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That noise you hear is the gold bugs banging their heads against the wall. Gold prices fell to a five-week low this week as the greenback strengthened on expectations of another Federal Reserve interest rate hike this year. But there could be a silver lining. Here are the top three fundamental reasons and four charts that show why it may be time to buy gold.
1. Gold is due for a mean reversion.
The theory of mean reversion suggests leaders eventually become losers and vice versa as prices return to the mean or average in the long run. Perhaps it’s because of investors selling winners to book profits and redeploying money in bargains or out-of-favor areas.
Gold prices, as tracked by SPDR Gold Trust ETF rose 8% year to date, through June 20, while losing 4% in the trailing year, according to Morningstar. By contrast, SPDR S&P 500 climbed 10% so far this year and 19% in the past 12 months.
SPDR Gold Shares ETF fell 5.4% annualized over the past five years while SPDR S&P 500 surged 15% annually on average over the same period. Going back 10 years, gold rose 6% annualized while the S&P 500 increased by 7 % annualized, according to Morningstar.
After underperforming the stock market for five years, gold and other commodities are arguably undervalued compared with the stock market.
“In relation to the S&P 500, the GSCI commodity index is currently trading at the lowest level in 50 years,” Ronald-Peter Stoeferle and Mark Valek, of the Liechtenstein-based investment firm Incrementum, wrote in the “In Gold We Trust” report. “Also, the ratio sits significantly below the long-term median of 4.1. Following the notion of mean reversion, we should be seeing attractive investment opportunities.”
What’s more, the U.S. stock market is overvalued on many metrics as the bull market celebrated its eight-year anniversary in March, suggesting a pullback is long overdue.
“Regardless of which version of the S&P 500 price-to-earnings ratio (P/E ratio) you look at – generally accepted accounting principles (GAAP) earnings, operating earnings, median P/E or Shiller P/E – stocks are expensive on an absolute basis,” says Rob Breed, senior vice president and portfolio manager at F.L.Putnam Investment Management Company in Portland, Maine. “These P/E ratios now stand at 23.7, 21.7, 23.6 and 29.6 versus their long-term medians of 16.3, 14.8, 17 and 16 respectively. Any shock to today’s confidence – some might call it complacency – could lead to a significant decline.”
The stock market is “significantly overvalued” in terms of its historical ratio to gross domestic product, or GDP. The ratio is closer to the historical high of 148% last seen during the 2000 tech bubble than in a fairly valued range at 75% to 90%, considering the stock market capitalization-to-GDP ratio printed at 133% as of Tuesday, according to Guru Focus,
Total Stock Market Capitalization-to-Gross Domestic Product Ratio