Score some stock returns for us!

As many of you might know, if you’ve been following Squirrelers, I sometimes delve into data to identify trends and find insights.

For example, I’ve looked at stock market returns by month to identify which months perform best/worst. Another example, among others, was analyzing how the best companies to work for have had excellent stock performance in the past. Whether stocks or other areas of personal finance, it’s often interesting to slice and dice data to to find some information that might be useful in some form or another.

In this case, I thought I’d look at some data from another angle, this one more just for fun.  With the football postseason in high gear, I set out to identify trends related to the Super Bowl and stock market returns.

Objective

Are there any trends we can identify by looking at who won the Super Bowl in prior years, and how the stock market performed in those years?

Methodology

I first collected information on who participated in the big game since it first kicked off in 1967, and which team won or lost. Then, I pulled stock market data from each year since then, and calculated the annual return for the market. Specifically, I used the S&P 500 to analyze stock performance.

In looking at the data, the natural split seemed to be by conference: NFC or AFC. Organizing it by which team won the championship in any given year, I was able to pull together tables. Keep in mind that through the 2011 game, the NFC has won 24 championships, and the AFC (or old AFL, for the first few years of the title game) has been victorious 21 times.

Results

The first table shows the results by seasons the NFC won, and the second table does this for seasons the AFC won.

As can be seen, there is a notable difference in stock market returns based on which conference emerges with the victorious team.  Clearly, there is a Super Bowl Effect – which might as well be referred to as an NFC Effect.

Years where the NFC wins the game end up with an average return of 11.06%.  When the AFC wins the game, market returns average just 3.95%.   Additionally, when the NFC wins, the stock market is more likely to have an overall positive year: 83%, vs 67% when the AFC wins.

Takeway: GO NFC!

OK, this is all in fun. Plus, the sample size isn’t that great in terms of total numbers. 45 years of data seems like a lot, but it’s not a huge data set. Besides, correlation doesn’t mean causation! But hey, if you don’t have any particular rooting interest in the game – and if your favorite team isn’t there (like me) – why not cheer for a potential winning outcome for the market!

My Questions for You

Have you heard of the Super Bowl impact on the stock market?

Who are you going to be pulling for in the Super Bowl?

It’s a popular question among some personal finance enthusiasts: is it better to invest in index funds or individual stocks? There can be evidence pointing in multiple directions, though it’s become more popular of late to focus on index funds.

Personally, I’ve been leaning that way. My approach has evolved to having index funds as a foundation for stock investing, with some opportunistic purchases along the way, based on market events and historical anomalies.  With respect to the latter, regular readers of Squirrelers have seen period analysis I’ve done with provides reasoning for occasionally making such purchases. Just to point to 2 examples, analyses done on stock market returns by month as well as market reactions to the japan tsunami disaster can show how there are times where there truly are opportunities to jump  in.

That being said, as I mentioned up front, I’ve been liking index funds – and regular investments in them whether large or small. With that in mind, I set out to do an analysis of comparing individual stocks from “best company” lists to the S&P 500.

Hypothesis – Phase I

My original hypothesis was that if you looked at a list of so-called top companies, or best companies, etc – you’d find that they probably don’t do much better than the S&P 500 as a whole in terms of stock returns. Therefore, if you invested in an index fund with low turnover and low expenses, you would do better than you would with more active trades or just buying a bunch of individual stocks. In this case, I’m basing this on changes in stock price.

Methodology – Phase I

The steps I decided to take involved looking at a list of top companies, as I alluded to earlier, and comparing stock performance to broader markets as a whole.  In order to do that, I searched for top companies, and located a list of Business Week’s top global companies. I chose the 2009 list of top 40 companies, as that would give me 2 years of data afterward for which I could use in my comparison.

The article was dated October 1 of that year, so ended up selecting October 2009 through September 2011 as my 2 year analysis period. Additionally, in looking at the 40 companies in the list, I actually included the ones that were publicly traded on U.S. exchanges. This meant that the analysis consisted of 14 companies.

What I did was to take the 14 companies and calculate the change in stock price during that 2 year period for each one. Additionally, I did the same thing for the S&P 500 during that time period. Then, I did a simple average of the 14 calculations and compared to the S&P 500 results for those two years.

Results – Phase I

Here are the findings:

As I looked at the results, it appeared that the hypothesis did not turn out to be correct. Interesting.

