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Post Investing in Gold
Created by John Eipper on 06/12/17 1:50 PM

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Investing in Gold (Tor Guimaraes, USA, 06/12/17 1:50 pm)

When it comes to economics and finance my friend Ric Mauricio (11 June) and I justifiably belong to a mutual admiration society. We are mostly in agreement, which is good for a change in this contentious world.

Regarding the love-hate relationship between asset prices and inflation, the Brazilian experience may be an excellent source on what to do about massive and prolonged inflation.  It is an incredible world: first thing to do is to keep as little cash as possible and owe as much as possible in the local currency. As soon as you get income (like your paycheck) buy something you need like food and other things whose price change every day. Yes, everyday prices can go up under heavy inflation that we Americans never experienced before, but which might be coming someday soon.

How about gold and the US dollar? As the Fed raises rates to control inflation, the value of the dollar should go up and gold should go down, but not yet. That will happen, but remember Keynes' most relevant wisdom: the market can behave irrationally longer than you can remain solvent. Another important consideration:  If gold turns you on is how do you buy it?  Bullion (where to store it?), collector coins (too risky and only if you know the gold market and the collectors' market), gold ETFs, gold producers' stocks, or gold producers ETFs?

Like Ric, I know financial institutions do well by ripping their clients off routinely. Wall Street is just like Las Vegas but with crooked games. So I don't trust any brokers or any company stocks unless they crash and I know why. Most important, if you can figure out how the game is crooked, you can make money with the house. In Las Vegas most games are not crooked, but you will lose in the long term because the odds legitimately favor the house, and you must play against it.

I like to play with C-4 and dynamite so I trade with ETFs, including gold producers ETF like NUGT and DUST. GLD is too boring for me. But before you invest your retirement in NUGT or DUST, look at their 5-year chart. That is right, they both look like dog doo. They are supposedly inverse ETFs in the short term (daily or weekly), but you could have made a fortune over the last 5 years had you shorted both of them. I bet my friend Ric is going to love this insight and will know what to do with their options. The rest of you should diversify your asset portfolio and try to beat the S&P.

JE comments:  In a nutshell, diversify!  (Oops, I said that already, but here's an aside to Big Brother:  Tor Guimaraes was speaking metaphorically about the C-4 and dynamite.)

Short of wartime or the total collapse of an economy, is gold ever a good investment?

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  • Investing in Gold ETFs (Jordi Molins, Spain 06/13/17 2:17 AM)
    In response to Tor Guimaraes (12 June), NUGT and DUST are ETFs that invest in gold mines--leveraged three times on a daily basis, long and short, respectively.

    Due to the daily basis leverage, NUGT and DUST are both statistically guaranteed to lose 100% of their value in the long term. NUGT and DUST only should be used on the very short term, when the trader is convinced that a trend for the underlying index is existing, and the market will go up (or down, respectively) all the time.

    Unfortunately, it is not possible in practice to short NUGT or DUST.

    Any investor should do better by diversifying. Unfortunately, most investors suffer from a massive home bias. For example, most US investors are under-invested in Frontier Markets.

    JE comments:  DUST:  what your money turns into?  How about these ETFs--SMOK and MIRRS? 

    An investment question for Jordi:  what's the point of a fund that goes both long and short on a specific sector?  Isn't this an exercise in futility?

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    • Ric Mauricio on Gold Investment (John Eipper, USA 06/13/17 12:07 PM)

      Ric Mauricio writes:

      When Tor Guimaraes (13 June) mentioned that he likes to play with C4 and dynamite with the ETFs DUST and NUGT, I chuckled to myself that Tor was having fun with us. And as Jordi Molins pointed out in response, it is as close to a guaranteed return as you can get. A guaranteed loss for an investor; a guaranteed gain for ETF creator Direxion. Yes, one must be able to time and predict the direction of gold on a daily basis (there are similar ETFs for other commodities, such as oil). As Clint Eastwood would say, "Do you feel lucky today?" But the long-term play on these ETFs is absolutely not there, due to contango, which is the rolling over of futures contracts that these ETFs hold.

