Baron Nathan Rothschild, 18th century nobleman and member of the Rothschild banking family, is credited with saying that "The time to buy is when there's blood in the streets - even if it's your own."
After the pivotal battle of Waterloo in 1815, rumors swirled as to who had actually won. Rothschild, who some claim had early knowledge of Wellington's victory, used the uncertainty and panic to buy assets at bargain prices. Once it was clear that Napoleon had been defeated, markets reversed rapidly and Rothschild made a fortune.
And so it's been down through history: Those who go against the crowd and ignore the fear often do well - sometimes very well.
Today, blood is indeed running in the streets for precious metal investors. With gold around $1,225 and silver near $20 - off 2011 highs of $1,900 and $47 - precious metal holdings have been a "nightmarish" portfolio the last couple years.
A Quick Look At The Carnage
After treading water in 2012, many of the larger gold mining companies nose-dived 50% or more in 2013. Goldcorp Inc. (NYSE:GG) fell 42%, Yamana Gold, Inc. (NYSE:AUY) fell 50%, and Barrick Gold Corporation (NYSE:ABX) plummeted 53%. The junior miners fared even worse. They were absolutely decimated last year. Some, such as Sandstorm Gold Ltd. (NYSEMKT:SAND) and Gold Resource Corp (NYSEMKT:GORO) were (and mostly still are) down 70% or more.
Gold bulls including John Paulson and George Soros lost billions as they exited losing positions.
So what happened? Why has gold declined so precipitously? Since central banks have never ceased expanding their balance sheets (the major reason for gold's rise in previous years) what changed in 2013?
Reasons For The Current Weakness In Precious Metals.
All bull markets have corrections and, after 10 years of steady price appreciation, gold and silver were long overdue for a sharp correction.
And it's not just technical. Several fundamental reasons have also come into play.
First, you can't pay your bills with gold. You have to sell to get the cash to pay and tough economic times have governments, institutions, and individuals selling gold to meet their obligations. Net selling drives prices down.
Second, central bank monetary expansion, the adrenaline of precious metal prices, is falling off. In the U.S. we have "tapering." In Europe the monetary base is falling. Even the People's Bank Of China is slowing its balance sheet growth (see here, page 7).
And as to all that money which has already been "printed?" It's mostly sitting in bank vaults as bank reserves - unused and not in circulation.
Third, instability outside the U.S is growing. Unrest in the Middle East, tensions in the South China Sea, deflation in Europe, and the debasement of the Japanese yen all sends money fleeing to the perceived safety of the U.S. dollar - at least for now. A stronger dollar drives gold and silver prices down.
Finally, with gold production costs now around $1,100 an ounce while gold sells for a little over $1,200 an ounce, miner's margins and profits are fading, dividends are being eliminated, and negative share price trends accelerating.
Beware Of Falling Knives
Are precious metals near a bottom? Well, maybe ... but bottom picking is very difficult and by buying now you may just add your blood to that already "in the street" as prices continue to fall.
All markets eventually turn and precious metals will be no exception. It will likely take some kind of crisis or blow-off event, however, to reverse the trend.
So What's A Cautious Investor To Do?
At this point it's probably a good idea to have a small core position in precious metals This protects you from "black swan" events such as a sudden war or currency crisis which could spike precious metals very quickly. No one knows what lies ahead so keep a small core insurance position.
It may be smart to now have (if you don't already) some physical gold and silver such as coins and maybe a small position in the miner ETFs: Market Vectors Gold Miners ETF (GDX) and Market Vectors Junior Gold Miners ETF (GDXJ). By holding ETFs you minimize corporate risk such as bankruptcy and other negative company specific events.
GDX has holdings in 32 of the world's larger gold mining companies. The top 3 holdings are Goldcorp Inc. - 12.0%, Barrick Gold Corporation - 10.5%, and Newmont Mining Corporation (NYSE:NEM) - 8.5%. You can see GDX's top ten holdings here.
GDXJ has holdings in 79 junior gold mining companies. The top 3 holdings are Argonaut Gold Inc. (OTCPK:ARNGF) - 5.3%, Torex Gold Resources Inc (OTCPK:TORXF) - 4.9%, and China Gold International Resources Corp Ltd (OTCPK:JINFF) - 3.7%. You can see GDXJ's top ten holdings here.
Conclusion And Summary
Right now both technical and fundamental indicators seem to point toward continued weakness in precious metals. It is not inconceivable that gold will fall below $1,000/ounce and silver below $15. If that happens I think investors could safely add significantly to their positions.
In any case now may be a good time to start taking positions, if you haven't already, in precious metals. But keep the positions small and add to them only on major dips.
Eventually the market will turn, probably bottoming during some sort of crisis, and then likely move quickly to the upside. That is how things worked well for Baron Rothschild and hopefully will for you.
Disclosure: I am long GDXJ, SA, . I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.