Let's be honest. As investors, the word inflation sends a chill down our spines. Inflation erodes the purchasing power of the U.S. dollar and as if that isn't bad enough, inflation also takes a bite out of dividends total returns provided by stocks. In theory, if inflation rests at three percent and your investment portfolio returns just five percent, your total return is going to rest at a scant two percent. If most of your portfolio is invested in equities, a two percent return is hardly worth the risk because you can likely do better with fixed income and money market accounts.
In other words, inflation is just a bummer for equity investors, especially those that are building income-generating portfolios. Unfortunately, inflation isn't the only negative economic data point stock investors need to monitor. Where inflation lurks, a weak U.S. dollar can usually be found. A weak dollar can be a good thing for short periods of time, especially for multinational companies that derive a majority of their sales from international markets.
Blue chip companies like McDonald's (NYSE:MCD) and Procter & Gamble (NYSE:PG) get a boost to their bottom lines when they convert strong currencies like the Australian dollar, British pound and euro back into U.S. dollars and rising earnings with blue chips stocks can often portend rising dividends. That said, prolonged periods of dollar weakness, say multiple years, are not a scenario investors want to see. And that's just what we've been seeing since the Bretton Woods Accord. It's fair to say the greenback has been in a downward spiral since moving away from the gold standard in the early 1970s.
Inflation and a weak dollar are a toxic combination, but that doesn't mean investors are without ways to combat this phenomenon. Historically, the most common way of fighting inflation and a weak dollar is to invest in gold. Investing in gold can be tricky to say the least. Tapping the futures market is risky and certainly not an advisable option for conservative investors. Combine the volatile daily price fluctuations in the gold futures market with the sheer amount of cash one needs to properly play gold futures and it is clear that futures trading is not an avenue most investors should get involved with.
Of course there are the naysayers that claim gold even lags the performance of stocks over the long-term. Well, that may or may not be true. It all depends on what one considers to be “long-term.” Usually, we agree with most of what renowned University of Pennsylvania professor has to say about investing for the long haul. And we agree that his book Stocks for the Long Run is a must-read for investors. All that said, Siegel says that $1 invested in stocks from 1802 to 2001 returned almost $600,000 while gold actually lost money with that $1 falling to 98 cents over the same time.
Obviously, no one has a 200-year time horizon. Many investors consider “long-term” to be something along the lines of one year, three years or five years and beyond. And the recent performance of gold has been robust to say the least, leaving many investors wondering how they can get some gold and other precious metals exposure in their portfolios. Thank goodness for exchange traded funds (ETFs). As the ETF world has exploded in popularity, the product offerings have grown to include hundreds of precious metals-based ETFs. This is a boon for investors as these ETFs present a far better avenue for getting access to gold, silver and other metals than the futures market does.
Lots Of Ways To Play Gold
Perhaps the most popular precious metals ETF is the SPDR Gold Shares (NYSEARCA:GLD). When it comes to commodities-based ETFs, GLD is one of our favorites because it doesn't invest in risky futures and derivatives contracts like many oil and natural gas ETFs do. GLD holds physical gold, which substantially reduces the risk of investing in this ETF. In fact, GLD is the sixth-largest holder of gold bullion in the world. GLD owns more gold than China and Switzerland!
Beyond that, the performance of GLD is nothing to scoff at. Over the last five years, certainly a long-term time frame, GLD has returned more than 120% while the S&P 500 is down more than five percent. So yeah, it's fair to say that gold does in fact beat stocks over specific long-term time frames.
(INSERT A CHART OF GLD VS. THE S&P 500 HERE)
While GLD gets most of the press in the world of gold ETFs, there are plenty of other offerings that investors should take note of. Another gold ETF that has really caught our eye recently is the Ultra Gold ProShares (NYSEARCA:UGL). UGL seeks to replicate twice the performance of gold bullion measured in U.S. dollars using the p.m. fixing price for delivery in London. That may sound complex and investors should note this ETF is NOT attempting to deliver twice the daily returns of gold futures contracts.
UGL is currently resting near its 52-week high of and has outperformed the S&P 500 by about 10% over the past three months. While it is difficult to hold leveraged ETFs for a long time frames, and UGL is a leveraged ETF, we believe that investors that use conservative stop-loss orders can be comfortable owning UGL while waiting for gold to rise $15-$20 per ounce, which would probably add another $10-$15 to UGL's share price.
(INSERT UGL VS. SP 500 CHART HERE)
Of course, investing in gold ETFs isn't all about getting exposure to the commodity itself. Some investors may want to mix in some gold stocks with their gold ETFs and again, there's an ETF to help you accomplish this. When we talk about gold stocks we're talking about miners like Barrick Gold (NYSE:ABX), Goldcorp (NYSE:GG), and Newmont Mining (NYSE:NEM).
The share performance of gold mining stocks in intimately linked to the price action in the underlying commodity and that makes investing in the Market Vectors Gold Miners ETF (NYSEARCA:GDX) an ideal way to play the gold mining sector. Picking the best stocks in the gold mining sector can a tough gig, especially when considering that some companies have higher costs than others and that impacts their share prices, so we recommend removing the stock-picking burden and taking a look at GDX.
