It’s nearly impossible to watch TV for more than an hour without coming across at least one commercial from a gold dealer. But even if you’ve already decided to invest in gold and want to get your hands on the physical asset, the loudest gold proponents won’t necessarily give you the best deal.

The explosion of exchange-traded funds that hold gold, such as SPDR Gold Shares and iShares Gold Trust, has made owning gold, at least on paper, cheaper and easier. In the last year, its price per ounce has shot up nearly 25% to $1,735. More than 44% of gold purchased in this year’s third quarter was for investment purposes, according to the World Gold Council, an industry association representing 22 gold miners—up from 39% in 2009 and less than 10% in 2001.

But for a certain subset of investors, nothing beats owning the actual metal.

People Are ‘Scared’

“People buy [physical] gold because they’re scared,” says David Ader, head of government bond strategy at CRT Capital Group, an institutional brokerage in Stamford, Conn. “If you own the physical gold, you can look at it and go, ‘Well, I can always buy a can of something with this.’”

Investors who have reached the point of wanting to own physical gold probably will want to have it easily accessible if an emergency strikes. So most should keep it in a safe at home that’s bolted to ground, says Bert Whitehead, a financial adviser in Franklin, Mich.

With the rise in gold prices, advertisements for gold salesmen have multiplied, and regulators are worried that some consumers might be taken advantage of.

The city attorney for Santa Monica, Calif., recently accused prolific advertiser Goldline International and some of its executives of using high-pressure sales tactics to sell collectible coins to unwitting consumers at huge markups. A Goldline spokesman referred to a statement made by the company last month that said the attorney’s complaint is without merit.

However that case plays out, it pays to be wary.

First, be clear on what, exactly, you want to purchase. Most gold investors seek exposure to the actual metal and care less about the collectible value of “rare” gold coins that might be pushed by some gold dealers, says Mr. Ader.

In that case, you will want to target gold that carries the cheapest price per troy ounce, whether it’s in the form of a coin or a gold bar. Bars will typically be the cheapest, he says.

Looking for a gold dealer? Steer clear of ones who advertise on TV or radio, says Donald Dempsey, a financial planner in Williston, Vt. “As a general statement, with all the ones you hear advertised on talk shows, you pay an extra premium,” he says.

Charging a Premium

Instead, he suggests getting recommendations from a financial planner. Alternatively, the World Gold Council has a listing of dealers on its website. The site also shows the spot price of gold. Gold dealers typically charge a premium of 2% to 5% for gold bullion and extra if you want to pay with a credit card rather than cash or a wire transfer, says Mr. Dempsey.

You should check prices with at least three gold dealers before buying to make sure you’re getting the best deal, says Mr. Whitehead.

Also, check the price at which the company would buy your gold back if you need to sell, says Chris Wills, a senior wealth adviser at R.W. Roge, a wealth-management firm in Bohemia, N.Y. Dealers will usually pay more for gold they originally sold, since they can more easily verify its authenticity, he says.

But most investors should buy physical gold only if they’re not planning to sell except in an emergency, he says, since the trading costs of frequently buying and selling are high.

Article source: Wall Street Journal

 

If you are a gold investor, you’re probably quite pleased with yourself right now. It’s been one of the best-performing investments this year.

Indian stocks are down 16.5% so far, bonds have been middling, with 7% to 10% returns but gold – that’s been stellar with its 22% gain over the last year.

A customer tried gold bangles inside a jewelry showroom at Noida in the northern Indian state of Uttar Pradesh in this April 21, 2011 file photo.

So, today being Dhanteras, an auspicious day to buy gold, perhaps you won’t think twice about investing in the yellow metal. But you should.

Will gold continue to gain value from these high levels? Yes, said Bollywood actress Hema Malini recently. She said that the recent price gains are clear evidence of why it will continue to be a good investment.

Ms. Malini aptly summed up how thousands of gold-lovers – who don’t actively follow gold demand or supply markets or euro-zone crises — think.

The argument that price will go up simply because it has risen in the past is not exactly a logical investment case. But science can explain this thesis.

Many of today’s gold lovers are inflicted with what psychologists call the “recency” effect – the tendency of human beings to give most importance to what has happened in the recent past.

We experience this every day.

Think back to your last work performance review. Most likely, it was determined by what you did or didn’t do in the few weeks or months before the review date.

If you had to decide whether to watch a new movie, you’ll likely base your decision on the last couple of movies made by that movie’s director or actors. You won’t seek out all the movies made by the director in the last 10 years to make the most rational assessment.

These are examples of how our current behavior is often driven largely by a handful of recent experiences, as opposed to an average of experiences over a long period of time.

It won’t hurt you too much if you pick a bad movie to watch but recency bias can have harmful consequences when investing your money. This is what propels individuals toward “hot” investments, often after they have reached their peak.

