Followers of Austrian School Economics are often labeled as Gold Bugs, Gold Nuts, Gloom and Doomer Nuts, or just plain “nuts.”
Visit any Austrian themed website and you are likely to see numerous advertisements for gold, as in physical gold.
While I certainly wouldn’t discourage anyone from holding physical gold, like anything it does have its limits. Security and storage come to mind, but more importantly, if an economic collapse were to cause the end of the world as we know it, gold coins might not be as valuable as you think. As the saying goes: “you can’t eat gold.” The 1959 post-apocalyptic novel Alas Babylon, does a good job of illustrating this point.
Other options such as “paper gold” via gold futures or the Gold ETF’s work well as a tracking instrument, but are not without their critics.
If that were not enough, insomnia can quickly ensue at the thought of gold confiscation. While a direct confiscation is unlikely, if gold were to go parabolic and stay at elevated levels, our politicians would be tripping all over themselves to enact a “windfall” profits tax. How high such a windfall tax might be is hard to say, but remember that the marginal tax rates in this country were at one point in excess of 90%.
The politicians won’t have to confiscate the gold, they will simply confiscate the profits.
So once one has reached his or her personal capacity for gold exposure, where can an “Austrian” put their money to work in a way that will protect against government induced erosion of purchasing power of currencies. While you won’t be able to “eat” the following ideas any better than gold (should the muck hit the fan), they do provide an avenue for investors to diversify away from gold, while keeping the basic investment theme intact.
For the typical individual investor, basic strategies can be broken into “real” asset exposure or foreign currency exposure.
If one expects the dollar to weaken against real assets but remain strong relative to other currencies (i.e for all its faults the U.S. Dollar is still the reserve currency of the world and benefits during a flight to safety), the choice is to gain exposure to real goods, which may be accomplished in a couple of different ways.
Futures based commodities ETFs provide exposure to real assets via the use of futures contracts packaged in an ETF. The products are generally designed to provide dollar for dollar exposure to the price of the underlying commodity, and thus do not use leverage. The biggest players in this space are the USO, which tracks the price of oil and UNG which tracks the use Natural Gas. It should be noted there are some structural issues with these products that make it difficult for the ETF’s to track the underlying price. The biggest issue is the contango effect, which can be so severe that Dan Dicker referred to them as the worst investments on the planet (for further discussion on the effects of contango please see Are Energy ETF’s Really The Worst Investments On the Planet).
Another approach in, the same space is offered by Invesco PowerShares. PowerShares offers a lineup up of futures based ETFs that utilize a proprietary roll yield optimization process, which can reduce the effects of contango and enable the ETF’s to do a better job of tracking underlying commodity. The lineup includes DBA – the DB Agriculture Fund , DBB – the DB Base Metals Fund, DBE –the DB Energy Fund and the DBC – the DB Commodity Index Fund. PowerShares has a number of other offerings as well, including some based directly on gold and oil.
Another way to gain access to real assets is through the use of sector or industry ETF’s that invest in the common stock of companies that ply their trade in real assets. The advantages of the stock approach is that one doesn’t have to deal with the effects of contango or potential counterparty risk via the use of swaps or the failure of an exchange. Generally speaking, on an industry basis, the stocks have a good correlation to the underlying commodity. The drawback is that unlike the price of a commodity a company can go bankrupt or have assets seized by unfriendly governments. In times of high inflation (which is what you are trying to protect against) rising resource input prices (think labor, energy, materials) can make it difficult for the companies to be profitable, and the stock price can decouple from the price of the underlying commodity.
There are numerous offerings in the stock based real asset ETF space. The IGE – iShares North American Natural Resources ETF provides a broad based exposure. More specific exposure can be found via the XLB – Materials Select Sector SPDR, the XLE – Energy Select Sector SPDR. The MOO – Market Vectors Agribusiness ETF, as the name implies provides exposure to companies involved in farm machinery, ethanol production, as well as poultry and grain production.
Investors who would like to protect against the decline of the US dollar relative to other currencies, and without taking on broad stock market risk, may choose to invest in international bonds or foreign currency ETFs.
By investing in international bonds, an investor is in effect holding a foreign currency(ies) and would stand to gain when the US dollar were to drop in comparison to the currency utilized. International bonds also provide yield, but are subject to interest rate risk and depending on the nature of the investment , credit risk. Choices in the is category include BWX – the SPDR Lehman International Treasury Bond and IGOV – the iShares S&P/Citigroup International treasury ETF. Investors concerned about interest rate risk may look to the shorter term based BWZ – Barclays Capital SPDR Short Term International Treasury ETF.
The currency ETF’s generally will not provide yield, but will also not have interest rate risk. While technically speaking there is no credit risk in terms of a bond being defaulted on, there is potential counterparty risk if the ETF is using swaps to gain exposure or utilizes an ETN (Exchange Traded Note) structure. Another advantage the currency ETF’s have over an international bond ETF, is the ability to target a specific currency for exposure (International bond ETF’s are generally broad based, not specific to a given country). Rydex offers two of the major players in this space the FXE Currency Share Euro Trust and FXY the Currency Share Japanese Yen Trust. There are a number of other currency ETF’s available including more recent additions that give exposure to the Chinese Yuan.
For those looking to employ more sophisticated strategies Pro Shares offers short currency and ultra short currency ETF exposure for both the Euro and Yen. It is important to fully investigate the legal structure and holdings of the Currency ETF/ETN space as “counterparty” risk may be higher in this area than other ETF type categories.
Investors should not overlook the use of TIPS as well. Inflation protected securities provide a small coupon and the principal returned is based on the Consumer Price Index (CPI), so that if CPI rises over the term of the note, at maturity the investor will receive a payment greater than the original principal. An obvious potential shortfall of the TIPS is that many believe that the government is significantly understating the true rate of inflation. In this environment an investment in TIPS would underperform when compared to the real rate of inflation. It should also be noted that in a period of deflation or negative CPI periods TIPS could also yield a negative return. While such a return would likely be better than other risk-based assets, it is important to understand that even though an investor is utilizing a “treasury” there still remains the possibility of such a negative return. ETF exposure to TIPs can be obtained via the TIP – iShare Barclays TIPS Bond Fund ETF.
This is by no means a complete list of ETF’s that can be utilized in the pursuit of “Austrian Investment” themes, nor is it a complete list of ETF’s within the categories mentioned. It is however a place to start and potential investors should be sure to do their own research and consult their financial advisor before making any investment decisions.
It should be noted that at the time of this writing the BIA Model portfolios and clients and principal of Barnhart Investment Advisory are holding positions in many of the ETFs mentioned, including ETF’s with short exposure to the Euro. Positions are subject to change without notice. While Barnhart Investment Advisory does utilize many of the securities mentioned, investments that are suitable for one investor, may not be suitable or appropriate for another investor. In addition a critical factor in determining whether an investment is appropriate for any particular investor is the size of the investment exposure in relation to the investors overall investment profile and holdings.
DISCLAIMER: Nothing in this article should be construed as a personal recommendation or investment advice. Nor should anything in this article be construed as an offer, or a solicitation of an offer, to sell or buy any particular investment security. Investors should conduct their own due diligence and seek the advice of a financial and/or investment professional before making any investment decisions.