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Flirting with Gold and Silver

My timing of articles can be rather bad. Sometimes when I write something contrarian about something, it turns out the opposite. However, I think in most instance its just my brain playing a trick on me. I get it right and wrong as frequently and an unashamed to admit it.

One of the best value plays out there currently is the buying of hard metals such as gold, silver and platinum the likes. Since 2011, they have been in a funk.

I am writing this because I realize more and more of the folks around me are getting enamoured about it.

Prior to 2011, these hard metals have been on a 9-10 year great run, and by average they did very well.

The problem is that Investors do not know when to rebalance their holdings and start pilling into an asset class that did very well.

It really didn’t help that many investors make their evaluation based on titbits spoken by financial gurus forecasting $5000 gold.

The fundamentals of hard assets aren’t well understood by many, just like trying to understand certain niche businesses such as a litigation financing firm, or an industrial company. You develop an edge if you dig deep and do research in a very systematic manner.After that, do a valuation what is the fair price based on the situation here.

I am sure many investors are not well aware of the fundamentals, but.even after deep research you might be blindsided because you think your research is fundamentally sound

The problem with hard assets prospecting is that many married how politically driven these hard assets is with the business of making money. The flaw here is that politics is essentially a chess game, and can play out in a lot of ways. Most often it is a chess game that might only be in your favour 10% of the time. Now think about that, you are going to based the majority of your wealth building on something like that if you deem that precious metals is going to do well because of the huge conspiracy theory that precious metal prices are deliberately suppressed and that the world is very inflationary because the inflation numbers are manipulated. What if these gurus understanding turns out to be very flawed?

Most of the time the problem for investors is:

  1. Failure to understand investing in general. They are mostly speculators without realizing they are, buying on hope. If these precious metals are really good wealth building instruments, you could probably hold them for 30 years and you can easily sell them off bit by bit to fund your retirement. Are we able to do that with precious metals?
  2. Failure to grasp the timeframe of the ‘investment’. One of the big problems with listening to so call experts is that, you failed to understand the time frame that they are talking about. They can go on and on to talk about the conspiracy theory and that eventually the price will go up. But would the precious metals investors time frame be aligned? Perhaps they are putting it into precious metals hoping that it will go up $80% in 1 year while the guru will be thinking 5 years but he is not telling you that
  3. Failure to assess the risk properly. They buy in to something so much that they failed to assess what if this isn’t the case. Investors are rather prone to endowment effect, where they look at what they already own very favourably or confirmation bias where they search for information subconsciously to justify that they are right
  4. Failure to allocate properly. Due to most of these factors, they allocate a high proportion to precious metals. So it becomes all or nothing
  5. Failure to rebalance. When assets appreciate, they don’t put what is appreciating in value into assets that are in their portoflio where value is getting more attractive

Technically Gold and Silver Charts Look……

Gold, commodities and the like are often justified by price targets on technical charts. How do they look? Not a good reader of charts but lets see what some of the season folks say about them:

Here is a weekly bar chart of Silver going back to the rally that got going towards the end of 2010 that took silver close to $50/oz. There are a few things that I want to point out here. First of all, notice how many times Silver has tested this support just below $19. This area is key because not only was this former resistance in 2010 but it also represents the 161.8% Fibonacci extension from the early 2012 counter trend rally, which was the biggest one before the eventual breakdown last year:

The more times that a level is tested, the higher the likelihood that it is going to break. After this many tests of support, my experience tells me that a big break is likely coming soon. To come up with a downside target we want to take the 161.8% Fibonacci extension from the size of the recent consolidation. In this case, the base of the descending triangle from the 2013 June-August rally gives us a target of $13.75. There is also some support around $14.80 from prior support in early 2010 as well as a measured move target based on the size of the last two bounces in Silver that took place throughout 2014. – All Star Charts, 11 Sept, 2014

The daily and weekly graphs of Gold and Silver indicate that lower prices are most likely. Key chart levels are giving way, calling for a possible sharp drop from current prices. Let’s review these charts.

