Why we bought Gold Stocks last year
Late last year we identified gold stocks as the greatest contrarian play of 2016. We wrote about it here
As a result of this work, in December 2015 the Affluence Fund made a small investment in the Baker Steel Gold Fund. We expected we would double our money on this investment sometime in the next 3-5 years. But we didn’t know exactly when it would happen. And because the asset class had been so volatile in the past and could very easily have continued to fall by 20% or more, we limited the investment amount.
Sometimes you get lucky. We managed to time that investment almost to perfection. Sentiment and the gold price both rapidly improved from January 2016 onward. The value of the investment took off and by July 2015 we were up over 140% on the purchase price. The recovery was sharp and sustained, fueled not only by a 25% rise in the Gold price, but also by an almost total transformation in investor sentiment, from extremely bearish to extremely bullish.
Why we’re now sellers
We recently decided to take some profits on the gold stocks investment. Here’s why:
- The market had identified and priced in many of the positive reasons to buy that we identified in our original thesis.
- Mainstream fund managers were beginning to catch on – and adding gold miners to their portfolios.
- Australian large cap gold miner Newcrest had risen strongly, returning to a rather lofty P/E multiple, although admittedly on significantly lower earnings than the previous boom.
- Positive articles began appearing in a number of mainstream and financial papers, indicating the herd had caught on.
Most telling of all though, we could see that traders and other speculators were holding record positions in gold and sentiment toward the metal was very near an all-time record. This implied that a significant amount of the recent price appreciation was due to momentum trading and we felt that prices had recently moved some way ahead of fundamental value.
It is important to note that we’re still believers in the long term trend. We do expect significant further upside in Gold mining shares in coming years. But the sector was looking a little too hot for us. And as the saying goes, nobody ever went broke taking a profit. So in July we redeemed half the Affluence Fund investment in the Baker Steel Gold Fund.
We replaced that holding in August with a small amount of exposure to oil and agricultural commodities such as wheat and corn which are currently at or very near to 10 year lows. We see plenty of upside in these and will write more about that soon.
The lesson to be learned from this experience is in the power of sentiment and market psychology to impact prices, both positively and negatively. Some extraordinary investment returns can be made when sentiment is extremely low and investors are at their most pessimistic. But you have to be able to do three things:
- Remain calm and resolute in the face of extreme peer pressure;
- Be patient enough to wait for the turnaround; and
- Be brave enough to potentially stomach significant downside on your investment before you see the upside.
It’s hard to be a contrarian.
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