“The average person buys more aggressively in response to recent price rises,” said Terrance Odean, a finance professor at the University of California Berkley, in the neuro-science book, “Your Money Your Brain.”

Mr. Odean, who has studied 3 million stock trades by 75,000 American households, added that it’s not just yesterday’s boom that spurs buyers. “What makes people buy is a combination of very recent rises and any longer-term ‘trend’ of rising prices that they might perceive,” said Mr. Odean.

This “trend” is basically a few instances we put together in our minds to create a pattern.

Coming back to gold, for instance, my mother will argue that gold’s price has gone up over the long term. It was at around 330 rupees ($7) per 10 grams in 1973 and was recently trading at 26,300 rupees ($530) per 10 grams more recently.

This long-term trend is at best a fallacy. Prices of everything have gone up over the last four decades. Even milk – as per my mother’s recollection – has gone up by as much or more!

The fact is, when adjusted for inflation, gold is more than 30% below its price in 1980.

Still, we get carried away with its recent performance.

Money managers and fund companies are well aware of this recency bias and use it to sell us their products.

They’ve been launching several gold-investment funds this year, which aim to provide the return of gold without having to own physical gold. HDFC Asset Management Company introduced such a fund earlier this month, and last week IDBI Asset Management Ltd. launched its offering.

If gold is a good investment today at $1,612 an ounce, then it was an awesome investment in 2007 when it cost just $750 an ounce, right?

Yet, more than two-thirds of the 18 gold-oriented mutual funds that are available in India today were launched after 2010. Why didn’t we see a rush of gold funds in 2007?

Because at that time fund companies were busy launching stock funds when — you guessed it — stocks were booming. The Sensex gained 50% in 2007.

Investors who joined the stocks bandwagon then because of recent price gains, were in for a rude shock. In 2008, the Sensex lost more than half of its value.

So-called investment experts are not much better at getting away from this recency bias. Numerous stock market pundits today will advise you to buy stocks of fast-moving consumer goods, like toothpaste-maker Colgate-Palmolive (India) Ltd. and food products company Nestle India Ltd., which as a group have gained nearly 9% over the last year.

But if you want to make money, don’t you want to buy something cheap which you can sell for a higher price later?

Even if you are not a stock investor and haven’t been hurt in recent stock market crashes, it doesn’t hurt to learn from other people’s mistakes. Your brain is wired pretty much the same way.

Think about that before you decide to buy gold as an investment this Dhanteras.

Write to Shefali Anand at shefali.anand@wsj.com

Article source: Wall Street Journal

 

Inflation is typically a hot-button political topic, but it is important to note that the ‘real’ rate of inflation is different for everybody.  The reason for this is because all products & services do not rise & fall in price equally, and people all purchase products and services in different proportions. Most people pay attention to the published consumer price index, which is based on a defined “basket” of goods and services.  This basket is intended to represent an “average” urban consumer, but is not necessarily representative of everybody.

Generally speaking, commodity products (Bricks & Sticks) such as oil, gold, food, and building materials tend to rise in price over time.  Generally speaking, monetary inflation impacts commodities first.  The reason for this is because commodities are purchased in large amounts with cash on a regular basis.  This means that as more cash moves through the economy, the first place it typically lands to drive up prices is commodities.  Over the long-term his price rise tends to be linear, unless a market bubble temporarily pushes prices up or crashes down prices.

Conversely, technology products (Bits & Bytes) such as computers, cell phones, televisions, smartphones, etc tend to decrease in price over time for a relative level of technological performance.  Another way this phenomenon manifests itself is when new technology products are introduced at the same price as the prior generation, but with more features or better performance.  In this case, the price per unit of performance is decreasing even though the total price may be staying the same.  The dramatic price declines of technology are a primary driver new business models that consistently emerge, based on new digital economics.  Consumers benefit greatly from the technology curve, since it allows them to consistently buy things that are better for the same amount of money or less.

The average level of market inflation is based on a presumed mix of commodity products that are increasing in price and technology products that are decreasing in price.  (This average is publicly reported through the Consumer Price Index, which has a fair number of its own quirks concerning how inflation is comprehended)  The way that this phenomenon translates into our life is that the level of inflation we personally experience depends on our pattern of consumption between commodity and technology products.  By and large, a person is more susceptible to inflation when the relative amount of commodity products they consume is higher.

In this way, inflation typically impacts people of lower incomes the most significantly.  The way that this happens is by inflating the cost of commodities such as housing, food and energy.  Since people of limited means typically spend a larger portion of their income on housing, food, and energy it means that they feel the effect of inflation much more sharply.  Conversely, people who spend a lower portion of their income on housing, food, and energy are less directly impacted by inflation since their personal basket of consumption is weighted more toward technology products that naturally deflate.

