Precious Metals Aren't Working: Why?

Copper and FCX Showed Us The Path
Copper and the benchmark stock for copper, Freeport McMoran ($FCX, FCX) have led the way much lower. FCX alone has dropped 40% since August. The other precious metals have followed suit, with gold and silver grabbing more headlines. We can attribute some of that weakness due to over all strength in the US Dollar, as the dollar index has risen 10% (give or take) during this same period. However, that isn't the entire story.

Government Fiat Is On Trial, and Losing. Big Time.
Gold has been used as a type of anti-governmental stimulus mechanism. Simple really. Don't believe in the credit of a nation, or believe that additional stimulus will lead to a path of hyperinflation/deflation, gold was perceived to be the safe haven. Within limits, that perception has been widely held, and as a result gold has appreciated a great deal. However, that run has been dominated by a more powerful force. In short, we are well beyond the limits when precious metals serve their purpose as a hedge against governmental fiat.

Correlation Isn't Your Friend, and There is No Hedge (almost)
When the panic button is hit, then you will be able to tell because the correlation of ALL RISKY ASSETS approaches 1. That is what you have now. This is a major tell: managers of risky assets are liquidating, even the assets with handsome gains, in order to get into the safest assets (the US Dollar, and US Treasuries). In short, gold and other precious metals isn't safe either.

What then could be seen as a hedge for risky assets? Financials ($XLF/$FAS/$FAZ)
Financials are the only potential hedge. Even beyond the weak fundamentals, the lingering balance sheet problems, and flattening yield curve, a short financials could be seen as a hedge to the correlation of other assets. Only a short financials position addresses all of the ills that exist, plus offer a correlation hedge of sorts. Experienced persons in financial markets know that there is no hedge, per se, to correlation. That is the challenge of risk managers everywhere. The scenarios cannot be measured when correlations converge to 1. That is what we see right now. That said, a short financials position isn't risk free, and short $FAS / long $FAZ are full of structural problems due to the daily rebalancing of the instruments. However, a short $XLF position may be the best position until the correlations recede.

Precious Metals: Lower

Scenarios for Gold and Silver Are Both Bad
Gold is down about $120 from the all-time nominal highs.  Where now?

Scenario #1: Governmental Fiat Failure
Let's say that Greece defaults and pressure builds on Ms Merkel and the ECB to issue Eurobonds.  It is the view of the LTZ Vortex that Ms Merkel, at the end of the day, will have to cave.  One potential solution: partially gold-backed bonds.  Germany and France reach a compromise by telling the PIIGS: you want liquidity, put up the nation's assets that have a firm price, i.e. gold.  Greece, Italy, Spain, Portugal hit the sell button on Gold to fund the backing.  That would satisfy the rest of the Eurozone who don't want to bail out the weak, and avoid the Lehman scenario (maybe).  Result: gold lower.

Scenario #2: Kick the Can, and the World Buys It
Risky assets get a huge bid because the world is convinced that governments will succeed.  Those investors using gold as the safe haven sell gold to buy riskier assets.  Simple, and well-known scenario.  Actually, risky assets need not appreciate, they just need to stop whipping around 2% a day in order for this to occur.  Result: gold lower.

Recommendation: Sell the rips in gold against your long equities/risk-on assets.

Silver: Only If Fundamentals Change
The worst trade of all is the gold/silver ratio trade.  That is a total punt.  Silver is part industrial metal, and part precious metal.  Which one dominates is anyone's guess, unless you know something VERY specific about the supply/demand equation that isn't reflected in the market prices.
If you want a hedged position with volatility, I'd prefer Gold/Copper, or Freeport McMoran ($FCX).  It is very, very interesting that FCX hasn't participated in the recent 70 handle increase in the S&P.  The experts call that "divergence," ie when there are conflicting signals.  The all-out green light will be if FCX starts to run, but if it starts to drop (and XLF stays muted), then it could be time for a reversal and more volatility ahead.