Archive for October 2007
The Gold Lining?
In a recent Forbes magazine report, Tom O’Brien, provided his insight into gold as an investment:
Rarely have so many factors pointed to a “buy” signal on gold. Yet, when the Federal Reserve announced a rate cut last month, the stage was set for a sustained bull market for the commodity.
They key markets for the physical demand are India, the Middle East, Turkey and greater China… the demand in these markets has increased by 37% year-over-year… when we look at these countries, we also see stronger income growth from the consumer looking to own gold.
Could he be correct?
While O’Brien’s statement might suggest the odds are on gold, the true odds are that we don’t know what the odds are…
Let’s look at an scenario to help us understand:
Economics Professor Richard Thaler of the University of Chicago has put the following question to a number of people over the years:
Steve, a 30-year-old American, has been described by a former neighbor as follows: “Steve is very shy and withdrawn, invariably helpful, but with little real interest in people or the social world. A meek and tidy soul, he has a need for order in structure and a passion for detail.” Which occupation is Steve currently more likely to have: that of a salesman or that of a librarian?
Can you guess how people answer?
Most folks think that Steve is more likely to be a Librarian… and given what we know about Steve, it seems his probability of that profession is high.
What if we had some more information?
The Bureau of Labor Statistics database suggests that in the United States there are 15 million salespeople and just under 200,000 librarians. Does this help to reframe the scenario? It should certainly help reinforce the odds…
This tendency to disregard or discount the overall odds is what Nobel Laureate Daniel Kahneman and Amos Tversky termed “ignoring the base rate,” and the evidence of this phenomena can be witnessed each year as thousands of otherwise sane investors throw away good money in the commodities markets as they are led astray by the opinions or recommendations of others.
After reading O’Brien’s comments, you might think that the time it right to buy some gold. Yet, if you understood the base rate – that an estimated three out of four investors, both amateur and professional, lose money when they trade in commodities – you would probably decide to look elsewhere.
