How to Buy Gold for a 50% Discount

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It's no news that gold has been one of the hottestinvestments in the past decade. With the dollar on a steady decline, gold has gained more than 500% in the past 12 years, crushing the S&P 500's paltry 12% return. Take a look at the meteoric gains below. Anyone who's invested in the yellow metal has made alot ofmoney ...

And the trends that have been driving gold higher in the past 12 years are still well in play.

The U.S. dollar continues to depreciate under heavy stimulation from the Federal Reserve and lingering trade deficits. And the world still views gold as a safe haven againstinflation and social instability, with political events in Europe and the Middle East fueling more demand.

But owning bullion is unrealistic for most investors. Not only is it incredibly difficult and dangerous to store bullion, but it's also capital-intensive at $1,650 an ounce.

That's why many investors, including former Texas congressman Ron Paul, are focusing on gold-miningstocks . 

[See also: Revealed: An Inside Look at Ron Paul's Portfolio ]

Problem is, miners have performed poorly in the past two years, as they are vulnerable to the whims of thestock market more than underlying gold prices, leaving most investors with big losses as you can see in the chart below...

As you can see, although precious metals keep jumping higher each year,investing in gold isn't as easy as it looks.

That's why I am such a fan of an exchange-tradednote ( ETN ) that lets investors buy gold at a 50% discount.

PowerShares DB Gold Long ETN ( DGP ) seeks to replicate, net of expenses, twice the daily performance of the Deutsche BankLiquid Commodity index - OptimumYield GoldExcess Return . The key feature of this note is its use of 100%leverage , essentially reducing investors' out-of-pocket cost to invest in gold by 50%.

But the fact that this is a leveragedinvestment doesn'tmean investors are at risk oftracking errors and unwanted volatility, which are a few factors that have plagued the leveraged exchange-tradedfund and ETN space. 

PowerShares DB Gold has an excellent track-record because contract spreads in gold are relatively tight. There isn't as muchcontango between front- and back-month contracts, creating less price slippage whenfunds roll to front months.

The second factor driving this ETN's tracking accuracy is the decision by Invesco PowerShares Capital Management to link it to a special goldindex designed to decrease price discrepancies between roll months. The index is called "Optimum Yield" because it rolls to the contract with the best implied roll yield. It also includes the theoretical return of Treasury bills that would be held in amargin account .

Beyond its use of leverage and unique tracking strategy, DGP only trades for a little more than $50. This gives investors much more flexibility with strategic decisions about allocating capital into precious metals.

Buying DGP also requires no storage, just a simple brokerage account to execute a transaction. Hauling gold between different vendors and then trying to find adequate storage is expensive and time-consuming.

Cash-for-gold dealers also frequently buy and sell a few percentage points above or below market prices, gouging their customers with a lightly-veiled transaction cost. Transaction fees at discount brokerage firms to buy and sell stocks have never been lower, making the cost of buying or selling an ETN virtually inconsequential in a highly liquid and transparent market.

All of these benefits have made DGP a popular destination for investors who are looking to cash in on thebullish trend in gold. With assets under management of $450 million, DGP is one of the biggest and most successful ETNs in the market. It outperformed the S&P 500 during each of its first three years in existence from 2008 to 2011 before closing neutral in 2012. The average daily tradingvolume of 250,000 provides plenty ofliquidity for even big institutional investors.

DBG also looks like a great deal, with anexpense ratio of 0.75%, safely below its category average of about 1%.

Risks to Consider:  This is an unsecured financial instrument offered through Deutsche Bank. If Deutsch goes bankrupt, like the Lehman Brothers, then investors lose everything. By using leverage, investors also increase their risk as a percentage of invested capital.

Action to Take --> Investing in DBG is a great way for investors to beef up their precious metal holdings while cutting their out-of-pocket cost by 50%, essentially buying gold for half the price. With gold being on a 12-yearbull run and with projections for this trend to continue, this is not an opportunity investors should pass. 




The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.

© Copyright 2001-2010 StreetAuthority, LLC. All Rights Reserved.


This article appears in: Investing , Commodities

Referenced Stocks: DGP , ETN

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