Gold ETF Security And Profit Prospects When Market-Makers Worry About Stock Prices

Includes: DBP, GLD, SIL
by: Peter F. Way, CFA

Behavioral analysis of Market-Maker hedging in VIX options, recently reported, coupled with substantial declines in precious metals prices and the ETFs that track them, provide possible substantial portfolio benefits, either in price gains or refuges to avoid stock losses.

Here is what has been happening to metals prices, as tracked by three widely-traded ETFs:

(Yahoo Finance)

Over the past two years, the contra-cyclical experience of precious metals ETFs and stock prices, as reflected by the S&P500, is quite clear. Metals ETFs highs in September 2011 and stock price lows at the time swapped places as events evolved up to the present. Stock price averages are up +30% from two years ago and metals ETFs are down -20% to -50% over the same period. From the September 2011 extremes, the differences are even larger.

If the cautious stock price outlook stance implied by market-maker hedging, referred to in our earlier article, impacts stocks, it would be wise to consider the defensive alternatives. Here is what their hedging in precious metals ETFs provides as upside and downside price potentials by comparable analysis:

(used with permission)

In this opportunity map, the upside and downside percentage price changes from current market quotes to the top and bottom of each ETF's forecast price range are laid out so that, for a buyer, attractive items are toward the lower right, and scary things are toward the upper left. Securities with an equal upside to downside balance are on the diagonal.

In the case of PowerShares Precious Metals ETF (NYSE:DBP) at point [9], its entire forecast price range lies above its then current market quote. ProShares Gold ETF (NYSEARCA:GLD) at [6] offers a +15% upside, with very little drawdown exposure being forecast.

Included for purpose of stock contrasts are the SPDR S&P500 ETF (NYSEARCA:SPY), its (3x) long leverage cousin from ProShares (NYSEARCA:UPRO), and the peculiarly leverage-powerful inverse ETF based on short-term VIX futures, (NYSEARCA:SVXY). Their plots are at [5], [7], and [3], respectively.

A long-term portfolio with average prospects of SPY has little to gain defensively from the best such alternative Swiss Physical Gold ETF (NYSEARCA:SGOL). UPRO holdings in such a move might find drawdown shelter of -5% to perhaps -2%, which for many investors might seem too small to bother with, given that an upside gain prospect of +9% might be reduced to +6% by a defensive swap into SGOL. Investing is filled with such trade-offs.

But for current holders of SVXY, the drawdown exposure of -17%, compared to its possible further +13% upside, looks very expensive, when the alternative of DBP appears to have the same gain potential, without any likely drawdown.

All of these comparisons are as seen by the knowledgeable self-protective actions of market-pros taking hundreds of such stances a day. And as prices change, so may their reasonable price range forecasts. Our prior article (linked to in the first paragraph of this one) shows the history of such changes for UPRO and SVXY. Here are the recent histories of the forward-looking forecasts of DBP and GLD.

(used with permission)

Silver-driven ETFs at points [1] and [10] in the Reward~Risk tradeoff map are dominated by the Global-X Silver Miners ETF (NYSEARCA:SIL) at [8], which appears to present prospects for greater gains at less drawdown exposure risk. The potential for problems at mine sites appears to be regarded by MMs as no greater than the future-price appraisal risks of a world-traded metal commodity, which is the basis for the other silver ETFs.

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.