Should I Invest 10% of My Portfolio in Gold?

With all this talk about inflation in the distant future, I’ve been wondering whether I should invest 10% of my portfolio in gold. The theory is that we will incur so much debt that foreign holders of our currency will get nervous and “diversify.”

Let’s say I’m in China and I’m nervous about the USD. Where will I choose to go? The yen is unofficially tied to the USD. The euro is grossly over-valued and the European economies are a running circus. That takes care of the three major currencies. Let’s list some of the other options:

• Russia – Nyet! Corruption.
• Brazil – Where’s the price of oil going?
• Canada – Where’s the price of oil going?
• Australia – Where’s the price of oil going?
• All other countries – Too small and/or too unstable

Yes, its sounds great to “diversify” but in reality there is only one USA, even if it’s only the best of the bad.

I believe we are going to break the March lows in the S&P 500 before the spring of 2010 and that we will see a second wave of financial crisis from continuing falling real estate prices and the decline of commercial real estate. I do not have too much faith in government bailouts of any part of banks except its utility function of providing liquidity to personal and commercial interests. Anyone depending on using a bank or major financial institution as the guarantor of a structured note, swap or any other over-the-counter derivative will be sorely disappointed. The “banks” will not fail, but all the capital markets, insurance and money management arms will be at risk. In the next financial crisis, the government will have no choice other than to carve up “too big to fail” banks into necessary utilities and “at-risk” entities.

The USD, like gold, is where investors flock as a safe haven in distressed times. As the next crisis unfolds, both the dollar and gold should rise as investors seek safe-havens. Until someone can seriously answer the question where else one can realistically go other than the USD, then I am going to take the controversial position that absent better alternatives, the US government will be able to finance their debts with very low interest rates for an extended period of time. As its balance sheet improves, the U.S. economy will also improve and the prospects for the US dollar, too.

Gold, on the other hand, will not likely get the long term and often mentioned “home run” as an investment. It won’t give spectacular returns without a return of inflation. As the U.S. economy recovers after 2012, gold should quietly enter a substantial bear market rally.

Much has been said about the increase in the monetary base as being inflationary. No doubt, but not until the economy resumes substantial growth. It can be argued that the carry trade provided more expansion of credit than did U.S. banks. It was the rise in capital markets derivative banks that really provided the expansion of credit. It is true that an increase in the monetary base can be inflationary, but I do not see this coming until after the financial crisis is resolved, which will take a few years.

Until then the problem will continue to be containing deflation. Long term high quality bonds look like a great buy now as they are pricing in inflation fears that will not be as bad as presumed. That being said, the issue of quality is of primary importance.

I really don’t think that many financial companies deserve credit ratings above BBB and many should be rated BBB or lower. The credit agencies still have their heads in the sand on this one. A high quality bond portfolio that includes many financials should be questioned seriously. In addition, some non-financial bonds with large credit subsidiaries are also too highly rated by the credit agencies, in my opinion. The economy is too weak to say that any company with a large credit subsidiary or that is over leveraged will not fail. That means that most need to be rated BBB or lower.

An area of interest is municipal bonds. Like corporate bonds, there are lots of areas where credit agencies are behind the curve. However, with high rated GOs and some very strong revenue bonds, there are also some good buys in the universe. Make no mistake, there will likely be more municipal bond failures in the coming years, but states will do everything to preserve their key funding source. Therefore, be wary of municipals with poor fundamentals. And remember, you can’t depend on a credit rating only in making municipal bond or corporate bond decisions.

In summary, for the next two to three years, gold looks like it will fare better than most investments but it will likely move in tandem with the US dollar as opposed to inversely. Stocks and most risky assets will fall again in price as investors seek safety. This period of safety will last much longer than the last one as investors will be too scared to return soon after being burned twice.

During this slump in the stock market, low quality bonds will also fall. High quality bonds and US Treasuries will keep their value and perhaps increase. The US government will likely take advantage of the new demand for the safety of U. S. securities to raise much needed capital at extremely low interest rates from the years 2010 until 2020.

After the US has repaired its balance sheet and funded its obligations (including social security and Medicare), it will begin to be in a position to resume long awaited growth for the next generation.

Disclosure: I have no position in gold

Comments

[User 357705:]

YES!

Jul 15 04:02 AM

[User 357705:]

Only 10%?

Jul 15 04:02 AM

[AlphaDude:]

I'm already in 10%, and planning on increasing to 25%.

