http://www.martinlee.sg/genneva-gold-placed-on-mas-alert-list/

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.

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.