So, am back to keyboard tapping after a period of mindful idleness.
I have long been enamoured by Maya….ah….illusion, I meant. No, I’m neither religious nor philosophical. It’s just that I’m sold on the notion that the world around me is an illusion.
As is my wont, I’ll proceed to invoke the spirits of the investing world to unfashionably debunk the fashionable art of sounding intelligent in the investing profession. Most things in investing is Maya and it would probably serve humans well to realize that. What essentially I’m indulging in as an investor is to forecast the demand/supply situation for an asset at some point in the future.
“What do you think of Gold at $1,400/ounce?” And I hear a volley of the usual; inflation hedge, hedge against the US dollar, investment-for-2012 apocalypse, it is the ultimate currency, diversification…
An asset that throws out a stream of cash over time lends itself to valuation using the beauty of mathematics and discounting. How does one value an ‘asset’ that throws nothing? Humans have waited for centuries and this ‘asset’ has coughed up no cash flow, but remarkably has tended to appreciate in price. Gold bugs use esoteric techniques to justify some price as fair price. For them, gold remained a buy at $850 in 1980 and it remains a buy today at $1,400.
Will it remain a buy if the price were $20,000/ounce? Ah, unsure; that seems a little too high now, doesn’t it?
Decades ago, $35 of paper currency could be converted into an ounce of gold. How was $35 the Holy Grail-ish fair price? And, the fair price remained constant even as time (and inflation) ticked by…
The mind turns to other rarer candidates. Platinum, for instance. Yes, it shines like gold. Is used in jewellery, like gold. Ah, but it is rarer than Gold. About 180 tons of Platinum is mined every year compared to 2,400 tons of Gold. And Platinum is arguably more useful to humanity as it finds industrial use as an auto-catalyst…while Gold mostly adorns lockers tucked away in the confines of safe vaults and god-knows-where. And yet Platinum is priced at a 30% premium to Gold and there have been long periods when it has been priced close to parity with the yellow metal. People just don’t love Platinum as much as they love Gold.
Or, aromatic Saffron. About 300 tons are produced annually and the flower in various forms finds wide usage in food consumption. Doting soon-to-be mothers mix it with milk…apparently it leads to fair skin (Maya or reality?). An ounce is worth $200. People consume this rarity almost daily but it is valued at 1/7th the price of an ‘asset’ that adorns shelves…People just don’t love Saffron as much as they love Gold.
Gold trades at its level (and keeps going up) because human beings perceive it to be of more utility than other rarer candidates. Never mind the rational basis. It is worth whatever people think it to be worth. So long as one can posit that humans, in the future, will continue to perceive Gold in the manner they do today…it is a good idea to own the commodity. Faith is key.
I kept italizing price above. For good reason. Gold is priced in US Dollars. ‘All the money-printing globally will surely lead to inflation and so gold should go up’, goes the voice of reason. And gold goes up. Rather than perceiving the up-move in Gold as a vote of confidence on the metal, one could perceive the same as investors losing faith in the US Dollar.
Just what is the fair price of the US Dollar anyway? Price in relation to? Hmm…gold, platinum, copper are priced in US Dollar. So how does one price the US Dollar itself? In relation to? Gold? Er…we move into the world of circular relationships. (Maya floats in my brain).
Fiat currency is defined as one that has no intrinsic value. It retains value and is propped up solely on faith and because governments around the world say they have value. So the currency darlings; US Dollar, Euro, Yen, Swiss Francs, Monopoly money (er, yes, the last is fiat currency too, except that it isn’t globally accepted as one!) have no intrinsic value.
So long as investors believe in the US Dollar (or Euro, or Renminbi) it will retain value. Fair price?
Faith is key.
Ah, I couldn’t leave these untouched. I wrote (quite intelligently) above:
An asset that throws out a stream of cash over time lends itself to valuation…
The cash that the asset throws out every year is counted in some currency.
And we just saw above that paper currencies themselves have no intrinsic value.
So, cash flows coming out of a business have no intrinsic value either.
So, the value that is computed from the above…
Maya is the only reality. Perception manifesting as Faith plays a pivotal role in determining asset prices. And one cannot quantify Faith, in my humble opinion. An investor is essentially a Perception Forecaster. It is when man endeavours to embellish perception/faith/intuition in the apparent beauty of logic that gyrations begin in asset prices…
…but hey, gyrations (volatility) itself can be traded! (But I digress).
As a parting note, most human beings would readily ascribe no value to an empty head. But an empty piece of land seems to be an entirely different matter!