Gold is all the rage again, but you shouldn’t expect a trade write-up from me anytime soon. It’s not the kind of trade I like to play. The reason is that it isn’t an investment, so much as the expression of a narrative. It’s treated differently than any other investment vehicle, but without any evidence that it should be. In the last few weeks, quite a few clients have become enamored with it. Rather than try to talk them out of it, my goal is to make sure they see it for what it really is, rather than what they want it to be. In doing so, they improve their odds of turning a profit on the idea, because it allows them to create a trading plan that matches their expectations. It’s not easy to do though, for it requires serious cognitive strain. Allow me to explain.
One client is working on his Global View Log. In it, he details his view of the world from the very highest level, covering all of the beliefs he holds with great conviction, along with the evidence to support them. He lists the signals that, if they were to come true, would indicate to him that his view is either no longer valid or has become seriously compromised. Finally, he provides a list of Winners and Losers in the world he has described. In 3 of the 5 key themes, he listed gold as a winner.
The first is under “Weak Global GDP Growth”, where he reasons that weak GDP growth will lead to the only true solution, central bank funded fiscal stimulus. The second is under “Global Disinflation”. He believes that disinflation will lead to defaults, and again, central bank funded fiscal stimulus. I happen to agree with both views. However, my job is not to tell him whether he is right or wrong, but rather to be sure he is consistent with himself. That is why I had difficulty with his rationale. You see, right below the list of winners in each of these themes, he had assets he deems to be “Losers”, such as equities, inflation linked bonds, commodities and emerging markets. The reason he considers them losers is that the characteristics of these themes are not conducive to growth in those assets. What makes gold inconsistent is that his argument for deeming it a winner is not a continuation of the theme, but the end of it. On the other hand, his argument for the losers is a continuation of the theme. If they were treated in the same way, gold would be listed as a loser. After all, weak growth and disinflation are hardly arguments in favor of higher gold. Therefore, there must be something else to it.
Based on my discussions with others who are bullish gold, both now and the last time around, that “something else” is that all fiat currencies are being theoretically devalued by global monetary policy. Makes sense, but if that were the case for fiat currencies across the board, we would expect to be dealing with serious inflation consequences including higher commodity prices. As you know, we are not. Conceptually, it’s difficult to get our heads around the lack of ramifications from negative rates and helicopter-type policies. At the same time, when analyzing commodity prices in isolation, it’s understandable that they should be going down, even when priced in those fiat currencies, because they are driven by the laws of actual supply versus actual demand.
Then how do we express this deeply held belief that someone, somehow must be held accountable for the policy actions that are clearly diminishing the value of those currencies as legal tender? What we need is an asset that has no real growth in supply and no natural demand as an input for something else, like say oil, or wheat. Optimally that asset would be globally recognized as a currency in its own right, a barometer by which everything else is measured. Rather than it fluctuating in value, everything else would fluctuate around it. Enter, gold, a store of value, exchangeable for anything and everything. It is fungible. It gives life to nothing, except value itself. As one client said to me, “gold is the same as money.” But is it?
Gold’s value is set according to its dollar value, not the other way around. If you wanted to transact with it, say by going into a car dealership to purchase a new Tesla, the dealer would convert gold into dollars (and possibly the local currency from there). Presumably, they would charge an additional fee to cover the expense of converting that gold into cash for deposit in their account. In converting gold holdings back to US dollars in order to conduct a transaction, you are vulnerable to fluctuations in its value, just like every other asset in the world. However, this “money” fluctuates a whole lot more than most other assets, and not just in one direction (see chart). US Dollars, on the other hand, effectively fluctuate in value by the rate of inflation. Now, you might argue that that is what you’re betting on. That inflation is going to skyrocket. Understood. Among the questions that should be asked, as they are for all investments, are, “how do you know when you’re wrong?” and “when do you take profit?”. If you can’t define those, then how do you know if it offers attractive risk/reward? Could it take ten, fifteen, fifty years or even longer for this to pay off? What kind of drawdown are you prepared to experience in the meantime? Since gold has value solely because the collective believe it has value, what differentiates it from the beads accepted by the Lenape tribe in exchange for Manhattan or the cigarettes accepted as currency in prisons across America? You might argue than I am getting too deep in the weeds, thinking too deeply about the gold trade. It’s simply a “buy and hold” trade. I agree. So long as you have no risk limits, high water marks, speed bumps or stop-losses to worry about. However, if you do manage money for someone other than yourself, I would suggest getting down in the weeds with me. Be honest with yourself about why you have it on. Make sure your plan is consistent with your mandate, because p&l is p&l, whether its driven by gold or any of the other assets you use to express a view.
