Stock market volatility and uncertainty has been the theme for the last couple of months. The VIX, which measures the implied volatility of S&P 500 index options, has remained at an elevated level for an extended period, which is quite unusual.
The volatile markets have created a difficult environment for traders. As a result, many traders have simply stepped away and taken money off the table. And with liquidity withdrawn from the market, volatility has been further exacerbated. On the chart below you can see the seesawing motion in the S&P500 index.
I have been a big advocate of investing in gold and precious metals and the data points to higher prices in the future. However, I do not recommend allocating 100% of assets in to gold and precious metals, nor do is suggest taking a traditional approach such as a diversified portfolio of mainstream stocks and bonds. Wide diversification of assets that are in a bear market certainly grantee a mild loss at best.
As we have discussed before, certain assets do better during certain times periods and other assets do better during other investment cycles. Right now gold and precious metals are in a bull market so it would only make sense to add a larger allocation to these metals. But there will be opportunities in a small number of equities, such as gold mining companies and energy companies. During the mania phase of the last gold bull market in gold it was not unusual to see the market cap of some junior exploration companies increase by hundreds or even thousands of percent, much like the .com mania. So it may make sense to allocate a portion of your capital to this sector.
We are living in a world of currency depreciation and the purchasing power of the money in your bank account is slowly dwindling away. And even though I am a huge advocate of gold, it is still necessary to keep some “dry powder” on hand. Having cash and being liquid gives you courage and it opens up opportunities to take advantage of bargains that may present themselves in a liquidity crunch.
However, some currencies are better than others and it’s important to diversify your holdings. Since the fiat currencies today are not backed by gold or any other commodities, the strength of a currency depends of the strength of that country’s economy. Favorable characteristics for a strong currency include, a positive balance of trade with other nations, positive real interest rates, and a stable monetary base, to name a few. Running a budget surplus and keeping a reasonable debt load also contributes to a sound economy.
There is an old saying that “the trend is your friend” and this is as true today as it was ten or twenty years ago. An investor that that can identify a positive trend and have the audacity to stay with it throughout its ups and downs is set out to make huge returns.
Most large returns are made by getting on a trend early. Identifying a new trend early requires a bit of research and some contrarian thinking as the majority of the public is often latecomers. This was the case for internet stocks at the beginning of the new millennium, as well as for real estate during this latest mania, and it will probably be the same for gold and precious metal at the end of this bull market.
There are strong fundamentals in favor of silver. The metal is in short supply and demand is rising. With bullish signs in favor of silver, many prominent silver investors see the price of silver increasing several times and eventually hitting a 1:15 ratio against gold. Industry veteran Eric Sprott, called gold the investment of the last decade and silver the investment of this decade.
I have provided some facts and figures in this article to show why silver is undervalued and has a lot of upside potential. Part of the argument for higher silver prices in the future is shortages in supply and a growing usage in technology. Another reason is that silver is a monetary metal and will attract investors during what I believe will be an inflationary times ahead.
Different asset classes have proved to be more or less favorable during different time periods. History has shown that the bigger returns have been made from being in the right market at the right time. The fluctuations among different assets are called wealth cycles.
Simply put, a wealth cycle is a way for an observant investor to forecast market direction and move money from an overvalued asset in a bubble to an undervalued asset class. Then ride the new asset up until it becomes overvalued, sell, and repeat the process with a different asset. But you must pay close attention to the market and know when to get out. It is also important to watch what's happening in other sectors and look for the next big opportunity.
The most prevalent word in the trader's lexicon these days has surely been volatility. Although its presence can cause an adrenalin rush in the collective trader community, the "whipsaw" action that has characterized pricing behavior over the past several months can also result in a "buzz-killer" of sorts. The sensitivity to any news in Europe, whether a political shift or a few basis point rise in Spanish debt, will now have a new "competitor" across the pond as the "Super Committee" nears its deadline to resolve the deficit conundrum in the United States.
As uncertainty, the "cousin" of volatility, persists, investors are continuing their rush to "safe havens", hoping the storm will pass in the near term. Under such conditions, conventional wisdom would suggest that a prudent investor look to precious metals as a store of value or switch to currency trading where wavelike patterns can be anticipated with some degree of statistical probability. Analysts, however, are confused that normal correlations are not holding up. In other words, the trading environment is quickly morphing into what was seen three to four years back, and no one wishes to witness a repeat performance of those horrendously de-leveraging markets.
Anyone that has been following gold for a while know that the metal has a seasonal factor with strong price performance in the fall and winter and weaker performance in the spring and summer. Since the beginning of this decade long bull market, gold has made an annual high in November or December, except during 2006 and 2008. This year gold made a high in September and we are yet to see if gold will test the old highs or perhaps make new highs.
The chart below shows the seasonal strength and weakness of gold. It is calculated based on the monthly average annualized increase in gold over the last 10 years.
I have been investing in gold mining companies for a number of years and although this sector can offer spectacular returns it also has quite a number of challenges.
First of all, gold mining is a very tough business. It is capital and energy intensive, it requires large upfront investments, and there are a vast number of environmental laws and regulations that companies must comply with.
Government fiat currency currently serves as money throughout the world, but it is far from ideal. At present, it works well as a medium of exchange but it is a poor store of value. A good money (a medium of exchange, and a store of value) has certain characteristics. Aristotle defined these characteristics 4th century BCE, and they are still valid today:
1 - Durable: A good money is durable and should not fall apart in your pocket. It should be close to unbreakable. This is why we don't use fruit as money.
I have written extensively on why and how to invest in gold and silver. Party because gold and silver is in the midst of a secular bull market with many years left, and partly because I see it as the best and safest investment moving forward.
Uncertain economic conditions, sovereign debt worries, and currency debasement are all factors that have driven investors to own gold. Because gold is not somebody else liability it offers safety and protection against risks such as inflation and a systematic breakdown.
