It’s tough to watch the market rise sharply if your portfolio has been treading water.
That’s the reality facing many investors that stepped to the sidelines earlier this year after seeing their portfolios soar in value since the bottom in March 2009.
But it could have been worse. You could have invested in some absolute duds.
Morningstar keeps track of the performance of all major exchange-traded funds (ETFs) and calculates a major loss for hundreds of these funds in 2013. The key question for investors: Which of these 2013 duds will morph into 2014 heroes? Let’s take a closer look.
Leveraged Gold? Yikes!
It hasn't paid to be bullish on gold this year, as the yellow metal lost its status as inflation hedge. But it’s proved to be downright foolhardy to buy leveraged ETFs that move at two or three times the rate of change in gold prices. These gold leveraged ETFs lost most of the money tied up in them and are clearly too risky to own.
If you are bullish on gold for 2014, you may be better served by buying gold miners or straight-up gold funds that simply move in tandem with gold prices. No need to be greedy with such a speculative and risky asset.
The Factor Shares fund has the ignominious distinction of going long gold (with leverage) and shorting the S&P 500. That was a lousy idea and should be shut down by the fund sponsor. Factor Shares, incidentally has tried this approach elsewhere, with similarly dismal results. The FactorShares 2X: Oil Bull/S&P 500 Bear (NYSE: FOL) and the FactorShares 2X: TBond Bull/S&P500 Bear (NYSE: FSA) are both down more than 60% this year.
Notice the fourth name in this group (which is not comprehensive and merely a sampling). The Global X Gold Explorers ETF (Nasdaq: GLDX) had the bad timing of owning miners in a year when mining economic turned south. But that doesn’t mean this ETF will always be a loser. This fund owns mostly Canadian miners, and in this cyclical industry, lean years are often followed by better subsequent years, as lower prices lead producer to curtail output down to the levels of demand.
The other gold fund that spit the bit in 2013 but could rally in 2014 if gold prices stabilize: The Market Vectors Junior Gold Miners ETF (NYSE: GDXJ), which has fallen a stunning 55% this year. According to Morningstar, the average holding in its portfolio is valued at 0.63 times book value. Assuming the companies in this fund don’t need to write down assets, value investors are likely to flock to them once they sense that gold prices have stopped falling.
Volatility Still Doesn’t Pay
One of the key hallmarks of this bull market is a complete lack of fear that the gains will be reversed. Even bearish analysts and investors don’t anticipate a major market plunge, perhaps because balance sheets are so much stronger than they were five years ago. In that light, an ETF that was positioned for a spike in the VIX -- a key gauge of market fear, popularly known as the "volatility index" -- has been a real dud.
These ETFs are the worst in the group because of how they are constructed. Their focus on short-term VIX movements has left them vulnerable to a bleeding out of value as front-month contracts get rolled over. My take: Volatility will return -- someday -- but why would you want to keep betting on this losing wager? It’s more like playing roulette than investing.
There are dozens of other ETFs that are down more than 40% this year, and they all share a common theme: a leveraged investment against the major indices and specific industries. I won’t say more about them here, except to note that the only time that you should buy a double- or triple-leveraged fund is when you have an extremely high level of conviction that your investment thesis is correct.
Searching For Bargains
Putting funds that focus on gold, volatility and/or use lots of leverage, what else is on the list of 2013 losers? After reviewing them, here are my picks for solid bounce back potential in 2014.
|1. iPath Pure Beta Coffee ETN (NYSE: CAFE)
2013 performance: -34%
|This exchange-traded note, which tracks coffee prices, has been on a losing streak ever since it was launched in the spring of 2011. That’s because good weather and an expansion in planting has left the world awash in coffee beans.
Yet signs are emerging that current coffee prices are causing too much distress among coffee growers. Yearlong protests in Brazil, the world’s largest coffee producer, has led the government to take action to prop up prices, The Wall Street Journal reported recently.
Speaking of agricultural commodities, corn prices have also plunged, leading to a 27% plunge in the Teucrium Corn ETF (NYSE: CORN). Yet these kinds of markets have a way of correcting supply/demand imbalances in the next planting season. Other Teucrium agriculture funds are also off sharply this year:
|2. Market Vectors Brazil Small-Cap ETF (NYSE: BRF)
2013 performance: -29%
|This ETF has historically been one of my favorite ways to invest in emerging markets, as its domestic focus can profit from rising spending by a growing middle class. Yet Brazil, Indonesia, Turkey and other dynamic emerging markets are seeing a clear slowdown in spending this year after a multi-year binge.
As a result, this ETF, which had risen from $25 in 2009 to $60 a year later, is now back all the way down to $31. Still, the long-term drivers in place for further middle-class gains, and this ETF owns a portfolio of stable Brazilian companies. (I would add that the iShares MSCI All Peru Capped (NYSE: EPU), which is down 28% this year, holds similar appeal.)
|3. Global X Uranium ETF (NYSE: URA)
2013 performance: -28%
|Here at StreetAuthority, we’ve been tracking a major change in the uranium market, as a key supply agreement with Russia is set to expire, forcing the U.S. to fulfill its uranium needs elsewhere. That’s expected to push up uranium prices.
But this catalyst hasn’t played out yet, and uranium prices have remained weak on fears of declining interest in nuclear power. Our take: Nuclear will still play a key role in China, India and elsewhere, and this commodity -- and ETF -- are poised for a bounce back.
Risks to Consider: When investing in ETFs, always keep an eye on expense ratios and bid/ask spreads. If they are relatively high, then you should consider them for longer holding periods.
Action to Take --> Forget about leveraged funds, and forget about volatility. They underpinned strategies that didn’t work in 2013 and represent more risk than most investors are willing to stomach. But the sharp plunge in agricultural prices and emerging-market stocks should get your attention. These are shaping up to be solid values. Beyond the funds profiled here, you’ll find many other emerging markets and agricultural commodities funds worthy of further research. (If you are a Morningstar subscriber, you can scan the 2013 ETF performance list here.)