Protecting yourself from market risk

[markymark]

Hi,

I want to give some good advice on how to protect yourself from market risk. I'm sure some of you already practice this. It might even be mentioned somewhere on the forum but I didn't see it. I've read and see that some of y'all lose money when gold goes down. You guys have given me a lot of great advice so I'm going to return the favor with this piece of advice.

So when the market goes down before you refine and sell your gold, you lose money, right? It doesn't have to be that way. There's something I learned in college. It's called hedging. When you buy gold to be refined, it's like taking a position in gold on the commodities exchange. What you need to do is simultaneous sell short the gold that you buy. As refiners, you shouldn't be gambling on the price of gold. That would be senseless. The big boys hedge their gold by taking by selling futures contracts and buying put options. To do this, you need 100+ fine troy ounces minimum . I'm sure some of you have this much gold but I for one, don't. I usually have, at any given time, 10 at the most. So how to I protect my small amounts? I buy inverse gold ETFs. These are funds that you can buy just like stocks. You can buy them online from any brokerage, such as E-Trade and Charles Schwab. My favorite ETF is DGLD. It moves 3x the inverse of gold. So for example, if gold goes down 3% on a given day, DGLD will go up in value by 9%. Here's an example: Let's say you have $30,000 worth of fine gold and today's price is $1575/ozt. Gold tanks $100 like it did in February, to $1475. This means that your gold is now only worth $28,000. For a lot of us, 2k is a lot to lose. To prevent something like this from harming you, what you do is buy $10,000 worth of DGLD. When your $30k gold position depreciates to $28k, your $10k DGLD position will have appreciated to $12k (it can of course diverge a little bit, but not by much). Your net gain/loss is zero.
I do this all the time. I've tested it in real practice. It works. In fact, I'm going to buy some shares today to cover the gold I bought over the weekend. I always maintain a proper level of shares given the amount of gold I have.
As final note, you should diversify your ETFs if you can. That's what my finance professor recommended to me. There are 3 other inverse-gold ETFs that do the same thing. The are: GLL, DZZ, and DGZ.

 

[Dan Dement]

Marky,

Or you can sell your gold and lock in the price. My preferred Refiner will lock in the price up to about 2 weeks and avoid the up's and down's. Instead of playing the futures games, you can also turn the gold more often. I find that selling twice a week or 600 grams level is a safer way of doing it, Of course, your always going to get caught on some weekends but that is the nature of the beast. Turning your investment 100 times a year will be more profitable than playing the highs and low of the market for me. When you get to the level of the Big Boys, the super small margins and overhead becomes more of a Banking Business than Refining. Personally, I think the first rule and most important issue, IS What is the actual purity of the metal you have! As time marches on, the Big Fish eat the Little Fish! In a maybe declining market with margins of 1% and Profit margins even less, it always boils down to What do I really have!

Thanks for your input,

Dan

 

[kkmonte]

How I look at it, is the gold that I buy/refine i'm planning on keeping long term (30+ years). Just because the price of gold goes up and down now, I'm don't actually lose money unless I sell. Just like my 401k that went in the toilet 5 years ago, its finally back to where it was, I never actually lost 50% because I didn't get out of it, i just was patient and it came back.

 

[element47.5]

Yes, it works. And I am sure any good sized bullion dealer does this. But as one does this with/in stocks the temptation to "play"; eg speculate is ever present. I bring this up only as a caution, because unless you dispose of your hedge at the same moment you dispose of your physical, in other words you REFUSE to price-speculate, the sale of either leg unhedges you, and by default, you are engaged at that point in a directional bet in some [other] way, typically the opposite of your [natural] gold long. That is not necessarily a bad thing, again, I only bring up the need to dispose of your hedge at the same moment you dispose of your underlying.

 

[NobleMetalWorks]

1. Purchase the material you refine

2. Purchase the material you refine for 25%-50% of it's real estimated value

3. Keep track via an excel formatted sheet or other method, how much gold you purchased for whatever price

4. In your excel sheet make available a column that accumulates the amount of gold you can sell, at whatever percentage you wish to make

5. Whenever you need money, check your excel spreadsheet and sell whatever you need that exists in the column at the percentage of profit you desire to make

6. Rinse-repeat

Make your profit when you purchase material and you will never have to worry about attempting to make it when you sell your material. Safest/easiest way to insure you make more money than even your competition.

Scott

 

[markymark]

I only bring up the need to dispose of your hedge at the same moment you dispose of your underlying.

Yes, I always close my hedge positions as soon as dispose of my physical. My refiner won't lock in the price unless they physically receive my material. That's when I lock in the price. I lock in the price with the refiner at the same time that I close my ETF position. I can do it from my smart-phone once the refiner gives me the word. As for weekends--yeah. I get burned sometimes. And sometimes however, the market moves to my benefit of course.

