It was the most controversial call of his career…
In 2000, the finance world was full of optimism. Investors thought we had reached an age when profits didn’t matter.
The Nasdaq had almost doubled the previous year. It looked like it would never go back down.
Meanwhile, gold was in a 25-year downtrend. It dropped from $850 per ounce in 1975 to $288 per ounce in 2000… a 66% decline.
Some investors even considered gold a relic of the past.
Maverick economist and longtime PBRG friend Bill Bonner wasn’t among them…
Bill is the founder of Agora Inc. Agora is one of the largest independent newsletter publishing companies in the world.
He also co-wrote two New York Times best-selling books: Financial Reckoning Day and The New Empire of Debt.
Bill has always been a contrarian by nature…
As the Nasdaq continued to reach new highs… Bill realized U.S. stock valuations would eventually stretch their limits.
And when he saw gold was near multi-year lows, he knew it was getting dirt cheap.
That set up the biggest contrarian play of Bill’s career: short U.S. stocks and go long on gold.
If you had followed Bill’s advice in 2000, you would have made more than 150% on the combined trade in the decade following…
You would have also made 150% more than those buying and holding the S&P 500. In fact, those who invested in the S&P 500 made no money on their investments over the following 10 years (even after reinvesting dividends).
Meanwhile, gold began its long ascent from $288 in 2000 to over $1,900 by 2011. That’s a 560% gain.
So, how did Bill pull it off?
It wasn’t a fancy chart, sophisticated method, or crystal ball.
It’s a financial trend every contrarian investor should understand: reversion to the mean…
One of the Surest Forces in the Market
Reversion to the mean simply means asset prices will return to their averages over time.
Expensive assets become cheap… And cheap assets become expensive. Eventually, assets return to their normal level.
The trick, though, is to identify what’s “normal.”
In finance, there are several metrics you can use to find a company’s value. The price-to-earnings (P/E) ratio is one of the most widely used. But there are many others.
Let’s take IBM for example. (IBM triggered a buy signal at the beginning of 2016.)
Big Blue trades off its price-to-free-cash-flow (P/FCF) ratio. Its ratio average is 12.5.
If the ratio dips to 9.5, that would be a good entry point because it will likely rebound to its average of 12.5.
But if it goes above 15, that would be a sign to sell, as the pullback will be dramatic (as you can see in the chart below).
When IBM’s P/FCF ratio dropped below 9.5 in late 2008, investors who bought then saw three consecutive years of gains. Those who bought in 2011, when the ratio was above 15, saw their investment shrink 30% over the next four years.
If you follow the reversion-to-the-mean rule as Bill did in 2000, you’ll be ready to buy and sell accordingly.
But stocks aren’t the only assets that revert to the mean… Some of the most profitable reversions happen in the commodity space.
Tomorrow, we’ll tell you about one hated commodity that’s primed for a rebound. The last time it reached this level, it went on to soar over 500% in two years.
Regards,
Nick Rokke, CFA
Analyst, The Palm Beach Daily
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CHART WATCH
The stock market’s market-cap-to-GDP ratio also reverts to its mean.
That’s why it’s one of Warren Buffett’s favorite indicators. He uses it to determine if the market is overvalued. And stocks are valued higher than ever…
We took the Wilshire 5000 Index (which tracks the size of all U.S. securities with price data) and divided it by U.S. GDP.
The chart below shows this ratio is at record highs… Even higher than before the last two major market crashes in 2000 and 2008.
Over the past 55 years, the average ratio was 0.59. Today’s average is 1.39, meaning stocks are 135% overvalued. That’s setting up a potentially steep drop back to its average.
—Nick Rokke
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MARKET BRIEFS
Bitcoin ETF Worth $300 Million: A proposed bitcoin ETF could attract as much as $300 million in its first week alone if approved. Per a report on CoinDesk: “The [ETF] … would likely drive the price of bitcoin up significantly.” The U.S. Securities and Exchange Commission (SEC) is expected to make its final decision on the ETF in March.
We’ve been following this story for months now in the Daily and recommend you own some bitcoin to capitalize off this trend. PBL subscribers can learn how to buy bitcoin by watching our tutorial videos.
Social Security’s $11 Trillion Hole: According to a researcher at George Mason University, the Social Security trust fund will run out of money by 2034 if the federal government doesn’t plug an $11.4 trillion hole. One proposal would cut average annual payments by more than $1,500 per year to make up for the shortfall.
If you’re at or near retirement, we suggest you read The Palm Beach Letter’s special report on America’s retirement crisis. It contains safe and practical steps you can take to protect your wealth in your golden years. PBL subscribers can access the report here.
A Golden Term: President Trump’s first few days in office have sparked uncertainty in the markets. And when uncertainty spikes, so does gold. According to one analyst, gold prices have climbed by an average 15% in inauguration years dating back to the 1970s. If you’re a PBL subscriber and want to get in on the gold rush, check out our “No. 1 Way to Own Gold” report right here.
MAILBAG
From Elaine S.: I like the new Daily format. Much easier to read on my mobile phone. Thanks.
From Daniel O.: The new format for The Palm Beach Daily is a huge improvement. It was very good before… but now it is great. Lots of very helpful content. Five stars.
From Tracey C.: Your new format looks great. Much more “readable” and a lot more interesting.
From Lynnette H.: Positive change in the newsletter layout. I like it!
From Paul W.: Yes, I like your new format. Easier to "digest" each issue separately. Thank you.
Editor’s Reply: Thanks for the positive review, guys. But we’re not content to rest on our laurels. We’re constantly looking for feedback to improve the Daily. If you have any suggestions to make the Daily more valuable to you, share them with the Palm Beach community right here.
From William Y.: This is in response to Teeka’s essay on the two rules to hold on to long-term winners. My simple rule is to have sell stops in place. I use TradeStops. Using stops ensures that I stay in the trade until it stops out. Then, I place the stock on my watch list, in case I want to get back in.
Editor’s Reply: You’re spot-on, William. Stop losses make up the third leg of our Three-Legged Stool of Safety. We also use them in The Palm Beach Letter and Palm Beach Confidential. For those unfamiliar with stop losses, it’s simply a preset price at which you will sell a stock if its price drops that low.
IN CASE YOU MISSED IT…
Make sure you circle March 31 on your calendar… That’s the date a new “gold law” goes into effect that some analysts predict could push gold to $5,000 or higher.
Our friends at Casey Research say there’s one virtually unknown gold trade you can make based on this new “law” that can return 27 times MORE money than simply holding bullion.
Get the full details right here…
