Gold, History and Diversification

Discussion of the Gold portion of the Permanent Portfolio

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Gold, History and Diversification

Post by craigr » Tue Apr 27, 2010 1:48 am

I found this quote I saved from user "Mephistopheles" on the Diehards forum:
The only people who need to buy gold, or other precious metals or gems, are those who want to be diversified. Those who want to be diversified are usually students of history. So, if you are not a student of history, or have no interest in diversification, you need not buy any gold.

ole meph
It kind of summed up my reasons for owning gold in a portfolio.
Last edited by craigr on Tue Apr 27, 2010 2:03 am, edited 1 time in total.
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Re: Gold, History and Diversification

Post by pplooker » Tue Apr 27, 2010 5:03 pm

Well... just to be a stick in the mud  ;):

Technically any time you're adding a new asset class you didn't have before, you're diversifying, so why's gold so special that only it can provide diversification?

I mean technically if I had everything in cash and then bought bonds too, I'd be diversifying.

Now yes only buying gold will diversify you into gold, but no asset holds the claim on diversification.  You can buy futures, antiques, LEAPS, baseball cards or anything you want to diversify.  Doesn't mean you should!

And owning a bunch of different stuff doesn't mean you're well diversified either, because, well, some things are more different than others.  I know some people who do not own stocks.  At all.  They just can't handle it emotionally.  They're still diversified with CDs, three money market accounts, GNMAs, and treasuries of various durations, just not into stocks.  The list of individual funds and investments they hold is quite long actually.  But I'd say they're not very well diversified however as most of their investments will act the same in most circumstances as they are fundamentally the same.
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Re: Gold, History and Diversification

Post by craigr » Tue Apr 27, 2010 5:32 pm

Actually I don't think adding any new asset alone is necessarily diversifying.

For instance many think that slicing and dicing the stocks adds some diversification. I don't. At least, not much to matter. The asset classes should have very different economic drivers behind them for me to consider it a diversifier. So owning a bunch of different stock allocations wouldn't count because they all have the same fundamental risks. Same for owning a bunch of different types of bonds. I wouldn't consider owning gold and silver diversified either. Etc.
And owning a bunch of different stuff doesn't mean you're well diversified either, because, well, some things are more different than others.
Totally agree with you. I think assets in a portfolio should each have a very specific reason for being there.

But I hear you about not owning stocks for some. I too know people who lived during the Depression and won't touch them even to today. They don't trust the markets. Tough to imagine an economy so bad that 80 years later it's still seared into the memories of those that lived through it.
Last edited by craigr on Tue Apr 27, 2010 5:37 pm, edited 1 time in total.
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Re: Gold, History and Diversification

Post by pplooker » Wed Apr 28, 2010 8:51 am

What's strange, to me anyway, is the people in my example are relatively young, less than 40.  And they didn't get this way in 2008 either.

I currently have at least two good friends who have completely eliminated stocks from their portfolios as a result of 2008.  One is out permanently, or so he says, the other is predicting a major 2012 crash that he absolutely knows about ahead of time but no one else does. ::)

Several of my university professors were incredibly conservative as well.  One of them held one third of his portfolio in a money market, one third in CDs, and the last third in treasuries.
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Re: Gold, History and Diversification

Post by MediumTex » Wed Apr 28, 2010 10:31 am

I used to have a dog that was the sweetest, most even-tempered animal you would ever want to meet.  He was one of those dogs that is almost human-like in his ability to relate to people.  I got him when he was about two years old and he had been in a couple of homes when I got him.

The one tick he had was that he was terrified of brooms.  I suspect someone had been mean to him with a broom before I got him and the fear stayed with him.  I always had to be careful when sweeping that I didn't freak him out.

I think a lot of investors are going to have a similar thing to my dog and the broom with stocks for a long time.  The unfortunate thing is that what they should be afraid afraid of is not stocks as an asset class, but rather too heavily weighting stocks in their portfolio as part of their overall allocation.  Alas, though, this would have been like telling my dog about how there is nothing inherent in brooms that should be frightening.  I'm sure he would have said "yeah right, you've never been abused by one".
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Re: Gold, History and Diversification

Post by craigr » Wed Apr 28, 2010 12:03 pm

pplooker wrote:I currently have at least two good friends who have completely eliminated stocks from their portfolios as a result of 2008.  One is out permanently, or so he says, the other is predicting a major 2012 crash that he absolutely knows about ahead of time but no one else does. ::)
That's a shame because stocks are a powerful generator of wealth. When I travel for instance and see someone drinking a Coca Cola I sometimes think "They just handed me some money." Stocks are generating profits around the world 24/7 for just about every product people use every day.

The problem of course is that stocks are a bit temperamental. When they get grumpy you just have to leave them alone a while and let them settle back down and get over their mood swing. That's what being diversified helps you do.
Several of my university professors were incredibly conservative as well.  One of them held one third of his portfolio in a money market, one third in CDs, and the last third in treasuries.
It could be they are tenured or have good retirement packages that they don't feel the need to diversify. This just comes down to personal circumstances and what they feel comfortable doing. However I've always been skeptical of pensions and other promises of worry-free retirement planning. While it's nice if these things work out, I'd want to have a backup plan in place (such as my own investment portfolio) just in case my "guaranteed" retirement package isn't there in 20-40 years when I need the money.
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Re: Gold, History and Diversification

Post by Roy » Wed Apr 28, 2010 7:14 pm

pplooker wrote: And owning a bunch of different stuff doesn't mean you're well diversified either, because, well, some things are more different than others.  I know some people who do not own stocks.  At all.  They just can't handle it emotionally.  They're still diversified with CDs, three money market accounts, GNMAs, and treasuries of various durations, just not into stocks.  The list of individual funds and investments they hold is quite long actually.  But I'd say they're not very well diversified however as most of their investments will act the same in most circumstances as they are fundamentally the same.
Correct.  The Diversification question is intriguing in that most "camps" claim to have it.  Even Jim Cramer runs a spot called "Am I diversified?".  And he'll tell you, if you call him.  I almost called about the HB 4x25 just to see him wig-out (honk horns, whack buzzers, etc.).

