Leasing PP Assets to VP?

[TripleB]

I feel gold will have a rough year in 2012. I'd like to best against it in my VP.

I feel silly going long with gold in my PP, and short with gold in my VP and having these transactions go through a 3rd party, with counter party risk and transaction expense.

I'm considering leasing some gold holdings from the PP to the VP to "short." Here's a sample of what I'm considering using rough numbers:

Suppose I had $100k in PP and $20k in VP. In the PP, there is $25k Gold.

I'd like to short gold in the VP. I'll "lend" $10k of gold from the PP to the VP. The VP will "sell" the gold and sit on cash. The VP will use the other $10k will sit in cash as well. The idea is if I only borrow half as much gold as I have in the VP, from the PP, then even if gold doubles in value, I should be able to cover returning the appropriate number of "ounces" of gold back to the PP that I borrowed.

At some later point, perhaps 12 months from now, I return the gold back to the PP. If gold rose, no problem, it means my VP took a dive, and I have to pay more for the gold from my VP than it borrowed it at.

If gold dropped, then my VP realized a profit and it's cheaper for it to return the gold.

In order for this to work, I'd have to keep it legit, and run an equivalent to a margin call if gold substantially rises more than my ability for the VP to re-purchase it at the new higher price.

The alternative would be to use short-gold ETFs with high ERs in my VP, while maintaining the long position on gold in my PP. That seems silly.

There's a risk that gold could go up 400% overnight due to some crazy black swan event and make it impossible for the VP to pay the PP back. I believe that risk is mitigated by only "lending" half of the gold from the PP than it has. i.e. I will keep 12.5% of the PP in actual gold and 12.5% in self-dealed IOUs. So if gold jumps 400%, then the 12.5% of my PP that's gold will have jumped 400% and even if the stocks, bonds, and cash become worthless, the 400% gain on my 12.5% position still keeps me happy, especially relative to all my neighbors.

The bigger risk is of lack of discipline where gold slowly rises and a 3rd party brokerage would initiate a margin call, but I keep riding it out, due to emotional attachment to my VP gamble. To mitigate this risk, I'd write out a contract with myself to outline how I must re-purchase gold if it rises too high for the VP to cover it, and give myself one to two weeks to add new money to the VP to maintain adequate cash to cover my bet. That's a benefit compared to a brokerage because they might only give 2 days to cover before giving a margin call and forced liquidation. If I know I am guaranteed an employer-paycheck in 2 weeks for enough to meet my self-imposed margin-requirements, then I can delay the "margin call" by at least 2 weeks and potentially ride out the gamble if necessary. A brokerage would tell me "tough shit" if I swore that I had a paycheck coming.

I'm describing this strategy with gold because I feel gold will fall in 2012. It could equally be done with stocks or bonds as well, using the same mechanics. I feel it could work if you're honest about the risks, and maintain HB's cardinal rule of VP, which is not to borrow from the PP to pay back the VP. If you keep the accounts separated (at least on paper, even if they are at the same brokerage), and treat them as such, it should be safe.

Thoughts?

[stone]

Triple B, don't you need a vitual buyer ("sucker" in your estimation) as well as the virtual lender (the PP) and virtual seller (the VP)?
If you genuinely are bearish about gold you could for real sell 7ounces now from your PP to some real "sucker" in the real market and keep $20k in the VP to genuinely buy 7ounces at the market rate next year. Your PP would hold an IOU from the VP in the meantime. If you are currently adding a lot to your PP, then rather than actually selling gold, you could simply forego buying it and instead "add" such an IOU.

Our houshold savings are set up as a PP that I look after and a larger cash pool that my better half looks after. I suppose in effect we have a cash VP (not my choice). Your proposed set up sounds much like ours but with an imaginarium as a bonus .

In principle I guess you could have a whole virtual zero sum world of massive pyramids of financial derivatives built from the PP assets, HFT, government interventions with political funding from your VP camp so as to rip off your PP camp and vice versa, etc etc. Didn't LTCM at one point have 1000:1 leverage? With virtual stealth bail outs assured from your virtual fed, the sky's the limit. All the trading profits your left hand creamed off could be ploughed back into paying off your right hand's losses .

[TripleB]

Triple B, don't you need a vitual buyer ("sucker" in your estimation) as well as the virtual lender (the PP) and virtual seller (the VP)?
If you genuinely are bearish about gold you could for real sell 7ounces now from your PP to some real "sucker" in the real market and keep $20k in the VP to genuinely buy 7ounces at the market rate next year. Your PP would hold an IOU from the VP in the meantime.

I may have explained it poorly, but that's exactly what I'm doing. The PP will sell gold to a 3rd party "sucker." The VP will place an IOU for the gold to the PP.

