In the world of economics, we classify goods, services, and industries based on how demand for each responds to fluctuations in the market.
For the purpose of this conversation, we’ll keep it simple...
The demand for normal goods and services correlates directly with the swings of the economy. When consumers make more money as a result of economic upswing, the demand for normal goods increases — goods like televisions, cars, restaurant meals, etc.
The sales of normal goods and services usually align pretty closely with the DOW.
It’s simple: consumers make more, so consumers spend more. If consumers make less, they therefore spend less.
However, not all goods and industries parallel the direction of the market.
Inferior goods and services are the exact opposite of normal and actually thrive during recession. When the economy is experiencing an upswing, the demand for these goods decreases. However, when the market is in a downturn, demand for these goods skyrockets.
Think Ramen noodles, community colleges, dollar stores, instant coffee.
You probably don’t buy as much Ramen when you’re having a good financial run, unless those sodium-laden noodles really satisfy your palate. Rather, you might go out to eat more often or purchase groceries that cost more than $0.20 per unit.
When the economy — and therefore consumers — experiences stress, families or individuals seeking student loans tend to lean more towards affordable community colleges rather than expensive, private universities.
If I’m trying to pinch pennies, I might choose a discount store (but never Wal-Mart) over a fancy boutique or instant coffee over a $19.00 Starbucks latte. Between 2008 and 2012, the three largest American discount chains — Dollar Tree, Dollar General, and Family Dollar — each constructed thousands of new locations.
Inferior goods and services thrive when you and the larger market do not. They move in the opposite direction of the economy.
Also think about the (sometimes morbid) essentials: funeral homes, accountants, waste disposal, pharmaceutical companies, etc. No matter the economic environment, people will always get sick, accumulate trash, pay taxes, and die — not necessarily in that order.
Therefore, those industries are generally stable regardless of economic swings; they’ll keep trucking along no matter what.
We’re telling you all this because it’s definitely a good idea to understand how the components of your portfolio might respond during recession. It’s an even better idea, no matter the stage of your investing career, to keep some “recession-proof” options on hand in your portfolio.
The recession-proof industries aren’t always the most glamorous, but they are stable, and demand is relatively inelastic.
There are investors who buy up shares of Maruchan Noodles' parent company during economic downturns. You could do that also, but we believe that’s an overreaction to the trend. It’s noisy investing and doesn’t offer stability.
Consider commodities. The nature of commodities trading makes them more robust to a financial crisis.
The issue with investing in companies is the volatility attached to market movements. Commodities, on the other hand, are not locked in step with stocks and bonds. Adding commodities to a portfolio also means adding diversification and thus security.
These commodities require a confident investor focused on the larger financial picture.
And that brings us to old faithful…
Short-term fluctuations will take place, but in the long term, gold is the closest you’ll get to a guarantee of stability.
You’ve probably heard it before, and this surely won’t be the last time, either: Gold is the security blanket. It doesn’t necessarily fluctuate inversely to the larger market. Rather, you might say gold has a mind of its own. The metal fluctuates independently.
Gold is immune to inflation and has the potential to hedge some other losses you might experience during an economic downturn.
The yellow metal has thousands of years of history and has earned its reputation for maintaining value. During the Great Depression, the purchasing power of gold soared while other prices plummeted.
This past week alone, in the light of global economic contraction, gold prices have risen 4%. It’s now trading at six-week highs.
This tends to signal some stress on the market — just in case the data coming from China hasn’t been enough to convince you. Gold is a crisis metal, and in times of financial concern, it gets scooped up by the bucket loads by those who fear for the stability of traditional currency.
If you’re interested in owning gold but not interested in hiding solid bars under your mattress, then you should be looking at iShares Gold Trust (NYSE: IAU) and other exchange-traded funds. To own shares in an ETF is to own gold transferred to the trust in exchange for shares issued by the trust. IAU experienced a large decline in short interest throughout August, declining more than 60% over the month. The short-interest ratio currently sits at 0.3 days.
