Simple volatile uncorrelated VP

[moda0306]

The 4 PP assets are the most "predictably" non-correlated because of the macroeconomic principles they're based on, but the VP can "fill holes" in the PP.  Gold miners may not be so reliably non-correlated to EDV as we'd like, but given some technicals (gold's price ratio to the miners prices) one can assume that there's some reversion to a mean yet to occur.  If one is bearish on the economy at this point, I think it's relatively safe to say that gold miners and EDV could make a nice duo in the VP.  It won't be as reliably non-correlated as our PP assets, but the VP is a speculative portfolio in nature, so I don't think we ever expected to fall upon another PP within our VP by accident.

[BearBones]

You can't just choose random assets because some of them have shown negative correlation over one or two decades. Gold and Gold Mining Stocks do extremely well during inflationary conditions and Long Term Treasuries do extremely well during deflationary conditions. It would be difficult to find two assets that are more negatively correlated from an economic standpoint.

Gumby, you are convincing me that this is indeed a good duo, especially if I want exposure to the high stakes world of gold mining stocks without taking such a high risk of losing most of my money with the next market crash. Another thing that I have considered is just GDXJ and cash, perhaps 60/40. This would dilute the returns of pure GDXJ (which could still be phenomenal), but the rebalancing bands would force me to pull cash off of the table in good times and buy in bad. Anyone see the logic in this, or am I off base?

[6 Iron]

As the volatility of GDXJ appears to be substantially greater than EDV, why would you prefer it to GDX in this intriguing variable portfolio idea?

[BearBones]

As the volatility of GDXJ appears to be substantially greater than EDV, why would you prefer it to GDX in this intriguing variable portfolio idea?

Good question for which I do not have an intelligent answer.  I was initially attracted to the junior miners because of their higher upside potential. However, you may be on to a better pair. That is exactly the kind of thinking that I am looking for here. Thanks.

[Gumby]

So... if you take 50% GDX and 50% EDV, starting on Jan 29, 2008, and you rebalance whenever one of the assets becomes twice the value of the other asset....these are the results (including dividends and rebalancing in Nov 2008, May 2009 and Dec 2010):



But...I suspect that during a period of prosperity this portfolio would underperform.

I would also point out that there are more than a few times over the past three years where purchasing this portfolio would have caused you to underperform PRPFX.

[AdamA]

Another thing that I have considered is just GDXJ and cash, perhaps 60/40.

It seems reasonable, but one of the reasons I like the miners/zeros combo is that it gives you exposure to things that aren't already in your PP. 

On the other hand, probably not a bad idea to have a bit of cash in the portfolio so that you wind up taking some profits occasionally, although it will likely dampen the yield a bit over the long term. 

[BearBones]

So... if you take 50% GDX and 50% EDV, starting on Jan 29, 2008, and you rebalance whenever one of the assets becomes twice the value of the other asset....these are the results (including dividends and rebalancing in Nov 2008, May 2009 and Dec 2010):

Thanks! Amazing how you whipped this up.

But...I suspect that during a period of prosperity this portfolio would underperform.

Very true. This VP is a bet on the days of economic prosperity being largely behind us.

[Gumby]

Hmmm..... I just realized that it's all about the Cash.

In the portfolios you're seeing above, there is no extra cash. If you add cash to any of these portfolios, you simply get results that are pretty much equal to PRPFX over the long run. The portfolios all wind up in the same place.

So, that gave me an idea to try a "riskier" PP of:

25% EDV
25% GDXJ
25% QQQ (Nasdaq 100)
25% Cash

...and guess what happened? The results were still pretty much the same as a real PP, but with more volatility. So, if you wanted a PP with more risk and volatility, the easiest option would be to simply remove the cash from a PP and let it ride.

From what I can tell, even if you tried QQQ, EDV and GDXJ, without any cash, the results would still look very similar to the 50% GDXJ and 50% EDV portfolio. Removing the cash is really all you need to do to add volatility to a PP.

Personally, I think Clive is the best person to ask about this. I've seen a lot of his balanced and speculative portfolios and almost all of them would make excellent choices for VPs. Not sure if he has any with 2-4 assets though. Send him a message and see what he says.

I have a feeling that without significant speculation, any negatively correlated portfolio is going to generate PP-like returns — with the biggest factor being the amount of cash held.

