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Dirk Steinhoff
October 11, 2018

The Buying Opportunity of the Decade

Wherever I go, I run into people who think very little of owning precious metals. To most, gold is an arcane relic. Silver, who needs that? Investors are dumping their gold ETF holdings. Public sentiment ranges from indifference to outright aversion towards precious metals. At the same time, institutional and smart investor deals are running hot. Those selling or not buying at this point, are making a BIG mistake.

How did we get to this point where people react to gold like that? Well, with the longest bull run in the S&P 500 in history, people have become complacent. With more than 3500 days in a row in the S&P 500 without a 20% correction, mere extrapolating is replacing critical analysis and even common sense.

Although it’s only been 10 years since the last financial crisis, only a few seem to remember it. The financial crisis of 2008 had its origins in too much debt (back then in real estate) and an insatiable appetite for derivatives (back then mortgage backed securities). The reason why only so few seem to remember the last crisis lies in the developments that followed. In 2008, we had much lower government debt levels (especially in China) and a global environment with significantly higher interest rates than today. This set of circumstances allowed for fiscal and monetary policies that saved the world from a deep recession or perhaps even a depression, at least until now.

September 17th 2018 marked the 10th anniversary of Lehman Brothers’ insolvency, presenting an appropriate time to reflect on the lessons learned and the progress made. So where do we stand today? The answer is as disappointing as it is worrisome. For the last decade, we have merely been the postponing the consequences of the 2008 crisis, instead of neutralizing or reversing them. In fact, upon closer examination of the situation today, we are arguably at more precarious position than we were shortly before 2008. Today, we have not only record levels in car loans, credit card loans, student loans and higher US house prices than in the 2007-2008 period, but global government debt has also risen to new highs, while we have also more derivatives than in 2008. As if that weren’t enough, interest rates are still overall artificially kept low and in some major economies (e.g. Japan, Germany) close to or at zero. What this ensures, is that the “cure” prescribed in 2008 will most likely not be an option in the next crisis.

Clearly, no one can tell for how much longer the stock market and bond rally will persist. However, nothing goes on forever and the serious risks pointed out above will eventually come to the surface. The current environment is strikingly reminiscent of the years before the 2008 crisis and the stage for the next one seems to be all but set. What the trigger will be and when the next downturn will begin are of less importance than the fact that it is already on the horizon.

The next crisis might not be as easy to contain and to overcome as the last one. It might not be immediately followed by a historical bull market in stocks in combination with a strong bond market. This time central banks and governments have less dry powder to fight with and the effects of the next crisis could be severely more widespread, lasting and devastating.

Of course, there is always a chance that this analysis will be proven wrong and I sincerely hope it will. But investing should not be based on hope, nor should we examine the facts through the lens of wishful thinking. An objective and sound economic analysis shows that the potential for a severe crisis within the next years is realistic. Thus, for any prudent and forward-looking investor, now is the time to prepare.

Taking some profits at the current elevated levels and investing in something what is relatively cheap and could also protect you in a potential downturn would be a smart move. Presently, precious metals clearly fit this description. As can be seen in the chart below, for the last 47 years, there was only one time when gold was more attractive than today, relative to the stock market as measured by the Wilshire 5000 index. From that perspective, the precious metal is at historically low levels and strongly supports the case for taking profits from the stock markets and buying gold.

Wilshire 5000 to Gold ratio

Source: Bloomberg

Far from a barbaric relic, gold remains a crucial building block for your nest egg and an essential defense against the next downturn. It is also useful to remember that planning ahead before the outbreak of the crisis paid off very well in the 2000-2008 period. Gold anticipated the coming crisis and went from below USD 300 per ounce in 2000 to USD 900 in 2008. After a short-lived setback to USD 730, it afterwards not only resumed but accelerated its price rally to almost USD 2000 in 2011!

Gold price from 2000 to 2012

Source: Bloomberg

Although gold is traditionally seen as the go-to safe haven, investors would do well to also consider adding silver to their precious metals portfolio, especially at its current price levels. Silver prices are down more than 70% from their 2011 highs, while the gold to silver ratio, which simply represents how many ounces of silver it takes to buy one ounce of gold, is at extreme highs. Historically averaging around 60 for the last 100 years, the ratio is now well over 80, making silver an attractive investment option.

Gold to Silver ratio

Source: Bloomberg

Today we might be facing a situation similar to the mid 2000’s. In the 2008 crisis the big gains have been made by farsighted investors who started to build up their gold positions years ahead of the actual outbreak of the crisis. Given the lessons of the past and the multiple risks that lie ahead, prudent investors should start building a precious metals portfolio today.

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