Unconventional wisdom: Has speculation run rampant with gold and crypto?
Much is made of the difference between speculation and investing but we all need to play a game we can win.
Conventional wisdom is a byproduct of groupthink that presents solutions good enough for the average person while simultaneously not being right for any individual. You follow it at your peril. Each Monday I will challenge the investing norms that just may be holding you back from living the life you want.
Unconventional wisdom: Has speculation run rampant with gold and crypto?
“Another great evil arising from this desire to be thought rich; or rather, from the desire not to be thought poor, is the destructive thing which has been honored by the name of ‘speculation’; but which ought to be called Gambling.”
- William Cobbett
My walk to work takes me through Martin Place in Sydney. In recent weeks I have started to notice a daily queue. Another cult croissant purveyor from Melbourne? Thankfully no. A cheap coffee? Unfortunately not.
The people are lined up to purchase gold from ABC Bullion. The line is once again proof that people will buy anything once it has already skyrocketed in price.
In the past three years the price of gold is up around 144%. Crypto is up more. The price of Bitcoin has increased more than 500%.
Against my better judgement I will be wading into gold and crypto today. But I’m going to try to do it in a way that is universally applicable to all investors.
Why it is easy to dismiss gold and crypto
The way that people like me dismiss investing in crypto and gold is the cash flow argument. It goes a little something like this…
Future cash flows are the key input into any valuation approach. Since crypto and gold don’t generate any cash flows there is no way to value them. That means that anyone buying them is a speculator who might as well be collecting beanie babies in the vague hope that somebody will pay more for them down the line.
I believe in this argument. To me the share market is simply cash flows. For instance, in 2024 the S&P 500 had an earnings yield of 4.14% and a dividend yield of 1.25%. That means for every $100 invested in the index the companies you own generated $4.14 in earnings and paid $1.25 in dividends.
You can reasonably argue that is too much to pay for those cash flows but you can’t dispute their existence. You can’t dispute that owning a business that generates cash is a good thing. Those cash flows are what underpin the value of the share market.
There are some readers who will nod their head in agreement with that argument. But there are others who will think I’m out of touch and overly academic in my definition of investing. They may be right. That is why I’m going to dig a little deeper.
Animals that act without thinking
I recently made my friend’s daughter cry. I suggested that kangaroos weren’t the smartest members of the animal kingdom. She is an animal lover and told me I was being insensitive to her feelings. Her distress was obvious. Her logic less so.
This conversation started when I showed her my video of kangaroos on a golf course. You are likely familiar with the behaviour I filmed.
One of the kangaroos heard something and froze. Then the whole mob did. There they stood with ears twitching in unison to pick up the source of the sound. Once one made a move you know what followed - they all started bounding across the fairway.
This is classic herd mentality. It is a frequent topic of discussion in the investing world and not behaviour any of us aspires to. It is easy to see that the people lined up in Martin Place are doing the same things as the kangaroos. But there is a little more nuance involved.
The recursive thinkers of the animal kingdom
We are not animals. We can do something that nothing else on this planet can do. We can think about what others are thinking. This capability allows us to do wonderful things and not so wonderful things. We can be loving and anticipate the needs and desires of others. We can manipulate people. And we can speculate on investments.
The ‘theory of mind’ references the human ability to think, know, perceive or feel what others think, know, perceive or feel. It isn’t just thinking about what somebody else is thinking. It is anticipating what they will do next.
Think about a game of chess. A good chess player is not just randomly moving pieces around a board. A good chess player is anticipating what their opponent will do based on each move. A great chess player is anticipating multiple moves in the future.
This is called recursive mentalising. That is psychology speak for the social coordination that takes place around things that are considered common knowledge. Recursive mentalising builds on the theory of mind.
The foundation of our ability to anticipate how others may act is common knowledge. Common knowledge is like the rules of chess. Both players know the rules which allows them to try and anticipate the next move of the other player.
A good example of this is money. Money used to be made from precious metals. It was valuable because coins were made of silver or gold. When paper currency was introduced it was backed by precious metals. People were confident it had value because they knew they could exchange it for gold sitting in a vault.
Once the gold standard which linked the money supply and gold reserves went away the value of money lies in the common knowledge that it is valuable.
That underlying common knowledge that money has value allows us to anticipate how people will react to money. You can influence behaviour with money because people can use it to get things they want and need.
What does this have to do with gold and crypto?
For thousands of years gold has been a store of value. Logically this makes little sense. Gold isn’t particularly useful in comparison to other metals. It isn’t the rarest of metals. It is malleable and it can be crafted into jewellery - but so can silver, aluminium and copper. It can be argued gold is beautiful. But lots of things are beautiful.
