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The Risk vs. Reward Equation Strongly Favors Gold over Common StocksDr Richard
Appel
The Dow Industrials are leading U.S. common stocks higher by extending their multi-month advance, and are threatening to ultimately better its all-time high. Gold on the other hand appears to many to be on the cusp of again breaking down to test its May $372 low, and possibly fall to even lower levels. Yet, despite what most investors expect or believe, all may not be as it seems. The U.S. stock market has been trading for an extended period within a relatively narrow band. For nearly nine months it has ranged between a low of about 9,800 with10,800 as its upper limit. Historically, times marked with such low price volatility have been preludes to major, extended, market movements. As I discussed in the last issue of Financial Insights, "The last time that a similar narrow price range transpired was in 1996. Then, common stocks backed and filled across an eight month time-frame, when the Dow Industrials were held between about 5,200 and 5,850. When the Industrials finally broke above the upper trading limit it rapidly moved higher. Its first stop was above 7,000 before a short correction occurred, and the rest is history." Another month has now passed and common stocks have continued to remain range-bound. They have refused to render their verdict. Both the bullish and bearish forces continue in what may prove to be an epic struggle to see which group will be victorious. And, when either the upper or lower limits of this 9,800 to 10,800 range finally give way, the market's decision and the victor will be announced. Long periods of low price volatility are typically replaced by those exhibiting great price movements. In retrospect, these quiet times occur when the market is attempting to sort out its true underlying direction. When extended, sideways moving markets appear it is as if all of the players are struggling to determine which group, whether bull or bear, has the upper hand and is correctly aligned with the market's underlying secular trend. First the bulls gain control and bid prices modestly higher, only to be followed by the bears leaving their lairs to move stock prices lower. This repeated alternation occurs within a tight price range and functions to wring the earlier excitement out of the market. Such times produce restrained price movements with their accompanying declining volumes. I believe that both our government and the Federal Reserve have done their best to keep the stock market bubble sufficiently inflated in their effort to prevent the economy from softening, and to help our residing officials remain in office. As we approach the November election the odds are increasingly favoring that they will succeed in both of these goals at least until after all of the ballots have been counted. However, despite the unprecedented increase in our monetary aggregates, the effect of generational low interest rates, as well as the ubiquitous official pronouncements attesting to our strengthening economy by government and Federal Reserve officials alike, the market still cannot explode to the upside. They have succeeded in preventing further market weakness, but the question remains unanswered if all of their efforts are only temporary palliatives, and are ultimately doomed to fail. As long-term readers know I am convinced that U.S. equities have entered a major secular Bear Market. As night follows day, all Bull Markets are followed by Bear Markets, and the larger the earlier bull one the more vicious has been the following Bear Market. To my mind, January, 2000, was the month that America's greatest Bull Market breathed its last breath. That was when the Dow Industrials posted their final highs. The Bull Market had its birth in late 1974, at a Dow low of 577. The ensuing 27 years witnessed the unfolding of an incredible Dow Industrial advance to11,722. Think about it! The Dow Industrials rose twenty-fold over this period while more speculative stocks fared even better. When is enough, enough? True, stock valuations have already weakened. Yet, the price earnings ratio of the S&P 500 is still above 20 and its dividend yield remains well below 2%. These parameters have historically marked Bull Market peaks rather than the hoped and prayed for beginning of a new Bull Market, upon which most investors are staking their financial futures. For this reason, given my experience and stock market knowledge of the great American Bull and Bear Markets, to even hope that the breaching of the upper band at 10,800 will lead to a renewed Bull Market represents little more than believing in the tooth fairy. Gold and gold stocks on the other hand have labored since gold posted its $252.50 Bear Market low in August,1999. It then rocketed higher and touched the $325 zone a few short months later, after the Washington Agreement which announced. That accord, underwritten by fifteen major central banks, limited their gold sales and gold leasing for the following five years. From that fleeting high point the noble metal again dashed the hopes of its adherents, only to strike a double bottom low at $255 in January, 2001 The ensuing three and a half years of gold's renewed Bull Market saw it painfully drudge higher amidst verbal scorching attacks. These made all who would hear gold's deriders, believe that gold was needed for little more than to be used in jewelry or to fill one's teeth. Further, the yellow metal also was forced to endure additional outside influences that stifled all of its price advances. This was recently chronicled in the excellent, detailed account entitled, "Not Free, Not Fair: The Long-Term Manipulation of the Gold Price" by John Embry and Andrew Hepburn. Despite the fact that gold has moved over 60% higher in price and numerous gold stocks have performed far better during this time, few other than the diehard gold bugs are today invested in the gold universe. Gold is no longer pressured by the decade plus long gold producer hedging practice. Similarly, the central banks have reduced their sales and the amount of gold available for leasing. These all acted to increase the amount of gold offered on the market and helped suppress any upward gold price movement. Today, the gold producers are actually reversing their positions and are reducing their hedges. This acts to reduce the amount of available gold and will help stimulate a rise in gold. Further, gold has been in a supply deficit for a number of years which is threatening to worsen. World gold production is on a decline and given the results of a World Gold Council sponsored report last year, should continue for at least the next few years. Most importantly, the U.S. government seems determined to maintain or expand both its fiscal and current account deficits. These are the primary underlying factors that have weakened the international desirability of the dollar, and its value on the international markets. Additionally, if the U.S. continues on its path of $500 billion fiscal deficits, which appears likely, it will only further increase the