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Stock market investors sometimes believe it is best to "buy the dip" so they can benefit from short-term declines.This often works because stocks have what is known as a "long-term upward bias."Over the long term, a time frame measured in years or decades, stocks should go up. This is true because earnings will grow for successful companies to match the rate of economic growth. In the United States, this relationship is shown in the chart below.
Both the S&P 500 and the Gross Domestic Product (GDP) have been rescaled to equal 100 in January 1957. Over time, the lines tend to converge. This chart also provides long-term hope for stock market bulls since the stock market index is currently below the long-term rate of economic growth. The relationship shows stock prices should move higher over the next few years. This relationship between economic growth and stock market prices has also been seen in other countries.Commodities are different. There is no reason to expect an upward bias in their prices. Technology could lead to changes in supply, as it has for some agricultural products, and increased supply leads to lower real prices (which are adjusted for the rate of inflation).There are complex models that can be used to determine the supply and demand of commodities. For example, it is very likely that Starbucks (NASDAQ: SBUX) has a model of consumer demand for coffee and information that allows them to forecast the production levels of the commodity. Based on this, they can develop an estimate of what coffee should cost and develop an appropriate hedging strategy.The chart below shows that the price of coffee is about the same as it was in 1978, even though demand has more than doubled over that time.
Gold is a commodity, so there is no reason to expect a strong upward bias in gold prices. Yet gold is widely believed to be pushed higher by inflation. Even if that is true, gold has actually gotten ahead of inflation.
Because there is no reason for the real price of any commodity to rise over time, buying on their dips can be a money-losing strategy. Despite that reality, many investors are wondering whether they should buy gold simply because it has suffered a sharp pullback.
Twenty years ago, one of my competitors complimented all the effort I was putting into my trades… and then told me I was doing it all wrong.
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