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Hedging the Twilight Zone

 -- Published: Tuesday, 26 May 2015 | Print  | Disqus 

By Michael J. Kosares

Candid mid-year assessments from some of Wall Street's big hitters

"[T]he time had come, as in all periods of speculation, when men sought not to be persuaded by the reality of things but to find excuses for escaping into the new world of fantasy." – John Kenneth Galbraith, The Great Crash of 1929 via Hussman's Weekly Market Comment

twilightzone"No one saw it coming." That was the popular refrain following the 2007-2008 financial crisis – explanation and excuse all rolled into one short, neat sentence. This time around, though, it's different. A chorus of naysayers, led by some of Wall Street's most respected figures, has come front and center to warn investors of a troubled economy and tenuous financial markets. One analyst aptly described the situation facing investors as being "trapped in a Twilight Zone" between the end of Fed's money printing policies and its first rate hike. Remaining fully committed to the Twilight Zone, though, is a matter of choice not necessity. It can be, and should be, hedged. Consider not just what is being said in the digest below, but who is saying it. These are some of Wall Street's big hitters, not the bottom of the batting order.

• Jon Hussman of Hussman Funds summarizes the state of the markets as follows:

"If you turn off CNBC and think about the market independently for even a few minutes. It is clear that this market displays none of the conditions which have historically been followed by sustained market advances, and all of the conditions which have historically been followed by market crashes. The aphorism 'Buy low, sell high' has long been discarded. The replacement 'Buy high, sell higher' has also been abandoned. The rallying cries of investors are now just 'Buy' and 'Get me in!'. . . . . In short, given currently extreme valuations, the most historically reliable valuation methods instruct us to expect total returns of roughly zero for the S&P 500 over the coming decade. If one believes that depressed interest rates 'justify' obscene valuations and associated expected returns of roughly zero for the S&P 500 over the next 10 years, then one is quite free to call stocks 'fairly valued' – it's just that those 'fairly valued' stocks are still likely to go nowhere over the coming decade, with some spectacular interim losses along the way."

• Ray Dalio of Bridgewater Associates, one of Wall Street's most successful and respected fund managers, at a Council on Foreign Relations conference when asked if he owns gold:

"Oh yeah. I do. [Nervous audience laughter] I think anybody, look let's be clear, that I think anybody who doesn't have…There's no sensible reason not to have some. If you're going to own a currency, it's not sensible not to own gold. Now it depends on the amount of gold. But if you don't own, I don't know 10%, if you don't have that and that depends on the world, then there's no sensible reason other than you don't know history and you don't know the economics of it. But, I. Well, I mean cash. So cash…view it in terms as an alternative form of cash and also view it as a hedge against what other parts of your portfolio are. Because as traditional financial assets, and so and in that context as a diversifier, as a source of that, there should be a piece of that in gold is all I'm saying." (Video link)

• HSBC's Stephen King writes in Financial Times sees Titanic problems,not enough lifeboats:

"We may not know what will cause the next downswing but, at this stage, we can categorically state that, in the event we hit an iceberg, there aren't enough lifeboats to go round. . . .Whereas previous recoveries have enabled monetary and fiscal policy makers to replenish their ammunition, this recovery – both in the US and elsewhere – has been distinguished by a persistent munitions shortage. This is a major problem. In all recessions since the 1970s, the US Fed funds rate has fallen by a minimum of 5 percentage points. That kind of traditional stimulus is now completely ruled out."

Greenlight Capital's David Einhorn talks of monetary distortions adding risk:

"We have passed the point where Jelly Donut policy [EdNote: QE and zero percent interest rates] is merely slowing the recovery. Distortions are now adding risk to the banking and insurance markets and leading to poor incentives for the largest players in the financial system. Monetary policy and regulations have combined like a failed chemistry experiment to create a potentially destructive force that should not exist outside of fiction. I think this adds to the ultimate attraction of holding gold instead of green."

• Janus Capital Group's Bill Gross provides a money manager's insight as to when and how the financial markets simply run out of gas.

"When does our credit based financial system sputter / break down? When investable assets pose too much risk for too little return. Not immediately, but at the margin, credit and stocks begin to be exchanged for figurative and sometimes literal money in a mattress. We are approaching that point now as bond yields, credit spreads and stock prices have brought financial wealth forward to the point of exhaustion. A rational investor must indeed have a sense of an ending, not another Lehman crash, but a crush of perpetual bull market enthusiasm. . . Stanley Druckenmiller, George Soros, Ray Dalio, Jeremy Grantham, among others warn investors that our 35 year investment supercycle may be exhausted."

• Michael Hartnett of Bank of America Merrill Lynch brings Rod Serling into the mix:

"[investors are] trapped in a Twilight Zone between the end of QE and the Fed's first rate hike. Markets it says will "be cursed by mediocre returns, volatile trading rotation, correlation breakdowns and flash crashes. For this reason we continue to advocate higher than normal levels of cash, adding gold and owning volatility in mid 2015. . . [A]cleansing drop in asset prices cannot be dismissed."

