Now is a good time to stay defensive in your investing. But what does that mean?
Cash isn’t necessarily a bad place to be during a bear market. But since cash and short-term debt instruments pay virtually nothing, they can’t today be called investments. Holders of them are virtually guaranteed to lose purchasing power over time.
Longer-term Treasuries do carry at least something of a yield. But the heavily manipulated Treasury bond market registered wildly overbought technical readings recently, making bonds an especially risky place to put money at this time.
Conventional safe havens aren’t really that safe anymore. Fortunately, there are a few unconventional alternatives that offer downside protection with upside potential.
1. Congressional Effect Fund
The objective of the no-load Congressional Effect Fund (CEFFX) is to protect investors from the adverse market effects of Congressional actions and capitalize on the tendency of stocks to rise when Congress isn’t able to act. The strategy is simple:
According to the Congressional Effect Fund’s Fact Sheet, the fund aims to “invest in the U.S. stock market (through securities reflecting the S&P 500 index) on days when Congress is out of session and… be out of the U.S. stock market on days when Congress is in session.”
I spoke to Congressional Effect’s manager, Eric Singer, in 2008 – shortly after he launched the first-of-its-kind mutual fund. He told me he started it because he “felt that it was an excellent way to make money and something that would also, as a byproduct, make people understand the costs of government.”
He says the strategy he employs exposes investors to about one-third of the risk of the S&P 500. Year to date, Congressional Effect is up 11.5%, while the S&P 500 is up less than 1%.
2. Market Neutral Instruments
Another conservative way to survive and potentially profit amidst a bear market is through market neutral or long/short funds. These instruments can – but aren’t guaranteed to – appreciate in any stock market environment. A 10% drop in the Dow, for example, might correspond with a small gain or a small loss in any given such fund. It all depends on how the fund’s hedging strategy plays out, not on the direction of the broad market.
Viable options in this category include:
3. Inverse ETFs
If you’re more aggressive and aiming to profit directly from market declines – or perhaps looking to hedge out your existing exposure to the stock market – then inverse exchange-traded funds may be for you.
Inverse or “short” instruments move in the opposite direction of the index to which they are pegged. So if the Dow falls 10% over the next month, then the inverse Dow ETF can be expected to gain roughly 10%. Inverse vehicles are prone to tracking error over longer periods of time, so they should be used as short-to–intermediate-term hedges or speculations only.
To minimize risk when venturing into inverse ETFs, stick with the broadest, most liquid, non-leveraged ones. They include:
4. A Bet on Rising Market Volatility
When the stock market heads down, investor fear intensifies – and as a usual consequence, so does volatility. Believe it or not, there is a way to profit from market volatility itself!
The VIX index is a popular measure of volatility based on options premiums. An instrument that tracks it is iPath S&P 500 VIX Mid-Term Futures (VXZ). This unusual vehicle has performed well in 2010, and if the market enters panic mode it could outperform the inverse ETFs previously mentioned.
5. Precious Metals
When all else fails, gold is a time-tested safe haven. In 2008, when the stock market melted down in epic fashion, gold bullion managed a gain for the year. After outperforming the stock market rebound in 2009, gold prices are up smartly once again in 2010 while stocks have struggled.
Historically, September is the seasonally strongest month for gold and gold mining stocks as jewelry demand tends to pick up around this time of the year and remains strong into the winter holiday season.
Going all the way back to 1969, gold has gained an average of 2.51% in the month of September, according to Bloomberg. That translates into an annualized rate of appreciation of better than 30%.
Gold or Silver: Which is the Better Buy?
Gold is usually a more reliable safe haven than silver during financial meltdowns and panics. But such events, though they can be devastating in their impact, are typically short in duration. Investors who have a longer-term perspective shouldn’t be tempted to react to each and every market gyration.
We’ve suggested accumulating – and holding onto – gold and silver since Independent Living newsletter’s inception in 2006. (And American Lantern Press has consistently recommended precious metals since 2003 in its other publications.) Big picture: both metals are still going much higher.
Yet the two metals don’t necessarily offer identical relative value. Gold’s premium over silver has been seen to expand and narrow in oscillations that can last years within a broad historical range.
So which metal now offers the best value and biggest long-term profit potential – gold or silver?
While the world’s inflationary monetary policies combined with ongoing financial market turmoil certainly auger well for gold’s prospects, silver appears to have even stronger fundamentals – such as this monetary metal’s exploding industrial, medical, and high-tech uses combined with an even tighter supply situation than gold.
America’s Foremost Silver Expert Clues You In
We also posed this question to renowned precious metals guru David Morgan.
Here is Mr. Morgan’s response: “I think, another decade out, that the gold/silver ratio will narrow. Right now the ratio is at about 65 to 1, which means it takes 65 ounces of fine silver to purchase 1 ounce of gold. But as silver becomes more and more valuable relative to gold, the ratio could get to, for example, 30 to 1. What that would say is that silver has actually doubled in price relative to gold. And I really do believe that will happen over time.”