Go for the Gold

01/13/2009 11:00 am EST

Focus: ETFS

Carlton Delfeld

Editor, The La Jolla Letter and Pacific Gains

Carl Delfeld, editor of Chartwell Advisor Global ETF Report, says gold prices are heading higher, and he says a popular ETF should profit from the move.

The investment case for gold as a hedge in your portfolio is the notion that the overvaluation and excessive supply of the US currency has funded a decade of unsustainable consumption and investment. The American total debt to gross domestic product (GDP) ratio is at unprecedented highs, approaching 400%. The government budget deficit could top $2 trillion next year.

According to [Nobel Prize-winning economist] Robert Mundell, as recently quoted in The Wall Street Journal: “There will come a time when the pileup of international indebtedness makes reliance on the dollar as the world’s only main currency untenable. It is no longer necessary or even healthy for the US or the rest of the world to rely solely upon the dollar.”

The price of gold will also likely rise as the dollar-based system of credit and commerce falters under an overload of bad debt, weakening financial institutions, and a stagnant economy.

Creditor nations like China are buying as much gold as is possible without greatly disrupting prices in a big way and some countries have indicated that they intend to convert the majority of their foreign exchange reserves into bullion. Demand for gold for jewelry and other uses is stable as well.

From a technical viewpoint, gold appears poised to break out of its counter-trend down move, leading to the possibility of higher prices. It broke out of its 50-day moving average on strong volume recently and is approaching a 200-day moving average breakout.

The dollar, and fiat currency as a whole, is under tremendous pressure. Some speculate that the global monetary system will have to return to some sort of precious metal backing, directly or indirectly.

The key question is what will happen to the US dollar in 2009. If it begins to falter, then gold prices will move upwards. Capital inflows into gold will also relieve inflationary pressure in the US due to the spending and debt spree by the US government in an attempt to stimulate the US and global economy.

Gold is purely a store of value without any income stream, so valuation is a difficult task. Some analysts compare the price to silver or other precious metals based on historical data, but this approach has clear limits.

Gold exposure should probably not exceed 5% to 15% of your portfolio. The SPDR Gold Shares ETF (NYSEArca: GLD) is the most popular gold ETF on the market with $20 billion in assets and 18 million shares trading on an average day.  Investors may use a smaller allocation to the leveraged ProShares DB Gold Double Long ETN (NYSEArca: DGP).

The risk factor is moderate to high, [so we] suggest an 8% trailing stop loss. (GLD closed below $81 Monday—Editor.)

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