How to Keep Your Financial Head Above Water

The tides of investor sentiment across the global markets can shift on a dime and without a moment's notice. To avoid getting caught in a perilous rip current, let's decide which way to swim after this latest sea change.

The Dow Jones Industrial Average (INDEX: ^DJI  ) surged more than 400 points (3.5%) by midday Wednesday, after a spate of monumental moves by central bankers and finance ministers around the world signaled some coordinated resolve to address the risks associated with Europe's very dangerous financial crisis. The central banks dominated headlines with an orchestrated move to reduce the interest rate charged on currency swaps conducted under a pre-existing set of swap agreements.

The measure -- involving the central banks of Canada, England, Europe, Japan, Switzerland, and the United States -- seeks to "ease strains" in financial markets by establishing mechanisms to inject liquidity into troubled portions of the financial system as needed (and in whichever currency required). After watching helplessly as Europe lollygagged with makeshift reactive measures that seemed several steps behind emerging-market pressures, the appearance of a cooperative and proactive measure seemed to reassure embattled equity investors.

Think of this measure as an emergency triage center for the front lines of the central banks' war on systemic deleveraging and global debt contagion. It could prove effective as a temporary means of dressing wounds and stabilizing patients, but it will do precisely nothing to prevent the onslaught from continuing. That's because debt is the true aggressor in this battle, and despite half-hearted lip service that is paid to the notion of austerity, the overarching policy response to the global debt crisis continues to involve ever-increasing scales of debt-funded intervention. As a matter of fact, the growing commitment of sovereign debt to mop up an unrelenting flood of toxic paper came into full view this week in another major development out of Europe this week.

Europe calls the IMF for reinforcement
European finance ministers met this week to discuss their next move, with many observers gunning for an aggressive leveraging of the European bailout fund (the EFSF) to some USD$1.3 trillion. Instead, the latest indications suggest that the fund will be boosted to a capacity of between $670 billion and $940 billion. Compared with the rapidly escalating scale of the sovereign funding shortfall across multiple European nations, that figure will surely not suffice, and this week the ministers conceded as much. As the European nations fail to raise adequate debt to stem the contagion, they have set their sights on the International Monetary Fund (IMF) as the next bastion of defense. Dutch finance minister Jan Kees de Jager stated clearly: "It's very important that the IMF globally will increase its resources either by raising its capital or by bilateral loans so that it can lend more money to eurozone countries in need."

But IMF managing director Christine Lagarde has indicated that the IMF -- with about $390 billion available for lending -- is itself underfunded for such a large-scale regional role. The idea floating around in Brussels this week, then, is to use bilateral loans or Special Drawing Rights to "rapidly explore an increase of the resources of the IMF so it can more adequately match the firepower of the EFSF." I've seen several ideas floated as possible sources of capital to fund such an expansion of the IMF's coffers, but I would suggest that it remains a wide-open question as to the final list of counterparties to additional IMF debt.

Swimming in the right direction
The pace of new developments remains fast and furious amid this complex web of intertwined financial fates. As the stakes continue to rise in the world's collective response to a crisis that I view as a contiguous event with the earlier chapters that struck the United States a few years ago, I encourage investors to keep as well informed as their time will allow. China made some key moves of its own this week, easing reserve requirements for Chinese banks in a clear reversal of direction from its prior efforts to cool the pace of growth. Alongside recent indications that China will invest $1.7 trillion over the next several years in priorities like alternative energy, biotechnology, and advanced equipment manufacturing, I am increasingly convinced that China will emerge from this global debt crisis in a position of relative strength. More specifically, I am focusing much of my own investment interest on the bulk commodity demand that is implied by that outlook.

Although commodity equities could conceivably succumb to additional rounds of indiscriminate panic selling like that which gripped markets for portions of this year, the inevitable resumption of relative strength in the stocks of bulk commodity producers strikes me as one of the few financial scenarios I can look to with any substantial degree of confidence. While leaving my core positions untouched, I will look to build my own cash position into this latest rally in order to increase my commodity exposure into any forthcoming market malaise. For a steady flow of ideas as to which commodity stocks and sectors look attractive, please be sure to bookmark my article list. I maintain a particularly bullish long-term demand outlook for copper and metallurgical coal, so Teck Resources (NYSE: TCK  ) -- which mines them both in droves -- looks like a nice play to me. But as deep as the recent correction in copper equities dove, even a sector ETF like the First Trust ISE Global Copper Index Fund (NYSE: ETF  ) gained allure, and I intend to stick with my corresponding bullish CAPScall. For a more targeted exposure to coal, I consider Peabody Energy (NYSE: BTU  ) the undisputed king.

