Precious Metals: Their Place In A Portfolio

by: JJ Butler

When considering the place of precious metals in a portfolio, and gold in particular, investors fall into one of two distinct schools of thought: believers and unbelievers. History is rife with hyperinflationary currency collapses. Yet the Western world and particularly the U.S. saw relative monetary stability for decades with gold bugs being outside the mainstream. While the gold bull market of the 1970s was spectacular, consistent gold bug predictions of currency collapse have yet to seen fruition.

True believing gold bugs populate the internet with many websites. Having a broad view of history, they point out all fiat currencies eventually return to their intrinsic value of zero. Without an anchor, politicians always eventually succumb to temptation and print, even to the point of monetary destruction.

The symptoms are obvious imbalances. Today's credit bubble took decades to reach a crescendo. The crisis of 2008 only transferred much of the debt from the private sector to sovereign governments with the ability to print money by fiat. Today's negative real interest rates are theft from savers to borrowers.

In a world where gold is determined to be money by free association, these imbalances are not allowed to be built. The scarcity of gold course corrects long before outrageous borrowing and lending occurs. Moreover, the discipline of a gold standard keeps the malinvestment of spectacular booms and busts from massively distorting the economy. Profitable investment drives worker productivity and thus the standard of living.

Today society is left with unsupportable and unsustainable debt. Debate centers around inflation and deflation. Will the debt be defaulted or debased away? The textbook examples of each are the default and deflation in the U.S. of the Great Depression and the debasement of the German Weimar hyperinflation. Neither path is appealing. Which path is taken and the degree of severity will be decided by policymakers. Government officials and central bankers are trying to steer a path between the two extremes.

The natural path would be for the heavy debt loads of this current world to largely be relieved by default and deflation. Had the financial crisis of 2008 been allowed to run its course debts would have been defaulted. Policy makers state financial armageddon was on the brink without the significant and rapid interventions and they are not exaggerating. However, the drunk with a hangover was given a drink for relief. Rather than experience the pain to fix the problem, the problem was pushed out and made worse.

Europe has debt problems of its own, even if the political structure is different. Greece is in big trouble and the can was kicked down the road. Now Spain's troubles are making the rounds. The end game choices are the same: default or debase.

Default is the course nature would choose while human nature dictates intervention. In today's markets asset prices rise and fall in tandem to perceptions of whether or not money is being printed fast enough to keep the party going. Quantitative easing, operation twist, and government deficits are the drink for the drunk. The gold bug expects the money printing to ever increase. The only question is what does the deflation look like before the hyperinflation. Perhaps 2008 was the deflation scare; perhaps another will occur on the path ahead.

Meanwhile, investors must invest. The place for the precious metals complex in a portfolio in a credit bubble fiat world can be described as heavy. More interesting is the security selection within the precious metals group. Strangely, in a hyperinflationary world gold coins do not serve the investor well in practical terms. Coins would be so valuable as to be able to purchase only the most expensive of goods and services. Consider silver coins to hold in physical possession.

The SPDR Gold Shares (NYSEARCA:GLD) represents gold well. The price moves with the price of gold with only a small holding cost. GLD transactions are easy to accomplish and have much liquidity. If an investor would like to mimic the price of gold the GLD serves usefully. The iShares Silver Trust (NYSEARCA:SLV) performs well for silver.

The investor may want to own productive assets. The Gold Miners ETF (NYSEARCA:GDX) represents the gold mining group accurately. Investors tilted toward research and accepting of heavier risk may consider picking individual stocks within the sector. Investors looking to mitigate the individual mining shares risks could look to Silver Wheaton (SLW), Royal Gold (NASDAQ:RGLD), and Franco-Nevada (NYSE:FNV).

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.