Profiting from a burst in the gold bubble


If you are like me and think that gold prices are in a bubble akin to the real estate bubble of yesteryear, there is a way you can profit from the bursting of the gold bubble.

There is an ETF security that trades just like a stock called Proshares Ultrashort Gold (NYSE: GLL), which attempts to provide an investment return of 200% of the inverse of the movement of gold prices. If gold prices go down 10%, the Proshares Ultrashort Gold should go up about 20%.

Trying to catch a bubble at its top is a very risky proposition. I am reminded of a friend of mine that took a large short position of home builder stocks in 2004 and was forced out of his investment due to massive losses. His prediction proved true in 2008, but that was too late.

Using an ETF with a long term horizon is already safer than taking a short position. There is no risk of a margin call for starters. It’s also a good idea to dollar cost average. I’m still thinking about the best approach, but I’m thinking of splitting my planned investment in five and investing 20% every three months. I think such an approach starting now in Proshares Ultrashort Gold has a high chance of success.

One problem with such ETF’s however is that the financial instruments that are used to simulate the desired return of the underlying security and the fees erode the target return. Therefore, a 10% increase in gold prices will cause the ETF to drop slightly more than 20%. Similarly, a 10% decrease in gold prices will cause the ETF to increase slightly less than 20%.

1 Comment

1 Comment

  1. John Hoffmann  •  Oct 20, 2011 @1:59 pm

    Glad you are averaging in for your safety sake :)
    At 1620 gold is sitting right on a 30 week moving average. It has not closed intra-week below that average since it started this uptrend in 2008.

    You know I see gold as a store of wealth competing with the debt backed (insolvent) currencies of the world. Europe needs to roll 2 trillion in debt over the next year. My bet is that a few years from now governments around the world will need to rework their currencies in order to keep them viable – and gold backing will play a huge role in that process.

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