Since individual people don’t have the ability to affect market prices, it is not possible to change the level of market inflation.  However, since each of us has the power to choose how we consume products & services, we DO have the power to change the level of our personal inflation.  When oil prices increase, we have the ability to carpool, purchase a more fuel efficient car, move closer to work, or use public transportation.  Conversely, we can also choose to shift more of our purchase decisions toward products and services that benefit from advances in technology.  These types of changes are not always desirable, but they do give us power to influence the impact of inflation on our lives.

In this way there is a personal rate of inflation for both me and you that we can influence at the margins.  In the torrid journey of life, it is easy to become upset about inflationary government policies that push-up prices.  And in many cases, this anger is well founded.  However, it is not something that any of us have the power to directly change.  Each of us only have the power to change the decisions that we make as individuals.  In that way, the most important change to make is one that changes your personal situation and the situation of your family.

 

Taking a loss is hard to take. But avoiding a loss can be much worse.

U.S. stocks have lost some $4 trillion since their peak in October 2007, but investors aren’t fleeing the market en masse. So far this year, according to investment-research firm Morningstar, investors have taken $14 billion more out of U.S. stock mutual funds and exchange-traded funds than they have added. That is less than 0.4% of the total assets of U.S. stock funds.

Can losing money feel good? Recent experiments show that reward circuits in the brains of investors who have losses will fire intensely whenever money-losing holdings have an uptick in price. Jason Zweig has details on The News Hub.

In other words, while some investors have taken their losses, most are grimly sitting on them.

That could be a mistake. Research published in 1998 by behavioral-finance professor Terrance Odean of the University of California, Berkeley, showed that individual investors are 50% more likely to sell a winning stock than a loser—even though, on average, the stocks these investors sell go on to outperform while those they hold onto underperform.

Why the reluctance to bail? Selling an underwater asset, says Mr. Odean, “isn’t primarily about economic loss, it’s about emotional loss.” Once you sell below your purchase price, he believes, you can no longer tell yourself, “I still made a good choice, and it’ll come back.”

Individual investors aren’t the only ones who can’t make peace with their losses, according to numerous academic studies. Mutual-fund managers who cling to losing stocks underperform, by roughly four percentage points annually, the managers who cut their losses.

Christophe Vorlet

While some investors have taken their losses, most are grimly sitting on them.

On average, professional futures traders and stock traders hurt their returns by clinging to their losers. Real-estate investment trusts hang onto properties that are losing money longer than they keep those that are in the black.

Unpublished research presented at the annual meeting of the Society for Neuroeconomics earlier this month sheds new light on this old problem. Neuroeconomics is an emerging field that combines the techniques of neuroscience with theories from psychology and economics to study financial behavior.

In one study, led by Gregory Berns of Emory University, people lay inside a brain scanner while deciding to hold or sell an investment; the price of the asset changed randomly up or down. The researchers focused on the ventral striatum, a region of the brain that has been shown to respond to rewards, particularly when they are unexpected.

When an asset was underwater and its price rose, activity in the ventral striatum of the typical person in the experiment was “blunted,” or insignificant, rather than robust. “Many of the participants told us they had hope for a rise,” says Andrew Brooks, a co-author of the study. Perhaps because these people got what they expected, an uptick in price “wasn’t surprising,” Mr. Brooks says, and therefore didn’t excite this part of the brain’s reward center.

That suggests that many investors who are losing money may automatically assume—rightly or wrongly—that their position is bound to recover.

Other research at the meeting pointed to a second flaw in how investors might think about losses. A study led by Camelia Kuhnen of Northwestern University found that people are much worse at estimating whether a bad investment will produce mild or severe losses than they are at predicting whether a winning investment will generate small or large gains. “Learning [about probabilities] is particularly faulty,” Prof. Kuhnen says, “when people are in a bad environment with losses left and right and they have their own money at stake.”

There are several steps that can help you dump your losers.

First, get a second opinion, from a financial adviser or an investor you respect, on your money-losing positions. Ask not whether you should sell the investments, but rather if they are worth buying at today’s price. If the answer is no, consider selling.

Measure how long you hold your losers and your winners. If you hang onto your money-losing positions much longer than your winners, then put yourself on a regular schedule of looking for losses to harvest. (You don’t have to wait until December.)

Taking a loss is easier when you think of it as a swap—in which you replace a loser with a new investment in a similar (but not identical) asset—rather than a sale. That makes taking action easier, since you aren’t forced to admit that your original judgment was a complete failure.

Finally, realize that a loser can change from a liability to an asset when you close it out at a loss, since you can use losses to offset up to $3,000 of ordinary income on your tax return.

“Think about the term ‘harvesting your losses,’” suggests Meir Statman, a finance professor at Santa Clara University. “That should put you in mind of strolling in an orchard picking ripe peaches rather than rotten losses.” Just be sure to check with your accountant to make sure the loss is worth taking.

