Quotes from two Friday readings
Item one:
The entire article “Pensions Leap Back to Hedge Funds,” WALL STREET JOURNAL, May 27, 2011 by Steve Eder, Gregory Zuckerman and Michael Corkery is worth reading. However, for those without access, here’s an interesting quote:
“Public pension plans are lifting hedge-fund investment, seeking to boost long-term returns despite losses suffered in some funds in the financial crisis.
Also, pension officials are using the historically strong returns of hedge funds to justify a rosier future outlook for their investment returns. By generating more gains from their investments, pension funds can avoid the politically unpalatable position of having to raise more money via higher taxes or bigger contributions from employees or reducing benefits for the current or future retirees.”
Item two:
The article worth reading is “Fire your hedge fund, hire your congressman” BARRONS, UP AND DOWN WALL STREET, May 26, 2011 by Randall W. Forsyth, subtitled “House members outperform the stock market, though not as much as Senators, study finds. The ultimate insiders?” Again, however, the interesting quote is:
“You'd think that Republicans would have the better investment results since the GOP is seen as the party of Wall Street. You'd be wrong. The Democrats did four times as well as the Republicans, generating excess returns of 73 basis points per months versus 18 basis points.
The study's authors' interpretation: during the period covered by the study, Democrats controlled the House for 10 of 17 years. ‘Furthermore, Democrats were deeply entrenched in the leadership of the House for decades prior to the study. Thus when Republicans finally took control in 1995, they arguably had far less experience at handling the reins of power and may therefore have been unable to immediately enjoy all its perquisites,’ the academics write.”
The Hedged Economist’s observation:
With a little observation of institutions, the academics wouldn’t be so naïve as to believe Republicans are the party of Wall Street. As hinted at in item one, some Wall Street industries would hardly exist without Democrat public sector pensions. The hedge fund industry is a prime example. Absent pension funds and academic endowments, the hedge fund industry would be much smaller. Further, a strong argument can be made that hedge fund fees would be lower, but that’s a theoretical argument while the capital flow from pensions to hedge funds is a fact. In general, pension funds are a blatant example of just turning money over to Wall Street, and who are the traditional defenders of defined benefits pensions? It’s not the Republicans.
The Democratic Party’s ties to Wall Street go way beyond hedge funds. If the author of the study read a few histories of investment banks, they’d recognize a long history of Democratic ties. More recently they might learn something from the difficulty Republicans have had recruiting Wall Street types. It was close to traumatic for Henry Paulson to cross party lines to go from Goldman to a Republican administration. Even in commercial banking, it’s hard to find a Republican at the executive level in a Wall Street bank; community banks yes. They’re far more representative of the voting public in general, but we’re talking Wall Street.
If the authors of the study approached the finding objectively they wouldn’t need an elaborate years in control / entrenched power explanation. There are deep philosophical reasons for the relationship. Both Wall Street and Democrats thrive on other people’s money, both believe in entitlement, and both believe in their superiority to the masses. In the authors’ defense, the authors state that Republicans “may therefore have been unable to immediately enjoy all its perquisites.” Perhaps that is just a polite way of saying Democrats are better crooks because they had more time at it. A Republican would respond that it isn’t time; it’s philosophy. Now there’s a debate for a political blog. Let’s hope any such debate is based on facts, analysis and observation not the blind acceptance of mistaken conventional wisdom.
Saturday, May 28, 2011
Thursday, May 19, 2011
On Investing: Part 14
Real estate, starting with home sweet home.
All the other postings on investing included a musical reference. With a home, a musical reference would be too easy and a cheap shot. The same would be true of any reference to “Our House.” (Oops). But, it is a very, very fine house, even if it isn’t on the range.
Seriously, real estate should be a part of any portfolio. Problem is that it is hard to separate real estate investments from leverage issues. Nevertheless, there are a number of misconceptions about real estate that commentators repeat. They are now mouthed more frequently than the wisdom repeated back in 2006 that a general home price decline couldn’t occur. They should be noted by anyone serious about the issue. The nonsense said about housing and the potential financial mistakes it causes will be the subject of the next few postings.
One that’s particularly interesting is statements like “for most consumers a house is their biggest investment” or “a home is most people’s biggest asset.” First note that these are two very different statements. The value of an asset is quite different from the amount invested in the asset. People who take a 100% mortgage have nothing invested; it’s just a big asset with an offsetting liability. However, the interesting thing is neither statement (i.e., biggest investment nor biggest asset) is accurate.
