Martin Lee @ Sg
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The Gold Label Liquidation

Back in December 2010, it was reported that The Gold Label was in cashflow difficulties.

For the uninitiated, The Gold Label is a company (among a few) that sells gold at a markup to retail investors and then offer them a “guaranteed” buyback option with a cash rebate. The cash rebate can amount to more than 10% a year if the rollover is done continuously.

I haven’t seen any latest news report of The Gold Label being liquidated yet, but judging from the comments posted here by their customers, looks like it’s game over for all the Gold Label investors.

I wonder how many of their customers managed to hold on to their gold (hope it’s real).

For those who are contemplating investing into similar schemes, I hope you know what you are getting yourself into.

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lioninvestor says 8 years ago

Actually, the option pricing don’t make any sense. You can read an explanation here:

tiger in the lion den says 8 years ago

My mother was nearly a “victim” of the Genneva scam until I talked her out of it. For goldbug investors who need an appreciation of how this works and understand how such an underlying investment strategy is riskier than it apparently seems. Do read on.

First thought, where is this so called attractive yield from holding a non-interest bearing asset derived from?

The answer is obvious, for people who are familiar with the underlying workings of bank structured products. The “yield” is an option premium that the company receives for selling a contract which gives someone else the right to buy or “call” a specified amount of gold from the company at a fixed price, anytime before the contract expires.

Let’s look at an example. Suppose that the market price of gold is now $1400/ounce. The company writes a contract to sell 1 ounce of gold at $1450/ounce at anytime within 1 year and receives $20 premium. For the buyer of the contract, he only breaks-even if he/she is able to sell gold in the market at a price of $1470/ounce. If the market price of gold rises above $1470 anytime within 1 year, it makes sense for him/her to exercise his/her contractual
right to buy gold from the company and sell it on the open market to pocket the difference as profit. (e.g. market price $1500 – contract price $1450 – option premium paid $20 = profit of $30)

If you understand where I am going so far, you will know that you have been taken for a ride. Basically, an investor who thinks he/she is holding “risk-free” gold and can do no wrong holding a collateral from the company, he/she is in fact exposed to one of the most price volatile hard assets in recent times. However, this is not the essence of the scam. Afterall, the investor is paying an equal measure of money for an equal amount of gold.

How the company makes money, is that it shares the option premium paid to it with the investor. Think of it this way, the option premium is a compensation for the risk undertaken by the contract writer who may have to sell gold at below market price. Which is $1450/ounce, in the above example.

You see, the investor owns the market risk of owning gold, is compensated for the risk he/she undertakes for potentially having to sell gold below market price, while the company take a cut of the compensation, absolutely risk-free to them! e.g. the option premium may be split 50/50, i.e. $10 to the investor and $10 to the company.

Let’s put it all in perspective by analyzing some scenarios.

It is actually all well if the market price of gold continues on an upward or sideways trend. The company which writes options to sell gold get exercised. No worries, the company simply has to replace the gold that gets “called” by buying at a higher market price. Does it make sense for a company to accumulate an asset which is getting more an more expensive? Well remember, the risks of holding gold are being transferred to their investors, or rather the next investor that comes along. In any case, their investors get to enjoy an appreciating asset as well with “attractive yields”.

What if the gold bubble starts bursting? Well, on a positve note, the options written by the company will not get exercised. i.e. the company gets to keep the option premiums without having to give up any gold at below market prices. Maybe, at $1,100/ounce gold, it may test investors’ nerves. They may think, well, I am losing out on the price of gold, but at least I am buffered via receving a steady stream of income. If the market price of gold goes to $800/ounce, and investors start getting petrified, you can start betting your house that the show is over. Quite predictably, the run on the company starts. Do you think the company will buy back your gold at the $1450/ounce it sold you?

Nothing illegitimate about the investment if the company provides caveat emptor, however as with most dodgy investments, most investors are ill-advised or poorly advised about the risk-rewards.

For investors who are extremely bullish on gold prices, I suggest you think back to what happened with “black gold” just 2 years ago. May I also suggest that you try reading a children’s story called “The Emperor’s New Clothes” and try to understand the moral behind the story. 2011 has been a bad year for gold investors so far, let’s see how this further unfolds.

    tiger in the lion den says 8 years ago

    I forgot to address how the company takes care of the risk of rising gold prices if they are being “called” at a lower than market price, as required by contractual obligation. It can simply use some of the option premium received from selling call options to buy put options on gold. If it is getting a bit technical already, just know that it just means that the company uses some of the risk-free income it receives to protect against the risky part of the venture, and pockets the rest as profits.

    Michael says 8 years ago

    Great analysis.

    However, I beg to differ about your view being that 2011 has been a bad year for gold investors so far. It depends on your time frame, ie, when you purchased, don’t you agree?

    Just using a month’s trading time to judge whether gold is a good year is not a great measure is it? I, for one, have been trading physical gold and there is no such thing as a bad year.

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