Article source: Wall Street Journal

 

One of the ideas that has become quite pervasive within the minds of investors is the notion of a “good stock” or a “good property” to own.  This notion stems from a general desire on the part of most people to own things of quality.  In our personal life, this frequently manifests itself as a desire to own a comfortable home, and a reliable automobile.  Quality gives us a feeling of safety and security.  Thus, it seems completely natural to want our investments to be the stock of a high quality company, the bonds of a high quality corporation of government, or a property that is desirable in both its quality of construction and location.  The problem with this view is that it only provides one half of the information that you need to determine whether an investment is a good deal.

The second half of this investing puzzle is price.  Put bluntly, the quality of a stock, bond, or property investment only matters in relation to its price.  This means that a ram shackled, blighted property can be a phenomenal deal at a certain price.  The stock of media darling companies such as Apple, Google, and Amazon can all be terrible investments at a certain price.  It is certainly true that high-quality investments can frequently justify a higher price than lower quality investments.  However, it is equally true that any investment can be a spectacular deal if the price is right.

The key for investors is to determine when the price of a high-quality stock, bond, or property is over-valued, or conversely when the price of a lower quality stock, bond, or property is under-valued.  Any investment is a good deal at one price, and a poor deal at a different price.  Unfortunately, it is frequently very difficult to determine exactly where these two boundaries are drawn for any particular investment.

When estimating the appropriate price for a particular investment, there are two relevant factors that need to be considered.  The first is the expected future price, the second is expected future cash flow, and the third is taxes and inflation.  When combined, they will create a holistic picture of the value for any particular investment.

Expected Future Price

• In the world of stock and real estate investing, this is referred to as appreciation.  Fundamentally, it represents the expectation that the future price of an investment will be higher than the price you paid to purchase it.  This is frequently referred to as the ‘buy low, sell high’ philosophy.  For most investors, this is the primary source of value that they see.  Stock market tickers report the price of securities, and the Multiple Listing Service reports the price of properties.
• However, the ubiquitous availability of price information frequently causes people to over-emphasize price appreciation as a source of value.  It is most certain that price appreciation is an important source of value for investments, but it is certainly not the only value vector.  The fact that so many people focus on market prices has made them become very volatile over the past few years.  Values for stocks, bonds, and real estate have all fluctuated significantly.  This has made future price appreciation very difficult to predict.
• In addition to all of this, there is one further characteristic of price that investors must take into consideration.  In order to capture the benefit of price appreciation, you must sell the investment.  This means that watching the value of your stocks or real estate skyrocket means absolutely nothing unless you sell and lock-in the gain.  Thus, in order to realize the full gains from future price appreciation, it means that you must sell at the right time.  In practice, this is very difficult to do and frequently results in selling while values are still going up.

Expected Future Cash Flow

• Another key characteristic of what makes a good vs. bad deal for investors is the cash flow that is produced.  In the case of stocks, this comes from dividends.  In the case of bonds, this comes from interest payments and the future return of the bond face amount.  In the case of real estate, this comes from rents that are paid by tenants for the use of your property.  The importance of cash flow to the value of an investment is that it represents a current, tangible return.  Typically, investments that produce the best cash flow don’t always have the best appreciation.  However, they also tend to be less volatile since the price tends to be more highly correlated with the rate of cash generation than the market expectations for future price increases.
• The way that most investors articulate the future cash flow of an investment is through its yield.  In simple terms, the yield of an investment represents its annual cash flow divided by the price paid for the asset.  In the case of stocks, the “dividend yield” is the annual dividends divided by the current market price.  In the case of rental real estate, the “capitalization rate” is calculated by dividing the annual net operating income of the property by the purchase price.  In the case of bonds, the discounted future value of all payments is compressed into an internal rate of return, which is articulated as the bond yield.
• In most cases, the rate of cash generation for an investment is much less volatile than the market price of that investment.  Stocks that pay dividends tend to adjust their dividend rate at a much slower rate than the market value gyrations of its price.  Rents from income properties tend to shift much more slowly than the value of the property.  Bonds typically feature a fixed interest and repayment price, with their market value being determined by the movement in yield rates for similar instruments.  When market yields increase, the price of bonds currently on the market go down.  When market yields decrease, the price of bonds currently on the market go up.