Rather, it looked like the basket of analyzed companies from the 2009 best company list significantly outperformed the S&P 500. In fact, the increase in stock prices over that time period was 28% for the best companies, versus 10% for the broader market basket.  Now, if you look at the list, there were two clear outliers: Amazon and Apple. Fair enough. However, even when those 2 companies are removed from the analysis, the remaining 12 still have a 12% increase, which outpaces the 10% of the broader market.

Well, then. So much for the idea that an index would be better than some list of best companies!

Hypothesis – Phase II

After taking a look at the preceding analysis based on the aforementioned best companies list, I thought it might be worth it to try again with a different list of companies. Maybe then we could see if we got a different result. I didn’t originally plan to look at another list, but this “Phase II” seemed like a good idea to continue this line of thought. Again, recall my original thought that index funds would perform just as well.

Methodology – Phase II

In this second scenario, I examined the list of Fortune’s best companies to work for, also from 2009 to keep things consistent with the prior analysis. Here, the date noted was February 2009, so I used data from February 2009 through January 2011. In this case, I went from the top of the list down, and selected companies that were publicly traded. Additionally, I chose 14 companies in order to align with the assessment of the Business Week list, and chose the highest ranking ones starting from the top.

As I did previously, I took this set of companies and calculated the change in stock price during that 2 year period for each one while doing the same thing for the S&P 500 during that time period. Once again, I did a simple average of the 14 calculations and compared to the S&P 500 results for those two years.

Results – Phase II

Here are the findings:

First of all, this was a period of an extraordinary rebound in the market. That’s evident in the 56% return in the S&P during this 2 year time period. Granted, most people saw their portfolios tumble in value prior to that time period, so this was a market recovery in some ways.

That being said, the performance of the top 14 traded companies on the list of best companies to work for showed a 140% increase in stock price, easily exceeding the 56% gain of the S&P 500 during that time.

This second list had only one company in common with the first one: Google. The rest of the companies were different.

Overall Implications

Putting it all together, it appears that the hypothesis that index funds could match “best company” list performance didn’t find it’s way into the results. Rather, the best company lists outperformed the market average by a broad margin.

Now, I suppose that there could be other lists that under perform the market. If those were viewed in a stand alone analysis, we might be having an entirely different conversation. So, we can’t jump to any conclusions that such lists always outperform the market. I doubt that would happen, as rule anyway.

However, it does lend some credence to the notion that perhaps there are some types of companies that just do perform better than others, based on pre-defined criteria. Maybe the reality that these were companies that were perceived to be well-run and/or good employers is indicative of their potential to beat expectations and increase in value?

My Questions for You

What do you think of the idea that investing in companies that are regarding as well-run and great employers can help yield better returns than investing in the broader market?

What criteria do you use to evaluate companies in which you might invest?

Where do you stand on the issue I brought up in the first two paragraphs, where I expressed the view that index fund investing is a great primary foundation, with other investments made only made opportunistically?

I was talking to someone very recently about general business topics, and and we ended up briefly delving into a discussion on international markets. As a part of this discussion, I mentioned that I have been wanting to increase my exposure to non-US markets, but am currently well under 10%.  My comments were that I thought I need to revisit this ratio.

The guy with whom I was talking paused for a second, furrowed his eyebrows, and then stated that he didn’t believe he had any direct international investment. He went on to comment that he’s fine with that, because how was he “supposed to know what consumers in China want?” He used China as a proxy for any market distant from the U.S. Essentially, he was saying that he didn’t understand foreign markets, so why invest in them? Right away, it seemed to me like he had a home country bias.

There’s an old maxim that you should “invest in what you know”. It’s a general philosophy that was a big part of Peter Lynch’s teachings. Lynch is probably best known for being the acclaimed manager of the Fidelity Magellan fund, as well as for authoring several popular investment books.  Lynch has probably forgotten much more about investing than many of us will ever know. In other words, he knowledgeable. Clearly, Lynch achieved quite a bit of success, so there’s obviously something to the the application of this principle of investing in what you know. Furthermore, he’s just an example to point to – there are scores of investors who take this approach. Yes, just like the guy with whom I was having the aforementioned discussion.

Now, I might not be someone to dispute this approach….but then again, I’ll do it anyway:)

My view on the idea of sticking to what you know is that it has merit, but it can be misapplied and taken too far.

