Portfolio Hedging with Precious Metals

Let’s discuss the financial principle of holding precious metals as a hedge against economic instability or a collapse. To be totally candid, I don’t currently employee this practice. However, it is something I’ve been considering more as my wealth grows. So what is a precious metals hedge? Precious metals like gold, silver, platinum, and palladium have historically been considered a store of value and a form of wealth preservation. Here are some key points to consider:

1. Store of Value: Precious metals have been used for thousands of years as a medium of exchange and a store of value. Unlike paper currencies, which can be subject to inflation or devaluation, precious metals have intrinsic value.
2. Hedge Against Inflation: Precious metals are often seen as a hedge against inflation. When the value of fiat currencies decreases due to inflation, the relative value of precious metals tends to rise.
3. Diversification: Holding a portion of your wealth in precious metals can be a form of diversification. This means spreading your investments across different asset classes to reduce risk. If traditional investments like stocks and bonds are performing poorly, precious metals may provide a counterbalance.
4. Crisis Protection: In times of economic crisis or uncertainty, precious metals can provide a form of financial security. They are tangible assets that can hold value even when other investments are underperforming.
5. Liquidity: Precious metals are generally considered to be highly liquid assets. They can be bought or sold relatively easily in various forms, such as coins, bars, or exchange-traded funds (ETFs).
6. Non-Correlation with Other Assets: Precious metals often have a low or negative correlation with other financial assets like stocks and bonds. This means their value may not necessarily move in the same direction as the broader financial markets.
7. Long-Term Perspective: Investing in precious metals is often seen as a long-term strategy. While their value can fluctuate in the short term, they have historically maintained value over extended periods. Just look at the price of Gold in the graph I included below. For about the past decade the price hasn’t been that amazing, but it has maintained its value.
8. Risks and Considerations: It’s important to note that investing in precious metals also comes with risks. Prices can be volatile, and they do not generate income or dividends like stocks or bonds. Additionally, there are costs associated with storing and insuring physical metals.
9. Form of Wealth Preservation: In the event of a collapse or severe economic crisis, precious metals may serve as a form of wealth that is not reliant on the stability of a particular currency.
10. Legal and Regulatory Considerations: Depending on your location, there may be legal and tax implications associated with owning and trading precious metals. It’s important to understand and comply with any relevant regulations.

Let’s look at one theoretical application of how precious metals might protect your wealth. Jim Rickards an American author, economist, and financial commentator has written extensively about the global economy and financial markets. He is known for his views on currency and the role of gold in the monetary system. In his book The Death of Money, author James Rickards notes that: “A useful way to think about (precious metal’s) insurance function is that a 500% return on 20% of a portfolio provides a 100% portfolio hedge.“

You might be thinking what the heck does that mean? This statement is highlighting the insurance-like function of precious metals within an investment portfolio.

Let’s break it down:

1. “A 500% return on 20% of a portfolio”: This part of the statement is a hypothetical scenario. It’s suggesting that if you have allocated 20% of your portfolio to precious metals (such as gold, silver, etc.) and the value of those metals increases by 500%, it would result in a substantial gain in that portion of your portfolio.
2. “Provides a 100% portfolio hedge”: In this context, a “portfolio hedge” means a way to offset potential losses in other parts of your investment portfolio. If you have a 100% portfolio hedge, it means that the gains in the precious metals portion of your portfolio would be sufficient to counterbalance potential losses in the rest of your investments.

Here’s an example to illustrate:

Let’s say you have a $100,000 investment portfolio, and you allocate 20% of it ($20,000) to precious metals. If the value of your precious metals holdings were to increase by 500%, that would result in a return of $100,000 (500% of $20,000), effectively doubling the value of that portion of your portfolio.

Now, if other parts of your portfolio were to experience losses (let’s say a 50% decline), the $100,000 gain from the precious metals could offset these losses, effectively providing a hedge against the declines in the rest of your investments.

The statement above implies that Rickards, along with other experts, predicts that if there is a sharp decline in the value of the US dollar (commonly referred to as a “dollar crash” or “tanking”), it could have a significant impact on the price of precious metals. If there is a severe devaluation of the US dollar, many believe the value of precious metals could potentially increase by a factor of five, or 500% which would cover the losses of your other assets assuming 20% of your portfolio consisted of precious metals. Outcome graphed below.

Keep in mind that this is a simplified and hypothetical scenario. In reality, the performance of investments, including precious metals, can be influenced by a wide range of factors, including economic conditions, geopolitical events, and market sentiment. Also, it’s important to remember that past performance is not indicative of future results, so there are no guarantees in investing.

In summary, experts like Jim Rickards and others foresee a potential surge in the value of precious metals in the event of a economic collapse. The 500% projected growth is viewed by some as a conservative estimate, suggesting that the actual increase could potentially be even greater. While such forecasts offer insight into the potential role of precious metals as a hedge against currency devaluation, it’s crucial to approach these predictions with caution. Market dynamics are influenced by a multitude of complex factors, and unforeseen events can swiftly alter trajectories. Thus, maintaining a diversified and well-informed investment strategy remains key in navigating the complexities of the financial landscape.

Let me know what you think, does this topic make you want to add more precious metals to you portfolio of investments?