Taxes and Inflation

• The final key characteristic that differentiates good vs. bad investments is inflation and taxes.  Inflation represents the erosion of you investment’s purchasing power and taxes represent the amount of your gains that need to be paid to the government.  One of the oldest and most important concepts in finance is that “It’s not what you make, it’s what you keep” … fundamentally, this means that the “real” rate of return for your investments is much more important than the “nominal” performance.
• Starting with inflation, it is important to understand that when the amount of money in circulation expands more quickly than the amount of goods and services being traded, it creates upward pressure on prices.  For some asset classes, the effect of inflation is relatively benign, for others it is beneficial, and for some it is devastating.  By and large, property values tend to be lifted in proportion with inflation, while cash flows from dividends and rents are also increased by inflation.  Some stocks move up with inflation, but certainly not all.  On the other hand, bonds with a fixed interest rate are destroyed by inflation since it de-values the interest payments.  Conversely, fixed-rate debt that you owe is wiped away by inflation as the dollars you use to re-pay the loan become less valuable.
• Another key characteristic to understand is taxes.  Different types of income are subject to different rates of taxation.  Generally speaking, income that is earned from a job encounters the most taxes.  Income that is earned passively encounters less taxes, and income earned from capital investment encounters the least taxes.  Astute investors also understand the impact of legitimate business deductions, non-cash expenses such as depreciation, and deferring capital gains through a 1031 exchange to reduce their tax burden down to the legal minimum.  In many cases, it is tax advantages that turn a good investment into a great investment.

Ultimately, it is the responsibility of each person to determine what constitutes a superior investment deal.  Since people have different appetites for risk, there will always be a variety of investors bidding for a variety of assets.  What is most important for the individual investor to do is take an honest assessment of their personal investment tolerance and make decisions that incorporate all of the major value factors.  By balancing the future price, future cash flow, inflation risk, and tax characteristics, it will allow you to build a strong portfolio of optimized deals.

 

Growing numbers of investing experts have been declaring that gold is a bubble: an insanely overvalued asset whose price is bound to burst.

There is no basis for that opinion. And understanding why can help point an investor toward clearer thinking about frenzied markets.

Even as gold has shot up past $1,800, gold-mining stocks have gone basically nowhere. And as Jason Zweig explains on The News Hub, unless gold goes way down, mining stocks look pretty cheap.

Sure, gold seems expensive. At its recent price of $1,813 an ounce, gold is off only slightly from the record high of $1,912 touched on Sept. 6 (unadjusted for inflation). Gold is up more than 40% over the past year, largely on fears that paper currencies like the dollar won’t retain their value.

But that doesn’t mean it is overvalued. Unlike bonds, which provide interest income, and stocks, which produce dividends and earnings growth, gold generates no cash flows. As John C. Bogle, founder of the Vanguard funds, told me two weeks ago, gold “has no internal rate of return.” As a result, there isn’t any reliable way to tell what it is worth.

So the people who say gold is in a bubble might well be right. But the people who think gold is heading for $2,500, $5,000 or $10,000 also might be right.

Folks on both sides would be more intellectually honest if they admitted that they are just guessing what gold is worth. With no measures like price/earnings ratios or bond yields as benchmarks of value, figuring out whether the precious metal is cheap or dear is like trying to solve a Rubik’s cube while you are blindfolded.

Decades ago, the great investing analyst Benjamin Graham pointed out that there is no such thing as a “good” stock; every company is good at one price (when it is cheap) and bad at a higher price (when it is too expensive). But try asking a gold bug at what price he would sell, and you are likely to get an answer somewhere between $6,000 and “never.” Ask a gold skeptic at what price he would buy, and you be met with silence, followed by “never” or a quavering “$900, maybe?”

Precisely because I don’t know how to determine its fundamental value and have never been able to identify anyone else who can, I haven’t written about gold for years.

But there is one aspect of gold investing where it is possible to make rational estimates of value: the stocks of gold-mining companies. And, by historical standards, they seem cheap—based not on subjective forecasts of continuing fiscal apocalypse, but on objective measures of stock-market valuation.

“We haven’t seen [low] valuations like these since 2008,” says Joe Foster, gold strategist at Van Eck Global. But financially, gold miners have “never been in better shape.” Van Eck’s Market Vectors Gold Miners exchange-traded fund holds 30 mining stocks.

Several big gold-mining companies—among them, Barrick Gold and Newmont Mining—are trading around 14 times their earnings over the past four quarters, virtually matching the Standard Poor’s 500-stock index at 14.5 times earnings. Even with gold at record highs, the shares of gold miners are trading at an industrywide average of roughly 18 times earnings, at 2.4 times “book” or asset value (versus 2.0 times for the overall stock market) and at one of the lowest ratios on record to the price of the metal itself.

Yet mining companies have rarely if ever been more profitable, and should be able to generate high returns so long as gold stays above $1,500 or $1,600, points out John Hathaway, manager of the Tocqueville Gold Fund.

Gold stocks aren’t a low-risk play; like the metal itself, they can burn you, especially if you expect to get rich quick. And gold mining has been the classic boom-bust industry, with managements squandering money on acquisitions and bad investments during the fat years and retrenching during the lean years.

“The industry has done terrible, asinine things,” says John Tumazos, an independent metals analyst in Holmdel, N.J. “I own 23 or 24 gold stocks, and I probably have a loss position in half of them even with gold at $1,800,” he adds. “One of them I bought when gold was at $300.” Smaller gold companies can be particularly risky.

