Paul Mladjenovic - Investing in Gold & Silver For Dummies

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Political risk is probably one of the biggest dangers that investors and speculators don’t see coming. It’s the one that comes out of the blue and blindsides your portfolio. What is political risk? Political is a reference to politicians who, in turn, run government. As far as you and I are concerned, political risk and governmental risk can be synonymous. In other words, politicians are Dr. Frankenstein, while government is Frankenstein’s monster. The bottom line is that political risk means that the government can change laws and regulations in a way that can harm your investment or financial strategy. This can happen in your own country or by another country.

Consider what happened in the 1930s right here in the United States. In 1934, Franklin D. Roosevelt (FDR) and Congress passed the Gold Reserve Act, which made gold ownership illegal. Had you bought gold in prior years to preserve your wealth in the midst of the Great Depression, well, you were now out of luck. FDR then issued a presidential order fixing the price of gold at $35 an ounce, which stuck for decades to come. FDR didn’t want private citizens to have an alternative outside of the official paper currency.

Fast-forward to current times. Political risk is alive and well (unfortunately). In many countries, such as China and Venezuela, the government nationalized (taking private property by force) properties by foreign companies — among them, mining companies. Had you owned stock in these mining companies, you would have seen the share prices drop. Sometimes the share prices drop at the mere threat of government action. In 2005, for example, the Venezuelan government mentioned that it may take property owned by the Toronto-based gold mining company Crystallex International. Its share price fell by a whopping 50 percent in a single day. Venezuela’s dictator Hugo Chavez did increase taxes on many foreign companies while nationalizing some industries.

That’s the problem with political risk. As an investor or speculator, you can do all your homework and make a great decision with your portfolio backed up by great research and unflinching economic logic and still lose money because of a government action that could have been unforeseen.

An ounce of prevention is worth a pound of cure. It’s best to stay away from investments (such as mining companies) that are too exposed to risk in a politically unstable or unfriendly nation. There are still plenty of precious metals opportunities in politically friendly environments such as the United States, Canada, Australia, and Mexico (at least until the next election!).

The risk of fraud is as real in precious metals as in every other human endeavor. It’s tough enough trying to make a buck when the market seems honest. But you must understand that as a market becomes popular or “hot,” it also becomes a target for scam artists. Fraud can materialize in a variety of ways, but I think that it can be safely categorized into three segments: scams, misrepresentations, and market manipulation.

Scams: Those events that the consumer organizations always warn about. The image is conjured up about those boiler-room operations where a slick con artist calls up a little old lady in Pasadena and talks to her about riches to be made in gold and silver if she could crack open her piggy bank and send off a nice money order chunk of her savings. This is certainly a real risk, and it becomes more apparent when the source of potential fraud is popular. When internet auctions became a hot consumer area, there were more internet auction–related scams. When the real estate market became red-hot in 2005, there were more real estate scams. When precious metals become the “bubble du jour,” then you’ll need to be wary of scammers here as well.

Misrepresentations: I put this as a separate topic from scams because it can be a different animal. Basically, the point is that you may put your money into a venue and you may not be getting what you think you’re buying. A good example is what the respected silver analyst Ted Butler warned about regarding silver certificates. There have been millions of silver certificates issued in recent decades, but there’s the real possibility that there isn’t any real silver backing them up. In other words, there are purchasers of silver certificates who believed that they could convert their paper into actual silver in due time but, in fact, won’t be able to. That sounds like a misrepresentation to me.

Market manipulation: Early in 2020, the financial media reported a serious matter regarding naked short selling among smaller stocks. Short selling can send a stock’s price plummeting. Some large brokers and their clients have been caught illegally profiting through a manipulative technique called naked short selling. This was an especially egregious activity with the stock of smaller mining companies. In naked short selling, the perpetrator can sell massive quantities of stock essentially created out of thin air to force the price of the stock to come crashing down. Imagine if you owned shares of a small mining company, and you saw the share price plummet by 40 or 50 percent or more for no apparent reason.

First of all, don’t forget that including precious metals (to whatever extent) in your portfolio minimizes risk because precious metals such as gold and silver have historically helped investors in times of economic uncertainty and political and financial tensions in the world at large. The long-term picture for precious metals should continue to bear this out. But as this chapter points out, nothing is without risk. Precious metals do carry risks, and you can minimize your risks with the help of the following sections.

Risk (or the lack of it) isn’t just where you put your money; it’s also how you go about doing it. ’Nuff said.

The more you understand how markets work, the better decisions you’ll make and the more you’ll minimize risk in your financial situation. I remember getting into options on silver futures some years ago. It was early 2004, silver was rising very well, and my account was performing superbly. I thought to myself, “Gee! What a genius I am!” Then along came April 2004. Silver plummeted by nearly 40 percent. I thought to myself, “Gee! What a moron I am!” In retrospect, it worked out just fine, and I made some great profits, but I was sweating bullets that spring. Seeing the value of your “investment” drop by 40 percent can make you freak out. I would have jumped out the window, but I’m on the first floor. The point is that I learned that precious metals futures and options could have very wide and scary price swings. That is the nature of the market.

In fact, it isn’t uncommon for precious metals to “correct” by 20 to30 percent or even more at least once a year (I’ve come to learn that a “correction” seems awfully incorrect at the time). The terms correct or correction mean that a market came back down after going up too far and/or too fast. Don’t confuse a market “correcting” with a market experiencing a bear market — a long-term falling or decreasing market. The correction is a temporary pullback in the price of the asset that is in a long-term bull market, or rising market. In other words, the difference between a correction and a bear market is the same difference as fainting and dropping dead. In the former, you recover and get back on track. The point is that gaining knowledge about your market helps you understand moments such as the difference between a correction and a bear market.