Oh, how quickly everything can change.
There really are no winners when the market drops, unless you are one of the few people left trying to short stocks in a reckless bull market that loves to find shorts to squeeze.
Yet, I have to admit I got quite a kick out of watching the market collectively freak out over the last two and a half months.
I wish I could say that there isn’t a smug component to it, but part of it is the vindication of what we have been discussing for years while the “pros” mocked caution and moderation at the Fed-spiked punch bowl that has been fueling the stock market party for many years.
It is encouraging to see exactly what we’ve been talking about all year suddenly find space in the editorials and articles of Reuters, Bloomberg, and The Wall St. Journal.
Headlines talking about dangerous valuations, volatility being here to stay, and intrinsic flaws in Fed policies are springing up everywhere, and were all but unimaginable in early January.
Another reason I got a kick out of it was watching the market march to a drum that isn’t played by the Fed. For once, a major market theme emerged that hadn’t been clearly obvious for months or years to anyone with a bit of foresight.
Sure, the Fed is still a major factor in market behavior, but it seems like investors are realizing this is less of a parade and more like a game of musical chairs.
We’re not all marching together. The Fed isn’t keeping everyone in formation as we head off into a brighter future together. It is picking winners.
Investing is a zero-sum game and when the music stops, people lose. Sometimes it is a lot of people.
A nine-year bull market made a lot of people forget the rules of this game, and a little uncertainty really rustled their jimmies.
Though we may have an advantage of being ahead of the curve on the big picture in these regards, all of this doesn’t really do much for us unless we find an application for our knowledge.
We need our money in something, and one sector stands out right now.
The Fundamentals
People like to look to macro events to explain things, but their influence is normally overestimated.
For a lack of anything else to do, we’ve turned back to our old Cold War targets, Russia and China, as the boogeymen. I certainly won’t defend either, but let’s be real about this.
You have to trust fellow citizens to try to vote in their interest. Democracy is mutual trust. And, quite frankly, we as a nation can hardly point fingers when it comes to throwing a bit of money at a foreign election and seeing if it sticks.
Then there is the “new” trade war with China. Which is actually just a continuation of the same one that has been happening for decades. $50 billion on each side is a rounding error compared to both nations’ GDPs. Plus, we’ve been continuously fighting each other in the WTO for decades.
The real problems facing the domestic stock market are the fundamental mismatches in the domestic stock market.
Market gains have dramatically outpaced economic growth and index revenue growth for close to a decade.
Stock buybacks executed at all-time-high stock prices have painted a rosier picture in quarterly financial statements and headline metrics, along with unsustainable cheap debt that has swallowed more and more corporate cash flow at the expense of capital expenditures.
The market is sobering up and realizing that long-term growth isn’t going to catch up for quite some time. More and more investors are realizing that they haven’t priced in the kind of boring day-to-day risk that comes from company press releases and financial statements instead of attention-grabbing headlines.
This isn’t even a “new normal” thing. It has been going on for half a century.
Take a look at this chart of historical data from economists at Fulcrum Asset Management:
Gains Return to Gold
So equities investors are reassessing the risk baked into years of front running the economy, only to discover that the economy can’t grow much beyond inflation rates these days.
That leaves gold in a pretty unique position right now. The gold market has shed speculators who helped fuel massive price rises through 2011, then fled to equities to chase gains.
The best-in-breed gold mining companies are leaner and meaner than they have been for years, if not decades, and are returning strong cash flow and revenue numbers.
Debt is contained, and acquisitions are picking up.
Essentially, gold miners went through a painful period several years ago and are now reemerging, right as the broader market is approaching the same painful cycle: Contraction, wealth and debt destruction, then recovery.
As compared to the market, prices are very appealing as well. Take a look at the Dow-to-Gold Ratio since the market bottomed in March 2009:
At about 18 ounces of gold per point in the Dow, the last time gold was this relatively cheap — or the Dow this relatively expensive — was right before the equities market crashed.
In other words, there is a lot of room for gold to go up and provide a windfall to gold miner investors, or for the Dow to drop and push gold miners that are pegged to gold prices, rather than broader market movements, into market-beating performance.
There are bullish trends the rest of the stock market simply cannot match these days:
- Long-term demand growth, while equity market inflows dry up and people sit on the sidelines
- Vastly improved balance sheets for gold miners after the sector correction
- Strong demand for late-stage exploration projects after years of neglect
- Upswing in acquisitions to replace depleted reserves heading towards dangerously low levels
In a stock market that has so dramatically outpaced economic, revenue, and profit growth, there is a lot more risk than many investors risk already baked into the market.
To keep that risk in check and outperform a vulnerable, sideways-trading, wildly volatile market, gold is the way to go.
