Saturday, December 20, 2008

Taking out the trash

And trash is the best way to describe the mantra of "buy and hold stocks for the long term." This is very misleading, wrong, and inappropriate advice, yet it is dispensed as sound advice for retail investors and taught in academic finance courses. An example of the fallacy of this proposition is about to be painfully experienced by millions of American (and global) investors.

General U.S. stocks, using the proxy of the Dow Jones Industrial Average, are in a wicked bear market that is absolutely not over. Before this bear market is over, the Dow Jones average should fall below 6000 and it might be significantly lower at some point during the ongoing readjustment of stock prices.

Gold, on the other hand, is in the midst of a secular (i.e. measured in decades) bull market that should take the price conservatively to $2000/oz and potentially much higher. The gold price is currently near the end of a normal corrective phase in its bull market.

Cash is the place everyone is clamoring to be right now, but I think even novice investors know cash is a dangerous long-term investment option due to inflation.

Stocks are risky, but no risk no reward, right? Holding gold is silly because it doesn't pay dividends and has no growth potential, right? Well, let's look at the potential 100 year returns for stocks, cash and gold. I am picking 1913 as the start date, because this is the year we gave a no-bid cash printing contract to the [not so] Federal Reserve and it will give us nearly 100 years of data.

The assumptions I am asking you to swallow are that the Dow will reach 6000 in the next few years and gold will double from its closing price yesterday. I know there are no guarantees in life, but this is a very conservative estimate of what's to come. If this occurs as predicted, then the roughly 100 year returns will look like this:

Now, the effect of dividends for the Dow was ignored for this calculation. If we assume a 4% dividend yield (generous assumption and clearly hasn't been the norm over the past 20 years) over 100 years, this would make the return for the Dow closer to 7300%, still far less than gold. Don't forget also that until roughly 20-30 years ago, you had to buy individual stocks in the Dow and couldn't buy mutual funds or ETFs, so the company risk was much higher and companies would come and go from the index.

This table carries a powerful message that is about to get very loud in our lifetimes: burying pieces of metal in your backyard can be a better way to plan for your retirement than general stocks. The data doesn't lie. Please do not forget the Dow to gold ratio chart, which predicts a return to a one to one ratio where the price of one ounce of gold will equal the "price" of the Dow Jones Industrial Average. This would make the returns on gold obscenely higher than the Dow Jones over the past 100 years!

Do you think you'll ever see a table like this on Cramer's show? How about Suze Orman's show? Maybe in one of Ben Stein's columns or on CNBC?

For the skeptics out there, how about an actual long-term example from history? How about 1913 to January 21, 1980, the day the gold price reached roughly $850/ounce? The high (not the closing price) for that day in the Dow Jones was 880. Using the table above for the 1913 prices yields a 67 year return on the Dow of 980%, though if you include a 4% average annual dividend yield your return would be more like 1350%. Gold had a 67 year return of 4100%! Any questions?

In the gold versus paper debate, gold is about to show once again how delicate the pieces of paper backed by the promises of Wall Street, bankers and bureaucrats really are. Buy and own some physical gold coins and/or bars to anchor your investment portfolio. Hold this physical metal yourself and keep it out of the hands of those who make promises too easily and fail to consider how they will make good on those promises when times get tough. It is the one investment choice for a long-term buy and hold philosophy that currently makes sense.

Wikinvest Wire