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The Mindlessness of Mind

Gold

In the wilderness one quickly learns that the mind often plays tricks and is not to be relied upon, especially if other, ‘harder’ indicators are available. How often have I been convinced that the destination was one way when the compass pointed another. Along the same lines, it’s only too easy to underestimate the time it takes to hike uphill compared to hiking on the flat, unless one knows the rule of thumb that it takes approximately three times as long. Similarly, optimism springs eternal in the wilderness and it’s an experienced guide who heavily discounts the euphoria of a macho group of climbers setting out on a beautiful cloudless day to summit.

What the wilderness teaches us with respect to the limitations of the mind has been rediscovered and developed, albeit more rigorously, into the new discipline of behavioral economics. The bottom line, scientists tell us, is that the mind is riven with cognitive biases. These biases evolved at a time when they no doubt had utility, but although they have now outlived their usefulness, we are doomed to carry them around inside our heads like the cursed sailor carrying an albatross around his neck in the Rime of the Ancient Mariner.

According to cognitive scientists we are lazy and tend to favor information that confirms our beliefs. We tend to ‘anchor’ on irrelevant numbers, so while the asking price of a house should have nothing to do with its value, it does seem to affect the price we are willing to pay. Events in the recent past influence us more than events from long ago. We tend to overestimate the likelihood of visible risks such as a terrorist attack and ignore risks of which we are unaware. We tend to rate ourselves as better than the median. Losses cause us pain out of proportion to the pleasure of winning. We have a tendency to dwell on bad news rather than embrace good news. We are biased towards inertia and so fail to get around to taking action, even on things we want or have agreed to. Finally we tend to make choices based in large part on how the questions are framed.

These biases explain why investment success is as much about behavior as it is about investment performance. The recent price action in gold illustrates this principle and the importance of using a ‘compass’, a ‘handrail’, or some type of objective measure not subject to our cognition, to determine when to sell an investment. Objectively the fundamentals have created an almost perfect backdrop for investing in gold. Unprecedented global money printing to support asset prices and stimulate debt burdened economies, global currency wars as countries compete to stimulate exports, a growing list of possible political and/or economic black swan events, and most importantly, the unique advantage that gold presents of owning an asset with no counter-party risk in a world increasingly aware of such risk. However, despite this glowing backdrop the price of gold has dropped from a high of $1,921 on September 6, 2011 to $1,232 today, a 35 percent fall. It was crystal clear from the gold price chart when gold needed to be sold. After an 18 month period of moving sideways gold was either in the process of consolidating for another push skywards or it was making a huge top. The collapse of gold in April through key support around $1,520, was a decisive message that, for whatever reason (deflation anyone?), gold had actually topped back in 2011.

If you were still holding gold after the drop in April and you started to think that the Fed was manipulating the gold price lower to disguise inflation, or that the big players such as JP Morgan, wanted you to sell so that they could buy back gold cheaply, or that you were going to keep your gold, come what may, because it was the only true source of value in a fiat world, then you were letting your mind play tricks on you. The charts may be wrong but, unlike your mind they don’t deliberately deceive.

(Please note that posts will be somewhat sporadic during the summer as travel plans interfere with writing schedules.)

_________________

“Lying to ourselves is more deeply ingrained than lying to others.”  Fyodor Dostoevsky

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About Malcolm Greenhill

Malcolm Greenhill is President of Sterling Futures, a fee-based financial advisory firm, based in San Francisco. I write about wealth related issues in the broadest sense of the word. When I am not writing, reading, working and spending time with family, I try to spend as much time as possible backpacking in the wilderness.

View all posts by Malcolm Greenhill

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15 Comments on “The Mindlessness of Mind”

  1. sally1137 Says:

    Everything’s upside down right now. I trust that your chart is correct, but not the government and bank entities behind the scenes.

    Reply

    • Malcolm Greenhill Says:

      Sally, thank you but the point is not that we are both wrong in our assessment that the government and bank entities are upside down but that we cling irrationally to these beliefs to justify holding on to investments that should have been sold long ago. The investment becomes a symbol, as it were of the strength of our faith and that is a big mistake.

      Reply

  2. Richard Friesen Says:

    Malcolom, your third paragraph (According to cognitive scientists…) “nailed” the major biases our brain creates. You packed a lot of information into one clear paragraph. I may quote you!

    Reply

  3. becwillmylife Says:

    I was just reading in the newspaper about a man who lives in our area. He is back in prison for swindling investors out of thousands of dollars to operate his ponzi scheme. Keep in mind, he was imprisoned once before for the same charges, yet he was able to convince people to invest in something else. Proof to your findings that the mind will let us down and not to get swept away by the euphoria of what if it pans out and I make some money out of the deal. I know our minds can be deceived but my example seems like pure stupidity.

    Reply

  4. Othmar Says:

    Dear Malcolm,
    indeed very interesting the comparison between human behaviour in the wilderness and in economics. Just because I want to get to the top and I have a few hours before I have to leave and it is sunny right now, does not mean there will be a way to reach the peak.
    I am glad that you are naming some behavioural factors in the world of investing. We indeed tend to fool ourselves with superficial and self-serving information. Human beings are often driven by wants instead of needs, and our minds have a strong tendency to present us those wants as needs.
    I have done some work on poverty reduction. In general, we tend to see it as a structural problem. Therefore we can establish poverty lines for incomes and similar administrative definitions to facilitate welfare programs and charities. Or we see poverty as a moral problem: People who are not willing to work hard deserve to be poor. It is a form of blaming the victim and avoids shared responsibility for the common good.
    But it is hard to find a voice in the literature that supports the notion, that there are indeed behavioural factors that contribute to the occurrence of poverty. If spending levels are higher than income levels, it will lead to poverty (no matter what the social and economic status is).
    People’s minds are caught in biases. Therefore, it is good to use the humbling experiences in the wilderness, being subjected to elementary forces, and to practice an openness of the mind. Instead of racing to the top, we can simply enjoy the beauty along the way and make the best journey with what we have.

    Othmar

    Reply

    • Malcolm Greenhill Says:

      Othmar, thank you. It’s always refreshing to get your perspective. I suppose competition plays a similar role to “elemental forces” in keeping damaging behavior within limits. The less competition the more prolonged harmful behavior can be. If a corporation or government has a monopoly they can continue to exploit customers and citizens respectively without check.

      Reply

  5. Warren Gibson Says:

    Malcolm, my takeaway is that we are able to identify and counter our biases, difficult though that may be. From that perspective, the piece could have been called “The Mindfulness of Mind.”

    Reply

    • Malcolm Greenhill Says:

      Warren thank you. I agree with you that it is possible to identify and counter our biases but it is extremely difficult. Cognitive therapists confirm that it takes much time and practice to change even one bad tape that we play to ourselves let alone all of them. That is one reason why therapists and financial planners are still in business and why ‘auto-pilot’ systems such as, for example, 401k lifestyle funds that automatically change allocations with age, work so well.

      Reply

  6. skywanderer Says:

    After reading your post I am wondering what sort of bias has made you write a post on the “mindlessness of the mind”? ;P
    The topic has made me associate to this mindful thought:

    Reply

    • skywanderer Says:

      Applying the topic to economics it made me remember Nash’s rather mindful works, which have been awarded with a Nobel prize for delivering the astonishing solution for tacit cartel formations, because what the Nash-equilibrium implies (inter alia) is that even under Hayek-dreamed “free market” conditions the largest players can mindfully control the economy while allowing the phenomenon to appear the result of mere mindless market dynamics.

      Reply

    • Malcolm Greenhill Says:

      Thank you. That’s funny.

      Reply

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