© Bloomberg
I’ve felt for a while now that stocks have been a bit overvalued. One needs to look no further than historically-high cyclically-adjusted price-to-earnings (CAPE) ratios to see that similar levels in the past have been followed by steep declines, namely during the Great Depression and the Dot Com Bubble.
I’m also well aware that it is nearly impossible to time the market, and harder still to predict the magnitude of a draw-down when it happens, whether it be 15%, 50%, or 90%. I do have a (limited) understanding of Nassim Taleb’s theories of antifragility, where systems get stronger, not weaker, as they’re exposed to stressors, and it’s an excellent approach to take with one’s portfolio.
With this in mind, it’s important to remember stocks/equities are not the only investible financial instruments out there and that there are in fact alternative asset classes, such as bonds (“fixed income”), commodities (oil, soy beans, cattle, etc.) and precious metals. These asset classes may have inverse correlations to equities and thus may serve as appropriate hedges to stock market exposure.
Traditionally, bonds have been the asset of choice in times of uncertainty when investors have fled to safety. These days, however, bonds have rallied to the point of reaching negative yields. Hedge funds have been able to turn a profit on these bonds- they are, after all, rising in prices- but I can’t help but think they’re playing a game of hot potato as eventually investors will decide paying custodians to hold cash is a better proposition than ensuring losses through negative yields, and ultimately the last fund “holding the bag” will suffer painful and inevitable losses.
That brings us to gold. The US is finding itself in an increasingly precarious fiscal position as its payment obligations continue to exceed its tax receipts. To keep up, it may need to print more money and continue to keep interest rates low, which will erode confidence in the dollar and cause international investors to shift to non-dollar reserve assets, including gold.
Appetite for gold has already increased, as shown by the doubling of demand for the precious metal compared to the same quarter last year, fueled by buying by ETFs and investors buying gold bars and coins directly.
I’m not saying go all-in on gold, but it is definitely an asset to keep an mind when looking for alternatives to equities.