McQ wrote: ↑Wed Mar 22, 2023 10:05 pm
Gold: a deep out-of-the-money put?
The barbarous relic is sometimes described as a put against civilization. To my knowledge, such an option cannot otherwise be purchased, thus perhaps explaining investors’ passion for gold. A Treasury note backed by the full faith and credit of the hegemon does not provide such a put; rather, that Treasury note is civilization incarnate, whose collapse is precisely the thing you are trying to hedge against.
And right here we discover that there is not a single homogenous population of investors when it comes to gold. Consider instead the investor resident in and attempting to build wealth in Argentina. Their government issues a default-free instrument, same as the US Treasury; but of course, it is not the same as a Treasury note. Those Argentine government obligations have become effectively worthless again and again.
When the Argentine investor buys gold, they are not buying a put against “civilization.” They are purchasing insurance against the fecklessness of the local sovereign. Like the homeowner buying fire insurance, at most they can expect to be made whole.
It’s different for US investors, aka investors building wealth in the US in terms of the local currency; which isn’t a local currency at all, but foundational to … civilization as we know it. A US investor who chooses to buy gold may indeed be purchasing a put against civilization.
Contrary to my prior post, which used fire insurance as a metaphor, a US investor who purchases gold as an out-of-the-money put against civilization might reasonably be planning for a big, big payoff. If everything goes south.
Investors in most other domiciles can be arrayed in between the US and Argentina, as to whether gold is like fire insurance for a sturdy brick structure, or flood insurance for residents up a creek, or a deep out-of-the-money put that could give a stratospheric payoff.
Caveat: when I say the dollar is foundational to civilization as we know it, I don’t mean that fluctuations in its foreign exchange rate threaten civilization; I am talking about COLLAPSE of its value. The dollar could fall overnight by half against a basket of Euro and yen, and that wouldn’t qualify as “collapse” as I am using the term. Collapse means “almost no value left.” Like how much you can buy with an Argentine peso from three iterations ago, or what a paper mark was worth in Germany in 1923.
You bought a put on civilization and scored—now what?
There is no Options Clearing Corporation for a put against civilization. There is no financial authority, independent of civilization, who can guarantee that you will collect when you attempt to exercise your put by assigning it to … whomever.
You will have to do your own clearing. A little reflection will show that, per seajay, if you must do your own clearing then you will have to hold gold in hand. But that may not work out either.
The first two demonstrations show the folly of NOT holding gold in hand.
#1: gold on deposit
Everything has gone south. Some kind of worldwide destructive cyber hack, as far as you can tell. Internet and email are intermittent and when up, both the NY Times and the Washington Post sites are unresponsive. Likewise CNN. Not entirely clear what’s happening. Your bank is surrounded by sandbags and armed men. Local post office is boarded up. Rumors are supermarkets are only accepting $100 bills and give no change. If they let you in the door.
No matter. You, James Jones, are an NYC resident with $100,000 in gold in a secure depository, about 50 troy ounces. You have a receipt and you know the Depository address. Time to harvest your winnings.
You take your receipt out of the vault under your bedroom floor and head downtown. To the consternation of passerby, you are whistling. It looks like that put option you bought on civilization has paid off big time.
The sidewalk in front of the depository is deserted. You don’t pay too much attention to the brown stains on the sidewalk—dog owners who don’t pick up after their pets, g__d__n, you’ve always hated that. You also don’t give much thought to those small brass cylinders scattered in the corner.
You climb the stoop to the front door and press the bell. The speaker crackles: “Gold Depository, how may I assist you?”
“Hi, I’m a depositor and I’ve come to withdraw my gold, preferably in coin, but small bars are fine too.”
“Do you have a depositary receipt?”
You take it out, unfold it, and hold it up to the camera lens: “yep.”
“Please hold the receipt against the red light to the left of the door so that we can scan and authenticate.”
“Okay.” You press it up against the red light.
To your horror, a brown burn hole begins to appear in your receipt as soon as you place it against the red light. Before you can snatch it away, the whole piece of paper is aflame.
“WT6th letter!” you exclaim, shaking your burnt fingers as the fragments of ash drift down.
Klaxon sounds. Loud voice now, on bullhorn speakers overhead. “INTRUDER! You do not have a receipt! Back away. We are authorized to use lethal force to protect the depository from unauthorized intruders. Get off the stoop or die.”
You stumble off the stoop. Guess you do not own 50 ounces of gold after all. It appears that after civilization collapsed, unscrupulous individuals, with the aid of armed force, have seized your gold on deposit and made it their own.
Probably should have kept those 50 ounces under the floorboard, and not just the receipt.
Cashing in a put against civilization is really quite difficult.
#2: Gold in an ETF
Sam Smith figured it would be best to own gold in the form of an ETF. Let someone else deal with the hassles of physical storage. Own an instrument with complete liquidity that tracks the price of gold. Buy and sell at will within your brokerage account in fractions of an ounce, harvesting the rebalance premium as prices fluctuate.
Now assume the same cyber hack, same chaos. “Thank the Lord I don’t have to travel downtown,” says Sam. It was disconcerting to have no Internet access, but that was only for a few days. On Thursday Sam tries for the 20th time to log on to his brokerage account. Success!
He pulls up the account balance screen. “Whoa! My $40,000 of SPY is trading at $400,000! After civilization collapsed? What the …”
At that point Sam noticed an icon he hadn't seen before on the upper right corner of the account screen: “new/old $$”
He clicks on ‘old’. Now what had been $40,000 of SPY is requoted at $3,963. “Okay, that’s more what I expected from the collapse of civilization.”