If somebody asks me to make a big investment in a bauxite mining operation, as an example, I’d pass. Now, it just might be a great opportunity, but since I know absolutely nothing about that business, I wouldn’t make such an investment. In that case, I’d stick to what I now, or at least avoid what I don’t know.

However, there are other legitimate examples of when it’s good to ignore the ”buy what you know” approach:

1. Mutual Funds. If somebody asks me to make small investments across a representative set of companies traded in the stock market, I’ll think about it. Why? Well, isn’t that what index funds are, more or less? I might not know a lot about these companies, but I know enough to say that historically, stocks have earned a rate of return that well outpaces inflation.  That’s enough to get me to buy stocks in a ton of different companies, all through an index funds. Index funds are a great example of how taking the “invest in what you know” approach can go too far. If you follow that approach too closely, you’d miss out on all the advantages of investing in funds.  Including funds that hold positions in companies that you know nothing about.
2. Investing in a Company other than Your Employer.  I’ve heard of several people who simply wanted to invest in the stock of their employer, because it’s what they know (or so they think). In post from the early days of the blog, I shared the story about a guy who invested everything in the company stock. He told a large gathering at a retirement party that he invested everything in the company stock over the years and that it worked for him, so we should consider doing it too. Surprisingly, he got an ovation for that. Meanwhile, I sat quiet thinking that he was so totally wrong. Maybe he got lucky with his investments, but it’s very risky to put all of one’s eggs in one basket. You already have employment risk in a company, why add investment risk too
3. Investing in International Stocks. This applies to the guy I mentioned above, who might want to at least consider diversification. A prior post I wrote a while ago discussed the topic of international stocks and diversification. In that post, I referenced another article which stated that at the time, the U.S. held 43% of global stock value, yet American investors hold 70% of their stock portfolios in American companies. Frankly, I’m surprised it’s that low! What’s also interesting is that the United States’ share of the world stock market value was 90% back in 1945, and has since declined to the 43% figure I mentioned above. This phenomenon of home country bias is not exclusive to the U.S. either, as it’s been seen in even more drastic terms in some other countries, as I noted in the prior post. Yes, it seems like we all need to realize that’s there’s a world out there!

My Questions for You:

Do you prefer to strictly invest in what you know, or do you branch out?

If you do branch out, do you follow each of the 3 approaches above?

Do you know anybody who carries a home country bias with investments?

Are there certain specific days that are better than others, when it comes to investing? It just might be that there’s historical evidence of a pattern of  better stock market returns on certain days than others.

As regular readers might notice, I occasionally like to dive into the data to find trends about stock market returns.  While I generally focus on more of a passive, index fund strategy, I do think that it’s also interesting to find patterns that might give us an edge if we choose to be a bit more active.  This way, we may have something to tip the odds in our favor a bit.

A prior analysis I did on monthly stock market returns showed how there are some historical patterns that seem to indicate better stock performance in some months than others. A subsequent analysis on the September effect delved further into that particular month, indicating that September is historically poor performing relative to others.  The premise held up the very next month after the post, as the market plummeted by over 7% in that 30 day period.

This got me thinking – if we could go beyond identifying monthly stock returns, and instead looked at daily stock returns, could we find any discernible patterns? In other words, are there certain days that provide better returns than others?

As I did before, I pulled raw historical stock market data from the S&P 500 index. This time, I just looked back to 2000, but I changed the data points to daily. I had to set up the spreadsheet with a variety of formulas, so it took a bit of time to convert the raw data into a place where I could generate some insights.

But when I got done, I found something interesting:  Stocks tend to go up, higher than they otherwise would, on the first trading day of the month.

Essentially, looking back since 2000, it’s clear that there have been more first days of the month that went up versus those than went down. So, from January 2000 to November 2011, the breakout was as follows:

• “Up” first trading days of the month: 90
• “Down” first trading days of the month: 52.

Interesting. It became clear that first trading days of the month tend to have stock price increases, more so than stock price declines. But what about the actual returns themselves?

I broke out the different types of classifications of trading days and totaled them as follows:

• First trading days of the month: 143
• Other trading days of the month: 2,837

Then, I did a simple calculation of taking the average daily return (up or down), summed them, and divided by the total number of days in each respective category. Granted, this isn’t a weighted average, but a direct simple sum and divide approach. Here are the results:

• First trading days of the month: 0.192% average daily return
• Other trading days of the month: -0.005% average daily return

Now, this was even more interesting. The first trading days of the month yielded an impressive average of a 0.19% daily return. If that seems small, remember that it’s for an average day. Just a day. By projecting out over a larger number of days, we can see that getting returns like that is pretty good! All the while, when removing these first days from the mix, and looking at all other days – we can see that the market fell short of breaking even.

