While much information circulates in our community regarding the impetus to buy gold, there is one classical item which could use attention with respect to the value of buying during corrective periods.
That item is the power of dollar cost averaging over time.
When one creates and reviews a set of dollar cost averaging numbers, it becomes apparent that during these periods of severe price decline and accompanied mental exhaustion, great wealth is made.
From Tekoa Da Silva, Bull Market Thinking:
For example, illustrated below are two hypothetical price performance periods in gold:
(click to enlarge)
Gold Scenario A depicts a 12-month period of increasing gold prices compounded at a 2% rate, producing a total of a 24% bull run. Gold Scenario B depicts an extremely painful 30%+ correction and subsequent recovery to starting-point levels over a 12-month period.
At first glance, one might assume an investor gained 24% under Scenario A and nothing under Scenario B—except for potential losses and grey hair.
A closer look at a set of dollar cost averaging data however, tells a wildly different story.
Let’s assume an investor has the courage to create and execute a $1,000 a month investment program towards gold. In applying that program to the two scenarios laid out above, a fascinating result begins to emerge:
As the numbers demonstrate, Scenario A’s 24% “bull run” produced a pitiful return on capital, and as a headline figure was very misleading. A disciplined investor allocating $1,000 a month under this scenario, saw a total real gain of only 12% at the end of the twelve month period.
Under Scenario B however, our disciplined investor’s $1,000 a month investment program produced a total real gain of 28% on his or her capital—in what could be described as a “sideways” (or unprofitable) gold price environment.
What’s also interesting to note, is that not only did Scenario B produce a far greater gain, but it do so at a (counter-intuitively) much lower risk.
To illustrate, let’s assume that at the end of the 12-month period Scenario A suffers a “minor dip” in price, returning to its initial starting level at $1,000 per ounce. Let’s also assume Scenario B jumps by 24%—effectively switching places price-wise with Scenario A. Here is a chart of that price swap:
(click to enlarge)
As mentioned, while this price swap appears to be just a “minor dip and corresponding jump”—as the numbers will indicate, the risk of financial loss in Scenario A becomes staggering, while the upside gains under Scenario B become equally explosive:
(click to enlarge)
As demonstrated, a correction to starting point in Scenario A produces a real total loss of 10%. A price swap in Scenario B on the other hand (ie. a move from $1,000 per oz. to $1,243 per oz.), produces a 59% total gain.
Therefore, the disciplined investor who continued to allocate $1,000 a month in the face of a frightening 30% collapse—was rewarded tremendously.
The moral of the story here is to continue to add fresh capital to your investments during declines. And it doesn’t have to be in just gold—it can be silver, mining shares, commodities, or shares of businesses which own or produce real assets.
Additionally, when struggling through the corrective depths of any asset’s “Scenario B”, it’s important to ensure that whatever you’re accumulating has real (and strengthening) fundamental value. Therefore, the longer the corrective period persists—the greater will be your ultimate upside in the subsequent recovery. In other words, with strengthening fundamentals time is laboring for you rather than against you.
Bottom Line: The discipline of incremental investment over time may position one for explosive upside gains and reduced downside risk. Ensure that whatever it is being accumulated however, is fairly priced, and of increasing fundamental value.
Extra Item: To aid in your careful study and preparation of a monthly investment program (should you choose), here is the excel spreadsheet used to produce this article. It contains embedded formulas which will hopefully count out many new dollars added in your future: