There are two overarching reasons to be concerned about the stock market right now: Stock valuations are alarmingly high, yet volatility is eerily low. When this has been the case in the past, these two trends reversed course, with stocks falling and volatility rising.
If you're worried about the height of the stock market, you may want to start thinking about ways to hedge your holdings. Image source: Getty Images.
It's possible that stocks will keep rising to infinity, though that doesn't seem probable. Stocks could rise if tax reform is passed, but at some point, stocks will correct. And when they do, at least according to the head of JPMorgan Chase's (JPM 0.06%) investment bank, the correction will be acute.
Savvy investors should take note of these trends when buying their next stock, favoring safe stocks over speculative ones -- or, rather, stocks that could help to hedge against a drop in the market. Which stocks fit the bill? In this environment, I would argue that three of the safest stocks to buy right now are all tied to the price of gold. This includes:
- SPDR Gold Shares (GLD 0.32%) is a trust that is designed to track the price of gold.
- Barrick Gold Corp. (GOLD 0.06%) is a leading producer of gold and copper.
- Yamana Gold (AUY) is also a gold miner, though it is meaningfully smaller than Barrick Gold.
Which of these three gold stocks you buy depends on your risk tolerance. The SPDR Gold Shares trust is the least volatile, followed by Barrick Gold, the largest of the two miners, and Yamana Gold, the smallest miner of the two.
According to my colleague Reuben Gregg Brewer:
Miners, in general, tend to have a little bit of leverage to the price of gold on the upside and downside. That said, there are reasons to like large, established miners [like Barrick Gold], and reasons to prefer smaller miners [like Yamana Gold]. For one thing, a large miner is likely to have a more predictable production outlook and cost structure, often producing at the lower end of the cost curve.
Smaller miners, meanwhile, often need high prices to turn a profit because of their relatively high costs. That means that small miners can outperform when gold is rising since higher prices can be the difference between making money and bleeding red ink. Also, smaller miners like Yamana are often more leveraged to production growth via new mines and expansion projects.
I am aware that anyone who claims that gold is a prudent investment can be categorized as an alarmist who has succumbed to emotions and naivety. Lest you think I fall into those categories, it's worth noting that I would not be alone.
Among others who think similarly is Ray Dalio, the chairman and chief investment officer of Bridgewater Associates, the world's largest hedge fund. Dalio is one of the most revered and successful hedge fund managers in the world, if not the most revered and successful given the size of Bridgewater.
Dalio has been arguing all year that the market could be in for a nasty correction, along the lines of 1937. That was the year the U.S. economy plunged back into the Great Depression after seven years of turmoil and recovery.
"I believe that ... politics will probably play a greater role in affecting markets than we have experienced any time before in our lifetimes but in a manner that is broadly similar to 1937," Dalio wrote on August 21.
It was earlier that month that Dalio recommended that investors allocate 5% to 10% of their portfolios to gold-related investments (emphasis added):
When it comes to assessing political matters (especially global geopolitics like the North Korea matter), we are very humble. We know that we don't have a unique insight that we'd choose to bet on. Most importantly, we aim to stay liquid, stay diversified, and not be overly exposed to any particular economic outcomes. We like to hedge our bets, though we are never completely hedged. We can also say that if the above things go badly, it would seem that gold (more than other safe haven assets like the dollar, yen, and treasuries) would benefit, so if you don't have 5-10% of your assets in gold as a hedge, we'd suggest that you relook at this.
And most recently, last month, Dalio expanded on his thoughts on one of the underlying trends in the economy that has him worried: income inequality (emphasis added):
Average statistics camouflage what is happening in the economy, which could lead to dangerous miscalculations, most importantly by policy makers. For example, looking at average statistics could lead the Federal Reserve to judge the economy for the average man to be healthier than it really is and to misgauge the most important things that are going on with the economy, labor markets, inflation, capital formation, and productivity, rather than if the Fed were to use more granular statistics. That could lead the Fed to run an inappropriate monetary policy. Because the economic, social, and political consequences of an economic downturn would likely be severe, if I were running Fed policy, I would want to take this into consideration and keep an eye on the economy of the bottom 60%.
Is it possible that someone as successful and committed to stripping emotions out of decision making as Dalio is could be succumbing to naivety and emotions? Yes. But it's also possible that he isn't. And given Dalio's track record, his thoughts on this should, at the very least, be taken into consideration by investors.
It's for this reason that I believe three of the safest stocks to buy right now are the SPDR Gold Shares trust, Barrick Gold, and Yamana Gold. Adding one or more of these to your portfolio will offer a hedge against the possibility that Dalio is right.
