In The Lead – A Balancing Act To Rival The Flying Wallendas


Precious Metals CommentaryThe new trading week got off to a relatively muted but also somewhat weak start in the precious metals’ complex. While the US dollar did give up one-tenth of a percent on the trade-weighted index, it still remained near 83.26 on the same and with only a less than 20-cent advance in crude oil and with the euro threatening to break the $1.23 mark against the dollar, the metals’ advances at opening time were small, to say the least.

Spot gold climbed $3.70 to open at $1,586 per ounce and silver commenced the trading day at $27.24 the ounce with a 14-cent advance. Platinum on the other hand fell $1 to start at $1,440 while palladium rose $7 to open at $582 the ounce. No changes were noted in rhodium at $1,250 per troy ounce.

Standard Bank (SA) analysts noted this morning that while they look for investment demand to possibly be able to lift the precious metals somewhat higher during the present quarter, they — as regards-silver — do not expect the white metal to be able to convincingly vault above the $35 level.

The most recent commodity market analysis by the Standard Bank team notes that

"Post the FOMC announcement two weeks ago, silver was hard hit by a speculative sell-off (the hardest hit among the precious metals). COMEX silver net speculative length declined by a massive 817.0 tonnes, all as a result of the 881.9 tonnes added to speculative shorts (the largest addition of the past 12 months). By comparison, a meagre 65.0 tonnes were added to longs. In previous weeks the futures market seemed conflicted over its outlook on silver."

Some (perhaps most) of the negative sentiment manifest towards silver currently stems from the perception that global industrial demand is failing to do its share to bolster the white metal’s value at above the $30 mark. With news such as described below, that kind of sentiment might indeed have solid fundamental justification. For example:

Chinese Premier Wen Jiabao did not mince any words when he cautioned his fellow countrymen during a visit to the Jiangsu province on Sunday that the nation’s economy still faces what he called a "huge pressure" to slow in spite of the government’s current and previous efforts to stimulate it. Such, statements coming from the very top of China’s leadership, are being seen as heralding a possible GDP reading of as low as 7.3% for the second quarter and they contain several important implications, including ones involving the commodity sector and the perma-bulls in that space who had banked on anything but such a slowdown (the worst in three years) occurring in the world’s second-largest economy.

Premier Wen also singled out the importance of thwarting the culture of greed and profiteering that has been permeating the property market in China. In fact, Premier Wen flat-out said that "we cannot allow [housing] prices to rebound" and that property controls will remain in force aiming to contain speculation-based "demand" in that niche.

Thus far, the Premier’s goals have not exactly been achieved very successfully; the country’s new home prices actually rose for the first time in nearly one year during June. A bounty of deceptive and speculative information has been making the rounds in the property market of late and it has yielded not only fast-changing price expectations but a bunch of panic-based transactions by a buying public that believes that it might be "missing the boat" on housing once again. You know how that usually ends.

The trading week that ended on Friday tallied the largest decline in values in a fortnight and with a definite turning of the "risk" switch button by market participants to the "off" position. Gold prices lost just about 2% on Friday and they ended the abbreviated week of sessions with a net loss of 1.6% (more than $30) in the active August contract on the Comex. The lower than anticipated US jobs additions figure from the Labor Department did not manage to lend support to the yellow metal as speculators apparently felt that the number was not negative enough to twist the Fed’s arm and result in a fresh batch of easing measures.

Gold market players were also back to obsessing about the euro and its value just one week after the "be-all / end-all" EU summit. The common currency touched a two-year low against the greenback, which, in turn, gained the most in ten months (3.1%) to reach $1.225 and also climbed to nearly 83.50 on the trade-weighted index. The dollar’s breakout and gold’s breakdown from previously formed congestion triangles has resulted in several re-formulations by market technicians of near-term price prospects.