      When I mentioned commodities or gold as an asset allocation class, the GLD ETF was mentioned, but as Tor pointed, on a 5-year term basis, it is not quite a good investment. But check out the gold royalty and streaming companies. An excellent return with less volatility over the 5 year (I like to look at a 10-year return since that period includes both bull and bear markets). As usual, one should do their research when investing.

      And I am sure that someone will ask the question, which company is that?

      JE comments:  OK Ric, I'll ask--got a tip?  "Contango" for a Humanist (and a Latin Americanist to boot) sounds like a type of dance.  So I'll let the experts explain it (see below), but my understanding of contango is the money you pay to postpone the settlement of a futures contract.  This is why the investment will eventually disappear.  And yes, it takes two to contango.


      Cameron Sawyer also wrote to describe gold as a dead asset, with no intrinsic value and no income.  He adds that investing in gold is to bet against (short) the entire aggregate economy.  And sometimes this play works.  (In the meantime, you can send your cumbersome gold to WAISworld, c/o John Eipper, Goldsmith Hall, Adrian College, Adrian Michigan 49221 USA...)

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      • A Stock Tip from Ric Mauricio (John Eipper, USA 06/15/17 10:41 AM)

        Ric Mauricio answers the unanswered question from his last post:

        JE asked for my stock tip with regards to commodity (specifically gold) investing. Here is my favorite: Franco Nevada. Symbol: FNV. FNV has been around a long time, but it was taken private, then offered to the public again in October 2008. So how has it done? Since 2009, the total return has been 23% per year. Compare this to GLD, the gold ETF, which in the same period has a total return of 5% per year.

        My current allocation in my portfolio to this asset class is 5% and yes, it can be volatile. It had a drawdown of 27.5% in 2013, which, of course, provided us with an opportunity to buy it on sale.

        JE comments:  Thanks, Ric!  You've found a stock worth its weight in gold.  I'm going to reflect on "drawdown" as one of the euphemisms of our age.  Unpleasant, but gently so.

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    • How Do You Make Money with Gold ETFs? (Tor Guimaraes, USA 06/15/17 3:08 AM)
      Jordi Molins's post of June 13th is totally correct except for one statement: "It is not possible in practice to short NUGT or DUST." I know that Jordi has much experience with derivatives (options in particular), so I must assume he is speaking about the traditional way of shorting: borrow shares, sell when the price is high and buy back when the price comes down.

      Similarly, commenting on NUGT and DUST, Ric Mauricio stated, "[they are] as close to a guaranteed return as you can get. A guaranteed loss for an investor; a guaranteed gain for ETF creator Direxion. ... the long-term play on these ETFs is absolutely not there." I respectfully disagree.

      Remember what I said earlier, "Wall Street is just like Las Vegas but with crooked games... Most important, if you can figure out how the game is crooked, you can make money with the house." In practice, there are many ways to short both NUGT and DUST using options. Theoretically the simplest way would be to sell calls way out of the money on both ETFs. In practice you better take some precautions, i.e. look at the yearly charts and sell the calls on the ETF whose share price is high on the cycle and wait to sell calls on the inverse ETF when it is high. I like combinations of call spreads which are bullish in the money and increasingly bearish going out of the money, including selling naked calls at the high end. Needless to say, patience and timing are important. Also remember the wisdom "pigs get slaughtered."

      JE comments:  Perhaps we should take a step back and ask for a primer on calls--especially when they're naked.  Tor?  Ric Mauricio could also explain this splendidly to us layfolks.

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      • Naked Options Explained; from Ric Mauricio (John Eipper, USA 06/16/17 12:43 AM)

        Ric Mauricio writes:

        Ah, does being naked with options mean that you are an exhibitionist? Well, yes, it does. Being naked means you are exposed. But first, let's clarify one disagreement that Tor Guimaraes had with my comment. Tor, if you noticed, I said "long term." This means that holding the Direxion NUGT or DUST cannot be held for a long term without contango eroding the play. I believe your Las Vegas comparison would be more apt if NUGT or DUST were traded short term, which is what they were designed for anyway, but I found many investors don't understand this. And yes, Tor, I believe Jordi Molins was thinking the traditional shorting technique.  Put options are available on NUGT and DUST, but they are rather expensive.

