Role of gold in absence of inflation

[I Shrugged]

Like many of us, I don't blindly accept the PP without healthy skepticism.  I am not worried about not keeping up with a Bogle portfolio, a Mathjak, or any other.  But I do want to understand whether or not the PP would be developed by HB today.  It's quite possible that inflation was a brief anomaly, which happened to be the environment in which the PP was concocted.  We know what the PP used to be before it was 4x25.

So would 4x25 be developed from scratch today, using the same reasoning as before?
Do you count on gold first and foremost for inflation protection?  Or for collapse protection, as hard money, portable/quiet wealth, overseas wealth?  I see it being for as the latter things.  I began my investing in the mid-80s as inflation was coming down.  OTOH as long as I've been old enough to be aware of it, my dad has been an inflation doom guy.  Like Harry, it shaped his worldview.

I think gold has an important role.  But maybe one that can be separate and distinct from an investment portfolio.  Is this a distinction worth considering?  If so, the plan might be to accumulate gold at a fairly high rate until you have "enough to survive with".  Then...?

Do we need gold as a return-driver and return-smoother in a portfolio?  Or has it turned out to be mostly black swan insurance? 

[fi50@fi2023]

I am new to gold and I have to say that I love adding it to my portfolio.  My favorite aspects?  Lack of counter party risk, portable wealth, inflation hedge (I do not believe that inflation is over). 

[MediumTex]

From 2001-2011, inflation was tame, but gold performed exceptionally well.

I think that gold does more than provide an inflation hedge.  In fact, it hasn't done especially well as an inflation hedge over the life of the PP compared to simple t-bills, but it has nevertheless provided exactly the volatility that the PP has needed along the way to keep delivering those nice smooth returns.

[mathjak107]

Gold does not know itself what it is supposed to respond to.
First it was supposed to be an inflation hedge and it lagged behind everything else.

Then it was times of trouble and political uncertainty , it lagged there.

Then it was supposed to be a weak dollar so when we had that happen the world central banks dropped the dollar and bought  inflation proof treasury's as a hedge against a falling dollar.

Those did not exist in harry's day but we saw them become the darling of the world central banks as they dropped the dollar for them getting interest and protecting against a devaluing dollar.

So at this point gold is still trying to find what it is supposed to respond to other than just a run up out of the blue like we saw followed by a collapse because it had no condition to support it that wasn't done better by something else.

I guess you can call it insurance against a total collapse of faith in the dollar but if that happens and trillions are lost there is a good chance no one will have money to bid up the price of gold as a world depression is the likely out come.

All in all it is a question no one can answer since in 40 years no matter what the scenario something else always  picked up the ball and ended up doing the job better.

To many ways today to bet against the markets that are as simple as buying an inverse fund.

Gold still looks pretty and conducts electricity very well.

I can see a max of 5 to 10% in it but i think if harry was around today he would feel 25% of ones portfolio was quite over insuring based on probability and the fact all the things that happened in the world  that he envisioned gold would respond to it never did.

As far as controlling volatility in the pp anything that wasn't stock would have done pretty much the same.

At one time in the past the very conservative income and capital preservation portfolio went as high as 40%  in balanced  and growth and income funds which is high for that model which tends to range from zero to 30% .But the volatility was tamed by 25% cash which was paying 4% or so and the rest bond funds. It worked fine simply because it wasn't stock.

[barrett]

Math,

Serious question... What do you think drove gold prices up almost seven fold between 2001 and 2011? Was it just a few nut jobs holding their PPs or was there something more fundamental going on?

[mathjak107]

Good ole speculation drove it up . It was really nothing more than the bigger fool theory. There was no solid basis why it should have run up like that which is why when there were no more fools the bottom fell out.

Assets get mispriced on greed occassionaly.

Gold at 800 in the 1980's , nasdaq at 5000 15 years ago ,  home prices in the 2000's along with golds run up all were based on nothing but greed and a bigger fool buying it, no sound basis for prices at all.

These are price levels they should never have been at .

Then like water they plunge back towards reality and  find their correct level.

[barrett]

But there have been times when you have liked the PP. Do you think gold has a role to play in any investment portfolio. If so, when?

[mathjak107]

My opinion is if i held gold at this point it would be a tiny position and speculative in nature once again hoping for a bigger fool theory wave .

The fundementals for sustaining anything other than that i just don't see in place and not worthy of committing money to  as the wait may be so long that it  could double and not replace what was given up waiting.
If you got drawn in to the last run up gold still has to double years later just to break even , not even figuring had it been in equties it would have doubled to tripled instead of being still down 40% .

