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Gold as Portfolio Insurance

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In holding on to gold and silver even during corrections, you accept small losses in hope of enormous gains should serious economic turmoil materialize.

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My firm has always emphasized the need to diversify while putting together your portfolio. Of various kinds of diversification, one is particularly important at the very beginning when you decide to commit yourself to the precious metals market. This is the ability to divide your capital into three separate parts, each managed in a different way, and to stick with this structure even when the market is getting hot.

We are of the opinion that such a division:
  • Limits your risk,
  • Provides significant upside potential and exposure to the great bull market in silver and gold, and
  • Takes into account key major factors that could come into play in the following years like a collapse of financial system, and lack thereof.
So what is exactly our suggested portfolio structure? Please, take a look at the table below.



A short description of this structure:

  • Insurance - This is your protection against the large financial crisis that is very likely to be seen in the next decade. You may have read somewhere that even those who hate gold and silver should still own some "just in case." This insurance part of your portfolio is kept in precious metals. It's essential that it be held in physical bullion and geographically diversified if possible at all times even if you think that gold and silver are likely to decline.
  • Investment - This is the part of your portfolio that like the insurance part is kept invested for the long term. Unlike the insurance part of the portfolio, you can temporarily limit the exposure by hedging or selling your holdings before highly probable and significant declines (like the 2008 decline).
  • Trading capital - This is the part of your portfolio that you use for trading, i.e., for betting on short-term rallies and/or declines in gold, silver and/or mining stocks.
While the general idea of dividing your portfolio between long-term and speculative capital (the latter is only the money you can afford to lose) is not a particularly new one, the inclusion of the insurance part in the portfolio may make it more robust to financial blow-ups. We will now focus on that: Gold and silver as insurance against severe financial turmoil.

Gold may be perceived as insurance if you believe that; because of psychological reasons, it appeals to investors as a wealth-preservation vehicle. In case of financial turmoil, they turn to precious metals, the increased demand causes an increase in the price, and gold and silver deliver on their promise to provide an alternative to government bonds.

There is also another dimension to it. In the past, gold and silver were used as money. As a matter of fact, gold had been indirectly used as money up to 1971 when US President Richard Nixon officially announced that the US government would cease to adhere to its promise to redeem the greenback in gold. Since that moment, money has been only paper and a promise of the government to accept payments in it.

Some investors fear that excessive deficits as seen in the US will result in money being printed on a large scale (which actually is already the case: open-ended QE) or even in the implosion of the dollar. The bigger the deficits, the more likely such a scenario seems. This is shown on the chart below.



It seems that since 2000, increases in the US debt have been accompanied by increases in the price of gold. This might reflect investors' fear that the US government will eventually default and their belief that gold may be a safe haven in case of such a development.

The aforementioned points may lead to the conclusion that gold may skyrocket if things get out of hand in the US or in the European Union. The main problem here is that nobody knows when (if at all) the paper currencies will begin to visibly deteriorate or disappear completely. Precisely because of that, we suggest holding on to gold and silver at all times with a part of your portfolio.

We call this part of your portfolio "insurance" because by holding on to gold and silver even during corrections, you accept small losses in hope of enormous gains should serious economic turmoil materialize. Economic crises have the inherent quality of catching most investors off-guard. We don't want you to be among them.
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No positions in stocks mentioned.
The information on this website solely reflects the analysis of or opinion about the performance of securities and financial markets by the writers whose articles appear on the site. The views expressed by the writers are not necessarily the views of Minyanville Media, Inc. or members of its management. Nothing contained on the website is intended to constitute a recommendation or advice addressed to an individual investor or category of investors to purchase, sell or hold any security, or to take any action with respect to the prospective movement of the securities markets or to solicit the purchase or sale of any security. Any investment decisions must be made by the reader either individually or in consultation with his or her investment professional. Minyanville writers and staff may trade or hold positions in securities that are discussed in articles appearing on the website. Writers of articles are required to disclose whether they have a position in any stock or fund discussed in an article, but are not permitted to disclose the size or direction of the position. Nothing on this website is intended to solicit business of any kind for a writer's business or fund. Minyanville management and staff as well as contributing writers will not respond to emails or other communications requesting investment advice.

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