Fools may have noticed that gold and silver rebounded strongly Wednesday as markets digested all this new information, and certainly a portion of that strength relates to the sudden drop in the U.S. dollar that accompanied a general reversion to "risk-on" mode. But gold and silver are not "risk-on" assets, and to view them that way is to misunderstand them completely. To the contrary, they are the ultimate safe-haven assets while governments continue to address this debt crisis with ever-increasing mounds of debt. My precious-metal CAPScalls have served me well since I created my CAPS portfolio in 2006, and everything I have observed on the world's macroeconomic stage since that time has materially enhanced the long-term outlook for the prices of these metals. The recent pledge of currency liquidity from the major central banks -- or, more precisely, the very real systemic risks that precipitated the move -- lends further support to the outlook. The additional borrowing that will be required to expand the lending capacity of the IMF is, very clearly, bullish for gold and silver. For those seeking shelter from the unavoidable consequences of this massive worldwide blitz of debt issuance, gold and silver will have no peer. I consider cash an important defensive allocation as well, but I simply believe investors cannot afford to eschew gold and silver. Aurico Gold (NYSE: AUQ  ) and Primero Mining (NYSE: PPP  ) continue to top my list of favorite gold stocks. Goldcorp (NYSE: GG  ) looks best to me among the major producers, while its brainchild Silver Wheaton (NYSE: SLW  ) is bound to enjoy explosive profit growth going forward.

The floodwaters of toxic debt contagion have grown too high for investors to remain dry, but with a careful eye toward anticipating some key implications of the mess, I believe savvy Fools will continue to swim in the right direction when they swim toward some allocation to cash, precious metals, and select bulk commodities. It's bound to be a wild ride, and I look forward to discussing the journey with you once we're back in dry land. In the meantime, consider sounding off in the comments section below to indicate the direction in which you intend to swim.

Fool contributor Christopher Barker can be found blogging actively and acting Foolishly within the CAPS community under the username TMFSinchiruna. He tweets. He also owns shares of AuRico Gold, Goldcorp, Peabody Energy, Primero Mining, Silver Wheaton, and Teck Resources. We Fools don't 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 November 30, 2011, at 5:37 PM, DJDynamicNC wrote:

    Not sure how you square this circle. You say:

    "That's because debt is the true aggressor in this battle, and despite half-hearted lip service that is paid to the notion of austerity, the overarching policy response to the global debt crisis continues to involve ever-increasing scales of debt-funded intervention."

    But then you say:

    "Alongside recent indications that China will invest $1.7 trillion over the next several years in priorities like alternative energy, biotechnology, and advanced equipment manufacturing, I am increasingly convinced that China will emerge from this global debt crisis in a position of relative strength"

    In other words, governments need to spend less in order to solve the crisis, but the one that is spending massive amounts is the one with the strongest economy and the one likely to emerge in a position of strength.

    Given historical evidence (see: New Deal, World War II) I think your second statement is on the money, but that directly contradicts your first.

  • Report this Comment On November 30, 2011, at 8:39 PM, rfaramir wrote:

    "reduce the interest rate charged on currency swaps conducted under a pre-existing set of swap agreements" sounds like a kind of default to me. Changing the terms on existing contracts? Really?? They sound desperate.

    "cooperative and proactive measure" to steal our purchasing power

    "war on systemic deleveraging" is a War on Economic Health. No one denies that these institutions are over-leveraged, but no one wants the pain of deleveraging. Fighting the free market is wrong and dangerous. Violating property rights is how they are doing it, but few see it that way, yet.

    "China will invest $1.7 trillion" and will suffer from some of the same inflation we in the West are suffering. The austerity you referred to, which has not really been tried, is the right direction. You may be right about China emerging strong, but this won't be the reason.

    "The additional borrowing that will be required to expand the lending capacity of the IMF is, very clearly, bullish for gold and silver." And why, exactly, is this "clearly bullish" for PMs? Because of fractional reserve banking. What? Yes. Because they are not borrowing the savings that some hard worker has already saved. They are creating fiduciary media from thin air, stealing the purchasing power of savers through inflation of the money supply, instead of paying them for the use of their saved funds (which is what the interest paid on borrowed funds is).

    "gold and silver will have no peer" I completely agree!

  • Report this Comment On December 02, 2011, at 12:10 PM, Frankydontfailme wrote:

    DJD the difference is China isn't deficit spending, they are a creditor nation - and have earned the surplus to spend.

    That being said I think China is in for some tough times in the short run.

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