It's been a turbulent few days in the financial markets. The VIX (volatility index) spiked above 20 for the first time this year, an increase of 98.3% from its multi-year low in March and within 4% of its 52-week high. The volatility index is often referred to as the fear index. A high VIX indicates that fear is elevated, which usually coincides with bargain stock prices. Conversely, when VIX is low, it usually coincides with overpriced stock prices. An easy saying to remember is, "When VIX is high it's time to buy. When VIX is low, It's time to go." VIX is such a useful indicator that I keep it at the very top of my list in the stocks app on my iPhone.
Due to the elevated VIX, obvious signs of panic as well as other reasons mentioned below and in previous updates, I was a buyer of commodity funds recently near their lows. Unless one is investing in options, leveraged funds or using margin, the short term movements in the market, despite how extreme they may become, rarely cause any long term damage. For instance, the 200-day moving average price of gold fund GDXJ sits more than double today's closing price. Unless one's average price is significantly higher than $18.25, history would indicate that the risk of loss is extremely low.
I believe my good friend, Steven Jon Kaplan explained Thursday's selling wave very well in his "True Contrarian" email update that day. I've been following Steve since 2007 and he's the reason why 2008 was such a profitable year for me as an investor, despite the massive drop in stock prices that year. He's achieved double-digit positive performance for over six years straight, which is a claim most investors and their advisors cannot claim.
I sometimes refer to Steve as the Rain Man of the investment world. If you saw the movie of the same name, you'll remember how Dustin Hoffman succeeded in helping Tom Cruise make a fortune at the blackjack table, a game that most players lose. While Steve is not an autistic savant like Hoffman's character, he does consistently succeed at investing, a game which most players lose. Steve is not your typical Wall Street type. He's more like a math professor and he knows the markets better than anyone I've ever studied in my twelve years of investing. He's been at it for over 30 years and formulated a disciplined, reliable strategy for success that has stood the test of time. I'm sure it will be no different this time around.
Here's what Steve had to say:
"Most news stories "blame" the Fed for recent market activity, but what is a more important factor is that there have been many undecided investors who had considered selling their worst-performing positions in recent months but hadn't yet done so. Instead of acting, they decided to wait for another key announcement. After hearing yesterday's report, many of those who had been wanting to sell finally had an excuse for doing so--figuring that if the Fed wasn't going to help them, then it was hopeless. This is very similar to the situation in late February and early March 2009 when many general equity holders were becoming increasingly disappointed, but held off just in case there was a change in the headlines. When a terrible employment report was announced an hour before the open on March 6, 2009, this served as an impetus for those traders to finally sell the S&P 500 and similar assets just before they experienced one of their strongest ten-month bull markets ever recorded. I don't know exactly how the next few days or weeks will develop, but we are likely to experience amazing percentage gains for the most disliked assets within one year.
The following unusual multi-decade analysis of gold mining shares goes all the way back to 1938. During the past seven decades, whenever the specific readings mentioned in the article drop near recent levels, gold mining shares have roughly doubled thereafter:
GDXJ was trading above 20 as recently as January. The financial markets make stunning moves in one direction, and once everyone is convinced that they're "permanent", they proceed to make equally powerful moves in the opposite direction. It's tempting to think that it's different this time but of course it will surely be the same."
Furthermore, the smart money--commercial traders and corporate executives have been buying at record levels recently and physical gold buyers have been lining up around the block to buy gold at these levels.
Unfortunately, we're required to "Stress Test Our Resolve in the Gold Markets" (link to a well-written article) and it's important to stick with the game plan. The best investment will always seem gloomiest just before it most strongly brightens.
In order to succeed as a contrarian investor, one needs to buy low when almost everyone else hates an asset, continue to buy into extended weakness and know that short term losses will eventually result in long term gains. It's not always easy, but after so many consecutive years of positive performance, you can't argue with results.
Disclosure: I am long GDXJ, GDX.