The Permanent Portfolio, Investing, Finance and Random Thoughts.
Posts tagged Gold
Governments Like Inflation
51 week ago
Let’s talk about Treasury Inflation Protected Securities (TIPS) again. It’s no secret that I dislike them vs. gold in the Permanent Portfolio. But will they ever “default” as some say? No, they won’t. But this doesn’t mean they don’t have other serious problems.
I don’t believe the US will ever default on its debt because they control the money it is denominated in. They can simply print money to pay it all off. Not a good thing, but technically not a default. If you own $10,000 in TIPS and the Treasury hands you a $10,000 bill in the future they technically paid off the obligation. Of course the money may be worthless, but you did get paid back as stated in the agreement.
Now, what causes inflation? Inflation across an entire economy is caused by politics, not economics. It’s different than a shortage of a crop like corn that cause prices to spike in that one area. Inflation as a policy makes all prices go up together. This is a unilateral truth if you look at financial history.
Therefore, the idea of relying on the government causing the inflation to protect you from the inflation is a really bad idea. If the government really cared about protecting you from inflation they would implement monetary policies that balanced the demand for new money each year with the supply so inflation was 0% +-. But that’s not what they do. They target 3-4% inflation and often get it wrong and all sorts of things happen as a result.
Governments like inflation. They have no desire to protect their citizens from inflation or they wouldn’t use it as a monetary policy at all.
What does this mean? Simple:
Governments like inflation. They have no desire to protect their citizens from inflation or they wouldn’t use it as a monetary policy at all.
Why buy a product like TIPS from an entity that is actively working against your interests behind the scenes?
Even the much vaunted “independence” of the Fed is an illusion. Enormous pressure can be put on the Chair of the Fed to react in certain ways. I really enjoyed this paper for instance that discussed the Nixon tapes and the pressure put on Fed Chair Arthur Burns. Nixon wanted an easy money supply for political reasons at the risk of sending inflation even higher and it appears Burns complied. The taped quotes are interesting:
How Richard Nixon Pressured Arthur Burns: Evidence from the Nixon Tapes
What’s the lesson from this (and likely other manipulations by later administrations)? Well it’s that true inflation protection is not going to be gained by trusting the people with their hands on the printing press.
TIPS may be wonderful if inflation is low and steady. But I have a very difficult time believing they are going to do any better than a simple short-term Treasury fund in terms of offering inflation protection under higher rates. In other words, they are very likely to just tread water or probably lose a little each year in the game of catch up if bad inflation comes to the US.
Don’t buy TIPS for the Permanent Portfolio. Gold is immune from a lot of political shenanigans that can affect the actual reporting of inflation and subsequent inflation adjusted payments. There’s nothing wrong with keeping 25% of your wealth in a form of money (gold bullion) that is not subject to the whims of those in power.
Harry Browne in 1970 Discussing the Coming Devaluation of the Dollar
0Harry Browne in September 1970 on the TV show “Firing Line” with William Buckley, Jr. He is discussing how the US government is going to break the gold standard and the kinds of repercussions it may have. The gentleman in the middle, Eliot Janeway, was proven completely wrong when Nixon did in fact end the gold standard on August 15, 1971 and touched off a decade of very bad inflation.
Hat tip to MediumTex on the forum for this video.
The Misleading Stocks for the Long Run Chart
1 month ago
by craigr
in Permanent Portfolio
I see this chart posted from Jermy Siegel’s book Stocks for the Long Run from time to time to defend why owning lots of stocks is the way to go and why owning gold is some kind of chump move.
Well I think this chart is misleading for several reasons. Gold is useful in a diversified portfolio along with stocks and bonds. It should not be 100% of a portfolio just as stocks shouldn’t be nor bonds.
First let’s explain a few things about this gold line you see here. We must understand that for the first 130 or so years of the founding of the United States gold and the dollar were the same thing (aka. the Gold Standard). With that, let’s look at this chart with this gold standard in mind:
1) From 1802-1913 the value of the dollar was strongly linked to gold and there was slight deflation over this time. There was essentially no inflation except for the period around the Civil War when Lincoln printed a lot of money to pay for things. That’s the blip you see in the early 1860s. Gold went “up” simply because the dollar was going “down.”