The weekly Gold chart is attempting to complete a 15+ month H&S failure pattern. A decisive close below 1240 will complete this chart configuration and indicate a possible target at low as 1040. HERESY! … the Gold bulls proclaim. It must be market manipulation — after all, the destiny for Gold is $5,000 per oz. – Peter Brandt, 12th Sep, 2014, Putting the current bear markets in Gold and Silver into a longer-term perspective

Perhaps we have a very flawed mental model of current economic condition

Or perhaps it is rather difficult to understand how this economic machine works. If money printing and government policies is just one side of the equation. Perhaps the time frame is too short for what the gurus deem the ‘end game’ will not arrive yet.

You could argue that gold is the only universal form of money and has been for quite some time (though I think that is waning to some degree).  Because of this its users embed a premium in its price when it is seen as protecting against fiat money and its potential inflationary problems.

But a weird thing has happened in recent years.  Despite continuing QE and huge government deficits the price of gold has fallen 35% since its peak in 2011 and is down over 10% from its highs this year.  Is there a logical explanation for this?  I can’t be certain and I could be totally wrong, but if I had to guess I would argue that some of this “faith put” is coming out of the price over time because the inflation bet has been obviously wrong.

Said differently, gold investors embedded a huge premium in the price of gold betting on a disastrous inflation in 2008 & 2009.  And as it’s become more and more obvious that that high inflation isn’t coming the premium has been sucked right back out.  That’s my theory anyhow.  Who knows if it’s right, but it would seem to make a good deal of sense to me…. – Cullen Roche

If you say something long enough, one day it will come true

A bigger problem with the gold story is the question of why you should expect it to earn a good return. For gold’s price to keep rising steadily due to the failure of the fiat money system, it has to be the case that more and more people will steadily realize that the story is true. So a bet on this gold story is a bet that your macro perspective is way, way ahead of the macro perspectives of most other investors. That’s a highly speculative, risky bet.

So you should beware of media outlets that constantly push this story on you. The most important such website is probably Zero Hedge. If you read Zero Hedge, you’ll see this story about gold and fiat money being promoted again and again and again, often mixed with a healthy dose of politicalideology and references to “Austrian economics.”

If you actually take Zero Hedge’s constant gold-flogging to heart, you could lose a lot of money. Since gold hit a peak in 2011, it has lost about 33 percent of its value in real terms. Zero Hedge kept touting gold all the way down. For example, in November 2011, Zero Hedge ran an article saying that gold could be “on its way to infinity.” In March 2012, Zero Hedge urged its readers to “stay long gold.” An October 2012 article made the same recommendation. As the price fell, Zero Hedge assured us that the collapse was only in “paper” gold, not the physical commodity. Needless to say, if you took Zero Hedge’s advice at any of these points, you would have lost a lot of money. – Gold Dreamers face harsh reality

And they might eventually be correct, perhaps 2 years later perhaps at the end of this bull market which may run from 2009 to 2020. Think about it. You will need to assess your investing performance over 11 or 12 years when it effectively moved nowhere, not over that 1 year where it went up.

You will realize that this quite mirrors what we talked about in value investing, such that waiting for a business that you purchase at half price to realize its value. It might take forever. The situations might be similar. You have to make sure that you understand the fundamentals, you have to understand the time frame you are willing to wait, you have to understanding the risks and you need to size your allocation to this properly.

However, the difference with these businesses is that, there is very little conspiracy there! Its just assessing whether the assets are there, and the motivation of the owners or prospective people take over will realize the value.

These precious metals are not easier to understand, its that the investors blank out tough things that matter in the hope that those shitty scenarios don’t happen to them.

Precious Metals: Still all about valuation

I list out in my blog page on Mental Blocks, Doomsday Scenarios, Misinterpretations that kill your wealth that, precious metals like all other things depend on valuation to do well.


