There’s much discussion in the news about Gold’s new price high (about $1300). The word “bubble” is getting tossed around a lot. There are a flood of articles (and advertisements) about buying gold and an equal flood about selling gold. What to do?

Talks about gold seem to devolve into market timing arguments. But for someone holding gold as part of their total asset allocation, such as the Permanent Portfolio, it should be treated like stocks or bonds with no market timing involved.

The only reason to be timing the market with gold is if you are treating it as a speculation. In this case it’s no different than relying on various indicators to sell out of all your stocks or sell out of all your bonds, etc. So use what you feel is best because they are all equally unreliable as market timing doesn’t work.

I can recall seeing these gold conversations when it hit $600 an ounce. I recall them when it hit $850 an ounce (matching the high in 1981). I can recall them when it hit $1000 an ounce. I can recall them when it hit $1100 an ounce. And of course I am seeing them all over as gold hovers near $1300 an ounce. The price of gold could fall at any time, but then again it could just keep going up responding to world events. We have no way of knowing these things.

If you own gold in your portfolio already then be sure you keep it rebalanced and use the profits to buy your laggards. If you don’t own it already, be sure you are doing so with a logical plan in place why you are doing it and not some knee jerk reaction to what you are seeing in the news.

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This topic is being discussed on the forum.

In January of last year I asked what people thought would perform the best of the four Permanent Portfolio Assets (Stocks, Bonds, Cash or Gold). While I tossed my hat into the stocks camp (which have recovered sharply since last year), the gold bulls seem to be winning. Here’s the breakdown according to Morningstar using a standard ETF version of the Permanent Portfolio for ease of performance tracking:

SPDR Gold Shares (Ticker: GLD): +30.54
Vanguard Total Stock Market (Ticker: VTI): +25.44%
iShares Short Treasury Bond Fund (Ticker: SHV): +0.20%
iShares Barclays 20+ Year Long Term Treasury Bond Fund (Ticker: TLT): -17.76%

YTD Morningstar Total Returns (capital gains, interest and dividends): +13.21%

Gold has been able to beat stocks so far this year. I was pretty sure that stocks would rebound strongly but didn’t expect gold to still do so well. We still have a month to go, but looks like the gold bulls may be buying the champagne come New Year’s Eve.

Long term bonds took a beating so far, but usually it is the case that one or more assets in the portfolio may be doing poorly while one or more may be doing well. Normally what happens are the gains from the winners can offset the losses from the loser. Not always, but mostly. So even though LT bonds are down almost 20%, the stocks and gold have provided more than enough power to grow the portfolio in total. And of course that’s what really matters. Don’t look at assets in isolation, look at how they work together in the total portfolio value.

Right now is also a good time to remind taxable investors to start planning for end of year rebalancing sales to capture losses (such as the Long Term Bonds), to take gains to offset against losses, etc. If this is confusing to you, talk to an accountant for some advice as smart tax loss harvesting can significantly reduce your tax bill.

Happy Thanksgiving…

If you want some no-nonsense ways to own Gold you can read my FAQ:

Gold FAQ

People are wondering about the gold price. Is it going to go higher? Is it going to go lower? Etc. Well the unexciting answer is nobody knows. That’s right, nobody at all knows. I don’t care how pretty their charts are or what logical arguments they have for or against. What I do know is that too many people are talking about the stuff.

If you own gold as part of your Permanent Portfolio allocation then you should stick to your plan and rebalance when it is needed. However, I would not go out and buy gold for my speculative Variable Portfolio bets right now.

I don’t think any particular asset class looks like a great buy for a Variable Portfolio speculation. So personally I’d just stick to the four way Permanent Portfolio split and not do much gambling with my money.

Now if you own gold in your Permanent Portfolio again I’d say to stick to the plan. That means you have a rebalancing band of either a low of 15% and high of 35% or a low of 20% and high of 30%, etc. If you are at or above your band then you should sell down your gold and rebalance the proceeds into your lagging assets.

Yes, I know it’s hard when you read all the doom and gloom but you have to do it. The point is you take an asset everyone wants and sell it to buy something that less people want.

The Permanent Portfolio is designed to limit risks and perform contrary buys and sells in the market. At any one time you probably are going to have an asset doing very poorly and another doing very well. This is how it is designed to work. But you need to be sure you do your part. That means selling down assets when they are doing great and using the money to buy the things people don’t want to touch at the time.