One such interpretation, being offered by former Fed examiner and Boston University faculty member Mark T. Williams labels gold as an asset bubble that has begun to leak. Based on the March breach that occurred in the GLD’s long-term trendline, Mr. Williams now cautions that if and when a break under the $150 level on that vehicle’s price chart were to take place, gold could experience a sizeable subsequent decline. We are already at a year-to-date juncture wherein the Dow has outperformed gold by a 2:1 margin — the first such development in over ten years. This is what the chart in question looks like, courtesy of

GLD Chart

Whether or not the outcome(s) being suggested by Mr. Williams turn into reality remains to be seen and we may not have too long to wait to learn what direction the yellow metal feels more ‘comfortable’ to be headed into. There is, on the other hand, at least one other consideration that long-term buyers and holders of the precious metal probably ought to consider at this point in time, and while gold is still some 2.5 to 3 times above its cost of production. FYI: On a historical basis, that ratio (mining cost to market price) has been nearer to the 1.5 level. We will let you do the math on that equation even though we would suggest that Mr. Williams’ estimate of $500 per ounce is more likely closer to $650 per ounce at this point.

Either way, according to Richard Gotterer, who is a Managing Director at the Wescott Financial Advisory Group in Miami, gold investors who have accumulated the metal over the past decade-plus, are in a windfall paradigm that dictates a re-evaluation of their holdings.

Mr. Gotterer advises that "without any trimming or rebalancing along the way, gold’s decade-long rally has probably created a significant overweight in one’s portfolio. It would be prudent for [financial] advisors to review their clients’ portfolios and recommend reducing their exposure if it’s become too large."

The estimation of what might be "too large" of an exposure to gold certainly depends on one’s own risk-tolerance levels and/or investment objectives, but tactical asset allocators generally advise holding no less than 5% as well as no more than 15% in the precious metal. At the height of the actually highly inflationary 1979-1982 period, the normally conservative Swiss money manager crowd was advising wealthy clients to hold as much as (but no more than) 15% in bullion as a hedge.

Subsequently, the recommended gold allocation percentage in a conventional and well-diversified portfolio of assets was reduced to (and remained at or near) 3-5% for a very long period of time (1982-2002). World Gold Council-commissioned studies have placed the "efficient frontier" for gold in a basket of assets at anywhere from 2% (for low risk portfolios) to 10% (for high-risk ones).

We have traditionally gone along with a prudent, 10% earmark of gold as an insurance policy with a multi-decade long time horizon for one’s investment allocation "pie." However, it is certainly true that what used to be a 10% gold reserve holding valued at, say, $650 per ounce has now morphed into a 25%+ slice that is clearly an over-weighted position for many an individual investor.

Successful money managers know that the act of bringing a portfolio that has deviated from a client’s asset allocation targets back into line is an essential periodic strategy. The process of selling certain over-weighted assets and using the proceeds to purchase other, under-weighted ones has proven to be a wise course of action over the years.

The basic concept at work here is the fact that, as time passes, an investor’s originally intended asset allocation shifts into a different and often less desirable direction as certain assets perform and other do not. Often, a portfolio that was built to be conservative may actually become riskier owing to such distortions. One of the commonly used rebalancing strategies is to bring a portfolio back into line any time a particular asset’s allocation deviates by more than 5% from the original equation.

When one buys gold for the "right" reasons, there really is no wrong time or price at which to buy it. However, once a core insurance allocation in gold has been established (at around the 10% level) it might be beneficial to revisit that holding from time to time in order to ensure that its presence in the portfolio is not excessive or insufficient.

The bull market in gold since 2001, and especially so since 2008, has very likely changed the original profile of many an investment portfolio in precious metals without the owner of such a basket of wealth realizing the benefits, opportunities, and, indeed, certain dangers that such a change has brought with it. With the noticeable shift in gold’s decade-long trend since last September, many clients have begun asking some very basic questions about their investments. One might safely be able to say that it is time to take note, take stock, and probably take action for many individual investors at this juncture.

Take, for example, Mr. & Mrs. Smith who were wise enough to allocate a 10% portion of their million-dollar basket of assets to gold in early 2006. They spent $105,000 and bought 200 ounces of gold at $525 per ounce and started to get a better night’s sleep after the fact. Now, our happy couple — after six excellent years in the gold market — finds itself owning $320,000 worth of gold and with their portfolio still only worth $1.2 million (well, they did not do very well in real estate or in stocks) the gold allocation has now swollen to represent 27% of their estate. This is not necessarily a good situation. Let me explain:

The 300%+ gain that Mr. & Mrs. Smith have not realized any portion of is…like money in the bank.

