The Gray Hair Speaketh

Advice that is largely Unsolicited..

Why I cannot comprehend some types of valuations?

If you are thinking that this must be about some astronomical valuations that unicorns are getting, well, this piece is NOT about those valuations.

(I cannot fathom many of those valuations also, but that is a subject for another post, someday!)

As I have been reading about the hot new topic of NFTs (“non-fungible tokens), while I appreciate the tech behind it, and the concept of NFTs per se, one of the consequential story around suddenly finding a lot of value in say, a sports card, or some other random memorabilia, got me thinking about a peeve that I have had, around some kinds of investment areas.

Say, gold, for example.

Why And How To Invest In Gold?

Gold or sports cards or a T-shirt autographed by someone, while of some value to you for sentimental reasons, can continue to command a rise in valuation, only provided the demand for these, continues to be higher than it’s supply.

Let me elaborate the idea.

Yes, almost everything is valued fundamentally, on a demand vs supply scale. If there were ample diamond stones available and being sold to you by street vendors, they would have cost a few cents and not the thousands of dollars of price that these command. Everything else about the product remaining the same.

It is only the limited supply and a larger demand, that continues to give the diamonds a higher price.

And then came factory manufactured diamonds, with qualities that were so close to the mined stones, that it made it hard to decipher the difference between the two. Factory manufactured diamonds, not being constrained for volume productions, suddenly skews the demand-supply gap, potentially leading to a drop in prices. While this phenomenon is a work-in-progress, the idea just explains how something valued only on basis of a demand-supply gap, can have challenges.

Let’s consider gold.

At a fundamental level, it’s a shiny yellow metal, with certain qualities, and used for jewellery making, and maybe some small industrial uses also. But often held in. raw form, as blocks of the metal, in vaults (folks who would have seen the popular series, Money Heist, might remember the vivid details!). So, just sitting idle in that vault, doing nothing “productive”, how does the value just appreciate? Since that has been the basis of gold being viewed as a part of your asset mix, in your investment portfolio?

Think about sports cards or some limited edition Barbie dolls or Marvel comics, etc., and other such “assets”! They are not even a shiny metal that can convert into a necklace. The value of these is only and only based on the assumption that there will be a continuing demand for these, from people, and being limited edition, therefore, the price will keep going up.

Is there a risk that the appetite for some sports cards or an old Barbie doll goes down? Or that people are not that fascinated by gold anymore? Since, as a hedge to currency risks (for which also gold is used), there are now other options like Bitcoins, say?

Considering the fact that these items are almost worthless, except for the inherent demand to hold them, anything that goes out of favour, stands a big risk of a sudden devaluation!

So, the question can then be that, this aspect of demand-supply drives valuation of everything, and not just the kind of examples that I listed above. You may say that an equity share is also valued thus, because of the limited number in the market, or that silver and copper or foodgrains or a piece of real estate, etc. are also valued on the same basis of demand-supply gaps.

Right, that is a fact. However, as long as these items have a functional role to play, besides the demand-supply gap, that potentially drives their value, then there remains a difference in the way you perceive them.

Say, when you invest in equity. While the price may have been dictated by the demand for the stock, once you invest, your money is part of that pool, which is being used by the company to create value, and which translated to an appreciation of the value of the stock.

The value of silver or copper is also connected to their respective utilisation in industry. And if the prospects of the produce of those industries are good, the demand for the products, and hence the supply chain in terms of silver or copper, go up. Leading to the value appreciation.

A piece of real estate may be valued on it’s demand, but it serves a purpose of housing an office block or a factory or providing residence to people, and creating inherent value in doing so. And as long as that core functionality keeps growing, the demand and hence, the value of the real estate asset also grows.

What you see in these examples is that while, value is decided by the demand, the demand itself is not based on people’s fascination and interest to hold that asset, but rather, on basis of a core value that the product is enabling to create.

Which is why, I am unable to reconcile putting much of my money in gold (irrespective of the history of price and demand growth, whether it will continue to do so, in a changing scenario of bitcoins, NFTs etc. remains a question mark) or in sports cards or similar limited edition items (irrespective of NFTs!).

I feel more comfortable putting money in equity knowing that my money is contributing say, to more medicines being manufactured to serve the sick of the world, or to producing food stuff to feed our millions, or to entertain people with their sports or video games etc.

I know that my financial advisor is not very happy, as she shares her conventional wisdom of distributing my assets into different classes, including gold. But as you can see, somehow, I am not fully convinced.

March 31, 2021 - Posted by | Uncategorized

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