24 July 2014

The Sirens Sweetly Singing

'Free' as in free storage is perhaps a red flag for potential risk, according to Ted Butler as he muses in his latest article, Still Waters Run Deep.

I think there is an obvious and substantial difference between the unallocated metals accounts at Kitco and Perth in terms of 'backing' given that Perth has ties to the government, and Kitco is working through an insolvency.  And Ted rightfully allows for that.  

But considering the matter from another related angle,  I would think that one's investment choices should flow from one's reasoning and objectives in the first place.

If you want to own gold and silver for protection and 'insurance' in unusual and even catastrophic six sigma financial events, unallocated storage is a less expensive but weaker way to do it, unless you are content with the risk of a forced cash settlement and/or a possible loss of capital depending on who is holding your counterparty risk.   If you are content, then no worries.

On the other hand, if you are buying gold and silver for a short term trade or some other reason, then the lower cost alternative might be very logical and just the thing, if not perhaps to everyone's taste.

What brought this to mind was a discussion I had the other day with a very nice fellow who is playing the short to intermediate swings in silver, trading in and out.   He does this by buying and selling at a coin shop. 

He was complaining that now that he wishes to buy back in to silver, that they are demanding a twenty-five percent premium and he would like to get back in.  I suggested that if he was just trading the metals, there could be much lower cost alternatives with much narrower premiums, such as the various precious metals funds. 

He said, and I quote, "I prefer to hold my bullion closely." 

And of course I can understand that sentiment under some conditions, but then I would wonder, what is the real objective here?  Is it for insurance, or for short term profits or what?  

If one is trading gold and silver on even an intermediate term, the spreads (difference between buy and sell) that one obtains by buying metal at coin shops would represent a fairly significant transactional friction for those trades. Not to mention the other associated costs of this method, versus just buying a position in some reasonably sound fund that may even offer the option of physical delivery, of which there are some that appear to be reasonable.

In other words, if you are just trading, why care if you are actually holding the metal, and especially in one of its more expensive forms?

I would not presume to judge what a person chooses to do with their trading money. But I would like to point out that being consistent in your goals and your methods is quite important if you wish to have any chance of being successful at it. 

And you do not need to commit to one or the other approach either.  It used to confuse my conventional brokers, back when I still had them, that I could take some high beta short term trades in one account, and then take longer and much more conservative trades in another, and be very adamant about not diverting from either one.

They were failing to accept that there was a rather obvious reason for having two different accounts, and that one could have different money amounts and very different objectives in each!  But it did not make sense to those who think that there should be just one optimal solution and you should put everything on that, and all your effort should be concentrated in being 'right.'  If I had listened to this nice young man, I would have gone down in flames with his other clients in the tech market crash of 2001.  And probably 2008 for that matter.  

The concession to portfolio theory was to buy some lower beta stocks and 'diversification by stock sector.'  The snare is that it pays off, and sometimes very well, in long bull equity markets such as we have recently enjoyed. 

It is in times of change and trend that otherwise well-intentioned but forgetful people fail to be fully aware to the changing market context, and get lulled into overly directional trades by false stability of returns.  And they can take some rather big hits on those excessively directional bets. 

This not only holds true for stocks but for bonds and commodities as well.  But I have never seen the 'buy and hold' no matter what mentality more generally expressed as sound advice in stocks, backed up by adjusted numbers from stock indices that change their own composition quite regularly.

When people start believing that stocks can only go up, it might be time to start considering your portfolios structure in light of rougher seas ahead, the Fed's promises of oceans of liquidity notwithstanding, and the barbarism of doubting their omnipotence. 

I will and can never claim true knowledge of the future, and I have never found anyone or any 'system' that can.  Besides betting on a sure thing, which requires quite a bit of money and control of the exchange rules in order to gain an unfair advantage, the markets maintain their elements of risk and uncertainty, sometimes more so than others, particularly at the extremes.

How many times has the Federal Reserve and their Banks failed to avert crisis in the past twenty years?  Not hardly enough, and too often they seem to be near the center of them, especially since the repeal of Glass-Steagall.  

As you know,  I think that the Banks need to be restrained and brought back into balance as utilitarian functions in support of the real economy, and that the Fed needs to find another solution other than top down monetary stimulus.  And the Government needs to be reminded of its responsibilities and purposes.

But given the allure of hot money, and the sirens of wealth sweetly singing, we are more likely heading for the rocks, again.

Note: A reader informs me that Perth Mint no longer offers unallocated accounts since 2011, and instead offers 'pooled accounts.'  As in all such situations you should familiarize yourself with the particulars and make a judgement whether this conforms to your objectives, which was one of the primary messages of this writeup. 
"I reported last week of recently discovering that Kitco Metals, which is currently in the process of an insolvency reorganization, holds $260 million in precious metals pool accounts (mostly gold and silver) for clients. I found this disturbing since the ultimate backing to a precious metals pool account is the financial strength of the issuer because the metal backing the pool accounts is not specifically identified...

It’s no wonder the offer of free storage has been responsible for the immense popularity of the Perth Mint’s unallocated silver certificate program. After all, what’s better than free? But it is also true that a prudent person should beware of anything if it seemed to be too good to be true. That, in a nutshell, is at the core of my longstanding distrust of silver pool and unallocated accounts, including Kitco’s and that of the Perth Mint. In other words, the most likely explanation for why and how no storage fees are charged is because no metal (or not enough metal) is being stored and set aside for customers holding pool or unallocated accounts."

She rides the frothing ocean waves,
Upon a crimson shell,
Her skin is of the milk white reef,
Her breasts, the ocean's swell.
In her eyes behold the fathoms of the deep.

Aphrodite of the shifting seas,
and of the languid bays,
Riding with her dolphin band,
Across the sea-skipped waves.
Aphrodite from the depths where dark things sleep.