Post by oldman on Oct 19, 2013 7:24:35 GMT 7
Your First Million, 2nd Edition
Chapter 6: Tools of the trade
If one looks at the gold chart for the past 10 years, gold has risen from US$300 an ounce to its current US$1,621. This is an amazing rise of 440% over 10 years.
However, if one looks at the gold chart for the past 36 years, gold has been relatively stable at around US$400 an ounce between 1981 and 2004. This is a period of over 20 years. Sure, there was a spike in the gold price from 1974 to 1981 which brought the price of gold from US$100 to US$800 an ounce – a rise at that time of 700% over seven years.
The period of stability of over 20 years is of interest to me because the currency issues that we face today are not much different from then. If I recall, the US dropped the gold standard in 1971 and from thence on, their currency was no longer supported with gold. The US government was then able to print as much money as it needed. No different from today although it is fair to say that the general population are now more aware of governments printing money freely compared to the past.
What I am trying to say is that investors in the ‘80s and ‘90s are equally as smart as investors today. If they did not think that gold was the safe haven then, why should investors today think differently.
If you think about it, gold is, to all intents and purposes, indestructible. Worse, it can be recycled perpetually. Hence, the quantity of gold is actually increasing all the time as more gold is being mined while existing gold remains in circulation. Gold jewelry is melted down and even computer equipment with traces of gold can be crushed and the gold extracted. Hence, the amount of gold available in the years to come will increase all the time.
In many ways, gold has similiar characteristics to the world currencies. Governments print money and increase the amount of notes available. Miners mine more gold and increase the amount of gold available. Both are indestructable and recirculated all the time. Hence, investing in gold does not overcome the issue of un-regulated supply that can result in an over-supply situation.
From an investors’s standpoint, the ideal investment is one in which supply is limited and even better, supply is constantly being consumed and cannot be recycled or the cost of recycling is so high that it is prohibitive. A good example of an ideal investment is an investment in a branded product company like Louis Vuitton (LV). LV bags will perish with constant use. LV as a company is careful not to flood the market with too many of the same products. As the existing products will deteriorate with use, and the supply is carefully regulated, LV can raise the price of their bags and yet, there will be ready buyers to pick up their products.
Gold does not have these characteristics and hence, I think the recent meteoric rise of gold is primarily due to demand and supply inequalities as a result of investor greed. Like the tulip mania, one day, investors will realise that gold may not be the safe haven that they are looking for and fear will set in, resulting in a collapse of the price of gold.
Though I have my own views on the price of gold, I have not taken any positions on this. The reason is that the only available instrument that I know are the put options. The problem with options is that it is a double-edged sword. If one guesses the direction wrongly, he has to pay dearly for his mistake as he is responsible for the total downside as well. As an investor, I do not take such risks. I am alright to buy put warrants as the downside risk to me is only the price of the warrant and not the total downside.
In other words, if I were to have bought the put option and gold rose to US$2,000 an ounce, I will lose at least U$379 per ounce assuming an entry price of US$1,621. The higher the gold price rises, the more I will lose if I bought a put option on gold. If the price of gold zooms up to the moon, I will lose my pants and more. In other words, if I bought a put option and the market goes against my position, my losses can be unlimited. As a fundamental investor, I can never accept such risks and this is why I do not trade options.
If I were to have bought a put warrant instead and the price of gold went up instead, I will only lose the price of the warrant. As I am unable to find put warrants on gold, I have not taken any position on gold.
Investors must always be aware of the downside risks before taking any positions in the marketplace, regardless of how potentially rewarding the opportunity may be.
Chapter 6: Tools of the trade
If one looks at the gold chart for the past 10 years, gold has risen from US$300 an ounce to its current US$1,621. This is an amazing rise of 440% over 10 years.
However, if one looks at the gold chart for the past 36 years, gold has been relatively stable at around US$400 an ounce between 1981 and 2004. This is a period of over 20 years. Sure, there was a spike in the gold price from 1974 to 1981 which brought the price of gold from US$100 to US$800 an ounce – a rise at that time of 700% over seven years.
The period of stability of over 20 years is of interest to me because the currency issues that we face today are not much different from then. If I recall, the US dropped the gold standard in 1971 and from thence on, their currency was no longer supported with gold. The US government was then able to print as much money as it needed. No different from today although it is fair to say that the general population are now more aware of governments printing money freely compared to the past.
What I am trying to say is that investors in the ‘80s and ‘90s are equally as smart as investors today. If they did not think that gold was the safe haven then, why should investors today think differently.
If you think about it, gold is, to all intents and purposes, indestructible. Worse, it can be recycled perpetually. Hence, the quantity of gold is actually increasing all the time as more gold is being mined while existing gold remains in circulation. Gold jewelry is melted down and even computer equipment with traces of gold can be crushed and the gold extracted. Hence, the amount of gold available in the years to come will increase all the time.
In many ways, gold has similiar characteristics to the world currencies. Governments print money and increase the amount of notes available. Miners mine more gold and increase the amount of gold available. Both are indestructable and recirculated all the time. Hence, investing in gold does not overcome the issue of un-regulated supply that can result in an over-supply situation.
From an investors’s standpoint, the ideal investment is one in which supply is limited and even better, supply is constantly being consumed and cannot be recycled or the cost of recycling is so high that it is prohibitive. A good example of an ideal investment is an investment in a branded product company like Louis Vuitton (LV). LV bags will perish with constant use. LV as a company is careful not to flood the market with too many of the same products. As the existing products will deteriorate with use, and the supply is carefully regulated, LV can raise the price of their bags and yet, there will be ready buyers to pick up their products.
Gold does not have these characteristics and hence, I think the recent meteoric rise of gold is primarily due to demand and supply inequalities as a result of investor greed. Like the tulip mania, one day, investors will realise that gold may not be the safe haven that they are looking for and fear will set in, resulting in a collapse of the price of gold.
Though I have my own views on the price of gold, I have not taken any positions on this. The reason is that the only available instrument that I know are the put options. The problem with options is that it is a double-edged sword. If one guesses the direction wrongly, he has to pay dearly for his mistake as he is responsible for the total downside as well. As an investor, I do not take such risks. I am alright to buy put warrants as the downside risk to me is only the price of the warrant and not the total downside.
In other words, if I were to have bought the put option and gold rose to US$2,000 an ounce, I will lose at least U$379 per ounce assuming an entry price of US$1,621. The higher the gold price rises, the more I will lose if I bought a put option on gold. If the price of gold zooms up to the moon, I will lose my pants and more. In other words, if I bought a put option and the market goes against my position, my losses can be unlimited. As a fundamental investor, I can never accept such risks and this is why I do not trade options.
If I were to have bought a put warrant instead and the price of gold went up instead, I will only lose the price of the warrant. As I am unable to find put warrants on gold, I have not taken any position on gold.
Investors must always be aware of the downside risks before taking any positions in the marketplace, regardless of how potentially rewarding the opportunity may be.