The global scene for financial markets has changed forever & it will continue to evolve rapidly. With debt levels now far higher than what precipitated the 2008 GFC & central banks seemingly wedded to printing money as the only solution, we can expect significant volatility in the coming decade. This makes it extremely challenging for independent investors to build wealth with any degree of confidence.

Independent investors fall into one of two categories. The first operate their own self-managed fund but largely take their asset allocation advice from financial planners who in turn typically direct their money into managed funds. These managed funds by & large track the performance of the overall stock indices because they are basically a buy & hold exercise on the major stocks that make up the index. This approach seeks to use diversification to manage risk but my firm view is that it guarantees under performance while not really achieving the aim of reducing risk. One only has to look at the decimation of many superannuation funds during the GFC which has dramatically changed the retirement plans of many investors.

The second category of investor seeks to make their own individual decisions about which stocks to own based on their own research or gathering of information from various sources. Now any financial investment carries some risk, even so-called risk free government bonds – just ask investors in Greek government bonds who have just taken in excess of a 70% loss of capital. However the investing formula below provides the most assured way to build wealth over time at risk levels which are lower than many people unknowingly engage in by owning so-called “blue-chip” companies. To know this is a true statement just think about the “blue-chips” like;

• HIH Insurance – Australia’s 2^nd largest insurer at the time
• Babcock & Brown – Australia’s 2^nd largest merchant bank on par with Macquarie Bank
• Centro Property Group – one of our largest shopping centre owners supposedly offering a secure income stream
• ABC Learning – a global player in child care centres

These businesses all disappeared taking investors’ money with them, but what about the incredible underperformers over lengthy periods of time such as;

• Telstra – remains at only 36% of its peak value 13 years later

• Macquarie Bank – at 30% of its pre-GFC highs

• Billabong – 85% below its peak price in 2007

• Amcor – still below its highs of 1994 & 2002

• AMP – 71% below its 1998 highs

• Boral – 50% below its 2006 highs

• David Jones – 60% below its peak in 2009

• Insurance Australia Group – 52% below its peak

• National Australia Bank – 45% below its peak

• Qantas – 71% below its peak

• Bluescope Steel – 95% below its 2008 highs

There are numerous others which were regarded as safe “blue-chip” companies that have cost investors dearly because they left their money in the hands of the managed fund industry thinking that diversification meant low risk. This has simply been a disaster for many people.

We are now in an age where many old practices & supposed “truisms” must be thrown out & a fresh look taken at effective investing. There is no question the next decade or more will be one for astute stock picking, having a small number of high quality businesses which are monitored regularly & thoroughly. As Warren Buffet says – “have a small number of eggs in your basket & watch that basket closely”.

So what are the key questions for investors?

1. What type of investments offer the highest reliability & performance over time & what are the elements that make them such consistently strong performers?
2. What do you require to stay on track with this strategy over the long term?

The best investments:

The key elements are companies that;

• Produce high & consistent return on shareholder equity (ROE) which drives value to shareholders
• Produce above average & consistent growth in earnings per share
• have low or comfortable debt levels which can be easily managed through even crisis financial conditions
• have continued strong growth prospects in their industry sectors irrespective of the global macro conditions
• require little in the way of additional funding from shareholders to continue to grow
• management that uses shareholder funds efficiently & treats shareholders well by sharing the wealth created rather than squandering it on over-priced acquisitions or outlandish bonus schemes for themselves

There are not many companies that fulfil these criteria at the level which I require but they are out there. Furthermore this is a dynamic world we live in so continual research is imperative to ensure the current investments still meet the stringent criteria.

The final elements that are required for the independent investor to succeed over the longer term are;

• to have an information source which is constantly appraising the current investment portfolio & market opportunities
• to know when prices are truly attractive both from a fundamental & technical view
• finally to have a high level of support that helps to maintain clear perspective during market highs & lows. It is one thing to have a game plan devised with a cool head but it can be another thing altogether to be able to make clear & appropriate decisions when market gyrations & the media lead to emotional responses.

You can become a world class investor generating compounding returns that over time can grow to be well above the norm. Warren Buffett became the world’s greatest investor not just because he knew how to buy stocks cheaply although he did do that in the early days. His real secret was investing in “safe” businesses that could compound their earnings decade after decade. You can do that too with a little help.

The reality is that the strongest leg of gold’s 11 year bull market is yet to come. There are three reasons why I am so certain a huge run in gold & gold stocks is coming. The first reason is because the growth in fiat money globally is progressing at around 8% per annum while the supply of gold actually being produced has only been rising at 1% per annum. One does not need to be terribly clever at maths to deduce that gold prices must rise as paper currencies are devalued & tangible assets which are in finite supply become increasingly valuable. It is important to distinguish between the short term gold price which is set by the futures gold market, a heavily manipulated scenario, & the actual physical availability of gold to purchase. The vested interests (think Central Banks) which are holding the price down will only be able to do so for a period of time. Eventually real market forces will take over & gold will sky-rocket as investors scramble to buy the real thing & not a paper contract that may not be honoured in a financial panic situation. The unavoidable reality is that the debts of Europe can never be repaid with high unemployment & an ageing population so large scale default is a given in my view & large scale default can only occur if Central Banks buy up all the rubbish which means massive money printing.

