Archive for January, 2009

The Permanent Portfolio uses gold as its primary protection against inflation. Recently there has been a lot of promotion about Collateralized Commodity Futures (CCFs) from companies like Pimco. The claim is CCFs provide better inflation and unexpected event insurance for portfolios than gold and other hard assets. I think this is simply a marketing claim that has many problems. 

In response to an article that Larry Swedroe wrote called All That Glitters is Not Gold I present a short list of why Gold is better than CCFs for high inflation and other currency crisis protection: 

1) He is data mining from a period of time when gold was at speculative peak to make his point. I can pick any investment asset (stocks, bonds, etc.) and do the same thing to make any of them look bad. 

2) He fails to consider the market conditions at the time that may have been driving the high price in gold. For instance, the Prime Rate was 20% in the early 80’s and 30 year mortgages in the mid-high teens. Who’s to say the dollar wouldn’t have kept falling if the Fed didn’t finally get a handle on things? 

3) He’s not looking at how the asset does in a diversified portfolio but looking at it in isolation. Diversification only works when you hold multiple uncorrelated assets together. It doesn’t work when you concentrate your bets because if you’re wrong you can take tremendous losses. If you concentrate your bets on stocks, bonds, cash, real estate, etc. you can and will have the same problem of too much risk. 

4) He’s working with piles of simulated data on CCFs to draw his conclusions against an asset (gold) that actually existed.  Gold has been tested under high inflation and currency debasement conditions for thousands of years in countless countries.  Many CCF funds have been around only six years based on only about 40 years worth of data for their simulated backtested performance numbers. 

5) Treasury Inflation Protected Securities (TIPS) have been around for only about 10 years in this country (since 1997). They are a completely unproven high inflation hedge. He assumes that they are going to respond well to high inflation when in fact nobody really knows what they’ll do compared to gold. At the minimum, even if TIPS keep up with inflation they will not go up enough in value to offset the impacts of inflation in your other investments (unlike gold which has done this in the past). 

6) Physical gold ownership has no counter-party risk and is very easy to understand compared to complicated and opaque CCF funds. CCF funds could be engaging in activity behind the scenes that puts you at risk but you may never even know. 

7) Gold is a commodity, but is also a monetary metal. So you get the protection of commodity ownership but also the protection during financial crises that are threatening the currency. 

8 ) CCF funds are expensive and tax inefficient compared to gold. Gold ownership usually includes a small storage and insurance fee unless you hold it yourself. Other than that it generates no taxable events until it is sold. 

9) As 2008 has shown, when banks are teetering on collapse people are happy to hold gold to hedge the risks but are not happy to hold CCF funds which were brutally wrecked. Gold was up 5% in 2008 and CCF funds were down over 50%!

Gold is far better as a hard asset over commodity funds. It is easy to understand, easy to buy, easy to sell and reacts strongly to conditions that are bad for many other investments (such as high inflation). If you are going to purchase a hard asset for your portfolio (as the Permanent Portfolio does) then you should only buy gold and leave the commodity futures funds alone.