Wednesday, June 30, 2010

Gold Or Precious Metals Stocks?

Recently, I proudly and confidently proclaimed that GOLD was ready to head for $2,000.  As Bill Clinton's former press secretary, Dee Dee Myers, used to saying when Billy was caught lying, that forecast is "no longer operational".

An interesting dynamic has put itself into motion.  As GOLD continues to hover near its highs, the equity market is rapidly falling apart.  Precious metals mining companies are battling a tug-of-war between higher metals prices versus a vastly more difficult environment for equities.

This sets up a very difficult question:  how does one play the market volatility?  Carefully.

During the financial meltdown of 2008-09, GOLD held up pretty well, gaining a "flight to safety" bid.  Despite the very good action in GOLD, however, mining stocks got blasted for losses of up to 90%.  Any one of a number of events could trigger an explosion in the metal:  war in Iran, a breakdown of the Euro-Zone, more quantitative easing or more problems in the financial system.  This list is hardly exhaustive.

The above notwithstanding, many signs have emerged that another DEFLATION scare is imminent.  The money supply is plunging at un-precedented rates.  DEFLATION.  Bond yields have broken to new multi-generational lows.  DEFLATION.  Bank loans and credit are contracting at historic rates.  DEFLATION.  The dollar, despite all the government spending and low interest rates keeps rallying.  DEFLATION.

The "Gold Bugs" index, also known as the HUI, has been carving out an ascending wedge pattern.  These are normally, but not always, bearish.  The HUI has also approached the 500 level on several occasions, and can't seem to break through.  A material violation of either 475 on the downside or 500 on the upside would provide a pretty good indication of what to do. 

It's possible that GOLD itself could rally while precious metals stocks could decline.  So, for now, the best bet is the metal itself.  I would be VERY cautious about the equities at this juncture.  I tend to think there will be a better buying opportunity down the road.

As to the metal, I would use $1,225 as a stop level.  If it breaks below, chances are that we will see some decent downside and there will be a much better entry point.  For now, the amber light is flashing.
Warning Will Robinson!

So, what to do here?  If you're going to stick with your portfolio of miners, I would at least add a hedge to insulate against equity pressure.  Personally, I like the inverse ETFs FAZ, SKF and TWM.  There are plenty of others you can use.  I would NOT recommend purchasing a GOLD inverse ETF.  What's the point of being both long AND short?

As investors, it is ever so important to not get wedded to a particular point of view or to stay either perma-bull or perma-bear.  The easiest way to lose money in the world is to be stubborn and insist that your pre-conceived notions must be correct.  Minimize your losses and wait until a better opportunity presents itself.

Marko's Take

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