You hear that term “Bubble” being overused a lot now? “Gold Bubble”, “Stock Bubble”, “Bond Bubble”, “Bubble Bubble”. Well the way you limit losses due to “bubbles” is by rebalancing. No elaborate market timing is needed. If you own too much, you sell it down until you own less of it and buy something else. Simple stuff.

Are you nervous about the rise in gold prices and all the hype? Well I know some people are because I’ve heard about it. Here’s my advice:

If you have a rebalancing band that is 35% and your gold has risen to, for example, 33% of your allocation then perhaps you can sell it down early to 25% and re-deploy the money. I don’t think selling early in your rebalancing bands is going to hurt you much if it makes you sleep better at night. Perhaps in the future you make your rebalancing bands the 20%/30% thresholds so you keep a tighter control over how much money you have at risk in each asset. This can incur added tax and brokerage fees you need to be aware of, but it’s not terrible if it makes you feel comfortable. Remember, this isn’t a science so there are no precise answers to be had.

The one thing I would not do though is let any allocation slice rise above 35%. If you sell out too early and harvest those profits you will be OK. Sure you’ve not milked out the very top of something. But, as they say, only liars sell out at the very top and buy at the very bottom. But if you wait and let an allocation go to 40%, 45%, 50%, etc. you can set yourself up to take a tremendous loss if the markets turn suddenly. This isn’t just a warning for gold, it’s a warning for any asset class you hold.

This is just a reminder to not make gold a religion and use it intelligently in a portfolio. I don’t know what the gold price is going to do, but I don’t think you should listen to all the hype in the news about it either. Stick to your plan and don’t take risks with money you can’t afford to lose.

A reader writes:

Thank you for your very useful and informative website.  I have read the Harry Browne book and we already own the PRPFX mutual fund.  I am now interested in replicating this strategy on my own with other money in order to diversify the holding of our assets. Your site has helped give a lot of practical information for doing such.

What comes to mind are the following questions regarding depositing and withdrawing money from the portfolio:

1) After it is all set up and initial money is invested, when you add more money do you automatically split the money up into the 4 parts equally, or do you use that as an opportunity to rebalance the portfolio and increase the value of an asset class that is currently low?  I have been trying to determine if this matters or not either way.

[craigr] I’d put the money into the lagging asset. It’s usually at a better price and I like buying things on sale because you get more for each dollar. Also helps save on taxes because you rebalance less later.

2) Likewise, when you take money out of the portfolio, do you remove it just from the current top performer or from all 4 asset classes equally?  I realize the permanent portfolio strategy is not meant for frequent withdrawals, but nonetheless, I would like to know the correct strategy for when I need to do so.

[craigr] I take money from the “cash” allocation and replenish it once a year personally. That way I can let the other assets grow if they are so inclined. Cash is the least likely to appreciate of all the assets. This also has less turnover costs as your “cash” will probably be in a money market fund that works with smaller withdrawals without additional costs and extra bookkeeping (like tracking gains and losses).

It seems that using a deposit or withdrawal as an opportunity to somewhat rebalance the portfolio would be the way to go, after all, if you buy more of the low asset it then automatically decreases the percentage of the higher asset.  But, I would like to hear your thoughts on this from your experience and analysis.

[craigr] I think you’re looking at this the right way. Buy your lowest performing asset first. If you don’t want to do this constantly, then put the money in your “cash” and then once a year make a bulk purchase into your assets that are lagging to save on transaction costs if you pay them. This is not a problem with open-ended mutual funds (as index mutual funds won’t charge you purchase fees most of the time). But this is an issue with ETFs as you pay a broker fee for buying/selling.

Thanks for writing and I hope that helps.

An interview with Rob Arnott describes the portfolio of Jacob Fugger (“Fugger the Rich”) who lived from 1459-1525. The portfolio that made him so rich sounded very familiar and I wanted to share this part of the interview with Mr. Arnott:

Rob Arnott: Where do we go from here?

Audience Question: It seems you’re simply promoting a diversified approach to investing. How is this different than basic portfolio theory?

Arnott: There’s nothing new under the sun. Questions: How many people follow a truly diversified approach? How many think of their stocks as ownership of an enterprise (à la Graham & Dodd), rather than as some assemblage of portfolio characteristics? In the 15^th century, Jacob Fugger (“Fugger the rich”) put his money in shares, in loans (bonds), in property and in commodities. And he’d rebalance when the mix drifted away from one-fourth each. The shares and the real estate did well when the economy was strong; the loans and commodities did well when it was weak; the commodities and real estate did well when the government was debasing the currency; and the stocks and bonds did well when the government and the currency were sound. Old ideas have a lot of power, and keep getting rediscovered.

