Thursday, January 9, 2014

Barry Ritholtz Mischaracterizes Gold Bugs

A recent article written by Barry Ritholtz titled ‘10 Reasons the Gold Bugs Lost Their Shirts’ highlights some important points that any investor would do well to consider, i.e.

‘Beware the Narrative’ – Don’t rely on stories that get you emotionally involved in a trade / investment.

‘Ignore History at Your Own Peril’ – Most things come into and out of fashion, what goes up usually comes down.

‘Leverage is Always Dangerous’ – The leverage involved in futures contracts runs the risk of margin calls if the trade doesn’t go your way.

‘What’s In the Price Already?’
– By the time rumours make their way to the average retail investor it's probably already priced in.

As Ritholtz says in the article, many of the tips can be applied to any investment, not just those who hold Gold.

However in my opinion he makes some critical mistakes in his analysis of Gold and those who hold it (‘gold bugs’).

Ritholtz says part way through the article:
"Like all commodities, gold is purchased via futures contracts."
This one sentence mischaracterizes a majority of those that I would consider to be 'gold bugs', who for the most part are wary of the futures market and other 'paper markets', sticking primarily with physical bullion, bars & coins (which don't even get a mention in the article). 

While I have seen the question posed on precious metals forums, "Should I take out a personal loan to buy precious metals?", it is far from a common query and usually met with a resounding "No". Gold bugs are rarely leveraged to the extent of futures traders (Ritholtz says typically this is 15 to 1), so are unlikely to 'lose their shirt' in the event of a large correction or crash.

He characterizes gold bugs as investors who are holding the metal specifically with the intent to make a fiat currency profit, when for many that is not the case.

In an article I wrote 12 months ago (Gold Speculator, Investor, Trader, Saver or Gambler?) I described five labels for those I see in the Gold space (it's likely this list could be expanded on). The purpose of Gold for these individuals will vary, from trading the metal for a profit, as insurance in the case of financial crisis or as a vehicle for transitioning wealth from the current monetary system to whatever comes next. 

Others again own Gold with the expectation they will need the metal for exchange of goods after a financial or monetary collapse (SHTF), does that sound like someone performing a trade (in the article Ritholtz claims 'Everything Eventually Becomes a Trade')?

One of the points made in the article gives the impression that gold bugs will usually hold 'no matter what':
Ask yourself, “What would make me reverse this position? What would make me sell this long or cover this short?” There is usually a long list of technical and fundamental answers. They may include break in support, a violation of a trendline, a decline in earnings, a slowing of growth, etc. Often, a simple modest price decrease is sufficient to get traders to cut their losses.

Yet many of the gold bugs I have spoken with over the past five years had no pain point. “I'll Stick With Gold” was a common refrain. There was no conceivable set of circumstances that could either reduce their ardor or their holdings in the metal.
While I am sure that there are a few of these types out there, I highly doubt that it represents a majority of gold bugs. Ritholtz is probably not posing the right scenario for the gold bug to reconsider their holding. For example if we were to see anything that significantly impacted the relatively stable supply of the metal relative to total stock, e.g. a significant advancement in mining technology that increased new annual mine supply from 1.6% to 20% or if the central banks all unanimously decided to sell all their Gold holdings (flooding 40,000 tonnes into a 4,000 tonne per annum market) then I think we would see significant divestment out of Gold even by some of the hardcore gold bugs. However, their response to such a question is more likely to be 'it would never happen' rather than actually addressing what they would do if it did.

Another observation that Ritholtz makes (my emphasis):
Gold has run up only be to trounced in repeated massive selloffs: 1915-20, 1941, 1947, 1951-66, 1974-76, 1981, 1983-85, 1987-2000 and 2008.
During the years I've bolded above Gold was a fixed price in US Dollars, so I'm not even sure what he is referring to when he claims it saw 'massive sell offs' during those periods (the other dates align with Gold price corrections which we saw post closure of the Gold window in 1971).

Ritholtz's characterization of gold bugs as those holding leveraged futures with the intention to turn a buck reminds of me this story dug up from the archives of 'Another' posted on FOFOA recently:
A gentleman leans over the fence and tells his neighbor that gold is going to rise in price from its current $300. As the person on the other side of the fence thinks differently, they both agree to a binding bet. In three months, we will settle up with a payment of the change in the price of one hundred ounces of gold. Whatever it rises, the "bull" collects that amount. Likewise, whatever it falls, the "bear" collects from the bull. Each puts a $1500 payment guarantee into a common shoe box and gives it to another neighbor for safekeeping.


As an observer of the above, we have just witnessed the creation of a wager not unlike a comex futures contract. On each side of the fence stands a long and a short, that together create an open interest of one contract. Neither has any intention of buying gold, nor do they expect physical gold to be a part of this bet. Yet, at cocktail parties and on public internet forums, one claims to have "bought gold" and the other states that he "sold gold".

