Gambling & Gold: Safe Havens

Gambling & Gold: Your Safe Haven In An 'Impossible' Economy

By Ian Davis | 1 February 2008

The U.S. economy is about to endure the impossible... for the second time in our lifetimes. Fortunately, a few sectors may offer safe haven. Before the 1970s, economists believed that a slowing economy and high inflation could never occur simultaneously. The two conditions seemed mutually exclusive. When an economy experiences slow economic growth, the unemployment rate tends to climb. This decreases the spending power of consumers and causes the demand for goods to fall. As demand falls, oversupply leads to lower prices and thus a slower rate of inflation. This sounded like a good theory... until the 1970s came along.

In the 1970s, the U.S. endured so-called "stagflation" (a stagnant economy combined with inflation). In 1973, the price of goods rose 8.9%. Then, in 1974, the price of goods rose a painful 12.1%. Meanwhile, the economy weakened. The U.S. gross domestic product (GDP) rose only 4.1% in 1973 and fell by 1.9% in 1974. The stock market suffered as well. The S&P 500 fell 48.4% between January 1973 and October 1974.

After the 1970s, economists reevaluated stagflation. They now attribute the 1970s occurrence to a "supply shock"— when the price of a critical, relatively price-inelastic good (like oil in an oil-importing country) rises sharply. In the 1970s, OPEC manipulated the global oil supply, causing prices to skyrocket. The sudden rise in the price of oil led to an increase in the cost of goods (since producing and transporting goods almost always requires oil). In addition, the spiking oil price also slowed the economy by making production less profitable and leaving consumers with much less discretionary income.

So, if history does repeat itself, where should we invest for the next one to two years? To answer that question I looked, once again, at the 99 DataStream sector indexes. Ninety of them had histories dating back to 1973.

The result is somewhat surprising and doesn't bode well for the stock market. For example, only two sectors ended the 1973 bear market with a positive return... the gambling and the gold-mining sectors. The following table shows the five best— and five worst-performing sectors during the 22-month 1970s selloff. The table also shows how well these sectors have fared so far during this market downturn [[which has probably barely started, so comparisons are difficult: normxxx]].

Best-Performing Sectors Gain 1/5/1973 -10/16/1974 Gain 10/9/2007— today     Gambling 14.6% -27.4%     Gold Mining 7.2% 15.7%     Aluminum -4.0% -22.8%     Coal -8.6% 28.4%     Nonferrous Metals -15.6% -29.6%     Worst-Performing Sectors     Home Construction -84.3% -6.9%     Apparel, Retail -86.4% -17.1%     Real Estate Holding &   Development -86.8% -23.3%     Transportation Services -88.6% 3.0%     Drug Retailers -94.3% -11.4%     S&P 500 Composite -48.4% -14.4%

As you can see, there is little consistency between the performance of the sectors today and their performance back in the 1970s. In the 1970s, many hard commodity stocks weathered the downturn admirably [[they hadn't been artificially inflated by the housing market activity, as today: normxxx]]. Of the top five best-performers, four were mining stocks... everything from coal to gold. Today, however, these commodity stocks are producing mixed results. Gold-mining and (relatively uninflated) coal stocks have risen, while aluminum and nonferrous metal stocks have crashed.

The performance of gambling stocks also differed between the 1973 bear market and today's. In 1973, the index did extremely well... rising by double-digit amounts. However, since the current downturn began in October 2007, gambling stocks have fallen by more than 27%. Other notable differences include the home-construction and the transportation-services indexes.

Look at home construction stocks. They were destroyed to the tune of 84.3% during the 1973 bear market. Today, they have fallen by only about 7%... and they have been rallying in recent days [[they had taken their hit early— anyways, lots earlier than the start of this table: normxxx]]. The oversold state of the housing market going into this downturn seems to be mitigating any damage that would otherwise be occurring.

The performance of the transportation services stocks also differed between 1973 and today. During the 1973 recession, transportation services stocks fell by 88.6%, but the sector is actually showing a 3% gain so far this downturn [[again, they've taken their hit earlier: normxxx]]. Traditional inflation hedges— like gold— as well as cheap alternatives to oil— like coal— tend to do well during periods of stagflation. Conversely, retail stocks— like retail apparel and retail drug stocks— tend to do poorly... invest accordingly.

Good investing,
Ian Davis

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Normxxx    
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