The Permanent Portfolio, Investing, Finance and Random Thoughts.
Posts tagged Gold
Gold in the Permanent Portfolio….Again!
5 months ago
by craigr
in Permanent Portfolio
Whenever the gold price spikes or is in the news a rash of threads spin up on investment forums about the asset, and an increasing number pop up about the Permanent Portfolio because it holds 25% in gold. And it always seems that the same worn out arguments come up again about it. E.g:
1) Gold is just a worthless metal.
2) Gold doesn’t produce interest and dividends.
3) Gold is in a bubble.
4) Only paranoid people hold gold in a portfolio.
Etc.
Of course I’ve been hearing these things since gold was $600 an ounce and today it’s near $1800. Gold has in fact had a terrific run the past 10 years and could crash tomorrow. We just don’t know. But this is why I always advocate holding gold in a diversified portfolio with stocks and bonds. I also always advocate rebalancing the gold when it hits the upper rebalancing bands. Permanent Portfolio investors that have followed this advice have used gold safely and effectively to weather some serious market storms and turn in nice profits along with their stocks and bonds.
So let me just lay out again my thoughts on gold. Even for those that are not using the Permanent Portfolio.
Gold is the most controversial part of the portfolio. Gold is held in the portfolio because of the way our monetary system works. It is not designed to generate returns like stocks and bonds. Gold is there to protect the portfolio against inflationary scenarios that will be very bad for stocks and bonds.
I have said on this site repeatedly that all portfolios should hold some allocation to a hard asset. I prefer gold. But if that’s not your thing then make it commodities or physical property. I don’t think they will work as well as gold for this purpose of high inflation insurance, but will work much better than stocks, bonds and certainly TIPS.
It’s not a religious issue for me. It’s just a nod to financial history that sometimes paper currencies do very bad things very quickly.
Certainly one of the more interesting analyses I’ve seen of the Permanent Portfolio’s gold allocation performance was Iceland in 2008:
http://europeanpermanentportfolio.blogspot.com/2009/08/permanent-portfolio-in-iceland.html
The hypothetical portfolio followed by an Icelandic investor significantly reduced losses in 2008 when their market and currency collapsed. This is a first world country where this happened, BTW. Even though gold was only up +5% for that year in US Dollars, in Icelandic currency it was up +259% which really helped cushion the blow for those investors.
The point of this is that the gold is a currency neutral part of a portfolio no matter what the other components are priced in. It is a very good idea to hold some assets that can be independent of your home country currency. The Permanent Portfolio uses 25% as the figure along with stocks, bonds and cash and it just seems to work fine. But for someone else’s portfolio strategy the figure may be smaller as they see fit.
My personal opinion continues to be that even if you are not following the Permanent Portfolio, you should always hold at least 10% of your portfolio in a hard asset like gold.
The above opinion I’ve posted here for years and is independent of the price of gold. Gold should always be used in a diversified portfolio of stocks and bonds. Like all assets, it should not be used un-diversified.
Yes, gold does not produce interest and dividends. Nobody disputes that. But gold is also not subject to the same risks as stocks and bonds. Further, gold has shown itself to be an extremely powerful diversifying asset in a stock and bond portfolio.
I’m sorry, but gold is not a useless metal. Nor is it only owned by paranoid kooks. Investors can choose not to own any and that is fine. But please notify me when every major govt. and central bank on this planet sells their last ounce of the stuff from their vaults and I’ll be ready to listen to the gold is worthless argument. But until that happens the debaters on this point are just tilting at windmills.
The Permanent Portfolio holds gold. It’s a required part of the strategy for you to get the full package of protection it offers. If you don’t want to own gold then the Permanent Portfolio strategy is not for you. But just be aware that the history of gold as an investment asset is long and storied for a good reason.
US Credit Downgrade
5 months ago
Well most people at this point know the US credit rating was downgraded by S&P from AAA to AA+. The market result was a huge selloff in Treasuries today and the price crashed.
Just kidding! They are up like crazy. Strange world, eh?
I implore investors to stay out of the market timing, future predicting, and guru advice listening business. Nobody can predict the future and I don’t care how many degrees they have, what books they’ve written or what predictions they got right (luckily) in the past. It just can’t be done.
Ok, enough lecture. What does this mean for the Permanent Portfolio? Not much. The portfolio holds an allocation to gold for these situations and the gold is doing very well (even better than LT treasuries). US Govt. debt, even with the downgrade, is still a better bet than most other places (the Euro for instance is in much more jeopardy now than the Dollar). Not only this, but if the Dollar does the Swan Dive, the gold will go through the roof. And if it doesn’t Swan Dive? Well you’re still collecting nice interest payments to boost your returns. Also, there is always the chance that the US Govt. will be forced to cut down on spending and the credit rating could go back up (my hope). So, there is no need to get fatalistic about it yet.
