An Alternative Explanation for the Permanent Portfolio

General Discussion on the Permanent Portfolio Strategy

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Tyler
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An Alternative Explanation for the Permanent Portfolio

Post by Tyler » Sat May 13, 2017 11:09 am

While it has been a little while since I read Harry's and Craig/MT's works, the traditional explanation for the four PP assets is pretty well-known and boils down to selecting assets that perform best in the four economic conditions:

Stocks: Prosperity
Cash: Recession (or "tight money")
Bonds: Deflation
Gold: Inflation

The more I study historical data for these assets (not just in the US but also in other countries) the more I appreciate Browne's insight and believe these four assets are indeed a great mix for diversification purposes. That said, I think our traditional explanation may be due for a revision. Here's how I'm starting to personally understand the assets:

Stocks: Economic Prosperity
Gold: Economic Uncertainty
Bonds: Falling rates
Cash: Rising rates

Basically, I think that maybe we should flip cash and gold in terms of what we assume they protect against. When you look at the data, interest rates are closely tied to inflation and properly invested cash really is an impressive inflation hedge (link). Also, gold is very clearly negatively correlated to stocks (link) and I'd argue that a rare event like hyperinflation where gold soars is really more of an economic chaos problem than a normal inflation problem.

Now maybe it's just semantics, but I suspect that this alternative explanation may also help with two common roadblocks that the PP faces with new investors -- an aversion to gold and cash. Lots of people get hung up on gold as an inflation hedge (rightfully so, IMHO, as gold price is affected by much more than inflation), but have an easier time understanding gold as a flight-to-safety asset. And lots of people don't see the point of cash, but perhaps if they understood how well it works in a rising-rate/rising-inflation environment (something the same people still fear) it would look a lot more appealing.

Does that make sense? How do you personally view the four Permanent Portfolio assets?
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Matthew19
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Re: An Alternative Explanation for the Permanent Portfolio

Post by Matthew19 » Sat May 13, 2017 8:32 pm

Well written and interesting post on your site!
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Re: An Alternative Explanation for the Permanent Portfolio

Post by sophie » Sun May 14, 2017 7:26 am

Great food for thought post Tyler!

I've also thought that there is way more to Harry Browne's framing of the assets than he says in Fail Safe Investing. What I realized upon studying the PP is that the four assets were carefully selected as being orthogonal to each other to the maximum extent possible, while still being conservative, "safe" assets. Other assets such as corporate bonds that form part of many portfolios act as a mixture of one of the basic 4, so having them in a portfolio is redundant. They make it look like you are diversified, when in reality they contribute nothing to diversification if you were to add them to the PP.

Also, it's worth listening to the radio show episodes where Harry Browne discusses gold. He describes it as the world's second reserve currency after the dollar. When the dollar gets shaky, which it does when inflation gets up into the 10% range, that's when investors start shifting to gold. There are of course other situations that might make people nervous about the dollar - witness 2008, and what might happen if the U.S. were to default on Treasuries.

Also also, this tells us when we might consider dropping gold from the PP: when it stops being a reserve currency. Not happened yet, but it could one day.
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Re: An Alternative Explanation for the Permanent Portfolio

Post by barrett » Sun May 14, 2017 7:42 am

I don't disagree with any of that, Tyler, and am mainly posting so that this thread gets a bump from May 13 to May 14.

One thought I have is that assets, with the exception of bonds - which clearly do way better when rates are rising - are often "multi-purpose." What I mean is that it's hard to sum up the conditions under which they thrive in two words (rising rates, economic uncertainty, etc.). For example, I think moderate inflation is probably good for stocks, gold may do well when there are negative real rates, etc.

Another example outside of the core four is real estate which I would expect to do well both during economic uncertainty (it's a hard asset like gold) as well as during prosperity (people have more money and more certainty about their jobs and are therefore willing to pay more for a house).

I also struggle to really understand the 2000 to 2010 period. Having recently read John Tamny's book Popular Economics, I tend to think that gold did well because Bush The Younger wanted a weaker USD. Ditto for housing up to a point... and that stocks did poorly because of economic uncertainty. Tamny says that people shy away from equities (and toward hard assets) when they are less certain what future dollars will be worth. The reason that I am so focussed on understanding this particular period is that citing gold's performance in the 1970s just meets with all kinds of resistance... much of it warranted in my opinion. People who have a hard time accepting gold into their asset mix tend to look at the 2000s as a 'greater fool' period. But something big is clearly at play when an asset goes up seven fold.

And thanks Tyler for continuing to dig and assess. Your work has really given us all way more information to work with.
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Re: An Alternative Explanation for the Permanent Portfolio

Post by eufo » Sun May 14, 2017 6:49 pm

This post is very timely from my own perspective.

I was thinking about a kind of reverse look at our economic situation by studying what the different asset classes were doing. For example, when gold, stocks, and bonds are all falling, we're seeing "money tightening".

I'd like to cover all 8 possible scenarios (Cash not included since all other asset values are in relation to it) and name the condition, but I haven't quite figured them all out yet. I'm looking for assistance from anyone that also finds this of interest, please rename as you see fit:

1) Gold UP, Stocks UP, Bonds UP - "Loose money"
2) Gold UP, Stocks UP, Bonds DOWN - "Inflation"
3) Gold UP, Stocks DOWN, Bonds UP - "Recession"
4) Gold UP, Stocks DOWN, Bonds DOWN - "Stagflation"
5) Gold DOWN, Stocks UP, Bonds UP -
6) Gold DOWN, Stocks UP, Bonds DOWN - "Prosperity"
7) Gold DOWN, Stocks DOWN, Bonds UP - "Deflation"
8) Gold DOWN, Stocks DOWN, Bonds DOWN - "Money tightening"
Don't agree with me too strongly or I'm going to change my mind
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Re: An Alternative Explanation for the Permanent Portfolio

Post by Smith1776 » Mon May 15, 2017 2:20 pm

Tyler, I think the paradigm you've posited acts as a great complement to the "traditional" way we investors view the Permanent Portfolio. Your post reminds me of some arguments that MediumTex made about gold in particular, where he said that gold is an uncertainty hedge first and an inflation hedge second. It does especially well when both inflation and great uncertainty are at play simultaneously.

