The TRUE cost of Capital Gains

Last week in Bangkok, Thailand, a gun-wielding robber stole $70,000 in gold from a jewelry store. When captured by police, he confessed that he had stolen the gold to cover his losses in the crypto market.

I’m just going to let that marinate for a minute.

If you tune into mainstream media, bubbles are popping everywhere. Crypto and equity collapses are underway, with real estate next up to bat.

There is an infinite number of financial media pundits ready to tell you why what just happened, happened, so I will ask a different question - does it matter?

The answer to that question is not simple.

If you were betting on a 10% return this quarter, and now your portfolio is down 70% YTD - then yes, it matters.

But it doesn't matter as much if your portfolio is down 70% YTD and your time horizon is ten years.

It all depends on what game you are playing. Every seasoned investor knows that the true cost of green days is red days. There are no risk-free rewards.

A forty-year bet on the S&P 500 in 1982 would have been a brilliant decision.

As would have a 20-year bet in 2002, a ten-year in 2012, and a five-year bet in 2017.

But for all these bets, the returns came with a cost - not financial, but emotional. The costs were seasons of plummeting stock prices, scary uncertainty and unrestrained ridicule from “I told you so” doom and gloom pundits. Investors that held on and paid the emotional cost were rewarded.

Can you pay that cost? In theory - we all say yes.

“I would have no problem ignoring the short-term volatility, knowing that my time horizon renders it a minor event…”

In theory.

But in practice - when that bill comes due and your net worth drops 20%, it is another story.

Market crashes result from most investors not wanting to pay that bill. They panic and sell at the bottom. Prices fall, and more panic and sell at the new bottom.

Here is a theory - this year, the markets have not crashed. The S&P 500 is down roughly 18% YTD as I write this. But the chart doesn’t look like a crash - in fact, it seems like a relatively orderly - albeit consistent, sell-off. It has not looked like a panicked free fall.

If I were to speculate, I would say that the bill hasn’t come due for many investors yet… And if it does and the market plummets for a few weeks - I ask again - does that matter?

See my note above.

It’s a Hot Potato

When a market crashes, pundits talk about the mass destruction of wealth. This year, the crypto crash has “wiped out” over $2 trillion in wealth. Another $5 trillion has been lost in stocks. These numbers make great headlines, but they are a bit misleading.

To sell an asset, you must buy something else - an exchange must occur. Most frequently, stocks are exchanged for US dollars, and as a consequence, as the share price of stocks fall, the relative purchasing power of US dollars goes up.

If you invested $100,000 into JT Company, and the price of JT Company shares dropped by 90% - to you, it feels like your $100,000 was “destroyed.” But in reality, your $100,000 still exists (unfortunately, whoever sold you the JT Company shares has it now), and you still have the shares of JT Company. Worthless, relative to dollars as it may be, you still have the asset you purchased, and the seller still has your money.

I find it a helpful exercise when buying stock to ask the questions:

Why do the seller and I disagree about the value of this asset?

Why are they selling it if I think it is a good buy?

What is my competitive advantage in this transaction?

Framed like this - buying shares in a bull market makes far less sense than buying in a bear market. As a general rule of thumb, buying anything from a seller who is in a position of strength (earning profits) is less favourable than buying from a seller in distress.

I don’t think that distress has hit the market yet.

In every market cycle (rally, crash and recovery), trillions of dollars in wealth are transferred from reactive investors to patient ones. Play the long game.

In the penny stock business, liquidity can be so thin during a bear market that investors get “trapped” at the bottom - no buyers at any price for the shares they want to sell. Those are treacherous waters, beware.

What About Gold?

The most common question I receive from subscribers nowadays is, “why isn’t gold performing better given the global uncertainty and market crashes?”

Since February, gold is up in Canadian Dollars, British Pounds and Euros. It is way up in BTC and up significantly against US equities.

It is relatively flat in US dollars.

So gold not being “up” is a US dollar story, not a gold story. Hang tight.

I interview three or four money managers weekly for my Youtube channel and podcast. I ask everyone where they are allocating cash right now. If I hear consensus in a thesis, I know there is a wave of money moving towards one thing. In the spring of 2020, 90% of my guests said they were building a bitcoin position - some large, some small - but collectively, that meant a tsunami of money moving to one asset. I knew what to do.

Right now, I am hearing the sentiment build for gold. I am not referring to gold bug investors - I listen to them with a wary ear (as I do any dogmatic investor); I am referring to the generalist funds. I wouldn’t call it enthusiastic, but almost as if to say, “I’m putting some cash in gold - for lack of a better idea.” The tide might be coming in.

I am loading up on high-quality mid-tier gold producers. This is not investment advice. My time horizon is longer than yours.

I am also buying Bitcoin.

I hadn’t bought any bitcoin in over a year, but I started re-allocating last week.

I wasn’t early to bitcoin; I started dollar-cost averaging in the spring of 2020 (when 90% of my guests were pushing money that way). Since I believed it was too young of a technology to determine what it may or may not become, I committed to a five-year time horizon with minimal cash every month. However, when it hit $20K per coin, I thought it was getting a bit frothy, so I parked myself on the sidelines and stopped purchasing for a while.

The position turned into a much more significant percentage of my portfolio than I intended - and of course, I was tempted to cash out. But I recalled my rule when I began buying - I would not try to time the market; I would increase my position with an immaterial amount of cash every month and ride out the inevitable 70% plus drawdowns that have been cyclical since bitcoins’ inception.

I don’t know what bitcoin will become - maybe nothing more than speculation. But it is a speculation that the entire world can participate in - and therefore, bolstered by the network effect - a connected network of users keeping the ecosystem alive - which is the underlying value of all of the world’s most prominent social media platforms - the network of users.

To all my readers who are still stuck on choosing Team Gold or Team Bitcoin - be careful loving your asset. I guarantee it will never love you back.

I am comfortable speculating in bitcoin because I own gold.

What’s the lesson? Our friend above should have robbed the jewelry store before he went speculating (and not gotten caught). He could have ridden out the crash with a calm mind.

Enjoy your Sunday :)