Our current strategy at Fat Prophets includes a positive view on both gold and oil. We believe these two commodities are in a long term bull market and consider such exposure integral to any investor's portfolio. But we don't advocate such exposure with expectations of rapid short term gains.
Corrections of varying magnitude punctuate all long term upwards trends and investors should acknowledge this. Many investors make the mistake of interpreting a correction as a crash and sell out at the wrong time.
Take gold for example. In May, the yellow metal hit a 26-year high of US$740 an ounce. The run-up to this level was very sharp indeed and a correction at some point was inevitable. We note that many commentators had earlier called for a top in the gold price at around US$500!
Instead of trying to anticipate the correction we advocated sticking with the long term trend. The gold price did correct - viciously - and while the yellow metal remains volatile we believe this is merely the consolidation before the next move higher. While the timing of the next upward leg is uncertain, we are confident of its inevitability.
Our reasoning for investing in gold is simple. We see the precious metal as a stable currency in limited supply. Gold is simply a measure of the worth of paper currencies - specifically US dollars.
Given the precarious, debt ridden nature of the US economy, we believe it inevitable that authorities will attempt to engineer an inflationary environment in the years ahead. Inflation erodes the real value of debt and in such an environment, gold should thrive.
Oil is another commodity of strategic importance. In our opinion, the world's supply of easily accessible, cheap oil is running out. Many oil importing countries are looking to lock in long term supplies at today's 'heightened' prices. Taking a long term view, perhaps they do not believe today's oil price is overly expensive.
Furthermore, ongoing tensions in the Middle East are likely to underpin the oil price for many years to come. The US occupation of Iraq is deteriorating daily and has facilitated an increase in Iran's regional influence.
We initially recommended gold at US$262 back in March 2001. Since concluding a 19-year bear market in 1999, gold has been in a long term upward trend, and at the May high had increased by close to 200 percent.
Oil has similarly experienced a strong bull market in recent years. From a low of close to US$10 a barrel in late 2001, oil come within touching distance of US$80 in July. However like gold, the price of oil has also corrected lower.
Over the past few years our strategy has been to steadfastly stay with the dominate trend in both gold and oil. Primary bull markets typically carry prices to levels widely considered inconceivable at their onset. In our opinion, the key to maximising profits is to stay invested for the duration of the bullish cycle.
However this strategy is by no means straightforward. The difficulty facing investors is the myriad of corrections encountered along the way. No upward trend travels in a smooth line, and corrections routinely act as a counter balance to each advance.
Despite the prospects for further consolidation in the gold and oil markets, the longer term outlook remains overwhelming positive in our view. In time, we believe that gold will trade beyond the 1980 all-time high of US$850, while oil will exceed US$100.
We therefore believe investors should look to build, or maintain, overweight positions in both gold and oil. Overweight means different things to different investors. Most professionally managed funds would struggle to have anything more than 5 and 2 percent exposure to oil and gold respectively, so we would consider anything over this amount as overweight.
However, individual investors have different risk profiles and different income and growth needs, so an overweight position in gold and oil really depends on individual circumstances.
With a core weighting in gold and oil stocks, our strategy is to supplement this with larger blue chip industrial companies with a defensive bias.
The FTSE350 index is very much in an uptrend currently, doubling from the March 2003 low of 1624 to this month’s decade high of 3252. However despite the rally there still remain pockets of opportunity.
Some sectors have underperformed materially in recent years and this is where future opportunities may lie. In any case, we suggest investors should have some exposure to the gold and oil sectors.
Greg Smith is the Managing Director of Fat Prophets. If you would like a further sample of their expert research please click here.
If you have any questions or inquiries about this article feel free to email info@fatprophets.co.uk or call 0800 389 0705