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Volatility Does Not Equal Risk

September 28, 2011

The mainstream media does a terrible job with analysis. No secrets there. However, some aspects of this incompetence are so fundamental to their basic duties as to be completely unforgivable. So it is with the abysmal failure by the media to distinguish between the totally separate concepts of "volatility" and "risk". Indeed, so terrible is the performance by the media here that these two, separate concepts are often treated as virtual synonyms.

As always, the place to start with such analysis is definition of terms, with which the intellectually lazy mainstream media is usually too lazy to bother. Let's start with "risk", since it is the simpler of the two concepts. In the context of investing, "risk" represents the probability that an asset which we bought and hold will (at some point) be sold for less than what it cost us.

There are two facets to such risk, however. Not only must we consider risk in the context of the basic probability that we might experience a "loss" on a particular asset, but the second aspect of risk of which we must be conscious is the potential magnitude of any loss. In very general terms, a low probability of incurring a large loss is something we need to guard against just as much as the high probability of incurring a small loss.

In looking at this "dual aspect" to risk, obviously what must be avoided at all costs are scenarios with a high probability of large losses. Conversely, we need not get especially concerned in scenarios where there is only a low probability of a small loss. Those are the basic dimensions of "risk". Unfortunately, virtually the entire realm of business "journalism" regularly sabotages any discussion of risk by mixing-in issues of volatility.

Volatility refers to nothing more than the average magnitude of deviations from the mean. To put this into simpler terms, the more "volatile" the asset, the more wildly the price tends to bounce up and down. Over the long term, there is absolutely no connection or overlap between the concepts of risk and volatility.

Where the myopic media encounters its problems is that virtually none of these talking-heads ever looks at the "long term" picture of anything. Rather, they have been carefully conditioned over a period of many years to look only immediately behind themselves and/or at the ground immediately in front of their feet.

It is because the mainstream media is oblivious to "the long term" that it is utterly incapable of distinguishing between risk and volatility. Over the short term, while there is absolutely no causal connection between risk and volatility, "high volatility" tends to imply some degree of risk. Why is this?

Remembering our definitions, volatility is the size of "deviations from the mean". Thus another way of describing a very volatile asset class would be to describe the movements in price as "erratic". In the context of the shorter term, if we were ever forced to do our buying and selling over that time horizon then with any asset which moves erratically, at the time we went to sell it, it might have suffered a sudden plunge - leading us to suffer a loss.

At this point we need to introduce the mainstream media to "the long term". Over the long term, volatility becomes totally irrelevant. Put another way, when we go to sell our long-term investment at some point in the future, it will not have mattered in the slightest whether the price moved from "A" to "B" in a smooth, steady line or whether it zig-zagged up and down like a seismograph.

Having now distinguished the two concepts, it is now possible to discuss them together (in an intelligent manner). When we combine the two, again we see a specific array of possible scenarios. There will be assets with high risk and low volatility. There will be assets with low risk and high volatility. There will be assets with low risk and low volatility. Lastly, there will be the dreaded asset classes with high risk and high volatility.

Looking at that array, it's quite obvious that asset classes with low risk and low volatility will be highly sought after - for "security". Thanks to constant market-manipulation, automated trading algorithms, and markets populated almost entirely by schizophrenic lemmings there are no longer any asset classes with low risk and low volatility.

This leaves us the less-than-ideal choice of looking at assets with a high degree of volatility and a low level of risk, or assets with a low degree of volatility and a high level of risk. For reasons I just explained, there is no "choice" at all here - for any/all long-term investors. Since volatility is irrelevant over the long term, any/all rational investors will opt for high volatility/low risk over low volatility/high risk.

In the context of our current markets, we have an example which precisely mirrors this choice between asset classes: precious metals versus bonds.

Once upon a time, bonds were an asset class with low volatility and low risk. Those days are also gone. Today, any/every bond-holder is confronted with two, huge, imminent risks. First, with many/most Western economies insolvent, and several teetering on the edge of outright default, there is the obvious risk that the entity issuing that particular bond will not honour the debt.

Losses here range from the probability of a mild "haircut" all the way up to a 100% loss. If that isn't enough to frighten the bond-lemmings out there already, the other "risk" to bonds isn't a risk at all - but rather a certainty.

With most of the governments in the world currently engaged in "competitive devaluation", apparently none of the chumps holding bonds even understand these words. Our governments are rapidly driving down the value of all the currencies in which all bonds are denominated. In other words, this isn't a "risk" that one's bonds will lose value - it's an absolute guarantee. Thus while bonds may be (at the moment) a "low volatility" asset, it is an asset-class which comes with a 100% guarantee of losses.

Then there is gold and silver. Unlike banker-paper, precious metals are a class of assets which could never even theoretically go to zero because they have intrinsic value. They are the world's only "good money". For those who don't think this attribute constitutes "intrinsic value", ask yourself this question: how many days could the modern, global economy continue to function with a barter system?

If you're a steel-maker needing iron and coal to manufacture your product, those digging up that iron and coal will not accept payment in steel. They need "money" to pay their labourers, purchase their own inputs for production, and generally operate a business. What makes gold and silver "good money" (and the best money) is that they are the only currency which we have ever used which has retained its value over the very long term (i.e. 5,000 years).

There is literally no asset class on the planet which carries lower "risk" than precious metals. Thus in comparing bonds to gold and silver, on the one hand we have an asset class which guarantees losses (even 100% losses), on the other hand we have gold and silver which represent virtually zero risk.

Naturally this situation terrifies the banksters: producers and holders of $trillions in worthless and near-worthless paper. And so we see the new "campaign" the banksters have launched in the gold and silver markets. One half of the plan is simply to create lots and lots of volatility.

The other half of the plan is to dredge up a chorus of media-stooges who can be relied upon to confuse the distinction between volatility and risk - and "warn" people about non-existent "risk" because they don't understand the difference between risk and volatility. As we have seen, an entire "flock" of Chicken Littles has recently been reporting that "the sky is falling" on gold and silver.

Meanwhile, not only do these same fear-mongers not "warn" people about the perils of the bond market, they refer to bonds as a "safe haven". An asset class where there is a 100% guarantee of losses is touted by the media talking-heads and the legion of "experts" whom they parrot as being "safe" - while these same mindless fools try to frighten people away from the safest asset class in history.

"Reporting" on things which it doesn't understand has become a constant problem with the corporate, media propaganda-machine. Their minions report on risk and volatility every day, while not even understanding the definition of those terms. They report on "competitive devaluation" of our currencies - and then prove they don't know the meaning of those words by calling bonds a "safe haven".

These are not complicated subjects. A dictionary and five minutes of careful reading is all it should take for a mentally competent adult to have a basic understanding of such concepts. The fact that the entire media "herd" all regularly demonstrate that none of them understand such concepts is another terrifying example of the group-think which has reduced much of our population to economic "zombies".

People must learn to think for themselves. It is only those of us who develop the capacity for such critical analysis who will be able to identify all the malicious propaganda and vacuous nonsense spewed forth by the mainstream media every day.

There is nothing "safe" about assets (like bonds) which guarantee losses. Equally apparent, the short-term volatility of gold and silver is entirely irrelevant regarding either the risk or the value of these assets. Those not capable of understanding this distinction are certain to pay a terrible financial price for their ignorance.

Jeff Nielson

Jeff NielsonJeff Nielson is co-founder and managing partner of Bullion Bulls Canada; a website which provides precious metals commentary, economic analysis, and mining information to readers/investors. Jeff originally came to the precious metals sector as an investor around the middle of last decade, but soon decided this was where he wanted to make the focus of his career. His website is

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