To me the cycles in gold take just to long and gold in my portfolio is more about timing the market than time in the market.

It just has not responded to the stress and fear world wide harry thought it would to be consistant enough for my taste. There are lots of other ways to balance portfolio volatility  that can do it with more consistancy just because they are not stocks including cash .
But thats is my opinion .

[barrett]

What I specifically heard Harry Browne say in one of his podcasts was that gold would react strongly to serious inflation. The example I believe he gave was anything over about 6% We obviously haven't seen that for 35 years or so. He also expressed no surprise at all that it didn't react to geopolitical events… that, for example, it shouldn't have been expected to react to the events of 9/11.

Math, humor me and watch five minutes of this Ray Dalio video from 47:00 to 52:00

https://www.youtube.com/watch?v=SFaRazMpxcM

Though he doesn't give percentages, he is essentially outlining at least a version of the PP. Thoughts?

[barrett]

Math,

Serious question... What do you think drove gold prices up almost seven fold between 2001 and 2011? Was it just a few nut jobs holding their PPs or was there something more fundamental going on?

My own theory is that gold "came into favor" in the early 2000's, due to the combination of economic upheaval, terrorism and war.  The resultant rising price attracted new investors, and the availability of gold ETF's was like throwing some gasoline on a small fire, driving the price even higher.  GLD was launched in 2004, providing well-marketed gold access to the masses.  The 2008 crash made gold even more attractive, due to fear and uncertainty about the future of the world economy.  The bull market was finally killed off by rising equity prices, which caused everyone to forget about the barbarous relic and flood into equities.  I'm sure gold will have its day again, but it could be a while. 

Note that none of the above has any relation to inflation. 

All interesting. I would just point out that from early 2009 until well into 2011, gold and stocks were both going up strongly. I remember when we have batted this question around before, MT posited that fear of inflation due to money printing was most likely behind gold's rise... and that when that fear turned out to be unfounded, gold's price came back down to earth.

I have posted before on this forum that I think it's critical to understand this 2001 to 2011 period if one is going to devote 25% to gold.

[mathjak107]

Like all assets we own, we will all rationalize and find a purpose for still owning them or justify why we have thenvwhether the reasons pan out or not. No one likes to be wrong  so no matter what the asset is we have a vision in our head supporting it.

[buddtholomew]

HB intended gold to buoy the portfolio in times of significant unexpected inflation. The PP is designed to protect purchasing power in times of extreme economic conditions. You will not lose your life savings. How the portfolio performs in the interim while being tugged in four directions is anyone's guess.

[sophie]

The PP was not just designed to deliver investment returns - it was designed to provide maximum protection for your financial assets.  That's an important distinction.  Gold serves two roles in the portfolio:  it's a hedge against high inflation and high uncertainty, as previously discussed, and it also serves as a store of wealth that can survive threats to your other assets. HB talked about this at some length in his radio show - very interesting stuff.

The 2008 event, where money markets were locked up, banks and brokerages failed, and investment portfolios tanked, is an example of threats to your wealth from the financial system.  However, there are also things that might just affect you personally, e.g. getting sued, having your accounts frozen or assets seized.  Keeping part of your wealth in physical gold can ensure that you aren't completely wiped out, or can at least give you time to fight the action as there will be a delay before your gold assets come to light.

All unlikely events, true.  If you're not worried about such things then there is probably less reason to keep a large proportion of gold in your portfolio.

[mathjak107]

Protects against uncertainty has been a tag line attached to gold as long as i can remember.

I have seen enough uncertainty in my 30 years as an investor and especially the last few months to last a lifetime.

There is always some reason some other asset class gets passed the ball and runs with it.

The time is just never right for gold. I mean can markets have anymore uncertainty then the last few months.

I vote to remove that unproved tag line from golds responsibilitys until it actually responds to uncertainty and not just under certain ideal conditions for it which we do not even know what they are.

[MediumTex]

Math,

Serious question... What do you think drove gold prices up almost seven fold between 2001 and 2011? Was it just a few nut jobs holding their PPs or was there something more fundamental going on?

My own theory is that gold "came into favor" in the early 2000's, due to the combination of economic upheaval, terrorism and war.  The resultant rising price attracted new investors, and the availability of gold ETF's was like throwing some gasoline on a small fire, driving the price even higher.  GLD was launched in 2004, providing well-marketed gold access to the masses.  The 2008 crash made gold even more attractive, due to fear and uncertainty about the future of the world economy.  The bull market was finally killed off by rising equity prices, which caused everyone to forget about the barbarous relic and flood into equities.  I'm sure gold will have its day again, but it could be a while. 

