November 08, 2010
Commodities Are Risky, But Then So Are Governments
By Rob Davies
www.minesite.com/aus.html
As gold makes a new record high of US$1,389 an ounce, and copper, at US$8,521 a tonne, nears its previous high the financial media is at pains to point out how risky commodities are because they have gone up so much. But oddly enough few observers identify assets that have fallen as being low risk.
The fact is that all assets are risky and, as is neatly pointed out here, in an article entitled "Losing the Lender of Last Resort", from a blog which looks at the psychology of investing, there is no such thing as a risk free asset.
Which seems to mean that classifying assets by risk is simply an exercise in choosing shades of grey. There is no black, and there is no white, in this world of gradational risk. Of course, one reason commodities are deemed to be risky is that they do not generate any income. Fine, if you want income try some ten year Irish bonds at 7.7 per cent? Not good enough for you? - well how about the Greek version, they offer 11.6 per cent. In theory government debt is supposed to be risk free. Yet in reality, more governments have defaulted than not, usually at around the same time as one of the 120 bank crises that have happened in the last 210 years has hit.
In fact the problem is even worse than that, because some countries that have technically never defaulted, like the US, have done things almost of equal proportion. In the case of the US it suspended convertibility during the Civil War, devalued against gold in 1933, and finally ended the gold link in the 1970s. It has a track record of default through inflation.
Modern portfolio theory is built around the concept of a risk-free return as a base line from which to judge all other investments. Getting your head around the idea that there actually is something without risk is not easy. But without a frame of reference how can you measure anything?
This stuff is all very interesting in theory, but what has it got to do with real life? Lots, if you happen to live in one of the periphery countries of the Eurozone. Last week the sovereign wealth funds of Norway and Russia quietly let it be known that they viewed the bonds issued by Ireland and Spain as too risky.
The noises from German politicians about the need in some countries for bank bond holders to take some pain have also increased. Moreover, US financial policy is attracting withering Teutonic scorn as its currency fell 0.9 per cent against the euro. British politicians, though, kept quiet even as sterling rose 1.2 per cent against the dollar.
And the professional pundits are now wading into this stew of scary news. The respected commentator Samuel Brittan of the Financial Times has called for the Euro to be broken up, and Martin Wolf of the same organ has applied his intellect to describing exactly why the world cannot go back to a gold standard in this article, here.
In short it seems no one knows what is going on, and everything is risky. In many ways it looks as if the ingredients for another first class financial crisis are being assembled. It is rather odd then that the two asset classes most associated with risk - commodities and equities - both made good progress last week.
Could it be that in today’s Alice in Wonderland world of finance, assets that were once deemed risky – those same equities and commodities - are now viewed more benignly than assets, like dollars, that used to be seen as safe. How that apparent trend will develop is anyone’s guess. But, in the absence of a true risk-free asset, gold looks like being a better bet than most, despite Mr Wolf’s views.
Commodities Are Risky, But Then So Are Governments
By Rob Davies
www.minesite.com/aus.html
As gold makes a new record high of US$1,389 an ounce, and copper, at US$8,521 a tonne, nears its previous high the financial media is at pains to point out how risky commodities are because they have gone up so much. But oddly enough few observers identify assets that have fallen as being low risk.
The fact is that all assets are risky and, as is neatly pointed out here, in an article entitled "Losing the Lender of Last Resort", from a blog which looks at the psychology of investing, there is no such thing as a risk free asset.
Which seems to mean that classifying assets by risk is simply an exercise in choosing shades of grey. There is no black, and there is no white, in this world of gradational risk. Of course, one reason commodities are deemed to be risky is that they do not generate any income. Fine, if you want income try some ten year Irish bonds at 7.7 per cent? Not good enough for you? - well how about the Greek version, they offer 11.6 per cent. In theory government debt is supposed to be risk free. Yet in reality, more governments have defaulted than not, usually at around the same time as one of the 120 bank crises that have happened in the last 210 years has hit.
In fact the problem is even worse than that, because some countries that have technically never defaulted, like the US, have done things almost of equal proportion. In the case of the US it suspended convertibility during the Civil War, devalued against gold in 1933, and finally ended the gold link in the 1970s. It has a track record of default through inflation.
Modern portfolio theory is built around the concept of a risk-free return as a base line from which to judge all other investments. Getting your head around the idea that there actually is something without risk is not easy. But without a frame of reference how can you measure anything?
This stuff is all very interesting in theory, but what has it got to do with real life? Lots, if you happen to live in one of the periphery countries of the Eurozone. Last week the sovereign wealth funds of Norway and Russia quietly let it be known that they viewed the bonds issued by Ireland and Spain as too risky.
The noises from German politicians about the need in some countries for bank bond holders to take some pain have also increased. Moreover, US financial policy is attracting withering Teutonic scorn as its currency fell 0.9 per cent against the euro. British politicians, though, kept quiet even as sterling rose 1.2 per cent against the dollar.
And the professional pundits are now wading into this stew of scary news. The respected commentator Samuel Brittan of the Financial Times has called for the Euro to be broken up, and Martin Wolf of the same organ has applied his intellect to describing exactly why the world cannot go back to a gold standard in this article, here.
In short it seems no one knows what is going on, and everything is risky. In many ways it looks as if the ingredients for another first class financial crisis are being assembled. It is rather odd then that the two asset classes most associated with risk - commodities and equities - both made good progress last week.
Could it be that in today’s Alice in Wonderland world of finance, assets that were once deemed risky – those same equities and commodities - are now viewed more benignly than assets, like dollars, that used to be seen as safe. How that apparent trend will develop is anyone’s guess. But, in the absence of a true risk-free asset, gold looks like being a better bet than most, despite Mr Wolf’s views.
