Gold Stocks in a Failing Fiat Currency

David Galland, Managing Director
Casey Reserach

As the U.S. dollar takes a nosedive and precious metals gain more and more attention from individual investors, the number of questions and concerns is increasing as well. The following reader email addressed to Casey Research is representative of so many inquiries that we decided to provide an in-depth response that may prove instructional to others as well:

I have been agonizing about getting metal after dumping paper metal I held and was reading the Daily Dispatch looking for investment clues. I was pondering the ratios of thirds that you mentioned in a recent Dispatch and the pursuing of metal stocks when an issue occurred to me that was not mentioned.

On the one hand, you discuss the dollar trap of investors running from one currency to another, away from the dollar and back to it. I fear that the dollar is doomed as are other fiat currencies, and time is getting short. So the question that came to mind is, what happens if one is invested in metal stocks or any vehicle that is denominated in a fiat currency, and that currency goes bust, blotto?

What value does that investment retain? Does it become a total loss? Redefined into the currency of the locality that operations are in? Converted into some other New World Order monetary unit, SDR’s or nationalization of any regional assets by the locals? Is this impossible to plan for?

I realize I am probably speculating on a subject that can only be determined by psychics and crystal balls, or those with a sixth sense on the subject, but it is an issue I have not heard anyone ponder, except those who only beat the drum for physical metals.

If I allocate away from physical into speculative investments denominated in fiat in the ratios you suggest, it might provide an additional boost if one’s timing is impeccable. But weighing that against being trapped in a depreciating currency unit, along with the possibility of physical metal becoming unobtainium, it does not seem to be a prudent decision.

I would appreciate a further explanation for your ratios, and does the ratio vary with total personal asset amount? Is your ratio determined by finances or politics?

Chet

Here at Casey Research, our current rule of thumb suggests a portfolio allocation of approximately one-third in precious metals and related investments; one-third in cash (spread among several currencies), and one-third in “other” – namely deep-value stocks, energy, emerging market investments, etc. These ratios are meant entirely as a general guideline, as everyone’s circumstances will be different.

The concept is that the one-third dedicated to a mix of physical precious metals and stocks (the mix determined by risk tolerance) will offer you “insurance” against further currency debasement as well as some very attractive upside potential… with the amount of the upside determined by the amount of risk you are willing to take on
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Which is to say, with the true Mania Phase of the precious metals markets still ahead of us, the micro-cap junior resource explorers still hold the potential for explosive profits. But they require being able to hang in there through periods of extreme volatility. Moving down the risk/reward scale, the larger producers will provide very handsome upside, but without the risk of being “trapped” in a thinly traded junior. And finally, for the precious metals component of the portfolio, the amount you hold in physical metals should be viewed as a core holding of “good” money.

The one-third dedicated to cash reduces overall volatility and gives you ammo to jump on new opportunities. By spreading the money across a number of better-managed currencies, as well as your native currency for general expenses and liquidity, your currency portfolio can preserve value better than a “red or black” bet on a single currency such as the U.S. dollar or euro.

Our subscribers have done well with the “resource” currencies of the Canadian dollar and the Norwegian krone. In time, as the purchasing power of the fiat currencies begin to decline, we’ll be looking to reduce this segment of the portfolio.

The final one-third is something of a catch-all, where we opportunistically follow some key themes such as energy, food, inverse interest rates, foreign real estate, and so forth.

Again, that particular allocation is necessarily general – with some focusing more heavily on the precious metals, others on the cash component, and others on more traditional stocks.

Now, as to the part of Chet’s question dealing with “what happens if one is invested in metal stocks or any vehicle that is denominated in a fiat currency, and that currency goes bust, blotto?”

To answer that, I adroitly hand the baton over to Terry Coxon, one of our Casey economists and editors.

Here’s Terry…

Not to worry. You may be confusing “denominated in” with “quoted in.” Every bond and every CD is denominated in a particular currency, which means that what it promises to pay you is a certain number of units of the currency. A U.S. Treasury bond, for example, promises you a certain number of U.S. dollars. An investment’s denomination is part of the investment’s character. In most cases, an investment is quoted in a particular currency. Prices of U.S. Treasury bonds, to use the same example, are customarily quoted in U.S. dollars. But that is only a matter of customary practice. You could, if you found it convenient, quote the price of a U.S. Treasury bond in Swiss francs. For all I know, there are people in Zurich who do just that. That’s the difference between denominated in and quoted in. The denomination is inherent in the investment. The currency used for price quotes is a matter of convention and can change. By convention, stocks trading in New York are quoted in U.S. dollars, stocks trading in London are quoted in pence, and stocks trading in Tokyo are quoted in yen. Notably, some stocks are quoted in more than one currency, such as Canadian stocks that trade both in Canada and in the U.S. – a demonstration that the currency used for quoting a stock’s price is a matter of choice and not something inherent in the investment. So in what currency is a common stock denominated? No currency at all. A share of common stock doesn’t promise to pay you a certain number of units of a particular currency. Instead, it promises to pay you a pro-rata portion of whatever money or other property the company distributes as a dividend. If all paper currencies lose all value, successful gold mining companies will still own their properties and can still operate profitably. But when they pay dividends, they won’t be paying out dollars or any other paper currency. They will be paying out whatever has replaced the paper currencies – perhaps gold itself. Carefully chosen gold stocks won’t evaporate when paper currencies do. They will rise in value.

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