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Wednesday, August 24, 2011

Why not Gold Stocks?

There are so many shills, gurus, con men, and analysts out there touting the inevitable break out of gold stocks. The logic all has to do with reversion to the mean analysis. The argument - that has not worked for the last ten years - claims that gold stocks have always outperformed the bullion price in every gold bull market. They are lagging now. Therefor, at some point, they most explode upward.

First, let me say that reversion to the mean analysis is sloppy dim witted analysis. Because, as Nassim Taleb has conclusively argued in his seminal "The Black Swan," unpredicted events of massive impact (Black Swans) occur with such regularity in the financial markets that "The Mean" becomes meaningless for investment purposes.

Nevertheless, let's examine the current situation for reasons why gold stocks are losing money while bullion is exploding upward:

First: all stocks involve an enormous amount of trust on the part of the investor.

First, You must trust the management. You must trust they are honest and not stealing from the company in any number of ways. You must trust the numbers they deliver to the markets. You must trust that they understand their business well enough to take into account difficult to predict events of massive impact that could affect their production capacity.

Second, You must trust your government and how they will tax your gains from holding stocks, and how well they will regulate the industry you will invest in.

Third: you must trust the governments of the countries in which the company is doing business.

Fourth: you must trust the currency in which the stocks are traded. Is it stable? Is it strong? Is it appreciating?

Finally, you must understand that stocks trade at arbitrary multiples of earnings. As trust in the markets erode: MULTIPLES CONTRACT.

Slow-witted - or Dishonest - reversion to the mean analysts will argue based on suspect earnings projections that multiples may be at historic lows. But multiples can contract to any level depending on the level of TRUST currently in the markets.

How much trust do you have right now in corporate America? How much trust do you have in our government? How much trust do you have in our currency?

That's how well gold stocks will do versus gold bullion.

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