Jul 15 04:39 AM

[Living4Divi...:]

My answer: NO!

See justification in this article I wrote:
seekingalpha.com/artic...

Jul 15 05:40 AM

[DONE_SONZ:]

All in.

Jul 15 07:12 AM

[Vuke:]

Keep what you want to protect in gold, silver and your home and business. Invest carefully in what you know and can be sure of. There will be some great winners (and losers) as the economy resets.

Jul 15 08:30 AM

[The Economi...:]

You're forgetting about the crisis point that tests America's very existence and leads to another world war. In the next 10-20 it will happen.

Jul 15 08:48 AM

[doubleguns:]

All of that bond selling is a lot of debt. How do we repay the debt. We have nothing to sell but dollars, treasuries and promises.

Cant see the dollar performing well here even as the least ugly sister who would buy it when there is gold, silver, etc....

Gold yes!!!!

Jul 15 08:55 AM

[ScroogeMcduck:]

I'll see your 10% and raise you another 15%

Jul 15 09:27 AM

[blacksilver:]

yes,and trow a little silver in there for good luck

Jul 15 10:30 AM

[Gold Miner:]

Interesting read. I still believe my 50% retirement invested in silver eagles and gold buffalo proofs, 4 coin proof sets, pcgs and ngc grades coins was a good move. Across the board they have been consistently on the rise. I pulled out of stock market back in august 2007 and bought where ever I could gold and silver bullion and collectable coins. Get yours while you can.

Jul 15 10:34 AM

[CoinMiner:]

The replacement for the USD will not be an existing currency. Instead a new currency will replace the role and function of the current USD; the dollar may still exist for national trade.

One cannot dismiss the intent behind the Russian president, Medvedev, passing out a new coin to the leaders at the G8 summit. Currently, three of the eight have publically called for a new unit of international trade.

Just a matter of time before that minority position becomes a majority position. And yes, do believe gold will function quite well as that shelter in the storm during the transition period.

Jul 15 11:04 AM

[Dean M:]

This talk of an alternate reserve currency is a complete red herring, the real question is do the export countries want to float their currencies against ours or do they want to inflate our currency vs theirs through foreign exchange manipulation to improve their trading position.

Jul 15 11:56 AM

[goldrealmny:]

25-35% bullion (more silver than gold at these prices)
25-35% precious metal resource stocks (stick to producers - big majors (NEM GG GFI KGC, emerging majors AUY AEM IAG PAAS, juniors with great balance sheets/fully funded, low debt/cashed up, superior undervalued assets, competent mgmt, reasonable share count, again don't forget silver exposure
Maybe 20% trash cash preferable in a better currency than the US dollar (Candol, Swissie?)
I don't think all stocks should be avoided - quality consumer staples, agriculture, energy, maybe a smidge of emerging alt energy like solar, cigarette companies or blue chip solid div payers, etc.

Just get long and stay long with conviction - if you keep a decent amount of trash cash you will be able to deploy on any market crashes and buy hand over fist. That's my strategy. We all know gold will be worth far more than $1000 US Federal Reserve Bankruptcy Notes in the future, I could care less if it doesn't happen tomorrow, next month or next year.

Jul 16 08:04 PM

[Spartacuss:]

Inflation, deflation, which, and for how long...it is always a "when" it seems. That the dollar is ultimately doomed is a slam dunk. But, not yet. The author sees the same as I see. It will be a while as the great deleveraging, unwinding continues and thus strengthening the dollar.

However, I must say that being a significant holder of the metals, I fully expected the metals to seriously decline during the scramble for dollars and actually such is not the case and for a variety of reasons that are too lengthly to go into here.

I really don't expect good performance until such time as there is a serious dollar decline which I think will show up in late 2012 and perhaps a little sooner, but first we have to wade through all this paper soon to become bad coupled with more government emergency actions that will only make things much worse. The congress has collectively lost it's mind; fools running amok.

A lot of damage has been done out there and as usual the hacks are trying to smooth it over with more "green shoot" nonsense. Like lately, the burgeoning Chinese economy...really? Based on what? Certainly not production. No, all the Chinese stuff is a) cooking books, and b) stimulus spending. The Shanghai market has gone into orbit and China is trying its best to attract foreign capital using any means whatsoever.

Beleive what you want, but for me, I am going to hide in the bushes for now and run my greedy old fingers through my gold and silver stash and then too, the ammo.

Jul 17 11:28 PM