The current scenario in the global investment landscape can at best be summed up as ‘precarious’. Investors have a tough task laid out in front of them that calls for capital preservation as their primary goal, with capital appreciation as a secondary objective.

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The modern portfolio theory has clearly proved through countless research papers that investors who manage to walk out of relentless bear markets with their capital (investment float) largely intact, have a sizable advantage over those whose portfolios suffer erosion and need to come back to ground zero (breakeven) before yielding alpha (profits) in following bull markets.

While equities, as an asset class, can undoubtedly be relied upon to beat inflation over the long term, they provide little protection during the actual bear market. My personal experience in equity markets since 1986-87 tells me that equity prices witness large-scale attrition in high inflation periods, like we are currently experiencing, and provide almost no place to hide.

In a punishing bear phase, you only have the option of deploying funds in stocks that will at best fall less than the benchmark indices. While this “relative out-performance” is fine for high net worth individuals (HNI) and “buy only” institutions, the retail investor undergoes the horror of absolute returns that are negative. Try paying your electricity and telephone bills with relative returns alone and you know what I am getting at!

Are gold and silver a ‘safe’ haven?The answer is a confusing yes and no! Yes, because high inflationary periods imply that commodities are a lot more “honest” to an investor and actually appreciate in such turbulent times, and no because in the market place, the price rules supreme and your returns are dependent on the sole factor of buying at the right price. Many technical studies help us gauge the appropriate time to invest in bullion, equities, ETFs and currencies.

The primary yardstick is the age old system of “range expansion”. The technician relies on price charts to track periods when the prices of the underlying asset are moving in a quiet, measured and lower beta (volatility) calibration.

Any “breakout” of such a measure of routine acceleration (rate of change) should alert the trader / investor that the outlook for the underlying asset or the market as a whole is changing gears. It is then a matter of being nimble footed to latch on to the moving bandwagon of prices and riding the “waves” or bull / bear phases. In the current scenario, avid bullion investors will break apart the price volatility of gold and silver into two phases - pre -August 2010 and post -August 2010. While silver was trading at close to Rs30,000 / Kg, gold was trading steadily at Rs 18,000 / 10 gms before August 2010. The price acceleration in both these precious metals has been swift and parabolic at times. The sum and substance of the argument is that an investor should deploy money when sanity prevails in price patterns rather than chase uptrend for the fear of feeling “left out”. Case in point - any investor who bought silver in the latter half of April 2011 saw a price erosion of up to 30 % within a matter of three weeks.

Where are we now?Both silver and gold are consolidating after a period of high volatility and parabolic price rise. The probability of short -term weakness should not be ruled out. While the larger scheme of things indicate that the uptrend is by no means fractured, market mechanisms are attempting to “shakeout” the weaker hands by extreme price moves that result in decisions that are more emotional (fear / greed driven) than logical.

Typically, the leveraged players who participate in the action via futures will see maximum stress as mark-to-market payments and span margin commitments will require deep pockets to just fuel existing long positions with little / no scope for enhancing long positions on price declines. The age old adage that “money makes money” rules the roost here and nothing beats taking delivery of the precious metals in physical format or ETF and e-silver / e-gold. While the exposure levels maybe smaller as compared to futures markets, you manage to skirt emotional pitfalls arising out of funding an existing position when your broker demands fresh funds to keep your positions “alive”. Less is indeed more and small is of course beautiful, at least in the case of the bullion investment game.

Should you buy, and why?I think you can ignore bullion and depend on equities and / or fixed income investments alone, at your own financial peril. While equity prices are likely to remain under pressure and provide negative absolute returns for some more time, fixed income investments will mean negative real effective returns as your Bank FD interest rates are lower than your food inflation at the street level. Bullion will offer a store of value and also capital appreciation opportunities provided you think of timelines in multiples of 12 months and incremental in similar multiple periods thereafter.

Remember, barring ETF’s where long term capital gain protection is available after 12 months (only Gold ETF’s are on offer in India), all other modes of investment (physical bars, coins, e-silver etc) are required to be held for 36 months before gains are protected from taxes. If you attempt to speculate in bullion so you can throw a grand New Year party, chances are you may erode your capital base.

The “why” of investing in bullion is all too apparent to a seasoned investor - fiat currencies are likely to lose purchasing power in the coming few quarters / years.

Asian countries may prove to be a power house of economic revival in the coming years, but their population is rising much faster than their resources supply side economics. That spells high inflation - a highly conducive scenario for bullion investors willing to dig their heels in these assets, with a long term outlook.

The Tao of bullion investing Deploying all your money in one go is a loser’s game. Battle hardened investors seldom empty their bank balance in a single cheque. Periodic investments, especially at prices lower / equal to your last purchase is the way to go. Typically, buying progressively slightly larger quantities when the prices are on the way down south makes sense. That way, your average acquisition costs are relatively closer to the current ruling market prices, reducing your anxiety levels. Since currencies are likely to play a dominant part in domestic bullion prices, you need to monitor interest rates and fix markets to time your bullion buys.

As a contrarian player, I would buy gold / silver whenever banks raise interest rates and drive bullion prices lower in the short term, knowing that the prices would rally all over again, whenever economic pressure points re-emerge at a later date. Over the next 36 months, this strategy should navigate you towards above normal profits. Start nibbling at silver at sub Rs50,000 levels and gold below Rs25,500 levels. Remember, systematic investing at lower values (averaging) will be required, so plan your finances accordingly. Do not get rattled to see a 15 - 20 % dip in prices, especially if some highly leveraged hedge fund in the western markets decides to unwind positions due to financial/ regulatory constraints. History provides ample evidence that such events have occurred with unfailing regularity. LTCM, Amaranth Advisors, Bear Sterns are some examples. These are times when bullion baiters (and haters) have screamed “I told you so”, but bullion has prevailed, and will continue to prevail.

— The writer is the author of A Traders Guide to Indian Commodity Markets which has been sponsored by the NCDEX and invites feedback at vijay@BSPLindia.com