2) In 1933 FDR broke the gold standard. He raised the price from $20.67 an ounce to $35 an ounce to deliberately try to cause inflation. This was done after prohibiting Americans from owning gold. That’s the rise in gold price you see in that year and also when the dollar started to rapidly decline in value. A gold convertible currency prior to that keeps paper currency honest because if people think the government is printing too much money they could turn in their paper dollars for gold specie and drain the Treasury. After 1933 that was no longer possible. This was a stupid idea that achieved nothing but allow the inflation genie out of the bottle and send the dollar on a downward trajectory from that day forward.
3) In 1971, after nearly four decades of artificially low gold prices due to government price controls, Nixon broke the last of the gold standard for foreign holders of dollars. Dollars could now be converted to gold by nobody. You see the gold price spike the first couple years as it adjusted for the prior price controls. After that, I believe it was simply responding to the very high inflation. The dollar also this year begins a very big decline. By the end of the 1970s the dollar bought about only 50% of what it did in the early 1970s. By today it’s lost something around 80% of its purchasing power.
4) Gold is not volatile. It’s a piece of metal. It is only volatile against the currencies it is priced in which are the real culprits. Price spikes in gold are more of a reflection in the value of the dollar than anything. Gold is a form of money and people buy it when they think the dollar is going to have problems keeping its value.
Now back to the chart in general. This chart is misleading for several reasons:
1) The data going back to 1802 is suspect to me. Nobody could have invested that way if they wanted to even if the data is accurate (which is another debate). This chart is what stock bugs use to justify why you only need to own stocks. It’s as bad as when a gold bug shows you a chart of gold vs. the dollar and insists you only need to own gold. No, you need to own a variety of assets like the Permanent Portfolio. Concentrating your bets in any one asset is a bad idea.
2) Nobody lives for 200 years. An investor’s timeline is like 30-40 years before they need the money. Stocks have had extended periods of bad performance in the past and this makes total returns very time dependent on the individual level.
3) Gold doesn’t have interest and dividends. This is a statement of the obvious. But it has much different risks than stocks and bonds and that means it is still useful in a portfolio. The same economic factors that are horrible for stocks and bonds can be quite good for gold and vice versa. That simply means you own gold as part of a diversified portfolio and not 100%.
4) This chart also shows that over 200 years gold has had a remarkably good record of stability in terms of preserving purchasing power. This is quite remarkable when you consider the history of the US, the wars, the booms, the busts, etc. that have happened. How many companies from 1802 are still around today?
5) Gold in a diversified portfolio can increase returns, decrease volatility, decrease risk, and provide protection under serious currency problems. All good things in my book.
This chart doesn’t make the case that gold shouldn’t be owned to me. It basically makes the case that owning a lot of different assets with different risk profiles is a really good idea. Stocks can be very powerful when the economy favors them, but when it doesn’t they can languish with big losses or zero real returns for protracted periods. A portfolio with stocks, bonds, cash and gold however can weather just about anything the economy is throwing at it. Diversification is your friend.
Fake Gold?
5 months ago
An interesting discussion came up on the forums about spotting fake gold coins:
Verifying Gold Coins are Real?
I talked about this in the Gold FAQ but thought I will go over the points again here.
First of all, understand that as gold prices go up the incentive to make fake gold products goes along with it. With gold at very high prices today it is possible that fake gold products could start showing up.
In the FAQ I wrote I even link to a Chinese company that produces gold plated tungsten products that will have near the density of real gold and would likely fool traditional tests such as weight and dimensions:
This kind of product could likely fool many people unless they have access to specialized analysis equipment.
So what can you do to prevent buying fake gold bullion?
- Use a simple measuring device like the Fisch Tool, or a Gold Coin Balance. These tools check the dimensions of common coins and the weight. A fake coin will not likely have the density of real gold so it will be difficult to pass these quick checks. I have used the Fisch tool and it works quickly and efficiently but is expensive. The Gold Coin Balance tool looks new and I will test one soon, but the principle looks the same as the Fisch tool for significantly less money.
- Don’t buy any gold bullion off of places like E-Bay and definitely nothing out of Asia. E-Bay has many fraudulent items for sale (not just gold) and is basically full of con artists. Ordering gold out of places like Hong Kong or mainland China is just asking to get ripped off.
- Only buy from well established coin dealers (check the FAQ). It is unlikely these dealers are going to allow fake gold bullion to enter their inventory. This is another layer of protection for you and is worth the small premiums they charge.
