Spot The Obvious First: Investing Simplified - Part II
When you build a puzzle do you dump out 1000 pieces and randomly try to put together the picture, or do you look for the obvious corners, flat borders, build the frame and then fill in the details? So why do investors try to match a million random pieces of information in an attempt to try to build a clear picture?
There is a lot of misleading information in the world of economics and investing. With all of the varied components, such as flawed theories and strategies, potential conflict of interest among advisers, potential conflict of interest within government, various opinions, countless indicators and different interpretations of them etc., it can be very difficult to see the forest through the trees. But in our opinion some things are much easier to understand and interpret than others. It is this understanding that helps us focus on our simple investment strategy in order to try and outperform the markets with more consistent, profitable trades.
In our opinion some of the very complex elements of investing are just too difficult to predict. For example, how good have economists been at predicting when the US consumer will be "tapped out"? How many times have you heard that prediction made inaccurately? If we based our investment decisions solely on a complex indicator such as US consumer spending, I think we would be broke.
But doesn't a good investor have to untangle and make sense of the web of data, indicators and press releases to be successful? Isn't this the only way? We believe following various indicators can help confirm or not confirm our position but we do not try to sift through thousands of moving parts to draw our conclusion. Instead, we make a hypothesis based on some obvious signals and work backwards. Let us explain.
We believe the world is so fixated on looking at the same indicators, and trying to follow each others actions that they get lost trying to interpret those signals. How can everyone follow the same news stories, standard indicators and strategies and then expect to outperform the competing investors who are doing the same things? For example, if every investor is watching what the Federal Reserve will do with interest rates on Tuesday September 18, 2007 as their unique insight to the market, how does that help anyone get ahead?
A handful of years ago we could not tell you when housing prices would fall, when oil would hit $80 per barrel or higher, when the US dollar would break below 0.80, when the Canadian dollar would hit parity with the US dollar, when silver would hit $13 and so on. What we could tell you is this:
Based on historical records, relative to other investments such as the US stock market, Precious Metals Investments were highly undervalued.
(We will explain more on the above chart in a moment.)
In our opinion this was all we had to know and from there we worked backwards to confirm or deny our hypothesis. From this starting point, every piece of data or news became an opportunity to confirm or challenge our investment decision.
You may be wondering; how did we determine Precious Metals were undervalued relative to other investments? Think of it this way. Is a dollar a good measure of your investments? We know that a dollar is regularly losing purchasing power over time. For example, since 1970 each US dollar will buy a smaller house, less gas for a car, less labor from an employee, less food, less entertainment, less energy for your home etc. Therefore we think a dollar is a poor measuring stick for our investments. We are more interested in knowing how much of one investment we can buy with the proceeds of another investment. In other words, we compare investments directly to one another, such as how much Dow Jones will my Silver buy.
The above chart is a custom built long term chart comparing precious metals such as silver and gold directly to US stocks. There are two important elements of this chart:
Relative Value: When the blue line is near the top of the chart in the red area with a score near the +10 level, it would take a smaller quantity of precious metals to buy a larger quantity of stocks and therefore it would be wise to sell some metal to buy some stocks. When the blue line is in the lower green portion of the chart with a score near +1 it would be wise to sell some stocks and buy some precious metals. As you can see from the grey line, the price of silver was very expensive in 1980 and relatively speaking very inexpensive in around 2000.
Trend: This chart also helps us visually see if metals appear to be gaining in value relative to stocks (eg. Blue line trending up 1971 - 1980), or stocks appear to be gaining in value relative to precious metals (eg. Blue line trending down 1980 - 2000).
As you can see, since 2000 it appears that precious metals have been aggressively heading higher relative to US stock markets. It also appears the trend is well in place and precious metals still seem to be undervalued to stocks when we compare a historical measure such as 1980. Also notice that the blue line was much higher in 1980 and like a pendulum swinging we expect the blue line to reach a level similar to this height again. Therefore this chart is very useful in helping us determine not only when to add to our metal investments, but also how aggressively we may wish to do so and when we should exit our positions.
So now that we have determined that silver and gold may be undervalued relative to other investment options, we filter and interpret other indicators differently than had we not noticed this major development. The popular media, Wall Street, US government etc. may not want you to sell your US dollar denominated investments such as US stocks in order to buy precious metals. These institutions may promote stocks, incorrectly justify what is happening with inflation, volatility, liquidity, interest rates etc. and confuse the public about their investment decisions because they may have a vested interest to do so. But some things are just too hard to hide. It is hard to hide the fact that back in 2000 it took far less stocks to buy a large amount of precious metals. At that time precious metals were obviously undervalued relative to stocks.
With this theory we now have the foundation for our belief. We then use indicators such as supply and demand, rising consumer prices, rising oil prices etc. to help confirm or challenge our belief. We can not tell you exactly when the US dollar will head lower or when the Dow Jones will correct in nominal value but we can tell you that we expect those things to happen. We believe this will help verify our hypothesis that silver and gold are undervalued relative to the general stock market.
Basically we believe most people try to make sense out of an inundating amount of different signals to decide what to do with their investments. In the process we think they become lost and misled by the overwhelming amount of random information available for consideration at different times. Instead, we look for the simplest, most obvious signs to decide what to do with our investments, and then we further filter through the host of different signals to confirm or challenge our decision. We find this process very effective in keeping our investment decisions less emotional and more profitable.
If you would like to learn more about our system and view updated versions of the chart above, we invite you to visit our website at www.investmentscore.com.