Trying to logically understand why gold is valuable is meaningless - it just is. Over thousands of years the common knowledge that gold is valuable has been established around the world.
Crypto is a little different. It has not been around for thousands of years as Bitcoin wasn’t invented until 2008. In this case we are witnessing the process of something becoming commonly accepted as valuable.
This process should be familiar to the Morningstar community. It is the network effect which is a moat source. A network effect is anything that becomes more valuable as more people participate.
Markets are a textbook example of the network effect. The more people that believe investing in the share market is a way to make money the higher it will go. The same is true about crypto.
I can keep making my argument about crypto not having cash flows but it will keep going up if more people start to believe in it. It isn’t a stretch to suggest that for younger generations it has become common knowledge that crypto is valuable.
Even the biggest cynics – and I’m up there – must admit that crypto has been resilient. It has survived steep price falls. It has survived Sam Bankman-Fried. People keep believing in crypto.
Are share market investors any better?
It is easy to turn your nose up at gold and crypto investors. There are elements to some of the justifications for holding gold and crypto that are a bit doomsday for me. I’m just not sure what benefit I will achieve from dedicating 5% of my portfolio to a hedge against the downfall of society.
Some of the explanations for gold and crypto price movements also seem to lack common sense. But many share market investors aren’t that different.
If you spend time with professional fund managers you are likely to hear the word ‘catalyst’. A catalyst is an event that will move a share price over the short-term. A catalyst is the opposite of letting a thesis based on fundamentals play out.
For all the talk about being long-term investors most fund managers are the opposite. Individual investors won’t use the word catalyst but most have short-term outlooks and abandon holdings quickly if they underperform.
Most share market investors are simply trying to anticipate what other people will do over the short-term. This is no different than anything happening in the crypto and gold markets.
All this speculation vs investing business may just be semantics. Speculator is just a label you put on people who invest differently than you. What matters is what is in your portfolio and how it does. People with gold and crypto have reasons to be pleased.
I can acknowledge that gold and crypto have value and still not invest in them. I just don’t know what drives the price of gold and crypto. I can’t justify investing in something I don’t understand. But if I’m honest I haven’t tried that hard to figure it out.
I have spent a lot of time trying to figure out what drives the price of shares over the short-term. I haven’t been able to come up with anything other than randomness. I also can’t justify investing in something I can’t possibly understand like randomness. That is why I’m a long-term investor.
Final thoughts
It all comes down to earning returns. That is why all of us invest. That is why people buy shares, crypto, gold and all manner of investments. Herd mentality, the theory of mind, recursive mentalising and the network effect all seem like noise through this prism. How does any of this help earn returns?
To me it is clear. Markets are not a chess board. There are no strict rules governing what people can or can’t do like there are in chess.
The way market participants react is shaped by conscious considerations, external influences and an unconscious belief system. Markets are complicated because people are complicated.
That is why it is impossible to be consistently successful with an investment approach that relies on trying to anticipate how people will react to a chain of events in an unpredictable future.
The randomness of short-term price movements produces some winners over the short-term. As time passes there are fewer winners that benefit from randomness.
Play a game you can win. Focusing on fundamentals may seem boring. It may seem out of touch with the excitement of short-term trading and skyrocketing prices of gold and crypto. But I think it is also the only reliable way to build wealth.
For another take on gold from somebody in the line in Martin Place (to sell it) read my colleague James’ article on Fristlinks.
If you are in Brisbane come hear Shani and I speak at the Queensland Investors Club on November 11th.
Email me at [email protected] with your thoughts.
Shani and I have a favour to ask
Our book Invest Your Way was released on the 8th of October. A big thank you to everyone who ordered a copy in presale.
Order now from Booktopia for a signed copy!
The book is also available on Kindle and audiobook.
Invest Your Way is a personal finance book that combines foundational investing theory, real-world application and our own experiences. It is designed to help readers create a financial plan and investing strategy that is tailored to their unique goals and circumstances.
Get Mark’s insights in your inbox
Read more of Mark’s articles
Read previous editions of Unconventional wisdom
What i’ve been eating
The cinematography on the Netflix show Chef’s Table could make me scrambling an egg look like the culinary event of the century. It is no surprise that it was hard to get a table at Firedoor in Surry Hills after the restaurant was featured on the show. I’m not as enamoured of the restaurant as everyone else seems to be but they do cook a great steak. The problem is to get it means ordering an addition to the required set tasting menu. Below is the dry aged steak which tasted just as good as it looks.
