Let me get my disclosure statement out of the way first: I do not own any gold, nor have I done for quite a few months. I confess to being somewhat biased where the precious metal is concerned. Some might accuse me of smugness in regard to the recent sell-off, but this goes too far. In fact, the recent gold crash has left me feeling very troubled. This is largely because none of the experts seem to have any explanation for the extraordinary selling orgy apart from the usual throwaway arguments.
10 April 2013. FRANKFURT (Börse Frankfurt). A perennial market discussion about the prospects for a major sell-off in the German equity market was re-inflamed last week. Stock prices slid to new lows for the year last Friday ahead of the publication of the disappointing US nonfarm payroll numbers – an anomaly some market commentators attributed to the figures being leaked in advance. It was remarkable, nonetheless, that the German benchmark index suffered more heavily under the tepid American employment growth than the US equivalents.
Research by Alok Kumar at the McCombs School of Business shows that investors’ age, location, and interest in activities like gambling have a larger impact on investment behavior than investors’ perceived preferences. In the past, it was believed that so-called irrational behavior of individual investors cancelled out when the market was considered in the aggregate, but according to Kumar, “those derivations from expected behavior are not random, but systematic. Many individuals make similar mistakes at the same time, and thus the effect of those mistakes is amplified.”
It’s the end of the quarter and it has not been a good one for issuers of gold ETFs. Since the start of the year total holdings, as measured by Reuters, has slumped at an unprecedented rate. For the ETF providers, who earn fees based on the amount of gold they hold on behalf of investors, this represents a sizeable loss of income, not just relative to what they earned before but also (and more importantly) relative to what they thought they would be earning.
It makes intuitive sense that the way people feel about something should dictate the way they behave—that our preferences and convictions are faithfully reflected in the choices we actually make. Although this seems a reasonable assumption, recent research in psychology and behavioral finance suggests otherwise.
International investors are fleeing former financial safe-havens in huge numbers this year. Compare this to 2012, when fears of a Greek departure from the eurozone prompted its well-heeled nationals shift their wealth into more economically-sound destinations within the zone, like, Germany, Austria and Finland or, better still, into non-eurozone countries like Switzerland and the UK.
I was recently asked for my thoughts on ‘Wine as an Asset Class” in a TV interview recently. The interviewer knew I was a Bordeaux enthusiast and was keen to know how I gauged the prospects for this ‘most illiquid of liquid assets’ in the aftermath of the roaring bull market for top Bordeaux and Burgundy crus in the years prior to mid-2011. Although I follow the developments in the Live-ex Fine Wine 100 index, I do not actually buy wines with the intention of selling them at a higher price sometime in the future.
When I heard that Vattenfall, the energy group, had decided to wind up its pension foundation and to invest the proceeds, the equivalent of a billion dollars, into its own business, I was almost deafened by the ringing of mental alarm bells.
Mark Zuckerberg, Bill Gates, George Soros, Larry Page, Sergei Brin – I could go on with this list of people who became super-rich by putting all their proverbial eggs in one basket. There is no doubt about it: to achieve extreme monetary outcomes, one has to accept extreme gambles. Portfolio diversification in the spirit of Harry Markowitz is alright for those who are content with middle-of-the-road returns – one will probably not go broke (at least, no sooner than everyone else) if one’s capital is spread across a variety of asset classes, sectors and geographical regions. However, with diversification, one’s investment returns are also unlikely to excel.
Markowitz-ian portfolio diversification really does work, if one has a long time horizon and one is patient. That, at least is the opinion of David Swensen, the Yale Endowment Fund manager. Professor Swensen is a known fan of broad risk diversification in the spirit of the Nobel Prize winner, but had to take a lot of flak in the wake of the financial crisis when he discovered what can happen when many professional investors around the globe follow precisely the same schema. The popular appeal of a broad diversification in supposedly unrelated asset classes (in many cases purchased with borrowed money) meant that previously uncorrelated assets became highly correlated when the crunch came.
When I learned recently that you actually had to pay to lend the German government money for two years, I couldn’t help but wonder what my late mother-in-law would have said. In the last years of her life, rest her soul, she complained how little pocket money she had because of the low yields on her savings, wholly invested in German Bunds. Back then, at least, the average coupon on the bonds in her portfolio was around four per cent, so she could still afford the odd indulgence. And this is precisely how she saw the income that flowed each time she cut a coupon, as income that she could use to treat herself to something nice. It wasn’t like income from other sources, or even like the capital that begat the coupon. This money was segregated from the others in her head – in a so-called mental account.
Financial incentives are a powerful force. It can encourage the brightest minds to embark on entrepreneurial ventures, persuade high-school students to further their education, or prompt to pre-grad college students to drop-out. However in the financial services industry, money incentives have repeatedly revealed negative aspects. The bonus culture has come under increasingly negative scrutiny in recent years as it seems to have encouraged bank employees to prioritize their personal gain over that of the firm or that of society in general.
A personal investment in a fund increases the fund managers’ psychological commitment to the investment decision. Commitment is not be confused with conviction. Unlike the latter, the former is rarely a good thing. Commitment can be thought of as the psychological glue that binds decision-makers to their decisions. When you hear someone described as being ‘married to their position’, what is being discussed is commitment.
I confess to having been deeply sceptical when I read an appeal last week by a boss of a fund management firm (Schnider,Walter & Kollegen) to make it an obligation for fund managers to invest personally in the funds they manage. For Mr Walter, the notion that having some ‘skin in the game’ makes for better investment decision-making is so self-evident it barely needs defending.
