Saturday, November 1, 2008

Getting ahead of the curve

Gold stocks are forming a base right now from which to start a powerful cyclical bull market that should last 3 or more years. General stocks are forming a base for a bear market rally that will last 2-5 months and then the general stock market bear will continue. You want to buy gold stocks or stay in cash or cash equivalents (gold or short term U.S. government bonds of 5 years or less duration) and you want to avoid stocks like the plague unless you are a trader looking to play the bear market rally bounce before the next plunge that will begin in the spring.

For longer term investors, the time to act is now. Forget "buy and hold forever" and forget "long term, the stock market always goes up." This is only true if you have a 50 year investment horizon, meaning it's only true if the fact that you'll be dead by the time you make money in stocks is of no concern.

Investors who bought in 1929 waited until 1955 to break even again (26 years). Investors who bought the Japanese stock market at the beginning of 1990 are down 78% in 2008 (18 years later). The year 2000 in the United States is the equivalent of 1929 here or 1990 in Japan. Get over it and adapt or lose all your hard-earned investment money.

Gold stocks or cash are the place to be for the next 2-3 years. Cash will be safe and gold stocks will make you money. Real estate, general commodities and the general stock markets are going to get crushed. Gold stocks do well during a contractionary / deflationary environment. If you know this, you don't fear the coming recession as an investor, you simply switch your investments accordingly. The stock market crash is already telling you what happens next in the economy.

Mark my words: the retards on TV are going to pretend to be surprised at the massive lay-offs and economic contraction coming. However, the stock (and bond) markets have already told you what's coming in the "real" economy: a crash.

Let's forget the bulltards in fantasy-land and get ahead of the curve by looking at the gold to oil ratio to see what's coming next for gold miners' profits:

Since energy and labor are major mining costs and the cost of energy and labor are going to fall much faster than the price of gold, gold miners' profitability will rise. This is the same concept as the "real" price of gold using a gold to commodities ratio. Additionally, the price of gold should turn around soon and start going up again. This means a higher price for the product they sell and lower costs of production. Basic market talk 101: profits will expand, dividends will increase, and the stock price will rise to reflect the increased profits. Gold mining is a difficult business and not all gold miners will do well, but a basket of blue chip gold miners will do great with very little risk due to diversification (translation: buy ticker symbol GDX).

Look at how gold miners performed during the last contractionary bear market from 2000-2003:

If you switched from general stocks (the S&P 500 indicated by the red and black squiggles in the chart above) to gold miners (GDX indicated by the smoother black line in the chart) once it was clear the bull market in stocks was over, you not only preserved capital, you made money. The NASDAQ lost a lot more than the S&P 500, but we're going to ignore that here.

Take two investors that used or ignored this strategy and didn't get the timing right (notice in the chart above that the exact tops and bottoms for stocks and gold miners were not used), both starting with $50,000.

Investor#1 listened to Cramer and Ben Stein and Suze Orman and held on for the long term. He/She lost 40% and ending acount balance was $30,000.

Investor#2 went against the buy and hold crowd and sold general stocks and bought gold stocks. He/She gained 100% and ending account balance was $100,000.

Investor#1 in this example would now need a gain of 233% to catch up to investor#2.

Take home message: sell general stocks and buy gold stocks. If you're too scared to take the plunge (or your crappy retirement fund doesn't offer the ability to buy gold stocks), sell your stocks and get into cash or short term U.S. government bonds. If you believe centuries of history contain more wisdom than Bernanke and Obama or McCain's brains, buy some physical gold as portfolio insurance and hope you don't need it (hint: you will).

Wikinvest Wire