I am no investing professional, but regular readers may recall that a month ago, I recommended looking into alternative investing options to the stock market, including my preferred safe haven, gold. Had you done so, you would have cleanly avoided the 15.52 percent decline that took place in the equity market in the last month, as the price of gold has remained at exactly $324.40.
While I was not as forcefully articulate then as I perhaps should have been – fly, fools, fly – it seems worthwhile to repeat the point. Why? Because if you look past the inane and self-interested declarations of CNBC’s analysts, you will see that nothing has changed since a month ago. Consider, if you will, a warning that was made some six years ago, and from the investor’s point of view, about five years too soon.
Seldom have the unwanted words of a Cassandra been more ignored than Alan Greenspan’s speech on “The Challenge of Central Banking in a Democratic Society.” In that speech, given on Dec. 5, 1996, he coined the now-famous phrase “irrational exuberance” in reference to “unduly escalated asset values, which then become subject to unexpected and prolonged contractions as they have in Japan over the past decade.”
It is worth noting that on that day of warning, the Dow opened at 6422.90, 19.38 percent lower than last Friday’s catastrophic open of 7967.20. This is a clear indication that the market not only can continue to go down, but probably will. The mention of Japan is especially significant, because the American markets appear to be following in the Nikkei’s footsteps, which hit its peak at 40,000 in early 1990 and steadily declined to below 10,000 in September 2001, where it currently languishes.
There are, of course, some major differences between the American and Japanese economies, but the most troubling aspect of the situation is the way in which the Federal Reserve has imitated the Bank of Japan’s unsuccessful strategies. Injecting more liquidity into the money supply by lowering interest rates to stimulate investment in the economy certainly works, for a time, but eventually one runs out of bullets as the cost of money approaches zero. Since Japan has not been able to escape this liquidity trap for over a decade, it seems most illogical to suggest that a lengthy down market is an impossibility.
Now, one thing the American markets have going for them is the position of the dollar as the effective world standard. However, because of our past dependence on foreign investment, which comprises approximately 11 percent of the equity markets, foreigners face a veritable grizzly bear in comparison with our own hairy beast. The Dow has declined 14.79 percent since the introduction of the euro in 1999, but thanks to the euro-dollar exchange rates, European investors have suffered an additional 12.37 percent loss. Given this additional hammer to the portfolio, it is easy to understand that the average European investor is probably even less inclined to get back in the water than someone who has seen his 401k melt down to a 201k.
I could not possibly provide an exact number for a definitive bottom, and I must say that I view predictions of $1,254 gold with the same jaundiced eye with which I once regarded the 36,000 Dow. I have heard men whose financial acumen I respect greatly, tell of their expectations of a bottom in the neighborhood of 2,500 Dow and a 500 NASDAQ. If we are to finally take Mr. Greenspan at his word and recognize that a 6,400 Dow might have actually been irrationally exuberant, then it is important to realize that these dire prophecies are every bit as likely as the analysts’ daily assurances that this time, we really, truly, certainly have hit rock bottom.
So what to do? It seems that many have elected to go into real estate, which doesn’t appear to be the best idea since prices are already at all-time highs and may already be well into a bubble of their own. Gold, on the other hand, is still in the lower range of its historical pricing, and the increased volatility of gold mining stocks (which tends to run triple the percentage change in the spot gold price) offers some real upside if you, like me, expect the equity markets to continue their long march down the hill.
Caveat emptor: I hope you understand that this advice may not be worth more than you are paying for it, but given the last month, it seemed worth mentioning. After all, if you can keep your capital while all about you are losing theirs, then you’re not doing so bad.