Unfortunately, we mean that literally, as banks pay practically zero percent on deposits these days. Taking $200,000 off the "table" would allow the couple to first of all keep 75 ounces (worth $120,000 or 10% of the value of their current estate) at a "no-cost" basis per ounce. Taking the same $200,000 and buying — for example — palladium or platinum with it could offer lower potential downside risk and potentially higher percentage returns over the short-to-medium term, especially if there is a cyclical change in the making in the gold market, as some analysts believe.

Most importantly, the rebalancing of the Smith portfolio brings the gold component back "in line" with the couple’s original objectives and it removes a good deal of potential volatility from the asset pie by virtue of the reduction of the allocation from what would normally be considered an "over-weighted" situation. The rebalancing process thus keeps everything that should be present firmly in place, but is allows for a good deal of newly harvested investment capital to be put to work in areas that might offer good (and/or better) returns from this point forward.

If the couple had the inclination to trade metals on a more frequent basis, they could consider investing in silver. Over the past several years there have been numerous occasions on which one could have purchased the white metal and realized better than 10 percent gains over a relatively short period of time. Of course, discipline and specific buying and selling targets would have been essential to observe, but the point is that the opportunities were there.

Platinum and palladium are still considered to offer positive supply and demand fundamentals and to play an indispensable role in the world’s modern economies. Investors have begun rounding out their gold and silver portfolios with the so-called "noble" metals as a matter of necessity. This is not some kind of "diversify or die" panic-driven investment, but, rather a "diversify the pie" prudent, and potentially profitable, calculated move.

We have, for example, seen several market forecasts calling for $1,000 or even for $2,100 palladium in three-to-five years’ time, based on tight supplies from South Africa, dwindling (to zero) Russian state-owned inventories, and on robustly growing global auto sales. It is worth asking the question whether it might be easier/more likely for palladium to reach such a number, of for gold to climb to more than $5,600 within that timeframe for a move of an equal size.

Finally, according to Standard Banks (SA) analysis, the current environment, while it might still offer certain potential in the commodity niche, presents some possibly quite lucrative opportunities in the area of foreign exchange investing.

The team notes that "For commodities, there could be specific arguments for a couple of markets, such as oil if there is a supply-related shock, perhaps associated with the situation in Iran. And for gold, as another big dose of Fed quantitative easing could lift the yellow metal. But, as a general asset class, our commodity analysts are not that enthused.

"So, why foreign exchange as an asset class? In our view there are a couple of key reasons. The first is that liquidity generally remains good in major currencies at times when liquidity disappears from other markets. Hence, if we take a very bearish view of the world, and the euro zone crisis in particular, not only could we see the euro fall dramatically, but liquidity is likely to remain pretty ample even if it has disappeared from many other asset classes. A second reason to trumpet foreign exchange as an asset class is that investment managers tend to generate returns that are often low, relative to other assets, and usually less volatile than other assets. In other words, it’s a bit ‘boring’. But, in the current environment we’d argue that boring is good."

Therefore, with gold and silver at potentially pivotal points in the wake of almost non-stop gains over the past decade-plus, it might be a very good time indeed to sit down and take stock of one’s basket of investments. One might discover that perhaps they own too little gold or that they have too much silver. They might tally a handsome but unrealized gain in silver, or they might find that their gold was acquired at a sufficiently higher price that a cost-averaging purchase and the reinstatement of the 10% core allocation are in order. The point is that a thorough "inventory" of one’s holding will likely reveal some items that need one’s attention.

"They" often say that "the key to life is balance." One might be wise extend that maxim to include one’s financial life as well.

Until Wednesday,

Jon Nadler

Senior Metals Analyst — Kitco Metals

Jon Nadler
Senior Metal Analyst

Kitco Metals Inc.
North America

Disclaimer: The views expressed in this article are those of the author and may not reflect those of Kitco Metals Inc. The author has made every effort to ensure accuracy of information provided; however, neither Kitco Metals Inc. nor the author can guarantee such accuracy. This article is strictly for informational purposes only. It is not a solicitation to make any exchange in precious metal products, commodities, securities or other financial instruments. Kitco Metals Inc. and the author of this article do not accept culpability for losses and/ or damages arising from the use of this publication. and

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