The Ultimate Safe Haven Assets

A nimble investor can buy almost anything on Wall Street today. With a click of your mouse, or a tap on your iPhone's touchscreen, the world is your risk-imbued oyster. Through the advent and ceaseless proliferation of ETFs, a Fool can bet long or short on virtually any region, sector, index, or strategy imaginable.

But here amid the aftershocks of our gruesome global financial crisis -- the root causes of which have hardly been curtailed -- I ask: Is a true safe haven even available for defensive-minded investors who seek to truly safeguard a portion of their hard-earned investment capital? Let's have a look.

The usual suspects
Holding a cash position within one's investment portfolio can certainly provide a valuable measure of protection against the sort of indiscriminate selling across all asset classes that pervaded global markets following the demise of Lehman Brothers in September 2008. Over time, however, these negative real interest rates that we're presently experiencing make cash a patently unattractive safe haven.

Traditionally, investors have confidently turned to U.S. Treasury bonds when discomfort arose regarding equities or other asset classes. As the Federal Reserve's second round of quantitative easing draws to a close, however, the world's largest bond fund has eschewed all exposure to U.S. government debt. In fact, PIMCO recently went a step further and built a short position in Treasuries to accompany its $73 billion cash hoard (31% of assets).

The gold and silver conundrum
While I do maintain a variable cash position to mitigate downside risk, I have personally selected gold and silver as my safe havens of choice. However, all one has to do is review the horrific sell-off in these metals in 2008 and 2009 to see that even these stalwarts of recent outperformance proved susceptible to the vagaries of indiscriminate selling. Given the sharply reduced attractiveness of U.S. Treasuries since that time, however, I consider a repeat performance of that degree of weakness extremely unlikely. Rather, the next time push comes to shove and investors run for the exits -- and unfortunately I do think it's just a matter of time -- I expect that gold and silver's true potential as ultimate safe haven assets in a world of tattered paper will gain overdue recognition among individual and institutional investors.

But risks certainly reside in gold and silver as well, and they must be fully understood. For starters, following a phenomenal run like that achieved (particularly by silver) over recent months, the specter of a sharp and abrupt near-term correction must be seen as rising in parallel. Provided one's confidence in the long-term trend remains clear, that may not present a true risk; but especially for newcomers, the risk is palpable. With respect to physical bullion, there are storage costs, storage risks, and peculiar tax implications that likewise must be taken under advisement. Popular bullion proxies like the SPDR Gold Trust (NYSE: GLD  ) may present another sort of risk entirely.

With those considerations in mind, my own approach to gold and silver as a safe haven play has evolved into an unconventional dance between growth-focused equity exposure to miners and explorers on the one hand, and a highly variable cash allocation designed to mitigate downside risk. Simply stated, after surveying the universe of purported safe havens, and finding few (if any) truly viable options, this equity-focused approach strikes me as a fairly reasonable compromise.

There is an unmistakable irony here, however. Although I consider my long-standing price target for $2,000 gold an entirely safe bet, the corresponding mining equity sector is fraught with a daunting array of risks all its own. As it happens, one particularly dangerous risk vector facing mining equities has stepped into the spotlight once again this week.

The geopolitics of gold and silver
Along with his stated intention to renationalize certain mining operations that had been privatized under prior administrations, Bolivian President Evo Morales issued a powerful reminder to investors that they must dutifully mitigate jurisdictional risk. The sudden announcement sent likely target Pan American Silver (Nasdaq: PAAS  ) scrambling to seek clarification from the Bolivian authorities with respect to its San Vicente silver mine. Such clarification is still pending.

While the move may have come as a surprise, it certainly did not come from left field. In other words, anyone with investment exposure to mining operations in Bolivia possessed a duty to themselves to recognize the nationalist tendencies of the Morales administration; particularly after Morales seized the Vinto tin smelter from Glencore International back in 2007. As it happens, Glencore is once again in Morales' crosshairs, as the remaining three mines targeted for "recovery" belong to Glencore subsidiaries. The timing is especially unfortunate for Glencore, since the company is preparing for an $11 billion IPO of its shares in London and Hong Kong.

This is, in fact, a topic of concern in multiple corners of the South American continent. Former miner Crystallex International has been essentially destroyed by the nationalization of its Las Cristinas gold mine in 2008 by Venezuela's Hugo Chavez administration. Kinross Gold (NYSE: KGC  ) is moving forward with a $1.1 billion investment to construct its Fruta del Norte mine in Ecuador, but as someone who lived in Ecuador and remains familiar with the political environment there -- and despite the recent reformulation of the nation's mining law -- I perceive an elevated risk that President Correa could choose a similar path with respect to some form of nationalization of key mining assets.

Because of the number of major operators and the scale of identified resources involved, the stakes are even higher in Peru. Peru recently pulled the plug on Southern Copper's (NYSE: SCCO  ) Tia Maria project, after a round of intense public protests that resulted in several fatalities.

