Seth’s Blog on Finance

All That Is Gold Does Not Glitter

Wouldn’t it be great if your investment gave you such returns as seen in this chart? Consistent and impressive indeed.

This was one of Madoff’s funds which gave abnormally consistent returns for almost two decades before crumbling spectacularly and revealed as an elaborate Ponzi scheme in 2008.

While everyone knows of the adage of something being too good to be true, many people are still seemingly caught up in dubious “investments” that promise quick, high and guaranteed returns. While Madoff’s investment scandal may be a bit far from home, Singapore does have its fair share of such schemes, with Sunshine Empire happening not too long ago. Still, it appears to me that there are people who continue to be lured by such dazzling returns.

Most recently, I have spoken with someone I know who is vested in a scheme that offers some 2% per month return, which is more than 24% per annum. It works like this: If the price of 1 kilogram of gold is $60,000, the company will sell it to her at $72,000 per kg, a 20% premium over the market rate. The company will then apply a “discount” of 2% to the price, so the person buys the gold bar at $70,560. A month later, the company will purchase the gold bar back at $72,000, making the person a neat profit of $1,440.

The person “investing” in this was clearly confident of the soundness of this scheme, stressing on the authenticity of the gold and the long time (of about two years) that this company has been operating.

The inclusion of a gold bar distracts the person from the dubiousness of the whole operation as people become fixated on whether or not the gold is real, rather than whether the scheme is a sustainable investment. The time it has been operating also has no significant bearing – Madoff’s scheme ran for almost two decades!

Here’s how I believe the company will wrap up its operations – it knows the number of people coming back on any single day to sell their gold. Once they have reached a mass critical enough to reach a figure they desire, they would “buy back” the gold, issuing cheques that are destined to be bounced as the people responsible take off. People who have returned their physical gold will lose their entire capital, while people still holding onto the physical gold will have lost the 20% premium they have paid (less if gold price increased during the month).

Indeed, while I have not been paying close attention to such news, I have read articles of the Malaysian equivalent being investigated, and I have no doubt cracks will start appearing in the local operations. I have also personally talked to one of the company’s agents who stressed on the word “discount”, not “return”, ostensibly to distance itself from being an investment not under the purview of relevant regulators.

While there may be some people who will eventually profit from this, as there were in the Madoff investment scandal, I think one has to be honest in the appraisal of the risk level of such an “investment” – make no mistake, it is exceedingly high. The person I know is no longer as confident, but has become paranoid due to all the news reports she has been reading. Still, she continues to put, in her words, a “small amount of money” in the scheme, seemingly addicted to the returns she has been getting. I wish her luck.

Do you know anyone who has put money into such schemes?