Dr. Doom And The Mystery Of The Vanishing Gold Tail Risk

Includes: GLD, SLV
by: Robert Wagner

I've written many articles on gold, and one of the bearish arguments I always use is that "a repeat of an event like 2008 is highly unlikely." In this video, Dr. Nouriel Roubini, aka Dr. Doom, provides the term that captures this concept in a much more elegant manner: "tail risk."

Tail risk is a statistical term to describe how the return distribution of investments is skewed due to extreme events, and does not fit a "bell curve" or "normal distribution." The specific term used to describe a typical investment return distribution is "leptokurtosis," which means that investments typically have small variations around the mean but every once in awhile have large deviations, resulting in the distribution having "fat tails."

Additionally, investment return distributions usually have a "negative" skewing to them, meaning that the average return is relatively small and positive. But every once in awhile a catastrophic negative event hits, skewing the distribution. The markets may have 10 years of +5% to +10% returns, and then one year with a -20% return. Positive returns are far more frequent and smaller, and the negative returns are less frequent and occasionally extraordinarily large. These are often referred to as "black swan" events.

I would argue that gold or SPDR Gold Trust (NYSEARCA:GLD) and its close cousin iShares Silver Trust (NYSEARCA:SLV) have experienced multiple black swans that are unlikely to be repeated anytime soon:

  1. The U.S. financial meltdown in 2008
  2. The euro crisis, the PIIGS crisis, and Cyprus
  3. QEfinity
  4. Global QE
  5. Record-low interest rates
  6. Extraordinary fear of inflation and currency collapse

In conclusion, in my opinion, the main reason gold remains as high as it is is because of the "fear factor." Gold has had multiple black swans since 2008, an occurrence that is highly unlikely to be repeated. Going forward, the trend in gold is likely to be more toward returning to "normalcy" than reaching new levels of panic. During black swans, the most successful investors will do the opposite of the herd. They will buy when others are selling and sell when others are buying.

The old saying goes, "buy when there is blood in the streets, sell when they are celebrating." After a bloody 2008 and the years that followed, it may be getting near the time people start celebrating. And when that happens, there will be little left to hold up the price of gold.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.