One of the most difficult things for an investor to do is look beyond the current environment. One of the biggest reasons that many investors underperform is because of their own human biases.
This is perfectly natural, as we tend to expect more of the same in terms of what has been recent history. In this way, investor sentiment becomes far too complacent.
Is there a way that you can take advantage when investor sentiment is causing the markets to be mispriced?
Absolutely, but you first need to have an understanding that this is indeed occurring. A perfect example over the past couple of years has been with gold bullion. During the run-up in gold bullion prices, investor sentiment became overly bullish as some people assumed that the price would continue rising forever.
Obviously, that’s completely unrealistic, but this led to a position where investor sentiment was leaning too far toward the bullish camp. Conversely, gold bullion in the second half of 2013 was the recipient of massive levels of negative investor sentiment.
In that case, people looked at the recent price trends for gold bullion and assumed that the sell-off would continue—again an unrealistic expectation, but a natural human reaction. There’s an old saying in the market that the right trade is the tough trade. When the market in gold bullion was selling off and very few people were talking about it, this negative investor sentiment was an excellent opportunity to begin accumulating, but it’s not easy to be contrary to the crowd.
The future is unknown, and a perfect example is the current situation occurring in Ukraine. With “pro-Russian forces” taking over the Crimean peninsula, the world is now watching a potentially catastrophic situation. Naturally, in times of uncertainty, people are also turning to gold bullion and investor sentiment is beginning to increase.
I really started becoming bullish on gold bullion at the end of 2013, not because I foresaw this conflict in the Ukraine, but because the level of investor sentiment became so bearish that the long-term risk-to-reward scenario for gold bullion was extremely attractive. This is a situation in which I am moving ahead of the crowd, not following or reacting to the current environment.
If the situation worsens between Russia and the Ukraine, I think gold bullion will continue increasing in price, which will create additional bullish investor sentiment. As the trend continues in favor of gold bullion, this reinforces the bullish investor sentiment, and this cycle continues until the environment becomes overbought. In that case, one needs to begin adjusting to the shift in investor sentiment by reducing exposure and moving towards areas in the market that offer value. The market is one big cycle, swinging back and forth on a pendulum of emotions.
Chart courtesy of www.StockCharts.com
The fact of the matter is that to be financially successful, you need to be dynamic in your approach, adjusting your portfolio to take advantage of these swings in investor sentiment. With the price of gold bullion now exceeding the 200-day moving average, this should help bring additional bullish investor sentiment into play, but remember: nothing moves in a straight line.
Following the bounce up off the lows in 2013, there will certainly be some consolidation of this move. The price might pull back slightly, but the next big test for gold bullion is the area just below $1,500. Overall, I think 2014 should be a positive year for gold bullion.
This article Making This “Difficult” Trade Now Could Set You Well Ahead of the Crowd was originally published at Daily Gains Letter