• Saxo Bank's Stephen Jacobsen talks of fundamental changes in asset allocation in coming years:

[Saxo Bank] "rarely makes significant changes to its long-term outlook, but this quarter is different. Not only do we expect a steep increase in yields but higher gold and energy prices too. The dynamics at work are plenty: The model's predictions are always based on the lead-lag of different economic factors. . . .The biggest "news" is that we are very close to the secular low in interest rates globally. This will have material impact on stocks, fixed income and asset allocation over the coming one to five years, and probably an 'upside-down' return profile relative to performance since the financial crisis started. Commodities will outperform and yields will move up by another 100 bps before Europe once again slides to downturn and the US flirts with recession in early 2016.

• UK Nobel Prize winner Andrew Smithers offers a brief but keen insight:

"QE is a very dangerous policy, in my view, because it has pushed asset prices up and high asset prices, we know from history, are very dangerous. It is very strongly indicated by reliable measures that we're looking at a stock market which is something like 80 percent over-priced."

• Universa Investments' Mark Spitznagel pulls no punches in a recent Bloomberg interview:

"The beautiful thing about the business is when the markets get really rich, really overvalued, really distorted like today, the cost of insurance goes way down. There's incredible complacency. People are selling (tail insurance). This is another one of those carry trades that are so popular today. We're back to this Great Moderation. There's a religious belief that the Fed is our savior. And it's priced into the market. We're at an extreme point today. We're as extreme as we've been n the last hundred years except for 2000. . . You can read into that what you want. (The year) 2000 was one of the great bubbles in human history. So here we are today just shy of that. . . Giant liquidity holes are a part of market dynamics. If you think you're going to lean on these buy orders (in order to get out) is the height of naivete." (Excerpts as posted at Zero Hedge)

• Legendary money manager Jeremy Grantham predicts a bust like no other:

"Over the next seven years we think the market will have negative returns. The next bust will be unlike any other because the Fed and other central banks around the world have taken on all this leverage that was out there and put it on their balance sheets. We have never had this before. . .Assets are overpriced generally. They will become cheap again. That's how we will pay for this. It's going to be very painful for investors. . .There is no evidence at all that quantitative easing has boosted capital spending. We have always come roaring back from recessions, even after the mismanaged Great Depression. This time we are not. It's anecdotal evidence, but we have never had such a limited recovery."

• "Federal Reserve Chair Janet Yellen, surveying the financial landscape for signs of bubbles after more than six years of near-zero rates, warned that both stocks and bonds are richly valued. 'I would highlight that equity-market valuations at this point generally are quite high,' Yellen said in Washington on Wednesday in response to a question at a forum on finance. ' Now, they're not so high when you compare the returns on equities to the returns on safe assets like bonds, which are also very low, but there are potential dangers there. Yellen said bond yields 'could see a sharp jump' when the Fed raises its benchmark interest rate. Most Fed officials predict that will happen this year for the first time since 2006." (Bloomberg article)

Editor's Note: In the two year period between July of 2007 and July of 2009 – what many consider to be the peak years of the financial crisis – stocks fell by 40% and gold rose by 50%.

Exit stocks and buy gold?
Bottom line, make sure your portfolio is not underweight gold for the times

By Jonathan Kosares

"I would highlight that equity market valuations at this point generally are quite high," Yellen said. "There are potential dangers there." – Janet Yellen

I know two things that aren't 'overvalued'….One starts with a 'g' and ends with an 'old' and the other starts with an 's' and ends with an 'ilver'. In that same question and answer session with the IMF's Christine Lagarde, Fed chair Janet Yellen makes an interesting side comment about open-ended mutual funds – in which 46% of households and better than 90 million Americans hold assets (very often in their retirement plans). Here's a great article on the statistical distribution of ownership of mutual funds.

It should be noted that the most common investor in mutual funds is your average, every day worker, saving for retirement and hoping for a better future. If what Yellen says is right, as is often the case, when stocks start to slide, it won't be the big guys that get hurt. It will be everyone else. Those holding overweighted percentages in stocks would be wise to ask themselves whether or not they'd prefer to be 'early' or 'late' when this inevitable cycle plays out…because if what Yellen is saying is correct, if you're late, it might be a question of whether or not you can get out at all in that moment, or are forced to make a choice to liquidate well below the market, or days to weeks later.


When looking at the DOW/Gold ratio (the relative value between the two), buying gold today is very similar to buying gold in late 2007…and you'd hard pressed to find investors who don't wish they had purchased gold in 2007. It doesn't take an economics degree to see the almost overwhelming similarities between today's market and that of 2007, despite the almost comical short-term memory of the investment community. 2008 was only seven years ago! Yet here we are again, where the majority seem to believe that both real estate and equities will continue to rise forever. (Shaking my head).

Even though we are precious metals brokers here at USAGOLD, we don't recommend a 100% portfolio allocation to gold and silver. We believe in prudent diversification, and a modest 10-30% of assets in precious metals – depending, of course, on your own personal financial picture, as well as your particular level of concern about the state of the US and world economy, the future of fiat currencies, and the potential long-term ramifications of our out of control debt, among other things. But no matter where you stand, today may be a good day to look at the value of your equity positions, look at the value of your real estate, and make sure that gold is still holding an appropriate percentage in your overall position. It may prove time well spent, and may prove to be the very move that keeps you resting easy when the 'dangers' Yellen speaks of move from the realm of 'potential' to full blown reality.