(emphasis added)

Here’s another quote that I’ve seen attributed to Fugger in numerous places (Although none referenced the original source. If you know of it, please let me know.):

“Divide your fortune into four equal parts: stocks, real estate, bonds and gold coins. Be prepared to lose on one of them most of the time. During inflation, you will lose on bonds and win on gold and real estate; during deflation, you lose on real estate and win on bonds, while your stocks will see you through both periods, though in a mixed fashion. Whenever performance differences cause a major imbalance, rebalance your fortunes back the four equal parts.” (emphasis added)

- Jacob Fugger

I found it amazing that Fugger’s portfolio was so close to the 25% split that the Permanent Portfolio uses (Was this the inspiration or a rediscovery? We’ll never know.). Although, real estate is something the Permanent Portfolio avoids due to the illiquid nature of the asset and holds cash instead (if you own real estate, count it as part of your Variable Portfolio).

Note how Fugger’s approach sounds very similar to the Permanent Portfolio’s idea of holding assets that correlate to economic cycles of Prosperity, Inflation, Deflation and Recession. This insight is something that is missing from most portfolio allocation advice you see. Further, it’s also why many portfolios get blindsided by extreme events or protracted periods of underperformance in my opinion.

Now here’s something in Fugger’s quote that many people have a problem with:

Be prepared to lose on one of them [an investment] most of the time.

I get questions about some asset being too high and something being so bad that they couldn’t possibly go out and buy it. Yep. That’s pretty much how it always works. Here’s my official response:

Don’t look at asset classes in isolation. Look at your portfolio as a whole instead.

What do I mean by that? Well, it doesn’t matter if you lose 10% on an asset in a year if your total portfolio has gained in value. A 10% loss in gold but a 25% gain in stocks and bonds puts you ahead. A 20% loss in stocks but 30% gain in bonds also puts you ahead. The individual losses were offset by the winners enough to give you a profit in the total portfolio.

As it is, the Permanent Portfolio is designed to hold assets that are volatile so a decrease in one is almost always offset with gains in another. At any point in time you’re going to have something in the portfolio that is really hot and something that is a real dog. It’s almost guaranteed too happen. Why? Because the economic environments of prosperity, inflation, deflation and recession will never happen all at once. Since the assets are geared towards responding to these conditions individually you are going to have something that is always doing well and something that isn’t. It’s just the nature of the diversification.

The problem is that since we can’t predict the future we don’t know what asset is going to do well and what is going to do poorly ahead of time. So our solution is simple: We own them all no matter what.

If you don’t own all the assets, all the time, you don’t have the protection of the portfolio. It’s just that simple. You also need the guts to rebalance out of your winners and buy your losers. Something that has been talked about here in the past.

It looks like Fugger had this pegged a long time ago which is why he was Fugger The Rich and not Fugger The Pauper. It’s comforting to know that good ideas really are timeless.

Let’s look at how the Permanent Portfolio has done so far in 2009 according to Morningstar. A sample Permanent Portfolio comprised of the following ETFs has these total returns for the year. This assumes you bought in January and held on without touching the assets until today:

Vanguard Total Stock Market (Ticker: VTI): 21.27%

SPDR Gold ETF (Ticker: GLD): 14.31%

IShares Short Treasury Bond (Treasury MMF Equivalent) (Ticker: SHV): 0.11%

iShares 20+ Year Treasury Long Term Bonds (Ticker: TLT): -18.18%

Total Returns 2009 YTD: 6.70%

Now let’s look at what I consider a pretty standard portfolio made of 60% stocks and 40% bonds:

Vanguard Total Stock Market (Ticker: VTI): 21.27%

Vanguard Total Bond Market (Ticker: BND): 2.82%

Total Returns 2009 YTD: 14.74%

Some comments:

1) The Permanent Portfolio had almost 7% returns so far even though one of the assets (Long Term Bonds) has done quite poorly. Yet, this is normal. At any time you’re probably going to find at least one asset in the portfolio that is doing very well and another that isn’t. Last year it was LT bonds that came in at the last moment to save the day when stocks took a large loss. This year it looks like positions are reversed. This unpredictability is standard in the markets which is why the portfolio does not attempt to guess the markets. This is also why I tell people to just buy all the assets at once and not attempt to guess whether one is too high or too low at any point in time.

