25 May 2008

Investment timeframes Part I

When I moved to Perth from Sydney to take up the job of Depository Administrator I thought the best way to get up to speed quickly would be to go through each client file (we are talking good old paper here). This way I could see first hand how transactions were done, how I should word correspondence, etc. As I worked my way through the files, I started to see a pattern – the client would open the account, purchase a large amount of gold and then, nothing. No further contact, no further purchases or sales, no enquiries as to the price of gold, nothing.

Initially this puzzled me, I mean if you had a substantial investment, wouldn’t you be constantly reviewing your portfolio allocation and making adjustment accordingly? The behaviour seemed very odd, very un-investment like, especially for such obviously wealth persons. In a lot of a cases we were talking about periods of 5-10 years without any trading or contact.

As I got to trading and talking to a wide variety of the Depository clients, I came to understand that there were a lot of different reasons for buying gold. Associated with each reason was usually a timeframe, and by that I mean how long they expected to be invested in gold before selling out - hopefully at a profit. I ended up classifying them into three groups: short, medium and long term timeframes. The “no further contact” clients were in the long-term group, and specifically what I call insurers.

Now my definition of what those timeframes were may not accord with their definition as used in other markets or yours, but it does fit what I saw when analysing the transaction behaviour of the Perth Mint's Depository clients (and I did a fair bit of analysis, partly because I am a numbers person and partly because I was always looking to understand gold buyers).

Long Term

By long term I mean timeframes that are measured in years, indeed in some cases we are talking decades. This group can also be broken down into two sub groups - strategists and insurers. Common to both is the fact that they have a very strong, if not emotional, attitude towards gold. These are your classic buy-and-hold investor. Their view is historic and economic, broad brush. Their investment is more about wealth preservation than wealth generation.

The main difference between the strategic sub-group and the insurance is that the strategic do have an end game where they will get out of gold at a profit once the economic cycle has shifted back towards conventional investment classes like stocks. They are in for the long haul, but only because they see an extended period of poor returns but do generally prefer wealth creating assets. They may also hold a small permanent position in gold (say less than 1-2% of wealth) and are just upping the allocation to precious metals as a defensive measure for a period of time and then back down to a relatively low level.

The insurance sub-group on the other hand have no end game in sight, they hold a core position in gold that, once established, is rarely added to. They don’t care about the price and profit is not the focus. They are using gold as insurance, insurance against events that you cannot get insurance for – major depression, civil war, world war, societal breakdown, currency collapse. There are invariably very large amounts involved. These are people who have enough money that they can park some “lazy” capital into gold, enough that they can reestablish themselves with should the unthinkable occur.

Why I was initially puzzled by these clients was because I assumed that you bought gold as an investment, but the motivations of insurance are different. The way I like to think about this reason for buying gold is if you buy car insurance and then at the end of the year you have not had an accident, you don’t say to yourself “well that was a waste of money, I paid the premium and never got to claim on the insurance policy”. Instead you say “great, I didn’t have an accident, how lucky” and you write-off the premium. This is the same attitude these clients have towards gold – if the price goes down, they don’t moan about the money lost, they consider themselves lucky that there was no economic breakdown. They don’t want to make a lot of money out of gold, because in their view this means that they have lost all their other investments.

Medium Term

Medium termers, or tacticians, talk in timeframes of months, usually 6 months to less than 2 years. A lot of times they end up in gold for longer than that, usually because their assessment was out or they want to ride a trend a little bit longer, but in mindset they are generally not long termers. The motivation here is purely profit, the analysis behind their position is usually economic/currency valuation based.

Sometimes there is a blurring between medium and long temers, with some holding a strategic view on gold and so they plan on being invested in gold but cannot resist the opportunity to sell out at peaks and buy back in on corrections as they ride the bull market. They are definitely not buy-and-hold type investors.

I would also put into this category non-goldbugs who are just hitching on the “commodities story” and think the bull market in gold will run for a few years at most and that they will get out at the top (or near to it) in time, ready to deploy their profits into the next investment fad.

Short Term

Short termers have timeframes counted in days or weeks. Speculation is another word for it. My definition of 6 months or less is probably debateable and could be shorter. In any case, quick profit is the goal and there is no philosophical belief in gold.

Unlike the medium and long termers, this approach is one that I do not recommend, because I have seen few, if any, who have been able to do it. Why that is the case has little to do with the investor’s competency (although I have seen some who did lack any trading acumen) and more to do with the nature of the gold market itself.

Anyway, that for next week’s blog …

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