Financial Post - Backing Up The Truck

The Financial Post has an interesting debate about borrowing to invest, namely mortaging your home to invest. Basically swapping debt for equity.

If this is how people obtain leverage to invest, then its easy to see why they might prefer ETFs, especially those with physical bullion. You can also argue that a certain dividend would provide a return against leverage used, and see some capital appreciation.

The common expression is called: "backing up the truck," where you pull out all the stops and buy with both hands. But its also a reason why people sell, not necessarily out of an emotional panic, as some investment writers suggest.

You can also wind up carrying the cost for an extended period before seeing any return, thus technically sitting on losses. This is why the liquidity bubble in gold mining shares has basically been busted.

You would pay a mortgage anyways if you had a home, so the time involved is indefinite. But you have to preserve your home, rather than your investment. So my guess is investors in physical ETFs are not that much in danger, while investors in mining shares are in a very peculiar position of having their home at risk.

Commercial traders by contrast obtain immediate returns through derivatives, and cannot tolerate any losses due to the amount of leverage used, and are responsible for quarterly returns. Thus they parry money into treasuries, where there is literally no risk as central banks are purchasing bonds out of the market. The Black Scholes model is a risk management scheme designed to mitigate risk.

So a gold mining company makes a perfect vehicle to fit in with this model, because there is a certain lack of arbitrage risk, meaning people will not leverage up and buy shares. That arbitrage risk changes when dividends come into play, because then it becomes possible to back up the truck and service debt.

http://business.financialpost.com/2012/05/28/maybe-mulcair-had-it-right/

-F6