Why holding on to a core position in gold and silver makes sense, buy on the dips

Posted on 06 February 2011 with 1 comment from readers

Traders are always itching to sell and cash in on the latest market cycle. But it is seldom that easy to be 100 per cent right, except with a time machine. The book thought to be the memoires of that great trader Jesse Livermore, ‘Reminiscences of a Stock Operator’, written in 1923 has some timeless advice.

Livermore reckoned that in a long-term bull market for a stock or commodity you should only ever add to your position and never sell. The risk of being out of the market in an unexpected rally was just to big, and that outweighed the risk of missing out on a quick in-and-out trade.

Risk of being out

Now if one of the greatest traders of all time could not manage this, what hope is there for the rest of us? Markets are great humblers, and the decapitation of the bold is a frequent occurance. Think back to gold and silver last summer.

The bold trader might have thought a stock market correction was obviously coming, and that would have been it for the gold and silver recovery from the 2008 sell-off. A very reasonable and logical conclusion. But completely wrong! The seller would have missed the big rally of the autumn.

Sitting tight in a long-term bull market makes sense simply because you cannot time the rallies properly, and that means being out of the market at any point carries a higher risk than staying in it. It is a simple piece of analysis that Livermore says he learnt the hard way by being wrong.

How does this help us today? We could today apply the same logic as last summer and say it is time to take profits on gold and silver, and sit back and wait for a stock market correction. Heaven knows with the Dow above 12,000 and the economic recovery incredibly weak and the bond market at risk of falling over, there is plenty of reason to doubt the capacity of stocks to carry on rising.

Then there is the Chinese dichotomy: do we have a billion buyers of gold and silver about to come back from New Year holidays with precious metals on their minds? Or is the Chinese property bubble about to blow, leading to a big sell-off in precious metals by the biggest buyers of gold and silver recently?

Known knowns

However, what we do know is that the Fed is promising under all circumstances to carry on inflating the money supply. We know that the Chinese authorities reacted in the same way only more vigorously in the global financial crisis, and their apparent success suggests they will do it again.

We also know that gold and silver have a relatively fixed supply. We know that if stocks, real estate and bonds fall together – a rare combination but a likely consequence of an inflationary squeeze on profit margins and higher interest rates – then precious metal prices will go up with unimaginable velocity.

Jesse Livermore’s advice was always to add to a winning position in a pull-back and never sell. Perhaps precious metals investors should be considering that option. But is this the bottom of the dip? Now that is still a difficult call for the investor but at least do not trade out of your core position.

This correspondent first tipped gold strongly at $455 and has seen the yellow metal nearly $1,000 higher since then with no sign of an end to this trend. The ArabianMoney newsletter this month reviews how to best invest in silver (click here to get your copy) which we think has the best outlook for 2011 (click here).