Profit From the Coming Panic

Most investors would just as soon never see another year like 2008 again. One historically unprecedented bad year in a lifetime is enough for just about everyone, and plenty of people didn't have the discipline to stick with their investments as they plummeted in value.

Just hoping for the best, though, won't really help prevent a repeat of last year's financial catastrophe. The better thing to do is to take steps that will ensure that you won't make a major mistake with your investments the next time bad times come around. The right preparation can get you ready for whatever the market throws at you in the future.

Cycles you can count on
When you're in the middle of a major market move -- whether it's a downdraft like last year's financial crisis or a huge bull move like we've seen since March -- it seems like it could go on forever. Often, even when you're absolutely sure a particular move is completely unsustainable, it does its impression of the Energizer Bunny and keeps going and going and going.

No matter whether you invest in stocks, bonds, commodities, or Beanie Babies, you'll find that prices generally move in cycles. Gold and oil are a couple of excellent examples of cycles at work.

Solid gold returns
Gold has made an explosive move upward over the past 10 years, rising from under $300 to more than $1,100 currently. Many gold bulls see the potential for the yellow metal to extend its gains substantially, with targets as high as $5,000 being thrown around. That's pushed shares of stocks like Freeport-McMoran Copper & Gold (NYSE: FCX  ) and Newmont Mining (NYSE: NEM  ) up strongly in the past year.

Yet we've seen big runs in gold prices before. During the late 1970s, inflation ravaged the U.S. economy along with stocks and bonds, and gold prices hit then-record levels. Yet once the inflation crisis ended, gold quickly reversed its advance, losing over half its value before hitting bottom.

Don't be crude
Most commodities have gone through dramatic cycles that have had huge impacts on investors. For instance, throughout the 1990s, oil prices languished at prices that seem ridiculously cheap today. Energy stocks like ConocoPhillips (NYSE: COP  ) and Valero Energy (NYSE: VLO  ) were seen as dead-money investments that at best made modest profits and paid reasonable dividends but offered little potential for growth.

We all know what happened next, though. Prices recovered with a vengeance, and long-ridiculed energy investors suddenly found themselves in the most popular sector in the market. Oil has taken a real roller-coaster ride in the past year and a half, dropping as low as around $30 per barrel from its peak above $145 last summer, and it's clear that investors can expect ups and downs to continue.

The cure for cycles
The main problem that most investors have with cycles is that they try to fight them. People like stability, which is one reason why dependable companies like Procter & Gamble (NYSE: PG  ) and Johnson & Johnson (NYSE: JNJ  ) attract investor attention despite lacking the excitement that a stock like Perfect World (Nasdaq: PWRD  ) generates with its higher past growth rates and future potential.

Instead of fighting cycles, though, you should embrace them. In particular:

  • When prices rise, don't get caught up in the euphoria. Recognize that trends can continue longer than anyone expects, but also stay prepared for the inevitable day when those trends reverse.
  • Similarly, when prices are falling, you can't afford to focus on how much wealth you're losing on paper. Instead, it's the perfect time to buy assets on the cheap -- in recognition of the fact that at some point, the cycle will again switch gears and once-scorned investments will suddenly be in demand once more.

As glad as everyone is to put the big losses of 2008 behind us, don't kid yourself: Eventually, you're going to face falling investments again. By reversing your mindset and seeing the opportunities that bear markets present, however, you can put yourself in the best position to take advantage of them rather than panicking when they come.

If you want to know what stocks offer the best opportunities right now, listen to Matt Koppenheffer. He explains why you should forget about the rally and points you to great stock ideas.

Fool contributor Dan Caplinger isn't immune from panic, but he's come a long way. He owns shares of Freeport-McMoRan. Perfect World is a Motley Fool Rule Breakers pick. Johnson & Johnson and Procter & Gamble are Motley Fool Income Investor recommendations. The Fool owns shares of Procter & Gamble. Motley Fool Options formerly recommended writing puts on Perfect World. Try any of our Foolish newsletters today, free for 30 days. The Fool's disclosure policy is a rock in times of trouble.


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  • Report this Comment On November 16, 2009, at 8:10 PM, xetn wrote:

    I think you have overlooked a fundamental issue. The price of gold and oil is based on supply and demand, like all other things economic. But where you err in your comments is with money, the value of which is also based on supply and demand. With actions of the Fed and to a large extend its fractional-reserve banking system) have been creating massive amounts of money out of thin air for many years, culminating in the boom/bust cycles. This is called money inflation and usually results in price inflation (a decrease in the value of money). So, we could fairly say that the steep rise in the "price" of gold is due to the steep rise in the number of dollars.

    In fact, since the creation of the Fed in 1913, the value of the dollar has dropped over 95%, with a loss of purchasing power of over 60% since 1990.

  • Report this Comment On November 20, 2009, at 8:21 AM, sofpan wrote:

    Nice article but I think that the right timing can make a difference in your returns.

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