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Why You Shouldn’t Short Sell Stocks

By LINDON, Utah - June 26, 2018 No Comments

Stocks are overvalued by most historical standards, so it might seem tempting to engage in short selling. The truth is that you should never short stocks because buying gold is a far safer and more profitable investment for stock bears. I hope that a little bit of history, a few facts, and some important statistics will be enough to convince you.

A short seller borrows stocks from a brokerage and the brokers then sell the stocks on the short seller's behalf. The short seller hopes to profit by buying back the stocks at a lower price. The hopes of short sellers are often disappointed because stocks have gone up for 34 of the last 40 years. It gets even worse. When stocks go up by 100% or more, short sellers lose everything and sometimes even go bankrupt. 

It may seem a bit unusual that stocks win so often. There is no mystery when you consider the standard of comparison is paper money. The Federal Reserve has a limitless supply of paper dollars, and they are not reluctant to intervene on behalf of the stock market. When the market crashed in 2000-2002, the Fed slashed interest rates from 6.5% to about 1% to save the stock market. The market crashed again in 2008, so the Fed cut rates from around 4% to near 0% and bought up over three trillion dollars in assets. The short sellers can never win because the Fed will not let the stock market fail.

Fortunately, there is still a way to profit when stocks seem headed for a crash. Gold went up 24% in 2002 when stocks went down 22%. The relationship is rarely that exact, but gold has done exceptionally well during most major bear markets. Gold went up an incredible 187% during the 1973-1974 bear market. While gold only went up 3% during 2008, it also went up 32% in 2007 and 28% in 2009.

The profitability of gold in bear markets is a direct result of the same money printing that consistently defeats the short sellers. Gold investors actually get the money that short sellers hope to make. During the brutal bear markets of the early 21st century, successful short sellers achieved a reputation in the press as the smartest of the smart money. Many of these funds lost money after 2008, and the short selling superstars have faded. Merely buying gold was enough to earn you a 198% return between 2000 and 2008, while short selling stocks can never produce gains of more than 100% without using leverage and increasing risk. More importantly, gold has shown a long-term return of about 7.7% a year since 1971. Short selling leads to a 100% loss in the long-run. When bear markets come, the smart money is on gold.