Buy Gold Now: High Reward, Low Risk

November 25, 2015

First things first: Dr. Strangemarket is not a gold bug or a conspiracy theorist. Above all, the goal of this website is to provide realistic and practical commentary about the markets. And quite simply, financial markets have now reached the point where gold offers a combination of low risk and high reward that seems almost impossible to find in any other major financial asset right now.

So many assets appear wildly overvalued right now. Think about it this way: Is the US or world economy really in better shape right now than it appeared to be say 10 years ago, before the Financial Crisis? Of course not! Anyone with a little bit of common sense can tell you that. So why are stock prices higher than they were 10 years ago? Apparently because of faith in central bankers keeping interest rates low, keeping debt cheap to prop up companies in a weak or shaky financial position. Um, you may fairly ask, why should anyone have more faith in bankers now than before the Financial Crisis? Good question! Again, anyone with a little bit of common sense can tell you it doesn't make sense.

That in a nutshell is the great danger of owning stocks as your main investment for retirement or anything else. They could hold their value, or go higher as they have in the past, but they could just as well lose 90% of their value in a crisis, and next time they may never recover the way they did after 2008. There is no guarantee, legally or otherwise, that you will ever get that investment back. Even though every stock fund prospectus formally states these risks and warnings in the fine print, and classifies stocks as a higher risk investment asset, the extent of these risks is rarely emphasized and far too few everyday investors are as aware of the risks as they should be.

Bottom line: Stocks are a high risk investment, and right now the risks appear greater than ever.

Real estate is a much better long-term investment than stocks: land has a real lasting value that a share of stock in a company that may or may not survive simply does not have. But right now, real estate has become overvalued again, so in the short-term and medium-term, it is also a high risk investment. Take a look at the most popular real estate fund for investors today, Vanguard's Real Estate Investment Trust (REIT) fund with the ticker symbol VNQ. Its market value in 2015 has returned to the same range that it was back in late 2006 and early 2007, before the subprime mortgage housing crisis broke out. Housing and real estate probably won't be the center of the next crisis, but at the current high values there is once again plenty of room for prices to fall dramatically.

So for now, real estate is a high risk asset, especially if it's in the form of a REIT fund traded on the market rather than actual physical land.

US Treasury bonds are a much safer investment. Dr. Strangemarket is bullish on Treasury bonds: that's why this blog is named after them. But bonds cannot be considered a high reward investment, because Treasury bond prices have already increased so much, as yields have fallen, over the past 34 years.

Many "value investors" have eagerly gone bargain hunting in energy stocks and commodities over the past year, since the price of oil and other commodities collapsed in the fall of 2014. It looked like the perfect combination of low risk and high reward. The problem is, no stock price or commodity price is ever so low that it can't go another 50% lower. Oil, energy, and commodities looked like bargains a year ago, but they have gone even lower since then, much lower. Have they bottomed out now? Probably not yet, since financial markets have not yet fully realized and priced in the extent of the weakness of the global and especially of the US economy. So as low as their prices already are, they still must be considered high risk assets.

Gold appears distinctly superior to all of these assets right now, for the combination of low risk and high reward that it offers.

The advantage of gold is that its price can rise along with commodities in bull markets or in inflationary periods, but its price does not fall nearly as much as commodities in bear markets or in deflationary periods, because of its status as a safe haven investment and a long-term store of value. As such, if you have the opportunity to buy gold at or near a low price point in the depths of a deflationary commodity bear market, you can gain the potential to reap the high rewards of the next upturn for what is very likely a relatively small downside risk. This strongly appears to be the point we are at right now.

The price of gold has fallen into the $1065-$1080/ounce range for the past week. $1000/ounce represents a huge technical and psychological support level for the gold price. In fact, in a certain way the transition of the gold price from under $1000/ounce to over $1000/ounce represented the shift from the pre-2008 to the post-2008 reality of the state of the world economy: Before the Financial Crisis, the gold price peaked at $983/ounce in March 2008, in the immediate wake of the crisis it reached $988 in February 2009, it touched $979 in May 2009...and finally in September 2009 the gold price blasted over $1000/ounce, went straight up to $1174 in November, and has never gone back to $1000 or lower since.

Dr. Strangemarket believes that this is very likely a permanent reflection of the post-2008 economic order. If the price ever fell below $1000/ounce into the 3 digits again, it's hard to believe that the price would not attract a great deal of interest from buyers around the world. So at the current price, the likely downside risk is limited to about 7% of your investment.

And on the upside, any number of financial, economic, or political events or crises could send the price of gold soaring again. In 2011 the $2000/ounce level acted as a limit on the gold price, and it peaked slightly under that level. In the next crisis, or in its aftermath, gold could easily test this price level again. And if it broke through $2000, there's no telling how high the gold price could go. $4000-$5000/ounce would become a realistic possibility.

Again, Dr. Strangemarket is not a gold bug. This is not a prediction or a guarantee or a recommendation that you put all or most of your wealth into gold. It is simply an observation about the current state of markets and assets and the likely risks and rewards of things as they stand right now.

Finally, Dr. Strangemarket does not want to tell you how to buy or invest in gold. Do your own research and decide for yourself. But I will mention one suggestion that you may wish to consider: the Sprott Physical Gold Trust, which trades on the market with the ticker symbol PHYS. It offers the convenience of an exchange-traded trust in a standard brokerage account, but unlike the popular GLD fund, PHYS shareholders own a claim to actual physical gold that is held in the Royal Canadian Mint. Again, this is just one of many options to consider, but I suggest you include it among the options in your research.

Good luck and be careful,

Dr. Strangemarket