To build a further understanding of this transaction: Both of these gentlemen, probably don't have the $30,000+/- to buy or deliver 100 ounces of gold. Human nature being as it is, if they did have that much, they would most likely increase the bet to ten or twenty contracts. Clearly, the intent of this paper market, is to bet on the price of gold as it is determined by the buying and selling of other physical traders. The western public should take these trades for the concept they truly represent. "I (the long side) bet on the "price" of gold not because we need or want the physical metal. Rather, my wager is that others will need real gold to protect themselves from bad monetary systems. In fulfilling that "need to own", these others will drive up the dollar price and I will make money while working within the confines of our good monetary system." The shorts make the opposite bet, in that they think the world monetary system will work itself out and induce "the others" to sell all their gold. That is, gold they bought in the first place, because they did not know that our money managers could repair the world financial system.

Yes, today Western longs and shorts are playing out these two views of the gold market. Yet, both sides are using paper gold bets to represent their beliefs. Truly, the major majority of this market does not buy or sell physical gold to represent their investment concepts. There are a few that buy coins and bullion, but, even in their large amounts, it is only a drop in the paper gold bucket.

This, my friends, is the very nature of western trading of gold. The mindset is to treat it as a concept for making currency, not protecting existing wealth.
I wouldn't call these neighbours 'gold bugs', really they are just a couple of punters who happen to think they know what the price of Gold will do.

On a final note and just to live up to the characterization that Ritholtz gives gold bugs (in the section titled 'Attacking the Skeptics'), lending some credibility to his profiling of us, I think he is a sell out, likely to be in the pocket of the Federal Reserve and a patsy for the administration.

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  1. I tried to engage with Ritholtz yesterday, and was disappointed when he dropped out of the discussion. I had said that I thought we were in for tough economic sledding, and that I would divest gold if/when we moved to a sustainable economic environment, with debt and unfunded liabilities handled. He responded that I'd be better off with food, guns and ammo, My response was that there was a "a lot of room between a Mad Max scenario and Gold as a hedge against Political/Fiscal/Monetary stupidity." I didn't hear anything else from him. I was disappointed, because I love nothing more then to test my thesis with the well-reasoned arguments of others.

    He's too smart not to have a better answer than silence...assuming there is one. Quite frankly, whenever I ask ANYONE to give me a reasistic path twthrough this mess that has it end well, I always get silence. It's like the question causes people to think about things that they simply don't want to believe - that our system will implode, either in a quick/disorderly way, or in a slow/orderly way.

    This morning I came around to the view that you espouse - I think the Fed/Gov't is working the gold issue on multiple fronts, and Ritholtz is simply one of those fronts. It may just be that his interests are aligned with theirs, or it may be something more overt. In any case, it's disappointing.

  2. The last line of my post was only tongue in cheek (suggesting Ritholtz works for the Fed), I was just ensuring that I met one of the criteria from his article ;)

    I just think he is an individual with his own ideas and no interest in considering the perspective of others. It is unfortunate that he paints gold bugs with such a narrow brush, but when the opportunity to have a reasonable conversation arises with those he is profiling, he chooses to ignore them.

    A user on MacroBusiness put Ritholtz's position quite succinctly:

    "Ritholtz essentially supports his analysis by treating fiat currencies as a bedrock, i.e. asset changes are all relative to this unchanging fiat value.

    Fact is that, at the first sign of deflation central banks started deflating fiat value (through asset purchases to protect bank balance sheets) and really shattered the myth that there is any long term value certainty to fiat.

    Fiat has shown to have short term predictability as a mechanism for exchange, and extreme volatility risk over time.

    All parts in this machine are moving – all assets, all pms, all fiat."

  3. Having one's own ideas is one thing...but turning off his critical thinking is beyond foolish. As I mentioned, he is too smart a guy to simply ignore comments that test his point of view...there's something else. Maybe he just has a blind spot - I don't really know. - but he's doing his readers a disservice.

  4. I learned a long time ago not to preach religion to the devout faithful. You have deeply felt beliefs. You are not objective -- hell, this site is subhedded "The trusted name in bullion."

    So you guys have a vested interest in gold and its price movement. You are not objective analysts, you have something you are selling. Whether its services or newsletters or gold bullion or a narrative. I recognize that. I am not a buyer. Indeed, I call bullshit on it.

    But ti answer TJ's question: Why wont I engage further?

    What good would it do either of us? I learned a long time ago this wisdom from Lazarus Long: "Never try to teach a pig to sing -- it wastes your time and annoys the pig."

  5. The 'Bullion Money' advert banner with 'trusted name' text is that of a site sponsor. Yes I earn a few dollars through sponsors and some affiliate links, just as you appear to have monetized your blog by selling your books, asset management services & speaking engagements...

    I don't sell bullion for a living, offer investment related services or sell a newsletter. I work in IT, invest privately and write this blog as a hobby. It's essentially a diary of my observations, opinion & analysis, it is as much a narrative as your own writing, which whether you would care to admit it is lined with your own biases.

    Yes I own precious metals, so I have a vested interest in their prices rising, as you have a vested interest in writing articles that will sell your name and services.

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