Keep on holding gold

I'm glad I took my holidays when I did. Being away meant that I missed the confusion of the market volatility the rest of the office had to deal with. But it also meant that I came back to find the stockmarket much lower and the gold price much higher than when I left. What more could a grumpy gold bug like me hope for on her return from a few weeks relaxing in the rain up north? The only thing that could have improved my mood would have been an even bigger fall in the markets.

We expected the decade from 2000-ish onwards to be a rubbish one. Prices, and expectations of future prices, were far too high and we started worrying about credit bubbles and debt crises long before it was fashionable to do so. Now, however, we are becoming what Sebastian Lyon of Troy Asset Management calls "frustrated bulls". We want to stop worrying and start buying. After all, the FTSE 100 is today lower than it was back in 2001. It's also over 20% down from its highs of 1999, and on most measures stocks look reasonably cheap.

But much as we'd like to do so, we just can't jump in wholeheartedly quite yet. Why? It is partly because, while some stocks might look cheap, they should be cheap. Look at the risks facing them. There is widespread doubt over the future of the euro. Global growth has stalled even Germany is flat-lining. The British economy is mired in stagflation. US debt is out of control. Stocks may, as a colleague put to me this week, look cheap relative to past p/e ratios, but "they are not cheap relative to the macro-economic risks that exist" all around them.

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It is also because they are not cheap enough. According to Andrew Smithers, the American market is 36% overvalued on the Q ratio and 43% on the cyclically adjusted p/e ratio (Cape). These are the only two valuation techniques that have a good history of actually forecasting the future.

This doesn't mean that the rest of this year doesn't have a reasonable chance of coming good. Mostly it is money, not valuations, that drives markets, and given the slowdown in global growth, it makes sense to expect more money to appear via quantitative easing in Britain, the States and the eurozone. Then, just as last time, all markets would rally temporarily. However, what it does mean is that the bear market probably isn't done with us yet.

So what to do? The same as we have been suggesting for some time. You hold gold as a hedge against everything bad. You keep some cash so that when the bear market is done with us you can buy cheap stuff. And you hold a portfolio of relatively high-yielding, high-quality stocks either individually or via a good and cheap investment trust, such as Troy's Personal Assets Trust (which also holds gold and a high percentage of cash). One day, stocks will be a lot cheaper, or politicians and central bankers will be a lot smarter than they are now. When that day comes, our advice will change.