Merk Gold Trust (NYSE: OUNZ) is a solid option for those investors who may decide to receive physical delivery of gold bullion in exchange for their shares at a later date. OUNZ has developed a proprietary process for converting its London Bars into gold coins in denominations set by the investor. The 52-week low of OUNZ is $10.75 and 52-week high is $13.02.
We’d also like you to consider a less “flashy” metal: copper.
Compared to gold, which lacks an array of practical uses, copper has an impressive resume. It’s arguably one of the most industrially useful metals — used in wires, plumbing, the automotive industry, and others.
iPath Pure Beta Copper (NYSE: CUPM) offers a unique strategy for copper investments. The fund maintains constant exposure to either one or two futures contracts, but unlike other ETFs, when it executes its automated roll process, it does not have to buy front-month futures. Instead, the fund can purchase futures of any maturity, helping to mitigate some of the contango issues that futures-based ETFs may confront. The 52-week high of CUPM is $34.99.
For those investors who prefer investing on the equity side, mining and exploration firms are another option.
Global X Copper Miners ETF (NYSE: COPX) exposes investors directly to companies actively participating in the copper mining industry. Contact is in Canada for the most part, then the UK and United States. Investment results correspond to the price and yield of the Global Copper Miners Index, designed to reflect the performance of the copper mining industry as a whole. The ETF saw unusually high trading volume over previous months.
Freeport-McMoRan (NYSE: FCX) is the largest publicly traded copper miner, operating in locations across the globe. Its portfolio includes resources beyond copper, such as oil and natural gas. FCX also engages in copper refinery and conversion, with facilities in North America.
The Encore Wire Corporation (NASDAQ: WIRE) manufactures copper wires for residential and commercial use. The cables are used in conductors, circuits, and for photovoltaic purposes. These are particularly important in regards to the solar industry, as the copper wires provide connections between panels, inverters, and collector boxes. With a 52-week high of $48.50 and 52-week low of $29.36, WIRE has had a consistent “Buy” recommendation over the past several months.
Metals aren’t the only way to enter the commodity game.
Recent oil prices might have you running for the hills — we’re seeing multi-year lows right now.
Like gold, keep short-term volatility on the shelf, and maintain an eye on the horizon.
As long as there’s oil in the ground, we will always need the resource for energy. It’s very unlikely that the sub-$40 prices we’re seeing now will be around for much longer. Most analysts are calling now the time to buy.
“Historically, energy stocks have been one of the best sectors to hold in late-stage bull markets. Since 1972, the energy sector has logged the best average performance among the 10 S&P sectors in the final year of a bull market, consistently seeing double-digit gains and beating the S&P 500 index in five out of six cases."
—Senior Analyst, InvesTech Research
With a 52-week low of $14.47 and a 52-week high of $15.05, United States Oil Fund (NYSE: USO) tracks the daily price movements of West Texas Intermediate (WTI) light, sweet crude oil. USO performance has been up 18% over the past three months.
For investors looking to be a part of a variety of oil and gas commodities, United States Gasoline (NYSE: UGA) is worth a look. UGA invests in a mix of futures contracts for gasoline, crude oil, diesel-heating oil, natural gas, and other petroleum-based fuels. It’s been called a stock to watch, with a market cap of $70.3 million, a 52-week high of $56.00, and a low of $28.20.
PowerShares DB Energy Fund (NYSE: DBE) is based on an index of the most heavily traded commodities worldwide: light, sweet crude oil, heating oil, Brent crude oil, reformulated blendstock, gasoline, and natural gas. Because of this range, there is a strong correlation with the overall performance of the energy sector.
The bottom line is that commodities, despite the chance for short-term volatility, have never failed to maintain value in the long term.
Trading futures can be a complex game, which is why ETFs are likely the safest bet.
Like we said, they’re not always the most glamorous, but these commodities and industries can play the crucial role of offsetting your losses in times of economic crisis.
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