Many professional investors have been led to believe that Mr. Market is always right and assets (whether real or not) will always be correctly priced because university and college professors for countless years have ‘spewed’ the efficient market hypothesis. This has pushed most investors into the land of speculation, where ‘I will buy an asset as long as I know that a person after me will buy it for a higher price’. Finance education has somewhat forgotten that shares of companies flying through the electronic world are actually fractional parts of businesses that create cashflow and grow and compete with other businesses.
Although the word speculating might have a negative connotation, this is far from what I am trying to portray. Many speculators have had incredible returns (George Soros comes to mind). I am not chin wagging speculators but merely trying to highlight the difference between the two. The best way to explain the difference is through an example which has been used again and again to highlight the difference between the two words.
You can only speculate in gold!
Take the example of Gold as an investment. Gold has minimal industrial value. It is taken out of the ground and moved to another area where it is stored, and then it is surrounded by gates and guards. It is never used for anything, apart from making jewelry which is in itself not an investment, and therefore has no fundamental value (like currencies). And because Gold has no fundamental value, it can never be cheap or expensive to buy gold.
Warren Buffet explained it best:
“You could take all the gold that’s ever been mined, and it would fill a cube 67 feet in each direction. For what that’s worth at current gold prices, you could buy all — not some — all of the farmland in the United States. Plus, you could buy 10 Exxon Mobils, plus have $1 trillion of walking-around money. Or you could have a big cube of metal. Which would you take? Which is going to produce more value?”
What is an investment then?
This leads to the inevitable question of what is an investment then? A true investment produces something and has a tangible value because of the cashflows it provides. When a person speculates, this person expects the ‘asset’ that they have purchased will be worth more in the future simply because others will be putting a higher price on the asset, like art collectors/speculators. Because an investment has an intrinsic value, it can be mispriced, and therefore be a good or a poor investment. Any stock with tangible value can become a good investment if the price is right. For speculators the decision to speculate has nothing to do with the value of the investment, but purely with the perception of value which is really left up to the whim of the short-term focused, extremely moody Mr. Market.
At the mercy of Mr. Market or on the right side of the fence?
Knowing on which side of the fence you stand can save you a lot of heartache. Being in between will lead you to chasing returns while rationalising your purchases with valuation and being at the mercy of Mr. Market. As a person with little market intuition, I prefer to stand on what I consider the more practical side of investing. If you are a speculator and making money, then good on you, as I could never do what you do and earn outsized returns. And while most investors fear volatility and busts, I personally love them because they provide good investment opportunities.
MattBolduc
SAXO BANK