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Nadig's Top 3 ETF Picks For 2014

Hey, I love Paul Baiocchi. After all, I hired the guy, but I saw his “Top 5 Picks” for 2014, and started wondering what might be in the water in San Francisco.

It’s not that his picks are flatly illogical. But ETFs like LIT (LIT | C-93) and SOIL (SOIL | D-40) and ZROZ (ZROZ | C-51) are flyers. So when I started thinking about “picks” for 2014—which should always be taken with a grain of salt—I started thinking about core exposures.

To my mind, the interesting opportunities are really around global recovery and managing rising interest rates, so here are two core picks, and, in the spirit of New Year’s, one flyer.

Pick No. 3:Equities – Europe, specifically the Deutsche Bank MSCI Germany Hedged Equity ETF ( DBGR | C-47 )

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What’s the case for Europe? It’s really all relative. Assuming that the developed world will maintain a general pattern of recovery in 2014—which seems a reasonable bet—the question is, What developed market is poised to recover fastest?

Given the not-so-cheap valuations of large-cap stocks in the U.S., it makes sense to look abroad. Germany is probably the answer. German companies are running at near-capacity in terms of productivity and utilization measurements, although investment in new facilities and equipment is low. Consumer confidence is low, but rising, and Germany remains the eurozone’s largest exporter, positioning it to benefit from recoveries in the U.S. and Asia as well.

The euro itself remains the thorny issue. The eurozone’s balance sheet isn’t great, and relative to the dollar—because currency is always relative—it’s hard to love the value of the euro. So the fund you’re left with is the Deutsche Bank MSCI Germany Hedged Equity ETF (DBGR | C-47).

It’s a solid fund, tracking a good index from MSCI, that just hedges out the euro. Not rocket science, but probably better than a blanket bet on Europe, like Vanguard’s excellent FTSE Europe ETF (VGK | A-95).

1_DBGR
1_DBGR

The fund only scores a C in our ratings system, largely because of tradability concerns but, in recent months, volume has stabilized, and it’s entirely ownable, with limit orders.

Pick No. 2:Fixed Income – Floaters, specifically the iShares Floating Rate Bond (FLOT | A-96)

Welcome to taper-land 2014!

While many pundits consider the micro-taper announced by the Federal Reserve to be a nonevent, it’s clear that easy money, eventually, is going away, and interest rates, eventually, are going to go up.

The big risks with bonds are always twofold:default (credit) and interest rate (duration).

A little-covered feature of the current bond market is that defaults are actually near historic lows. Moody’s speculative-grade (read:junk) default rate is currently tracking between 2.5 and 3 percent, which is well off historic averages and recent highs.

In other words, credit isn’t the big issue, and even if it were, default rates on investment-grade bonds are effectively zero, with minimal activity even in the B-grade credits and below. So that makes credit rather easy to predict and manage around.

So that leaves interest-rate risk. It’s a bit harder to predict interest-rate rises than it is to categorize default rates, but it seems clear to me there’s only one vector, and it’s northward. Luckily, near-zero duration, and thus interest-rate-insensitive, bonds aren’t that hard to come by. They’re called floaters.

There are two ways to play floating-rate bonds:investment grade and junk. I’m more inclined to think of the investment-grade products as viable core holdings, and my favorite in this area of the investment markets is the iShares Floating Rate Bond ETF (FLOT | A-96).

FLOT
FLOT

FLOT invests in the floating-rate debt of safe-as-houses corporate issuers, with a heavy tilt to financials.

Most of it is U.S.-based, but it does have exposure to other developed economies—again, mostly to banks, like Commonwealth in Australia or Royal Bank of Canada.

Short of a global financial catastrophe, I’m comfortable with the exposure here, and while the yield isn’t tremendous—about half a percent—it should scale nicely with any increase in interest rates.

Note:If you’re more inclined to look at the junky end of the spectrum, consider the PowerShares Senior Loan Portfolio (BKLN | B). It’s similar in approach, but takes on more risk—a lot more risk, down to credits rated in the C’s—to eke out a higher current yield, which is a lot higher, with BKLN’s current yield-to-maturity well above 5 percent.


Pick No. 1:Flyer – Gold Miners, specifically the Market Vectors Gold Miners ETF (GDX | A-54)

Finally, in deference to the spirit of New Year’s flyers, I’ll give you mine:gold miners.

I wrote a few weeks ago about how the decline in gold prices has decimated the entire ecosystem around gold, including miners. While the previous two picks all have charts pretty much anyone would love, this one’s a gut check:

3_gdx
3_gdx

Charts courtesy of StockCharts.com

I’m by no means a gold bug, so it’s pretty rare for me to be wringing my hands over the opportunity to dig into GDX.

It’s dominated by pure plays:Goldcorp, Barrick Gold and their ilk. And the cold hard reality is that whatever I think about gold, a lot of people will always continue to see it as an alternate currency and store of value, so it’s not actually going to go to zero. And the companies that are in the business of mining and refining the yellow stuff won’t go to zero either.

Even more to the point, many of these companies are actually integrated raw-materials companies that have a few fingers in a few other pies.

The biggest caveat to any play in GDX is the strong dollar. I think that relative to other currencies, the dollar is going to stay strong, and historically that’s a bad thing for GDX.

In this case, I don’t think that’s the driving factor here. I think the major factor is earnings and assets. The profit and loss sheets for a lot of these firms took enormous hits from write-downs of more than $25 billion in 2013. And there’s lots of reason for the declines—the marginal cost of production for many miners is now in unprofitable territory with gold at three-year lows.

So why in the world would you be a buyer? Honestly, it’s a multilayered hedge.

With GDX trading at a price-to-book of under 1, there’s just value here that at some point puts a floor under the share prices of these companies.

And I’m just paranoid enough to think that the U.S. economy—and the dollar—could go the other way. And if it does, we could see a rally in gold, and thus, the miners.

And I think any rally in miners will be dramatic, making GDX a high-flyer that maybe even Paul Baiocchi can love.


At the time this article was written, the author held no posisiotns in the securities mentioned. Contact Dave Nadig at dnadig@indexuniverse.com.

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