Financial Phoenix

I mentioned before the time to buy precious metals is during times of uncertainty. We have a few things going on: the Middle East, Iceland bankrupt, Ireland down the tubes… Portugal now! Will the euro survive? And that’s in addition to the lousy numbers the economy keeps producing. Yet somehow the markets keep climbing… oh wait that’s QE2 in action! Let’s see what happens in May/June when it comes to an end.

But what about recessions? Is that a good time to buy too? Economic numbers have not been stellar by any means during this “recovery.” Let’s look briefly at some of the big numbers that “influence” the market for February.

March wasn’t much better. There’s a lot of repeats here: retail sales, both new and existing home sales, TIC LT purchases… all BELOW expectations! Durable goods was ABYSMAL again and consumer confidence dropped. We’re not out of the woods yet.

Let’s look at how the Fed has been printing money (data from St. Louis Fed). Yes that is a blue line seemingly headed straight for the sky. We had only $800B in base money (M0) before the crisis. It took 94 years to get there. The Fed tripled that in just three! All that base money looking for somewhere to go (at some point multiplied by the fractional reserve system). But it hasn’t found a spot yet. As we can see from this chart from ShadowStats.com, M3 the broadest money supply… oh wait I forgot to mention the Fed stopped reporting that in 2006. But luckily they release most of the numbers that M3 was based off of so it’s possible to recreate it with near perfect accuracy. As I was saying… M3 decreased during this time. So M0 increased but M3 decreased… Hmmmm. Only other time M3 decreased was the Great Depression.

Gold During Economic Expansion/Contraction

Well let’s see how gold fared during good times and bad. This chart was constructed with data from Prechter’s free eBook from Elliotwave International.

The charts start at the late-60′s because gold was fixed to the dollar before then at $35/oz. (Yes I know it wasn’t until AUG ’71 that Nixon removed us off Bretton Woods I’m just repeating the data from the eBook.) As you can see gold is not really correlated to good or bad economic times. But lets go back to thinking in terms of cycles… let’s take a look at the DGR (Dow/Gold Ratio) and gold stocks from 2000 to the present. That wimpy blue line on the bottom is the S&P 500 returns for a comparison.

Introduction

Why would you want to get into precious metals? There is a time and place for getting into any investment class. There was the 2000 tech bubble. There was the 2007 real estate bubble. There was the 1987 computer-aided crash.

All these bubbles burst. I’ve read many articles that say government and other entities should actively try and prevent these from occuring. Just look at the destruction of wealth from the real estate and resulting financial crashes around the globe. Obviously preventing such occurances that hurt so many people should be a priority right? Well they are a “natural” phenomena in financial markets. Preventing it is like trying to hold back real natural events like the recent earthquake and tsunami in Japan. It can’t be done.

Timing: Getting In

Generally precious metals do well in times of uncertainty like today. Gold is considered the ultimate in safety. It was one of the earliest forms of money. People flock to it. It’s also good to get into when the dollar is excessively weakened. And then there’s one other factor that’s a good indicator of when to get in.

The best time to get in was when you would’ve been mocked by your peers and financial advisor around 2000. They would’ve rolled on the floor laughing at you. Only a complete fool would get into precious metals. But you would be up 700% today. Who’s laughing now. And there is still a lot of room to go up.

Why was 2000 a good time to get in and is there room for further movement up? Answering this question brings us back to bubbles. I’ll get into this in greater detail in another article but it basically comes down to cycles. Which is really just another word for a bubble. The end point being you can never have one type of asset outvalue all others. An acre of land cannot be so valuable as to buy up the entire stock market, or all the copper, or oil, etc. The idea at its very core makes no sense whatsoever.

Somehow people don’t realize this. But it happens all the time and it cannot continue forever. At some point the different asset classes must correct themselves. This process began in 2000 with gold and equities/real estate. Now we have entered the commodity bubble.

What keeps this bubble afloat? Quantitative easing by the Fed (i.e. severly weakening the dollar), their ZIRP (Zero Interest Rate Policy) are two factors. You can look at technical charts like this as well. This was done by binve, a blogger primarily writing about Elliot Wave analysis in the markets. His blog is Market Thoughts and Analysis. “Amazingly” technical analysis like this almost always corresponds well to factors in fundamental analysis.

Basically the census of the current bunch of us crazy people is that we’re on our way to a Dow:Gold ratio of 1:1 or 0.5:1 before this is over. There are plenty of fundamental and technical reasons this could play out. This means at some point one ounce of gold will be equal to or twice the value of the Dow Jones Industrial Average. If this does occur you can see there is still plenty of room for gold to go up.

How to Easily Participate in Precious Metals

If you’ve ever spent some time looking into this you’ll find premiums, storage fees, shipping fees, insurance fees…. and more fees!!! Also if you have a Roth IRA like me in an equity account but want to participate there are a bunch of hurdles to jump through… and more fees… to roll it over to a self-directed precious metals Roth IRA.

So you’re looking at a big hit in fees?!?! Well I didn’t like this one bit. I can’t tell you how cheap I am. So I kept looking at different options. There is always holding the metals by “proxy” by investing in mining stocks. The one disadvantage of this is that the stocks can follow the broader market and not the metal price. So you could have them go down while gold goes up. Also mining companies can hedge with futures so they will lag the price of gold. This is good when gold is falling but not so good when it’s rising.

That said though I do have some mining stocks. I spent some time researching how to evaluate them when I considered picking individual companies. There’s a good article about evaluating mining companies at kitco.com. In the end though I decided to go with ETFs. It was much easier on my brain. I personally went with five:

• GDX - Market Vectors Gold Miners
• GDXJ – Market Vectors Junior Gold Miners
• GLDX – Global X Gold Explorers
• SIL – Global X Silver Miners
• CEF – Central Fund Canada

If you’re looking just to invest in bullion in your equity IRA account without dealing with the hassles (and fees) of getting a precious metals IRA I like CEF over any other bullion ETF. One reason is that it is out of the U.S. Another is that if you hold it in a non-Roth account, specifically a regular trading account (non too sure about a traditional IRA. I’m no tax expert.) is that it is favorably treated tax-wise. It is considered a passive foreign investment company (15% LTCG) and will not fall under collectibles (28% LTCG) as the GLD and SLV ETFs do.

Another reason to consider CEF over GLD and SLV is that 90+% is backed by unleveraged bullion and it is routinely audited. If you’re wondering what leased bullion means… think of fractional reserve banking and apply it bullion. Forty or fifty people think they own the same piece of gold. If you’ve gone around the net and came across an article or two saying gold could reach $50,000 an ounce, this is why. Other reasons to avoid GLD/SLV are cited here.

If the idea of holding the physical metal appeals to you. My suggestion is BullionDirect.com. They have relatively low premiums for small orders. They run an exchange where you can find even tighter premiums (but they do charge a 1% clearing fee). They do not charge any storage fees. You can hold your metal there as long as you’d like and take possession of it whenever you want. So you can accumulate your holdings and pay shipping and insurance at your chosing and not every time you order.

If you are looking to learn more about assest cycles and precious metals (as well as other alternatives to equity markets) one site I have found very informative is the Elevation Group. It’s a subscription site (with two free introductory videos) that I personally have found very useful.