Don't Ignore Stocks in Favor of Gold

April 7, 2011
Marc Lichtenfeld

Gold bugs are celebrating, though they haven't thrown the victory party just yet. Many bullish investors believe the price of gold will reach $2,000 an ounce. But more than a century of data suggest that investing in stocks, rather than gold, is a better way to go.

Gold bugs are celebrating, though they haven’t thrown the victory party just yet. Many bullish investors believe the price of gold will reach $2,000 an ounce. Some predict $5,000 an ounce as a realistic target. It very well may be. But more than a century of data suggest that investing in stocks, rather than gold, is a better way to go.

Over the past 110 years, gold has risen by an average of 3.95% per year. On the other hand, the Dow Jones Industrial Average has appreciated 4.89%, not including dividends. Add in a dividend yield even at the historic low-water mark average of 3.2%, and the return rises above 8%. Double the return of gold.

The stock market just posted its largest first-quarter gain in 13 years. Through April 1st, the Dow industrial average was up 6.4%. The Oxford Trading Portfolio, which I help manage, has performed even better, gaining nearly 11% over that same period.

Still, investors have been climbing a wall of worry. And admittedly, there’s much to worry about.

• Radiation is spewing uncontrollably from a melted Japanese nuclear reactor.

• Our military is now engaged on three fronts.

• Government spending is out of control.

• People who should be in the nuthouse are running the highest levels of government.

• And food prices are going through the roof.

Yet despite all of these problems, the market keeps charging higher.

Despite Recovery Signs, Investors Still Piling Money into Gold

The market is a forward-looking indicator. Generally speaking, it tells you what’s going to happen about six months from now. When the market bottomed in early 2009, it was a signal that the economy would stop crumbling and start turning around later in the year. And that’s exactly what happened.

According to the Bureau of Economic Analysis, corporate profits jumped 36.8% in 2010, the largest increase in 60 years. Now that CEOs are seeing earnings return, they’re getting increasingly comfortable with hiring again. Last month, we saw some real progress on the job front as 216,000 jobs were added and the unemployment rate fell to 8.8%.

Yet despite these signs of recovery, many investors are piling money into gold without thinking about the future potential of the stock market.

I know the argument for gold:

• It’s a hedge against currency devaluation, which everyone is certain will soon sink the U.S.

• Gold is seeing increasing demand as an industrial metal and as a store of wealth.

I know. I know. You don’t have to leave comments below telling me why gold is great -- despite the fact that it underperforms stocks over the long haul.

I know. I know. This time it’s different, right?

We’ve Seen Social, Political, Financial and Natural Disasters

It’s important to keep in mind that people always assume that the problems their society is facing are among the worst in history.

My grandmother was sure the world was going to hell when my mom started playing Doo-Wop records and insisted on wearing blue jeans. In each decade since my mother was leading the world to oblivion by listening to Duke of Earl, serious issues have faced the world and its markets.

• We’ve had five decades worth of social and political crises, such as terrorist attacks, foreign wars, threats of nuclear war, race riots and assassinations. And yet despite how upsetting and perhaps life-altering these events were, life did return to normal for most people.

• We also had natural and man-made disasters, such as devastating hurricanes, earthquakes and tsunamis. Chernobyl, Three Mile Island, the Bhopal/Union Carbide disaster, oil spills and the Red Sox winning the World Series. And still, people soldiered on.

• And, of course, we’ve had decades of financial crises. No doubt, this latest one was a doozy. But past financial calamities were no picnic, either. The savings and loan crisis of the 1980s and 1990s, where 23% of the savings and loan associations failed, cost taxpayers $88 billion ($124.5 billion in today’s dollars) and was partially responsible for the large federal budget deficits of the early 1990s.

At the tail end of that situation, the U.S. went into one of its strongest periods of prosperity, balanced budgets and huge stock market gains. In fact, the Standard & Poor’s 500-stock index doubled in just three years.

The dot-com collapse in 2000 to 2001 caused many investors to swear off stocks forever (not surprising, since more than $5 trillion worth of wealth was destroyed). It was their loss, or rather, lack of gain. Investors sitting on the sidelines after the bubble burst missed out on huge profit opportunities starting in 2003.

And after the market was cut in half by the most recent crisis, investors have made back about 85% of their money -- and that’s if they bought at the very top.

Despite decades of financial, political and social problems, people still went to work, opened businesses, raised their families, celebrated milestones, weathered tough times, laughed, cried and lived their lives. And smart investors still made money.

So when you turn on the news (that is designed to do nothing but scare you), or you hear people talking about the end of this country, remember that we’ve been there, done that and own the worn, tattered T-shirt.

The problems we face today are serious. But so were the ones in decades past. When Ronald Reagan took office in 1981, things were bleak. A few short years later, it was “Morning in America.”

Time-Tested Strategies for Long-Term Investing

Don’t be scared so badly that you miss out on the gains that the market will deliver over the coming years. Asset protection is an important investor strategy. However, you should also stick to time-tested strategies such as The Gone Fishin’ Portfolio or investing in dividend aristocrats. Instead of investing solely in shiny gold rocks and ETFs such as the SPDR Gold Trust (NYSE: GLD), now is the time to seek stocks in potential high-growth industries emerging from the crisis, or quality dividend-yielding companies such as Clorox Co. (NYSE: CLX).

Although Grandma and Grandpa were certain that the Levi’s hanging in Mom’s closet signified the end of days, they continued to invest in the markets, real estate and the family business. It would have been easy to get sidetracked by any of the issues listed above over the past five decades. But ignoring all of the outside noise was the best decision they ever made as they achieved their financial goals and lived comfortably into their mid-nineties.

But THIS time it’s different, right? I’m sure you could have made that argument during two world wars and at any other period since 1900. And each time was different but, it’s tough to argue that history shows us that stocks outperform gold over the long haul.

And for those of you with a shorter time horizon, stocks should still prove to be the better investment. No doubt, gold has beaten stocks over the past 10 years, but that’s simply repeating a pattern where gold outperforms for about 10 years and stocks outperform for the next 20.

Source: Stocks-For-Beginners.com.

Will history repeat itself, or is this time really all that different?

Marc Lichtenfeld is a Senior Analyst at InvestmentU.com. See related articles by Marc here.