[Gumby]

If you look at something like the Coffee House blend then that holds some 10% in each of REIT and foreign stocks, which might be considered as being 20% commodity like. It also holds 40% in total bond, which could have perhaps equally have been 20% in ST and 20% in LT. It also holds 10% in each of SCV, LSV, SCB, LCB. So very generally it might be described as a form of PP. Some investors might prefer to swap out maybe either of the LCB or SCB parts to perhaps add 10% gold instead, which would generally have carried the portfolio better during the latter 1970's, early 1980's and more recent 2008/9 type periods.

Clive, you've often cited the Coffee House Portfolio as a PP-like portfolio that manages to outpace the traditional PP over the long run. However, it's worth noting that the Coffee House Portfolio holds zero cash. I wonder how a PP with zero cash (33% Stocks, 33% Gold, 33% LT) would stack up against the Coffee House over time? A PP with zero cash would allow someone to maximize a single VP retirement account with ease (due to fewer funds, less rebalancing).

[moda0306]

Clive,

Looking at how silver vs gold performed in the 2008 crash, is it fair to assume that maybe using silver to estimate PP gains in that period is a bit flawed?

I think maybe, due to its less monetary (more industrial) nature, it brought down your hypothetical PP more than gold would have in those years.

I'm not trying to delegitimize your charts... you are truly an asset here.  Keep 'em coming.

[SmallPotatoes]

The VP suggestions here seem to be very PP'ish in nature, but what about a PP antithesis as a VP?  You know like 4x25 with asset classes that act theoretically similar to the PP components, but are not?  For instance using REITs, Int'. Long Bonds, Oil, and... well whatever for cash or no cash at all.

What I'm thinking is a portfolio using PP fundamentals, but with assets that HB recommended against due to risk, etc.  Basically just a portfolio to do well when a PP might not, or a setup that's up on days when PRPFX is down by a similar %... am I making sense?

I was thinking VGPMX GTU and EDV might work, but I'll reconsider in the morning n

[MediumTex]

What I'm thinking is a portfolio using PP fundamentals, but with assets that HB recommended against due to risk, etc.  Basically just a portfolio to do well when a PP might not, or a setup that's up on days when PRPFX is down by a similar %... am I making sense?

As I have written before, a small dose of EDV is an excellent treatment for a PRPFX market snake bite.

As far as what assets we might choose that would do well when the PP was not doing well, I don't think the PP has done poorly for a long enough period to evaluate anything like what you are suggesting.

Honestly, I think you may be getting into leather chaps country with your proposed alternative to the PP.

[SmallPotatoes]

What I'm thinking is a portfolio using PP fundamentals, but with assets that HB recommended against due to risk, etc.  Basically just a portfolio to do well when a PP might not, or a setup that's up on days when PRPFX is down by a similar %... am I making sense?

Honestly, I think you may be getting into leather chaps country with your proposed alternative to the PP.

Haha.  Yes, you might be right.  Well, I've been considering a VP, but I can't seem to find anything that, in all honesty, gives me much confidence in light of my PP.

[AgAuMoney]

As a small satellite holding, I have a Roth IRA that I would like to set up as a high stakes variable portfolio.

I did that once...  It is really tempting to look at the Roth and imagine avoiding taxes on the transactions and all those tax-free gains rolling in.

In reality what happened with me is a whole lot of losses that I could not deduct.

I've since resolved to do my "high stakes" gambling in a taxable account where I can write off losses against gains.

Oh and to be complete, a normal tax-deferred IRA or 401(k) is even worse.  You cannot deduct losses, and you pay normal income tax instead of capital gains if it does work out.

So now I currently have a small GDX position in a Roth IRA.  It's about 5% of the account.  So far I've taken profits from it once or twice and put more money into it once to keep it about 5%.  I've been considering doing the same thing with GDXJ in my taxable account, but so far haven't because I really don't like holding funds in taxable accounts.

[MediumTex]

As a small satellite holding, I have a Roth IRA that I would like to set up as a high stakes variable portfolio.

I did that once...  It is really tempting to look at the Roth and imagine avoiding taxes on the transactions and all those tax-free gains rolling in.

In reality what happened with me is a whole lot of losses that I could not deduct.

In darker moments following an experience like this it also occurs to you that you paid tax on the money in the Roth that is now gone.

At least with losses in a traditional IRA you can console yourself that the IRS shared in your losses.

[AgAuMoney]

In darker moments following an experience like this it also occurs to you that you paid tax on the money in the Roth that is now gone.

Oh, thanks!  Like I really needed to remember that again!

And I had to work how long for that money?

And there is no way to make it up because of the annual limit on contributions?