The second reason is the enormous uncertainty surrounding the future of the US dollar, not only its relative value but also its status as the world’s reserve currency. There are moves underway for trade in oil between countries like Russia, China, India, Iran, Venezuela in currencies other than US dollars. No-one knows how the next 5 years will play out but the substantial uncertainty alone will cause an increasing movement into gold.

The third & most important reason is that all instruments in financial markets revert to a longer term mean or average when they have become historically extended. This is an irrefutable law of human nature built on fear & greed driving markets first one way to excess, then back the other way to over-correct. It has happened all through history & always will. So the massive disconnect between gold stock prices & the underlying metal will correct itself. In fact gold does not need to increase in price at all & gold producers could rise substantially in price just to catch up. The largest gains will not be in the gold majors, it will be seen in the junior producers, just as we saw coming out of the GFC lows in March 2009 when rises of 500% to 1000% & more were recorded amongst Australian producers. One has to remember that there are many gold producers these days which are very solid businesses with no debt, no hedging, high profit margins & high returns on shareholder equity. Some, these days are even paying dividends. In addition to all those wonderful attributes, these stocks are also very cheap by any scale of assessment.

So what elements do you need to have in place to capture these futures massive gains?

• You need to know what to buy based on solid fundamental evaluation. There are currently 47 existing gold producers listed on the ASX but I have identified the best 12 or so & probably the only ones worth trading. There are some major potential “nasties” among the rest & I don’t like getting surprises when I trade
• You need to have the ability to read crowd behaviour via chart patterns because in the short term the fundamentals often don’t mean much. You can’t just buy a good stock & expect it to go up. This is a skill that takes many years to develop & most traders don’t apply themselves sufficiently to ever get there.
• You need to be able to shut out the opinion of the masses (absolutely essential) & become a focused contrarian trader. With anything short of this you’ll probably lose money. In short everyone needs an environment where they can flourish by being supported for a lengthy period of time
• You need a clear & concise trading plan that defines how much activity is needed to achieve your annual profit target. Every time you take a trade you take on risk, so why do more than you need to – be selective, be decisive & be a consistent winner.

We are on the cusp of one of the great money making periods of this decade so ensure that you have the resources at your disposal to capitalise on these opportunities which really starts now.

Just look at the performance of stock market indices in the last decade compared to commodity prices like gold, silver, oil or copper. It is the price of commodities that determine your cost of living & those prices have been soaring in the last decade, just think about the cost of petrol, building or renovating a house, the cost of most consumer items due to rising manufacturing & transport costs, etc, etc. You know, & I know, that the cost of living is rising much faster than politicians are allowing us to be told because they massage the CPI figures.

Now consider the following;

• Copper is up from 85 cents/lb to $4/lb (370% rise)
• oil is up from $28 to $100/bbl (257% rise)
• gold is up from $265 to $1750/oz (560% rise)
• silver is up from $5 to $34/oz (580% rise)

Yet the All Ords index is only up 32% from 3200 to 4300 points with zero growth in value in the last 7 years & the S&P500 index has made no net gains since January 2001 despite a great of volatility. The fact of the matter is that if your money is in the stock market long term in the normal way through a fund manager, the purchasing power of your wealth is being rapidly destroyed. So what about the future? Will markets return to normal growth paths as the industry would have us believe or is this the new normal?

The answer emphatically is that the next decade is highly likely to be like the last, or worse. There are numerous reasons for this but the main one is there is a major global restructuring of society going on. The world has spent the last 40 years in a debt-fuelled consumption binge which has now finished & we are now entering a multi-decade deleveraging cycle which will render many sectors of the stock market redundant. That means if your investments are broadly exposed to the stock market, they will drastically underperform & will certainly lose purchasing power compared to real levels of inflation & may even lose value in nominal terms as well. I can promise you there will be some spectacular rises & declines in the market in the next decade & numerous panics where investors will feel bewildered & generally take inappropriate actions because that’s how human psychology works.

So what’s the answer?

It is very simple, there are some sectors of the stock market & a few specific businesses within those sectors that will perform outrageously well, regardless of what is going on around them. Let’s look at a couple of examples.

A $1000 investment in a now major engineering company called Monadelphous (code MND) in 2001 has grown to $33,000 in capital value plus they would have paid you $7965 in dividends along the way. But the real kicker in these days of highly volatile stock markets is that you would now be receiving a $1650 dividend payment in 2012 which is a 165% return per annum on your original investment. When you are receiving that type of return, who cares about the stock price. This is how Warren Buffet became a multi-billionaire – invest in great companies & let compounding work for you as long as they remain great companies.

