One Investment We'll Be Avoiding

"Newspaper headlines and the television screens give us the short view … yet it is the profound tendencies of history, and not the passing excitements, that will shape our future." -- JFK

If economic history tells us anything about avoiding massive losses, it's this: Don't buy what everyone else is buying.

History is full of supporting examples -- The Dutch Tulip Bubble of 1637, The South Sea Bubble of 1720, Pets.com circa 1999. In one famous case, JFK's father Joe Kennedy knew it was time to get out of the stock market bubble in 1929, after his shoeshine boy gave him stock tips. More recent examples included late-night infomercials explaining how you, too, could make a fortune flipping houses.

Despite the litany of examples warning us to avoid the fray, investors continue to participate in markets in which everyone else already seems to be.

Beware the famous people
So where are the masses putting their money today? Look no further than gold.

I have a rule of thumb when it comes to investing: I don't buy anything advertised as a great investment on a TV commercial by a celebrity endorser. These days, gold has a lot of televised celebrity endorsements. I mean, even the bouncer of the Jerry Springer Show has a commercial for gold right now. (Take a second to re-read that last sentence).

No offense to him personally (I'm sure he's a nice guy and all), but if that's not a sign that something is awry, I'm not sure what is.

The hedge fund Woodbine Capital's October 2009 investor letter did a superb analysis of this gold rush, which according to them follows all three criteria of a bubble:

  1. There is an initial, rational reason for a rise in an asset price -- for gold, that's a declining dollar, stronger emerging markets, and the 2008 financial crisis.
  2. There is one-sided exuberance  -- both good and bad news, deflation or inflation is supposedly evidence of gold's benefits.
  3. Market prices imply virtually no probability of downside risks -- it costs nearly three times as much to buy a call option 25% above current prices of SPDR Gold Trust (GLD) than it does to buy a put option 25% below current prices.

Also, according to Woodbine, gold for investment purposes has increased from a 10-year average of 15% of total demand to an astounding 47% in the previous year. In short, it's likely investors, not necessarily market forces (industrial use, jewelry, etc.), that are keeping gold prices lofty.

None of means that the gold bubble is about to burst. The funny thing about bubbles is they can last longer than you expect. I think this bubble, fueled by the hype, could last a while longer. My best advice to investors, then, is to follow our strategy at Motley Fool Pro and simply avoid putting new money to work in gold right now. There's a better strategy to consider.

Alternative investments
No single asset works in all types of markets, as gold advocates seem to believe,. Depending on your economic expectations, consider diversifying your portfolio across assets that do well in one or two of the following three scenarios …

  • You expect inflation and higher interest rates: Treasury Inflation-Protected Securities (TIPS), commodity-based companies like Alcoa (NYSE: AA  ) and Potash (NYSE: POT  ) , and strong companies that refinanced their debt during this low-interest rate environment, like AT&T (NYSE: T  ) and Boeing (NYSE: BA  ) .
  • You expect deflation and sustainably low rates: Government bonds (both Treasuries and foreign), companies with little or ideally no high-interest debt and some level of pricing power -- think Apple (Nasdaq: AAPL  ) .
  • You expect a weaker dollar: Foreign-based assets and stocks of businesses that do little or no business in the U.S., like Philip Morris International (NYSE: PM  ) if you're not opposed to tobacco, and America Movil (NYSE: AMX  ) if you don't hate cell phones.

Foolish bottom line
People buy into bubbles for any number of reasons -- the desire to "get rich quick" or to seek comfort and confirmation in numbers (i.e., better to not be wrong alone). Whatever the case may be, you'll live a less stressful life and have a better chance of generating long-term profits from your investments if you avoid investing alongside the masses.

By understanding previous bubbles in history, we can better learn to avoid them and, if we're correct in our timing, profit as they begin to lose steam. One way to profit when a bubble bursts is with options, which we use quite regularly in the Motley Fool Pro portfolio to not only bet against companies, but also generate income from existing positions and obtain better buy and sell prices for stocks we like.

If you'd like to learn more about our strategies at Pro, just enter your email in the box below.

Fool analyst Todd Wenning knows a lady who's sure all that glitters is gold, and the last time he saw her, she was buying a very tall stairway. He owns shares of Philip Morris International. Apple is a Motley Fool Stock Advisor choice. America Movil A.B. de V. and Philip Morris International are Motley Fool Global Gains recommendations. The Fool's disclosure policy is a golden god!


