Is the stock market index in a bubble relative to gold?

In this blog I will list some of my top Quora answers for the last few days, which focused on many interesting subjects.

In the answers shared today I focused on:

1. Is the stock market in a bubble? Is it normal for the gold:dow ratio to be at these levels?
2. How rare is rags to riches stories? Is riches to rags more common?
3. Is the UK likely to see out of control inflation due to Covid, QE and 0% interest rates? What about other developed countries?

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Is the stock market index in a bubble, and when will the indexes to gold ratio become more historically realistic?

Source: Quora

There are two facts to remember:

• Gold has never been a good long-term investment. Yes, it has good periods and bad. Sometimes it has an excellent 10–20 year run. Look at 2000–2011. Gold increased by 500% when stocks were stagnant. Over the long-term, however, gold’s performance against stocks is embarrassing. If your great great great grandfather had invested $1 in gold in 1802, $1 invested would have been worth $26-$28 in 2005. $1 invested in US stocks would be worth $10.3m today! AND stocks pay dividends. Gold doesn’t. If we accounted for dividends, the gap would be bigger. Now sure, inflation pays a big part in those returns, but gold has only kept pace with inflation long-term. Even gold bugs admit that gold “holds its value” – in other words it gives inflation or inflation +1% long-term. Stocks have given inflation +6.5%-7% in the case of US markets.

• As a result of the last point, the Dow to gold ratio, or Nasdaq or S&P500 for that reason, is always likely to go up long-term, especially adjusted for dividends as well. It won’t go up every year or decade, but the overall trend is like that.

Gold is a lump of metal. The supply goes up gradually over time, but not by a lot.

Demand fluctuates. Sometimes demand goes up, and sometimes it goes down.

Therefore, the dynamics are stagnation in real terms – not big falls or rises adjusted for inflation.

In comparison, the stock indexes have a social Darwinism to them. The weak firms get “knocked off the index” by the stronger firms.

Tesla recently joined the S&P500 index, knocking off one firm from the index in the process.

Over time, this makes a huge difference, as the survival of the fittest goes on indefinately.

This was innovation over 100 years ago:

Now this is innovation:

As more technology comes into the marketplace, firms can become more profitable over time.

Amazon and Apple in 2020 is stronger and more profitable than the biggest company was in 2000 (Microsoft).

I am sure whichever firms are strong in 2040 or 2050 will be much stronger and more profitable than Amazon, Apple et al in 2020, as they leverage more technology.

All the while, gold just remains as a lump of metal, which hasn’t changed in thousands of years.

That is one reason the price of gold has been stable in real terms since the times of Christ.

Again, that doesn’t mean gold won’t have periods in the sun, and stocks won’t crash.

That is besides the point. Long-term, gold isn’t even an investment. It is just a store of value.

As a final point as well, gold doesn’t even perform that well during crisis and timing the gold market doesn’t seem any easier than timing the stock market.

It is a misconception that it is a safe heaven which performs well during panics in the stock market.

Look at the last 12 years. Gold had a great run from 2000 until 2011, with the one exception being 2008–2009.

When people were really concerned, they went to government bonds. Gold only returned to its bull market in 2010 and the first half of 2011, after people realized that the world wasn’t coming to an end.

Gold then had a bad period from 2011 until 2016 or so. It went on a bull market run, but again that was cut short during the worst of the 2020 crisis.

Gold only resumed its bull run a few months after the worst of the covid worries’, when people realized the worst wasn’t going to happen.

Gold, therefore, tends to perform well, or OK at least, when people are relatively worried. When people are panicking they go to cash and short-term government bonds.

Let’s not forget as well that gold is now at about $1,900….the same level it was at 11 years ago.

A real-terms fall and gold hit a record high in real terms all the way back in the 1980s.

How rare is rags to riches?

Source: Quora

It depends how you define it. Going from poor to a billionaire is, of course, very rare.

Even being a billionaire is rare:

Yet most super wealthy people, and indeed wealthy people, didn’t inherit most of the money:

Once you get to people in the millionaire and multi-millionaire status, you see loads of “get rich slow” types, including people who are:

• Teachers
• Engineers
• Managers
• Accountants
• Dentists
• Doctors
• Pilots
• Many other people who are low-middle, middle and upper-middle income

All these people have done is invest for a very long-time, and gotten wealthy, even if they aren’t high-income.

In terms of high-income business owners, quite a few have came from nothing.

The reason is simple. It is easier to take a risk when you are younger and have few opportunities, compared to if you have had a great education and receive loads of good job offers after university.

Many very wealthy people got rejected from basic jobs, like Jack Ma, who was rejected countless times by KFC.

