How to Play the Precious Metals Squeeze

by David Fabian | June 30, 2013 8:00 am

Ouch! That is really the only way to describe the last 9 months for investors in precious metals and mining stocks. The damage that has been done to the price of these investments is on a level that we haven’t seen in nearly two decades. Both institutional and retail investors have been shunning these hard assets due to fears of global deflation. Taking a look at some of the biggest exchange traded funds in this sector shows just how bad the carnage has been since their 2012 high.

• SPDR Gold Shares (GLD[1]) -31%
• iShares Silver Trust (SLV[2]) -47%
• MarketVectors Gold Miners (GDX[3]) -59%
• MarketVectors Junior Gold Miners (GDXJ[4]) -67%

Investors typically flock to gold for one of two reasons: 1) as a safe haven hard asset or 2) as a hedge against future inflation. The biggest threat to gold and silver right now is the potential for a global deflationary environment in which consumer spending and global demand continues to taper off.

Emerging market nations such as China and India have previously been large buyers of precious metals, however the slowdown in their economies have put the brakes on further outsized spending. In addition, the strengthening of the U.S. dollar acts as a headwind for the price of these precious metals. Despite these devastating losses and continued downward momentum, many investors still hold high allocations in these ETFs.

So how do you play this sector that is continuing to get squeezed?

If you have been following my commentary[5] over the last several weeks then you have likely used a risk management approach to selling all or a portion of your holdings. GLD showed a clear line of support on the chart that was violated and ultimately led to further downside momentum.

However, I believe that the valuations in gold are starting to look more attractive, which is why I am watching this sector closely for a new buying opportunity.

If you have been diligent about sticking with your trading discipline[6], then you are likely in an excellent spot to look at re-entering this sector with a portion of your portfolio. One of my favorite tells for establishing a new position in an asset class that has been beaten to a pulp is media headlines.

Remember that headlines are most exuberant at market tops and most desolate at market bottoms. Right now the news is pretty bleak, which may be signaling that we are close to a bottom in precious metals.

If you do start to leg back into either gold or silver with your portfolio, I would consider doing so with small allocations that you average into over time. No one is going to be able to perfectly call the bottom in this sector, but by using these dips to your advantage you will have a greater chance for successfully navigating these choppy waters.

I am still recommending that you avoid mining stocks at this juncture because of their higher volatility and uncertain fundamental outlook.

No matter how you play the precious metals sector, I would recommend that you use a stop loss or similar risk management game plan for your portfolio. Even the staunchest gold bugs should not let conviction override their investment discipline[7] in this volatile environment.

David Fabian is the Chief Operations Officer and Managing Partner of Fabian Capital Management. To get more investor insights from Fabian Capital, visit their blog here[8], or click here to download[9] their latest special report The Strategic Approach to Income Investing.

 

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