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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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This is, however, not all there is to gold as insurance. Namely, the idea described above only makes sense if the insurance part of your portfolio is put into physical gold, not into any kinds of gold futures, options, ETFs, ETNs, or CFDs. If the scenario you are insured against (a financial crisis far more severe than the one that started in 2008) occurs, gold derivatives will most likely be rendered worthless or trading rules will change in a way that will prevent you from fully enjoying your profits. Furthermore, your counterparties could default on their obligations, leaving you with nothing at all.

Even though such a course of events seems unlikely, it is still a possibility you need to consider. Particularly if you keep in mind that in the past serious appreciation of metals led to enormous increases in margin requirements for futures contracts. This was the case for palladium in 2000.



In 2000, palladium appreciated from the level of $443 to the level of $956, boasting a stunning rate of return of 115.8%. During that time, however, the New York Mercantile Exchange raised margin requirements for palladium futures contracts in a series of steps that brought the margins as high as to $168,750 for a $72,000 contract. That meant that just to maintain your position open and reap the profits, you had to make a deposit exceeding the size of your position by 133.1% (!). At one point, the Tokyo Commodities Exchange even ceased trading palladium futures and demanded all positions in futures be liquidated.

If this case is anything to go by, exponential growth in the price of gold or silver (possibly 100% in one year) during the third stage of the bull market could result in hikes in margin requirements or in trading restrictions on the part of commodity exchanges. This alone could render paper gold, futures, options, and other financial instruments not backed with physical gold worthless or at least suppress their value. And if you realize that your counterparty could simply go bankrupt or default on their obligations, it becomes clear that from the insurance point of view physical gold and silver (or physically backed funds) are the only way to go.

To add an additional layer of insurance to your holdings, you should also diversify your physical holdings geographically. This is an appropriate way to preserve your investments if capital controls are introduced or governments begin to confiscate precious metals.

Thank you for reading. Have a great and profitable week!

For the full version of this essay and more, visit Sunshine Profits' website.

Twitter: @SunshineProfits
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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