2) The standard stock/bond portfolio is having a good year by comparison. This will always happen when stocks are having such a powerful recovery as they have so far in 2009. But also remember that this portfolio had a loss somewhere around 25-30% last year so it has a ways to go to recover from the losses in 2008. It still needs to go up another 15% or so to get back to even according to this chart.

3) The Permanent Portfolio is not designed to have rocket-ship like performance during good years. But it also doesn’t have rocket-ship like explosions during bad years. It is made to have just a smooth steady real rate of return year after year. Since the 1970s this rate of return has averaged about 9-10% per annum with the worst loss being about -4-6% in 1981.

Rebalancing – Emotionally challenging but necessary

Now let’s consider the rebalancing strategy of the Permanent Portfolio. As we know, the Permanent Portfolio splits the assets of stocks, bonds, cash and gold into equal 25% portions. To rebalance, you buy an asset when it falls to 15% or less of the portfolio and sell an asset when it is 35% or more of the portfolio. These are the standard rebalancing triggers. Some people use figures of 20% and 30% for buying and selling which is fine, too.

Just have a figure set for your portfolio and don’t go around changing it based on what you think the markets are going to do.  Also, don’t let any asset get above 35% of your portfolio because you open yourself up to taking a larger loss if that asset drops in value quickly. Likewise, don’t let an asset fall below 15% because you won’t own enough of it when needed to offset losses in other parts of the portfolio.

If you were following the strategy you probably did better than 7% this year because you were rebalancing. Rebalancing is critical for the Permanent Portfolio strategy to manage your risk. In late 2008, I encouraged readers to rebalance from their LT bonds into stocks:

By not rebalancing, you may miss out on large gains in your other assets by having too much of your money tied up in your current winners. Imagine missing out on a 20%, 30% or higher gain next year in stocks if the markets recover and things work out.

YES, I know that sounds impossible right now. But it’s happened before and YES it usually does it after a bad market crash.

Gains like I just mentioned happened after the early 1970’s recession (1975 +37%, 1976 +24%), after the recession in the early 1980’s (1982 +21%, 1983 +22%), after the early 1990’s recession (1991 +31%), after the early 2000’s Internet bust (2003 +29%) and they even happened during the 1930’s Great Depression (1933 +54%, 1935 +47%, 1936 +34%, 1938 +31%).

That was a profitable move but didn’t involve market timing. Just simple rebalancing. Now I’m reminding readers again that if your stock or gold allocations are at or above your rebalancing bands you should sell them down and redirect your profits to to your lagging assets (probably Long Term Bonds and Cash).

Yes, I know what the financial press is saying about Bonds (Inflation is coming so don’t buy them!). Yes, I know what they are saying about gold (Inflation is coming so you should buy gold!). Yes, I know what they are saying about stocks (We have green shoots of recovery all around us!).

I get it. Yet, I don’t care what others are saying. These people don’t know what the markets are going to do any better than you or I.

I know it’s hard. You have to sell out of your best performing asset that everyone says can only go up and take that money to buy some losers that everyone says can only go down. But, that’s the winning strategy.

If you rebalanced this year you were selling down your LT bonds and buying stocks in the Winter at a near decade low price. By Spring, gold had gone up in value and it is likely that you may have had to sell some of it down and buy stocks when they were even cheaper. Then Summer came and stocks have gone up near 50% since Spring and it may be that you’ll be rebalancing out of them by the end of the year. So it goes.

In fact, you probably are well ahead of the 7% YTD figure posted above if you did these things thanks to the powerful stock market recovery in the Spring and Summer that you bought into with your profits from LT bonds and gold earlier this year. All of this was done without any market prognostication or gimmicks. Just some simple arithmetic on calculating portfolio percentages.

This amount of rebalancing is unusual in the portfolio. But, the markets are very volatile right now which necessitates it. Usually, you don’t have to rebalance very frequently at all. Perhaps only every year at most (usually longer in fact). The point is don’t get emotionally attached to any asset because you’re not married to it. When it is too high, you sell. When it is too low, you buy. Don’t over-analyze it. It’s business. It ain’t personal.

Remember, the Permanent Portfolio strategy requires you to rebalance out of winners and into losers. It is forcing you to sell high and buy low. I know it can be difficult emotionally to buy into an asset that looks the worst. Yet, you must ignore what you see, read and hear in the press (or feel in your own gut) and rebalance your portfolio when it is needed. It works.