Essentially, the PP is "leasing" the gold to the VP, who sells it to a 3rd party, and places an IOU to the PP. I didn't want to say the PP sells the gold directly because that sounds non-PP-like.

It's exactly what I'd be doing if I wanted to short a gold ETF. I'd ask a broker to find someone holding a Gold ETF who is willing to lend me their shares. I borrow their shares, sell them, and have an IOU to the 3rd party. If my brokerage assets drop compared to the market price of gold, and it appears I am in risk of being unable to rebuy the gold ETF and make good on the IOU, the brokerage will force me to sell any of my holdings, and then immediately rebuy the gold ETF and return it to the person I borrowed it from. That's how short-selling works.

In that example, there's 4 people involved. The person lending me the gold ETF, the brokerage, and the person I sell the gold ETF to, and myself.

In my version, there's only 2 people involved. The person I sell the gold ETF to, and myself. I replace (a) the person lending the gold ETF and (b) the brokerage, so I have reduced counter party risk, and reduced transactional expenses.

[clacy]

I guess I don't see why you're making this more difficult than it has to be with the use of "loans" and IOU's etc.  It's not as if the PP and the VP are two separate companies that have completely different tax accounting,  and shareholders.  Both of these make up one portfolio, with all of your investable assets.

If you want to reduce gold holdings, do it.  Then at some point when you're more comfortable with adding to your gold position, sell whatever asset you need in order to buy more gold.

Am I missing something?  It sounds like you just would be more comfortable with less gold currently.

[AdamA]

I feel gold will have a rough year in 2012.

Why do you feel like this?

How rough a year?

[buddtholomew]

I feel more comfortable with an asset class when others believe it is sure to decline in 2012. When the sentiment is positive and sometimes euphoric, I cringe at the decline that is sure to follow. 4x25 is the best approximation if we remove all of our investment biases.

[clacy]

If you go to youtube and google you can find plenty of prognosticators, institutional traders and economists that can make great cases for why gold is in a bubble and will face a significant crash.  You can also find some of their counterparts that are equally intelligent, articulate and have extremely good "track records" that will make a strong case for why gold is just beginning to explode to the upside.

The same could be said for stocks or treasuries as well.

I am never able to make sense of it because fundamentally and technically, I can find reasons why each asset class will fall or rise. 

That is why I fell in love with Harry Browne and the PP.  It doesn't try to guess or predict. 

[AdamA]

If you go to youtube and google you can find plenty of prognosticators, institutional traders and economists that can make great cases for why gold is in a bubble and will face a significant crash.  You can also find some of their counterparts that are equally intelligent, articulate and have extremely good "track records" that will make a strong case for why gold is just beginning to explode to the upside.

Yeah, and the gold market is especially tough.  

Every other commercial on Fox News is for some kind of shady precious metals dealer.  They are very bubble-esque commercials.  (My favorites are the ones from Lear Capital featuring olympic gold medalist Mark Spitz, where they show him swimming the butterfly with his 1970's mustache.)

So I could see where someone might say gold could be in a bubble.  But, even if they were right, who's to say when it would end?  Gold could have a ways to go before any supposed bubble bursts.
 







 

[KevinW]

My $.02: loaning assets to the VP seems like a loophole to get around the PP rules against market timing and moving money from the PP into the VP.  I think those rules make sense so IMO this plan is too risky.

I think craigr's blanket advise to ignore the financial media, not worry about these things, and stick to a 4x25 out of sight out of mind, is best.  Second-best is Clive's suggestion of building a large VP that's invested conservatively but without any gold.

[stone]

I do see Triple B's point that if having short positions of PP assets in the VP is what you want, then it makes massively more sense to instead keep cash in the VP and reduce those PP assets. I suppose the issue is whether it is dangerous to have a short selling VP? If you had been in Iceland in 2008, would you have had time to buy back your gold before the price doubled? I'm not sure how fast the Icelandic devaluation was. Was it spaced over weeks or minutes? I guess any hypothetical future event might be entirely different anyway.

[craigr]

Shorting anything is usually a bad bet. You can only gain so much, but the downside is unlimited if you are wrong.

Instead of shorting assets, I recommend if you want to gamble to instead buy the asset outright you think will do best. Not only is this simpler in terms of portfolio management, but you have more to gain if you are right vs. a short bet against the asset you already hold in your portfolio.

If you think that gold is going to do poorly, instead of shorting it in your VP just buy more stocks that will probably benefit from a sharp gold correction. I think in the Variable Portfolio that short investing is just as bad as margin due to the amount of damage caused on a bad call. I'd avoid doing it.