2001 – A Gold Odyssey
What it took to become a successful gold investor at the turn
of the new century is pretty much what it takes now

"There's a religious belief that the Fed is our savior. And it's priced into the market. We're at an extreme point today. We're as extreme as we've been n the last hundred years except for 2000. . . You can read into that what you want. (The year) 2000 was one of the great bubbles in human history. So here we are today just shy of that." – Mark Spitznagel, Universa Investments

"Adjusted for the 1980 inflation measure the gold price is approaching its bear market low of 2001. In fact, gold is now below the 1975 price when it became legal to own it again! . . . . . . . .Don't worry about the current rangebound price. Buying now represents tremendous value and tremendous protection against the next economic crisis." – Jeff Clark/Casey Research

A healthy skepticism.

Those were the four characteristics almost all gold investors had in common in 2001. I can tell you that from personal experience as we helped a good many become gold owners in those times and listened carefully to what they had to say. Gold was stuck under $300 per ounce. Anti-gold rhetoric was all the rage in the mainstream financial media. The general public was high on stocks and apathetic about gold ownership. Stocks would rise forever, they thought, and gold would never rise again. The prevailing psychology in those years, though, was fertile ground for the contrarians and true-believers who took advantage of it by accumulating gold at what turned out to be bargain basement prices – many in large quantities.

They understood that the economy and financial markets were not all they were cracked up to be. (A healthy skepticism) They understood the inviolable law that markets cycle. (Insight) They understood gold's role in the long-term portfolio. (Belief) They acted on that belief despite much opposition and criticism. (Courage)

Years later, when the financial markets reversed and finally went into the tank, none in this group were heard to mumble excuses, like "We didn't see it coming" or complained that "they were not warned." They saw it coming. They acted. When it was all over, few acknowledged this group's vision. In turn, it stayed quiet, kept its own counsel. A good many invested enough to preserve their wealth while some some invested enough to, in fact, become very wealthy – even though their intentions for the most part were merely to preserve what they already had.

It seems we have come back to the place where we began. There are really only two kinds of people in the world when it comes to facing the potential for economic calamity, and I think most of us are aware of these psychological opposites. There are those who believe that the authorities are in full control of the situation and that all will end well, and then there are those, the more cautious among us, who hedge the opposite outcome. The first group will always hold the second with disdain, and the second will always see the first as lacking in common sense.


Reprinted with permission of Casey Research

Benjamin Franklin once said that 'Experience keeps a dear school, but fools will learn in no other, and scarce in that. . .' A wise man, Mr. Franklin. . . .Kipling penned his own warning along these lines: "[T]he Dog returns to his Vomit and the Sow returns to her Mire, [a]nd the burnt Fool's bandaged finger goes wabbling back to the Fire."*

Speaking of "the Fire", let me conclude with an Ed Stein cartoon published here at USAGOLD just after the 2008 debacle. If nothing else, it serves as a gentle reminder. Queen Elizabeth at the time had asked a group of economists at the London School of Economics "Why did nobody see it coming?" As mentioned earlier, some did see it coming.


* See The Gods of the Copybook Headings, Rudyard Kipling, Kipling Society, UK introduced to me by Chris Powell what seems too many years ago. (And also posted in full here with an interesting interpretation.)


Michael J. Kosares is the founder of USAGOLD and the author of "The ABCs of Gold Investing - How To Protect and Build Your Wealth With Gold." He has over forty years experience in the physical gold business. He is also the editor of Review & Outlook, the firm's newsletter which is offered free of charge and specializes in issues and opinion of importance to owners of gold coins and bullion. If you would like to register for an e-mail alert when the next issue is published, please visit this link.

USAGOLD Review & Outlook is the contemporary, web-based version of our client letter, which traces its beginnings to the early 1990s under the News & Views banner. Its principle objectives have always been to keep our clients informed of important developments in the gold market; condense the available gold-based news and opinion into a brief, readable digest; and counter the traditional anti-gold bias in the mainstream media. That formula has won it a five-figure subscription base (and growing). In addition to our regular newsletters, we occasionally publish in-depth special reports that focus on events and developments of interest to gold owners.

Valued for its insight, accuracy and reliability, this pubilcation is linked and reprinted regularly by a large number of websites both in the United States and around the globe. It also enjoys the goodwill of countless websites, individuals and organizations who contribute regularly to its content. To this group, we owe a deep debt of gratitude.

Disclaimer - Opinions expressed on the website do not constitute an offer to buy or sell, or the solicitation of an offer to buy or sell any precious metals product, nor should they be viewed in any way as investment advice or advice to buy, sell or hold. USAGOLD, Inc. recommends the purchase of physical precious metals for asset preservation purposes, not speculation. Utilization of these opinions for speculative purposes is neither suggested nor advised. Commentary is strictly for educational purposes, and as such USAGOLD does not warrant or guarantee the the accuracy, timeliness or completeness of the information found here.

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