Long Gold, Short Oil

A financial advisor explains his Gold Bullion allocation policy...

CEO and PRESIDENT of the fee-only Legend Financial Advisors, Louis Stanasolovich has been credited by Barron’s as one of "The Top 100 Independent Financial Advisors" and named by Investment Advisor magazine’s "top 25" list three times.

A Certified Financial Planner (CFP) since 1984, and admitted to the Registry of Financial Planning Practitioners in 1986, Mr. Stanasolovich is now also editor of Risk-Controlled Investing, a monthly newsletter which guides financial advisors on how to build investment portfolios with lower risk.

Here he speaks to Hard Assets Investor about the outlook in 2009 for oil, gold and other hard assets...

HardAssetsInvestor.com: Given all that's transpired over the past year, and given the state of the economy, should investors have exposure to commodities in their portfolios?

Louis Stanasolovich: Looking 10 years out, the answer is an unequivocal yes. In the short run, though, it's anybody's guess. That's why we use the Direxion Commodity Trends Strategy Fund (DXCTX), which tracks the S&P Commodity Trends Indicator. It uses a long/short approach. That worked very well last year; this year it's not working so well, so far. But that could change.

HAI: There's a great debate raging right now over inflation/deflation and gold. What do you think the outlook for gold looks like, both in the short and long term?

Stanasolovich: Again, we think that long term – probably starting a couple of years out – most currencies around the world will start to have problems, because so many governments have debased their currencies by taking out so many loans. And when you see currencies debased, especially on a global basis, that's a good time for Gold Investment.

We have bought gold and are Buying Gold on any weakness. We bought at the $880 an ounce level. We'll continue to purchase a little here and there if prices continue to drop.

HAI: Do you have a target allocation for gold? Is there a point where investors have too much gold in their portfolios? Or not enough?

Stanasolovich: For us it depends on price. We believe we will soon enter an inflationary period, but only if we don't go into deflation first, which is also a risk. But the truth is that gold has historically worked pretty well in deflationary periods as well as inflationary periods.

In the 1930s – the last deflationary period – gold had a very, very big move. The next big move was in the 1970s, when we had high inflation. And then we had a big move in the last few years as inflation picked up again.

Gold is a panic asset too, and it seems like a lot of the world's money is in a panic, so that bodes well for gold as well. The only period in which gold doesn't do well is during a period of low inflation.

So the short answer to your question is "No", we don't have a set maximum on gold exposure. If gold goes back to $400 an ounce, we might have 15% of our portfolio in gold.

HAI: Do you ever take positions in commodity-producing stocks – say, gold miners – as opposed to the commodities themselves?

Stanasolovich: When gold went to $880 an ounce, we bought 1% in GLD, the SPDR Gold ETF, and 1% in the First Eagle Gold Fund (SGGDX). First Eagle has had a very, very good period. They own Gold Bullion in the fund, but mostly, they own Gold Mining stocks. Over the last 12-15 years, the metal has done better generally than the mining stocks. But there are times when gold stocks have done well, so we decided to own both at this time.

HAI: What about oil? What's your outlook for oil prices, which have been, to say the least, extraordinarily volatile recently?

Stanasolovich: Long term, energy is going significantly higher. Last year's prices will look timid in 10 years. Could we have $300 oil? Yes, by 2022. Unless we as a world population start moving very quickly to alternative fuels in a very big way, we think oil could be $300 per barrel easily.

In the short term, however, it all depends on the economy. Quite frankly, I'm surprised oil is as high as it is, given how inventories are stacking up. I think we'll see oil take off again at some point here, but currently, we are shorting oil in our most aggressive portfolios. We'll take those shorts off once we get down to $30 per barrel.

HAI: Short oil? That's pretty bold.

Stanasolovich: We just don't see oil rising a whole lot right now. Technically, per energy unit burned, natural gas is cheaper. And we just don't see oil making a big charge upward any time soon. If anything, we see it lower. So we have a very small position in terms of oil shorts at this point, and only for our most aggressive portfolios.

HAI: Do you think that natural gas could finally get up off the floor?

Stanasolovich: It could. It depends on oil. If oil surges, I'm sure natural gas will move quickly.

HAI: What about the economy in general? Are we through the worst of it, or is there further to go?

Stanasolovich: Valuations are low on the stock market, but we're not anywhere near the worst valuations historically. The market would have to go down another 50% for that to occur. Does that mean we'll go down another level? No, it doesn't. However, the earnings that are coming out are highly suspect. Many banking institutions have earnings that are accounting-generated in a lot of cases. A good evidence of that is Citibank, which came up with a $2.4 billion accounting charge and is now trying to raise capital.

It just confirms that this severe recession still has a ways to go, particularly with the option-ARM mortgages and the Alt-A mortgages that are coming due and have to reset. That plus the existing problems of other mortgages...well, the mountain of resets is actually bigger than it was in subprime. So we expect more difficulty for financial institutions, plus housing dropping an additional 20% in terms of price, as inventories go up. The scary part could be if the Federal Reserve has to raise interest rates because people stop buying our Treasury securities. That will cause homeowners to pay even higher rates, which they can't afford.

It doesn't look good in our opinion. We see about a 70% chance that the economy gets worse, and a 30% chance that it gets better. If the economy continues to deteriorate, we believe we'll see at least a sideways market, if not a declining market. I don't see a 50% decline, but I do see the potential for a 20-25% drop. I think there's a good chance we'll retest the March lows.

HAI: Aside from gold, where are you finding opportunity?

Stanasolovich: Managed futures, long/short commodities, long/short equities. We think there's some limited opportunity in government agency-type securities. TIPS have largely run up already [Treasury inflation-protected bonds], so we are not excited about them. Corporate and municipals will at some point be very attractive to us, but we think it's premature at this point. Junk bonds will be attractive, but again, not yet.

Also, other currencies, especially emerging market currencies, will look attractive over the next 3-5 years. But we're not entering into positions there yet, either. There's still a ways to go. Really, we're not overly bullish on anything. This year, there's probably 10% upside, tops, on anything, across the board.