Meanwhile, presidential candidate Ollanta Humala emerged victorious in an initial vote last weekend, with a runoff election scheduled for June 5. Although both remaining candidates have proposed imposing a tax on miners operating in Peru, Humala is widely perceived as a wild card who could potentially pursue a more disruptive approach. Peru is a very significant global supplier of copper, gold, and base metals, and major players from BHP Billiton (NYSE: BHP  ) to Freeport-McMoRan Copper & Gold (NYSE: FCX  ) are no doubt tracking these developments with some concern. I recommend that Fools holding investment exposure to mining operations in Peru maintain similar vigilance. Having just recently acquired a promising copper property in Peru, miner HudBay Minerals (NYSE: HBM  ) also has a lot at stake.

In the final analysis, it may ring true that this particular period of the world's financial history offered investors little in the way of truly reliable and effective safe havens. Among the array of imperfect options, I consider gold and silver mining equities -- particularly when coupled with a steadily expanding cash position -- as a reasonably attractive alternative. By remaining diligent in the area of risk assessment as it relates to such assets, I believe investors can harness the long-term continuity of gold and silver price appreciation to effectively preserve capital and grow capital with a single precious strategy.

Fool contributor Christopher Barker can be found blogging actively and acting Foolishly within the CAPS community under the username TMFSinchiruna. He tweets. He owns shares of Pan American Silver. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


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  • Report this Comment On April 16, 2011, at 3:29 AM, silvermind wrote:

    Sinch,

    Important post! Nothing like a safe haven!

    Interesting how the 2008 crash took the Dow down by 50% but SLW went down from an average 2007 price of about $11.50 down to $5.00 and even to $2.50 (a dip at least as bad as the Dow) for a couple of weeks. Do you think something like that will happen again if the Dow goes down by 20 to 50%? According to Jim Richarts and Eric Sprott very few people are educated regarding the PMs ("there is no bubble" etc etc). In other words the public is about the same as in 2008 - even the investing public.

    Every time the Dow has gone down for the last 2 years the PM stocks go down an equal amount or by a greater percentage (as if the gold and silver reserves they have discovered were no longer there - it doesn't make sense - but that's what happened and I think will happen again if the Fed announces an end to QE). But - just like last time - I think the value of the PM mining stocks is unchanging (dollar is decreasing) and the market will recover for the sector.

    If the FOMC, in their April 28th meeting - which we should here about around May 15th (the Ides of May) - decide to announce an end to QE then many astute PM experts believe we will see the market move down AND the PM stocks move down too.

    I think your premise is valid. Cash still has some uses, even with the current level of 9%+- inflation (30% for fuel).

    By "steadily expanding cash position", do you mean that as an investor has the means to not need to profit from putting funds into PM stocks he should then put them into dollars and not into physical precious metals? How much cash position would you recommend as a maximum (e.g. 50% of total assets in cash)? Would you hold your cash only in US dollars or diversify into Canadian dollars etc?

  • Report this Comment On April 17, 2011, at 10:45 AM, XMFSinchiruna wrote:

    silvermind,

    Since 2008, I have observed an important sea-change in the recognition of risk baked into U.S. Treasury debt, and PIMCO's dramatic exit underscores the enormity of that sea-change. Although Sprott and others are absolutely correct that we are nowhere even remotely close to bubble territory for gold and silver, we have also witnessed a steadily accumulating recognition around the world of gold's reasserted monetary function and the viability of $2,000+ price targets. Given those changes since 2008, I expect any subsequent widespread sell-off event to yield a far less intense and short-lived contraction in precious metals and related equities than we witnessed in 2008. A palpable dip could well result -- which is another great reason to maintain a meaningful cash balance within the context of a precious metals exposure strategy -- but as before I believe any such dip would soon be understood as an historic buying opportunity for these safe haven assets.

    By steadily expanding cash position, I simply aim to remind Fools that the further these metals climb and related equities multiply, the greater the opportunity for investors positioned in the sector to capitalize on the strength by gradually increasing their cash position into that strength. Particularly in the case of silver, we have traveled quite some distance since the last major correction, and rather than guess at the timing of the next retracement, I advocate for a more disciplined approach of routinely selling strength to build or maintain a comfortable cash cushion that can turn a major retracement into a welcome development rather than a source of distress.

    I prefer not to advocate a given percentage, since I consider matters of allocation extremely personal in nature; but I will say that I personally intend to raise my own cash position to 20% from 10% over the near-term. I will retain the remaining 80% of my pm exposure because of the sheer number of indentifiable scenarios that could lead to abrupt upward repricing of the metals. In my opinion, the overriding imperative within a bull market of this nature is to retain exposure, and I am more than satisfied with the profit-tweaking potential of a 20% cash position in the context of a sell-off event. Had I held such a cash position in March of 2008, I would have been doubling down on SLW below $3 per share, and I don't need to tell you what a powerful impact that could have had on my portfolio.

    I made the mistake of eschewing a cash buffer once, and that is one mistake I do not intend to make again. By the same token, the greater tragedy in my view would be to miss the largest upward price gains of the entire bull market in an effort to telegraph a pullback.

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