Gold might be the “Trade of the Decade”… just like it was during the first 10 years of the current millennium.
During that entire decade, I had the pleasure of working alongside Bill Bonner, the founder of our parent company, to produce a quirky financial blog called the Daily Reckoning.
Although we covered a broad range of topics over those years, we continually revisited our “Trade of the Decade,” which Bill first introduced in 2000.
“Buy gold” was the first half of this trade. “Sell stocks” was the second half.
This Trade of the Decade provided a great thematic backdrop for everything we would write about during that eventful time frame. We would write about the coming housing bust, about runaway government deficits, and about lots of other things that provided very few reasons whatsoever to buy stocks, but plenty of reasons to buy gold.
Of course, not every investor embraced this trade with enthusiasm. In 2000, gold had been an undeniable loser for the preceding 20 years and seemed destined to forever remain a “barbarous relic,” as British economist John Maynard Keynes famously scorned the yellow metal.
At the start of the millennium, as you may recall, the dot.com bubble was propelling stocks to spectacular heights — producing millions of day-trading geniuses.
Making money in the market seemed so effortless, and so automatic, that few investors bothered to consider poorly performing alternatives like gold.
But just as nature abhors a vacuum, the financial markets abhor an extreme. And that’s exactly what the financial markets were serving up in early 2000 — extreme bullish sentiment for stocks and extreme bearish sentiment for precious metals.
These extremes were reason enough for a contrarian-minded investor like Bill Bonner to take the other side of those trades.
A Reversal of Fortunes
As we now know, that two-part trade performed brilliantly! From the end of 2000 through the end of 2010, the gold price soared more than 400%, while the S&P 500 Index fell 6%!
Even after including dividends, the S&P 500 returned just 14% during those 10 years.
Not surprisingly, after such a spectacular decade for gold — and such a miserable decade for stocks — these two inversely correlated assets were due for a reversal of fortunes.
And that’s exactly what happened.
Gold topped out in 2011 and drifted lower for the ensuing seven years. The stock market, on the other hand, continued powering higher from its 2009 low.
This most recent decade has not quite run its course. But the divergent fortunes of gold and stocks are clear.
Obviously, there is nothing scientific about measuring investment returns decade-by-decade. The financial markets do not follow the Gregorian calendar; they follow and/or anticipate financial trends.
But the two 10-year time frames I presented clearly illustrate the tendency of financial markets to cycle from lows to highs, and back to lows again. And as it happens, gold and stocks tend to cycle inversely from one another. Gold tends to move higher when stocks are moving lower, and vice versa.
At the moment both gold and stocks seem to be anticipating good things to come. They are both in rally mode.
Let’s hope that continues for a good long while. But the gold rally may be more long-lived and powerful than the stock market rally. In fact, I expect the yellow metal to perform better than the overall stock market from now until the end of 2030.
But please don’t bet the farm on that forecast! It’s hard enough to guess what might happen tomorrow, much less 10 years from now.
Let’s look a little deeper into this long-term guess …
What’s Bad for the Dollar Is Good for Gold
For starters, Federal Reserve Chairman Jerome Powell reiterated on Thursday that he and his Federal Open Market Committee colleagues intend to hold interest rates close to 0% and to maintain the Fed’s “easy” monetary policy for years to come.
That posture is great for gold, mostly because it is negative for the U.S. dollar. After Powell’s comments yesterday, the dollar tumbled close to its two-year low.
The trillion-dollar stimulus plans of both Republicans and Democrats could put additional downward pressure on the dollar.
In other words, both politicians and the Federal Reserve will be providing tailwinds to the gold market as we head into 2021.
Those same tailwinds will likely propel stocks higher as well … at least initially. But as the stock market moves deeper into the decade, it may encounter the powerful headwind of high valuations.
The U.S. stock market isn’t cheap, at least not based on traditional market metrics.
To be sure, the market contains hundreds of truly exciting stocks that will thrive over the next several years. But in aggregate, the stock market is pricey.
In fact, according to one high-profile valuation metric, known as the “Buffett Indicator,” U.S. stocks hit a record-high valuation last month – nearly double the average readings of the last 45 years.
According to this nifty indicator, which Warren Buffett has praised as “the best single measure of where valuations stand at any given moment,” a stock market is relatively cheap whenever its total capitalization (i.e., the total market value of all stocks on the exchange) drops well below 100% of GDP. Conversely, a stock market is relatively expensive whenever its total capitalization climbs well above 100% of GDP.
At the stock market lows of 2008, for example, the market cap of all U.S. stocks plummeted to less than 60% of national GDP. From that extreme bear market low, the S&P 500 Index soared more than 400%.
But now the U.S. stock market finds itself at the opposite extreme. The Buffett Indicator shows that the U.S. market cap totals a whopping 175% of GDP, which is nearly double the average readings of the last 45 years.
When stocks become this pricey, good things rarely happen. At the end of 1999, for example, the S&P 500 was trading at a lofty 144% of GDP. Over the next 10 years, the S&P 500 produced a loss of 9%.
Think about that: After one entire decade of investment, the stock market turned $100 into $91!
Clearly, price matters. It isn’t everything … but it matters.
Despite the stock market’s lofty valuations, all hope is not lost.
The market features an array of companies that are operating on the cutting-edge of revolutionary technological innovations — companies that have the potential to thrive over the coming years and to produce eye-popping share-price gains.
But selectivity is key to success. When stocks are trading at high valuations, investors cannot simply “buy the market” and expect to prosper … at least not for long.
Instead, I would suggest adding a bit of gold to your portfolio, and then invest selectively in the companies that possess unique potential to establish themselves as the technology leaders of the coming decade.
On the date of publication, Eric Fry did not have (either directly or indirectly) any positions in the securities mentioned in this article.
Eric Fry is an award-winning stock picker with numerous “10-bagger” calls — in good markets AND bad. How? By finding potent global megatrends … before they take off. And when it comes to bear markets, you’ll want to have his “blueprint” in hand before stocks go south.