Say you are driving down a highway, the day after getting your license, and pass a dreadful crash that has scared you out of your wits. In the rear-view mirror, you see the destruction scattered across the road. You promise yourself to never drive recklessly, as that driver obviously did. With the vivid image seared into your mind, you drive cautiously away. And so is the feeling of the younger American generation regarding financial markets, particularly stocks.
‘An embarrassment for Frankfurt,’ was how one described it; ‘disgraceful,’ said another, ‘a complete over-reaction on the part of the police. These were some of the quotes that circulated after last weekend’s Blockupy Frankfurt protest – and not just from left-leaning commentators. The attempt by Occupy supports to bring Germany’s finance capital to a halt over four days using peaceful, creative and colourful means, undeniably left the city’s authorities with egg on the faces.
I watched a TV interview with a retail investor last Friday. She had subscribed to the Facebook IPO and was standing among the crowd in Times Square in front of the NASDAQ board waiting (quite a while, as it turned out) for the stock to start trading. The journalist asked why she was so convinced about her new investment and she explained that she and all her family and friends were Facebook users and was impressed by its stellar growth. She also expressed her regret at not buying Google when it IPO’d a few years back.
The one wants to have it at any price; the other wouldn’t touch it with a barge-pole. There is no doubt that the Facebook IPO has polarised opinion. Still, if everything goes to plan, the social network will come to market at a price that values the company at $100bn. That is as much as a PepsiCo, a Total, or a Unilever. Is Facebook really worth that much?
A financial transactions tax (FTT) appears to be tiptoeing ever closer; it has escaped its moral, technical and intellectual shackles. Francois Hollande, the new French president seems bent on introducing the measure (his adversary in the electoral race had mouthed the words, but many people had their doubts). What’s more, Hollande has framed its introduction in a new way: no longer is it presented as a punishment for errant bankers, but as means to finance new pro-growth measures.
Even a dull picture can capture attention when colourfully painted by the media. The opportunity to do so emerged this week with yet another negative story from the eurozone. The target was a country that is stable, whose unemployment is among the lowest in the EU, and which boasts a trade surplus and years of responsible budget management. The collapse of the Dutch government was the result of disagreement over budget cuts in 2013 and movements to further austerity.
It is amazing what can become of a bond engagement if one happens to choose the wrong issuer. Yes, I was one of those unfortunate souls who decided to take a bet on short-dated Greek bonds in the middle of the eurozone bailout negotiations. In retrospect, it was not my best idea, but the engagement was small and entirely with my own money. Who dares, wins, I mused.
People like things that are familiar – they are rarely frightening and we enjoy the warm, comfortable feeling of having some control, or at least some understanding, of what is going on around us. The same applies to our investment preferences: someone who regularly sees BMW cars on the streets will tend to see themself as being better able to evaluate the merits of BMW stock than the stock of a lesser-known Japanese competitor. The BMW investor may have the impression of having the investment risks under control, although this feeling could be nothing more than illusory.
“When can I have Facebook, dad?” asked my young daughter at the weekend, obviously envious of the seemingly tireless preoccupation of her older sibling. I told her that she was still too young but, based on the age at which her big sister finally nagged me into submission, I assured her that she would probably have it in about three years.
“Three years?” she gasped. “Facebook probably won’t even exist in three years.”
I hadn’t planned on climbing back onto my timing-of-rating-agency-downgrade hobby-horse so soon. Sovereign ratings have been crashing and burning at the hands of S&P, Moody’s and Fitch for so long now that that the timing factor was destined for irrelevance. Indeed, in the case of the coveted French triple-A, S&P ‘erroneously’ issued a downgrade notice in November, so market participants knew that one was in the bottom drawer. This is why investors had been talking about an eventual downgrade in terms of ‘when’ and not of ‘if’ for weeks. So, for S&P to conjure up a market surprise from the eventual announcement would have required a very particular dexterity.
Gold mining stocks have a less than a shining reputation among precious metal investors. The expression ‘lame duck’ is appropriate for describing its performance this year. The NYSE Acra Gold BUGS Index (HUI), which includes the stars of the sector, currently stands at the year’s opening price. Perhaps it is for this reason that so many observers seem to relish at the idea of buying in. “Goldmines are unbeatably cheap”, scream the advertising slogans, “hopelessly undervalued”; “cheaper than ever”. Good luck with that one. The reality is that there is hardly any serious precious metal operator who hasn’t, at one time or another, already tried to exploit this apparent undervaluation.
“Most of the people in this room have it in them to become a rogue trader.” This is how I challenged a large group of institutional investors at one of my recent behavioural finance seminars. The suggestion raised numerous titters, but there was not a single word of opposition. They understood that loss-aversion is a powerful human motive and, in addition, that the passage of time dulls a person’s perception of the enormity of the damage.
As far as I am aware, the idea didn’t come from the Cabinet Office’s Behavioural Insights Team, but the plan for the UK Treasury to issue “project-specific bonds” is certainly deserving of a behavioural moniker. Instead of just issuing generic gilts to meet the government’s policy objectives, the Treasury is thinking about labelling the bonds according to the use the money would be put. So, for instance, the financing of new roads, hospitals, or bridges would be done through the sale of a specifically-labelled bond and the money raised would be put to that purpose only.
As I recently viewed one of the many political talk shows on the euro crisis, it occurred to me that good television should be uncomplicated. The EU summit had just concluded, so a few simple words of explanation for the TV audience would have been so welcome. A few well-known politicians had been invited, but I’d already learned not to expect too much from them in such a debate. Also on the set were the ‘experts’, who tried with difficulty to explain the complex issues in plain terms. Making puree out of solid food in order to spoon-feed it to unsophisticated diners avoids indigestion, but the individual tastes and textures are invariably lost in the process.