Gold and Silver: When to Take Profits?

3 questions before you cash out...

WHAT a year for gold and silver bugs! says Sean Ring in Addison Wiggin's Daily Reckoning.

Precious metals and mining stocks have surged higher.

Gold led the move, with global central banks driving demand.

Silver followed on a delayed schedule, but is now rocketing up towards its all-time high of near $50.

And over the past few months, miners have soared. With bullion prices high, and fuel costs low, mining stocks are churning out cash flow.

My favorite silver miner ETF (SILJ) has risen 102% since we mentioned it as a nice option in March of this year. Gold is up about 50% since I wrote my first piece about it for the Daily Reckoning just over a year ago.

With such a sudden and sharp move up in prices, some investors may be getting an itchy trigger finger. The urge to take profits is likely hitting some readers right about now.

Today we're going to discuss the conundrum of timing. When should we sell our precious metal positions?

The answer depends on a few key factors:

• What is your time horizon? How long do you plan to hold?
• Are there attractive alternatives? What will you buy instead?
• Are the gains long-term, or short-term? Tax efficiency matters.

Let's go through each of these points briefly.

First, time horizon. My belief is that this precious metals bull market is going to last at least another 3-5 years. So I am holding and haven't taken any profits yet (besides 1 miner out of 18, which was underperforming and its story had changed).

With that said, my investment horizon is very long. My goal is to hold these precious metal positions for 5 years, if not longer. I believe gold is headed to $10,000 and silver ultimately to $200 or more, depending on how bad inflation gets.

But there will be mini-crashes along the way. Gold and silver have rocketed higher this year, and it seems like a pullback is due at some point.

As we have covered a few times, during the 1970s bull market, gold rose from $35 in 1971 to $195 in 1975. It then crashed 46% to $105. But by 1980, it was trading at a peak of $850. To be clear, I don't expect a 46% correction like we saw in 1976.

To recap, gold went from $35 -> $850 in about 10 years in the 1970s… That's almost a 25x gain. But we need to remember there were major corrections along the way.

If one needs the money in the next year or so, it might make sense to take some profits. But leave at least a portion invested, if you can.

It all depends on your time horizon. If you can withstand the inevitable dips, and plan to hold long-term, I say hold, and buy the dips if you want more exposure.

Then, before selling, answer this question: What would you rotate the money into?

US stocks are at nosebleed valuations. Not attractive from my point of view.

Yields on cash are decent, and that's certainly an option. But personally, I don't want to have too much exposure to Dollars for an extended period. Inflation is likely to return, and rates are likely to fall.

What about cheap emerging markets, like Brazil (EWZ)? That's a good option, and one of my favorite positions in this market. But personally, I like precious metals and emerging markets as compliments to each other. I want both.

Pay off your mortgage? Not a bad option if you have a rate higher than 4.5%, perhaps. But if you expect to have steady income to draw from, there are probably better places to allocate cash.

As we can see, every option has risk and reward. Even cash and US bonds, long considered a "riskless" asset, have increasing risk of devaluation via inflation.

We also need to consider tax implications when deciding when to buy or sell.

Whenever possible, I try to hold investments for at least 1 year to make the gains "long-term" under tax regulations.

Short-term gains are taxed at regular income rates, and those can reach 40% or more. Long-term gains, on the other hand, are taxed at a 15% federal rate for most investors.

So if you can't decide whether or not to sell an investment, think about the tax implications. Over time, these make a massive difference in returns, as we covered in this recent newsletter.

One final point. Attempting to time markets is difficult. For the majority of my portfolio, I prefer to sit in long-term investments and let them grow and compound in a tax-efficient manner.

Eventually there will be a time to start shifting out of precious metals and into higher-growth assets. But we're not there yet.

Sure, if you're up 3x on some junior miner, consider taking some profits. If you're up big, there's nothing wrong with selling half of a position and letting the rest ride. But also consider keeping a portion of the position if you think it's a good long-term investment.

As problems go, deciding when to take profits is a good one to have. But it's still not easy.

Personally, I'm staying put. But each investor needs to consider their own situation to make a decision.