Gold Fear, Gold Fever

Jeff  Carter
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Posted: Sep 27, 2011 12:01 AM

Gold ($GLD, $GC_F) is off over $11 today after getting routed last week. Silver ($SLV, $SI_F) is also moving lower. When metals move, generally silver moves several times faster than gold. It’s whippier.

Since 2000, many have plowed a lot of money into gold. As fear crept through the economy post 9/11, and post Fannie/Freddie crisis of 2007-08, the velocity of money ran into all commodities. Fear is a powerful motivator.

You are now seeing a different kind of fear.

The conventional wisdom from salesmen on the street were that commodities were a new “asset class”. Let’s follow their logic. Are commodities measurable assets that one can list on a balance sheet? You betcha. Do they have daily price fluctuations? You betcha. Is there a liquid and ready market for them? You betcha. Hey, we can create a bunch of ETFs and make a lot of money for ourselves selling these things. You can hear the boys in the boiler rooms sharpening their pencils.

That faulty logic leapt from things like gold, and silver and extended itself to other commodities like oil ($CL_F) and grain ($ZC_F, $ZW_F, $ZS_F). I’d be walking down the street listening to people talking about grain prices and crop reports like they were Farmer Brown talking to the grain elevator operator.

What these “investors” are finding out is that the door to get out of the commodity room is a lot smaller than the door that lets you in.

This brings up a point that I want to drive home. Commodities are assets, but unlike fixed assets, they are more like inventory. The value of a companies inventory can be it’s most volatile asset. When you invest in the stock of a company, you are investing in its entire book of assets, and the performance a company can derive out of them. When you pick a commodity, you are picking one piece out of a company’s total asset pie, and placing a calculated bet that the asset will perform. It’s a lot different, and your rate of return should be different too. You are assuming more risk.

Commodity markets are deep and liquid. They are the most transparent markets in the world. They don’t exist for asset performance or capital raising like equities. They are there for risk management-hedging. It’s a key and very important difference. The function of the commodity marketplace also should tell people that they need to be regulated in a different manner than cash equities. Sure, there are prices, bids, offers, volume and money changes hands. But, that’s where the similarity ends.

Buying gold out of “inflation fear” or the “world coming to an end fear” is not a reason to be in the gold market. It’s especially dumb to be buying an ETF that is simply a piece of paper. What’s the difference between the ETF and the “fiat currency” gold bugs love to deride? At least if you trade the actual future you can take delivery and own the stuff.

I don’t mean to say you shouldn’t trade commodities. You can. The playing field in commodities is a lot fairer than the playing field in the SEC regulated marketplace. But you ought to realize what you are really trading, and why the markets exist in the first place. It makes a difference in strategy.

UPDATE

If you are a gold bull, ask yourself this question? Is the world in any different situation it was one week ago? If it’s not, or it’s worse, why is gold imploding?
SPDR Gold Trust ETF Price Stock Chart


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