In Harry Browne's book, Why the Best Laid Investment Plans..., I do recall him saying that gold had usefulness beyond inflation. I think he used the phrase "gold is the asset of last resort." It seems to me that he was cognizant of gold's role beyond inflation.

Your mentioning of cash and bonds having advantages during rising/falling rates respectively is also probably easier for some people first getting into the Permanent Portfolio to understand; tight money recession and deflation aren't really everyday concepts that the average citizen is going to be super well versed in.
"Talk is cheap. Show me the code." - Linus Torvalds
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Re: An Alternative Explanation for the Permanent Portfolio

Post by bitcoininthevp » Thu May 18, 2017 4:20 pm

I believe the gold portion of your post is how Harry believed it as well in some of his radio shows. Gold as the world's second favorite money next to USD. People go to gold during uncertainty and gold doesn't necessarily follow inflation except when inflation numbers are high.
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Re: An Alternative Explanation for the Permanent Portfolio

Post by barrett » Tue May 23, 2017 8:19 am

Hey Tyler, I've been thinking about your post a lot. I think the only issue I have with what you have suggested is that cash doesn't really outperform in a rising rate environment, so it's not a strong hedge (as, for example, long durations bonds are when rates are falling). I am now thinking of cash as "inflation neutral" which is a shift for me from the conventional wisdom that it loses out to inflation.

Your cash article lit a fire under my backside and I've now got all of my PP cash invested. I really got lazy when bank rates went to zero so thanks for the wakeup call!
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Re: An Alternative Explanation for the Permanent Portfolio

Post by Tyler » Tue May 23, 2017 9:30 pm

Fair enough. When distilling the assets down to core roles I admit that it's easy to fall prey to over-simplification, and I definitely agree with your point that they can be multi-purpose. I'm just excited to start looking at a few assets in a new light. I've gained a new appreciation for cash in the process.
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Re: An Alternative Explanation for the Permanent Portfolio

Post by barrett » Wed May 24, 2017 6:49 am

Tyler wrote:I've gained a new appreciation for cash in the process.
Me too. It's just amazing how tenacious conventional wisdom can be. I applaud you for asking questions that others feel have already been fully answered. As implied earlier, I had basically given up on cash providing any yield whatsoever. It used to be my favorite asset, I think because it was so obvious that it was in fact matching or beating inflation.
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Re: An Alternative Explanation for the Permanent Portfolio

Post by vnatale » Mon Apr 13, 2020 8:21 pm

Tyler wrote:
Sat May 13, 2017 11:09 am
While it has been a little while since I read Harry's and Craig/MT's works, the traditional explanation for the four PP assets is pretty well-known and boils down to selecting assets that perform best in the four economic conditions:

Stocks: Prosperity
Cash: Recession (or "tight money")
Bonds: Deflation
Gold: Inflation

The more I study historical data for these assets (not just in the US but also in other countries) the more I appreciate Browne's insight and believe these four assets are indeed a great mix for diversification purposes. That said, I think our traditional explanation may be due for a revision. Here's how I'm starting to personally understand the assets:

Stocks: Economic Prosperity
Gold: Economic Uncertainty
Bonds: Falling rates
Cash: Rising rates

Basically, I think that maybe we should flip cash and gold in terms of what we assume they protect against. When you look at the data, interest rates are closely tied to inflation and properly invested cash really is an impressive inflation hedge (link). Also, gold is very clearly negatively correlated to stocks (link) and I'd argue that a rare event like hyperinflation where gold soars is really more of an economic chaos problem than a normal inflation problem.

Now maybe it's just semantics, but I suspect that this alternative explanation may also help with two common roadblocks that the PP faces with new investors -- an aversion to gold and cash. Lots of people get hung up on gold as an inflation hedge (rightfully so, IMHO, as gold price is affected by much more than inflation), but have an easier time understanding gold as a flight-to-safety asset. And lots of people don't see the point of cash, but perhaps if they understood how well it works in a rising-rate/rising-inflation environment (something the same people still fear) it would look a lot more appealing.

Does that make sense? How do you personally view the four Permanent Portfolio assets?

Yet another gem by Tyler deserving to be resurrected and read by those who never had the prior opportunity to read it when it first came out live!

Vinny
Above provided by: Vinny, who always says: "I only regret that I have but one lap to give to my cats."
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Re: An Alternative Explanation for the Permanent Portfolio

Post by Kevin K. » Tue Apr 14, 2020 3:41 pm

It is indeed a gem of a post Vinny. Thanks for the timely re-post.
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Re: An Alternative Explanation for the Permanent Portfolio

Post by senecaaa » Wed Apr 15, 2020 10:50 am

Very interesting indeed!

So where would that put us now?


Screenshot 2020-04-15 at 17.43.30.png
Screenshot 2020-04-15 at 17.43.30.png (139.35 KiB) Viewed 474 times


Can we draw conclusions from this chart? "Economic Uncertainty" CHECK! Anything else?
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