        But back to being naked. Options could be classified as a call or a put. A call is a contract to sell a stock at a higher price. A put is a contract to sell a stock at a lower price. The most common option utilized is a covered call. A covered call is when one owns a stock and writes (sells) a contract (call) to sell it at a higher price than today's price. If it gets to that price (or a little higher), then the contract (call) buyer buys your stock at that higher price. If it doesn't, the writer of the contract (call) keeps his/her stock and the premium that the call buyer paid the investor because it doesn't makes sense for the call writer to buy your stock at a higher price. OK, now if you wrote a "naked" call, you would be exposed to the extent of the difference between today's price and the contract (call) price because you don't own the stock on which the contract was written. If the stock goes beyond the call price, the exposure is even more indecent (ha ha) because you would have to buy the stock to be able to sell it to the call buyer (contract holder).

        Now puts are interesting. I like being naked in puts. A naked put is a contract that is written to buy a stock at a lower price. If the stock price goes lower to the put price, then you buy that stock at that price. The nice thing about this is that it is very similar to putting an order to buy a stock at a lower price, but with a naked put, you get paid while waiting. And if the price does not go to that lower price, you keep the premium you collected.

        By the way, talking about Las Vegas, option buyers (and I emphasize buyers) statistically lose 90% of the time. And since there is a zero-sum game with options, in other words, to have a buyer, there must be a seller, that means option sellers make money 90% of the time. I like those odds. Better than Vegas. Oh wait, does that mean we can harvest profits from selling put options on DUST or NUGT?  I recommend that one write put options only on those stocks that one wants to own in the first place. And I don't want to own DUST or NUGT.

        JE comments:   I think I understand.  In any case, JE is a simple "buy and hold" kind of guy.  And what am I long on?  Remember this symbol:  WAIS.  The dividends are priceless.

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        • Gold ETFs, Again (Tor Guimaraes, USA 06/21/17 8:31 AM)

          Ric Mauricio stated on June 16th, "I believe [Tor's] Las Vegas comparison would be more apt if NUGT or DUST were traded short term, which is what they were designed for anyway, but I found many investors don't understand this."

          I believe Ric may have missed my point.

          If one looks at NUGT's 5-year chart for example, the share price went steadily down (relatively little fluctuation) from $7,584 (high) to a low of around $20. The 1-year chart high was around $136. And everyone seems to agree that going up long term is not likely, even though NUGT and DUST are promised to be inverse ETF's in the short run. The charts for DUST look not as bad, but bad enough for meaningful long-term bear trading.

          If we know all that then let's do some possible DUST plays right now for examples:

          The DUST share price now is around $31. Sell the DUST January 2018 at $70. Calls for $2.40 per share and sit on them for the next 7 months. Likelihood that the price will get to $70 by next January is practically zero. If you like more adrenaline, short the $45 calls for more money and risk.

          We can make things much safer by combining this play with a January 2018 call spread (I. e. buy the $20 calls and sell the $35 calls).

          We can do similar plays using NUGT shares, now that it has recently reverse split.

          That is what I had in mind when I said, ""Wall Street is just like Las Vegas but with crooked games. ... Most important, if you can figure out how the game is crooked, you can make money with the house." It is somewhat sneaky for the average guy for Direxion to sell NUGT and DUST as inverse ETFs, since they both go only down in the long term.

          JE comments:  Are you (also) confused about inverse ETFs?  Click below for an explanation from Investopedia.  To my mind, they look like formulas for losing lots of money--especially if an economy booms.

          Aren't the transactions outlined above zero-sum games, meaning, you have to find a transaction partner willing to bet the other way?


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