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How to Invest Amid a Summer of All Fears

Contagion in euro zone, falling precious metals may pose opportunities for investors

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Stay Away From European Financials

European banks are likely to be most affected here, as they lend into the problematic economies and have holdings of euro-denominated government bonds, whose values are declining at present, but no charges have been taken to mark down book values. The stock market has taken the charge for them as Banco Santander (NYSE: STD), BBVA (NYSE: BBVA) and Deutsche Bank (NYSE: DB) are all notably weak. Insurance companies like Aegon (NYSE: AEG) and Prudential (NYSE: PUK) may also be affected.

I recommend avoiding these companies on the long side, as they make much better short candidates right now — especially the banks.

STD Chart

I won’t try to pinpoint an exact downside target for these stocks, as I believe that it was CLSA’s Russell Napier who said that markets are like clocks with soft hands. You can see the movement, but it is often not precise. Instead, one has to watch for clues and often reevaluate the possible scenarios. The European financials mentioned here could easily have 30% to 50% downside this summer if the more negative scenarios from PIIGS debt contagion play out.

Buy Gold on Dips, But Not Silver (Yet)

If the dollar rallies further due to weakness in Europe, gold and silver will decline more. Gold will decline less than silver, as it is a safe haven. Consider that in 2008, gold ended up on the year, while all the other precious metals were down noticeably given their more industrial nature. Gold also has central bank support as it is being used as a tool to diversify swollen forex reserves — the central banks will buy the dips.

The SPDR Gold Trust (NYSE: GLD) probably has limited downside to about $130 or so, which is a great opportunity for investors that missed the latest run-up. While gold bullion will remain well bid, gold miners are likely to see further correction — the smaller the company, the bigger the sell-off. This is how it has always worked out in precious metals shakeouts.

SLV Chart

The leverage in the silver market is unwinding, and I am afraid that we will see silver in the mid-$20s this summer. In my view, a $25 target for the iShares Silver Trust (NYSE: SLV) is likely.

As we’ve seen since the beginning of the year, silver miners have been notably underperforming silver bullion. In fact, it got so bad that in April they were declining as silver was rallying. And we are likely to see more downside from present levels given a $25 silver scenario. You can trade this downside by going short the Market Vectors Silver Miners ETF (NYSE: SIL).

However, keep in mind that this is just a correction in the precious metals bull market that has several more years to run — at least until the massive forex and trade imbalances gathered in the global economy are resolved, orderly or not. But considering that precious metals corrections can be notoriously sharp, you cannot ignore them.

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