BOSTON – The market had scarcely closed on April 10 with gold futures above $600 an ounce for the first time since 1980 when the e-mails started from investors wondering if it was the right time to buy gold and what percentage of their portfolio to commit to precious metals.
But when the Russell 2000 closed Tuesday at an all-time high, finishing the trading day with its largest one-day gain in five years, the news was met with silence. No questions, no concerns, no one anxious to rush out and snatch up small-cap stocks.
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Sure, gold is glamorous not only in real life but in investing, where it often provides feast-or-famine performance that makes it mighty tempting to take a chance to get a seat at the banquet. But the Russell 2000 is a small-cap index, and small-company stocks historically have delivered returns that are just a bit superior to their much larger brethren.
Gold, like many speculative investments, can be a world-beater in the short run but often tends to lags stocks and bonds over the long term. Small-cap stocks, meanwhile, tend to perform at the top of the security pool over time.
There is a bit of a similarity, however, in that both types of investments are the kind of thing that the average investor doesn't know all that much about. While gold once was a staple of every portfolio, that stopped thanks to years of miserable performance relative to the stock market. Likewise, investors love the idea of buying small companies and getting the additional returns that have been delivered historically but they frequently can't stomach holding a portfolio of names that they don't recognize.
One other similarity: The news on both fronts is not a reason to buy now. In fact, it's a reason to get a bit nervous that you're late to the party.
Gold is up more than 40% in the last 12 months and is up more than 15% thus far this year. The Russell 2000 (RUT) is up more than 30% in the last 12 months and has gained almost 15% this year.
In both cases, it's pretty easy to find experts who will say the rally will continue, countered by an equal number suggesting that it already has gone on too long.
The interesting thing about the communication from investors — or lack thereof — that followed the two recent news events is that investors were looking to make a "play" on precious metals — which many observers would classify as "speculations" — and not the stocks, despite similar recent results, and much better long-term numbers, for the stock play.
Average investors shouldn't be looking to "play" gold, or any investment for that matter. That is an activity better left to folks with strong feelings about the direction of the market and the courage to place their financial bets on something volatile. Most savvy gold investors I have met over the years were able to ride out the bad times in precious metals, something average folks clearly never even tried, as most rushed away from gold for years and only have considered getting back in after missing out on multiple rallies.
Likewise, average investors shouldn't get too excited about the run in small-caps.
In both situations, the average investor should be concerned about long-term asset allocations rather than catching the current rally by what might be its tail..
If the strength of gold is enough to make an investor consider an allocation of 5% or 10% in metals, then it's always "time" to have some gold in the portfolio. If buying gold now is a way to implement what amounts to a permanent change in strategy — rather than a temporary play based on the news — then it's always time to make the change.
The same goes for an investor looking at small-cap stocks. Clearly, small-company stocks have a role in most portfolios; loading up on them now, rather than following an asset-allocation plan, sets an investor up for chasing whatever is hot, again and again and again.
For someone already allocated to gold and small-caps, the last 12 months may have created a different situation, namely one where rebalancing is necessary.
Rebalancing involves putting a portfolio back onto its target asset allocations. So if gold represented 5% of an investor's portfolio a year ago, but it makes up almost 10% today — due to gold's increase and some other asset groups not performing as well — the idea would be to cash in some winnings and reinvest the proceeds so that the portfolio is put back at prescribed levels.
That's hard to do when investments like gold and small caps have been running hot, but it also would have led an investor to buy into those asset classes back before the current run-up started, rather than sinking more money in and hoping the ride lasts.
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Copyright (c) 2006 MarketWatch, Inc.
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