Friday, June 19, 2009

A Wrong Way in Gold Investment - Pawning

Recently I came across a blog that teaches people in gold investment. Basically it is asking you to buy gold, then pawn it to get back 65% (Arahnu) cash, then use the money to buy more gold. It then shows you if the gold price goes up a little bit, you earn a lot more than just simply buy once. At the very end it also mention there is 'a bit risky' but absolutely in a misleading way.

Basically this is a method called Leverage. You have $10 and you know you can earn $1 out of it but if you apply Leverage techniques you can get more than $1. It is also the same way how Bank can lend out 10 times more than what they actually have. ( currency turns evil story )

However, his teaching is one of those 'seems cool' but Absolutely 'Digging your own grave' case! Which also shows how absolutely a nonsense fool can spread knowledge to make more fools. Also exactly the reason why there are still 90% of world population will NEVER achieve true finance freedom, while digging deeper to their own graves.

This so called Gold Pawn is a very common pratice among one of Malaysia's ethnic group. There is even a standard govern policy for it. Basically you can pawn your gold with them, get back 65% cash. Then you need to pay about 0.75% safekeeping fee per month. Usually You will need to repay your borrowed amount in 6 months.

If you have been following malpf, you may have known one key preaching topic is that 'you must look at the real numbers and NOT just the general concept'. To simplify this discussion, lets ignore the normal 4% price gap in gold trading. Lets just assume we only need to pay 0.75% for one month and the price move up down 10% in one month.

Case 1 : Buy Gold
You invest $10,000 and price moves up 10% in one month, you earn 10%

Case 2 : Buy Gold, Pawn Once and use the pawn money to buy gold again.
The price moves up 10% only, but after minusing the safekeeping fee and repawn back the gold to sell all, you will get 16.46% net return. (sample calculation)

Case 3 : Pawn twice so its as if you have 3 golds, but 2 at the pawn shop, 1 at your hand.
Price moves up 10% a month, your net earning would be 20.66%

As you can see, the total amount of capital is the same, $10,000 but you could earn 10% - 16% or 21%. That is the power of Leverage. But wait, lets see what happened when the price goes DOWN 10% instead.

Case 4 : Buy Gold once
Price goes down 10%, you lost 10%.

Case 5 : Pawn Once
You lost 16.54% (sample calculation)

Case 6 : Pawn Twice
You lost 20.79%

You may already observe that there is a slight difference between winning and losing ratio.
When you win, you win less and
when you lose, you lose slightly more.

Pawn Once : Win 16.46% Lost 16.54% Difference 0.08% Disadvantage
Pawn Twice : Win 20.66% Lost 20.79% Difference 0.13% Disadvantage

Basically there are 2 facts you can get out of this :

1) The longer you use this Leverage technique, the more you will lose.
2) The more number of times you pawn, the more you will lose.

Back to the beginning of this article, the Risk of this technique is NOT a bit but the Risk is DEFINITELY higher than the Reward. The best argument he can legitimately comes up with is the disadvantage rate is not that high. Ie. compares to casino gambling where the disadvantage is at the range of 4%.

Think you found a golden goose ? Look carefully next time ....