for Gold Avalanche
We don't recommend keeping all of your investments in Gold and gold stocks (yet). The recent sharp sell-off in this sector is one reason. More could be on the way. We're just not sure. Many people are calling the bottom, and many more are calling for more pain. Everyone has a 50/50 chance of being right in their predictions, so it's really useless to try. But it is quite helpful to be ready for anything!
So we do recommend investing in things that represent good value. Gold, Silver, and the miners are starting to look very, very tempting at this point. They have sold off far beyond anything I expected.
I am down 43% on the GDX ... that's crazy! If this sell-off escalates for any reason, I think we will be looking at an opportunity of a lifetime in this sector. I have my eye on this with anticipation ... but not at the expense of my portfolio allocation (beware of chasing other people's speculations at the expense of common sense!).
Take a look at the following Charts (click to expand).
Here's one more chart to illustrate.
For the bull market in Gold and commodities to be over, stocks need to represent such excellent value that to not invest in stocks would be insane. I don't believe this is the case, and I do believe that a correction (and thus a nice buying opportunity for stocks) may be coming. This correction, if it comes, will test the bulls - but since Dow Theory has already confirmed a major trend up is still in effect, I imagine that the markets will find a bottom someplace above the 12542.38 mark. This is the where the current cycle began - November 16th, 2012 - that same week we made the market bottom call, and a recommendation to buy the index. It's been a nice run, but the psychologically bent trader side of me is still really antsy. IF the market falls below 12542.38, and the transportations confirm the move by falling below 4891.27, well then we'd in a whole other ball game.
Thankfully, I'm not actually a trader. So I am not really that worried about a correction. I'm more worried that the bull market will keep irrationally chugging along without correcting. But at this point, I'm not adding to positions and instead building cash and waiting.
I'm also using a VIX play, since it's trading at around its historical average, as a direct hedge for my stocks and stock funds in the case of a correction. If the correction is big, they pay-off on that will be huge. It lets me sleep at night, anyway.
Here's an example of a VIX Hedge on a $25,000 account.
Investing 3% of assets, that would be a $750 investment in the VXX at $20 per share, for a total of 30 shares:
If the Vix spiked to 50, it turns into $1500
If the vix spiked to 100, it turns into $3000
If the Vix spiked to 300, it turns into $9000
If the Vix spiked back up to the 2008 highs of 500, it turns into $15,000
Now lets say the rest of this portfolio is dumped haphazardly into NYSE:SPY, the most popular S&P500 proxy. And let's say the worst happens - a 50% market decline! Oh no!
24,250 invested in SPY turns into 12,125.
750 in the vix spikes to, say, $9,000 for a total portfolio value of 12,125 + 9000 = $21,125
So the market declines 50%, but your portfolio declines 15% and you now have $9000 to dump back into your stock funds sometime around when the market bottoms. Then, if the market claws back 40% from there ...
1) 24,250 invested at 120 in SPY = 202 shares
2_)SPY falls to 60
3) You buy $9,000 of SPY at 70/share because you can't time the markets = 128 shares
4) Total accumulated shares of SPY = 330 shares
5) your new balance is $23,100
6) SPY climbs up to $84
7) Your new balance is $27,720!
8) if SPY claws back 100% of its losses, you would have $39,600
Not bad!
This is a worse case scenario -- but that's what hedges do. They can give you the confidence to invest and sleep at night, because if the investment doesn't work out, the hedge pays you back enough to make it worth your while. BUT, the hedge must be paired properly with other investments. And, it's possible to get so wrapped up in the idea that hedges have big pay-offs that you forget the other side of the equation: the investment!
So let's say the opposite happens and your hedge becomes worthless as your investment soars.
Hedge = $750 for 30 shares of VXX
Investment = 24,250 for 202 shares of SPY @ $120/share
SPY gains 20% while hedge loses 90%.
24,250 turns into $29,100
$750 turns into $75 for a total portfolio value of: $29,175
You see? Either way, you've risked a little captial to be able to sleep well at night.
While there is no guarentee things will work out exactly as they did in these scenarios, the point is that a well thought out plan that is doable and will allow your investments the time they need to grow and compound is an investor's best friend!
Happy investing
R
