Markets can often behave like a misguided teenager. You might know that your 15 year old son is fundamentally sweet natured and a nice lad but spends his time behaving like a juvenile delinquent. Ultimately of course his behaviour will correct itself and he will blossom into a delightful young man.
So stock markets, currency markets and virtually any other financial market you might think about can act in the most inappropriate fashion imaginable. It might be perfectly obvious to you that Gold for example is undervalued and can only go up. Every single indicator in the world may be flashing upwards but the price keeps going downward.
It is at this point that we should mention the efficient market hypothesis. This is the commonly accepted Markowitz work that says that markets are totally efficient and that prices are constantly correct. Now this article is not one dwelling on whether Markowitz was right or wrong or whether he meant one thing or another, but suffice to say that his work does explain much of what happens, whether you agree with him or not, and that a great deal of respect must be given to the theory in any commentary about market’s behaviour. The important point to take from this is that markets often behave in many ways, for many reasons, completely at odds with the fundamentals underlying them.
What investors need to remember when considering their investments is that just because you analyse and think about a position or situation, even if your analysis is right, does not mean that you can conclude that something will happen in the markets to reflect this.
So if you add up all the relevant facts that relate to the Gold Price and its likely future direction and it all points to Gold rising, there can still be many reasons, more difficult to quantify, which mean that the Gold Price may fall and it may fall more and for longer than you ever imagined possible. In this regard 2+2+2 might not equal 6.
There is a famous saying that markets can remain irrational longer than you can remain solvent. My own view is that embedding this saying into your thinking and mindset is probably more important than understanding the efficient market hypothesis.
Markets misbehave and this will be for any number of varied reasons, many of which may not be explicable.
It is very important that investors who are thinking about their investments and what to do with their money bear in mind that the possibilities of just about anything happening are higher than may be apparent. Yes the supply/demand position with Gold means that prices should go higher, yes the weakness of the dollar should mean the Gold price rises and yes Gold is generally a haven for money in times of difficult market circumstances. All of these may be true but this still doesn’t mean the price will rise! One of the reasons may be that if the arguments for increases in the price are so compelling then they will be obvious to everyone else as well as you and this may tip the balance with regard to buyers and sellers trading in the market against the buyers.
Personally I am not worried about the reasons I just have to factor in that there are reasons, when I contemplate investing.
In practical terms this means never over reaching any position. This means never believing that there is anything even remotely close to a sure thing and never stacking up a position so high that you rely on the fundamentals being right. Always measure your positions by the worst case scenarios and always assume that your beliefs and analysis may be wrong, if for no other reason than markets misbehave completely unexpectedly and irrationally nearly all the time.
If you take this view and use this as bedrock of your decision making when you invest in virtually anything for virtually any period from a few hours to many years you will not go wrong.