Note that none of the above has any relation to inflation. 

All interesting. I would just point out that from early 2009 until well into 2011, gold and stocks were both going up strongly. I remember when we have batted this question around before, MT posited that fear of inflation due to money printing was most likely behind gold's rise... and that when that fear turned out to be unfounded, gold's price came back down to earth.

I have posted before on this forum that I think it's critical to understand this 2001 to 2011 period if one is going to devote 25% to gold.

Remember, though, that when gold "came back down to earth" in 2011 it settled at a price level approximately 4-5 times higher than it was at the beginning of the bull market in 2001.

[mathjak107]

We can say that about nasdaq too hitting 5000 15 years ago . It too settled back down to a point that was higher than someother point.

Great but you are still down 40% from where you stood in gold.

It is like if stocks go back to 6000 i can say at least i am higer than i was back in 1987 when i started.

The reality gold does not respond well to uncertainty because there are to many qualifications for that to happen . It still has lagged everything else including t-bills as an inflation hedge  so we cant say it is a good protector against inflation. There are better choices.
So at this point as i said we have no clue what and when it will respond to other than speculation in the market place.
More mental masturbation than anything else.

[Xan]

We can say that about nasdaq too hitting 5000 15 years ago . It too settled back down to a point that was higher than someother point.

Great but you are still down 40% from where you stood.

It is like if stocks go back to 6000 i can say at least i am higer than i was back in 1987 when i started.

More mental masturbation than anything else.

Hang on...  When gold shoots up and then falls back 40%, that's terrible, because who would want to be down 40%.  You're ignoring that the PP pretty much did its normal thing, reasonable growth with little volatility, throughout.

Meanwhile you advocate that a portfolio should be 100% stocks which can easily tumble huge amounts like 40%.

So on one hand you say that being down 40% in a single asset despite the success of the overall portfolio is terrible, and on the other you say that everybody should be 100% in an asset that regularly has enormous drawdowns.

[mathjak107]

You could not possibly have been reading what i post if you  say i am advocating 100% stock portfolios.  In fact i challenge you to find where i advocated such a thing .

I never said any such thing and i am 50/50. If you want accuse me of advocating anything accuse me of advocating wellesley income a 40/60 mix which i mention all the time as a conservative alternative.

What i questine is here we are in a changing world that is very different from harry's world with assets acting very different from the way he invisioned it.

Well now we have no one at the helm of the ship to nudge things back on course ,evaluating whether past principals are even still valid.  Yet everyone still follows the script  as it was written when you do not even know if harry would have revised it over the decades. That would make me very nervous as well as leary  when no one is overseeing or steering .

I have a hard time believing harry would not have revised the gold allocation if he saw its behavior 40 years later. Yet everyone still follows the exact course without anyone even confirming the maps are still valid 40 years later.

[mathjak107]

Why do i think harry would have revised the pp ?

Because equal amounts of money in to outcomes that are anything but equal in percentage of chances of playing out is not what i think harry's idea of the balance he  hoped to get .

[I Shrugged]

I think a lot of that bubble was due to gold becoming easily buyable in the form of ETFs.  I bet a lot of mainstream sell-side brokers started pushing gold and stories about gold, and it went crazy.  Now it's just another speculative vehicle available to anyone with a brokerage account.  Prior to this you had to really be into it to be long gold.  I think it will behave more like other commodities going forward.  Just my guess!

[koekebakker]

Why do i think harry would have revised the pp ?

Because equal amounts of money in to outcomes that are anything but equal in percentage of chances of playing out is not what i think harry's idea of the balance he  hoped to get .

I think that's exactly the balance HB was looking for.

[KevinW]

The primary sources (Browne's books and podcasts) talk about how the gold bullion allocation is an all-else-fails backup in case your local economy stops working for you. Hyperinflation is one failure mode, but there are others.

As a thought experiment, put yourself in the position of a Syrian refugee. Conditions in your home country are so horrendous that you're willing to run away to any country that will take you, bringing only what you can carry. If your portfolio is all paper assets, you are now flat broke. If you have an orthodox PP, you can carry 1/4 your net worth on your person. At least you have something, enough to start over.