Read/Post Comments (13) | Recommend This Article (29)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On January 06, 2010, at 3:19 PM, jmt587 wrote:

    Sorry to split hairs, but that bouncer is shilling for a company that wants to buy gold, not advertising gold as a good investment. Doesn't that sort of refute your thesis? (Don't get me wrong, I'm no gold bug, and don't have any beneficial interest in gold's price increasing, don't plan on investing in it, so I don't care much one way or the other.)

  • Report this Comment On January 06, 2010, at 3:19 PM, jmt587 wrote:

    Sorry to split hairs, but that bouncer is shilling for a company that wants to buy gold, not advertising gold as a good investment. Doesn't that sort of refute your thesis? (Don't get me wrong, I'm no gold bug, and don't have any beneficial interest in gold's price increasing, don't plan on investing in it, so I don't care much one way or the other.)

  • Report this Comment On January 06, 2010, at 3:25 PM, dargus wrote:

    Let us also not forget that Steve has his own show now, remarkable similar to the Jerry Springer Show, and we should let him out from under the shadow of Mr. Springer.

  • Report this Comment On January 06, 2010, at 3:25 PM, dargus wrote:

    Let us also not forget that Steve has his own show now, remarkable similar to the Jerry Springer Show, and we should let him out from under the shadow of Mr. Springer.

  • Report this Comment On January 06, 2010, at 3:33 PM, spate103 wrote:

    I disagree with the idea of not buying what everyone else is buying, especially as a short term investment. Basic economics tells us that if more people are buying a stock than selling it, the price will go up. Isn't price appreciation what ever investor is looking for?

  • Report this Comment On January 06, 2010, at 3:34 PM, spate103 wrote:

    lkj

  • Report this Comment On January 06, 2010, at 3:47 PM, firemanstep wrote:

    has anyone ever tried to find gold? (or silver) its not easy. I know the 3rd world people are doing alot of the mining and that equals low costs. I was taught about supply and demand. Gold and Silver are being used and shipped to other countries at unseen rates. (China is one of the biggest importers of silver) Now by no way am I saying the gold is almost all been found, no it has not. It is being sold and used faster than it can be found. The mines have to go deeper and in more remote areas, just makes sense that the price will continue to climb. Now I'm just a dumb firefighter but I do read the news. I have been wrong before I've seen me do it..b safe

  • Report this Comment On January 06, 2010, at 6:10 PM, bernbern0 wrote:

    I agree with truthisntstupid!

  • Report this Comment On January 06, 2010, at 7:04 PM, TMFTypeoh wrote:

    A+++++++++++ Article!

    I use to be a gold bug, but many of the fools articles have convinced me to change my view. It really hit home when i heard even Dave Ramsey talking about "gold stash for cash.com" (or something like that).

    Could gold go higher? Of course! Bubbles can last a looooooooong time. Longer term? Pull out of gold, and put it in foreign stocks is my view.

  • Report this Comment On January 11, 2010, at 3:30 PM, matson15 wrote:

    How about providing real data rather than buggy blather?

    "The masses" are selling their gold baubles to eats....sometimes for rent.

    There will be a gold bubble ----- maybe as soon as 2018. For now its 7.5 Secular Bull remains intact.

    Anyone experienced in Precious Metals investing knows to expect gut wrenching whipsaws.....sometimes (thankfully rarely.... more usually the short term reverses have been more in 2-12% class.

    If economic history, and faulty TMF DOCTRINE tells us anything about avoiding massive losses, it's this: STICK WITH SECULAR BULL MARKETS.

    matson15

  • Report this Comment On January 11, 2010, at 3:35 PM, matson15 wrote:

    that's 7.5 year-old Secular Bull Market.

    Have you noticed any data about average length of Secular Markets? Well it can vary, but short would be 10 years -- long would be > 25 years.

    matson

  • Report this Comment On January 11, 2010, at 3:45 PM, catoismymotor wrote:

    typeoh,

    Dave also does not believe in individual stocks, only mutual funds and real estate. He is as risk averse as anyone I've seen. I like the guy. I think he is right 90% of the the time. But when it comes to precious metals in this market he is out of his league. Please don't take offense. I am not a gold bug, over zealous or otherwise.

    Cato

  • Report this Comment On April 29, 2010, at 9:24 PM, gabeh79 wrote:

    I am going to laugh when this gold bubble finally bursts. People (also known as speculators) have hiked the price of gold much too high because they are playing on people's long-term fears over our long-term financial security. The same thing could be said about oil prices and other comedity (sp?) prices.

    Unless these yahoos can justify these higher prices over real (and not imagined) economic fears, gold will fall in value quickly. As a result, I wouldn't want to own any gold right now.

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