There are not many companies where you can find this kind of performance but they are out there. A $1000 investment in another engineering business, Forge Group (FGE) when it was flashing buy signals in 2009 after the GFC is already worth $12,000. You would have already got 60% of your investment back in dividends & the company would pay you $280 in 2012, or a 28% return on investment. Do you care if the stock market falls? As long as the story stays intact your wealth is growing rapidly. What a great position to be in – how the stock market performs doesn’t impact your wealth or your income stream. These companies sailed through the GFC with no impact on their financial performance at all, it was just their share prices which took a dip. But when you think about it, this was just the market hanging out a “sale” sign. The vast majority of investors can’t bring themselves to buy them because the media & their biases convince them there is still worse to come.

Now what can go wrong with this approach if you were managing your own money?

• You need to ability to select great businesses. Most people don’t have the knowledge, the time or the inclination to do this in-depth analysis
• You need to have the discipline to regularly track the financial performance of these companies & the industry sector they are in & I’m not talking about just checking the share price. I mean a regular evaluation of the 6 monthly financial data
• You need to shut out the opinions of the world which are always (every single time) wrong at the extremes & will have you selling at the lows & buying near the highs.

The majority just aren’t in a position to do any of these tasks reliably. However, the alternative is to draw on the support & expertise of someone experienced in the market who can help you to focus on identifying & tracking the businesses that are like MND or FGE.

Now I hasten to add that I am not an advocate of buy & hold to create wealth as those days are long gone. Most of my investments are actively managed to exploit the natural cycles in the market. However there are some very specific investments such as those covered in this article which do lend themselves to holding longer term because the company is financially very solid & dividends are likely to grow rapidly & reliably over the long term. These are opportunities too good to pass up, but it is all about getting the balance right for the prevailing conditions.

So that brings me to the current times where we have an increasing number of people questioning whether the 11 year bull run in gold is finished. Gold is currently trading at $1665 & looking like it may have bottomed. I can make a case either way for gold to have one last thrust down to the big picture support around $1445 before commencing the most powerful leg of its run (yes the best is still in front of us) or to steadily move higher from here. Either way I suspect the action will be volatile & present plenty of great opportunities for profit so there is no rush. Equally gold stocks have underperformed the gold price to an almost unprecedented level since the start of 2011 & will play catch up in a major way. There are some things that will never change in financial markets & it has nothing to do with European or US debt or anything else;

• Prices will rise or fall to irrational extremes because of fear & greed
• They will then revert back to normal just as everyone jumps on the current trend

There is a massive disconnect between the prices of high quality gold producing businesses & gold itself & this anomaly will correct back to normal at least, & if history & human emotion is any guide will probably move to the other extreme. My firm conviction is that selected high quality Australian gold producers are at least 50% under-valued by any of several metrics. We are on the cusp of a wonderful period of catch up so ensure you are clear on how you intend to exploit this opportunity of a lifetime because it will not just fall in your lap. The vast majority of traders need a substantial level of assistance to perform well under the type of pressure which current day volatility exerts.

Now back to the gold price & a quick perspective on the trend. Gold is the only commodity to have risen in price every year for the last ten in succession. It has been tracking above the 200 day moving average for the vast majority of the last 10 years with only the very brief excursions below it. Many analysts who look too short term became excited when the price dropped below that line in December & declared the bull run finished. If only they would take a wider view they would see it has happened six times in the last decade only to quickly set a new high each time & it will be no different now. The only questions are how soon & from what low point.

Gold weekly chart 2008 to 2012

So that is the high priority charting perspective on gold. What about the fundamental picture?

With the largest buyers, being Central Banks & gold ETF funds, really accelerating their purchases & with mine supply continuing to struggle to keep up, the fundamental case built on supply & demand considerations just gets stronger every month. With the low hanging fruit (easy gold) in politically stable jurisdictions having been found & the relative scarcity of exploration capital I cannot see how supply is going to respond in a meaningful way. If supply struggled to keep pace for the last 7 years with large available profits, then why would that dynamic change now. The obvious answer is that it will not, & gold will head much higher.

There is a huge difference between the shortage of gold in the physical market & the fluctuations of the paper futures market which sets the price short term. Try buying physical gold these days & you will find out that it is not freely available.

There is little doubt that the futures market suffers from a degree of price manipulation, so therefore longer term investors can effectively ignore the week by week fluctuations because it is just “noise”. Shorter term traders can benefit by buying gold & gold stocks when they are oversold, knowing that as sure as day follows night, their prices will rebound.

There are some techniques that assist greatly with determining when the time is right to buy because one does not want to waste time & resources by going in too early & then have to sit through weeks or months of further declines. However at the end of the day you have to be a contrarian to really cash in & now is the time. Don’t listen to mass thinking on gold – plug yourself into an information source which can guide you to substantial profits over the next few years.

I have been researching gold & gold stocks extensively for 5 years. I have isolated the very best producers that Australia has to offer & provide that information through the various forums which we run.