Articles

What Risk Means to You

Before I make you paranoid about risk, keep in mind that it is ubiquitous and just a normal part not only in building wealth but also in living life. Heck, just getting out of bed in the morning could pose a problem. Here are the various types of risks (now that you are out of bed):

Physical risk Now I don’t mean that you may hurt your back from picking up precious metals (heavy metal is a different animal altogether). It just means that if you have gold in physical form then you have to understand that having it has risks as does owning any valuable property. You have to keep it safe. For some that means keeping your physical metal (such as gold, silver, and platinum) pos- sessions in a safe-deposit box at the bank. For others it means in a secure hiding place at home. You have to decide. Gold as a physical holding means you need to be con- cerned about the risk of loss or theft. Then there’s relative risk; in other words, what if your relative finds out? Removing some risk always means common sense. After all, if gold hits $3,000 an ounce, I don’t think you should be boasting about your investing skills at the local bar.

Market risk Market risk may be the most prevalent risk associated with gold. Market risk refers to the fact that whenever you buy an asset (physical, common stock, and so on) its price is subject to the ups and downs of the marketplace. In gold, as in many investments, the price can fluctuate and it could do so very significantly. What if you buy today but tomorrow there are more sellers than buyers in the gold market? Then obviously the price of gold would go down. The essence of market risk in commodities such as precious metals is supply and demand.Another element of market risk can occur when you are involved in a thinly traded market— in other words, there may not be that many buyers and sell- ers involved. This is also called liquidity risk.This can happen, for example, in futures. Although futures are usually a liquid market (an adequate pool of buyers and sellers) there may be some aspects of it when it might not be that liquid. Say that you want to sell a futures contract that you recently bought that is not an actively traded contract. What if there are no buyers when you want to sell? Your order to sell through the broker may sit there for a long time. The sale price of the contract would drop and you would lose some gain or even end up with a loss. Be sure to communicate with the brokerregarding how active that particular mregarding how active that particular market is.

Exchange risk This one sounds odd. What the heck is exchange risk? Well, it’s not a refer- ence to currency exchange; exchange riskis a reference to the risks that could occur at the exchanges where futures and options are traded. When futures and options are transacted at the exchange such as at the Chicago Board of Trade (CBOT) or the New York Mercantile Exchange (NYMEX), they are done so under the rules and regulations of the exchange. The exchange can either purposely or accidentally encourage market outcomes by chang- ing the rules and regulations on an ongoing basis.

Political risks Political risk is probably one of the biggest dangers that investors and specu- lators don’t see coming. It is the one that comes out of the blue and blindsides your portfolio. Politicalrefers to politicians who in turn run government. As far as we are concerned, political risk and governmental risk can be synony- mous. In my seminars I mention that politicians are Dr. Frankenstein while government is Frankenstein’s monster. The bottom line is that political risk means that government can change laws and regulations in a way that can harm your investment or financial strategy. This can happen in your own country or by another country. Consider what happened in the 1930s right here in America. In 1934, FDR and congress passed the Gold Reserve Act which made gold ownership illegal. Had you bought gold in prior years to preserve your wealth in the midst of the Great Depression, well . . . you were now out of luck. FDR then issued a presidential order fixing the price of gold at $35 an ounce which stuck for decades to come. FDR didn’t want private citizens to have an alternative outside of the official paper currency. Fast forward to our times. Political risk is alive and well (unfortunately). In many countries such as Bolivia and Venezuela, the government nationalized properties (government taking private property by force) by foreign compa- nies, among them, mining companies. Had you owned stock in these mining companies you would have seen the share prices drop. Sometimes the share prices drop at the mere threat of government action. In 2005, for example, the Venezuelan government mentioned that it may take property owned by the Toronto-based gold-mining company, Crystallex International. Its share price fell by a whopping 50% in a single day. Venezuela’s dictator Chavez did increase taxes on many foreign companies while nationalizing some industries (maybe he needed the funds to buy toilet paper from Zimbabwe).That’s the problem with political risk. As an investor or speculator, you could do all your homework and make a great decision with your portfolio backed up by great research and unflinching economic logic and still lose money because of a government action that could have been unforeseen.

The risk of fraud The risk of fraud is as real in precious metals as in every other human endeavor. It’s tough enough trying to make a buck when the market seems honest. But we must understand that as a market becomes popular or “hot” so it becomes a target for scam artists. Fraud can materialize in a variety of ways but I think that it can be safely categorized into three segments, which I discuss in the following sections: scams, misrepresentations, and market manipulation. Scams Scams are those events that the consumer organizations always warn about. The image is conjured up about those boiler-room operations where a slick con artist calls up a little old lady in Pasadena and talks to her about riches to be made in gold and silver if she could crack open her piggy bank and send off a nice money order chunk of her savings. This is certainly a real risk and it becomes more apparent when the source of potential fraud is popular. When Internet auctions became a hot consumer area, there were more Internet auction–related scams. When the real estate market became red-hot in 2005, there were more real estate scams. When precious metals become the “bubble du jour” then we will need to be wary of scammers here as well. Misrepresentations I put this as a separate topic because it can be a different animal. Basically the point is that you may put your money into a venue and you may not be getting what you think you are buying. A good example is what the respected silver analyst Ted Butler recently warned about regarding silver certificates. There have been millions of silver certificates issued in recent decades but there is the real possibility that there isn’t any real silver backing them up. In other words there are purchasers of silver certificates who believed that they could convert their paper into actual silver in due time but in fact will not be able to. That sounds like misrepresentation to me. Market manipulation Earlier in 2007, the financial media reported a serious matter regarding naked short selling among the smaller stocks. Short selling can send the stock’s price plummeting. Some large brokers and their clients have been caught ille- gally profiting through a manipulative technique called naked short selling. This was an especially egregious activity with the stock of smaller mining companies. In naked short selling,the perpetrator can sell massive quantities of stock essentially created out of thin air to force the price of the stock to come crashing down. Imagine if you owned shares of a small mining company and you saw the share price plummet by 40% or 50% or more for no apparent reason.