Paper and gold

The Merk Hard Currency Fund is a mutual fund that provides exposure to a range of non-US dollar currencies. We initially recommended the Fund last year, as a low risk, cash alternative to US dollars. Since the recommendation, the fund has performed modestly, returning around 7 percent.

While we still maintain a bearish view towards the dollar, we are no longer enamoured with the paper alternatives. Moreover, we think better opportunities lay elsewhere. The table below shows the Fund's currency exposure as of June 30.

The recent decline of the dollar has been reflected in the strength of the Euro in particular, as well as the Pound and the Canadian dollar. To date, paper currencies have absorbed nearly all the weakness in the US dollar, whilst gold has continued to trade in a small range.

Richard Russel, editor of the Dow Theory Letters, recently summed up the currency action nicely; "Precious metals doing zip -- the action now is in the currencies. You're afraid of the dollar, then buy the pound or the NZ dollar or the euro. When you're afraid of them all -- move into real money, gold."

The action has indeed been in the currencies, while gold has been left on the sidelines. While we're not exactly afraid of the US dollar currency alternatives, at this point, we think gold is a better long term risk/reward situation.

For this reason, we are switching our exposure into the Van Eck Gold Miners ETF (AMEX: GDX). The Fund, established in May 2006, seeks to replicate the performance (before fees and expenses) of the Amex Gold Miners Index. As such, GDX provides broad exposure to a number of high-quality gold producers and explorers (see FAT49 for details).

An investment in gold is likely to display greater volatility than a basket of currencies, however we think the long term rewards will provide more than adequate compensation. For those Members who prefer to minimise risk and volatility, the Gold Miners ETF is a solid option.

GDX holds around 37 gold miners, including large, mid and small cap companies. The table below shows the ETF's top ten holdings.

We initially recommended GDX at $37.20 during January and last reviewed the fund in June in FAT68. From a charting perspective, there has been little change to the short-term outlook since our review in June, with consolidation remaining the major theme. As visible on the daily chart, prices remain within a broad range between resistance at $43.32 and support at $36.19.

In July, prices again retested the upper boundary of the consolidation range, reaching $43.30, only to retreat back into the range. The failure to make a sustained break above this resistance level points to further consolidation in the near term.

As visible on the weekly chart of the underlying AMEC Gold Miners Index, the longer-term outlook remains compelling. Given the strength of the longer-term upward trend, once the current consolidation period is complete, we anticipate that prices will break through to the upside. This will signal a revival of upward momentum and will translate into substantially higher levels for GDX.

Of course, timing is the issue. With the US dollar showing considerable weakness of late, many gold investors (including us) were expecting the gold price to head higher. This has not happened.

Perhaps concerns over a deflating US housing market are easing fears of inflation, taking investment demand away from gold. In the short-term, the ability of the housing situation to drain liquidity from the financial system may have a negative effect on the gold price.

However, this is likely to set the scene for further Fed easing, and we believe such a scenario will be the catalyst for a significant rise in the gold price.

Given our view that gold will soon begin to outperform ALL paper currencies, not just US dollars, we recommend selling the Merk Hard Currency Fund around $11.15 and buying GDX around $39.80.