Here’s an idea that most investors won’t ever consider: the financial markets are largely illusory.
It’s an important idea to consider. What I mean is that the financial system is based on the illusion of trust. It relies on simple promises etched on bits of paper. And when fear grips the markets like it did last week, that trust can evaporate in an instant.
A share, for example, is nothing more than a promissory note that says you’re entitled to a cut of future profits. You don’t have a claim on any assets. All you can ever do is exchange your piece of paper for another one.
Similarly, a government bond is nothing more than a promissory note that says you’re entitled to a cut of future taxation. And so it goes on. Whether it’s futures contracts, or corporate bonds, they’re all just a promise for future delivery.
Here’s the point. The value of these promissory notes is massively influenced by fear. And that makes most financial assets horribly vulnerable to collapse.
I’m not talking about small-time private investors selling shares in a panic, or old grannies withdrawing savings from the bank and sticking it under the mattress.
I’m talking about the fear that causes a professional, well-heeled City suit to cower at their desk. The kind of raw fear that we saw last week. One that rarely surfaces – but could now signal the start of a huge run up in the gold price in the months ahead.
How to survive in a climate of fear
We saw during the last credit crunch how fear can utterly paralyse the economy. At the time banks simply stopped lending to each other. They were frightened that counter-parties would go bust without repaying their debt. Fear paralysed the whole system and smashed the value of paper assets.
Technically, what happens is the value of the future promise is being discounted at a higher rate of interest – the fear premium goes up. And that knocks valuations down.
It’s little wonder that bank stock prices took a whack. As the depositories of all those promissory notes, they are the most vulnerable when trust evaporates.
I’m not saying these bits of paper are worthless. Far from it. All I’m saying is that their value is massively influenced by fear. And in a climate of fear, we need to tread carefully.
Some stock sectors are more vulnerable than others. The financial sector looks like one to avoid.
Stocks that are backed by strong balance sheets and low price to book values should prove more resilient (I’ve got my eye on a few that I’ll reveal in forthcoming issues).
But one asset stands above all else. And right now, the rest of the world seems to be waking up to its great value during these volatile times.
In fact, I think the action in gold looks like it could portend the start of a classic gold bull run.
Many investors assume that gold is going up simply because the Fed is about to print more dollars. Yet yesterday’s announcement that the Fed isn’t about to deliver another round of quantitative easing (QE) didn’t really affect the gold price.
What’s going on is more than simply the fear of inflationary QE. It is fear itself. And the problem is there’s far too little gold around to satisfy the amount of paper money already in existence.
I’m sticking to my gold plan
I’m going to keep buying each time gold bounds up another $100. To see my plan, read Buy gold – buy high and buy higher still.
Those entry points are coming around quicker and quicker. If the gold mania kicks off, we could see $100 moves in a day!
Unfortunately, as gold hit my $1,630 entry point, I tried to be too clever. Rather than paying $1,630, I suggested we might wait for a pullback to $1,600 before getting in.
It didn’t work! The market shot straight through to the next entry point of $1,730. Damn!
So I’m sticking to my classic pyramiding strategy. It doesn’t matter where you start buying; just keep adding to your gold position on every $100 leap.
I said this was going to be an interesting summer. And the summer isn’t over yet!
So buy gold and stay safe.
• This article is taken from the free investment email The Right side. Sign up to The Right Side here.
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