Are ETF Investors Only Making Money on Paper?

Includes: GLD, PGJ, PST, SPY
by: Gary Gordon

Fiat money is money that a government has declared to be legal tender. It has no intrinsic value since it is not backed by actual “stuff,” like a precious metal.

Hard money typically describes currency that is made of or backed by hard assets like gold, silver or platinum. A government that uses hard money is backing the value of the currency by a tangible, durable material that is expected to retain relative value over time.

Many a hard money advocate believes that the U.S. dollar is not only weakening, but will someday collapse. Post-credit crisis, the doomsday dollar prognostication can no longer be dismissed as “preposterous.”

Personally, I don’t believe we are headed for hyperinflation nor the complete demise of the U.S. dollar; rather, the gradual movement away from the dollar as the world’s reserve currency seems more likely. (That’s scary enough!) Moreover, we should expect above-norm inflation with a Federal Reserve that’ll be late to act aggressively.

It follows that we have to invest dollars in ways that’ll maintain purchasing power or increase purchasing power. (Easier said than done!)

For instance, if the nominal gains on the S&P 500 SPDR Trust (NYSEARCA:SPY) are roughly 18.5% through 10/6/09 close, an all-stock portfolio is actually flat in real money terms (a.k.a. gold). That’s because the SPDR Gold Trust (NYSEARCA:GLD) is also up about 18.5% on the year.

Gold bugs might even choose to exacerbate your pain. The all-S&P 500 portfolio may have lost 37.0% in nominal dollar value in 2008, but it lost more than that in real money (gold) value. In 2008, gold gained 7.3%.

Over the last decade? Gold is up nearly 250% while the S&P 500 SPDR Trust (SPY) with dividends reinvested is basically flat. In real money terms, then, stock investors have lost approximately 70%! Ouch!

The question that non-goldies might ask is, “Why should I care how many ounces of gold my S&P 500 SPDR Trust (SPY) shares can buy?” After all, the local Albertson’s is still taking George Washingtons.

Yes, but it may require $10 for the carton of milk or, more aptly, $20 for that 6-pack of beer. And you may find yourself becoming a vegetarian by price, not by choice.

Granted, I don’t see it happening. I see the Fed coming late to the table, but when they come, they’ll genuinely defend the dollar (no ”wink wink”) and they’ll raise interest rates aggressively. Former Fed Chairman Volcker is in the Fed’s ear… so one should expect an aggressive rate hike campaign down the path.

As an investor, it may be paramount to prepare for the shift from deflation to inflation… ahead of the Fed. ProShares Ultrashort 7-10 Treasuries (NYSEARCA:PST) and Proshares UltraShort 20+ Treasuries should be a consideration for rising interest rates. Foreign equities from regions of the world where the currency is safer, particularly China, make sense for many stock investors as well. Consider the PowerShares Dragon Halter China Fund (NASDAQ:PGJ).

Full Disclosure: Gary Gordon, MS, CFP is the president of Pacific Park Financial, Inc., a Registered Investment Adviser with the SEC. The company may hold positions in the ETFs, mutual funds and/or index funds mentioned above.