Here’s the thing about big contrarian calls like this one. People tend to become attached to them. For many, it’s difficult to simply walk away, to stop talking and thinking about it, for it is the narrative to which they become attached. Narratives can morph if they aren’t pre-scripted, making it difficult to know when they end. However, if you treat it as simply another expression of a view, one with gradually diminishing risk/reward attractiveness, with specific and finite expectations, it is easy to leave it behind when they are triggered.
Social Unrest For more than a decade, experts in the developed world have been predicting large-scale social unrest that would lead to a shift in power with far reaching implications for the economy. Thing is, those predictions were for China. Interestingly, it’s actually playing out in the experts’ own backyards (US and UK). This is important, because it’s evidence of the global nature of the issues we are facing, and the lack of acknowledgment that we are all vulnerable.
Down Goes #1 The big news out of Wimbledon this week is that Novak Djokovic, the #1 ranked men’s tennis player in the world, was knocked out by Sam Querrey in the third round. It was quite a shock. After all, not only is Novak ranked #1, but for years now, he has been winning 90% of the matches in which he plays. Novak’s career stats when playing against Sam Querrey are better than his overall average, and he’s beaten him 7 out of the 8 times they’ve met in match play. All of which explains why everyone is so shocked.
Now, instead of looking solely at match results, let’s consider each of these players individually. It turns out, Querrey, the 44th best men’s tennis player in the world, is actually pretty good. In fact, he’s quite close to Novak when you drill down to individual points.
Turns out, it doesn’t take a huge adjustment to turn a loss into a win, or even 7 out of 8 losses into 7 out of 8 wins.
About the Author For nearly thirty years, Stephen Duneier has applied cognitive science to investment and business management. The result has been the turnaround of numerous institutional trading businesses, career best returns for experienced portfolio managers who have adopted his methods, the development of a $1.25 billion dollar hedge fund and 20.3% average annualized returns as a global macro portfolio manager.
Mr. Duneier teaches graduate courses on Decision Analysis and Behavioral Investing in the College of Engineering at the University of California.
Through Bija Advisors' coaching, workshops and publications, he helps the world's most successful and experienced investment managers improve performance by applying proven, proprietary decision-making methods to their own processes.
Stephen Duneier was formerly Global Head of Currency Option Trading at Bank of America, Managing Director in charge of Emerging Markets at AIG International and founding partner of award winning hedge funds, Grant Capital Partners and Bija Capital Management. As a speaker, Stephen has delivered informative and inspirational talks to audiences around the world for more than 20 years on topics including global macro economic themes, how cognitive science can improve performance and the keys to living a more deliberate life. Each is delivered via highly entertaining stories that inevitably lead to further conversation, and ultimately, better results.
His artwork has been featured in international publications and on television programs around the world, is represented by the renowned gallery, Sullivan Goss and earned him more than 50,000 followers across social media. As Commissioner of the League of Professional Educators, Duneier is using cognitive science to alter the landscape of American K-12 education. He received his master's degree in finance and economics from New York University's Stern School of Business.
Bija Advisors LLC In publishing research, Bija Advisors LLC is not soliciting any action based upon it. Bija Advisors LLC’s publications contain material based upon publicly available information, obtained from sources that we consider reliable. However, Bija Advisors LLC does not represent that it is accurate and it should not be relied on as such. Opinions expressed are current opinions as of the date appearing on Bija Advisors LLC’s publications only. All forecasts and statements about the future, even if presented as fact, should be treated as judgments, and neither Bija Advisors LLC nor its partners can be held responsible for any failure of those judgments to prove accurate. It should be assumed that, from time to time, Bija Advisors LLC and its partners will hold investments in securities and other positions, in equity, bond, currency and commodities markets, from which they will benefit if the forecasts and judgments about the future presented in this document do prove to be accurate. Bija Advisors LLC is not liable for any loss or damage resulting from the use of its product.