What gives you the upper hand or what is your "edge" in the financial markets?
If you don't know your "edge , then you don't have one and your odds are probably
more like those of a gambler in a casino. If you know your "edge" and you have
a slight, legitimate advantage over the rest of the market, then over time
you should make money. A casino has an "edge" over their customers and with
the odds in their favor they make money over time while the gambler, well...
gambles.
This article does not claim to be the edge you may be looking for but we may
be able to enlighten you to something most never consider. With a relatively
unique perspective to consider, you may find your own edge.
Does the public and do you really understand how inflation can either destroy
your financial health or make you rich? If you understand inflation you can
be more aware of its impact in the financial markets and use it to your advantage.
There is a lot of controversy about what inflation is; we happen to believe
it is an expansion of the money supply. However, in this article we will just
focus on the effects of inflation and how to take advantage of it.
Please consider the following individual points to understand our perspective.
- The "price" of something is a measure of both the item and the currency.
It is a relative ratio. The currency is measuring the item but the item is
also measuring the currency.
Above we can see that the "value" of the dollar, the measuring stick, is just
as important as the "value" of the item it is measuring. But what if the unit
of measure, the dollar, is constantly losing value? Wouldn't the changing value
in the currency make it harder to measure investment performance and difficult
to compare investment opportunities?
- A chart of a currency can be deceiving because a currency chart is measured
against other currencies. If both currencies are losing value, then they
will appear rather stable relative to one another.
In the above chart we can see a 43% loss in value of the US dollar but that
is relative to other currencies that may also losing value.
- Over time, goods as well as most investments seem to go up in "price",
suggesting the currency is constantly losing value and purchasing power.
This loss of value in the measuring stick can create all kinds of distortions
and misleading signals in the markets. Consider for a moment that assets
are measuring the value of the dollar. Now look at how many more dollars
it takes to purchase the same investment. That is a very real loss in purchasing
power.
In the above chart we can see that it now takes over $1,400 dollars to buy
the same ounce of gold that only cost $35 back in 1971. If you want a gold
coin you need way more dollars to buy it now.
In the above charts we can see that the value of the US dollar has tanked
relative to US Stocks as represented by the Dow Jones Index. This is another
example of the US dollar falling in value relative to assets, making the assets
true performance hard to measure.
-
A real world loss of purchasing power is a better measurement of the effects
of inflation than a government created measurement is.
-
Removing the effects of inflation from our analysis can really help clarify
what an asset is actually doing. Inflation can speed up and slow down causing
the measuring sticks value to change greatly at any given time. Therefore "relative
value" rather than "price" can really help us with our investment decisions.
We do not love one asset class over the other and we certainly are not "gold
bugs". There is not one great asset class in our opinion. Fortunes have been
made and lost on all asset classes and in our opinion it all comes down to
timing. If markets are cyclical then we must try to determine when one asset
is under or overvalued.
In the above chart we can see that US Stocks have been falling in value relative
to Gold since about the year 2000. Perhaps the effects of inflation have made
it hard to see this loss in stocks but when we compare one asset directly to
another the results are clear. Since 2000 it was very profitable to weight
a portfolio towards Gold.
In the above chart we can see that when we compare gold to the Dow Jones Index,
in the big picture it appears that Gold may still be undervalued. Even though
Gold has risen from roughly $250 to a high of nearly $2000/oz, from a long
term perspective and relative to stocks, Gold appears to be undervalued.
Does the above analysis guarantee that gold must go higher? No. Does this
mean that Gold is by far the best investment of all time? No. In our opinion
this simply means that at this point in time, from a big picture perspective,
gold appears to be undervalued relative to stocks, and capital may eventually
flow from one to the other.
This is a very basic example of relative value and we have built a collection
of proprietary indicators based around this concept. To learn more about our
system, read more articles like this one or sign up for our newsletters, we
encourage you to visit www.investmentscore.com.
Good luck!
