How Low Can Gold Go?

Gold has declined to its lowest price in more than four year, yet that doesn't seem to have sunk in with many of its devotees.
What's it worth to you?

One of the things I like to do in all of my musings is to find some thing or person who is wrong about an investing-related subject, then trying to figure out where they went awry. On occasion, small pearls of wisdom can be derived from this analytical process, as in this discussion on narrative. Other times, the lessons are simply an exercise in snarky fun, as in the "12 Rules of Goldbuggery."

Regardless, the underlying thesis is, "If only we can develop a set of intellectual tools to analyze investing errors, then we can apply them to ourselves and perhaps avoid making similar errors." The hope is that some degree of self-awareness avoids the sorts of systematic gaffes we see every day.

That brings me back to the gold-industrial complex. I have criticized this group for their religious fervor, lack of discipline and deficient risk management. Their money-losing approach to investing via the narrative process, while ignoring the data in front of them, continues to bedevil unwise investors. Every possible investment has its own group of cheerleaders, including sales people and other dependents who want to see their particular asset flavor do well. It is in their own financial interest for prices to rise, so naturally they pay no heed to various warning signs.

Gold's fall below $1,200 an ounce last week is the reason I bring this up again. Reaching its lowest level since early 2010, as other precious metals such as silver and palladium are at or near five-year lows, is a good enough occasion to remind some readers of the errors of their ways.

Why the precious metals and many of the mining companies are struggling isn't a great mystery. The U.S. dollar is at multiyear highs and gold prices tend to move inversely to the currency. Further, the economy continues to improve, which is rarely a positive for the catastrophe metal. The financial crisis is fading from memory, and now is six years in the rear-view mirror. Why the soft yellow metal continues to trade softly is obvious; less so are the many reasons why some investors remain overweighted in this underperforming asset class.

The idea that the world is ending and the accompanying demand for guns, canned food, bottled water and gold, is having difficulty attracting new adherents in an era of falling unemployment and rising wages. Indeed, many of those who hold those views are having a hard time reconciling their misplaced faith with reality. Regardless of your thoughts on the Wall Street bailouts and the Federal Reserve's balance sheet -- and I have been a loud critic of the former and an informed observer of the latter -- the general backdrop has been one of improvement.

I am not suggesting that gold is going straight to $800 -- a not-unreasonable price target -- or that we are not going to see any sort of a bounce. Rather, if you are upside down in gold -- or any other investment for that matter -- you should be asking yourself the following questions:

1. Why did I make this investment? Is the underlying thesis still valid?

2. What will trigger unwinding this trade? What is my risk management for this position?

3. Am I wrong?

These questions address three key aspects of anyone's approach to investing: Why a trade was put on, how and when that trade should come off and the trader's own psychology as it relates to that holding. Note this applies to any position, investment, asset class or approach to deploying capital. Think of those three factors as "buy, sell and me."

The last question is the one that so many people have trouble with.

Some jobs require a near-perfect performance record. Surgeons, sharp shooters, aircraft pilots are among those with very little room for errors. When mistakes happen, the results can be catastrophic.

Investing and trading is nothing like those fields. In the stock market, we all should expect to be wrong. Everyone is wrong in this field, and quite frequently. I find it helpful to think of investing and trading as more akin to being a hitter in Major League Baseball than being the captain of an oil tanker. You can bat .300 and be thought of as a strong player. Hit .350 and you are an all-star; break .400 and you are one of the all-time greats.

In finance, your job isn't to bat 1.000, but rather to manage those times when you don't get a hit. How you handle those incidents when you are wrong will have enormous impact not only on your on-base average, but on your win-loss record. Understanding your own errors and acknowledging them is an extremely important part of this process. It is why I do my mea culpas in public every year.

There is a fine art to being wrong, one that all investors should master. As we have written before, however, those who are never wrong find disaster in the markets. Avoid these people and their money-losing philosophy at all costs.

This column does not necessarily reflect the opinion of Bloomberg View's editorial board or Bloomberg LP, its owners and investors.