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What Do Goldman, Government and Gophers Have In Common?

|Includes: Goldman Sachs Group Inc. (GS)
I am an insider of TVI Pacific Inc., a copper mining company. Even though this column mentions the commodity market, and I have a vested interest in that market, the opinion expressed herein is my own and does not reflect the opinion of TVI Pacific and is unrelated to my role with the Canadian Investor Relations Institute.   

Evaluating investments has become increasingly difficult these past few years. Besides the old steadfast financial fundamentals you can use to decide whether or not to invest in a company, there are influencing factors that you can’t punch out on a calculator. Some have always been there like geographical risk, political risk and even full disclosure risk. Now, on top of those, we have ‘Gopher Risk’ to contend with.
Living on the edge of the Canadian prairies, I can’t help but draw a parallel between the ever-increasing barrage of allegedly "fraudulent” accusations coming in waves off Wall Street and the seemingly endless supply of gophers that infest the otherwise beautiful Alberta landscape. 
Consider this metaphor. There are prairie towns that pay cash for ‘gopher tails’ to inspire homesteaders, and the odd unemployed teenager, to organize “Gopher Derbies” to rid us of the pesky, destructive rodents. Side note about gophers: Although they love to pop out of their holes and strut around all cocky and arrogant, the danger lies underground in their destruction of the prairie farm land root systems, where you can’t see them, and you don’t realize what they’ve done until your crops die sometime in the future. No matter how many Gopher Derbies are carried out, the destructive field rats breed at an alarming rate and pop their furry little heads up another hole before you can say “completely unfounded in law and fact”. 
April 16, 2010, the SEC carried out a Gopher Shoot exercise and fired a round at Goldman Sachs with defrauding investors, misstating and omitting key facts about a financial product tied to subprime mortgages.  Shares of Goldman Sachs plunged nearly 13 per cent and wiped out $12.4 billion of its market value.  
But Goldman wasn't the only stock to drop on the news. Commodity stocks fell sharply, due in part to the position of Goldman Sachs in the precious metals market. The TSX Global Base Metals Index slipped 1.85% and the S&P/TSX Composite Index closed down 1.15%. 
Goldman holds a large stake in the biggest exchange-traded fund backed by physical gold, and the hedge fund managed by billionaire investor John Paulson was the biggest investor as of the end of 2009.  Side note about Paulson: John Paulson is at the heart of the Goldman charges. Paulson & Co. asked Goldman Sachs Group to structure mortgage deals that would include some of the poorest quality mortgages. The hedge fund's plan: bet against the deals and then hope for a bursting of the housing bubble—exactly what happened. 
Some argue that the SEC charges serve as a shot across the bow to the entire banking sector to clean up their act while others argue the timing is related to the heated banking reform debate in Washington DC. Either way, markets react negatively every time the SEC firing squad takes a shot at Wall Street. Whether you believe the SEC is acting in your best interest or their own, you can expect a lot more of this type of ‘aim and shoot’ news, and each time it will have a negative effect on the broader markets. I can only hope that the SEC is picking off gophers in the name of Joe Main Street.

I could go on forever about markets and the infinite number of factors that influence them, but I’ll stop here and summarize why I’m unsettled by all this Wall Street commotion.  What bothers me the most is that one shot by the SEC at one company in one industry results in a negative effect in many markets over numerous industries.  I would argue that this effect reflects the size and scope of the banking industry challenges (i.e.: break up the banks?) but that's another article all together.  I’m not advocating that banks be allowed to run amok unregulated like a  field of frenzied prairie rats, I am all for regulation.  What I am saying is that something had to be done and Gopher Derbies are the new Sport de Jour so we better get used to it. 
As Joshua M. Brown said in his Blog, The Reformed Broker, “Do me a favor...spare me the faux-populism and the sudden bouts of outrage, this garbage CDO factory stuff has been very widely known for a long time.  When was Zuckerman's Greatest Trade Ever book published?  Last year.  When did the New York Times start telling this story? January”.  In addition to these, Lawrence MacDonald's A Colossal Failure of Common Sense hit the shelves June 2009, Sorkin's Too Big To Fail was published in October 2009 and Mchael Lewis released The Big Short earlier this year. There's no shortage of information on this subject. And Brown is bang on. “The sun will come up the next day, you will go to work, then pick up your kid at Karate, then pay the utility bill”.   
Whether or not the field rats ever get eliminated by the Gopher Derbies or whether they just burrow under a different pile of cow manure, popping up again when the coast is clear, is anybody's guess (See point #6 in Joshua’s blog). Either way, the SEC cannot give up the chase.  I think its fair to say there will be plenty of bullets flying around for some time to come.
So, until Wall Street quits giving the SEC reason to accuse it of fraud and other misconduct, or investors get bored and lose interest, you will have to add a new metric to evaluate your investments … the ‘Gopher Ratio’, and discount accordingly for short term market volatility every time you hear gunfire on Wall Street.

Disclosure: Long