— what if your relative finds out? Removing some risk always means common sense. After all, if gold hits $3,000 an ounce, I don’t think you should be boasting about your investing skills at the local bar.
Market risks
Another element of market risk can occur when you’re involved in a “thinly traded market.” In other words, there may not be that many buyers and sellers involved. This is also called liquidity risk. This can happen, for example, in futures (covered in Chapter 12). Although futures are usually a liquid market (an adequate pool of buyers and sellers), there may be some aspects of it when it may not be that liquid. Say that you want to sell a futures contract that you recently bought that isn’t an actively traded contract. What if there are no buyers when you want to sell? Your order to sell through the broker may sit there for a long time. The sale price of the contract would drop, and you would lose some gain or even end up with a loss. Be sure to communicate with the broker regarding how active that particular market is.
Another example is the market risk of mining stocks. The stock of mining companies certainly can go up and down like most any other publicly traded stock. Stock investors can sell stock when they see or expect problems with the company. If, for example, you’re considering a gold mining company, the risk to consider is more than just the fact that it’s gold and the commensurate market risks with gold itself. It’s also about the company. Is management doing a good job? Is the company profitable? Are sales increasing? How about their earnings? Do they have too much debt? And so on. Mining stocks are covered in Chapter 7.
Futures exchange risks
What the heck is exchange risk? That sounds odd! Well, it’s not a reference to currency exchange; it’s a reference to the risks that could occur at the exchanges where futures and options are traded. When futures (see Chapter 12) and options (see Chapter 13) are transacted at an exchange, such as at the Chicago Board of Trade (CBOT) or the New York Mercantile Exchange (NYMEX), they are done so under the rules and regulations of the exchange. The exchange can either purposely or accidentally encourage market outcomes by changing the rules and regulations on an ongoing basis.
A real-life example happened in the spring of 2011 with silver futures at the NYMEX. Silver rallied to $49.85 (pennies away from matching its all-time high), and the exchange, in an effort to dampen what seemed like frenzied buying, aggressively raised the margin requirements on silver futures contracts to try to quell overspeculation. When normally you could put down 10 percent to speculate on a futures contract, the new amount would be raised to, say, 12 or 15 percent or possibly more. When you require people to put more funds in for the ability to speculate, then of course you’ll diminish that activity. If the margin requirements are raised too high, that will result in more selling. More selling results in prices dropping.
Margin requirements may change. I give an example earlier in this section, and this is the most common event that an exchange could enact.
“Liquidation only” can happen. Although rare, this means that the exchange may temporarily restrict the buying side, and only selling can occur, thus forcing the price down. This occurred with silver in 1980 when it hit its then all-time high of $50.
Trading is halted. Another rare event, the exchange may temporarily halt trading in a particular futures contract.
Political risks
Political risk is probably one of the biggest dangers that investors and speculators don’t see coming. It’s the one that comes out of the blue and blindsides your portfolio. What is political risk? Political is a reference to politicians who, in turn, run government. As far as you and I are concerned, political risk and governmental risk can be synonymous. In other words, politicians are Dr. Frankenstein, while government is Frankenstein’s monster. The bottom line is that political risk means that the government can change laws and regulations in a way that can harm your investment or financial strategy. This can happen in your own country or by another country.
Consider what happened in the 1930s right here in the United States. In 1934, Franklin D. Roosevelt (FDR) and Congress passed the Gold Reserve Act, which made gold ownership illegal. Had you bought gold in prior years to preserve your wealth in the midst of the Great Depression, well, you were now out of luck. FDR then issued a presidential order fixing the price of gold at $35 an ounce, which stuck for decades to come. FDR didn’t want private citizens to have an alternative outside of the official paper currency.
Fast-forward to current times. Political risk is alive and well (unfortunately). In many countries, such as China and Venezuela, the government nationalized (taking private property by force) properties by foreign companies — among them, mining companies. Had you owned stock in these mining companies, you would have seen the share prices drop. Sometimes the share prices drop at the mere threat of government action. In 2005, for example, the Venezuelan government mentioned that it may take property owned by the Toronto-based gold mining company Crystallex International. Its share price fell by a whopping 50 percent in a single day. Venezuela’s dictator Hugo Chavez did increase taxes on many foreign companies while nationalizing some industries.
That’s the problem with political risk. As an investor or speculator, you can do all your homework and make a great decision with your portfolio backed up by great research and unflinching economic logic and still lose money because of a government action that could have been unforeseen.
The risk of fraud
The risk of fraud is as real in precious metals as in every other human endeavor. It’s tough enough trying to make a buck when the market seems honest. But you must understand that as a market becomes popular or “hot,” it also becomes a target for scam artists. Fraud can materialize in a variety of ways, but I think that it can be safely categorized into three segments: scams, misrepresentations, and market manipulation.
Scams: Those events that the consumer organizations
