Investments: Voodoo Investing

Imagine—$2,000-an-ounce gold. Never mind that Western civilization is on the verge of collapse, you've got to think about making a killing in the market. Two-thousand-dollar gold would mean making nearly a 500 percent return on your investment if you buy gold bullion today; 3,000 percent, if you purchase South African gold shares or rare numismatic coins; and at least 10,000 percent, if you speculate in penny-mining stocks!

You've heard of voodoo economics? Well, this is voodoo investing.

Specifically, I'm referring to that incredible prediction that the price of gold will reach $2,000 to $4,000 an ounce—and silver, $100 to $200—by 1986. I suppose that it was easy for so many hard-money investment advisors to make such a prediction several years ago, when 1986 seemed a long way away. But 1984 is almost over, the magic year is less than two years away, and gold is languishing in the $300-to-$400-an-ounce range. Silver is less than $10.

Oh, I could be sympathetic with such a prognostication if it were based on the argument that a spendthrift government, throwing caution to the winds, will plunge us into a credit explosion—surely that could explain $2,000-an-ounce gold or even $2-million-an-ounce gold.

But a line on a chart? Most of these false prophets base their unfathomable forecast on the so-called six-year gold cycle.

Unfortunately for them, however, according to their charts, gold ought to be trading at over $700 an ounce by now! Anyone who looks at a 15-year chart for gold cannot help but conclude that the so-called gold cycle is not being repeated exactly as it has occurred in the past. It's not even close. The awful truth is that gold will not reach the lofty four-digit level in less than two years. Clearly, something went wrong.

To put it bluntly, technical trading systems that rely almost exclusively on past trends are bound to be foolhardy and unprofitable. They violate the simplest, yet frequently ignored, principle of investing taught by every street-corner broker: "Past performance is no guarantee of future performance."

Cycles are never exactly the same. Even the most die-hard cycle-follower will admit that trend lines are shortened and lengthened depending on various factors. For example, the run-up in gold in the 1970s was a reaction, in part, to the deregulation of gold after decades of government control. This once-in-a-lifetime effect will not be repeated.

The so-called Kondratieff economic cycle is another example of bankrupt cyclical theory. Named after a Soviet economist. Nikolai Kondratieff, the theory argues that the world economies inevitably go through a devastating depression every 54 years or so. (Sorry, but just because Kondratieff was banished to Siberia by the Communists does not corroborate his theory—the Kremlin isn't always wrong!)

The first time I heard of Kondratieff's theory was when investment writers were predicting a financial crash in 1974. When that didn't materialize, the date was shifted to 1979. Then it was moved to 1982, at which time all the planets were to be aligned, combining a devastating earthquake in California with a Wall Street debacle. But the Kondratieff followers are still alive and well, pushing the date indefinitely into the future.

There are all kinds of cycle trading systems, from the naive to the sophisticated. But none works, for one simple reason: they are mechanistic and deterministic in nature. They do not take into account basic fundamental change in human action. They ignore, for instance, the fact that Ronald Reagan is president, not Jimmy Carter, that Paul Volcker is the chairman of the Federal Reserve, not Arthur Burns, and that inflation is low and interest rates high. Indeed, fundamental economic and political facts can and do greatly influence consumer prices, interest rates, taxes, and the value of people's investments.

In short, most of the cycle chartists ignore the fundamental principles of economics. As a practical matter, I have found that almost every technical trader who bases his investment decisions entirely on cycles has not studied on his own the principles of economics (specifically, the "Austrian," free-market school of economics à la Ludwig von Mises, F.A. Hayek, and Murray Rothbard).

This is not to say that an investment advisor should ignore charts or technical analysis. He should take a close look at past trading patterns, whether for gold, stocks, or commodities. In fact, my most profitable speculations have been when both the fundamentals and technical patterns were moving in the same direction. For example, in the late '70s, the Federal Reserve was acting in a highly inflationary manner and gold was starting to move up, so I purchased a lot of gold coins and made a substantial profit. Timing is everything. In this case I knew my timing was right, because both the charts and my fundamental analysis were telling me the same thing.

Technical trading systems, whether based on computerized programs or past cyclical behavior, have never proven to work over a long period of time. While they may appear to be profitable for a few years, they inevitably collapse and require reworking. If you want to make money consistently over the long term, you have to interpret correctly the fundamental economics underlying your investments. As John Templeton, founder of the most successful mutual fund in history (the Templeton Growth Fund), states, "You must be a fundamentalist to be really successful in the market."

Mark Skousen is the author of The Complete Guide to Financial Privacy (Simon & Schuster). He and his family are living in the Bahamas.