desirability of gold ownership. The newly created dollars that will be needed to compensate for the government's taxation shortfall, will by supply and demand cheapen those dollars that already exist. I have heard from the time that I was a youth that humans are gregarious by nature; we tend to congregate and live together. However, what I learned later in life was that groups of people also tend to arrive at similar conclusions and hold like beliefs. Witness the countless historical episodes where a mob mentality or mania overcame disparate groups of people and drove them to act in a similar fashion. I believe that humans feel safer and more protected when we are members of a large group. I feel that this human quality also is the reason why the vast majority of individuals are not comfortable whenever they are either acting or thinking differently from the majority. For this same reason, most investors feel safer following the herd, and do as the majority of those around them. I suspect that this is the primary reason why most investors feel locked into owning common stocks and similarly shun gold investments without fully investigating with an open mind, the reasons for owning either investment class. Unfortunately, if I am correct, the passage of time will render losses, to the vast majority of those who follow the herd mentality, which may ultimately pale those that they have already suffered. There is no question that common stocks may break into new all-time high territory. Similarly, it is possible that gold and gold equities may move substantially lower. However, I approach investments with a constant eye upon their risk versus reward potential. I am a risk taker, but whenever I contemplate entering an investment I first do my best to discern the likely reward and compare it with my potential loss. The greater my perceived risk, the larger the percentage gain that the trade must offer. Further, I constantly reevaluate my investment as new information becomes available, review my original premises, and act accordingly, even if it means that the best action is to exit my position. In this fashion I have the greatest likelihood of achieving investment success over my lifetime. Despite what we hear and read, common stocks are trading at such historically overvalued levels that the greatest likelihood is for their valuations to move to areas where they are truly undervalued. This will entail sharply lower across the board prices where P. E. ratios will be eight to ten or lower, and dividend yields will surpass 5% and likely 6%. Gold on the other hand is not only in a confirmed Bull Market but it remains the black sheep of the investment world. I for one prefer to acquire my major positions in asset classes that simultaneously offer great value and are unrecognized by the crowd. I have often had to wait for the masses to recognize what appeared obvious to me. However, when they finally awaken to the undervalued nature of the investments that I had earlier found, they seem to simultaneously pour into them with abandon. I believe that the time is fast approaching when the masses will liken common stocks to the plague. Simultaneously, they will return gold to its centuries old position as the only true money, and clamor for its ownership. It is not too late to sell your common stock positions and invest the proceeds in either Treasury Bills or gold and gold stocks. Because if I am correct, the risk versus reward equation greatly favors those who invest in gold related investments. While the reverse is true for those who cannot separate from the crowd mentality, and who remain invested in common stocks. The above was excerpted from the September 2004 issue of Financial Insights ©2004. Dr Richard
Appel I publish Financial Insights. It is a monthly newsletter in which I discuss gold, the financial markets, as well as various junior resource stocks that I believe offer great price appreciation potential. Please visit my website www.financialinsights.org where you will be able to view previous issues of Financial Insights, as well as the companies that I am presently following. You will also be able to learn about me and about a special subscription offer. CAVEAT I expect to have positions in many of the stocks that I discuss in these letters, and I will always disclose them to you. In essence, I will be putting my money where my mouth is! However, if this troubles you please avoid those that I own! I will attempt wherever possible, to offer stocks that I believe will allow my subscribers to participate without unduly affecting the stock price. It is my desire for my subscribers to purchase their stock as cheaply as possible. I would also suggest to beginning purchasers of these stocks, the following: always place limit orders when making purchases. If you don't, you run the risk of paying too much because you may inadvertently and unnecessarily raise the price. It may take a little patience, but in the long run you will save yourself a significant sum of money. In order to have a chance for success in this market, you must spread your risk among several companies. To that end, you should divide your available risk money into equal increments. These are all specula-tions! Never invest any money in these stocks that you could not afford to lose all of. Please call the companies regularly. They are controlling your investments. FINANCIAL INSIGHTS
is written and published by Dr. Richard Appel and is made available
for informational purposes only. Dr. Appel pledges to disclose
if he directly or indirectly has a position in any of the securities
mentioned. He will make every effort to obtain information from
sources believed to be reliable, but its accuracy and completeness
cannot be guaranteed. Dr. Appel encourages your letters and emails,
but cannot respond personally. Be assured that all letters will
be read and considered for response in future letters. It is
in your best interest to contact any company in which you consider
investing, regarding their financial statements and corporate
information. Further, you should thoroughly research and consult
with a professional investment advisor before making any equity
investments. Use of any information contained herein is at the
risk of the reader without responsibility on our part. Past performance
does not guarantee future results. Dr. Appel does not purport
to offer personalized investment advice and is not a registered
investment advisor. The information herein may contain forward-looking
information within the meaning of Section 27A of the Securities
Act of 1933 and Section 21E of the Securities Exchange Act of
1934. In accordance with the safe harbor provisions of the Private
Securities Litigation Reform Act of 1995, the statements contained
herein that look forward in time, which include everything other
than historical information, involve risks and uncertainties
that may affect the company's actual results of operations. ©
2004 by Dr. Richard S. Appel. All rights are reserved. Parts
of the above may be reproduced in context, for inclusion in other
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