Be humble – or the market will do it for you

A few weeks ago, I wrote about a generational war that is happening among gold investors.

My Gen X friend told me that he’d bought gold out of fear, so did his colleagues and friends, he argued.

For his demographic, the distrust of the government was their main reason to buy alternative assets like gold. He added that he feels the generation after him, Gen Y, are far too optimistic and that using fear to invest in gold won’t work.

I disagreed, saying “… thanks to the effort of libertarian-leaning baby boomers and Gen Xers, millennials are going to embrace the shiny pet rock.”

The war of words is not yet over, but after writing that article, I received an email from a reader asking me, why would I call gold a pet rock?

That, dear reader, is an excellent question.

And a timely reminder that not everyone has spent as much time around gold enthusiasts as me.

For those in the gold industry, the phrase “pet rock” has been around for some time. Those who can’t stand gold, use the phrase to ridicule those who invest in it. For those who are passionate about gold, they use “pet rock” in an affectionate way.

However, the phrase itself came from Wall Street journalist Jason Zweig, who wrote an article in July 2015 called “Let’s Be Honest about Gold: It’s a Pet Rock”, saying:

Gold is supposed to be a haven amid hard times and soft money. So why, even as Greece has defaulted, the euro has sunk against the dollar, and the Chinese stock market has stumbled, has gold been sitting there like a pet rock?

… making Zweig’s analysis all the more sound at the time. Afterall, if these catalysts weren’t driving gold higher, what would? Zweig continued:

Many people may have bought gold for the wrong reasons: because of its glittering 18.7% average annual return between 2002 and 2011, because of its purportedly magical inflation-fighting properties, because it is supposed to shine in the darkest of days. But gold’s long-term returns are muted, it isn’t a panacea for inflation, and it does well in response to unexpected crises—but not long-simmering troubles like the Greek situation. And you will put lightning in a bottle before you figure out what gold is really worth.

Even rusted-on gold fans would struggle to refute this. Gold wasn’t performing in spite of having the idyllic macro set-up. A week after Zweig wrote this, gold fell even further, then to a five-year low of US$1,075 per ounce.

By December 2015, gold dropped all the way to US$1,04, a six-year low.

Gold, it appeared, was done.

Double or nothing

Too often people buy gold because they have this zealot-like belief in its monetary properties: that it is the one true form of money, and that governments must pivot back to gold.

Anyone who has studied currency will tell you we people are a clever brunch. The concept of money is as old as bartering, and gold is just one form of a medium of exchange. Anything can be currency if the other person is willing to accept it.  

Which is partly why non-gold analysts will be dismissive of the yellow metal when it isn’t doing what it’s traditionally expected to be doing.

Almost one year later to the day, Zweig wrote again, doubling down on gold being a wasteful investment:

Almost exactly a year ago, this column called gold a “pet rock” and said investing in it is ‘a leap in the dark.’ Gold traded then around US$1,130 an ounce. This past week, it surpassed US$1,360. Gold is up 20% since I ridiculed it; the U.S. stock market, measured by the S&P 500 with dividends reinvested, is up less than 1%.

“If you’re wondering, perhaps not for the first time, whether Jason Zweig is a moron, rest assured that you aren’t alone. I’ve been wondering that, too.

[…]

The future can always be different from the past. But if gold shoots far up from here, it won’t be following the precedents of the past. It will be violating them.

So am I a moron? On many things, yes. On gold, I don’t think so.

Gold had seen a strong rally, but Zweig was having none of it. Sure, he pointed to the reasons why people like to own it. It’s insurance. It’s been used for a millennium as a reliable currency. It does well during periods of stress and has the ability to preserve its purchasing power for remarkably long periods of time.

The problem with that remarkably long period of time, Zweig would argue, is that “people don’t lock their money up for a thousand years at time” and that “gold fluctuates so wildly that it is a poor hedge against the increases in the cost of living”.   

Again, all good reasons why not to invest in gold.

Gold does nothing for very long periods of time. Gold does so little, it doesn’t even rust. The problem with gold isn’t that it’s useless. It’s that it’s useless, until it turns out to be very, very useful…

If you’re going to be wrong, be wrong quick

When it comes to the markets, there is one rule: stay humble or the market will do it for you.

Zweig found that out the hard way.

Come July 2020 – exactly five years on from calling gold a pet rock – Zweig was forced to reckon with his past work. Humbly writing that month in an article called “A Golden Rule from a Golden Fool”:  

Almost five years ago to the day, a market commentator with a prominent platform called gold ‘a pet rock.’ Since then, gold has risen nearly 70%, hitting an all-time high this week.

That market commentator? Yours truly. How wrong was I, and what can we learn from my mistake?

Oh, was I ever wrong. The yellow metal didn’t sit inert. Since I wrote that column five years ago, gold has returned an average of 10.5% annually—barely below the gains on U.S. stocks. And so far in 2020, it’s up 24% even as stocks are as flat for the year as…pet rocks.

What is the biggest lesson we can learn here?

You’d think, as a passionate gold investor, that I’d take this opportunity to jump with glee, call Zweig all sorts of names and bathe in glorious righteousness.

Instead, the conclusion to today’s article isn’t even about the benefits of gold or why Zweig got it wrong (we’ll dance with that topic next week).

The answer here today, is that it’s ok to be wrong.  

Being right all the time when investing means that you’re either playing it safe, or lady luck is driving.

Don’t get me wrong, being wrong sucks. It often means losing money and that hurts. But once you’ve licked your wounds, get back to basics and ask yourself what went wrong.

Ask any institutional trader their market war stories, and the good ones will almost always start with the time they lost “big time”. If they start with their wins, run.

They are yet to be humbled by the market and don’t have anything to teach you.

Look, I’ve got a couple of bruises myself from over a decade of investing and trading. There’s been genuine tears on one very bad trading night too. The point is, it didn’t stop me from investing. Rather, it forced me to get better at it.

Losing money is the hard way to learn a lesson. Don’t squander the teachings though. Review why and move on.

Unlike our mate Zweig, if you’re going to be wrong, be wrong quick. Don’t take five years to figure it out.

Until next time,

Shae Russell
Co-editor, Exponential Investor