First, at any given point in time “most” people don’t have a lot invested in a home. For starters, 35% to 40% of households rent. In addition, a lot of “owners” haven’t built up much equity by paying principal. They may be consuming a lot of housing by living in a big house, but they aren’t investing in it unless they’re paying down principal. If they made a down payment, that constitutes an investment, but the days of 20% down as the norm went away over a decade ago.
So, in fact, it is probably more accurate to say a large MINORITY of people have a large investment in their house. For each one, over time it will become a larger investment and MAY become their largest investment, but there is a good chance it will be less than what they spend to borrow money for cars, their house, education (theirs and/or their kids’), and other consumption. Over their lifetime, most Americans spend more to consume tomorrow’s income than they invest in housing.
How about the largest asset claim? That claim is on less shaky ground, but still questionable. The validity of the claim depends on one’s definition of asset, and in particular, asset liquidity. An asset doesn’t have to be liquid. In fact, one definition of an asset is anything that produces a steam of benefits.
Real estate is not a particularly liquid asset. One definition of liquidity focuses on the cost of converting to money. Real estate is very illiquid by that definition. If you doubt it, compare the transaction cost on a stock verses real estate. The commission on a stock trade isn’t even in the same ballpark as real estate closing costs. Another dimension of liquidity is the time it takes to convert to money. Buying or selling real estate takes time. The most sophisticated (i.e., broadest) definitions take into account cost, time, volume, price stability, uniformity or interchangeability of offerings, and even information flows. Real estate is illiquid by each measure. Finally, even more serious is the fact that real estate markets aren’t guaranteed to clear. Governments may intervene to stop foreclosures from clearing, as is currently happening, or buyers and sellers may refuse to trade at current prices, also currently happening.
With real estate we’re dealing with an illiquid asset. In a previous posting, “Data is no substitute for thinking,” The Hedged Economist made the passing comment “…Shiller hasn’t gotten over the housing bubble; he still talks about housing prices as if one’s home where an asset rather than a place to live.” Technically it should have said “liquid asset.” Once one focuses on a home as a place to live it become analogous to any other stream of benefits (i.e., real income). A house is far from the largest stream of benefits. One’s income is the largest stream of benefits for “most people.” Thus, for MOST people the discounted present value of the income stream is their largest asset.
Nothing can ruin an investor’s day, or for that matter an economic and financial system, quicker than mistaken assumptions about the liquidity of assets. However, a close second is not knowing what has been invested and what has been consumed. Anyone who lets these misconceptions about housing influence their thinking is risking both mistakes. That’s true of investors and equally true of policy makers.
All the other postings on investing included a musical reference. With a home, a musical reference would be too easy and a cheap shot. The same would be true of any reference to “Our House.” (Oops). But, it is a very, very fine house, even if it isn’t on the range.
Seriously, real estate should be a part of any portfolio. Problem is that it is hard to separate real estate investments from leverage issues. Nevertheless, there are a number of misconceptions about real estate that commentators repeat. They are now mouthed more frequently than the wisdom repeated back in 2006 that a general home price decline couldn’t occur. They should be noted by anyone serious about the issue. The nonsense said about housing and the potential financial mistakes it causes will be the subject of the next few postings.
One that’s particularly interesting is statements like “for most consumers a house is their biggest investment” or “a home is most people’s biggest asset.” First note that these are two very different statements. The value of an asset is quite different from the amount invested in the asset. People who take a 100% mortgage have nothing invested; it’s just a big asset with an offsetting liability. However, the interesting thing is neither statement (i.e., biggest investment nor biggest asset) is accurate.
First, at any given point in time “most” people don’t have a lot invested in a home. For starters, 35% to 40% of households rent. In addition, a lot of “owners” haven’t built up much equity by paying principal. They may be consuming a lot of housing by living in a big house, but they aren’t investing in it unless they’re paying down principal. If they made a down payment, that constitutes an investment, but the days of 20% down as the norm went away over a decade ago.
So, in fact, it is probably more accurate to say a large MINORITY of people have a large investment in their house. For each one, over time it will become a larger investment and MAY become their largest investment, but there is a good chance it will be less than what they spend to borrow money for cars, their house, education (theirs and/or their kids’), and other consumption. Over their lifetime, most Americans spend more to consume tomorrow’s income than they invest in housing.