Hi Ho Silver!
There's more to investing in precious metals than just gold and investors should also keep an eye on silver, gold's less heralded cousin. Silver has never received the acclaim that gold has and that is probably attributable to the fact that there are significantly less gold deposits around the globe than are silver deposits. That said, silver is actually more practical from a consumption standpoint than gold is. Gold is primarily consumed for jewelry production. On the other hand, silver has many industrial uses and is used by aerospace, healthcare and technology companies, just to name a few.
Of course, silver is also prized by investors as an inflation hedge much like gold is and silver is also used by many central banks to back their currencies. All of this means silver is a bit more versatile than gold. It is a precious metal that can combat inflation and it is also viewed as an industrial metal. To be sure, silver prices usually rise in conjunction with gold prices and that makes now an ideal time to look at a few silver ETFs.
The iShares Silver Trust (NYSEARCA:SLV) is the most liquid of the silver ETFs and on a year-to-date basis in 2009, SLV has far outperformed its gold cousin, GLD, which we highlighted above. This ETF is probably the best proxy for silver that retail investors can access without tapping the futures market and with silver prices poised to ratchet higher, now is the time to consider adding SLV to your portfolio.
(SLV vs. GLD chart here)
If you're inclined to take on a little more risk, allow us to present you with the PowerShares DB Silver ETF (NYSEARCA:DBS). Don't worry, DBS isn't all that risky as it attempts to track the performance of the Deutsch Bank Liquid Commodity Index, but the ETF does use futures contracts to accomplish this aim, giving it a hint of volatility. It's hard to argue with the ETF's performance on a year-to-date as it has delivered exactly the same returns as SLV.
Another compelling way for investors to get some gold and silver exposure while mixing in a play on emerging markets is through the iShares MSCI All Peru Capped Index (NYSEARCA:EPU). A lot of investors don't realize Peru is actually the seventh-largest gold producer in the world with annual production of around 160 million tonnes. Worldwide gold demand rose to $102 billion in 2008 and it's safe to assume that number will head higher in 2009. International silver demand rose 2.5% in 2008 and Peru was the leader there, producing 118.3 million tonnes of the shiny metal.
Those statistics bolster the case for investing in EPU, which does hold shares of some of the largest mining companies in Peru as well as financials and other companies. See, there's more to investing in South America than just Brazil.
(A CHART ON PERU MINERALS OUTPUT IF IT CAN BE FOUND)
Pushing For Platinum
Platinum is often lost in the discussion on precious metals, but it should not be treated as a second-rate investment opportunity because, simply put, platinum packs plenty of potential for investors. In fact, platinum trades at a substantial premium to gold because platinum is even more scarce. Like silver, platinum is used in a host of industrial functions and as such, platinum prices are more volatile than gold.
(52-WEEK PLATINUM CHART HERE)
Platinum can be found in jewelry, dental products, laboratory equipment and electrodes, but the primary end-market for platinum is automobiles because the metal is an essential ingredient in making catalytic converters. That makes platinum a play on automobile purchases, so when the economy is doing well, it's not surprising to see platinum trade for twice as much as gold.
South Africa, Russia and Canada possess most of the world's platinum reserves, but the best way play the shiny metal is through ETFs. And with only six million ounces of platinum produced every year, the scarcity of the metal alone can drive prices higher.
The two best ways for retail investors to gain platinum exposure are with a pair of Exchange Traded Notes (ETNs), which are a little different than ETFs. Neither the iPath DJ AIG Platinum Trust Subindex Total Return ETN (NYSEARCA:PGM) nor the E-TRACS UBS Long Platinum ETN (NYSEARCA:PTM) hold physical platinum, both promise to pay investors the equivalent return in platinum prices.
We expect that ETF Securities will be launching an ETF that holds physical platinum in the U.S. later in 2009 and that might be worth waiting around for, but in the meantime investors due have options when it comes to platinum and this metal certainly can shine for your portfolio.
Another Pricy Auto Metal
Palladium is a kissing cousin to platinum in that is extremely rare and heavily used in the production of catalytic converters for automobiles. Going forward, we expect palladium demand to increase because it is cheaper than platinum. Currently, there are no palladium ETFs available to U.S. investors, but there are a few palladium ETF offerings that are awaiting SEC approval, so we recommend that investors keep an eye on what happens there because the long-term demand trends for palladium appear bullish.
(there's a palladium demand chart in this piece seekingalpha.com/article/163852-mine-dee...)
Don't Be Without Precious Metals ETFs
Whether it is demand for precious metals fueled by emerging markets or investors craving inflation and weak dollar protection, we believe the long-term trends for precious metals are decidedly bullish. This report should serve as a primer on a few of the precious metals ETFs we think stand poised to reward investors in 2010 and our new ETF newsletter will explore the names mentioned here and many more in greater detail.