Necessity is the mother of invention in these cases, and there are loads of similar examples.

This does depend on the economy and country though. I have noticed the following commonalities:

• In developed and “old rich” cities in Europe and beyond, it is more common to see inherited wealth compared to up and coming countries.

• New industries, or industries that suddenly open up, create more new millionaires. For example, the City of London in the 1980s created many newly wealthy people. Previously it was for public school boys, then it opened up.

• After the fall of the USSR, it was easier for people to create businesses in these economies.

• In some class conscious societies, it is harder for people to drag themselves up, but the internet is changing that as people don’t need to be constrained by their location anymore.

• It might seem obvious, but people who take more risks are more likely to become wealthy, regardless of the location. People who emigrate, move cities or get paid on performance and not salary are more likely to get there, especially if they are persistent.

• Personality type, character traits and habits are just as likely to result in success as our background. This even affects inherited wealthy people. Let me give you a simple example. A consciousness, diligent and hard working person is less likely to lose money from an inheritance, big bonus or for that matter an unlikely event like winning the lottery. There is a fairly obvious explanation for that. They have a less conservative personality compared to somebody who is a gambler. Likewise though, somebody who likes to take calculated risks, is likely to do even better than somebody who is too conservative. They are more likely to invest rather than save money, start up businesses etc. 

• Controlling “ruin risks” are more important than other risks. People are often obsessed with risks like losing money if an investment goes down by 10% and you need the money, and therefore can’t wait for the markets to recover. Few people are as obsessed by risks that could completely ruin a business or individual. Take Covid for example. Few businesses prepared for these kinds of events. Same during 9/11. Most airlines and travel businesses didn’t fix the roof when the sun was shining. For that reason, it also makes sense to not take big risks with your health.

So, rags to riches stories aren’t that common as riches aren’t that common.

Yet from those people that reach there, it is common that people have came from ordinary backgrounds.

Also let’s not forget that the opposite can be the case as well – riches to rags.

In fact it is more common – over 70% of professional sports stars go bust after retirement, as do most lottery winners and most third generation rich.

The point is, learning how to manage money tends to be more important than just knowing how to make it.

Will inflation in the UK be out of control following the economic hit due to COVID-19?

Source: Quora

It is unlikely. Not just in the UK but globally in most developed countries. Global demand, and domestic demand, is weak.

In addition to that, you have the following deflationary pressures:

• Technology. That Netflix subscription costs less than going to the move theatre as an example. It also results in fewer manpower hours being needed in some industries
• Outsourcing. It is now possible for businesses in the service sector to use cheap freelancers overseas as well. It isn’t just manufacturing like the 1980s.
• Oil prices are relatively low

Those 3–4 deflationary pressures are far stronger than the inflationary pressures, such as firms that localise supply chains as a result of Covid.

What is more likely to result in bigger inflation is an unexpected event, like a war in the Middle East and oil prices skyrocket, or the Pound falling hard on a no-deal Brexit deal.

That would push up imported costs, but it seems to be priced in to the current exchange rates.

Don’t listen to anybody that says inflation will rise due to 0% interest rates and QE.

The same people that said that in 2008–2009 are saying the same thing again…..or at least they were until 6-7 months ago.

Inflation has been falling in the UK and most developed countries for decades.

It has been higher in the UK than some other places since 2008, but it has been lower than the 2000s, 1990s and much lower than the 1980s and 1970s:

In recent years, inflation has only spiked above 5% when there has been external events.

For example, in 2011, oil prices rose well past $100 a barrel for various reasons, before falling back down again.

The far bigger danger is a Japan-style situation. In other words, close to 0% interest and growth for decades.

A debt-deflation trap whereby government debt stays high, demand low and inflation non-existence, alongside close to 0% growth.

The Eurozone have almost had that in the last decade or two, and that is more likely than huge inflation.

Globally, the only countries that have had high-inflation in recent years have been highly corrupt countries and those with super high GDP growth rates.

In 2010 and 2011, many developing markets saw huge capital inflows.

Some countries in Africa, like Ghana, and Asia, saw record high growth after coming back from the 2008 crisis.

In those years there was big inflation and currency appreciations. That has long since ended in most cases.

What is more likely is a big increase in assets price inflation, which has been happening since 2008 in most countries.

Stocks, REITS and some forms of real estate have had a good run over the last 12–13 years since 2007–2008, partly because there aren’t many other places to put your money when interest rates are at 0%.

Pained by financial indecision?

Adam is an internationally recognised author on financial matters with over 830million answer views on Quora, a widely sold book on Amazon, and a contributor on Forbes.