Case in point GOLD
Followers of this Dow Theory blog know I am quite
skeptical as to investing along the secular trend. My post “Fundamental versus Technical analysis and Dow Theory. Who is right?” highlights the risks pertaining to investing
along the secular trend.
When I refer to “secular”
trend, I mean trends lasting at the very least 5 years or longer. Dow Theorist
Schaefer spoke of trends lasting up to 14 years. The longer the time horizon of
our investment, the more important fundamentals become. Conversely, technical
considerations become of negligible importance.
Thus, investing along the
secular trend forces the investor to make a judgment call about economic
conditions. Her technical analysis skills are of little avail.
However, the appraisal of
fundamentals is easier said than done, since we are fallible and our assessment
may be proven wrong. Furthermore, even when the initial economic assessment is
right, economic conditions are not static and change. Failure to adapt to a new
fundamental scenario will result in losses. If determining fundamentals was an
easy feat, then all investors would be successful. Of course, a similar
criticism can be made of technical analysis. The sad truth is that to excel as
investors (be it “fundamental” or “technical”) is not easy.
Thus, I see two terrible
risks when investing along the secular trend:
1.
One can be wrong (either from the start or as
conditions change).
2. Even when right, investments along the secular trend
are subject to wild swings resembling a roller coaster. The longer the time
frame the more likely one will encounter draw-downs. I have repeatedly written
than drawdowns can kill the investor: both financially and psychologically. In theory,
it is easy to “digest” drawdowns. However, when a drawdown hits, the fortitude
of the investor is really put to the test. Even the best psychologically
prepared investor may not survive the drawdown if he lacks other sources of
income and must tap on his investments.
Of course, astute readers
might object: “You can control drawdowns by using stops." However, the use
of stops is technical analysis, and accordingly stops negate the very reason for
investing along the secular trend, which is to let time to build up profits. If
you anticipate a secular trend lasting 10 years, and you get stopped out in the
second year because the market went down -14%, you are out.
One thing is clear to me:
the investor should not mix investment styles. Either you trade cyclical bull
and bear markets, as those determined by the “Rhea/classical” Dow Theory, in
which case the use of stops is part and parcel of the trading strategy, or if
you take a leap of faith and invest along the secular trend you cannot chicken
out when a drawdown hits, unless you think the fundamental thesis no longer
applies.
“[s]uch secular view, even when/if
proven right, is not a straight line. The investments recommended by Rogers
have experienced and will experience in the future tremendous draw-downs. This
is why Roger’s brilliance was not and will not be useful to 99% of investors.
Not all investors have the resources (i..e liquidity) and psychological makeup to endure draw-downs. Those "secular" market forecasts, even when right (and I tend to agree with Rogers), have to endure long nerve wrenching periods. Many investors lack the liquidity to endure a 60% draw-down or even worse the psychological fortitude to remain unaffected. Hence, they sell out at the worst possible time.”
Not all investors have the resources (i..e liquidity) and psychological makeup to endure draw-downs. Those "secular" market forecasts, even when right (and I tend to agree with Rogers), have to endure long nerve wrenching periods. Many investors lack the liquidity to endure a 60% draw-down or even worse the psychological fortitude to remain unaffected. Hence, they sell out at the worst possible time.”
Since I am painfully aware
of my own fallibility and my low ability to stomach draw-downs, I tend to
eschew fundamentally-based investments (or at the very least never go all-in).
Having said this, I must
confess that in life, we all must make fundamentally-based judgment calls. When
we choose a job or a profession, we are making an assessment of fundamental
conditions. Most of our daily decisions involve the assessment of fundamental
conditions. Technical analysis or the Dow Theory will be of little help.
Furthermore, real investing
is not as clear-cut as writing blogs. I know of no real investors that entrust
his/her fortunes 100% to technical analysis. We all have our, hopefully little
and contained, egos. Furthermore, allowing some measure of secular trend and
fundamentals may entail wise diversification away from technical analysis. Of
course, it is up to each investor to decide upon the percentage of one’s assets
to be committed to fundamentally-based investments versus technically-based
investments. Personally, the more I think I understand a fundamental idea, the
more faith I’ll have in it when it is put to the test, namely, when the
draw-down hits. However, since I am not omniscient, I am skeptical as to my
knowledge.
So, in real life, it can be
good practice to be aligned both with the secular trend for some very specific
investments and with the long-term trend as defined by the Dow Theory (1-2 years)
when it comes to investing in stocks.
Gold provides us with a real
time example as to how we have to conduct ourselves when investing along the
secular trend or merely the long-term trend.
Personally, I adhere to the
free gold thesis when it comes to the secular, fundamentally-based opinion on
gold. Free gold has nothing to do with the typical gold-bug, nor with making
gold money again. Gold is too important to be currency. Gold is the reserve
asset per excellence. Those interested in understanding the fundamentally-based
free gold tenets are advised to study intently Fofoa’s blog which you can find here
Thus, since I buy into Fofoa’s thesis (namely that
physical gold will eventually experience a monster revaluation), I feel that
physical gold is an investment on a secular basis. It is not something to be
traded. To this end, one can use GLD.
However, and in spite of my liking physical gold for
the very long pull:
1)
I
can be wrong.
2) Even
if it plays out as predicted nobody can predict when it will happen. So, for
practical purposes, such secular trend may only result useful for people with
deep pockets and strong staying power. Staying power doesn’t necessarily mean
“rich” but merely, if not rich, to live within your means. As Keynes said,
the markets can remain irrational longer than you can stay solvent
(Paper) gold’s current lousy action is a good example of the
pain to endure when investing along the secular trend. The drawdown is
unavoidable, and, hopefully, the reward is uncertain, as it is dependent on
one’s thesis being proven right.
Sincerely,
The Dow Theorist
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