How to profit in a bear market

Bear markets needn’t be so bad. As long as you know how to take advantage of them.

Just as certain strategies work in bull markets, certain things work during the bear too.

The obvious example is to swap from buying the dips to selling the rallies.

Bear markets don’t just crash. They bounce back along the way. Those are great times to sell, before another leg down.

But what about buying back in? Well, it’s a bit early to do this at scale, if you ask me. But there is one strategy you might like to test out.

There’s an odd way to buy stocks during a crisis, which you won’t see many people write about.

I call it silly bidding. People do it in the property market sometimes too.

The idea is that, if you put in enough silly bids on enough different things, eventually someone will bite.

Sure, you can’t be quite as selective on what to buy. But the premise of silly bidding is that you snap up a sale somewhere eventually because a seller is desperate in an illiquid market.

Right now, a lot more stocks are a lot less liquid than usual. There are less buyers and sellers putting in orders above and below the last traded price. And there are a lot of forced sales. So prices move fast, creating situations in some stocks where the order books are not ready for the moves and “at market” orders trigger huge price swings.

Putting in bids at silly prices – way below the market price – could see you pick up shares on the cheap. Just make sure you really do want to buy those stocks and those prices, and keep monitoring those bids.

Of course, this only works well in smaller, less liquid stocks. And only during financial crises. Investors did pick up cheap stocks in this way in 2008.

Why not put in a few orders well below the market price for some small cap stocks you like the look of? The next time volatility hits, your bids could be too.

The converse is also true. Don’t buy or sell “at market” during a crash. Always specify prices. There’s enough volatility that you’re likely to enter or exit comfortably.

Another odd misallocation is currently occurring in the physical gold market. It had me smirking all morning. But we’ve got to start at the beginning, so you get a chuckle too.

The gold price is set in the paper gold futures market, where very little actual gold changes hands.

The physical gold market is worlds apart, especially right now. But it still uses the financial market gold price as its reference point. This is ok most of the time. But during a panic, when people want to hold physical gold, it leads to a shortage of physical gold, without the price going up in financial markets. But it does rise outside of financial markets. The two prices diverge.

Right now, there’s a gold shortage and anyone who does have physical gold can charge immense premiums because of this.

Strangely enough, this works both ways. Some gold dealers, according to Bloomberg, are offering their clients premiums to sell their physical gold back to the dealer. They’re promising to buy people’s gold above the market price. Because they can then go and sell that gold at an even higher premium to other desperate customers.

But the financial market gold price still isn’t reflecting those premiums, creating a gap between the real price of gold and the price in financial markets.

What makes this interesting is that some exchange-traded funds (ETFs) promise to actually have physical gold in storage. Which means, by buying those ETFs, you’re getting physical gold at a huge discount to the real price of physical gold.

Eventually, the financial market price of gold should reflect the physical market as the physical shortage is resupplied. Likely at a much higher price. Generating profits in the physical gold ETFs.

The underlying risk of this strategy is that ETFs are not the same as physical gold, even if they promise to have that physical gold kept in a vault somewhere. It’s still just a promise.

But if you accept this risk, there could be an opportunity for a trade in gold. It’s almost like arbitrage. Sell some of your physical gold at a premium to the market price and buy the ETF.

Dividend stocks that have already suspended their dividend are another opportunity. Many income-focused investors sell out as soon as the dividend is cut or cancelled. And so the price crashes, as it has in many stocks.

But that’s a great time to buy, if you’re willing to be patient and plan to hold for the dividends in the future. Your dividend yield will be far higher in the future, eventually, thanks to the lower entry price. You’re forgoing dividends in the short term for the higher dividend yield in the future.

You could also buy so-called fallen angels. Many funds are only allowed to invest in investment-grade debt, meaning ratings companies give them good ratings. When the ratings are downgraded, the funds have to sell out.

That leads to a mispricing and an opportunity for bond investors.

But perhaps the best bear market opportunity is this one. A certain batch of stocks have seen their goods double in price while their stocks remain flat thanks to Covid-19.

What do you think will happen next? Find out here.

Nick Hubble
Editor, Southbank Investment Research

Category: Commodities

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