Are Gold ETFs The Best Defense Against Euro Drama?

by on December 15, 2011 | ETFs Mentioned:

Investors’ confidence has taken a serious beating over the past few months as debt drama on both sides of the Atlantic ocean has paved the way for volatile price action across financial markets. Despite better-than-expected economic data releases on the home front, Euro zone debt woes have definitively taken center stage; sentiment on Wall Street has been largely influenced by rumors and headlines from overseas, while positive fundamental developments have been largely ignored. Amidst the ongoing uncertainty, many have turned to traditional safe haven asset classes, with gold being a popular choice [see Cheapskate Hedge Fund ETFdb Portfolio]. However, the precious yellow metal has lost a bit of its luster throughout this recent turmoil, as the hot commodity has failed to provide investors with much of a cushion.

Gold is a versatile commodity, capable of serving as a hedge against inflation, while often times it is simply regarded as a store of value that can take on safe haven appeal in times of economic uncertainty. Historically, the yellow metal has proven to be a viable instrument in defending against inflation since it is priced in U.S. dollars. Additionally, gold prices have also demonstrated the potential for uncorrelated returns relative to broad equity markets, further enhancing the metal’s reputation as a defensive tool.

Not So Shiny

The inflation-fighting and diversification benefits associated with the yellow commodity have come under scrutiny lately. Following Standard & Poor’s downgrade of U.S. credit quality in early August of this year, gold futures prices have fallen into an awfully correlated price pattern with domestic equity benchmarks [see Are Gold And Silver In A Correlation Bubble?]. Even more worrisome is the fact that gold prices have been range-bound as Euro zone debt woes have escalated, whereas many anticipated for the precious metal to embrace its safe haven reputation and soar higher amidst the uncertainty.

Debt woes stemming from overseas have added to the cloud of uncertainty looming over the global economic recovery, which has in turn sparked selling pressures across commodities thanks to worries of slowing demand for raw materials from developed and emerging markets alike. Also, inflation fears have taken a backseat as deficit drama has stolen the limelight; likewise, many investors have had to liquidate their gold position in an effort to raise cash in anticipation for continuing volatility in the markets. The current economic backdrop has been unkind to virtually every asset class, and gold has unfortunately been lumped in with the majority, failing to set itself apart as it has done so in the past. The SPDR Gold Trust (GLD) is up close to 15% year-to-date, although its more recent performance paints a gloomier picture; GLD’s trailing four week return comes in at a disappointing -10.9% (as of 12/14/2011) [see GLD Returns].

Although inflation is still a noteworthy concern over the long-run, fundamental uncertainty in the near-term has proven to be a real headwind even for the most precious of assets. From a technical perspective, gold prices have been stuck in a frustrating range, oscillating between $1,600 and $1,800 an ounce, since hitting a recent all-time high of $1,923 an ounce on 9/6/2011. Many experts are predicting that gold prices may continue to consolidate further as financial markets struggle to find balance and investor confidence in the global economic recovery slowly rebuilds [see The Five Biggest ETF Inflows Of 2011].

Tools For Uncertain Times

Thanks to the rapid growth and ongoing evolution of the exchange-traded product universe, investors can now choose from several “defensive” tools, ranging from short-term bonds to sovereign debt funds, to help protect their portfolios in these uncertain times [see Simple (But Effective) Safe Haven ETFdb Portfolio]. Below we highlight three popular products which may take on “safe haven” appeal as investors struggle to find their footing:

  • iShares JPMorgan Emerging Markets Bond Fund (EMB): This ETF offers exposure to a broad portfolio of emerging market debt securities with a twist. All of the underlying holdings are denominated in U.S. dollars, which means that EMB effectively removes the exchange rate risk that can be present in bonds denominated in the local currencies.
  • PIMCO 25+ Year Zero Coupon U.S. Treasury Index Fund (ZROZ): This fund focuses on ultra-low risk, long-term U.S. Treasury bonds, which make it an appealing instrument for those looking to follow a conservative capital-preservation strategy.
  •  Vanguard Dividend Appreciation ETF (VIG): Dividend paying securities have taken on mass appeal as investors are opting for a source of current income in lieu of lucrative capital gains in this uncertain environment. VIG holds a basket of about 130 equities, all of which have a history of consistent dividend increases for at least ten consecutive years [see Dividend ETF Investing: Four Critical Factors To Consider].

 Disclosure: No positions at time of writing.