Comments on the Metals Markets

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It’s been a while since my last edition of Worth Considering. This owes mostly to the fact that I’ve recently undergone a fairly comprehensive shoulder surgery and took things a little slower than usual in recent weeks. It also owes to the fact that I haven’t felt anything was worth taking up space in your Inbox.

But along came today.

Before I comment on the financial markets, I want to express the sadness I am sure we all feel over the tragic events in Boston this afternoon. On a day that was supposed to celebrate the Boston area’s historic importance to our country (Patriots’ Day), it was hit by the reminder that man isn’t exactly a peaceful creature. Today is also a day baseball fans know as Jackie Robinson Day. It commemorates the day when the color barrier was broken in the sport.

It was a day designed to show the better side of man. Instead, the day is now marred by a different form of ignorance and hate. Our hearts go out to the families who lost loved ones and we can only hope this number doesn’t rise as those injured are cared for.

Turning our attention to the financial markets, it was quite a day indeed. Yes, the stock markets took it on the chin a bit but the clear story is the metals markets. Gold lost well over $130 an ounce, pushing it down to levels not seen in more than two years. In fact, the two day slide it has seen is the worst two day dip since 1980 according to the repots I’ve heard on CNBC this afternoon. Silver was also routed, as were platinum and palladium. For simplicity’s sake I will comment mostly on gold, but I want to make it clear that my comments are universal for the entire metals complex. While silver’s industrial uses might give it a slight advantage against the rest of the pack looking ahead, I think it is safe to discuss it in connection with the full group of metals.

I have commented more than once in previous issues of Worth Considering, most notably here (4/3/12), and here (10/7/11), that I believe caution should prevail in these markets. My comments clearly stated that I thought gold is a sound investment for the long term, but is likely more vulnerable than valuable in the more intermediate term. I continue to feel this way today, now several hundred dollars below gold’s peak.

In simple terms, I would remain cautious on the price of gold (and all metals) for a while longer.

All things in these markets need to be kept in the proper perspective. Gold has been up so much over a 12 year period that a natural break had to occur at some point. This isn’t unusual or unhealthy. Look at the enormous bull market of the 1970’s. During the middle of the historic run gold fell in half between 1975 and 1976. No two market phases are identical, but if this particular history tries to repeat itself, gold could go south of $1,000 and still be in what many would consider a bull market.

What to do depends largely on your allocation to the sector, not necessarily how much you paid for whatever metals exposure you might have.

A firm rule of mine has always been to never tie a portfolio’s safety and growth to any one particular asset. Said another way in the 4/3/12 edition of Worth Considering, “own gold and silver as an important part of a comprehensive portfolio, but don’t make them a ‘make it or break it’ asset for you. Don’t do that with any asset for that matter…..ever.”

With this in mind, let me offer some guideposts.

As you look across the entire spectrum of your investable assets, if your current exposure to metals – specifically bullion and/or bullion tracking assets – is less than 5%, you should do some gradual buying on this pullback.

If you have greater than 15% of your portfolio in this space, I think you need to spend some time being honest with yourself about how you feel (and what actions you might take) if gold did fall another $300 or more. In my personal opinion, you are nearing the territory of excessive reliance on this one asset class for your financial future. You may decide this is quite comfortable for you, and that is fine. But you should absolutely examine your situation to know exactly how things could unfold for your financial life if your dependence works to your disadvantage.

Incidentally, I would advise the same if you held an inordinately large percentage of GE shares, treasury bonds, real estate, etc. Don’t ever lose sight of what happened to those who relied on their company stock at Enron; or those who felt gold was a “can’t- miss” asset late in 1979; or thought real estate was the ultimate asset in 2006. Investing discipline is a must across all asset classes.

If you have between 5% and 10% in metals, I would urge you to do absolutely nothing. At this point I would see no reason to be either a buyer or a seller.

The Permanent Need for a Spare Tire

I liken gold to the spare tire in your trunk. You don’t want to have too many of them and have no room for other things in your trunk; but you also don’t want to be caught without that spare in a time of need. So I won’t ever think 0% is a wise allocation to gold. Just like I won’t think it is ever wise to have so much invested in it that you rely on it for your financial well-being.

Clients know that I am an advocate of a trailing stop loss system. I firmly believe this discipline will be helpful in both protecting and growing a portfolio over time. To avoid confusion, let me reiterate the unique way I treat gold.

As I mentioned above, I think a portfolio is best served by always having a ‘spare tire’ amount of gold. From time to time, when conditions are right and favorable trends are in place, I think gold should carry a higher weighting in a portfolio. This is no different than if I were to suggest an overweight stance on stocks or bonds at any particular time. The customary strategy I’d use for knowing how and when to reduce that exposure is a trailing stop loss approach.

The same is true of metals related assets with the one notable exception that I would only reduce exposure down to that ‘spare tire’ amount and not eliminate it altogether. If a portfolio’s overall exposure is less than, say, 5%, I wouldn’t use this trailing stop approach. Instead, I would suggest maintaining the exposure as a long term spare tire in the trunk.

What About Mining Companies?

