The Longer It Takes, the More Dramatic the Reversal

June 13 2014

A lot of gold investors are disgruntled. The emotional pain involved in seeing ones gold holdings decline in value while stock and bond markets are reaching a phase of full-fledged exuberance proves to be too much for many. At such extremes, however, a reversal will be hefty. As markets become stretched far beyond their fair limits, a reversal will be deeper and take a greater toll on a majority o

The Longer It Takes, the More Dramatic the Reversal

A lot of gold investors are disgruntled. The emotional pain involved in seeing ones gold holdings decline in value while stock and bond markets are reaching a phase of full-fledged exuberance proves to be too much for many. At such extremes, however, a reversal will be hefty. As markets become stretched far beyond their fair limits, a reversal will be deeper and take a greater toll on a majority of investors.

In addition, with the passing of time, the odds of a major correction in stock markets and/or bond markets reset and increase continuously. Although mentally it can be tough to go against the crowd, especially when you are at a rather big loss and other investments seem to boom, it is the right thing to stick to your guns.

Investing: Disagreeing with the Market

The only way to make investment profits is to disagree with the market. An intelligent investor bases his decisions on the fact that participants in the market are, to some extent, wrong, and that current asset prices do not reflect what will unfold in the future.

Take European bonds. The Spanish and Italian 10 year bond yields went below the 10 year US bond yield. The market, it seems, thinks that US bonds and the dollar are more risky than European bonds and the euro. What do we do as investors when we disagree with such a thesis? We could sell Spanish and Italian bonds short or, at least, abstain from buying them. By acting in this manner, we influence the price structure of the market and, if our judgment is correct, profit from a readjustment of prices.

The act of investing is necessarily an expression of disagreement with other investors.

Gold: Time to Disagree with the Market

While 2011 was the year to disagree with the overly bullish gold sentiment, now it is time to disagree with the market on the overly bearish gold sentiment. Doing it the other way around is a dead-end. You will sell precious metals at their bottom and buy other assets at their very top: a disaster recipe for investors.

Investors tend to move with the herd, however. Consider though what famous investor and commodity trader Jesse Livermore once wrote: "It never was my thinking that made big money for me. It was always my sitting. Got that? My sitting tight!"

Who Are Actually Still Buying Stocks?

The answer is pretty straightforward and tells a lot about in which phase of the cycle we are at. Let’s call it a mania. Stocks are driven higher and higher on low volume and on corporate stock buy backs. Last month revealed one of the highest stock buy backs in history and stock buy backs have been elevated for some time. With cheap financing it is beneficial to borrow cheap money and lever a company up with debt, while at the same time decreasing the number of outstanding shares.

However, it should be clear by now that these companies do so at the worst possible time. Stock prices are elevated across the board and managements overpay for their own stock: they’re wasting precious capital. Yet it means, for now, that stock prices are pushed up to even further heights, stretched further from any fair valuation.

Message is Simple

The message is simple: don’t get discouraged if markets are slow to adjust. Investing should not be based on false optimism, i.e., “tomorrow will be better”, and when tomorrow is not better, “next week will be better”. It is a waiting game; waiting until asset markets readjust to reflect reality. Waiting can take little or long, but as Jesse Livermore would remind us, “sit tight”, gold investors.

Newsletter

Sign up for our periodical newsletter to stay informed about the gold and silver markets and special offers.