How about the largest asset claim? That claim is on less shaky ground, but still questionable. The validity of the claim depends on one’s definition of asset, and in particular, asset liquidity. An asset doesn’t have to be liquid. In fact, one definition of an asset is anything that produces a steam of benefits.
Real estate is not a particularly liquid asset. One definition of liquidity focuses on the cost of converting to money. Real estate is very illiquid by that definition. If you doubt it, compare the transaction cost on a stock verses real estate. The commission on a stock trade isn’t even in the same ballpark as real estate closing costs. Another dimension of liquidity is the time it takes to convert to money. Buying or selling real estate takes time. The most sophisticated (i.e., broadest) definitions take into account cost, time, volume, price stability, uniformity or interchangeability of offerings, and even information flows. Real estate is illiquid by each measure. Finally, even more serious is the fact that real estate markets aren’t guaranteed to clear. Governments may intervene to stop foreclosures from clearing, as is currently happening, or buyers and sellers may refuse to trade at current prices, also currently happening.
With real estate we’re dealing with an illiquid asset. In a previous posting, “Data is no substitute for thinking,” The Hedged Economist made the passing comment “…Shiller hasn’t gotten over the housing bubble; he still talks about housing prices as if one’s home where an asset rather than a place to live.” Technically it should have said “liquid asset.” Once one focuses on a home as a place to live it become analogous to any other stream of benefits (i.e., real income). A house is far from the largest stream of benefits. One’s income is the largest stream of benefits for “most people.” Thus, for MOST people the discounted present value of the income stream is their largest asset.
Nothing can ruin an investor’s day, or for that matter an economic and financial system, quicker than mistaken assumptions about the liquidity of assets. However, a close second is not knowing what has been invested and what has been consumed. Anyone who lets these misconceptions about housing influence their thinking is risking both mistakes. That’s true of investors and equally true of policy makers.
Sunday, May 15, 2011
Sometimes even a blind squirrel finds a nut
But, beware; pigs will root around in a forest looking for nuts
“Sen. Charles Schumer told regulators that sophisticated electronic traders should bear the cost of monitoring their dealings, with special fees assessed to firms that issue and then rapidly cancel securities orders.” (Fee Pitched for Fast Firms, Senator: High-Speed Traders Should Bear Cost of Oversight, WALL STREET JOURNAL, 5/9/2011)
Well, Chuckie may be on to something. Back in January 2010, well before the flash crash, The Hedged Economist pointed out that a trading fee could benefit financial markets. But, as “Efficient capital allocation doesn’t require perfect liquidity” pointed out, the great danger is Governments’ addiction to other people’s money.
After the flash crash of May 6th , a number of the postings in May 2010 also mentioned fees as a remedy. Throughout The Hedged Economist’s discussions of fees, the emphasis has been on the functioning of the financial markets. Unfortunately, Chuckie has other ideas as borne out by statements like: “bear the cost” or “such charges could defray the expense of building a new system to track in real time the orders.”
Clearly, Chuckie is more akin to the pig rooting around for grub than a squirrel that discovered a treasure. It’s scary that a Congressman thinks of the economy as just an instrument for supporting Government. Why build a new system for tracking orders in real time when a properly designed fee structure, one designed with market functioning in mind, would eliminate the need for the tracking?
Chuckie seems more interested in tracking problems than avoiding them. It’s enough to cause reasonable voters to abandon good ideas in order to keep people like Chuckie from perverting them.
“Sen. Charles Schumer told regulators that sophisticated electronic traders should bear the cost of monitoring their dealings, with special fees assessed to firms that issue and then rapidly cancel securities orders.” (Fee Pitched for Fast Firms, Senator: High-Speed Traders Should Bear Cost of Oversight, WALL STREET JOURNAL, 5/9/2011)
Well, Chuckie may be on to something. Back in January 2010, well before the flash crash, The Hedged Economist pointed out that a trading fee could benefit financial markets. But, as “Efficient capital allocation doesn’t require perfect liquidity” pointed out, the great danger is Governments’ addiction to other people’s money.
After the flash crash of May 6th , a number of the postings in May 2010 also mentioned fees as a remedy. Throughout The Hedged Economist’s discussions of fees, the emphasis has been on the functioning of the financial markets. Unfortunately, Chuckie has other ideas as borne out by statements like: “bear the cost” or “such charges could defray the expense of building a new system to track in real time the orders.”