Implications: It seems like while there’s certainly variability in the data, the first day of the trading month tends to outperform the average of the other days. Thus, perhaps there should be consideration given to this data when deciding when to buy or sell market baskets of stocks. Maybe buying toward the end of the month makes more sense, and selling soon after the first few days of the month makes sense.

I’m not completely sure why this phenomenon takes place, but it could be because there are more institutional investors putting money in the market at the beginning of the month, 401(k) plans putting in money at predetermined times, or maybe inherent optimism at the beginning of a new time period – much like people get fired up with resolutions at the beginning of a new year. Who knows?

It turns out that some others have discovered this concept of the first day of the month effect too, as I subsequently found out after doing this analysis. Well, that’s ok  :)  Of course, I still think that there’s a potential opportunity here that’s really been flying a bit under the radar. This isn’t discussed too often in personal finance circles. 

My Questions for You: 

What do you think of this effect? Is it something you’ve considered when making buying/selling decisions?

Why do you think that this clear pattern exists? There must be a logical explanation, right?

Show Me the MONEY!!

I don’t hear too many people talking anymore about how S&P downgraded the AAA credit rating of the United States. Remember that event? It wasn’t too long ago.

When it happened, it was a jolt that impacted many people. Even some people who barely follow the news had heard about this. Once that happened, it seemed like some kind of watershed moment that signified the potential peril that the economy of the United States was in.  Many people were concerned about the impact of the credit rating drop on the stock market.

The news hit on Friday, August 5, 2011.  I recall that weekend, people talking about how our terrible financial management as a country was finally having a clear impact, and that things would never be the same in the U.S.  There were probably a few people that feared an impending stock market apocalypse.

I mean, this just seemed so shocking: the United States credit rating downgraded from AAA?

Well, the following day of trading here in the U.S., Monday August 8, was quite turbulent. The S&P 500 dropped from 1,199.38 to 1,119.46, representing a 6.7% decline in stock prices.

Yeah, that scared the heck out of a lot of people.

I remember a conversation that weekend, where we were talking about how it was going to be that upcoming Monday. There was plenty of chatter in the personal finance blogosphere about it. We knew there would be some immediate impact.

That being said, there were some others that were really getting into a panic. A number of people talked about how stocks would plummet. I remember one individual talking about how he thought there might be a free fall. One blogger discussed pulling out of the market entirely, and putting money in cash.  Several of us tried to dissuade him.

Just over 2.5 months later, are we all talking about this? At all?

Now, I’m not minimizing what this downgrade represented. It wasn’t good. However, what I’m saying is that in reality, we tend to have short-term memories.

We just don’t talk about this as much anymore, in general personal finance circles. What was a crisis that got people panicked to the point of talking about pulling out of stocks entirely, is just not the hot topic of the day. The buzz – negative or not – is toned down quite a bit.

As of the most recent close, the S&P 500 stood at 1238.25. This is an increase of 10.6% since the S&P downgrade of U.S. Stocks.

Additionally, this increase means that the S&P 500 is actually higher as of this writing, 2.5 months later, than it was right before the credit downgrade. It’s actually increased 3.2% since then!

Think about it – despite all the panic, if you would have invested in the market right before the credit downgrade became widespread news, you could have seen your investment increase in value. Actually, 3.2% in just over 2.5 months is a pretty good return. We could have made money on this!

What does this tell us about how the stock market reacts to bad news – and then bounces back?

We actually saw a similar occurrence after the tragic Japanese tsunami earlier back in March 2011. The Nikkei plummeted from 10,254 right before the Tsunami (on March 11), down to a close of 8,605.15 two trading days later.  By March 31, the Nikkei was back up to 9,755. Clearly, there was a big bounce back in fairly short order – despite all the problems, including some involving nuclear plants. The markets there have since gone up and down (more down of late), but there’s no doubt that the market jumped back up off the canvas within no time after the events there.

My Questions for You:

Were you nervous about the markets after the credit rating downgrade news came out? Have you thought about this much less lately?

What do you think about the notion that the markets overreact to bad news, and these such times just might represent great buying opportunities?