More subtly, when you feel secure about being protected against doomsday scenarios, you are inoculated against wasting money due to worry about doomsday scenarios. When a perma-bear or prepper is chewing your ear off about how the US will collapse any day now, you can safely tell yourself "well worst-case scenario I'll still have the gold and land on my feet." Which blocks you from making a rash decision. So the gold protects you against losses without actually doing anything.

Further, humans seem to have an urge to hoard tangible valuables. When you invest in the PP, you can blow off that steam buying gold bullion coins, which are at least part of a coherent portfolio and are liquid. Without that blow-off, people tend to waste money on negative-return, illiquid collectibles. My grandfather bequeathed me baseball cards and stamps. My grandmother-in-law has been trying to sell expensive collector plates for years. I really wish these guys had bought bullion instead.

[mathjak107]

For us here gold is such expensive insurance against a remote chance of something like that happening and gold actually  responded to so little the last 40 years that i think by now harry would have revised it and cut that allocation down to match the level of possibilty.

It would make little sense to spend as  much to insure something when the odds are near zero as it costs to insure something when the odds are near 100%. 

Especially in light of the fact that at these levels the portfolio as it stands maybe making to heavy a bet on the direction of bond rates.

The point is the pp is  unguided  at this point and the right or wrong balance at this stage can never be known ,reviewed or fine tuned by those who created it.

That puts the burdeon on you to do . You can't assume like religon that you are following something that is correct in its thinking at every stage because the pp is only an investment strategy that may have reached a point of its peter principal. but that is something you now have to decide because there is no one at the helm steering it and guiding it for the future.

Blindly thinking something is forever when those who created it can't monitor it and the normals of the world are very different from those days may be hazardous eventually to your wealth and that is true of any investing strategy.

Harry had a vision he thought would work . He wasn't a devine god that deciples should follow blindly.. you need to watch the action on it , evaluate it and make sure it is still following your course because no one
else is watching it but you.

I used to recommend the pp alot as a wealth preservation portfolio but i am not comfortable doing it.
I have no way of knowing if i am recommending something that harry would have updated and changed and no longer not only fits the bill but may cause heavier losses than anticipated if gold and long term  bonds continue to get hurt even more. Yesterdays drop in long term bonds was almost the equal to a 250 polnt drop in equity's.

I truely believe the pp would have been revised at this point if harry saw how little gold brought to the party , was actually needed and what the expense was of sitting with it for those 40 years.


 

[barrett]

Math, Getting away from gold for a moment... You often mention that the PP is in untested territory with high stock and bond valuations and extremely low interest rates. Harry Browne certainly was able to look at Japan for the last decade of his life and draw some conclusions from their sky-high bond valuations, near-zero interest rates and a stock market that, even if we assume it was fairly valued after its major crash, was totally unable to pull itself out of its doldrums. I am not saying that we are definitely Japan, just that HB saw the Japanese situation, undoubtedly considered it, and yet never made any adjustments to his 4X25 recommendation.

Let's remember that HB settled on the 4X25 allocation in 1987 but that he was still out there doing radio shows in November of 2005.

In Japan, holding a bunch of gold and cash was surely a net positive over the last 25 years. Even holding LTTs gave a Japanese PP some juice for about ten years as they continued to pay out interest that was higher than the level of inflation.

Now, back to gold... Are we all really 100% sure that there in no chance of inflation in the future, say, the next ten years or so? I don't see it right now but with Japan, China, The US & Europe all trying to devalue their currencies, a lot can happen. Individual economies are ever more interlocked and stuff can happen outside the US that changes things here at home.

[mathjak107]

Harry was a gold bug , he loved gold and i believe he saw gold as sharing center stage with equity's and playing a much more responsive roll to world events and even our own.
Not just popping its head up under some unique set of circumstances we
Can't even identify with certainty as to what they are 40 years later  .


We are not japan nor have we  made the mistakes japan made .
We could have been in 2008 but we acted the total opposite they did when they mistakingly tightened sending them in to a deflationary spiral.

We can't assume harry would have kept the portfolio as is or not , we don't know what changes he would make today if any . But you have a whole bunch of followers who are just jumping on the train and not thinking about the fact there is no engineer.
maybe they will reach their destination maybe they won't . But it is up to everyone to watch the stops now along the way and make sure and not just use auto pilot without someone still checking the maps to make sure the bridge is still there.

I think if harry still had the newsletter we may have seen an adjustment down to 15 or 10% in gold ,  perhaps some adjustment now in long term treasury's with rates near the bottom poised to rise for what could be another 40 year cycle .