks [Bear Stearns (NYSE:BSC)] collapses and a few months later we witness the second largest bank failure in the history of the United States [IndyMac (IMB)]. And now we have news that Fannie Mae (FNM) and Freddie Mac (FRE) are insolvent and will need the Federal Reserve (i.e. taxpayers) to bail them out. Even the media cheerleaders are starting to look a bit less cheerful and entirely less believable when they suggest stocks are a bargain at these prices.

I’ve had family and friends start asking what they should do with their 401k, IRA and investments. They have received second quarter statements and are down anywhere from 10-30% year-to-date. Ouch. The average investor could stand to lose as much as 50% of the value of their retirement account during 2008 alone. Still, many investors are stubbornly clinging to the notion that the bottom is in and the markets and dollar will rally during the back half of 2008. Don’t ‘bank’ on it.

So what exactly should investors be doing to protect themselves and even produce positive gains over the next few years? The answer is simple: Get out of dollar-denominated assets. Go long gold and energy. Go short the Dow, Dollar and Financials.

The talking heads can repeat ad nauseam how gold is a barbaric relic that does not pay interest. I will let the following graph speak for itself. This is a comparison between the performance of the Dow Jones Industrial Average and the Gold Bugs Index since the start of the millennium. The blue line is the Amex Gold BUGS Index (HUI) gold stock index and the red line is the Dow Jones Industrial Average.

dow hui

If you had invested in the Dow Jones Industrial Average at the start of 2000, your return as of July 2008 would be 0%. Factoring in inflation and the devaluing of the dollar over that same time period, your true rate of return would be something closer to negative (-40%). During that same period, investing in gold stocks would have produced a return of over 500%! Barbaric indeed.

And what about shorting? A number of factors including the potential for unlimited losses have scared many investors away. However, with the relatively recent advent of short and ultrashort ETFs, investors can actually bet on a sector going down without actually shorting stocks. The ETF is geared to go up as the corresponding index goes down, eliminating the possibility of unlimited loss, providing diversity (which works in both directions) and allowing investors to go short within IRAs and other accounts that do not usually allow shorting. In addition, what about performance? The following chart shows the ProShares Ultrashort Financials ETF (NYSEARCA:SKF), which I have been recommending since March.

From May to July, SKF more than doubled in price from $90 to $210 for a gain of 133% in just two months. Even with the recent sell-off, the ETF is still up about 50% since May 1.

The energy sector has also been extremely profitable to traders and investors alike over the past few years. Oil has appreciated even quicker than precious metals and some of the better-managed alternative energy companies have seen astronomical gains. One of our most recent picks, Renesola (NYSE:SOL), more than tripled in price from our recommended entry point at $9. It has since given back a good portion of those gains, but is still up over 70% over the course of just four months.

The point is that there are always opportunities in the markets and just because the overall economy has slumped into a recession does not mean your investments have to do the same. Protecting your wealth and profiting during the current economic turmoil will take a shift in strategy, but your financial future could very well depend on it.

Disclosure: None

Source: Protecting Your Wealth and Profit During the 2008 Crash