- If a deal is too good to be true it probably is. Anyone selling gold for below market spot price is probably a con artist.
- Stick to well-known gold bullion coins like American Eagles, Canadian Maple Leafs or South African Krugerrands. They are well established and known by dealers who sell them.
- Don’t buy collectable coins or numismatic coins. There is more incentive to fake “rare” coins to sell to people that don’t know any better. Collectable coins are almost always a complete waste of money as they contain little precious metal content.
If you want to check your coins yourself you can get a digital scale and calipers and measure them using this table:
Fake gold coins are certainly possible, but not very likely if you follow the above advice.
A Portfolio with Firewalls
5 months ago
A firewall is something designed to contain severe damage of a house, building or car to only one portion. The idea is if a fire breaks out it can be easily contained and the damage cannot spread to cause severe catastrophe. In a modern townhouse you have firewalls in case your neighbor’s place goes up in flames. In buildings you have firewalls to keep fire from spreading quickly across a floor. In a car you have a firewall that separates the engine from the passenger compartment. It’s good design strategy to build in fail-safes like firewalls in case something happens you didn’t expect.
But did you know that the Permanent Portfolio has firewalls built-in? Yep, it does.
By limiting each asset class to an initial 25% allocation (Stocks, Bonds, Cash and Gold) any one of them can take a large loss and the portfolio damage is greatly contained.
The recent media darling has been gold. The Permanent Portfolio has gathered quite a bit of publicity because it holds gold and of course the critics point out how gold can crash at any moment. And, I agree it could. Which is of course why these pages have encouraged investors to stick to their rebalancing bands for all their assets all the time and not try to predict the market.
But what if? What if gold crashed by -50% tomorrow morning? It could happen. But -50% of a 25% allocation to gold is a -12.5% loss to the entire portfolio value (remember, only total portfolio value matters). That’s not great, but it’s not a disaster (compare that to the massive losses stock investors took in 2008 for instance). This also of course assumes no other asset like the stocks or bonds goes up in value in response to cushion the impact.
So how is this a firewall? It’s a firewall because the portfolio design doesn’t allow you to concentrate your bets. Many other strategies advocate asset class timing, adjusting stock allocations based on age, concentrating bets based on historical performance expectations, etc. These approaches allow investors to build up large single asset class positions that are ripe for the picking in a bad market. The Permanent Portfolio however advocates never letting any asset get higher than 35% in value and never lower than 15% in value. It is forcing investors to sell down winners when they are doing well and buy the losers when nobody wants them. And if an asset is somewhere in the middle? Well it keeps severe damage from ravaging your life savings because no asset is so concentrated as to cause a large loss. Simple.
But we still hear the complaints about holding 25% in gold. Ok I see the same things everyone else does about gold but I still advocate people stick to the plan. Frankly I’ve been hearing about gold’s impending doom since it was $600 an ounce and now it’s $1800.
So what if gold nosedives -50%? Will you really take the -12.5% loss? Probably not. Or at least not for very long. What the critics seem to overlook is that the Permanent Portfolio also holds stocks, bonds and cash. Investors taking their money out of gold are likely going to put it into one of these other places. Cash of course won’t appreciate much, but if the gold sellers decide to buy bonds or stocks the prices will soar and the value of the total portfolio (remember, that’s what we care about) will not be affected much. Or, it may actually post a gain in a gold market crash (this has happened in the past). This is just how the markets work. And, if we think about it, we’d probably realize it makes sense unless of course those investors take that money from the gold sale and shove it under their mattress which is unlikely.
A period where your stocks, bonds and gold are all going down together is possible, but just not very likely long-term. Nature abhors a vacuum and the markets do as well. That money from a big gold sell-off is going to go somewhere and chances are it’s into an asset class you already own. Just as it happened in 2008 when the stock market collapsed and the money flowed into bonds. In that case the stock firewall limited losses to that area and the other assets were there to soak up the capital as it fled.
While there is no way for us to predict the future, we can try to design a portfolio that has firewalls in place to mitigate potential disasters in any one asset. I’ve looked at a lot of portfolio designs and the Permanent Portfolio is the only one I’ve ever seen that builds this concept into the core strategy. Harry Browne was, once again, way ahead of his time.