Nope, tax free and tax deferred accounts are definitely the place for "investing" rather than "speculating".  I'd be so much better off if I knew even 15 years ago, what I've learned the past 10 years...

[stone]

The problem with cutting out cash is that the most obvious black swan for the PP would be a hike in short term rates to way more than the inflation rate. Goldminers and EDV might get hit even harder than the PP. The Fed has a dual mandate for full employemnt and price stability. If the USD started to slide really badly, then commodity prices could get so high that both mandates would be best served by a sharp rate hike to ensure USD strength and allow imports of commodities as required for keeping industry going. In 1982 cash gave 18% and that partially mitagated the simultaneous crash in the other three assets. What would be the consequence of a rate hike in a depression to 10%? If the non-cash part of the PP fell by >50%, a 10% yield from the cash might not be enough. On the lead up to such a scenario gold would probably do very well BUT gold and gold miners especially would be killed dead for decades by such an event. Would emerging market local currency debt be a possible proxy for gold (in terms of capturing a sliding USD) that would get smacked down less harshly than gold in the event of a rate hike? Would some sort of USD bullish currency ETF be a way to capture an upside from a rate hike? The South African Rand sounds like something that would suffer from a USD rate hike because it is both a "risk currency" and linked to gold mining. Is there a short South African Rand ETF? The only things like that I have seen have been long USD/ short Australian dollar ETFs. Maybe they would also work but I guess the Rand is more linked to gold. Basically I was thinking about some mix of say 30% emerging market local currency debt, 15% emerging market equities, 15% short Australian dollar, 40% cash. That would be a portfolio not designed so much for doing great now but as a back up for the PP if the PP came unstuck. I have to stress this is just whimsy. In reality I'm  PP except with the cash portion expanded to 82% because my better half only trusts cash. Also I'm in the UK so it is the bank of england not the Fed for me.

[stone]

I spotted something that backs up my fear that rising interest rates would cause a simultaneous plunge in both EDV and XAU. From http://www.hussmanfunds.com/html/gold.htm:

"The trend of long term interest rates is actually more important than the trend of inflation. When the 30 year Treasury yield has been below its level of 6 months earlier, the XAU has advanced at an annualized rate of 19.17%, compared to an annualized loss of -17.51% when Treasury yields have been rising."

[stone]

Clive "What economic factors would see gold falling (currency strengthening) Bond and stock prices falling (yields rising) ? - perhaps the higher yields attracting a net inflow of foreign currency in anticipation of higher/less risky yields."

Basically an effort to strengthen the currency by increasing interest rates much above inflation would do that. Currently all central banks are competing to devalue more than each other as they compete to protect exporting industries. If there was a threat to the USD status as the global reserve currency, then an interest rate hike might be tried as an attempt to reassert the USD. Another reason to hike rates might be if commodity price inflation got so bad that the central bank decided that commodity imports needed subsidizing by strengthening the currency. I guess the black swan would be a repeated series of attempts to gain control by hiking interest rates but that such attempts were unable to turn the tide and that in the end the current Developed World lost its  overwhelming purchasing power for oil, iron ore, grain etc whilst also having lost its expertise and industrial capacity due to high long term unemployment, outsourcing etc.

If you google for "Hong Kong double play" you can see how US hedge funds came close to appropriating a big chunk of Hong Kong in 1998. That speculative attack was based on exploiting the fact that the Hong Kong dollar was pegged to the USD. The only 'peg' that the USD (or GBP etc) has is an extremely loose one to oil etc. Looking into the future, if current trends for the richest getting richer continue, then perhaps it is not inconceivable that speculators could "fight the Fed" and win. 

[moda0306]

I really wonder whether a hike in short-term rates would mean disaster for long-term rates.  In 1981, LT bonds were hardly a panacea, but they didn't take a complete nose-dive.  I think raising s-t rates is a bit of a big mystery for the PP, even though we've seen it once.

How much would gold drop if ST rates were simply raised to 2-3%?  What would that mean for recovery (what would stocks do)?  What would that mean for long-term rates?

This is where there's such a weird circular domino effect that I don't really know what to expect... but I do know that I doubt rates will be raised any time soon.  When commodity inflation is the only inflation, 1) that deems bad for the economy and unemployment, increasing political will to keep rates low, and 2) increases investor "acceptance" of inflation-lagging rates, because if their only alternative is to invest in a commodity basket, they will grit their teeth for the most part.

