classification gold/silver as investment vs consumption asset

[Jo_]

Hi David,

After viewing the video and the study notes on Hull chapter 5, i'm still confused on how to treat gold and silver on the investment vs consumption asset classification.

In the study notes it says (quote): Gold and silver (...) are both investment and consumption assets. It's important to not fall into the trap of classifying gold and silver as one or the other.

However, the final practice question of the notes counts it as an investment asset, stating that "gold, fx and s&p 500 are investment and oil and copper are consumption commodities." Notice how gold is not mentioned as consumption asset too, implying it is treated solely as investment asset.

So if the question would be, how many of the following items are investment and consumption assets: gold, fx, s&p500, oil and copper, what would be the answer?
A. I = 3 and C = 3 (treating gold as both)
B. I = 2 and C = 2 (treating gold as none of both)
C I = 3 and C = 2 (treating gold as investment only, the current suggested answer on this question according to the notes (page 76)

Thanks for the clarification,

Joeri

 

[Alex_1]

Hi @JoeriG , that's interesting, I somehow also asked myself this question some time ago, but went through the Practice Questions and saw that (for 164.1) the answer was indicated as gold, FX, S&P 500 being investment assets so I stopped bothering.
Now I have looked in the original text from Hull, where he states: "Gold and silver are also examples of investment assets. Note that investment assets do not have to be held exclusively for investment. (Silver, for example, has a number of industrial uses.) However, they do have to satisfy the requirement that they are held by significant numbers of investors solely for investment. A consumption asset is an asset that is held primarily for consumption. It is not usually held for investment." So even in the original text from Hull the definition is in my opinion not 100% clear.

So now I also wonder why "Gold and silver (...) are both investment and consumption assets. It's important to not fall into the trap of classifying gold and silver as one or the other."...

Thanks

 

[David Harper CFA FRM]

Hi @JoeriG and @Alex_1 I agree with both of you that it's confusing. My apologies because:

• I do not like my own question 5 (on page 76). It's an old question, I guess I was trying to address the AIM ("Differentiate between investment and consumption assets") but, after years more experience with Hull, I think my question is weak ... I think I was trying to echo Hull's initial statement that "Gold and silver are investment assets."
• I also think this statement is misleading (sorry): "Gold and silver (...) are both investment and consumption assets. It's important to not fall into the trap of classifying gold and silver as one or the other." I need to edit this in the upcoming revision of the Hull notes.

I think the question needs to be replaced with one that speaks to the substantive difference and here is my better understanding, when we include McDonald and Geman (on commodities):

• My current view is gold and silver can be either/both investment and/or consumption commodities. However, i do not think this semantic distinction is important.
• The difference matters (for Hull) because, under his definition, the unique feature of a "consumption commodity" is the existence of a non-zero convenience yield. To Hull, what matters is that consumption commodities have convenience (when owned), contrast with investment assets which confer no technical "convenience" when owned. Because a convenience yield disrupts no-arbitrage conditions and translates the cost of carry model from an equality (=) to an less-than-or-equal-to (<=) which imples that, unlike an investment asset (with no convenience yield) where arbitrage implies an exact price, the consumption commodity's forward price lies within a region (interval). So, this is the important idea: a consumption commodity is a commodity with a convenience yield such that cost of carry gives us a (fuzzy) region instead an (exact) price.
• I think gold can be debated, but McDonald sums up the "debate:" gold clearly has a lease rate, which directionally has the same impact as a convenience yield (i.e., like a dividend or like negative storage cost), and it depends on whether you replace least rate with convenience yield, or (as some researchers seem to do), include them both as components.

I hope that makes sense, thanks,