Europe Mess Makes Risk Valuation Key

12/19/2011 8:15 am EST

Focus: MARKETS

Peter Way

Founder and CIO, Peter Way Associates

As long as Europe continues its one-step-forward-one-step-back solution to its economic challenges, US investors need to measure the risk of their current and potential investments, says Peter Way of Block Traders' Oil & Gold Monitor.

The Euro problem has lots more arm-twisting ahead of it. The 17 nations called the Eurozone that signed up for a common currency are now recognizing that currency sovereignty and political sovereignty are inescapably intertwined in the 21st century’s dash into global commercialism.

If everyone has a strong sense of responsibility and a common set of values in playing the game, then no real problems are likely to persist. But evidently some candidates from the 27-nation EU from the outset had a premonition that problems were inevitable.

The most obvious doubters are the UK, Sweden, and Denmark. Two that have absolutely no such appetite for either the EU or the EZ are Switzerland and Norway. The traditionally “neutral” Swiss are no surprise, and the economically independent Norwegians (thanks to North Sea oil) start to define the lines of demarcation not so obvious to many on this side of the pond.

The EZ countries challenged by weak national fiscal disciplines have so successfully exported their limitations to the other 10 to 12 that the whole boat is about to sink. The current hope of those facing that economic setback is that they can reach outside the EZ to find sufficient concern that the domino effect will not be limited just to them.

The game, on a national scale, is a lot like log-rolling in the US legislatures. And it will be played politically for the most part, rather than economically. Or in a Texas-hold-‘em game.

But then, I remember the comment to me of a well-known US economist in my early days in this business. He said “Only in the US do they teach economics—everywhere else, they teach Political Economics.”

For US citizens and investors, the threat is that the current administration in power in DC may get convinced that without Uncle Sugar coming to the rescue, the impact on the whole world will be worse than any minor inconveniences that might arise if we do.

When that conviction comes about, if it does, we can be sure that it will only be admitted to sometime after November 2012. With a transparency like that ultimately evidenced about the bank bailouts.

Meantime, the transaction ratio between gold and the US dollar may become dramatic. At least enough thinking financial professionals have that concern that significant potential continuing price gains in precious-metals securities make them among the most attractive current choices covered by this letter.

Our prevailing guide is “what is the cost of insurance against being on the wrong side of a proposition?” With stocks and ETFs, that is, fortunately, a more clearly discernable burden than in several derivative markets, where there is no disciplined and comprehensive clearing operation.

We know how to turn those listed options premiums into rational boundaries for prospective prices of the underliers being optioned. And we have been doing it consistently long enough to have background data collected each market day of this century. For many stocks, over 3,000 such evaluations provide a sense of just how likely it is that today’s implied forecasts may come to pass.

Combining the odds for price gains or losses with the average payoffs typically experienced following the kind of balance between price upside vs. downside now seen provides a helpful common risk-balanced metric. And balancing risk is what it's all about these days.

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