Clearly, Chuckie is more akin to the pig rooting around for grub than a squirrel that discovered a treasure. It’s scary that a Congressman thinks of the economy as just an instrument for supporting Government. Why build a new system for tracking orders in real time when a properly designed fee structure, one designed with market functioning in mind, would eliminate the need for the tracking?
Chuckie seems more interested in tracking problems than avoiding them. It’s enough to cause reasonable voters to abandon good ideas in order to keep people like Chuckie from perverting them.
Friday, May 13, 2011
This is either wrong or a new threat to national security
If this is accurate, Congress and the Administration should begin an investigation immediately
This posting quotes from “SEC Is Pressed on Firms' Disclosures of Cyberattacks,” WALL STREET JOURNAL, 5/12/2011. The source being used is important because this is so unbelievable. Here’s the background.
“The lawmakers want the SEC, by issuing guidance, to make it more clear [clearer] when attacks or data breaches rise to the material level and become subject to disclosure, rather than the current approach of relying on a company's interpretation of when an incident is material.” That seems reasonable, but here’s the problem: “Specifically, the lawmakers want to ensure that firms disclose when they have suffered a ‘material network breach,’ which would be a cyberattack or data theft that would affect the average investor's decision to purchase or sell a stock.”
That’s ridiculous. What would affect investor’s decision to purchase or sell a stock can’t be known ahead of time; ridiculous, yes, but not unbelievable. It’s just the foolishness typical of Congress.
Here’s the national security threat. “A Commerce Committee review of recent SEC disclosures found companies that did report their information-security-risk exposure were inconsistent in the level of detail they provided, the lawmakers said. None provided information on steps that were being taken by the corporation to close potential security gaps, they added.”
We actually appear to have someone advocating that we force companies to disclose steps they take to thwart cyberattacts. Someone should investigate. Seems to me that if the staff of the Commerce Committee or the SEC has been infiltrated by the cyberterrorists, we need to know it.
This posting quotes from “SEC Is Pressed on Firms' Disclosures of Cyberattacks,” WALL STREET JOURNAL, 5/12/2011. The source being used is important because this is so unbelievable. Here’s the background.
“The lawmakers want the SEC, by issuing guidance, to make it more clear [clearer] when attacks or data breaches rise to the material level and become subject to disclosure, rather than the current approach of relying on a company's interpretation of when an incident is material.” That seems reasonable, but here’s the problem: “Specifically, the lawmakers want to ensure that firms disclose when they have suffered a ‘material network breach,’ which would be a cyberattack or data theft that would affect the average investor's decision to purchase or sell a stock.”
That’s ridiculous. What would affect investor’s decision to purchase or sell a stock can’t be known ahead of time; ridiculous, yes, but not unbelievable. It’s just the foolishness typical of Congress.
Here’s the national security threat. “A Commerce Committee review of recent SEC disclosures found companies that did report their information-security-risk exposure were inconsistent in the level of detail they provided, the lawmakers said. None provided information on steps that were being taken by the corporation to close potential security gaps, they added.”
We actually appear to have someone advocating that we force companies to disclose steps they take to thwart cyberattacts. Someone should investigate. Seems to me that if the staff of the Commerce Committee or the SEC has been infiltrated by the cyberterrorists, we need to know it.
Wednesday, May 11, 2011
Data is no substitute for thinking
Bubble, bubble, toil and trouble
Robert Shiller argues that the last two recessions could have been avoided if we had better data on financial markets and the economy (See: Needed: A Clearer Crystal Ball). That is self-serving nonsense. The problem wasn’t measurement; it was interpretation. In addition, one cannot ignore counterproductive responses even among people who correctly interpret the available information.
It seems curious that Shiller, of all people, would be arguing that the bubbles in stocks during the internet bubble or housing during the housing bubble could not be seen from existing data. Shiller, after all, saw both bubbles in existing data. Perhaps the issue is that Shiller sees a bubble in any data he analyzes, just as some people never see a bubble no matter what data they see. More data won’t solve that problem.
There will always be differences of opinion no matter how much data is available. People can look at the same data and react differently. There are people who can’t resist participating in a bubble. Some see it as a bubble and want to “game” the bubble. Others think it’s a new world and don’t see it as a bubble at all. However, even when the interpretations are the same, reactions differ. Some people move away from bubbles. Others feel they can’t stop dancing while the music is playing, to paraphrase Charles Price who destroyed Citi Bank with his dancing.
