Gold vs. Stock Market: Investment Comparison
It's very easy to get caught up in the hype with stocks. After all, if you draw a long enough timeline, you would see that on average, American stocks at least perform at a rate of 12% or more appreciation per year.
If you draw the timeline at 30 years, that is impressive. We're talking about a 360% increase in the value of your investment portfolio plus a compounded appreciation. Factoring in dividends, that's nothing to sneeze out, it almost seems crazy to even think of gold in this particular context.
Is Gold a Better Investment Than Stocks?
Why would you invest in precious metals when stocks are doing so well? The problem is, when you look at that 30 year or 40 year timeline, you'll notice that there are several deeps. We're not just talking about the 2008 financial crisis or even the 2001 Dot-Com Debacle, we're also talking about the 1997 Asian financial crash, the 1987 Dow Jones crash – there are many disruptions in that timeline.
Also, those solid appreciations tend to focus mostly on blue chip stocks, these are companies that are solid and are very healthy financially. These are often market leaders and have a tremendous market share.
This timeline obviously doesn't apply to just your rank and file stocks. In that particular situation, it's pretty much hit or miss. With that said, you should still diversify your portfolio into gold. It's not a question of gold versus stocks in the sense that you're trying to pick gold or stocks; this is not an either or situation.
Instead, this is a diversification play. Gold has a significant chunk of your investment portfolio because gold can put you in a position to recoup whatever losses your stock holdings may suffer when the market eventually crashes. Notice that I said “when” instead of “if.” The reality is again going back to that 30 or 40 year timeline, there are periodic crashes in the stock market.
What separates winners from losers is that winners hang on when there is a stock market crash and when you invest significant chunks of your investment portfolio in gold, you can afford to wait out the market. Those people who get into the market, but borrowing either through marginal accounts or other forms of lending really position themselves to panic.
When the market starts to crash, they head for the exits and they lock in their losses, a lot of these people go bankrupt. By positioning yourself in gold to a significant extent, you enable your portfolio to recover quickly from stock market crashes.
(Recommended: Is It True That Gold Is Not in a Bubble Situation?)
Gold Moves in the Opposite Direction of Stocks
Assuming that there is a stock market crash 6 months from now, I can predict in very clear terms what will happen to the price of gold. 9 times out of 10, gold moves in the opposite directions direction of the stock market.
When the stock market crashes, gold spikes up, guess what else spikes up? Commodities, we are of course talking about crude oil, processed oil, gasoline, tin, copper or even coffee – that's how the market behaves historically. Again, this is 9 times out of 10.
There are some anomalies from time to time, but as a rule, the price of gold tends to spike up when the market crashes. Use this to your advantage. When this happens, gold is doing its job. If you park enough of your network into gold, this predictable movement will protect the rest of your investment portfolio from complete devaluation.
It's very important that you start scaling back on your very risky equity's exposure right before a market crash. Considering how heated the Dow Jones is currently, this is probably a good time to dial back Twitter, Facebook, and Google, definitely Yelp and other highly speculative stocks and stock classes like solar energy stocks.
Plow that money into gold investments. I highly suggest that when you're trying to decide gold versus stocks that a large chunk of your gold holdings go into exchange traded funds (ETFs). ETFs are great because they're as pure as a play in gold as you can get. You're not dealing with stocks, you're dealing with a pure index play of gold so the less fees involved, the better and ETFs are it when it comes to a pure play in gold. Try to devote a large chunk of your gold holdings into ETFs.
Of course as part of the standard financial planning advice, you should diversify even within your diversified portfolios. So, even within your gold holdings, you should diversify a chunk of that money into gold mining stocks and a small minority into actual physical gold. Once you have squared this away, you can then benefit from gold's historical tendency to move in the opposite direction as equity markets.
Making Money From the Crash
At this stage of the game, let's assume that the market has crashed. Let's assume that gold did its job and you are able to retain the value of your portfolio. For whatever percent your equity holdings crash to earth, the value of your gold holdings sky rocket.
You're looking good when they're basically trying to cancel each other out. It's time to make a move when the price of stocks continue to hemorrhage and the price of gold continues to spike. When this happens, you can liquidate some of your gold holdings so you can start buying a blue chip American stock at bargain rates.
We're talking about IBM, Goldman Sachs, Caterpillar, and of course General Electric and other solid American companies. Stay away from scooping up depressed internet stocks unless of course that stock is Google; Google may have some legs later on. This is crucial if you decide between this gold vs stock analysis.
You have to remember that when you are trying to determine the proper ration in gold versus stocks, you are looking at a timeline that will help you protect your investments as well as having your gold holdings position you to take advantage of temporary market crashes.
Usually, a depressed market tend to persist for maybe two to three, or even four quarters. They really last beyond four quarters. By talking about a depressed market, we're talking about a situation where the Dow Jones continues to hemorrhage and trend downwards.
The moment it breaks that pattern, you can then start liquidating some of the depressed stock holdings that you bought at market main basement prices. You can do this on a graduated basis so that you can replenish your gold holdings.
Ideally, there would be a double-dip, meaning the market crashes then recovers, and then crashes again. When it crashes again, you can stand to make another round of profit using the same strategy above. Gold versus stocks doesn't have to involve analysis where you pick stocks over gold, or gold over stocks.
Instead, when you're trying to decide between gold versus stocks, you are actually looking for a proper ratio that does not only position you to preserve the value of your overall investment portfolio, but would possibly position you to take advantage of a depressed stock market. Next, read our analysis on physical gold vs. gold stocks here at Focus on the User.