Or, is that we just have short-term memory, and markets recover too quickly?

When it comes to investing in stocks, some of us like to be highly active stock pickers. Others among us like to invest passively, even to the point of a “set it and forget it” strategy.

One example of active vs passive can actually be indirect, through mutual funds.  In this example, as many of us know, we aren’t exactly picking the investments in a fund. Rather, the fund manager is picking the investments. Sometimes, these funds can actively trade many stocks. So even though we buy into mutual funds at a price per share (based on the net asset value) similarly to how we do a stock, there can be tons of trades going on with our money even if we ourselves don’t sell anything. The fund manager is behind the scenes making the moves, making this an active strategy of sorts.

On the other hand, if we buy a mutual fund that’s simply index-based, there’s very little activity involved. An S&P 500 index fund, for example, is set up to mirror the performance of the actual index. The brain work is taken out of the process, and there isn’t a fund manager’s acumen influencing the performance of the fund. It’s all based on how the individual stocks in the fund perform.

This of course brings us to the established, oft-discussed topic of index funds vs. actively managed funds. Thinking about it based on what we’ve discussed above, we’re really choosing between:

• Professional fund manager input into our investment; or
• No professional input, just independent stock performance guiding our investment

On the surface, it just seems logical that all things being equal, a professionally managed fund should outperform one that’s not professional managed, right? We’re often told about the virtues of index funds, and passive investing, but shouldn’t there be value to having a professional guide the stock picking within a fund?

Well, maybe there isn’t always value to a a professional actively managing a fund.

An article I saw on Moneywatch further supports the case for index funds over actively managed funds. According to this article, data from Standard & Poors shows that active fund managers have been consistently outperformed by index-based benchmarks. This finding is across cap size and covers the last 3 years.

Here’s the extent of the disparity with these actively managed funds:

• Large-Cap focus: 64% were outperformed by the S&P 500
• Mid-Cap focus: 75.1% were outperformed by the S&P MidCap 400
• Small-Cal focus: 63.1% were outperformed by the S&P SmallCap 600

Thus, for all the extra fees that are being paid, investors are getting nothing back. In fact, one could say that investors are getting punished for going with actively managed funds!

Now, there are some funds that clearly do outperform the market. However, the majority haven’t been doing so.

Personally, I’ve been a fan of index funds, but have a mix of index and actively managed funds.  At this point, it’s hitting home that maybe I should jettison the actively managed funds and replace them by adding additional investment in index funds?

I suspect that many people (including me, apparently), have previously found index fund investing to be “average” or lacking risk taking or a pursuit of wealth.  Who wants to be average, right?

Well, maybe average actually means winning in this case!

My Questions for You:

If you own mutual funds, do you focus on index funds?

What do you think about the notion that the pursuit of average, in terms of market returns, is actually a winning strategy in some ways?

Why do you think people pursue actively manage funds, despite the evidence that index funds outperform them?

Stock market performance often seems unpredictable. One month stocks are up, the next month they’re down. Volatility seems to be the name of the game, right? Maybe, but there are some historical trends of stock performance that are actually quite noticeable if you crunch the data. One noteworthy trend is the “September Effect” – poor stock market performance in the month of September.

We first discussed the topic of this September swoon in prices in a prior post on stock market returns by month. Check out the data and the graphs in that post, and you can see that stock performance (S&P 500) in the month of September is not good over the long term.

Interesting findings from that post, specifically related to September, are:

• In the last 10 years, September is ranked 9th out of 12 months in stock performance
• During that decade, September is one of only 4 months with a negative monthly return (-0.97%)
• In the last 40 years, September is ranked 12th out of 12 months – dead last – in stock performance
• During those 4 decades, September was one of only 2 months with a negative monthly return (-0.77%)

Overall, it’s clear: September has offered low stock market returns over the short-term and long-term.

So, why is that the case? It’s an interesting question, as there have been some big drops in the market in September. Most recently, 2008 saw market drop 9.8% in September.  Most of remember that market decline of just a few years ago.  However, did you know that in 2002, the market dropped by even more in September? It dropped by 11%, actually.

Alright, so September hasn’t been the best month for stocks, over the long run. Maybe it’s best to enjoy the seasons changing, fall colors, the football season starting, or whatever suits your fancy. Just forget about making money in stocks in this particular month, right?

