Wednesday, April 25, 2012

On Yellow Metal Perils



With all the focus on the link between the price of gold and whether the US Federal Reserve will embark upon QE3, it seemed to be worth asking just what holding metal ingots is really a hedge against. The whole idea of hiding a stack of gold seems a bit dramatic, but it is a financial plan that is gaining mainstream acceptance. Everyone should have savings to fall back on in the event of a crisis. The question is whether it is actually useful to keep those savings outside of a bank, and yet then whether to convert them to the barbarous relic. 

The main criticisms of gold are that it pays no dividends, no interest, costs money to hold, and is driven by paranoia and bubbles, which is funny because given stock values, real interest rates, fund fees and the VIX, that sounds like pretty much everything these days.

The following table lays out examples of financial and economic risk scenarios some Euro area citizens could face under extreme circumstances, and compares holding gold as a mitigation...
These have been taken from news reports of actual incidents and some proposed solutions, along with examples from recent history of sovereign debt and financial crisis' as illustrated in books like Reinhart and Rogoff's, "This Time Is Different", Liaquat Ahmad's, "Lords of Finance", Niall Ferguson's, "The Ascent of Money", Michael Lewis', "The Big Short", among others. 

When taken together, the theme in the risk scenarios that support holding physical metals really seems to be about a change in the political environment where people suddenly find themselves on the wrong side of the law or caught in a dragnet. In those scenarios, gold provides some minor leverage, and perhaps some extra time. There are only a few scenarios which would be likely to affect people in middle America, or anywhere in the US in the near term. Almost none of them seem plausible in Canada unless you are a fugitive or laundering money,which would seem like a more immediate problem. More reasonably, it is a reliable hedge against almost all forms of counterparty and liquidity risk. (almost, anyway) Taking the stuff and burying it for a generation of grandchildren who will live in some kind of dystopian future,might be viable, though I would probably consider the alternatives first.  

(Ironically, dystopian is not in blogger or gmail's spelling dictionary, and yet nobody has bothered to mention this. At least, nobody who ever existed. Regardless, I've told my doorman that if the black helicopters arrive, they can find me at my club. )


The basic idea behind the table is to compare how holding personal savings in physical cash, cash account deposits, physical metals, or paper metals creates or mitigates exposure to certain political/economic perils and risk scenarios.  

This table is of course by no means complete, and notably excludes stocks, bonds and other securities.  It is utterly unsubstantiated by data, research, peer review or methodological rigour.  It is intended only as a way for me to organize some popular ideas about the debt crisis, and to evaluate how seriously I should take some of the factors that have led people to hoard metals...




Risk/Asset Table
Physical Cash
Cash Account Deposits
Physical Metals (Au/Ag)
Paper metals (ETFs, certificates, institutional deposits and contracts)       
Re-denomination of bank deposits in a national return to non-Euro currency.
Exposure
Exposure
Mitigation
Unknown
Monetary base and aggregates: high-inflation or hyperinflation.
Exposure
Exposure
Mitigation
Mitigation
Nationalization of banks or liquid assets, via swapping deposits for national bonds.
Mitigation
Exposure
Mitigation
Exposure
Appropriation or loss of land or home
Mitigation
Mitigation
Mitigation
Mitigation
Appropriation of shares
Mitigation
Mitigation
Mitigation
Exposure
Spurious and persistent liens or claims against registered assets
Mitigation
Exposure
Mitigation
Exposure
Capital mobility controls (tariffs or bans on capital flows)
Exposure
Exposure
Mitigation*
Mitigation*
Revolutionary government asset seizures
Mitigation
Exposure
Mitigation
Exposure
Compromise of banking privacy
Mitigation
Exposure
Mitigation
Exposure
Physical theft
Exposure
Mitigation
Exposure
Mitigation
Border or Customs seizure
Exposure
Mitigation
Exposure
Mitigation
Agent or brokerage insolvency (e.g. rehypothecation risk)
Mitigation
Exposure
Mitigation
Exposure
Credit Crisis or Bank Failure (bank runs, banking "holidays", etc.)
Mitigation
Exposure
Mitigation
Exposure
Salary, pension or contingency claw backs (public sector e.g. Greece, bonuses, etc.)
Exposure
Exposure
Mitigation
Exposure





Commodity price manipulation (negative)
Mitigation
Mitigation
Exposure
Exposure
Declaration of gold as contraband(e.g. variation of US EO 6102)
Mitigation
Mitigation
Exposure
Unknown
International sanctions in response to national default
Unknown
Exposure
Mitigation
Unknown

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