Contrarian investing is an investment strategy characterized by buying and selling in opposition to the current market sentiment. Investors utilizing this strategy believe that crowd behavior results in advantageous mispricing in the market. For instance, widespread market pessimism about a stock can drive its price below its true value, presenting contrarians with an opportunity to buy. Conversely, over-optimism can inflate a stock’s price, leading contrarians to avoid or short-sell such overhyped investments.
The Contrarian Investing Approach
In practice, contrarian investors buy when others are selling and sell when others are buying. However, this investment strategy depends on careful timing and thorough research since investments may be out of favor for considerable periods before the sentiment shifts again.
Differences Between Contrarian Investing and Other Strategies
In contrast to permanent bears, contrarians may not always believe the market is wrong; these investors merely seek mispricing opportunities presented by crowd behavior.
Contrarian Investing and Precious Metals
Gold and Contrarian Investing
A real world example of this can be seen in the precious metals market. During periods of economic uncertainty, the price of gold typically experiences a surge due to its status as a safe-haven asset. This over-optimism can lead to inflated prices. A contrarian investor might avoid buying gold at these high prices or even short-sell it, anticipating a price correction once the market stabilizes.
Silver and Contrarian Investing
On the other hand, silver might not see the same level of enthusiasm, as it is often overshadowed by gold. If silver spot prices remain low due to a lack of attention, a contrarian investor might see this as a buying sign. The belief that silver is undervalued and that the silver price will eventually rise as market sentiment shifts requires patience, but it may pay off.
Key Principles of Contrarian Investing
Moving Against the Grain
An investor who utilizes a contrarian approach rejects the market’s herd mentality, which may yield inflated and depressed prices. By identifying opportunities where the majority has undervalued an asset like silver, contrarians can make profitable investments.
Focus on Market Sentiment
While similar to value investing, investors utilizing a contrarian strategy place more emphasis on market sentiment, paying attention to trading volume, media commentary, and analyst coverage. They try to buy assets that are undervalued as the result of excessive market pessimism and avoid investments driven by exuberance.
Patience and Long-Term Focus
This approach requires patience because the market takes an indeterminate length of time to realize an investment’s proper value. Contrarians must be prepared to withstand short-term losses while waiting for the market to sort itself out.
Contrarian Investment Strategies
Market Timing
Some contrarians engage in market timing or trying to predict turning points based on historical trends and economic factors. This challenging strategy aims to profit by entering or exiting positions before the broader market reacts. One of the downsides of market timing is missing opportunities, as an exit during downturns results in missed growth during market recovery.
Short Selling
In short selling, contrarian investors bet against stocks they have identified as overvalued by borrowing shares and selling them in hopes of purchasing them again at a lower price. Shorting can be a high risk move since the price of an asset may rise further before stabilizing, which requires financial resources and patience.
Contrarian Strategies and Precious Metals
Platinum and the 2008 Financial Crisis
The 2008 financial crisis was marked by widespread uncertainty and flights to safety. Many investors sold their platinum holdings, which caused a sharp price drop in the platinum price. Between July and October, the price of platinum fell from $2045 to $796 an ounce. Contrarian investors who noticed the market overreaction and considered the fundamental value of platinum because of its industrial uses and rarity went against the grain of this trend. While contrarian investors had to exercise patience while the market stabilized, the price rose to $1,800 in February 2011, providing significant returns for those who invested in 2008.
Pros and Cons of Contrarian Investing
Advantages of Contrarian Strategies
Potential for High Returns
Contrarian investing seeks to capitalize on undervalued assets. By purchasing these mispriced assets, investors stand to achieve high returns when the market corrects itself.
Reduced Exposure to Market Bubbles
By moving against the current market sentiment, investors can reduce their exposure to speculative bubbles, mitigating the risk of price drops when the bubbles burst.
Disadvantages of Contrarian Strategies
High Risk
This investing strategy is inherently risky, especially when an investor is short selling. If stocks remain overvalued or undervalued for lengthy periods of time, investors must endure potential losses before realizing gains.
Time-Consuming
Identifying undervalued stocks and tracking market sentiment takes a lot of time and effort. Successful contrarian investors must be well versed in fundamental analysis and able to spend significant amounts of time assessing potential opportunities.
Mistiming the Market
Contrarian strategies strongly rely on advantageous timing. Both entering and exiting a position too early can create missed opportunities or sizeable losses, particularly in volatile markets, like that of platinum.
