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Worried about a Financial Crisis? Buy This Very Risky InvestmentBy
Friday, December 13, 2013
These days, everybody loves to read and talk about the next financial crisis.
But what should you actually do to prepare for a financial crisis?
I'll tell you what in a moment... but first, let's talk about Howard Marks...
Marks, the founder of Oaktree Capital Management, is the latest voice to join the "next financial crisis" discussion.
Marks is one of the greatest investors of our time. His book, The Most Important Thing, is one of the best investment books ever written. His shareholder letters are must-reads.
Marks' latest investor letter is about the excesses in credit markets he saw building up in 2007... and sees building up again today. He says the current market "has gathered steam" since the 2008-2009 crisis, but admits it's not "anywhere near the same degree" of craziness as it was in 2006-2007.
I agree. There are similarities between today's financial environment and the pre-crisis environment. In his letter, Marks noted that low interest rates are making it unattractive to invest in bonds... which is driving people to invest in risky assets with little regard to the value they're getting. This is what caused the 2008-2009 credit crisis.
Another well-known and highly credible voice is warning us about the next crisis: legendary value investor Seth Klarman. Most people have never heard of Klarman, but he's one of the greatest investors in the world.
At the Grant's Interest Rate Observer conference last month in New York, James Grant interviewed Klarman. Klarman was wringing his hands, as he has done every time I've seen him speak in public.
Klarman believes low interest rates and easy credit have distorted market prices. If the Federal Reserve wasn't printing money and buying bonds with it every month, Klarman says, "None of us know what the level of stock prices would be, what the level of corporate earnings would be, or, of course, where interest rates would be."
This clearly implies that interest rates should rise much higher in the near future.
Klarman went on to explain why he has 1.5% of his fund exposed to a rise in gold prices. He said he buys call options, which he admitted were expensive and routinely expire worthless. (Call options are leveraged bets that profit from rising prices.)
He said "the cool thing about gold" is that it's a good hedge to own should "the solvency of the United States" be called into question. If gold goes to $3,000, $5,000, or $10,000 an ounce, he called buying call options on gold "the most interesting hedge."
This is remarkable. One of the most conservative value investors of the last 30 years is buying call options on gold.
This is one of the riskiest trades in the world.
It's pure speculation. It's virtually guaranteed to lose money the overwhelming majority of the time... and make you a bloody fortune the one time it works.
Klarman sees it more as an insurance policy. It's a hedge against an enormous financial catastrophe, like a mass global exodus out of the U.S. dollar.
You don't buy insurance to make money. You buy it to keep from losing money.
That is classic behavior of a value investor. A true value investor's main objective is to not lose money. Other value-oriented hedge-fund managers – like David Einhorn and John Paulson – are also long gold, but through less speculative vehicles (like gold bullion).
If you're concerned about "the next financial crisis" like Klarman is, consider taking some kind of position in gold. For most folks, simply buying gold bullion is the best move. Buying gold stocks is also a good idea. If you consider yourself an advanced, experienced investor, you might want to look into the gold call options Klarman is talking about.
However you choose to do it, make sure you understand gold as Klarman understands it: As an "insurance vehicle."
When you buy insurance, you hope you never have to use it. That's how many professional investors see gold today.
Good investing,
Dan Ferris
Further Reading:
"99% of gold and silver owners are all wrong in the way they view their holdings," Dr. David 'Doc' Eifrig writes. "I take an unusual approach to my holdings. I hope I lose money on them." Learn what poor people don't know about gold here.
Classic interview: "Gold is not an investment, and has never been an investment," Doug Casey says. "I consider gold to be cash in its most basic form, much more so than the U.S. paper currency we currently call money." Find out why gold is the "real" money here.
Market NotesA CRITICAL LOW FOR GOLD STOCKS One of the market's great "boom and bust" sectors just hit an important level...
As longtime readers know, we keep close tabs on gold stocks. These stocks tend to go through huge booms and busts. Get in the booms early, avoid the busts, and you can make huge returns. But right now, gold stocks are in "bust" mode...
The Market Vectors Gold Miners Fund (GDX) holds positions in dozens of gold miners, like Goldcorp and Barrick. After bottoming in late 2008, the fund soared 283% over the next three years. Since then, gold stocks have been stuck in a long downtrend. Shares of GDX are down 68% since their September 2011 top.
And last week, GDX broke through its previous June low of around $22 per share. It's a clear signal the downtrend isn't finished yet. Sentiment toward the sector is terrible... And gold stocks are incredibly cheap relative to the price of gold. However, the next "boom" won't happen until all the sellers are out of their positions. For now, gold stocks are still searching for a bottom.
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