Critical Update on What to Do With Your Commodities Investments

There are three main routes into overseas markets.

1) You can invest in overseas stocks (or in domestic stocks that make a large portion of their profits from high-growth overseas markets).

2) You can diversify into currencies linked to high-growth overseas markets.

3) You can invest in commodities that high-growth overseas economies need to keep growing.

If you’ve been following our recommendations here at International Living Investor, you will have a strong weighting toward commodities and commodities stocks in your portfolio. These have been strong performers. For instance:

A weak dollar has played an important role in the rise of commodities (and commodities-linked currencies such as the Australian and Canadian dollars, the Brazilian real and the Norwegian krone).

You don’t need a Ph.D. in economics to understand why. Commodities are priced in dollars. So when the value of the dollar falls, the values of commodities rise in dollar terms.

You can see this relationship clearly on the chart below. It shows the exchange value of the dollar plotted against the CRB (an index that tracks 19 different commodities futures) since last September, just after Ben Bernanke hinted at his second round of “quantitative easing.”

In many cases, the run-up has been steep. Since last September, for instance, crude oil is up about 45% and silver is up about 140%.

So what should you do now? Popular commodities oil, gold and silver have taken big hits this week. Meanwhile, the exchange rate of the dollar relative to other major currencies has been rising. Is it time to sell your commodity-linked investments after their big run? Or should you hold on for long-term profits?

It’s an important question. Knowing when to buy assets is one important skill every investor needs to cultivate. But knowing when to take profits (or cut losses) is just as important. Otherwise, you end up sitting on a lot of no-good paper gains.

These may look good in your broker account. But you can’t use paper gains to buy a second home or pay for a vacation. You need to realize profits before they are any good to you.

The key here is to plan your exit strategy before you buy. The best way to do this is to use trailing stops.

Here’s how they work…

Let’s say you buy a stock that’s selling for $100. If you use a 25% trailing stop, this would be triggered if your stock falls to $75 ($25 below your purchase price).

But what if your stock goes up in price? Let’s say you made a good call, and your stocks rise to $150. Because your trailing stop “trails up” behind the stock price, it will readjust to $112.50 (25% below the new price).

Now, if your stock drops below $112.50, you are automatically “stopped out” of your position. And you make a tidy 12.5% profit on your investment.

If your stock rises in price again, say to $200, then your trailing stop rises too (to $150). Now, you stand to make a 50% profit on your original investment of $100 if you are “stopped out” of your position.

Using trailing stops means you will never sell out of an investment too early or ride a losing stock down to zero. And it makes using them a great “sleep well at night” way to invest.

To implement a trailing stop on any of your investments, simply talk to your broker. He’ll be able to set this up for you.

There’s no such thing as a one-way street in the investing world. And it certainly looks as though we’re in for a correction in commodities over the short term.

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