Wednesday, March 24, 2010

Update on the Big Dustup Index Fund (BDUIF)


The BDUIF is continuing to operate as it was designed to operate -- following the average of the ratio of the price of oil to the stock market and the ratio of the price of gold to the stock market.  As I mentioned in the introductory post here, and the last update here, the BDUIF is a way to invest in oil and gold that uses stock market short ETFs as a hedge against commodity price falls due to economic decline.

Since oil and gold have been following the stock market -- going up as the market goes up and going down as the market goes down -- "naked" investing in such commodities carries a risk.  If the economy were to decline, oil and gold prices would also decline, which may seem somewhat counter-intuitive to people who see gold and oil as safe stores of wealth.

What you give up with the BDUIF is any gain in oil and gold that follows the performance of the stock market.  The BDUIF is designed to hold steady with minimal gains and losses in "normal" circumstances.  So really, it is an investment technique waiting for a world event that causes the stock market and gold/oil to diverge.  Stagflation, or a war that disrupts oil supplies, would be examples.

A problem for the BDUIF would be if gold and oil prices declined as the stock market advanced.  This would happen if the Mideast were to announce a lasting peace, or if the economy continues to do well with no inflation.

The chart below shows the performance of the BDUIF against the ratio of oil to the Dow Jones Industrial Average (DJIA) and the ratio of gold to the DJIA, all normalized to 1000 on 4 February 2010 when the BDUIF was formulated.

The BDUIF is performing as designed
(click for larger image)

As you can see, the price of gold is not doing well in relation to the market right now, probably because the general sentiment is that inflation is not a problem.  The use of gold in the BDUIF has limited potential gains that could have been seen from the run up in oil in early-mid February, and has resulted in losses of about 3 percent over the last two weeks.  Here is a chart focused on gold/DJIA so you can see how badly it is performing -- down over 6 percent from the baseline:

History of the Ratio of the Price of Gold to the DJIA normalized to 1000 on 4 February

You may recall that I mentioned in the last update that gold was not performing.  Despite uncertainty in the Mideast, gold was flat, raising significant questions regarding its usefulness.  I had considered removing the gold position from the BDUIF, but held off to see what it would do.  I wish I had removed it.  I will make a decision this week and likely remove at least some of the gold position. 

The makeup of the BDUIF has not changed much over the last two weeks.

UGL: 2x leveraged gold futures bull
DBO: Crude oil various month futures bull
OIL: Crude oil next month futures bull
USO: Crude oil next month futures bull
BGZ: Large cap 3x leveraged bear
DPK: Developed markets 3x leveraged bear

I actually have a significant amount of money in this, but my other investments are doing much better.  We will see how it plays out.  The BDUIF hasn't made any money, but it hasn't really lost any either -- which is what it is supposed to do.

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