Attention Traders: The Value Of Cash Is Not Absolute

Over the last few years, as the price of Gold declined, several professional traders and financial commentators have taken it upon themselves to unleash their wisdom about the metal being "just a trade". They've decided that everyone should see the financial world through their narrow lens and have used it's declining price as "proof" you should always have a stop and be prepared to exit your position.

The way I've framed the above might suggest I have a problem with their view. In fact I don't, it's one way of looking at the assets in your investment portfolio. However, to take their view you also have to give thought to ALL positions and that includes cash, which should also be considered a trade as it's value can change.

Earlier this year I wrote about Ritholtz's position on gold bugs ('Barry Ritholtz Mischaracterizes Gold Bugs'), one of the rules in his article was:

The Danger of One-Way Trades: What would make you reverse your biggest present holding? What facts or situations would force you to change your views and sell? If your answer to that question is, “Nothing,” you have a huge, devastating flaw in your approach to investing.

I hear traders talking day in and out about 'going back to cash' or 'sitting in cash' after exiting all positions, but if a trader was to think about what they are doing logically, as they would any other position, they are simply moving from one asset which fluctuates in value to another.

What facts or situations would force a trader to consider a position in cash being unsafe? Answer that and you might be on the path to understanding the reasons that some investors choose to hold physical Gold.

A reader of my Ritholtz article commented: "Ritholtz essentially supports his analysis by treating fiat currencies as a bedrock, i.e. asset changes are all relative to this unchanging fiat value." I agreed: "Ritholtz claims to be ‘asset class agnostic’, but then measures the performance of other assets back to fiat which doesn’t have static value."

Newsflash: Cash / fiat currency is not a neutral position.

There is no asset which remains absolute in it's price or value relative to everything else (and yes that includes cash or Gold).

I tried to explain this briefly to one trader (Mark Dow) who regularly has a crack at gold bugs on Twitter, to my amusement he suggested that you don't have to hedge against fiat currency because it's "legal tender".

Click Image to Enlarge

How could anyone think that a currency being legal tender protects the holder from changes in it's value?

Sure it's a unit of account and may remain a constant relative to some assets, for example a $10,000 loan will always require $10,000 in cash (+ interest) in order to repay it, but the value of currencies can be affected in various ways, sometimes to devastating effect.

So how does one hedge or insure themselves against fiat currency and the financial system?

This question reminds me of a discussion that took place in the comments on Cullen Roche's site (comments since disabled, but they were here) a couple of months back when he suggested that those wishing to hedge against the financial system should take a short position on the finance sector. 

Imagine taking out insurance against your house burning down and then leaving the only paper work you could use to make a claim inside the very same house.

That is basically what Cullen proposed. Some of the sensible responses below his suggestion included:

“Gold like cash is a unique hedge because unlike options, or bonds or financial hedges it has infinite duration.”

“I have an allocation to gold and silver because its the only way that I can be 100% sure that my “insurance” isn’t someone else’s liability.”

Precious metals are unique in the sense that they are one of few assets which can be held physically outside of the financial system & can't be diluted in the same way as fiat currencies.

Some traders might argue that significant changes in the value of cash occur so infrequently that it's not worth worrying about (tell that to someone living in Russia, Japan, Cyprus, North Korea, Venezuela), but that's exactly the mindset that some of these traders criticise others for, that is, having a baked on view that holding an asset poses no risk. 

Holding a 100% position in any asset is risky, whether that's cash, Gold, Silver, property or anything else. Diversify or be prepared to wear the consequences if the value of that position moves against you.

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BB.

 

Gold Speculator, Investor, Trader, Saver or Gambler?

I recently had an interesting discussion with a few individuals in the comments section of a subscription site (so can’t provide a link) where we argued whether certain members were investing, speculating or trading (based on their strategy) in the precious metals sector.

The word speculator generally has some negative connotations, but I think many in the precious metals space who think they are investing are in fact speculating (myself included, but I’ve never had any issues with that label).

