Monday, September 5, 2011

Ways to profit if a gold bubble is forming

Monday, September 5, 2011

Q: Are there ways for investors to bet against the rise in gold?

  • Gold ingot from the Bingham Canyon Mine.

    Kennecott Utah Copper

    Gold ingot from the Bingham Canyon Mine.

Kennecott Utah Copper

Gold ingot from the Bingham Canyon Mine.

A: When investments start shooting up, some investors pile on. Yet others, sometimes called contrarians, start wondering when the rally will come crashing down.

Given the level of interest in precious metals, including gold and silver, it's natural some investors might start wondering if now's the time to bet against the crowd.Investors' fear about coming inflation has been a boon for precious metals investments. The SPDR Gold Shares exchange-traded fund (GLD) is up 6.2% this year, coming off an even stronger run in 2010.

Meanwhile, silver, commonly known as the poor man's gold, is also up for the year. The iShares Silver Trust (SLV) is up 22.5% this year, a remarkable rise that laps the impressive performance of gold.

When some investors start seeing such staggering moves, they start seeing ways to profit if some air is let out of the bubble. But how can one bet against, or "short," precious metals? There are several ways to do this:

Short the precious metals ETFs. The two ETFs mentioned above, the SPDR Gold Shares and the iShares Silver Trust, are examples of the many precious metals ETFs. If you have a brokerage account with access to short investing, you can bet against these ETFs. To short an ETF, you would first borrow the stock and sell the shares right away, pocketing the proceeds. And then later, you would "cover" your short by buying the shares back at the current price and returning them to the investor you borrowed from.

If you're right and silver is in a bubble, you can buy the shares back in the future at a lower price than you borrowed at. The difference between the price you sold the borrowed shares at and the price you bought them back, minus any commissions or interest, is your profit.

Beware: Shorting is tricky business, especially with a commodity with lots of upwards momentum. Since there's theoretically no ceiling to how high the price of gold can go, your losses can be unlimited if you bet wrong.

Buy an ETF that is short commodities. With the explosion of new commodity ETFs, there's been a boom in ETFs that bet against gold and silver, too. So- called inverse ETFs are designed to move opposite of the asset they're counterbalance to. So if the price of gold falls, the value of an inverse gold ETF would rise. There are many inverse ETFs and related investments called ETNs (exchange-traded notes) for commodity investors, including the PowerShares DB Gold Short (DGZ) and the ProShares UltraShort Gold (GLL). For silver, there's the ProShares UltraShort Silver ETF (ZSL) among other choices. Beware, though. These ETFs are rebalanced daily or monthly, so your long-term performance may not be a precise mirror image of the gold and silver ETFs you're betting against.

Use options. There are a number of ways for investors to use puts, calls and other options to bet against rising commodity prices. One strategy might be to buy put options. When you buy a put option, you have the right to force another person to buy a stock from you. If the price of a silver ETF falls, for instance, you could force the investor who sold you the put to buy the gold ETF at a higher price.

Beware. Options can be risky, especially when using them on volatile investments. And if you buy options, and your bet goes against you, you can lose all the money you spent on the options.

These are just a few of the ways to bet against the meteoric rise of some commodities, including precious metals. It's unclear if the runs these commodities are on will end anytime soon. But if they do, and you used one of these strategies, the collapse of the gold bubble could be a huge boon for you.

Matt Krantz is a financial markets reporter at USA TODAY and author of Investing Online for Dummies and Fundamental Analysis for Dummies. He answers a different reader question every weekday in his Ask Matt column at To submit a question, e-mail Matt at Follow Matt on Twitter at:

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