Not necessarily. September isn’t always a disaster. When I crunched the data some more, and looked at stock performance by month within the last decade, we can see that September has ranked across the board in returns, compared to other months in each year. Here is where the month ranked (out of 12) each year:

2010 – 1st

2009 – 6th

2008 – 11th

2007 – 2nd

2006 – 3rd

2005 – 5th

2004 – 9th

2003 – 10th

2002 – 12th

2001 – 11th

Clearly, it’s been across the board in that recent decade. There’s actually a good deal of variability in stock performance in September, on a year to year basis.  It’s no slam dunk that there will be September Effect each and every year. This is where overall data can be a bit misleading.

That being said, there have still been enough bad Septembers that the overall stock performance for that month over the long term, compared to other months, has been shaky.  It doesn’t mean that it will tank this year or next. Consider this for entertainment purposes if you will, but I’m still going to keep this in mind.  40 years is a long enough data set for me for me to at least take notice

My Questions for You:

Have you heard of the September Effect?

Do you believe in seasonal or historical stock trends, or do you believe that the market moves indpendent of such factors?

Would such information cause you think any differently about any pending stock moves during this time of year?

Have you ever heard of the Rule of 72?

It’s one of those personal finance calculators that’s been around for a while, and it’s about as basic as it gets. Yet, it’s been used by some people to quickly project results for a given investment over time.

The rule is essentially a quick way to determine how long it will take you to double your money at a current rate of return. It works as follows: start with the number 72, and divide it by the rate of return of an investment over time. The result will be the number of years it will take to double your money.

For example:

Let’s say you have an investment that will earn you a total annual return of 3%.  It would then take you 24 years to double your money (72/3 = 24).  Too long? Well, jack that rate of return up to 6%, and it will then take you just 12 years to double your money.

While I consider myself to be analytical, and comfortable with complex calculations, I do like such tricks such as the rule of 72.  They allow us to quickly, on the fly, do some basic calculations. In this case, we all could have quickly divided 72 by 3 (or 6) in our minds to get the answer in just a matter of seconds.

For whatever reason, this one in particluar has struck me as being nice for those of us who gravitate toward investment growth thoughts.  It”s a quick way to think about what money could become in the future.

As with any shortcut, however, there are pitfalls.  There are three that I see with the Rule of 72:

1. Taxes.   If you’re paying taxes on earnings, this needs to be considered in any calculation. So, if you’re earning 6%, but will pay some tax on that, your after tax rate may actually be somewhere in the neighborhood of 4% or so.  This needs to be factored in, or the Rule of 72 will give you erroneous results.
2. Inflation.  Let’s say you’re earning 3% after taxes for example. If inflation is 3%, you’re not really getting ahead. The $1,000 you have invested will turn into $1030 a year later, but will still buy the same amount of goods as $1000 did the year before. So, inflation needs to be taken into account.
3. Accuracy. This rule is meant to be a shortcut, so it’s not 100% accurate down to the decimal point. For example, if you wanted to see how long it would take to grow a $1000 investment into $2000, with a 3% rate of return, the Rule of 72 would tell you 24 years. If you calculate it manually, it actually comes out to almost 23 1/2 years. Close enough for an quick estimate, but important to note that it is in fact an estimate.

Personally, I find that many quick financial projections, particularly those that are intended to show the power of compounding over time, tend to ignore both taxes and inflation.  To the latter point, always keep in mind the time value of money.

In any event, as long as we’re aware of it’s limitations, the Rule of 72 can be a useful tool for quick projections of how long it will take us to double our money.

My Questions For You:

Have you ever used the Rule of 72?

Do you ever stop to question assumptions in such financial projections, such as I did with taxes and interest?

The price of gold has reached some pretty high levels this year, as we know. It’s busted through historical highs, albeit on a non-inflation adjusted basis. Still, gold has gone from almost an afterthought in some people’s minds to a high flying investment once again.

With this in mind, I did some reading on gold recently, looking at some articles online.  In doing so, I came across some stories that discussed some Warren Buffett quotes and conversations from earlier this year. Buffet had given his thoughts on gold as an investment, and how it compares to other alternative uses of capital.

Here’s a summary of his main points:

If you took all the gold in the world, it would be valued around $7 trillion. This would equal about 1/3 of the value of all U.S. stocks. By comparison, the value of all farmland in the U.S. is about $2.5 trillion. You could take that farmland, add 7 Exxon Mobils to it, and have an extra $1 trillion to boot. What’s a better use of funds? You could probably do more with these alternatives to gold, versus just staring at a giant block of gold that looks nice but doesn’t actually do anything.

