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Freeport-McMoRan Copper & Gold Inc. (FCX), Alcoa Inc (AA): How to Profit From a Continued Commodities Slump

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Commodities appear to be in freefall with lots of catalysts being thrown around: a stronger dollar index, changes in the global macro-economic outlook, core PCE inflation in the U.S still slowing, and the Fed openly contemplating tapering its asset-purchase program. All of these factors are likely to put commodities under further selling pressure. Naturally, investors can still profit from declining commodities by shorting companies that have high exposure to them or by purchasing ETFs with an inverse exposure to commodities.

The-worst performing commodity

Gold recently traded below $1,200 an ounce for the first time since 2010. Investors are quick to point out that after steadily moving higher for 10 years, the upward trend has broken over recent months, shattering the confidence of those who thought that gold would continue rising to new highs for years to come. I believe that the fundamental justifications for holding gold products (physical gold, ETFs, gold mining companies etc) have substantially diminished.

Freeport-McMoRan Copper & Gold Inc. (NYSE:FCX)

Going back a few years, the main argument toward accumulating gold was that the Fed’s QE would lead to a substantial increase in inflation with the term hyperinflation also thrown around. Reality is, five years after the Fed commenced its QE program, global inflation continues to fall, with core US PCE deflator inflation falling to the lowest level seen since the series was first calculated in the 1960s.

Bad news for the gold miners

Gold miners have been in panic mode for a few months as many companies have taken on large amounts of debt to finance big new projects. It made sense at the time: gold prices has been flying for the past few years combined with low interest rates, which made taking on debt a more attractive option rather than equity. In 2005, the cost of mining an ounce of gold was $280, while this number has risen to $775 in 2012.

There is no surprise that the Market Vectors Gold Miners ETF (NYSEMKT:GDX) lost around half its value in 2012, with more downside to be seen. So long as gold prices continue plunging, miners will be under tremendous pressure as it is the price of gold doesn’t cover the overall costs of many miners. Bottom line, with enormous fixed operating costs and declining gold prices, a mining company’s cash flow can end up swinging more dramatically than gold itself.

Investors can profit from the gold miners demise by purchasing the Direxion Daily Gold Miners Bear 3X ETF. The ETF is designed to provide investors with a daily return that is equal to three times the inverse of the Gold Miners index. The ETF is amongst one of the best performing in the entire market, up (at the time of this writing) over $80 per share. Leveraged ETFs such as this provide investors with a great opportunity take advantage of short- to medium-term negative trends that I have highlighted.

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