Here are the five labels I would give to those with capital invested in the precious metals space (more than one may apply to each individual):

Precious Metals Trader

The precious metals trader is someone looking for short term opportunity in the market based on chart and other technical indicators which suggest the future price direction of the metal. They might trade short or long on the metal (betting on the price moving lower or higher). They might have a view on the long term prospects for Gold/Silver, but this doesn’t (or at least it shouldn’t) affect their short term decisions. This means when the metals are overbought the trader will either sell short or close their long positions (some may follow the rule “Never short a bull market”).

Precious Metals Saver

The precious metals saver is a regular buyer of Gold &/or Silver. They buy the metals not to speculate on a rising price, but because they choose to hold their savings in ounces instead of dollars. Precious metal savers will generally not concern themselves with the price when they buy, rather they purchase at regular intervals (e.g. every pay day or once a month) and this is referred to as dollar cost averaging. In some cases they are doing so because they believe it will protect their capital from the effects of inflation or some save in Gold/Silver as they believe a new monetary system is likely in the near future and the savings in precious metals will allow them to safely carry their capital from the current monetary system to the next. The precious metals saver might be considered conservative even if they have heavy exposure to precious metals.

Precious Metals Speculator

The precious metals speculator is someone who is heavily exposed to precious metals with the intention of making spectacular gains as the bull market continues. They would have a solid understanding of the market and ensure the fundamentals support their decision. Their heavy exposure means that if something were to change dramatically in the market without warning this could impact the value of their portfolio substantially, a risk they are aware of and prepared for. Unlike the trader they may be prepared to weather significant price corrections with the intention of riding the longer term trend.

Precious Metals Gambler

The precious metals gambler is probably similar to the speculator in many ways; ultimately they are looking for a significant gain in their portfolio, but in attempting to achieve these gains they make poor decisions which might include: using too much leverage, blindly following the actions of a speculator without understanding reason for their choices or buying without knowing their own limits (for example they might buy high without the necessary patience to weather a long correction & sell out at the bottom).

Precious Metals Investor

The precious metals investor is someone who holds Gold/Silver as part of a balanced portfolio (for example they might hold 25% as per Harry Browne’s Permanent Portfolio, with the other 75% held in stocks, cash & bonds, evenly split). They will not be overweight in precious metals and their exposure is likely to be mixed, for example they might hold some physical along with dividend paying Gold & Silver mining stocks. If the goal of the individual is a modest and consistent return over a long period of time (of which the precious metals plays a part) then they are an investor. If they are using precious metals to multiply the value of their portfolio over the short to medium term, then chances are they are a precious metals speculator.

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Several of the above labels may overlap at times. For example the precious metals saver might occasionally trade some Silver for Gold (or visa versa) in order to play the Gold:Silver Ratio (GSR), but ultimately their goal would be to stack more ounces using this strategy (just the same as you might swap from one term deposit account to another with a better rate).

To a degree I would consider myself as having worn the first three hats (Trader, Saver & Speculator) at various times over the last five years.

I have a core position in physical Gold which is unlikely to be sold regardless of the prices we reach over the short to medium term. This core position will be held with the expectation we see a new monetary system at some point (perhaps something similar to Freegold, a concept previously covered on the blog or maybe it will be completely different). I would consider this core position as “savings”.

At times I have sought to benefit from short term moves in the price of Gold and Silver, including when I sold a portion of my Silver between $38 and $46 in early 2011 when I assumed we were nearing a major peak (but held the majority for continued bull market trend).

Primarily though I consider myself a precious metals speculator. I am heavily geared towards a continued rise in precious metals and it should be obvious to most longer term readers that the vehicles I’ve used can be inherently risky (for example junior mining stocks & options). My investment capital is positioned heavily (100% more or less) toward the expectation for a continued rise in the precious metals and while I think there is good reason to expect the bull market will continue, if the environment changes quickly and without warning (for example the US starts raising interest rates and tightening monetary policy) then there is the potential for significant loss.

The above descriptions and definitions are mine only. I have no doubt there are some whose opinion would clash with mine and I would encourage you to speak up in the comments below. Also if you think there is a group who hold precious metals but aren't covered by the above labels I would also value your input.

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BB.