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Prepare to buy gold and oil ETFs

Behavioural finance analyst Ken Norquay says: Be alert for a sell signal in both stocks and bonds. We should be preparing to buy gold and oil ETFs.

Gold bugs are investors or advisors who are continuously bullish on gold. Most argue that we live in times of fiat money, and sooner or later paper money will be useless and gold will be very valuable.

But, today’s fiat-money monetary system has been in use since the 1930s and revised in the 1970s. During that time, gold has sometimes been a great investment, sometimes not-so-great. Isn’t it better to invest in gold when it is a good investment and not invest in gold in the not-so-great times?

Financial planners have a similar strategy. Their statistical models show how, over the past 100+ years, the stock market has been in an up trend. They argue that modern western economies are efficient, that the economies are sound, and for those reasons, it is best to buy well-managed mutual funds and not sell them.

The long term total return has been over nine per cent annually. But, during those 100+ years, there have been times when the stock market has been an excellent investment and times when it’s been not-so-good. Isn’t it better to invest in equities in the good times and not in the not-so-good times?

Others investors like to change their asset mix from time to time to take advantage of swings in interest rates and the various markets. They use economic risk analysis models to tell them what percent of each asset they should own, and what mix is most suitable for a given investor’s goals.

As investors’ goals change, the asset mix changes. As the economy and interest rates change, the mix changes. This strategy is significantly more profitable and less risky that either of the two mentioned above.

In this column, we examine the trend of a variety of investment markets to help with this process. Our goal is to identify the favourable and unfavourable times for a given investment. Let us review our usual markets from the point of view of asset mix.

US long-term investment strategy: Caution

US Stock Market. The S&P500 index registered new all-time highs again last month. The long-term trend has been UP since March 2009, making this the longest bull market in financial history.

Let’s review and clarify our investment strategy regarding stock market risk at this time. We recognize that all stock markets rise and fall. Market tops are where we’d like to ‘sell high’ and bottoms are where we’d like to ‘buy low’. Tops are characterized by investor optimism (over-optimism?) and bottoms by excessive pessimism. We sell our stocks when everyone is excitedly buying, and buy when everyone is desperately selling. Basic stock market strategy.

At this time, with the up-trending market breaking longevity records, we know we are closer to the top of the cycle than the bottom. At the 2009 bottom, the S&P500 index was around 666 and now it’s 3155. Logically, we should be looking for the exit door, not looking for new opportunities to buy. Our long-term investment strategy seems fine.

What messages has the market been giving us on the intermediate term? In November 2016, Donald Trump was elected president of the USA. During the following year, the market’s up trend ‘went parabolic’. The market rose AND the rate of increase rose. This classic pattern is called a parabolic rise, aka, a market ‘blow-off’. It ended abruptly in January 2018, 14 months after the election.

Then it lapsed into a chart pattern called ‘the broadening formation’ or ‘the five-point reversal pattern’. (Edwards and Magee, Technical Analysis of Stock Trends, 1946, aka the Bible of technical analysis.) The pattern consists of four sharp price moves followed by a collapse. It’s a topping pattern and is not complete until the collapse sets in, in earnest. (Because of my ‘safety first’ approach to investing, I have been over cautious, declaring the pattern complete before the collapse is verified.)

What about a short term investment strategy? This column does not deal with the short term, but I will comment here. The market seems to be speculating on a satisfactory resolution of trade negotiations between China and the USA. The old traders’ saying is: ‘Buy on rumour, sell on news.’ The market is at the ‘buy on rumour’ stage now. Wouldn’t it be ironic if my long-awaited collapse of the broadening formation were triggered by this elusive trade resolution news?

The US market is in a long-term up trend and the yellow caution flags are flying high.

Canadian investment strategy: Caution

The Canadian stock market mostly follows the US, as do most of the world’s stock markets. The TSX Composite Index has lagged the US since the collapse of oil prices in 2014-15. It has risen just over 6 per cent in just under 2 years vs. an increase of 9.3 per cent in the S&P500.

Observation: although the Canadian and US stock markets hit new highs in November, their two-year rates of increase are around 3.1 per cent and 4.6 per cent annually. The long-term return of the stock market is around 9 per cent. But the feeling of bullishness is very high right now even though the actual rates of return are not. Investor optimism is out of sync with reality. Reality check: How optimistic are you about the stock market in the coming year? Is your personal optimism in sync with the mathematical reality of the markets?

The Canadian stock market is in a long-term up trend and the yellow caution flags are flying.

US and Canadian bond rates

For clarity, let’s review our terminology. Long-term bonds are bonds that mature in 10 to 20+ years. Long-term interest rates are the current yields of long-term bonds. The trend of long-term interest rates leads the trend of short-term interest rates. Examples of short-term interest rates are 90-day T-bill rates or the Bank of Canada overnight rate, which is set by our central bank. When long-term bonds go up, long-term interest rates go down. This column follows the long-term trend of long-term bonds or long-term interest rates.

A long-term up trend of US bonds began in 1980 and ended in January 2015. Then the trend of long-term US interest rates went neutral. The main characteristic of today’s bond market is big intermediate up and down swings, not long-term trend. From an investor’s point of view, the bond market is now a trader’s market, no longer a long-term investor’s market.

The long-term trend of the US bond market is neutral, the intermediate-term trend is up.

The Canadian bond market is marching to the same drum as the American. The intermediate term swings that have occurred since January 2015 have been: 10 months down, 10 months up, 2 years ragged down, 9 months up. There are early signs that the current 9-month up trend is ending.

The long-term trend of the Canadian bond market is neutral and the intermediate trend is up.

The US dollar vs. basket of non-US currencies

Since March 2015, there has been relative stability in the currency markets. The short-term ups and downs of Brexit and trade wars have led nowhere: the US dollar is close to where it was 4-1/2 years ago.

■ Canadian dollar vs. US dollar: Following the long term down trend from 2011, (one Loonie bought $1.05 US) to 2016 (one Loonie bought just under $0.71 US), the Canadian dollar has been neutral. Even the up and down swings are getting less and less dramatic. The long term trend is neutral.

■ Gold: Bullion, in US dollars, peaked in September 2011 at just over $1,900 an ounce. The subsequent down trend ended in December 2015 when the current weak long term up trend began. The up trend went neutral, then resumed in June 2019. Gold is currently in a short-term decline within its long term up trend.

■ Oil: Following the collapse of oil prices from July 2014 to February 2016, oil prices have been in a weak up trend. Within that long term up trend, oil is in a short term down trend.

Our strategy calls for owning securities in long-term up trends and not owning securities in down trends. Based on this, we should own stocks, gold and oil. We are currency and interest rate neutral.

Be alert for a sell signal in both stocks and bonds. We should be preparing to buy gold and oil ETFs. (N.B.—not gold or oil stocks.)

Ken Norquay, CMT, is the author of the book Beyond the Bull, which discusses the impact of your personality on your long-term investments: behavioural finance. He can be reached at kennorquay@yahoo.ca.

This is an edited version of an article that was originally published for subscribers in the December 2019/First Report of The MoneyLetter. You can profit from the award-winning advice subscribers receive regularly in The MoneyLetter.

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