The Search for Safe Assets for Mad Times

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 |  Includes: AAUKY, DBB, DBP, JJC, PCL
by: Paul V. Azzopardi

I missed the original FT article but got it from MarketWatch the day after, on May 16th, this thing about De Beers’ (AAUK) global push to persuade us all that diamonds are not only a girl’s best friend but also a safe-haven investment. No thanks!

In these unstable times, when the price of gold is near historic peaks, De Beers is going through rough times, thus the reason for the global campaign. One cause of this is that the cartel it managed to keep intact for so long broke down as new sources of supply came in. The second, and more relevant reason, is that consumers have always treated diamonds as a luxury item, not as a store of wealth for turbulent times, which shows that De Beers' late-in-the-day campaign may be blowing in the wrong direction.

Seeing that stocks are flying like dolphins, maybe it is a bit too late to promote safe assets – maybe it’s even too late to write an article about them. Perhaps De Beers should best push where it pushed successfully in the past, that part of the brain hidden deep in the body responsible for infatuation-cum-snobbery, the titillation and tintinnabulation of those wild weak spots of vanity and passion. Again, I think diamonds can indeed be a best friend, much better than a costly poodle, especially for someone who has run out of space at home, is due a gift which can in no way come cheap, and is desirous of something which does not really need to be registered. Indeed, diamonds can be flaunted or hidden away easily, a bosom friend of lovers and crooks throughout the ages – goodbye anti-money laundering procedures.

Of course, it may not be too late after all. This bull feast shows signs that it has gone too far too soon and may be short lived. Like a peeved rancher, the economic news may soon catch up with the bacchanal bulls - a straight bullet from the first derivative this time not green straws from the second. We still have a good chance, I feel, that the March lows will be tested and even severely punctured. It seems that the bulls are now off of developed countries and deep into the emerging. But I have diverted …..the study of safe assets usually comes into its own at times of war or financial meltdown and the latter now seems to have been averted.

The good thing about diamonds is that they can easily be carried on the body, or in it. Murders are known to have occurred at remote border crossings when X-ray machines reveal sparkling innards. Portability is one of the characteristics of safe assets. This portability is diamonds’ advantage over gold. It is difficult to swallow a small fortune in gold but with some dedication, pacing and roughage it can be done with diamonds. Importantly, though, both are inert, and won’t react with the chemicals which the body spews forth as it tries to digest them. It adds kudos to a safe asset if is it inert – it is not just the body which will want to chemically react: there’s also the damp, moss, soil, bugs, salt, and rats’ teeth.

The main reason I don’t consider diamonds as safe assets, as I call them, is that when you come to exchange them back to paper money, or other goods, you’re often held hostage by the buyer. In peaceful, decent times, I found you can somewhat narrow the spread if you work hard at it and know who you’re dealing with. Fortunately, I have never lived in really dangerous circumstances so I cannot be 100% sure but I would not want to be haggling over the worth of a diamond with Long John Silver with my wife and kids waiting for me outside. I guess the penalty you suffer on gold is lower because you can easily measure its purity and there is always an indicative price somewhere and if Long John wants to rip you off, you can at least look him straight in his one eye and make it known that you know what’s he’s up to – not that this is going to help much in evil times. With diamonds there is always uncertainty as to quality and value, which is maybe why lobbyists love them so.

My problem with gold is that, really, I cannot see any reason why anyone would want to own it except for its beauty. To say that one would want to own it because others would want it if you had it seems viciously circuitous. Gold seems to be a relic. Also, I have never been able to make any sense of its demand and supply figures. Maybe there are too few hands controlling the strings. And yet, many central banks and monetary authorities stockpile loads of gold which goes to show that its attraction runs deep (and also why supply is all over the place).

This table shows the gold reserves of different countries. Note that China recently reported that it had 1,054 tonnes of gold, rather than the 600 tonnes reported in the table. Silver is a little better in this regard. It is beautiful, somewhat useful, and apparently not so rigged. I would rather go for copper, though, if I had the space – very useful and very beautiful if you polish it. One can go the ETF way and invest in DBP (precious metals), DBB (base metals), or JJC (copper). The Chinese, phew, they really know what they’re doing in stockpiling useful metals.

The study of safe assets is one of my interests. At a cocktail party, in another country, at another time, I was asked by the head of state of a moderately large country where one should put one’s money if war broke out. I answered that I would keep the money in short US Treasury bonds, one third each via a bank in Britain, Switzerland and the US itself. That’s the best I could come up with, which did not turn out to have been bad advice, as much later confirmed last year in our real-world experiment where US bonds were rock solid as the financial sector melted around them.

It seems that statesmen and politicians love this idea of safe assets. The Kaiser, Wilhelm II, German Emperor and King of Prussia, had this question looked into and was advised that the best asset he could place his money in was timber. If you like this idea, take a look at Plum Creek Timber (NYSE:PCL). During the Kaiser’s time there were no real substitutes for wood but we are now in a new era of materials – plastics and composite metals changed the economics of wood.

Many believe that the best asset to hold is land. Recently, I read that the sale of new Rolls Royce cars is proportional to how well land does, not stocks or GDP. Land is fine, of course, but is not portable: if a government gets nasty, if there is blood in the street, you can’t take it with you to buy fair passage, as people in Eastern Europe and other countries found out. And the market for land can be really poor when you need to exchange it most.

I have to confess: I have not found the ideal safe asset as yet, but my quest goes on. Please write with alternative suggestions. Around the world, financial advisers are looking for an asset with a limited supply (ensuring a stable price), of lasting utility, with good market (especially in dangerous times), with physical possession, with portability, preferably chemically inert, and which does not require management (to avoid the agency problem, without which we would be spoilt for choice). Please don’t write and say some of these characteristics are contradictory – we suspect so, but can always be proven wrong.

DISCLOSURE: No position in AAUK, PCL, DBP, DBB, JJC.