When you look at it in those terms, it makes sense.  Gold, as such, has limited real world use. It’s considered a storage of wealth, but as an actual element, what does it really do? It doesn’t directly generate income, it doesn’t produce anything that directly generate cash flows. It’s a speculative investment that can go up and down in market value.

I’ve seen people pumping up gold lately, even hearing one guy talk about how there’s a lot more room for gold to increase in value. Basically, he’s totally bullish on gold, it would seem. Additionally, I’ve seen many more businesses out there which buy and sell gold. I even saw one a few months back in a local indoor mall. There was a kiosk that had a sign that indicated that the people running it would buy gold. In fact, it seemed like the kiosk was truly dedicated to gold and little else based on first impressions. Those types of businesses just didn’t seem as prevalent in the not so distant past, before the huge price appreciation occured. It reminds me of how all kinds of people got involved in the real estate industry while it was in full bubble mode.

Speaking of this price appreciation, I see that gold has surpassed $1660 per ounce as I write this! There’s a lot of uncertainty of where things are headed in terms of the global economy.  This debt crisis in the U.S. isn’t one of our better moments, and there have been all kinds of problems in Europe of late.

When I see how this has become such a hot market, I think of the Buffett comments. They make me pause to consider exactly why gold has maintained it’s place as a store of value over time, taken in context with what we’re seeing with the price of gold lately.

My Questions for You:

What do you think of Buffett’s comments earlier this year?

Do you ever think about the opportunity cost of owning gold, in this way?

What are your thoughts on where gold is at today, in terms of it’s value and it’s potential for continued growth?

There has been much talk lately about the price of gold, and how it has been reaching historic levels. Recently, it has closed at over $1,500 per ounce, which represents a huge increase over just a few short years ago. However, its performance pales in comparison to that of silver. Often in the shadows of gold in terms of investments, silver has shown staggering price increases in recent years.

If you looked at the price of silver 10 years ago, as of April 2001, you’d see it trading at just over $4 per ounce.  As of the most recent close at this writing (4/25/11), silver is currently trading at about $47 per ounce.  Think about that rate of return! Yes, it’s quite impressive. Those who invested in silver a decade ago have made out incredibly well.

Can you imagine a $40,000 investment turning into $470,000 in just a decade? That’s about what would have happened had you bought 10 years ago.

That type of return just seems hard to sustain. Look at what happened to tech stocks in the late 1990’s. Skyrocketed, then they plummeted.   Look at the once blazing real estate market, how people made a ton of money in it in the last decade before the bottom fell out in many markets over the last few years.  All good things must come to an end.  I wrote about this in my post on investment bubbles. This phenomenon has been in play since the Dutch Tulip Bubble of the 1600s.

Now, gold is reaching some pretty high prices as well, and many people have called this as a bubble waiting to burst. Whether or not that happens remains to be seen , but it’s being assessed that way by some people. I wonder what everyone thinks of silver?

Clearly, silver has increased in price at an even more prolific rate. Check out the charts below. They illustrate the following historical prices, as of April 25/26, 2001 to 2011:

1. Silver
2. Gold
3. Dow Jones Industrial Average
4. Gold/Silver Ratio
5. Dow/Silver Ratio

As can be seen, while gold has increased over time, silver’s recent increase is quite sharp.  The Gold-to-Silver ratio declined quite a bit since 2001, from 60 to 32. The Dow-to-Silver ratio has declined from 2,441 to 265!

This isn’t the first time silver has increased sharply in value. After trading in the $5 range in the late 1970′s, it spiked up in price dramatically in late 1979/early 1980, reaching over $49 per ounce. One reported factor in this decline was the attempt by the Hunt Brothers to corner the market. In any event, silver quickly retracted in price and dropped close to the $5 level within a few years. 

It appears that a silver bubble is forming.

This assessment is my own based on this analysis. I’m not an investment professional, and this is not a recommendation. That said, I’m really wondering when the price declines will kick in. Growth in silver prices seems unlikely to continue indefinitely, right? After all, what investment keeps going up without ever dropping?

My Questions for You:

What do you think of the silver bubble hypothesis?

Also, what do you think this phenomenon is telling us? Is it pure speculation, a sign of coming inflation, response to a weak dollar, or an indication that perhaps stocks have room to grow?