Still, Mr. Tumazos and others say a new generation of management in the gold industry is less tarnished, and that rising dividends are likely. As Caesar Bryan, manager of the Gamco Gold Fund, puts it, “We think they will be returning capital to investors instead of taking it from investors, which is what they’ve historically been good at.”

Of course, if gold goes back to $900, these stocks will go right down with it. But if the precious metal holds steady or keeps going up in price, gold shares could pan out, too.

—
intelligentinvestor@wsj.com; twitter.com/jasonzweigwsj

Article source: Wall Street Journal

 

Growing numbers of investing experts have been declaring that gold is a bubble: an insanely overvalued asset whose price is bound to burst.

There is no basis for that opinion. And understanding why can help point an investor toward clearer thinking about frenzied markets.

Even as gold has shot up past $1,800, gold-mining stocks have gone basically nowhere. And as Jason Zweig explains on The News Hub, unless gold goes way down, mining stocks look pretty cheap.

Sure, gold seems expensive. At its recent price of $1,813 an ounce, gold is off only slightly from the record high of $1,912 touched on Sept. 6 (unadjusted for inflation). Gold is up more than 40% over the past year, largely on fears that paper currencies like the dollar won’t retain their value.

But that doesn’t mean it is overvalued. Unlike bonds, which provide interest income, and stocks, which produce dividends and earnings growth, gold generates no cash flows. As John C. Bogle, founder of the Vanguard funds, told me two weeks ago, gold “has no internal rate of return.” As a result, there isn’t any reliable way to tell what it is worth.

So the people who say gold is in a bubble might well be right. But the people who think gold is heading for $2,500, $5,000 or $10,000 also might be right.

Folks on both sides would be more intellectually honest if they admitted that they are just guessing what gold is worth. With no measures like price/earnings ratios or bond yields as benchmarks of value, figuring out whether the precious metal is cheap or dear is like trying to solve a Rubik’s cube while you are blindfolded.

Decades ago, the great investing analyst Benjamin Graham pointed out that there is no such thing as a “good” stock; every company is good at one price (when it is cheap) and bad at a higher price (when it is too expensive). But try asking a gold bug at what price he would sell, and you are likely to get an answer somewhere between $6,000 and “never.” Ask a gold skeptic at what price he would buy, and you be met with silence, followed by “never” or a quavering “$900, maybe?”

Precisely because I don’t know how to determine its fundamental value and have never been able to identify anyone else who can, I haven’t written about gold for years.

But there is one aspect of gold investing where it is possible to make rational estimates of value: the stocks of gold-mining companies. And, by historical standards, they seem cheap—based not on subjective forecasts of continuing fiscal apocalypse, but on objective measures of stock-market valuation.

Christophe Vorlet

“We haven’t seen [low] valuations like these since 2008,” says Joe Foster, gold strategist at Van Eck Global. But financially, gold miners have “never been in better shape.” Van Eck’s Market Vectors Gold Miners exchange-traded fund holds 30 mining stocks.

Several big gold-mining companies—among them, Barrick Gold and Newmont Mining—are trading around 14 times their earnings over the past four quarters, virtually matching the Standard Poor’s 500-stock index at 14.5 times earnings. Even with gold at record highs, the shares of gold miners are trading at an industrywide average of roughly 18 times earnings, at 2.4 times “book” or asset value (versus 2.0 times for the overall stock market) and at one of the lowest ratios on record to the price of the metal itself.

Yet mining companies have rarely if ever been more profitable, and should be able to generate high returns so long as gold stays above $1,500 or $1,600, points out John Hathaway, manager of the Tocqueville Gold Fund.

Gold stocks aren’t a low-risk play; like the metal itself, they can burn you, especially if you expect to get rich quick. And gold mining has been the classic boom-bust industry, with managements squandering money on acquisitions and bad investments during the fat years and retrenching during the lean years.

“The industry has done terrible, asinine things,” says John Tumazos, an independent metals analyst in Holmdel, N.J. “I own 23 or 24 gold stocks, and I probably have a loss position in half of them even with gold at $1,800,” he adds. “One of them I bought when gold was at $300.” Smaller gold companies can be particularly risky.

Still, Mr. Tumazos and others say a new generation of management in the gold industry is less tarnished, and that rising dividends are likely. As Caesar Bryan, manager of the Gamco Gold Fund, puts it, “We think they will be returning capital to investors instead of taking it from investors, which is what they’ve historically been good at.”

