Why gold could be next to fall
What goes up must come down - eventually. Photo: David Gray
We have known for decades – and probably centuries – that our economies move in cycles.
The advantage for sharemarket investors is that while we go through both booms and busts, the general trend is higher. It's helpful to think about it as a steadily increasing trend line over the long term, but with short-term gyrations above and below that line.
The same cyclical nature exists for commodity prices. In 2008, oil shot up to a record of about $US140 a barrel amid expectations of a new normal. In fact, it had risen, largely unchecked since 1999, when oil traded closer to $US20 a barrel.
From that high point, oil plummeted to not much over $US40, seemingly in a matter of weeks. It then took a couple of years to break back through that $US100 price, but is yet to recover those 2008 highs.
The walk down memory lane is important. As the saying goes, those who forget history are doomed to repeat it.
With that in mind, we shouldn't be surprised to see iron ore prices fall back from recent highs. With plentiful natural availability and a sky-high price, it was only a matter of time until supply caught up with even growing demand – and that's not counting demand shocks such as a decline in the rate of Chinese growth.
I'm not taking credit for predicting it – I didn't. I'm with Sir Isaac Newton, who acknowledged he couldn't predict the "madness of men". No one could know when the decline would come, but the expansion plans of the world's iron ore miners almost guaranteed this day would arrive.
I'm also not sure the price will stay low – it's a market that is immensely susceptible to the moods of the crowd.
So if that's the case, how can investors hope to be successful? The answer is almost painfully boring, but universally applicable (and long proven). As always, you need to buy quality businesses at cheap prices, and if you're going to buy commodities, the same rules apply.
The time to buy iron ore miners is when the market can't take it any more – when the price suggests a future so bleak, it couldn't possibly be true.
Why gold could be next
And gold? The price of the yellow metal continues to spiral upwards, seemingly endlessly. Even some of the most diehard gold bears are giving up and joining the party, figuring that joining the bulls is easier than trying to beat them.
I don't know if or when the gold bubble will end. The party will continue for as long as someone keeps pouring the drinks. But when the drinks suddenly run out – because investors become less fearful of equities or because gold mining output increases to soak up the demand – prices are likely to fall.
If oil in 2009 and iron ore in 2012 have taught us anything, it's that those falls can be unexpected and breathtakingly quick – and the gains being enjoyed now can be erased in a matter of days.
One of the most difficult things in investing is feeling like the party is happening without you – especially when it goes on for a while. Soon we tell ourselves that "everyone else is doing it", and rationalise that it must be OK.
That's the thing with cycles, though - by definition, the longer the upswing has been going, the closer we are to the top. And the closer we are to the top, the closer we are to the clock striking midnight.
We don't know whether it's 9pm, 11pm or a minute before midnight for gold – and that's a dangerous place to be if you're running the risk of your portfolio turning into a pumpkin when the clock strikes 12.
If I'm wrong, I might forgo some gains. I can live with that, but if I'm right, gold investors have a lot to fear.
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Scott Phillips is a Motley Fool investment analyst. You can follow Scott on Twitter @TMFGilla. The Motley Fool's purpose is to educate, amuse and enrich investors. This article contains general investment advice only.