Disadvantages of ETF’s

Tracking Error

· Because of CFTC pressure to limit the number of positons that an entity can hold, commodity etf’s often have what is called a tracking error, where the demand of investors exceeds the supply, thereby creating a price that trades at a premium to the relative commodity price. Investors much decide whether or not it is worth accessing an etf that is trading at a premium to a commodity, when they can invest in the futures markets at the lower market price. Etfs also have expenses which investors collectively pay that they wouldn’t otherwise pay by accessing commodities via the futures markets.

· There is often a gap between the price of an etf and the futures price. This is well documented in etf’s such as UNG, the natural gas etf which has dramatically underperformed the futures price. Why? Well the etf actually buys the underlying natural gas futures. Say for example the purchase price is $5.00 btu and 100 million dollars of the etf are issued to investors @ say a price of $10 a share (so 10 million shares outstanding) and the price of gas sells off to $4.00 in the front month before expiration, in say the December futures. If the market is in contango, which it usually is, and the January contract is trading at $4.50 btu, than the etf must purchase nat gas at a higher price on the roll-over from December to January. The higher price means that the 100 million dollars of etf shares, that are now worth 80 million, or $8.00 a share because of the decline from $5.00 to $4.00 must now buy natural gas at $4.50. At $8.00 a share, the etf will not be able to buy as much Jan natural gas as it exited December, thereby lowering the etf price further than the drop in natural gas.

Taxes

· If held under 1 year, all proceeds are taxed at the short term capital gains tax rate

· Capital Intensive relative to futures.

· Double long and short etf’s have underlying costs, like margin costs, which therefore do not double the absolute value of the returns. Equity margin rates seven misconceptions about leveraged ETFs

Disadvantages of Buying Gold Bullion

· Cost. Despite what a gold bullion broker might tell you, over the long term it is more cost prohibitive to buy Gold Bullion and have it stored than it does to buy a long dated gold futures contract. I pay $7.00 to get into a gold futures contract at Titan Commodities and if I have over 10k in my account, I can actually place my funds in Tbills and collect interest on my money. I will admit that the ease of exiting the position does make it tempting for long term investors to sell after a rally and buy on a dip, but if you have the patience and are not so emotional about the markets, it is the easiest and most cost efficient way of investing in gold. Moreover, you are set up to access other markets as well, markets which may even be performing better than gold.

· Lesser capital requirements. For each $1.00 of physical gold you want to buy, you must put up $1.00. So a 10% move will yield $3,000 on a 30k investment. Conversely, you can put much less in a futures account to control 30k worth of gold. (Something like $1,000). This can be dangerous however as you don’t want to have too little or you will be forced out the market. If one decides to more conservatively fund their account with ½ the value of the underlying gold futures contract, the same 10% move on your 30k of capital will equate to $6,000 vs. $3,000. Leverage is something we are all familiar with and shouldn’t be viewed as a dirty word. Most did not buy their house by putting 100% down. Yet many have found out that putting too little down can cause significant issues. The same is true with futures contracts; you can easily get into danger if you put up the exchange minimums of 5-10%. Many people do this and this is why “leverage” and “futures contracts” can be risky. Futures contracts have no inherent leverage; it is up to the investor/trader to determine the leverage they wish to use.

· Liquidation. This is most evident with Gold Coins but also any physical metal storage. If the fed decides to raise interest rates, if confidence in underlying currencies increases, or if the market expectations relative to inflation changes, here could be a mad rush to the exits in the physical and coin gold markets, causing a glut. This may cause holders of coins and physical gold to sell at a lower price than they would be able to sell in futures markets. Liquidty and the ease of turning metal to cash is an issue that shouldn’t be ignored.

Disadvantages of Gold Mining Stocks

· The price of a mining stock often depends on the firm’s reserves which can decline as easily as it can increase. Declining reserves are great for the price of the metal, but terrible for mining companies whose reserves are declining. It is not infrequent for investors to invest in mining stocks only for them to vastly underperform the price of the metal itself. In addition, one is also subject to the same problems other firms deal with, managerial problems, cash flow problems, etc. Jim Rogers mentions these points quite clearly in his writings. As of this writing, 90% of the gold stocks with the highest market cap are underperforming the futures price. The futures markets as pure a commodity play as there is.

· There is more systematic risk in trading commodity stocks vs. commodity futures since stocks are traded on the stock exchanges and are therefore more susceptible to equity market fluctuations.