Of course, if gold goes back to $900, these stocks will go right down with it. But if the precious metal holds steady or keeps going up in price, gold shares could pan out, too

Article source: Wall Street Journal

 

Recent news has been ablaze with news of commodity price volatility.  Prices for gold, silver, and oil have all taken a sharp drop after rising significantly over an extended period of time.  These rapid price fluctuations demonstrate the effect to which commodity prices are being driven by leveraged futures contracts and speculation concerning future price movements.  The situation that has emerged in major commodity markets is one where upward movements have resulted in more people purchasing futures contracts to profit from future price increases, but any weakness in prices is met by a rapid rash of selling by investors who are looking to limit their losses

The implicit problem that is uncovered by this recent price volatility is that returns from commodity investment singularly flow from price increases.  Naturally, the only way that prices rise is if an imbalance of buyers vs. sellers pushes up the price at which people buy.  If this trend continues for too long, a ‘bubble’ results where people buy simply because they believe others will continue to buy and drive up the price.  During bubble markets, many investors will begin to make leveraged investments on anticipated price movements through instruments such as futures contracts.  A futures contract is where two parties agree to exchange a specified asset of standardized quantity and quality for a price agreed today but with delivery occurring at a specified future date, the delivery date.  People who correctly predict upward price movements when using futures contracts can make a lot of money very quickly by selling the contract before its delivery date for a profit.  Conversely, if prices move counter to what an investor anticipates, a lot of money can be lost very quickly.

The ability to buy/sell contracts for future delivery allow investors and speculators to employ a tremendous degree of financial leverage.  This leverage increases the perceived returns of asset bubbles since increases in prices are seen as pure profit to futures traders who simply flip a contract and make money.  This phenomenon then attracts more people seeking easy money until prices are driven so high that nobody can be found to take physical delivery of the product in question at the inflated prices.  At this point, the investors who have no desire to take physical delivery of commodities must sell quickly to cover their position.  If many investors end up liquidating their positions simultaneously, price crashes can occur.

In recent months, “speculators” have been a popular political target for attempting to draw attention away from turmoil in the Middle East, a continued ban on US offshore drilling, and money printing by the Federal Reserve as drivers of increased energy prices.  However, it is important to note that speculators can only capture profits if somebody else buys the other side of their contract.  In other words, they can only profit from the price of oil going up if people reasonably expect the price of oil to escalate in the future.  It would be very difficult to find people willing to pay increasingly higher delivery prices for oil if new exploration contracts were approved and drilling resumed on existing offshore wells.

The important thing to understand in regard to commodity price fluctuations is that they move in accordance with the number of people who are willing to purchase the commodity in question at a given price.  The advent of price collapses is nothing more than a by-product of chasing profits with leveraged futures contracts.  The same forces that compel people to pursue big money in commodity trading also compels people to sell their positions rapidly when prices decline, because of the high leverage they are using for their transaction.

Ultimately, price bubbles and price collapses are two different sides of the same coin.  All bubbles eventually end in a collapse, and collapses do not occur unless prices become disconnected from fundamentals.  In the end, market prices will always regress back to fundamentals over time.  It may take a series of gyrations, but the one principal that has born out throughout financial history is that no bubble can endure indefinitely.

 

It’s among the most important and difficult questions would-be retirees face: How much of my nest egg can I afford to spend each year?

The financial-services industry has some answers for you.

Some of the industry’s biggest players are introducing free or low-cost services that will help you convert your savings into a reliable stream of lifelong income. The products are aimed primarily at the millions of baby boomers who, though hesitant to hire a financial adviser, are unsure of how to spend their nest eggs without running a significant risk of going broke.

“People aren’t adept at figuring out how to translate a 401(k) balance into an annual income,” says Carol Waddell, vice president at T. Rowe Price Retirement Plan Services Inc., a unit of T. Rowe Price Group Inc. of Baltimore. “Many retirees spend their money far too quickly.”

Powered by sophisticated software, the services, which feature hand-holding from financial advisers, estimate how much a retiree can afford to spend annually. They typically provide advice on how to invest retirement savings to maximize the odds of making a nest egg last. In many cases, the sponsors can manage the money for you, issuing regular monthly paychecks.

Some of the services are more accessible than others. Fidelity Investment’s new Income Strategy Evaluator is open to anyone who walks into a branch, calls a toll-free number or logs on to the company’s website.

John Kuczala

In contrast, Charles Schwab Corp.’s Retirement Planning Consultation is available only to clients. Other services are reserved for participants in 401(k) and other defined-contribution plans. These include offerings from T. Rowe Price and several 401(k) advisers, including Financial Engines Inc. of Palo Alto, Calif., GuidedChoice.com Inc. of La Jolla, Calif., and Chicago-based Morningstar Inc.’s investment management unit.

What should you look for? Some services offer more comprehensive guidance than others. Those from Fidelity and Schwab, for instance, can take into account every source of retirement income available to an investor and his or her spouse—including Social Security, pensions and assets held in 401(k), brokerage and individual retirement accounts.

In contrast, T. Rowe Price’s Retirement Income Manager and Financial Engines’ Income+ offer recommendations only on drawing down assets held in 401(k) accounts. “Our target customer is a person for whom a 401(k) account represents a large share of retirement wealth,” says Christopher Jones, chief investment officer at Financial Engines.