The deflation and inflation debate

If the previous section doesn’t explain that gold doesn’t always behave like you want it to, whether deflation and inflation matters much to precious metals may influence your allocation.

In this case take a look at two ‘gurus’ Harry Dent and Peter Schiff argues whether inflation or deflation is coming. I hope this makes your wealth building easier.

In any case, here is an article profiling Mr Dent in August 2013 and his past record, including an ETF based off his ideas –  Harry Dent and the Chamber of Poor Returns

Here is one which may make you lean closer to Mr Schiff’s track record –The Doom in Investing with Doomsayer Peter Schiff

Precious Metals as an Inflation Hedge

Quantitatively from the valuation section above, it has been shown that Gold might not do what it is suppose to do during times of inflation. Market Watch has an article talking about Gold as an inflation hedge:

But gold’s track record as an inflation hedge depends greatly on your time horizon, according to Claude Erb, Harvey’s co-author on the National Bureau of Economic Research study and a former commodities and fixed-income manager at mutual-fund firm TCW Group.

Over the short term, he says, gold is a very unreliable inflation hedge. It is only over the long term that it can be a decent hedge — and he emphasizes that this long term must be measured over many decades at a minimum.

Based on the markets’ recent behavior, Erb is confident that if inflation and Treasury yields were both to rise over the next couple of years, the most likely outcome still would be a lower gold price.

What steps should you take in your portfolio if you think inflation is about to heat up? Erb acknowledges that there isn’t a great short-term inflation hedge. But he says that intermediate-term government bond funds should largely hold their own when inflation and interest rates rise, since they can reinvest in higher-yielding issues as their older bonds mature, thereby absorbing the losses of principal caused by those higher yields.

Erb points to the surprising resilience from 1966 through 1981 of intermediate-term U.S. government bonds — those with five-year maturities. This 16-year period is often considered the worst environment in recent history for bond investors, since intermediate Treasury yields nearly tripled. Nevertheless, according to Ibbotson Associates data, these bonds produced a 5.8% annualized return over the period. – Gold might be up this year, but its worth only $800


This isn’t meant to be a precious metals bashing topic, since I am shooting myself in the foot as I also own the Gold ETF. What is most unloved is where there is a value proposition.

The value houses such as Seth Klarman and Oaktree Capital are being rather active in this distress space:

The most significant negative impact on the equity portfolio came from gold miners, generating a loss of nearly 1% of capital. “The combination of a 28% decline in gold prices over the course of the year and a few uncorrelated negative developments at individual companies produced a negative result.  We continue to actively manage our gold positions.” Although, the letter does not specify gold miners, according to Baupost Group’s recent 13F, the hedge fund holds positions in Novacopper Inc (NYSEMKT:NCQ) (TSE:NCQ), NovaGold Resources Inc. (NYSEMKT:NG) (TSE:NG). Additionally, according to Gabriel Resources, Klarman is the 4th largest shareholder in the Canadian miner. – Baupost Group

Just yesterday:

Howard Marks‘ investment firm Oaktree Capital has filed a 13G with the SEC regarding shares of Molycorp (MCP).  Oaktree now owns 9.1% of the company with over 24.47 million shares.

This is a newly disclosed stake and the filing was required due to activity on September 11th.  The filing notes that the shares beneficially owned are a result of direct ownership of 18,358,019 penny warrants and 6,119,340 Oaktree Warrants which are defined in the filing here.

Fortune favour those who are willing to look for the deep value proposition and able to understand them.

My gripe is not so much on the asset class, but to provide a counter point to the one sided information friends have been digesting. Nothing is worth it to overload with a 70-100% allocation into one thing.

You are essentially speculating. You have to figure out how sure are you on the subject, be it equities, bonds, real estate or precious metals investing. And you better be true to yourself that you are not being bias about it.

Hope this makes you ask more questions and search deeper or that you realize that precious metals are not the Panadol to all your problems, or the holy grail of wealth building.

Do read other misinterpretations, myths and doomsday scenarios that ruin your wealth.

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