My comments so far have been specifically about the spot prices of the metals. This would essentially cover bullion, bullion tracking assets, and to a lesser extent royalty companies and coins. But it would not be fair to say these comments hold true for mining companies. In short, I don’t want to own much, if anything, in the way of mining shares. It is a tremendously difficult business for a litany of reasons, and it is my opinion that their CEOs haven’t done a very good job collectively navigating their companies through these choppy waters. I would suggest that investors should have the vast majority of their metals exposure in assets that closely track bullion and only a minority in mining shares. Yes, it can be argued that they are cheap and also that they have dramatic upside potential. But successful investors also know that cheap can always get cheaper, and substantial upside always come with a companion of substantial downside.

Will the Slump Extend to Stocks and Beyond?

It is natural that whenever there is a big break in a major asset class it temporarily impacts the broader markets. Assets can be highly correlated in the short term. Eventually they will move in line with their own fundamental underpinnings; but they might move nearly in lockstep for a while. This is mostly a response to investors liquidating other assets to account for the losses being seen in the current trouble spot. This could be forced on them if they own assets on margin, which is common in the hedge fund community; or it could be their natural desire to pull in their horns across the board to avoid further pain. In today’s marketplace, I would say it is probable that if gold loses yet another $100, for example, stocks and other financial assets would stay under temporary modest pressure as well.

But will that even happen? I have no way of knowing if this is the final wave of selling in gold’s bull market. I could be writing to you at the lows of the year, or perhaps only mid-way through the fall. I have no idea; and if anyone were to try to tell you they know I hope you all recognize that person as either a deceitful liar or as painfully naive. For all I know, by the time these words make their way through all the compliance steps required in our industry and ultimately make their way to your eyes, gold could be up $100 or down $100. It really won’t matter, though. The suggestions I’m making here are much more about allocations and expectations than guesses at short term price movements. My comments wouldn’t change much, if at all, if I knew the next $100 for gold or 1,000 points for the Dow.

Broader View

As I look ahead at what I expect from the whole of 2013, I continue to believe global stock markets will fare better than global bond markets. I also believe there will be a gradual rotation away from bonds in general and those dollars will find happier homes in a range of assets that will include stocks, energy assets, real estate, you name it.

This is at odds with the crowd who believe the bond bubble will burst with a big bang. For several reasons I believe the air will gradually leave the bond market bubble, but it isn’t likely to be an outright burst unless the Federal Reserve dramatically changes course with little notice. I also believe the metals are likely to continue a healthy corrective phase within a longer term bull market.

Corrections in financial markets are always painful at the moment of impact. This is even more pronounced in the highly volatile metals and commodities markets. If you hold them properly as just one component of a complete and balanced portfolio, this correction is something you should yawn right through. You might even want to look to gradually add to your exposure if you can do so and stay well below an outright reliance on the group.

You should be aware that it would be historically unusual for the correction to stop here in metals. This has been perhaps the strongest bull market ever seen in this space having lasted so long already without a correction of any sort; so perhaps it will also have unique characteristics in the dips along the way. But there should be no surprise if gold corrects more in the weeks ahead. I repeat that this would be historically normal and shouldn’t be seen as a disaster. No matter what is the next 10% move in gold, it should be seen neither as a huge victory nor a crushing defeat. It shouldn’t be seen that way for the metal itself, and there’s absolutely no reason for that to be the way it is seen for your overall portfolio.

Please don’t get me wrong – I believe in gold as a long term asset. And I fully realize that you can always print paper money and you can’t print gold. But I also recognize that all of the recent printing isn’t doing much to inflation rates yet anywhere around the world. Credit on a global scale is shrinking faster than the money supply is increasing. This means the next heyday for gold remains in the future. I wouldn’t suggest anyone position themselves for a huge rally in the metals at the expense of a well-rounded portfolio that would otherwise take advantage of these global trends of zero interest rates and slow-growth economic recovery.

The takeaways:

• There’s a saying in the investment world: don’t fall in love with your stocks, they don’t fall in love with you. The same is true for your ounces of gold or your bags of silver. They really don’t think about you nearly as much as you might think about them.

• Take a closer look at your allocations to the metals sectors and ask yourself how you could withstand a deeper correction from here – both financially and mentally. If you would only be shaken out at lower levels due to financial obligations or the inability to sleep; perhaps you should address that on whatever spikes are sure to come along the way in these markets.

• I continue to believe there is a tailwind behind global stock markets. There will be pauses along the path, but the upward trends are likely to stay intact. The US led the way by a wide margin in the first quarter. The notable exception was Japan. Most international markets were only able to muster a fraction of the US gains, and the collective emerging market averages were actually negative for the first quarter. I believe the developed foreign markets will begin to catch-up a bit to the US, but I would be a little less optimistic about the emerging markets.

• No matter what happened in your financial life yesterday, it pales in comparison to what is happening in the lives of those who lost loved ones in Boston. Temporary dips in markets are literally nothing when compared to the permanent loss of someone you love – especially for no good reason whatsoever. Let’s all be sure to give hugs and make calls we might otherwise take for granted.

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