Make your profit when you purchase material and you will never have to worry about attempting to make it when you sell your material. Safest/easiest way to insure you make more money than even your competition.

I wish it were that way! I make my money on the sale. I'll buy karat scrap from anywhere up to a maximum of 85%. To make money this way, safely, I absolutely must lock-in the price as soon as I buy my scrap.

 

[markymark]

I've been thinking deeper in to this and I must add another point. All along, I had been doing this slightly incorrectly. The reason is that when the market makes big moves, adjustments must be made to the hedge. For example, let's say I've got $30,000 worth of gold and $10,000 worth of DGLD. A day goes by, the gold is now worth $25,000 and the DGLD, $15,000. Unless I sell some DGLD, I'm way overhedged. If my gold goes back to $30,000 the next day, I'm screwed. To remedy this situation, I sell some of my DGLD and bring it down to a level of $8,333. This brings it back to level.
So, if any of you actually take my advice and use this hedging method for real, make sure you make adjustments for big moves in the market (You need not bother with small to medium movements... commissions will add up and be very costly). If you you're hedging with DGLD, you need to always make sure that the value of your DGLD is about (1/3) the value of your gold, as the market changes.

 

[Lou]

Sounds pricey. What's wrong with using Scotia?

 

[element47.5]

I don't have direct experience with your double-triple inverse gold ETFs, but I DO have experience with such stock market items such as SDS, SSO, SRS, etc; If your triple inverse is something you need to hold for let's say a month and its behavior is like SSO, SDS, SRS you are asking for problems.

These things are EVIL, if your intention is to use them for more than a few days at a time. Why?

Because there is a vicious, erosive piece of mathematics behind them.

Suppose you have a triple inverse something or other. You are long the underlying at let us say $1000. You buy 333 shs of the triple inverse as a hedge. So far, so good.

Next day, gold drops 5%, $50. Your hedge rises 3 * 5% = 15% (in money terms, which is all that matters) and you are, well, golden.

Next day, gold rises 5%. Your hedge falls 15% of 115% and closes at [the equivalent of a market short bet at] 97.75

Next day, gold falls 5%, Your hedge rises 15% of 97.75 to 112.41

I am probably not conveying the net effect of this, but the basic idea is that when an underlying falls 10%, it takes about an 11% gain to get back to even. If an underlying falls 20% it takes a 25% gain to return to breakeven.

Google "etf erosion" for any number of explanations easily better than I can assemble here. The point being: In a choppy market, these multiple etfs erode, erode, erode and will require some sort of fairly continuous adjustment to keep you hedged.

Now, if you own your physical long and wish to short GLD, a 1:1 etf that gives you price exposure to the market variations of the spot gold price, then I am fine with that. But these double, triple funds are in fact very sophicticated trading vehicles, and if you own them more than about 3 days and they haven't done what you want, you're almost always better off just getting rid of them. Don't get me wrong, they can be serious money makers but they pretty much require at least 2 and preferably 3 up (or down) days in a row of single direction movement of the underlying. If held long than that in a choppy market, the erosion is simply alarming. When folks wanted to short the market and casually bot SDS, they found their shares going from the 300's down to 40. Simply ghastly losses.

 

[butcher]

I can barely understand all of this talk of speculation of digital gold hedging, and but it all sounds like putting a quarter in a slot machine, and pulling the handle and hoping some coins drop out, or at least you get your quarter back before you go home.

I never played that game and I do not plan on it, seems to me they always get more quarters than they give, maybe that is why people call them one arm bandits, I still do not know why someone would drop a quarter into something they know may very well take their money, I guess the lure of getting more than they put in is too strong, and they will risk loosing everything on hope of a gain, Me I may not gain much by not playing that game, but I also do not lose what I have worked for.

I just feel safer with burying my little gold button, I know it will stay there, where I put it, I can get it when I have to, and it will most likely go up in value over time, if gold drops well that is fine too I will just use my paper printed money, which would be worth a few more penny's with gold price down, and leave the button there in the ground for that rainy day.

Buying paper gold in this market not me, I do not want to play with bandits, I want to hold real gold, at least till it is put back in the ground where it belongs.

I would rather have a small button in the hand, or in the ground, than have a piece of paper saying I had hundred in the bush somewhere, pull the arm and maybe some may drop out.

 

[element47.5]

Butcher, if I may, you are expressing a marked preference for physical over paper, and that I understand well. But at some level, it is a "faith-based" stance. I myself do not hedge my physical PM stash...but part of that is the fact that I own all my silver at about half of its current market price. Your gold and my gold is not especially for sale. You and I, while we may check the price of gold/silver often, perhaps even too often, do not rush to sell gold on a $5 drop or even a $50 drop. (Gold I own MUCH higher than silver, circa $1550.)