So again I advise just sticking to the plan, rebalance if needed, and ignore the news. You can’t do anything about these things you’re hearing. Not just this, but you can’t react faster than the markets to do anything about them anyway (even assuming you can guess what the markets will actually do with that information). The only protection you have is a strongly diversified investment strategy, which the Permanent Portfolio provides.
I’m sleeping soundly.
TIPS Are a Bad Idea: Argentina’s CPI
As a follow up to another post, I am blogging to mention this article I read today about Argentina. Yes, we’re not Argentina. But it is very constructive to look at other countries handling high inflation to see what lessons can be gleaned. This article exposes one of the issues with relying on the Consumer Price Index (CPI) to protect investors against high inflation. Namely, political risk. Specifically, political risk of having the CPI manipulated to make those in power look less culpable than they really are.
The point I’m driving at about TIPS for inflation protection is that when the CPI is very high, and you really need the inflation protection, is the point when CPI is the most likely to be gamed against you.
No One Cries for Argentina Embracing 25% Inflation
Index Underreported
And when inflation remained stuck at about 10 percent in 2006, Kirchner replaced the officials in charge of the CPI report. Since then, Lavagna says, the government has underreported the consumer price index. The bureau says prices rose just 10.9 percent last year, while research firm Ecolatina, which Lavagna founded 30 years ago, says the gain was 26.6 percent.
(emphasis added)
Again, just a possible risk what could happen with relying on TIPS or other inflation indexed products to protect you under high inflation. For all its faults, at least gold doesn’t need to worry about getting fired for going up too much in value against a collapsing currency.
This is one of many reasons why gold is held in the Permanent Portfolio for inflation protection, and not TIPS.
TIPS are a Bad Idea
People sometimes want to know my view on Treasury Inflation Protected Securities (TIPS) vs. Gold for inflation protection. Well, I have boiled my research on this topic down into two simple rules:
Rule #1 – Don’t let the people causing the inflation tell you what the inflation adjustment rate on the investment will be.
Rule #2 – Don’t let the people causing the inflation pay you in the same currency that is being inflated away.
Explanation:
Rule #1 – Governments lie. Yes, that even means your government. When inflation is raging it is the government that will lie about the problem to protect itself. I have studied the financial history on this and it is just what happens in every country. And is it really surprising when you have your population angry that they can’t afford life necessities due to poor management of the paper money supply? Of course the pols are going to lie to protect their necks. Gold though is independent of government spokesmen, incompetent economists and political speeches. The price of gold is going to react to market forces and is not going to be weighed down in govt. policy decisions about true inflation figures, etc. Gold doesn’t care. TIPS however have this huge conflict of interest involved.
Rule #2 – If there is high inflation, then why in the world would you want more of the currency being debased and losing value? You don’t. You wan’t much less of it. In fact, you probably want to hold only the bare minimum to pay for current living expenses and that’s it. Yet, TIPS are paying your inflation adjustments in dollars. If the dollar is falling rapidly under high inflation why would you want more dollars? This only benefits the currency issuer, not you.
Gold has its own quirks and I acknowledge that. However it doesn’t have these very serious drawbacks that TIPS possess. But when it comes to serious inflation protection I believe that TIPS are not the solution. I just don’t know how to say it any clearer. Don’t buy arson insurance from arsonists and don’t buy inflation insurance from inflationists. It’s just a really bad idea.
Analysis of the Icelandic Economic Collapse of 2008
The Mises Institute just released an e-book analyzing the root causes of the economic collapse in Iceland in 2008. I have just started reading it, but the authors are building a case of the usual suspects (Central Banks, fiat currency and economic planners) behind the debacle:
Deep Freeze: Iceland’s Economic Collapse
Failure analysis is an important part of learning. And, it’s cheaper to learn from other’s mistakes than to repeat them yourself. I like reading about these kinds of extreme events and what measures did and didn’t work to protect investment capital. As it were, Marc DeMesel did an analysis of how the Permanent Portfolio would have performed for Icelandic investors in 2008 here:
Permanent Portfolio in Iceland
Also there is an interesting book from FerFal that details what happened in his home country of Argentina. I reviewed it here and it contains some very interesting first-hand accounts of what happens when a currency does a swan dive:
Surviving the Economic Collapse
I’m not a doom and gloomer, but I do think that all portfolios should have some protection in place for sudden currency problems. It is often way too late to respond once the markets for a currency begin to go sour. You need protection in place well before and you must hold it at all times no matter what the market sentiment may be. This is why the 25% gold allocation in the Permanent Portfolio is so critical to have at all times in the allocation.
H/T to Lew Rockwell’s Mises Institute for this.
