Macro Tsimmis

intelligently hedged investment

SELL SPDR Gold Shares ETF (GLD) & iShares Silver Trust ETF (SLV)

Posted by intelledgement on Tue, 09 Feb 10

“When the facts change, I change my mind. What do you do, Sir?”—John Maynard Keynes, in response to criticism that his position on monetary policy was inconsistent.

We have held these positions since the inception of the IMSIP, and GLD and SLV have been very, very good to us. As of the close yesterday, GLD is up 64% for us (+17% on a compounded annual growth rate basis) while SLV is up 20% (+6% CAGR)…all this during three years and five weeks when the stock market overall declined 25% (-9% CAGR).

Our thesis for taking these positions has been that they constitute a hedge against the inevitable decline and possible collapse of fiat currency in general and the dollar in particular. And again this has worked well for us; since 29 December 2007, the dollar is down 4% (-1% CAGR) and is only that high on the heels of a furious rally since December 2009. Thus, we do not see precious metals as a good long term investment, but essentially as short-to-medium term insurance against exogenous macro events that may result in economic decline and concomitant value destruction in stocks and bonds. When the risk of such macro events grows, capital preservation is a higher priority than growth because it’s hard to recover from losses: if your portfolio drops by 50%, you need a return-on-investment of 100% just to get even!

So are we liquidating these positions because we believe that the risk of Bad Things has been reduced here? Absolutely not! We stand by the concerns we expressed last month in our 4Q09 portfolio report analysis. In fact, if you physically possess gold or silver, don’t sell it. (And if you don’t, you should seriously consider acquiring some as a prudent measure to protect yourself and your family in the event things get really bad.)

So why are we abandoning these positions which have served us so well, particularly when we don’t believe the danger of a dollar meltdown has abated? Well, in the long run, it is hard to see how the USA avoids default other than by inflating the dollar—and the dollar-denominated debt and a lot of folks’ savings—into oblivion. But that is the climate, and just now we are concerned with the weather. There are two particular conditions that—in the short run—tend to lend strength to the dollar. The first is when the USA’s political leaders fall into one of their episodic fits of austerity. These don’t generally last long and ultimately amount to exceptions that prove the rule, but in the rare circumstance where the Federal government cuts spending and maintains interest rates at a reasonable level, the dollar has performed relatively well.

We believe that the recent ascendance of Paul Volcker—hero of the 1980s fight against inflation—in the Obama administration over the previously dominant Keynesians Timothy Geithner—architect of the bailout—and Larry Summers along with Barack Obama’s new quest for “bipartisanship” signals an increased possibility that we are in for a move in the direction of austerity heading into the mid-term elections. This flies in the face of conventional Democratic-Liberal cant, but it is consistent with the experience of the Clinton administration after their attempt at health care reform fell short in the 90s, so we consider it a bona fide risk.

The second condition that lends strength to the dollar is increased systemic risk. This seems ironic—if the dollar is ultimately doomed, who would consider it a safe haven?—but there is a dynamic at work that, in the short run, trumps longer-term concerns about the viability of the greenback. With the prevalence of leverage in our financial system, the volatility attendant to increased systemic risk—when a number of normally unlikely scenarios come into play in which the range of contingent valuations of assets can vary greatly (that is, perhaps your Greek government bonds are worth 100 cents on the dollar or perhaps they are worth 25 cents on the dollar…or anywhere inbetween)—can expand violently. This was the case during the Great Depression and it was the case again during the 2007-09 meltdown. When banks and other heavy hitter investors make highly leveraged bets, it doesn’t take all that much of a move by the market to create a dangerous situation for them. And with everyone so tightly linked (and often betting the same way), there is the potential for a cascade effect, where losses—or even potential losses that are suddenly more likely—by one entity create or exacerbate the risk for several others. And if you are a proprietary trading operation with margined investments—meaning you have put up less than face value and borrowed the rest of the cost of buying the security and that underlying security is serving as your collateral—and those equities are suddenly worth a lot less, then you get a margin call, and you need to come up with cash to make up for the loss of value of your collateral. You probably don’t want to sell the security that declined in value and thus irretrievably suffer the loss, so instead you sell something that you’re ahead in—blue chips or emerging market equities or gold—to raise cash.

Now imagine a whole lot of folks experiencing that situation simultaneously. What happens to the price of Wal-Mart (WMT) or Petrobras (PZE) or gold? During the 2008 meltdown, the price of gold fell sharply.

And, of course, weakness is relative. If Germany has to bail out Greece—and potentially, Portugal, Ireland, Italy, Spain, et al—would you rather be holding Euros or dollars?

We fully expect to be back in GLD and SLV when the weather conditions return to being more congruent with the long term climate. But for now, we are standing aside here.

Previous GLD- and SLV-related posts:

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