The emphasis on more data seems to originate from a naïve belief that if we all had better information there would be an obvious path we’d all want to follow. Yet, given history, there’s no reason to think that would be the case. For example, there are numerous people who consider the years of the internet bubble a glorious period. Just ask a Democrat about the Clinton era if you doubt it. Similarly, even Shiller hasn’t gotten over the housing bubble; he still talks about housing prices as if one’s home where an asset rather than a place to live.
It seems to me that the call for more data is based on the strong desire for more group think. Witness the negative reaction to those who publicly refuse to participate in a bubble or invest in ways to profit despite the bubble. The truly dangerous trend isn’t lack of data needed to identify bubbles. It’s the people who demonize those who see a bubble and act on that knowledge; then there are those like Shiller who pretend the bubble itself is the problem.
Robert Shiller argues that the last two recessions could have been avoided if we had better data on financial markets and the economy (See: Needed: A Clearer Crystal Ball). That is self-serving nonsense. The problem wasn’t measurement; it was interpretation. In addition, one cannot ignore counterproductive responses even among people who correctly interpret the available information.
It seems curious that Shiller, of all people, would be arguing that the bubbles in stocks during the internet bubble or housing during the housing bubble could not be seen from existing data. Shiller, after all, saw both bubbles in existing data. Perhaps the issue is that Shiller sees a bubble in any data he analyzes, just as some people never see a bubble no matter what data they see. More data won’t solve that problem.
There will always be differences of opinion no matter how much data is available. People can look at the same data and react differently. There are people who can’t resist participating in a bubble. Some see it as a bubble and want to “game” the bubble. Others think it’s a new world and don’t see it as a bubble at all. However, even when the interpretations are the same, reactions differ. Some people move away from bubbles. Others feel they can’t stop dancing while the music is playing, to paraphrase Charles Price who destroyed Citi Bank with his dancing.
The emphasis on more data seems to originate from a naïve belief that if we all had better information there would be an obvious path we’d all want to follow. Yet, given history, there’s no reason to think that would be the case. For example, there are numerous people who consider the years of the internet bubble a glorious period. Just ask a Democrat about the Clinton era if you doubt it. Similarly, even Shiller hasn’t gotten over the housing bubble; he still talks about housing prices as if one’s home where an asset rather than a place to live.
It seems to me that the call for more data is based on the strong desire for more group think. Witness the negative reaction to those who publicly refuse to participate in a bubble or invest in ways to profit despite the bubble. The truly dangerous trend isn’t lack of data needed to identify bubbles. It’s the people who demonize those who see a bubble and act on that knowledge; then there are those like Shiller who pretend the bubble itself is the problem.
Saturday, May 7, 2011
Round two, just for fun
They’re still at it
If you missed round one, check out Round Two.
Fight of the Century: Keynes vs. Hayek Round Two http://www.youtube.com/watch?v=GTQnarzmTOc
For my two cents, check out the posting from September of last year.
If you missed round one, check out Round Two.
Fight of the Century: Keynes vs. Hayek Round Two http://www.youtube.com/watch?v=GTQnarzmTOc
For my two cents, check out the posting from September of last year.
Thursday, May 5, 2011
Up, up and away in my beautiful balloon, or is it a bubble?
Gold may float like a butterfly, but remember the rest of the line.
The Hedged Economist recently participated in a discussion of gold verses dividend growth stocks entitled simply “Gold vs. Dividend Stocks.” The website, www.seekingalpha.com, is actually more like a collection of websites on different financial topics.
Since the discussion mentioned above, a number of people have asked about gold or touted it as an investment. Nothing that has occurred since the previous posting on gold has changed. (Gold: Be sure you know what you’ve hedged,Gold again,
and Worth repeating and, yes, gold again)
The price goes up and down, and gold remains a shiny yellow metal. It still hedges the same risks, has the same risks of ownership, and doesn’t produce a thing.
Some of the exchanges are presented below mainly in order to add perspective to the previous postings on this blog. In general, I find it interesting to talk with people who have actually followed gold and looked at its price over alternative holding periods. It’s a lot easier than talking with someone who only knows that he or she bought gold in at $800 in ‘79 and has a negative return after inflation. The really hopeless ones are people who discovered gold in 2006. Talking to them is like talking to the dot com believers of the late ‘90’s or people who bought stuff they didn’t need because their house had made them rich.
