Selling gold to buy dirt-cheap stocks may not seem to be a sound move at first glance. Economic risks are high, and gold's defensive status may help to protect investors from further volatility in the stock market.
However, the precious metal's high price and low valuations on offer across the stock market could mean that equities provide a more attractive long-term capital return outlook.
The recovery potential for dirt-cheap stocks
While there are a wide range of dirt-cheap stocks on offer at the present time, history suggests that this situation will not last in perpetuity. No period of economic weakness or stock market decline has ever remained in place over the long run. Eventually, global GDP growth has always returned to positive figures and the operating environment for stocks has improved. This has always led to rising stock prices, and a shift towards a sustained bull market.
Therefore, investors who are able to buy undervalued shares today may be able to generate strong returns in the coming years. Certainly, in the coming months, equity prices may disappoint. There could even be a second stock market crash. However, on a long-term basis, stocks seem to offer greater scope for capital gains than other assets, such as gold.
Gold's high price
Dirt-cheap stocks may also be more attractive because of gold's high price. It has reached a new record high in 2020 due partly to factors such as continued low interest rates and an increasingly risk-off sentiment among investors.
While this has helped to push the gold price higher, buying any asset when it is trading at a record high may not be a sound move. It means there may be less scope for capital gains, since investors may already have priced in favourable conditions. For example, in gold's case, investors may have accounted for a period of weak global economic growth by sending the precious metal's price to a record level.
Changing investor sentiment
Although dirt-cheap stocks may have attracted some investors to equity markets earlier this year, thereby causing a rebound, many investors continue to be relatively risk averse at the present time. As such, gold's price may yet move higher in the short run, while stock prices could continue to be volatile.
However, investor sentiment is very likely to change over the long run in response to an improving economic outlook. This may shift the focus of investors away from defensive assets, such as gold, towards riskier assets with greater growth potential, such as stocks. The end result could be a disappointing performance from gold, and a return to a sustained bull market in equities.
As such, now could be the right time to sell gold and buy dirt-cheap stocks. They appear to offer greater scope for capital returns ahead of a likely recovery.