Who knows, though... with anti-fed talk getting a lot of support nowadays, and especially if Bachmann or especially Paul are elected (unlikely IMO), we could see what would usually seem a premature rate-rising scenario.

[stone]

Moda, I agree that things seem perfect for gold so long as all of the currencies are trying to devalue. The danger might come if some upstart currency rises as a much more attractive alternative. Would America let its per-capita consumption of oil/iron/grain etc drop to global norms (remember four times as many Indians as Americans). Were it to occur, fighting such a tide  might mean >10% interest rates not 2% to 3%. Both high commodity prices and high interest rates are awful for stocks and unemployment. Its a Hobsen's choice between two bad alternatives. Things can get into a downward spiral. With gold, remember if everyone jumps from both gold and the USD to some other currency then gold might not be the savior that it was for the Icelandic PP. I'm being really gloomy

I think a quick look at stuff about Hong Kong in 1997 is  a good SHTF lesson.

http://www.sktsang.com/ArchiveI/web988.html

http://news.sky.com/skynews/Home/Busine ... 2215545079

[moda0306]

For another currency to become "attractive" ours has to go out of style... I still can't get my head out of the order of operations here for a reserve fiat currency.

1) In the 80's our balance of trade starts to go all wack, and all of a sudden we're net-spending US Dollars in other countries.

2) They have to put that money somewhere, and if they're not buying more from us than we are from them, they'll keep acquiring more and more of it.  With that surplus they'll buy our bonds... mostly treasury to keep things ultra-safe from a default standpoint.

3) If something else becomes extremely "attractive" (even though foreigners don't buy our bonds because they're necessarily "attractive," they buy them because we keep spending money on their stuff and they have to do something with it unless they decide to start buying back), then these countries will have to net-spend US dollars in the US... otherwise demand for our debt hasn't changed... just changed hands.

4) So now they start BUYING our stuff, and that's what creates inflation... you could say they "hate our bonds" all of a sudden, but the natural result is a huge improvement in US balance of trade as they try to rid (read: spend) themselves of dollars.

5) While this will create inflation as our factories reach capacity, it'll be the very demand for our goods that increases employment and improves our balance sheets that will be causing the inflation.  I can't see how stocks would suffer in this scenario, as full capacity will be reached as foreigners buy our stuff for once instead of the other way around (in net).


Am I missing something here?  

[moda0306]

Building on the "attractiveness" theme.

What would an "attractive" currency look like?  

A gold-standard currency?  Doesn't that run into some of the same Euro default risk problems?

Let's pretend Canada (or another stable country) engineered a perfect fiat currency... How does China go about replacing their stock of US treasury bonds?  They don't issue this magical Canadian currency, but they somehow want to hold a bunch of it?  How do they get it? All of a sudden Canada would have to spend huge sums of money in China to even get the currency there in the first place... then, China & other foreigners would have to net-spend their US dollars here, thereby reversing our balance of trade (how can that be bad for us, though).

I just don't see how this is mechanically possible for a currency base as large as ours for some horrible hyperinflation or ultra-competitive currency to come into play without a spike in demand for our products first.

[stone]

Moda,  all available workers and factories being put into action and yet more dollars flooding in as all of China buys Harley Davison motorbikes or whatever would be nice inflation. My doomsday was for all of the rest of the world out bidding the USA etc for oil, iron ore etc etc. That is currency slide commodity price inflation. You could simultaneously have ever worsening commodity price inflation  and yet have  high unemployment with deflation (eg it might become cheaper to hire a lawyer or a cleaner).
China etc does not have to buy iron ore from Brazil using USD if both sides agree to use some other currency. USD could just end up sidelined.
I guess it is important to try and comprehend how we currently manage to get so much of the global commodity output in order to understand how things could change.

[stone]

Moda, use of the USD is already becoming less universal eg see:
http://en.mercopress.com/2009/06/29/bra ... -us-dollar.

An attractive currency would be one that was universally trusted to maintain purchasing power over time.

I don't think China needs to replace their stock of USD bonds. They might just leave them to rot. I think they amassed USD not because they ever hoped that they would be of any use but rather as a means to keep the Yuan undervalued so as to gain industrial expertise through having an artificial export advantage.

One alternative to the USD as a reserve currency might be a basket of currencies so as to avoid Triffin's dilema. Perhaps the Yuan, the Rupee, the Real and the Ruble would be basketted up just as developed world currencies are basketted up to form the SDR used by the IMF. That BRICbasket could be what gets used for international trade