The firms’ investment recommendations can differ widely, too. When structuring retirement portfolios, T. Rowe Price sticks mainly to mixes of stocks, bonds, and cash, or cash equivalents.

See how the typical household headed by an individual age 55-64 would translate their retirement savings into an annual income.

Financial Engines’ Income+ program moves about 80% of an average retiree’s 401(k) balance into bonds, says Mr. Jones. (The program sets aside a small portion to give the investor the option to buy an immediate annuity at any time up to age 85, thus securing an income for life.) To provide potential for growth, the company typically invests 20% in stocks, an allocation it gradually shifts into bonds as the account owner ages.

Fidelity takes yet another approach. Its Income Strategy Evaluator aims to cover such essential expenses as housing and food with highly predictable income sources such as Social Security and defined-benefit pension checks. Fidelity frequently recommends those with shortfalls plug the gap with annuities and mutual funds, says John Sweeney, executive vice president. But because annuities aren’t appropriate for everyone—and some people don’t want to purchase them immediately upon retiring—Fidelity also offers recommendations without annuities.

By ANNE TERGESEN

Article source: Wall Street Journal

 

Most people who have not been taking up residence in a cave are aware of Groupon, the web’s #1 group buying site and fastest growing company ever.  The notoriety of the company grew even greater when it turned down a $6B takeover bid by Google.  Many consumers are aware of the extremely low prices that are available through Groupon daily deals, but there is a basic problem implicit in its business model that may so the seeds of disaster for the small businesses that Groupon depends on for its revenue stream.

The Groupon business model is relatively simple, but quite powerful for generating profits.  The company sends out daily deals to its massive list of subscribers.  Those deals are from local businesses offering discounts that are typically in the range of 50% or more off of the retail price for their product or service.  The way that Groupon earns revenue from this is by collecting a share of the revenue that small businesses receive from their group advertisement.  Typically this fee is on the order of 50%.

The way that Groupon sells its services is by positioning a win-win proposition where local businesses get to attract a large wave of customers and Groupon earns half of the discounted revenue stream.  This basic concept has vaulted Groupon to the heights of media stardom.  However, there is a secondary effect of the Groupon business model that could spell disaster for local businesses and potentially for Groupon itself.  These dangers fall into two principal caregories.  The first is dead weight advertising, and the second is small business commoditization:

Dead Weight Advertising

Doing the math concerning Groupon’s business model shows a startling fact for business owners … namely that offering a 50% discount on your services, and then paying half of that discounted amount to Groupon means that you will only be left with 25% of your normal retail price.  In many businesses such as restaurants or other competitive business segments, this is not enough to cover variable costs and each Groupon customer results in a loss.  Thus, discounts through Groupon end up acting like advertising with a super-low sale price.  Typically, the desire on the part of business owners is to attract customers who will come back for a string of repeat business.

Unfortunately, what frequently happens is that the people attracted by Groupon are aggressive deal-seekers who will simply move on to the next low-priced promotion when yours is finished.  In this way, Groupon can become “Dead Weight” advertising, because it accomplishes nothing but attracting people who would not otherwise pay full price for your products or services.  In this case, the business would have been much better served with traditional advertising that emphasized the value of their offerings so that the people attracted to your business are those who will pay a higher price than what Groupon shoppers have come to expect (and in some cases demand).

Small Business Commoditization

The extended impact of the group buying phenomenon exemplified by Groupon is the fact that small business services have become commoditized.  With a consistent volley of deep discounts in people’s inbox from Groupon and all of the other group buying services, customers have become trained to expect substantial price reductions from small business vendors.  Thus, the “repeat customer” who previously came back regularly is now asking if you can meet the price of a competitor who is advertising a special deal through Groupon.  In this way, the extremely low prices funneled through Groupon have lowered the perceived value of small business services for customers.

Ultimately, this has become a textbook example of classical pricing theory … namely the dangers of deep price discounting to increase volume and grow market share.  When you establish a precedent of discounted prices, it lowers the customers perception of your product’s value.  You can most certainly gain more volume from discounts, but that additional volume results in lower profits.  Furthermore, most businesses find that if they attempt to start walking their customers up to previous price levels, they will begin to leave for competitors.

In the end, success as a small business is (and has always been) about providing a product or service that your customer values more than the price you charge.  This creates a perpetual win-win where the customer receives a product or service of value at a reasonable price and the business owner receives revenue that generates profits after the operating costs have been paid.  Attempting to short-cut this process through business fads like group buying at deep discounts can spell disaster for small businesses.

As time goes by, there is a risk that this small business disaster could become a Groupon disaster if enough businesses decide to stop offering their services through Groupon and the quality of their deals deteriorates.  As the deal quality declines, there will be less transaction volume, and lower profits.  If the trend continues too long, we could end up with a future Harvard Business Review case study for MBA students, warning them of the dangers implicit in trying to short-cut the ladder to success.