Rubbing his hands: “Let’s see what my AUM is worth.”
As he scrolled down, a box with red print popped up: “Pursuant to Executive Order No. 369-23, on 04-20-2023 all the gold held on deposit by AUM was purchased for 5,000 new dollars per ounce. After clearing, the cash for your AUM shares will appear in your settlement fund.”
Sam screamed. “My $10,000 of gold is worth $100 in old dollars and losing value by the day! Arghh!!”
Sam tried to log onto Facebook to complain but couldn’t reach the site. Bogleheads was down too. Reddit didn’t come up at all.
Sam probably should have kept the gold in hand. Armed force, this time under the aegis of the State, has again seized his gold left on deposit.
If you were President of the United States in this time of crisis, would you proceed any differently?
It truly is difficult to clear a put against civilization…
#3: Option clearing for gold held in hand
Peter was way smarter than James or Sam. He kept gold coins—American eagles—in a strong box on his property. He’d never placed that much trust in civilization. And he was an America First kind of guy: “No point in owning Krugerrands—no way anyone would trust the gold content if push came to shove, it’s got to be American gold, minted right here in the US of A.”
Peter lived outside of town on a hobby farm. He sold most of his produce, as a better deal than using it to feed his family; but he derived comfort from knowing that they would never suffer scurvy, even if things all went south.
And then it all did go south. Peter stayed on the farm for weeks; no way it made sense to risk going into town. Finally, it came time to stock up on supplies.
Peter took one gold coin, his smallest American Eagle, 1/10 ounce, out of the box. “This should be enough.”
As he drove up it was disconcerting to see the sandbags outside the supermarket, and the boarded-up windows on all the stores he passed. At least, parking was easier. Peter joined the line snaking outside the door of All-Grocery. The line moved relatively quickly. Seemed the few people turned away were on the disreputable side, no one he knew. Peter waved at the doorman, a relative. Cousin Bob waved back but didn’t smile or invite him forward.
When he got to the head of the line Bob waved him inside. “You’ve got 20 minutes. Cash only.”
Peter looked at him: “Gold coin okay?” For the first time, Bob livened up. “Absolutely!” He snapped his fingers. A boy appeared with a freshly sanitized cart. “Use this one, Cuz.”
Peter looked around once he was inside the store. Slim pickings on the fresh produce counter, not much in the way of fresh meats. Frozen cases looked pretty well stocked, and the canned and packaged goods aisles looked normal.
Peter started loading his cart. When it was stacked to the top he headed to the cashier. He observed most people in front of him paid with $100 bills, but they didn’t look the same as the bills he remembered. More colorful. Lots of gold typeface and shiny threads.
As Peter started to load his groceries on the belt he flashed the American Eagle coin. “Okay if I pay with this?” The cashier nodded so rapidly his glasses went askew. “But I’ll have to call a manager, the exchange rate changes hourly and only he can authorize how much change I give you.”
Peter shrugged and kept loading the belt. When the manager appeared, he seemed surprisingly apologetic, verging on the obsequious. “Sir, before we accept your gold coin I have to disclose to you that any change we make will be in paper bills, even though you are paying in gold.”
“Okay …” said Peter, bemused.
The cashier, who had finished ringing up, looked sharply at the manager: “I don’t have enough $100 bills in the tray to make his change, sir.” The manager went off to get more. Peter stared after him, rubbing his chin.
With the groceries bagged up, and the manager having dropped off a fresh supply of bills, the cashier started counting out change. It was … uncomfortable how everyone in the line stared.
“There you go, sir, $32,300 in change, three-hundred-twenty-three $100 bills against the $250,000 value of your gold coin at 2pm, less your purchases.”
Peter was stunned. But he had enough presence of mind to scoop the three bundled stacks of $100 bills into his pocket, while holding the loose 23 bills in hand.
“Help you out sire?” The bagger had everything loaded and was ready to wheel out the cart.
“Sure.”
With the truck loaded, Peter peeled off a bill and handed it to the bagger—who took it sullenly and strode away without a word.
“Huh--a $100 tip and that is the look I get?”
Peter shook his head and got into the truck cab. Driving off, he reflected: “gold—best investment I ever made.”
As he drove off, Peter didn’t notice the blacked-out SUV leaving the parking lot behind him. When he turned off the main road, and made the hog leg turn onto the side road, he didn’t notice that the SUV turned off the main road too. Peter was too busy whistling to the tune of “Happy Days Are Here Again,” while trying to remember just how many American Eagle coins he had put in the strong box over the years. He’d have to count them after the groceries were put away.
Four miles beyond where the pavement stopped, Peter pulled up in front of his house. He grabbed the frozen goods first and headed inside to relieve himself before unloading the rest.
When he came out of the bathroom Peter froze. Two men in ski masks carrying AR-15s were in the living room. Peter’s Glock was on the hall table just behind him, where he always put it whenever he returned from a trip out.
[You’ve watched enough pulp fiction to visualize what happens next.]
The last thing Peter heard before bleeding out was: “Take down the curtain rods and shake ‘em. Check for loose floorboards. Remove all the pictures, clear every closet and thump on the drywall. Let’s hope we don’t have to burn the place down to find where he stored his gold.”
It is very, very difficult to self-clear a put option against civilization. Even with gold in hand.