Last week was an excellent week for gold, silver, and related mining companies. These assets rose between 1-2 percent whereas the broader stock market was down by about 1 percent. The outperformance in the gold market was sparked by concerns over the banking system in Europe. In particular a Portuguese bank—Banco Espirito—was on the brink of failure earlier this week, although its management came out and claimed that the company was in okay shape and panic exited the markets for the time being.
However, investors shouldn’t be assuaged by the fact that Banco Espirito’s management is confident. Recall that in 2008 the CEOs of Lehman Brothers, Bear Sterns, Fannie Mae, Freddie Mac, and others, all came out and said that their institutions were in good condition right before they failed. Thus, I suspect that the bank is in trouble, and there is a heightened probability that we will see a bailout or a “bail-in: (i.e. when the bank’s liabilities are met by effectively “stealing” from the bank’s depositors). In fact the fear of a bail-in could lead the bank’s customers to withdraw their funds, and this could cause further problems.
With this in mind, I think the drivers of the gold and stock markets this past week could be in full swing in the coming weeks, and we can expect further weakness in stocks and strength in gold.
However, before gold bulls get too excited and jump on the bank wagon keep in mind that the gold market is sitting at fairly strong intermediate term resistance that goes back a year. If the gold market breaks above $1,340 – $1,350/ounce then from a technical standpoint I would be much more comfortable in the short term uptrend. But there is a downtrend that is still intact, and while I am very bullish of gold in the long run, I wouldn’t be surprised to see a pullback.
So with bullish and bearish forces at play what should you do?
If you are a long-term gold bull as I am, the best strategy is to dollar cost average. Allocate a pre-determined percentage of your income to the gold market and simply buy. You will take the emotion out of the decision, and you will buy more gold at lower prices and less gold at higher prices.
However, if you want to try to be more tactical, and assuming you already have a position I think the best strategy right now is to wait and hope for lower prices. The recent upswing in the market has generated a lot of bullishness, and bulls forget that while they could be right in the long run they could also be wrong in the short-term.
But if you don’t hold a gold position, I think you need to take one. Despite the recent strength in the stock market and positive economic forecasts, there are a lot of risks out there given the massive debt loads held by corporations, governments, and individuals in the western world. If we begin to see concerns in the debt markets, as the aforementioned Banco Espirito concern exemplifies, then gold will be one of the few assets that performs well. Everything else, including defensive stocks and most bonds, will act poorly.
Given these points, it is clear that allocating some of your portfolio to the gold market is crucial to portfolio diversification, especially given the heightened risk in the banking system. If you don’t own gold, therefore, you need to buy some. If you own gold already you have the flexibility to try to time the market, and while I am bullish I think that those who own gold can gamble a bit and hope for lower prices before buying. But the risk/reward clearly favors the upside.
Disclosure: Ben Kramer-Miller owns gold coins and shares in select gold miners.