PUMP AND DUMP CHUMPS

Posted in Rants on July 28th, 2011 by Ed

Yesterday I received an email nearly identical to emails I have received from two other people in the past few weeks, and it's getting me increasingly ticked off. Not that people I know want to share information with me or ask my opinion, but that such an obvious scam has managed to put down deep roots in the popular consciousness.

The content of the three emails boiled down to: I'm being told I should convert all of my liquid assets from cash into gold. Is this a good idea?

I do not fault anyone for asking the question. The idea has some intrinsic appeal. However, it brings me to the point of wanting to choke something to think about how many people are going to get screwed in the long run as a result of taking non-objective financial advice. If you choose to read no further or are even remotely considering jumping on the gold bandwagon, please read this piece on gold myths versus reality from Seeking Alpha.

Prominent media personalities, notably Glenn Beck, are paid handsomely to hit their gullible, elderly viewers over the head repeatedly with the buy-gold-now message. Gold interests have also taken to advertising directly, either encouraging viewers to buy gold or exchange gold for cash (which is a scam unto itself). Compounding the message, holding gold and silver as a "hedge" against future (and impending!!!1!!) collapse of the dollar has long been a popular idea on the survivalist, hardcore libertarian right. Forwarded emails from friends and family have multiplied the effect of advertising, Beck boosterism, and email spam campaigns extolling the virtues of gold. Of course, the mainstream media compound the problem by breathlessly – and accurately – reporting the meteoric rise in gold prices over the past few years.

Of course prices have increased dramatically – gold interests have been working very hard and spending a lot of money for years in an effort to convince people that they need to buy. Like any other investment, high demand drives up the price. In many cases demand is not driven by fundamentals or reality, but by speculation and what Mr. Greenspan called "irrational exuberance." In this case, however, demand is being driven by a paid, well-crafted marketing campaign. It is a classic Pump & Dump, a scam as old as investing itself.

I buy some gold at $400/oz, promote the hell out of it until other people drive up the price to $1600/oz, and then I sell high. By the time the bubble bursts and everyone realizes that it is not actually worth $1600/oz, I and my profits are long gone. If you get on board early and are smart enough to sell high, you'll make some money too. Everyone who gets on the train after the first station, though, is going to lose money. The average AM radio-listening elderly person who believes everything Glenn Beck says is going to get reamed like you wouldn't believe.

What we're seeing now is a flurry of OMGBUYGOLD hysteria using the debt ceiling issue as a selling point – get out of cash now before the US dollar becomes worthless! Which will happen soon! When this bubble pops, just imagine what is going to become of people who are buying now, at $1600/oz. Before Granny, your neighbor Joe, and Uncle Larry the Survivalist realize what happened, their "investment" will be worth somewhere between 25 and 50 percent of what they paid. Someone who really does convert his or her life savings to gold – especially physical gold which can't be liquidated quickly or easily – could easily be ruined.

There are lots of ways to lose money in investing, but few as transparently silly as the recent obsession with holding "precious" metals. Put simply, as Mike Konczal once told me, "When cabdrivers and USA Today are telling you to get in on an investment, it's time to go short."