Comment received:
• I've still got the first 1 oz. Kruggerand I ever bought back in the mid-80's. It cost me a bit over $250.
According to the BLS inflation calculator $250 in 1985 would buy $519.14 today. I guess the spot price of $1453 today means I've done reasonably well over 26 years with an equivalent 'yield' of 4% above 'official' inflation compounding annually.
(1453 / 519.14 ) (1/26) = 1.0403 -> 4.03%
Not great, but it beats a poke in the eye. ;-)
The Hedged Economist’s response:
I have a similar story. However, using inflation as the risk and differences in return after inflation as the measure of performance, it appears 7.64% is the real compound average annual growth rate on the S&P when dividends were reinvested if the investment were made January 1, 1985, and 6.96% if made December 31. Those figures are as of end of year 2010. I can't claim I did the calculation. The data are from a website entitled Money Chimp (www.moneychimp.com/).
The chimp says it uses the Shiller stock performance data and CPI as the inflation factor. I apologize for not knowing which CPI. If I explored the website a little more, I might be able to find it, but the reference was fine for the posting on timing investments that I was writing back in January. (Actually, I was checking my performance against that legendary chimp that often beats the professional investors. Don’t know if this is that particular chimp, but periodically the market makes a monkey out of most of us, so I thought I consult one).
The 4% return is why I refer to gold as a hedge similar to insurance. (See: Gold: Be sure you know what you’ve hedged) A 4% real return on an insurance policy would be nice to have. So, your K-rand makes sense from that perspective. (I didn’t check your math).
The only thing I accomplish by moving between mining stocks, gold miners, gold, etc. is to smooth the ride a bit (gold bounced around a lot). Also, occasionally looking for hedges that serve as alternatives to gold also keeps the amount invested lower than it would be if a gold exposure were the only thing one used. For example, for a while in the late ‘90s TIPS with over 3.5% real rates were available. Holding them gives one both an inflation hedge and interest rate exposure (two things one gets from gold). For me that allows me to keep more in stocks with growing dividends (d-g stocks). I also figure some d-g stocks, like energy producers, provide an inflation hedge.
There are things physical commodities hedge that no financial instrument hedges, namely a financial market freeze. But, then one still has to trade the gold. For many other risks, the choice between a 4% real return on gold or, for example, a +3.5% on a TIPS (when the TIPS offers a cash flow) is not a layup shot. For me, a stock’s return is more appealing for almost all my capital. I take the risk of a financial market freeze to get the greater return, but forgoing the higher return on the K-rand in storage isn’t going to bust most investors.
Another exchange on gold:
Comment received:
I have quadrupled my investments in gold coins and gold stocks in the past 10 years. Also, you can write covered calls on gold mining stocks, such as Goldcorp, to generate a 10 to 20 percent profit annually. So, do not tell me that gold does not produce an income. It certainly does. You just have to be knowledgeable and not prejudiced against gold like most people on this board.
The Hedged Economist’s comment:
Congratulations on Goldcorp (GG): it has been an excellent mining investment. But, also look at Barrick Gold (ABX) or Newmont Mining (NEM). It wasn't gold as much as a very successful miner. Now, in the precious metal space look at Silver Wheaton (SLW). Successful new ventures / stock issues in this space can do phenomenally well. Great pick.
I'm not real good at analyzing new issues of mining companies, so for new ventures and new issues I stick to other industries. In that space (i.e., new ventures) GG's performance would be a success -- but, the type of success one targets because not every new venture works out.
"The gold doesn't produce income" refers to physical gold. That will change if the regulatory proposal to allow gold as collateral on repo's is adopted. Right now I'm not aware of any way to write covered calls on physical gold. I would think it would be allowed on the ETFs. If you’re aware of something else, we're always interested in learning.
Nobody here is prejudiced against making money. We just each share our limited experience.
Another comment received:
With all of the talk above about gold being a hedge against various things (generally apocalyptic stuff), what's the hedge against gold losing its value? It's always been considered valuable, but its price has gone down from time to time (as noted above). What's the defense against that?
