Today, I want to shed some light on why we opt out of fad investing. A fad, by definition, is an ever-revolving door where yesterday’s crypto excitement gets crowded out by today’s gold enthusiasm to eventually be replaced by tomorrow’s AI craze, or whatever else is en vogue.
Our investment philosophy is not contrarian for the sake of it. Our contrarian posture is a byproduct of our beliefs/philosophy being at odds with the investing culture of the day. Our approach and our convictions remain consistent, but finance pop culture is ever-changing.
The Internet & AI
Take Artificial Intelligence (AI) for example…
Do I believe that AI is going to change our world in a meaningful way? Absolutely. I believe we all lack the imagination to really visualize how transformative this technology will be. The power and application of AI will be beyond what we could even dream up.
Let me make an analogy here, one I’ve often referenced. Imagine you and I traveled back in time to the year 1999. We take to the streets and begin surveying people about the internet. This was the peak of the tech boom, and the topic of the internet was dominating the headlines. Do you think people could imagine how transformative the internet would be? Would they be shocked if I told them a bit about my life in 2026 and all the things I can do from my minicomputer (phone) in my pocket? Again, in 1999, they lacked the imagination for how transformative this technology would be.
Now, what if, in the same breath, I told them that many of the internet stocks they were familiar with would go out of business? What if I told them that some of these internet-centric companies would be incredibly successful over the next 25 years, but their stock price still would not return to their 1999 peak? People would look at me puzzled. It just doesn’t seem like those two worlds could exist – how could the internet turn the world upside down while stock prices were retreating?
People underestimated the transformative power of the internet while overestimating the stock prices of internet-related companies. We need to fully grasp those two truths and, where appropriate, apply the same framework to the AI story of our day. There is such a thing as a great company, a transformative company, trading at an unattractive price.
Gold & Cryptocurrency
We can construct a similar discussion or framework around gold.
It seems that most investors want to avoid ever being labeled a speculator. The Oxford dictionary defines speculator as such: “a person who invests in stocks, property, or other ventures in the hope of making a profit.” The emphasis is mine, with the intent to highlight that “hope” is not a strategy.
Speculators will often get married to a thesis even when it is not validated by history. The common thesis around gold is that it’s a store of value, a hedge against inflation. The belief is that irresponsible government spending will erode the value of the currency (e.g., the dollar) and that gold, not connected to government debt, will rise in price/value. It sounds like a nice thesis, but as David Bahnsen often points out, it’s just not historically true. Gold spent some 40+ years generating an after-inflation return of close to zero, so not the hedge it’s promoted to be. Additionally, if you study gold prices in relation to government spending, you will clearly see there is no observable correlation as the thesis promotes.
Gold is a story best told in decades. In some decades, prices will grow more than one would’ve ever expected, and in other decades, the shiny rock will be incredibly disappointing. What decade comes next? I’m not sure, but a speculator will always hope for the best.
Source: A Wealth of Common Sense, March 7, 2024
Can the same thought sequence laid out for gold be applied to crypto? I believe so. Does this mean the AI story is yesterday’s internet story, and that crypto is the new gold? Yes, and no. It’s that “history doesn’t repeat itself, but it often rhymes” sort of thing or my preferred version from Mary Poppins, “Winds in the east, mist coming in. Like somethin’ is brewin’ and bout to begin. Can’t put my finger on what lies in store, but I fear what’s to happen all happened before.” Why? Because the common variable is humans, and our behavior isn’t always rational, but it’s incredibly consistent.
Investors & Speculators
I touched on it at the beginning of this article; it isn’t that we are front-footed about being contrarian or simply rejecting the trends of the day. It’s more so that our investment philosophy doesn’t align with what’s currently popular. Our philosophy is rooted in research, conviction, and supported by history. Again, hope is not a strategy, or at least not one we are willing to subscribe to.
So, what is this philosophy I speak of rooted in? A belief that value/price is based on a measurable expected return on investment. This is measurable because the associated investment has cash flow (profits, interest payments, etc.), and I can use that cash flow as an anchor point to measure whether the price today is fair, expensive, or perhaps a bargain. What is a stock price? The discounted value of future cash flow; one price today, reflecting what that price believes about cash flow in the future.
Let’s make this even simpler. There are two investment options in your neighborhood: an open lot for a spec (speculative) house or a house built years ago with an existing reliable tenant. Each opportunity is a $500,000 investment. What’s the return on investment for the spec house? We won’t know until construction is finished and we have a signed contract in hand from a buyer. What’s the return on investment for the existing home with the tenant? Our renter pays $2,000 per month, $24,000 a year, or stated as a percentage: 4.8% yield ($24,000/$500,000). Sure, there are other variables here (maintenance, appreciation, etc.), but most factors can be reasonably calculated and measured. This is a simple comparison of an investor and a speculator.
To be clear, speculators can make money, and the wins are often thrilling. The problem is that the risk increases the longer you speculate, the losses become more detrimental, and consistency is nearly impossible. If I’m a landlord and property values dip but my tenant remains faithful, I don’t have much to worry about. If I’m mid-project on my spec home and property values dip, I may have wiped out all my potential profits or even worse, be operating at a loss. Cash flow often helps investors weather the storm and the seasonal realities of markets.
Closing Thoughts
Forever and always, regardless of the casualties of the past, the draw towards speculation will be driven by this fear of missing out (FOMO). Warren Buffett’s famed business partner, Charlie Munger, described it this way: “The world is not driven by greed, it’s driven by envy.” Your greatest foe will be that desire that wells up inside of you wanting what your neighbor has. The worst part, often those investing battlefield wins told by your neighbor are riddled with embellishments that falsely lure you into speculative bets.
I suppose the key question here is, do you have an investment philosophy? Is that investment philosophy grounded in historical evidence? Or, whether intentional or unintentional, are you simply following the going trend of the day?
