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ABC Bullion

Gold as a Call Option

19 February 2015

One of the better publications I’ve come across this week came courtesy of Australian financial news site Livewire Markets, a source I visit (and occasionally contribute too) everyday. This week they contained an update from Freehold Investment Management, which correctly highlighted that cash, even though it’s low yielding, is still a valuable part of a portfolio.

Here is an excerpt;

“Just because cash is not ‘high returning’ does not mean it is not valuable… A major assumption regarding the attraction of the ‘yield trade’ is cash is an impaired asset class because it is earning such a low return. We strongly disagree. Despite cash providing little return, it provides an optionality that has value. Warren Buffet for example, thinks of cash as a call option over every asset class and with no expiration date. The question Buffet asks is “how much can the cash return if I have it when I need it to buy other assets that are cheap, versus the upfront cost of holding it?”.

Nassim Taleb, author of The Black Swan also highlights that the optionality of cash allows the holder to buy assets from people who are over exposed when a crisis hits. “Let’s assume that you have cash in the bank and there’s a big crisis. You have dry powder. You can buy anything you want. Cash is the opposite of leverage.” Conclusion: Despite cash returning little in real terms, it still has value in a diversified portfolio”

You can see Freeholds report here.

I couldn’t agree more with this kind of analysis, and it’s why I’m happy to hold cash in my portfolio today, even though I know it’s going backwards at the rate of inflation minus interest (what little of that there is).

It also helps highlight why I have such a large allocation to physical gold and silver in my portfolio, for they are the ultimate form of cash.

As Jim Grant once said, “nothing beats a little cash in a bear market, of course, and the oldest form of cash is gold”.

Now of course if volatility is your primary concern, then cash will be preferable to gold, as it won’t move around in price on a daily basis. But if preservation of purchasing power, and the elimination of counterparty risk are also concerns you’re trying to allay, then gold will prove a far superior option.

Indeed a look at the 5 worst years on the ASX since the 1970s will highlight, gold has provided a superior call option to cash in most instances, and often by a substantial margin.


As you can see, gold has been a far superior call option to cash itself if one was looking to capitalise on falling prices for risk assets like shares. And over the long run, it's almost guaranteed to be a better (if not only) call option, for the very reason that, unlike cash itself, gold won't be ruined by inflation.

For as Matthew Mclennan, an Australian Fund Manager based out of New York, where he runs circa $80 billion in assets for First Eagle Funds once commented; "The paradox of gold is that its utility as a monetary reserve is its uselessness as a commodity. ….. And as it does not rot, rust or waste, it is not just resilient but also a natural resource perpetuity, out-lasting corporate fads and sovereign regimes."

That comment comes from an excellent and very wide ranging interview that Mclennan had with Chris Joye at the AFR, the full transcript of which can be accessed here.

Jean Marie Eveillard, Mclennans predecessor at First Eagle, also understand the value of gold, and it’s role as the ultimate call option over financial assets. In a early 2015 interview with Consuelo Mack of Wealth Track, Eveillard was asked what would be the one asset class he thinks every investor should own. “My answer would be gold bullion” was his reply!

According to First Eagle’s January 31st, 2015 portfolio composition report, some 9.65% of their portfolio is in precious metal related investments, it’s third biggest exposure outside of technology and industrials.

Their latest portfolio is viewable here.

Conclusion: Despite the volatility and the lack of yield, investing in gold and silver is an incredibly prudent thing to do. By doing so, you’re doing the same thing that many of the world’s central banks and some of the most sophisticated asset managers on the planet are also doing. There is no need to change approach.