Full disclosure: I am by nature not prone to insure against risks other than the most obvious ones. I have car insurance and homeowner's insurance. I have enough life insurance to tide my wife over should I die. I have health insurance. That's it. None of my investments are hedged, unless you count sell-stops under my capital-gains investments as "hedging." I guess I don't find life nearly as much fun to live if I sit around all day thinking of all the things that could go wrong and then figuring out how to insure against every one of those risks. As lots of fear-mongers proclaim (and make a good living at proclaiming), the risks are endless. It seems like such a negative way to live.
I understand that therefore, I am unprotected against certain rare events that others are protected against. I'll take that trade.
The Hedged Economist’s comment:
For me, a hedge usually ends up being a long in something else. I'm always looking for something that zigs when other things zag. For me, the hedge to falling gold prices has been mainly stocks.
You mention "gold being a hedge against various things." I'd word it differently. I'd say "gold is USED as a hedge against various things." But, it isn't the only, or best, hedge for many of them.
If you’ll indulge me, let me give some examples. I’ve used other mineral miners to address some of the risks that gold is often used to hedge (long BHP, FCX). The stock of a senior gold producer whose cost per is below the price of gold will behave differently from a junior miner engaged in exploration or developing a new mine (long NEM). In a comment on another article I mentioned using TIPS (bought when they had attractive real interest rates) as a hedge against inflation. Many people use gold for that purpose.
Like you say, one should allocate resources based on probabilities. That's why I said I don't like the 5% in gold as a hard and fast rule. I can’t see any risk with a stable 5% probability that only gold addresses.
I have a slightly different philosophy. If I see a risk that I can eliminate at a low cost or with a positive return, I get rid of it. Then…“relax and enjoy life.”
EPOGOLG: This posting and the exchanges it reports were written between March 30 and May 1. Given developments this week, one additional comment: as the saying goes, “don’t try to catch a falling knife.”
The Hedged Economist recently participated in a discussion of gold verses dividend growth stocks entitled simply “Gold vs. Dividend Stocks.” The website, www.seekingalpha.com, is actually more like a collection of websites on different financial topics.
Since the discussion mentioned above, a number of people have asked about gold or touted it as an investment. Nothing that has occurred since the previous posting on gold has changed. (Gold: Be sure you know what you’ve hedged,Gold again,
and Worth repeating and, yes, gold again)
The price goes up and down, and gold remains a shiny yellow metal. It still hedges the same risks, has the same risks of ownership, and doesn’t produce a thing.
Some of the exchanges are presented below mainly in order to add perspective to the previous postings on this blog. In general, I find it interesting to talk with people who have actually followed gold and looked at its price over alternative holding periods. It’s a lot easier than talking with someone who only knows that he or she bought gold in at $800 in ‘79 and has a negative return after inflation. The really hopeless ones are people who discovered gold in 2006. Talking to them is like talking to the dot com believers of the late ‘90’s or people who bought stuff they didn’t need because their house had made them rich.
Comment received:
• I've still got the first 1 oz. Kruggerand I ever bought back in the mid-80's. It cost me a bit over $250.
According to the BLS inflation calculator $250 in 1985 would buy $519.14 today. I guess the spot price of $1453 today means I've done reasonably well over 26 years with an equivalent 'yield' of 4% above 'official' inflation compounding annually.
(1453 / 519.14 ) (1/26) = 1.0403 -> 4.03%
Not great, but it beats a poke in the eye. ;-)
The Hedged Economist’s response:
I have a similar story. However, using inflation as the risk and differences in return after inflation as the measure of performance, it appears 7.64% is the real compound average annual growth rate on the S&P when dividends were reinvested if the investment were made January 1, 1985, and 6.96% if made December 31. Those figures are as of end of year 2010. I can't claim I did the calculation. The data are from a website entitled Money Chimp (www.moneychimp.com/).
The chimp says it uses the Shiller stock performance data and CPI as the inflation factor. I apologize for not knowing which CPI. If I explored the website a little more, I might be able to find it, but the reference was fine for the posting on timing investments that I was writing back in January. (Actually, I was checking my performance against that legendary chimp that often beats the professional investors. Don’t know if this is that particular chimp, but periodically the market makes a monkey out of most of us, so I thought I consult one).
The 4% return is why I refer to gold as a hedge similar to insurance. (See: Gold: Be sure you know what you’ve hedged) A 4% real return on an insurance policy would be nice to have. So, your K-rand makes sense from that perspective. (I didn’t check your math).
