I continue to maintain that the Fed’s unprecedented and extreme current policy stance has already been deceptively inflationary, will likely lead to significant inflation in the medium to long term, and should lead to an accompanying large increase in the price of gold. I also must acknowledge, however, that I fell prey to a false sense of certainty. The combination of the consistency of the gold price rise over the course of a long period of time, my early success in this area and the rationality and logical basis of the investment thesis caused me to make exceptions to rules that I always had followed – rules against excessive concentration and rules preventing me from venturing beyond stocks, my area of expertise and the category of investment that I like best for good reason. I will never make such exceptions again.
I had previously never invested in unproductive assets such as currency-based investments, preferring stocks because they confer ownership stakes in large, profitable companies, no different than owning a small business, rental real estate or a farm in terms of being productive. I made an exception for gold and silver, because I considered them to be the ultimate form of money and likely to perform better than stocks in a highly inflationary environment. Upon further reflection after an unfortunate experience, I have concluded that one must have respect for the current form of money, regardless of whether it is being abused and debased. We live in a dollar-based world, and until gold is reintroduced into the monetary system (the prospects of which are not guaranteed as macroeconomic developments are notoriously difficult to predict), it is really simply a collectible no different than say fine art in that ownership provides no income as it has no cash flows associated with it. Instead the owner is reliant upon another investor or speculator being willing to pay more for it, thus voiding valuation techniques.
With all of that said, it is worth repeating that I do still believe that the price of gold is likely to rise very significantly over time. I expect that my fund will benefit from this insight, but not via physical gold holdings. Instead our focus is on mining stocks, which are productive assets that can be valued on the basis of earnings, dividends and the historical relationship between these stocks and the spot price of gold – all of which does not necessarily require a forecast of the gold price or a very strong view about it. With long-term interest rates rising and reported inflation falling, gold very well may remain under pressure, but even in such an event I believe that the miners are still priced attractively enough to deliver solid returns.
Moving on to my stock market outlook, it remains strongly negative for all of the same reasons that I have been repeating for quite some time. Each month that the market moves higher, conditions continue to become more extreme – namely overvaluation and extremely complacent investor sentiment measures. This long uncorrected and quite mature bull market is also now showing a record high level of margin debt associated with it on an absolute basis, and on a relative basis compared with the size of the economy it is now right around levels that have only been reached twice before – 2000 and 2007, just before the two most recent major bear markets. Increasingly I hear people only tempering their enthusiasm with expectations of a correction, as if a full-blown bear market is out of the question. But when the crowd agrees on something, it is usually wrong. It is vital to remember that markets move in cycles.
On the last trading day of the month, there was a steep late-day sell-off as fears of the Fed tapering its easy monetary policy (unlikely), weak Chinese data, Japanese stock and bond market volatility and now suddenly rising interest rates all came to the fore. Perhaps this is the beginning of what I have been anticipating, or perhaps the final top has still yet to be reached. Either way, my outlook will continue to remain negative until hostile market conditions are cleared. Accordingly, my fund still retains a limited market exposure and a very large cash balance, presently just about half of the portfolio. With so much cash it is important to repeat again that cash that stands ready to be deployed quickly is a weapon, as compared to cash that is allocated as such which over time is guaranteed to lose out to inflation.
Despite such a dismal market outlook, I will always remain a bottom-up investor. While I am concerned about indiscriminate selling, even at times such as this there are still pockets of value (the most prominent example of such right now being the gold miners as discussed above).