With risks facing investors being at a heightened level, many may consider turning to gold. After all, it has risen by around 15% since the start of the year and has historically offered a store of wealth during challenging periods for the wider economy.
However, buying gold may not enable investors to capitalise on the cyclicality of asset prices. In other words, buying FTSE 100 shares while they currently trade on low valuations may be a better idea than buying gold after its price has already risen.
Investor sentiment and the outlook for the world economy often move in a similar direction. However, they have never moved in one direction for a prolonged period of time without experiencing uncertainty and challenges. While such difficulties can lead to declines in share prices in the short run, they also present buying opportunities for long-term investors.
Therefore, it is possible for investors to take advantage of the cyclicality of the stock market. This may enable them to obtain a relatively favourable risk/reward ratio, since their holdings may already have margins of safety factored into their market valuations. This may produce higher returns, and pose a reduced threat in terms of losses in the near term.
At the present time, the world economy faces a variety of risks that appear to be holding back investor sentiment. This has contributed to a rise in the price of gold that could continue in the short run. It may also lead to further weakness for share prices over the coming months.
However, those risks could present a buying opportunity in the FTSE 100. Within the index are a number of companies that trade below their average price-to-earnings (P/E) ratios despite having sound track records of growth and strategies that could catalyse their future financial performances.
As such, now could be the right time to buy a diverse range of them while they trade at discounts to their intrinsic values. Certainly, this will require an investor to go against the views of their peers in some cases. But it could provide them with a more favourable risk/reward ratio for the long term.
In some cases, low valuations may be warranted. A company may have a difficult outlook or a weak balance sheet, for example. However, in many cases a cheap stock may be undervalued simply because investor sentiment is weak. It may be producing a rising level of profitability that could continue over the coming years, with weak investor sentiment being an overreaction to wider economic risks that may or may not come to fruition.
Therefore, while gold may appear to be a better investment than FTSE 100 shares at the present time, in the long run, buying undervalued companies and holding them may lead to a higher overall return.
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Peter Stephens has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.