But the idea is that if you are a dealer or a reseller and you are sold out and have to go buy gold today, at market, or face being out of business, then some price protection is something many wish to create for themselves. It's strictly a preference. Additionally, if you are a reseller, then you can't so much be a faith-based guy because you'd never sell. It is absolutely true that hedging can equally well keep one out of gains as well as protect one from market declines. What drives you (generic you) Fear? or Greed?

At $5-6-7 and $11-$15 silver, I was entirely confident that the stuff could not be dragged out of the ground, mashed up, melted, assayed, ingotized, and brought to a point of sale for such a price. I always liken it to a slice of bologna for a penny: You cannot birth the cow, raise the cow, feed the cow, slaughter the cow, package the cow, and bring the cow to market for such a price. It is below the cost of production.

Here's some rolls of junk quarters I was buying in 2001. $3.x face.

 

[butcher]

element47.5
I do like reading this stuff, although right now I must admit it is hard for me to understand it all, but I also know the more I read about it the more I will understand, so keep up the good work, and I will keep trying to learn more about it, I just like real gold, paper in the melt does not come out as pretty.

 

[glorycloud]

I just like real gold, paper in the melt does not come out as pretty.

:lol: :lol:

 

[element47.5]

Hi Butcher, since you take the time to explain & share so much of what you know re: refining. perhaps I can help you understand the notion of hedging. For this, I will use two opposite-direction and roughly equal-magnitude items in the stock market. Note that the OP suggested using a contra-item that moves 3x the price of gold. Although this is doable, it is a lot more sophisticated than the little tidbit below. Consider the following chart:

Here we show two securities, they happen to be called "etfs" exchange traded funds, but that is not important. What is important is that they move opposite each other in roughly (but not exactly) equal amounts. One is "DIA" a synthetic fund that is supposed to mimic the performance of the DJIA Dow Jones Industrial Average. Blue. The other item is also a synthetically created fund, DOG, intended to mirror the DJIA, symmetrical about the 0-line, the X axis. Green. (actually, the two are symmetrical about a hosizontal line at about -4%, but let us not quibble.) One thing you can see is that DIA, over the selected period, rose about 21%. DOG, however, fell about 27%, so the hedging performance is not perfect. That's over two years. Nevertheless, the illustration is valid, IMO.

In the case of physical gold, one would probably buy their physical gold and short, or sell (yes, without owning it) GLD, another synthetically created fund whose purpose is to mimic the performance of the spot price of gold. This would require a stock market margin account. There are a few other ways of doing just about the same thing, but I am trying to keep the illustration simple.

There are many conceivable uses for these items. (returning to DIA/DOG, the chart)

Consider May of 2012. Suppose you are generally long (are the owner of) stocks that you bot around the first of 2012. The market has advanced to a new high and is up about 10%. That's considered a decent year, and you hear the expression "sell in May and go away". So you begin to have some concern that the market will take back what has given you. One way is to sell out of your position(s). But if you like being in stocks, it is very, very hard to duck out of the market (with your gains) and re-enter at what you perceive to be some opportune moment after the market has corrected downwards. So another approach is to buy DOG at what you think is the top of the current ramp. So in May '12, you buy DOG, in roughly equal share amount to what you hold in stocks. WHILE YOU HAVE BOTH, eg; are "hedged", what one gains, the other one loses, so you are pretty much invulnerable to a change in value. Absolutely, if the market keeps going, your DOG hedge will fall in value and you will not get any benefit out of owning your stocks (other than divs) Fast forward to June. Sure enough, as you suspected, the market falls about 10% over the course of the next month, going almost all the way back to where it was 1/1/12. Now you have a decision to make. (or not!) Ideally, you would sell DOG, which has risen about 10%. Your overall port value has not changed because again, while you held both, what one gained, the other one lost. So in June, you sell your DOG, it's up 10% from where you bot it. Your other stocks have indeed fallen in value, but that loss in value has been offset by the gain you made in DOG. You sell DOG, and now you are straight long again. Well look at that, the market completes its correction and starts north again. Arguably, you have reduced your risk because even unhedged, with your straight long stocks, those stocks are cheaper now and there's an argument to be made that the market will perceive them as not being so pricey as they were in May.

That's (one way) how it works. Can you get it wrong? Absolutely! You can mis-time when you buy the opposite-way hedge. You can mis-time when you SELL the opposite-way hedge. You can try to be a wiseguy and DOUBLE the amount of DOG you buy, really trying to profit on the give-back. Nobody can predict the future: however, WHILE YOU OWN BOTH, your overall value does not appreciably change.

 

[butcher]

element47.5
I have just got back around to reading this topic, that was a very good explanation, thank you for taking the time to explain hedging.

 

[nickvc]

Not strictly on subject but if you want to read how badly things can go try reading Nigel Goldman How I Blew £14 Million Pounds... I found it amusing and even more so as I knew him and the company I used to work for did big business with him, he even tried to buy their old offices.