Economist Robert Higgs comments in the following piece about the prospect of inflation in 2009 and beyond:

The Fed versus the Banks: Who Will Blink First?

I have never been inclined toward touting doomsday financial scenarios. I raise the possibility now only because, as I consider the situation portrayed in the graph of excess reserves linked above, I am unable to foresee how the Fed and the Treasury can navigate through these treacherous waters – waters that their own previous actions have whipped to a foam – without creating terrible financial and economic harm. If the dollar survives the ministrations of Bernanke, Paulson, Bush, and the Obama gang, its survival will be something of a miracle.

Earlier in 2008 inflation fears were the bogeyman. Oil was at $150 a barrel (it’s now $40). Gold hit $1000 an ounce (it’s now in the $800′s). And the Dollar was at record lows against the Euro and other world currencies (it recovered greatly). The markets were sure that inflation was coming on strong. 

Ahhh, but Fall 2008 came and so did the popping of the Real Estate bubble. This caused a massive destruction of paper wealth that rippled through the financial markets taking out many large banks. By December, Long Term bonds (a powerful deflation shield) swapped places with gold, commodities and other inflation hedges for being the winning asset of the year. The US Dollar shot up in value at a rate never seen against the Euro. Deflation was on everyone’s mind and Long Term bonds proved their mettle as they powered ahead with 30-40% gains. This boost erased almost all market losses in the Permanent Portfolio strategy during the October/November stock crash.

Who would have thought that we’d start 2008 with the prospect of inflation only to end the year with our illustrious central bankers scrambling to prevent an all out deflation? The markets are like that though. Moody. Random. Unpredictable. 

But what should we do now?

Stick to the plan.

If you follow the Permanent Portfolio strategy you’ve probably done OK so far considering how bad the markets are. Perhaps you’re down only a couple percent compared to the 40% loss in the general markets. You dodged a bullet and may be feeling pretty good, but don’t get complacent!

During this time as stocks swooned your Long Term bonds have soared. You are probably finding that your bond allocation is now at or above your rebalancing bands in the portfolio. They could likely be 30, 35 or even 40% of your allocation. Yet, your stocks may have fallen by 40% and could be only 15% or so of your portfolio.

That’s not good. It’s now time to rebalance. 

If you are overweight on your bonds in the portfolio (e.g. they exceed 30-35% of your holdings), you should consider selling them down to 25% and using the proceeds to bulk up the other parts of your portfolio that are below the 25% allocation band (such as your stocks, cash and gold).

For those thinking their bonds have done great and don’t intend to rebalance, all I can say is be careful. It’s tough to sell a winning asset, but at any time your bond gains could be eroded as interest rates whipsaw upwards. If economist Higgs is right, the inflation we see could be quite bad. Instead of 30-40% profits in your bonds, you could be staring at 30-40% losses or worse. 

By not rebalancing, you may miss out on large gains in your other assets by having too much of your money tied up in your current winners. Imagine missing out on a 20%, 30% or higher gain next year in stocks if the markets recover and things work out. 

YES, I know that sounds impossible right now. But it’s happened before and YES it usually does it after a bad market crash.

Gains like I just mentioned happened after the early 1970′s recession (1975 +37%, 1976 +24%), after the recession in the early 1980′s (1982 +21%, 1983 +22%), after the early 1990′s recession (1991 +31%), after the early 2000′s Internet bust (2003 +29%) and they even happened during the 1930′s Great Depression (1933 +54%, 1935 +47%, 1936 +34%, 1938 +31%).

Virtually nobody during these years was predicting a big bull market would happen right in the middle of those bad economies. Yet, they did. If you find your stocks are up +40% next year that’s great. You’ll be selling off those profits to buy your new losers. That’s the essence of rebalancing. Same for any gains in your gold or even more gains in your bonds. If the markets turn against this year’s winner at least you’ll know you took those profits off the table and put them somewhere more productive before they had a chance to vanish. 

This is not a prediction (I don’t do predictions). Just a reminder that the markets do crazy and unpredictable things so you need to own all of the Permanent Portfolio assets and not try to guess what may happen. Be unemotional about rebalancing out of winners to buy your losers. 

One final note is that taxable investors may want to take the time to do a tax loss harvest on stock funds that are underwater before the end of the year. You can use these losses to offset their taxable gains going forward. If you don’t have any losses to take, it may make sense to wait until 2009 to take the Long Term bond gains to defer the taxes until next year. Talk to your accountant to see what option makes sense. Investors in tax-deferred retirement plans don’t need to worry about this.