The only thing I accomplish by moving between mining stocks, gold miners, gold, etc. is to smooth the ride a bit (gold bounced around a lot). Also, occasionally looking for hedges that serve as alternatives to gold also keeps the amount invested lower than it would be if a gold exposure were the only thing one used. For example, for a while in the late ‘90s TIPS with over 3.5% real rates were available. Holding them gives one both an inflation hedge and interest rate exposure (two things one gets from gold). For me that allows me to keep more in stocks with growing dividends (d-g stocks). I also figure some d-g stocks, like energy producers, provide an inflation hedge.
There are things physical commodities hedge that no financial instrument hedges, namely a financial market freeze. But, then one still has to trade the gold. For many other risks, the choice between a 4% real return on gold or, for example, a +3.5% on a TIPS (when the TIPS offers a cash flow) is not a layup shot. For me, a stock’s return is more appealing for almost all my capital. I take the risk of a financial market freeze to get the greater return, but forgoing the higher return on the K-rand in storage isn’t going to bust most investors.
Another exchange on gold:
Comment received:
I have quadrupled my investments in gold coins and gold stocks in the past 10 years. Also, you can write covered calls on gold mining stocks, such as Goldcorp, to generate a 10 to 20 percent profit annually. So, do not tell me that gold does not produce an income. It certainly does. You just have to be knowledgeable and not prejudiced against gold like most people on this board.
The Hedged Economist’s comment:
Congratulations on Goldcorp (GG): it has been an excellent mining investment. But, also look at Barrick Gold (ABX) or Newmont Mining (NEM). It wasn't gold as much as a very successful miner. Now, in the precious metal space look at Silver Wheaton (SLW). Successful new ventures / stock issues in this space can do phenomenally well. Great pick.
I'm not real good at analyzing new issues of mining companies, so for new ventures and new issues I stick to other industries. In that space (i.e., new ventures) GG's performance would be a success -- but, the type of success one targets because not every new venture works out.
"The gold doesn't produce income" refers to physical gold. That will change if the regulatory proposal to allow gold as collateral on repo's is adopted. Right now I'm not aware of any way to write covered calls on physical gold. I would think it would be allowed on the ETFs. If you’re aware of something else, we're always interested in learning.
Nobody here is prejudiced against making money. We just each share our limited experience.
Another comment received:
With all of the talk above about gold being a hedge against various things (generally apocalyptic stuff), what's the hedge against gold losing its value? It's always been considered valuable, but its price has gone down from time to time (as noted above). What's the defense against that?
Full disclosure: I am by nature not prone to insure against risks other than the most obvious ones. I have car insurance and homeowner's insurance. I have enough life insurance to tide my wife over should I die. I have health insurance. That's it. None of my investments are hedged, unless you count sell-stops under my capital-gains investments as "hedging." I guess I don't find life nearly as much fun to live if I sit around all day thinking of all the things that could go wrong and then figuring out how to insure against every one of those risks. As lots of fear-mongers proclaim (and make a good living at proclaiming), the risks are endless. It seems like such a negative way to live.
I understand that therefore, I am unprotected against certain rare events that others are protected against. I'll take that trade.
The Hedged Economist’s comment:
For me, a hedge usually ends up being a long in something else. I'm always looking for something that zigs when other things zag. For me, the hedge to falling gold prices has been mainly stocks.
You mention "gold being a hedge against various things." I'd word it differently. I'd say "gold is USED as a hedge against various things." But, it isn't the only, or best, hedge for many of them.
If you’ll indulge me, let me give some examples. I’ve used other mineral miners to address some of the risks that gold is often used to hedge (long BHP, FCX). The stock of a senior gold producer whose cost per is below the price of gold will behave differently from a junior miner engaged in exploration or developing a new mine (long NEM). In a comment on another article I mentioned using TIPS (bought when they had attractive real interest rates) as a hedge against inflation. Many people use gold for that purpose.
Like you say, one should allocate resources based on probabilities. That's why I said I don't like the 5% in gold as a hard and fast rule. I can’t see any risk with a stable 5% probability that only gold addresses.
I have a slightly different philosophy. If I see a risk that I can eliminate at a low cost or with a positive return, I get rid of it. Then…“relax and enjoy life.”
EPOGOLG: This posting and the exchanges it reports were written between March 30 and May 1. Given developments this week, one additional comment: as the saying goes, “don’t try to catch a falling knife.”
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