Earlier this week, I attended the Gold Symposium in Luna Park in Sydney. All in all, it was a great couple of days, with great keynote speakers. The final session was Q&A with a panel that included Eric Sprott, John Embry, Ben Davies and Egon von Greyerz. Anyway, there were a couple a questions that were posed to the panel that I don't think they did a great job of answering, and with the benefit of contemplation time, and a text editor, I'd thought I'd give them a shot.
Question 1: If I had invested 1 ounce of gold into the equity market 100 years ago, today it would be worth 1400 ounces (or whatever), yet if I had kept it as gold, it would still only be 1 ounce. So, why should I buy physical gold?
My answer to this is three fold:
Firstly, you are comparing invested capital with non-invested capital. Necessarily therefore, you are comparing capital that has been put at risk with capital that has not been put at risk. It is hardly surprising that capital that has been invested at risk outperforms capital that has not, otherwise, why would capital ever be put at risk?
Secondly, you are using a stock market index based growth model, which necessarily has survivor-ship bias. As each equity that was in the index went bankrupt, it was replaced by the next biggest equity just outside the index, and the index lived on happily ever after. Let me put it this way. Exactly which set of equities would you have invested in 100 years ago that are still in business today and still in the index today?
Thirdly, the point of the question - that equities outperform gold over the long term - is correct. The question is, on the eve of a depression, how long do you have to wait for that to become true, and how better off will you be if you time your swap from gold to equities near the end of the depression, rather than on the eve.
Question 2: How high will the price of gold go?
The panelists, who all believe in the inevitability of hyper-inflation, rightfully were reluctant to give a specific figure, but didn't have a great explanation as to why. Here's my take.
If you are still asking "how high can gold go?" you are still thinking with a trader's mindset, and you simply don't get what is about to happen.
If you view gold as a life boat, and fiat currencies as sinking boats, the question as to how far under water the sinking boat has to be before you jump off your life boat and back into the sinking boat is a silly one.
Can you not see that one boat is sinking to the bottom of the sea and the other is not?
My 2c..
*** Update 13 Dec 2011 ***
There was another question often asked during the conference - which was "How much gold should I own?". I've had a stab an answering that one in my post on asset allocation and gold.
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Hi DI,
ReplyDeleteI was also at the conference but unfortunately wasn't able to stay for the panel interview.
Your answer to question 1 is comprehensive and a strong one, well done.
In relation to the second, I would have thought that the answer would be because gold is money. Any pricing of gold in fiat money isn't really helpful because as fiat currencies lose value, there is really no limit to how high gold can go. It's like 1/x - as x approaches 0, the function (gold price) can theoretically go to infinity.
I think it would possibly make more sense to ask how high gold can go not in money, but in goods - how much oil or corn or sugar or whatever can gold buy? Because that's what a money is - a medium of exchange.
Also, I don't think holding physical gold means you will be necessarily better off in an absolute sense. You will be better off cf someone holding fiat currencies, but the purpose of gold is to preserve your value, not to augment it. Accordingly, it may be that 1oz AU 100 years ago bought you 10 barrels of oil, and now, it still buys you 10 barrels of oil. If that was the case, gold's held its value and done its job, if more USD/AUD/fiats are required to purchase equivalent amounts of oil/goods over time.
Does that sort of explain why it's hard to price gold?
Also, I'd be interested in what you thought about Alf's speech.
Hi there. Yes I agree with you.
ReplyDeleteI guess I was trying to get to the "you've missed the point" point. Many people still think that they'll be swapping their gold back to fiat at some point - hence the 'When do I sell?' question. Now, this may be the case for silver, but I don't think that it will be for gold.
Regarding Alf Field's speech - I thought that it was entertaining - but really only ok. His personal stories were interesting, but ultimately I found it disappointing that an "odds and probabilities" attached any significance to the "gold will rise" prophecy.
ReplyDeleteI'm also a bit skeptical of the Elliot Wave theory, given that he had no understanding of why it worked, nor could he see that it didn't work until he changed the rules - ie. wave 5 parts I, II & III.
If he had created some sort of model to explain the patterns, eg, using agents with a) margin loans b) an exponential price variance, and c) profit taking - and it made accurate predictions - then I would have been impressed.
Having said all that, I did enjoy it.
Agree with both your comments. I have no understanding of the Elliot wave and I didn't feel very much enlightened about it after his speech.
ReplyDeleteIt seemed like that there were the main rules and then exceptions for every time the gold price didn't fit the rules... Really doesn't say much about its predictive power.
Anyway, thanks for the comments. I notice that a lot of the people you read and many of your investing interests are very similar to mine, so I'll be following your blog. Keep up the good work!
Thanks & cheers.
ReplyDeleteSurvivorship Bias
ReplyDeleteI think your comments about gold are insightful (I almost wrote inciteful :) and pretty much correct.
A question though, about survivorship bias:
If share-market entity X is delisted (due to bankruptcy, or any other mechanism), what happens to the index?
If there are 1000 listed companies, and company X (which has a 0.1% value of
the total share market), is suddenly delisted, does the index go down by 0.1%?
If this is the case, then there is no survivorship bias.
If you go back in time and buy $10,000.00 of assorted stocks, and then (as some
of them become worthless/delisted), continue to gently diversify into other
stocks then how much money do you have when you time-machine back to 2011?
It should be possible to base an 'index' on this figure.
So how does the All Ordinaries or ASX-500 actually work?
Good question.
ReplyDeleteNote that the Dow Jones Industrial Average only has 30 companies that make up the index, but does have a dynamic fudge factor to adjust for: (From Wikipedia:) stock splits, spinoffs or similar structural changes, to ensure that such events do not in themselves alter the numerical value of the DJIA
Another wikipedia quote:
The original group of 12 stocks ultimately chosen to form the Dow Jones Industrial Average did not contain any railroad stocks, but purely industrial stocks. Of these, only General Electric currently remains part of that index
So, I really don't know for sure - but do suspect that it is suspect..