Some in the Slice/Dice (stocks) camp don't understand that while the individual blocks of their "Morningstar grid" may move at somewhat different tempos, they all share the the massive commonality of Beta exposure.  See 2008 for what a typical 60/40 ten-fund portfolio can do in crisis (including diversification with TIPs and other Bond funds), albeit that is just one year.  The problem is that because many of these "asset classes" often move together, an investor's capitulation point can be tested unless the overall beta was reduced by holding more of the less volatile assets (like ST Treasuries or Cash).  Larry Swedroe attempts to manage volatility (and thereby the capitulation point) by doing just this—with a small allocation to high risk/high return stocks and the rest in high-quality bonds.  And the returns and volatility of his approach are similar to the PP for 4 decades, though the approach is altogether different.  Still, most portfolios that had about 25-30% in beta exposure avoided crushing hits in the Bears.

The Total Marketeers often claim fullest possible diversification;  and in an "optimal" sense, within stocks, they have fuller diversification than the S/D.  Of course, that does not mean anyone should necessarily hold the "market portfolio," or that it is better than S/D.

All of those camps would likely judge the PP as overweighted, underweighted, and sector betted.

Is there something better diversified than the 4x25?  That question is worthy of exploration and we can't be sure what, if anything, Harry might have changed with greater information.  And a PP tinker's problem is the stellar track record established over 4 decades he's tinkering with.

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Re: Gold, History and Diversification

Post by Roy » Thu May 06, 2010 1:49 pm

craigr wrote: Actually I don't think adding any new asset alone is necessarily diversifying.

For instance many think that slicing and dicing the stocks adds some diversification. I don't. At least, not much to matter. The asset classes should have very different economic drivers behind them for me to consider it a diversifier. So owning a bunch of different stock allocations wouldn't count because they all have the same fundamental risks. Same for owning a bunch of different types of bonds. I wouldn't consider owning gold and silver diversified either. Etc.
People ask me about Gold all the time, partly due to PP conversations and CNBC ads.  What sort of Gold position, if any, would you (anyone can answer) recommend for people who have conventional portfolios?  And from where should that allocation be drawn (equity or fixed)?  Gold is different than stocks and bonds from a correlative standpoint (some argue CCFs from that view) so it seems some allotment to Gold is a good idea.  But since it is so volatile, and conventional portfolios are so different than the PP, perhaps drawing from equity is advisable.  What would be Gold guidelines for ordinary folks running ordinary portfolios?

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Re: Gold, History and Diversification

Post by craigr » Thu May 06, 2010 2:08 pm

I generally advise people not doing the PP to have at least 10% of their portfolio in gold. Take it from the stocks if they over-represent the allocation. Take it from the bonds if they over-represent the allocation. But 10% is the minimum for insurance purposes. Anything less and it won't do much good when needed. IMO.
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Re: Gold, History and Diversification

Post by Pkg Man » Thu May 06, 2010 8:39 pm

I generally advise people not doing the PP to have at least 10% of their portfolio in gold.
I have a question regarding gold in the VP.  I recently started a PP but still have a sizable portion of my assets in company stock which, for various reasons not important here, I plan to keep.  I do plan to gradually reduce my holdings, but that will occur over several years.

I am wondering if I might want to take the above recommendation into account for the company-specific risk I have in the VP?  I would keep the VP and PP separate, as HB recommended, and hold about 10% gold (over and above the gold in the PP) in the VP at least as a partial way to hedge against holding an otherwise non-diversified portfolio. 

I guess the choice is, given my decision to hold onto the company stock, to do this or just take what additional savings I would have spent on the "extra" gold in the VP and plow it into the PP in the traditional fashion.

Any thoughts, other than sell the company stock?    ;)

thanks
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Re: Gold, History and Diversification

Post by craigr » Thu May 06, 2010 9:05 pm

Pkg Man wrote:
I generally advise people not doing the PP to have at least 10% of their portfolio in gold.
I have a question regarding gold in the VP.  I recently started a PP but still have a sizable portion of my assets in company stock which, for various reasons not important here, I plan to keep.  I do plan to gradually reduce my holdings, but that will occur over several years.

I am wondering if I might want to take the above recommendation into account for the company-specific risk I have in the VP?  I would keep the VP and PP separate, as HB recommended, and hold about 10% gold (over and above the gold in the PP) in the VP at least as a partial way to hedge against holding an otherwise non-diversified portfolio.  

I guess the choice is, given my decision to hold onto the company stock, to do this or just take what additional savings I would have spent on the "extra" gold in the VP and plow it into the PP in the traditional fashion.

Any thoughts, other than sell the company stock?    ;)

thanks
When you hold a large allocation to company stock you taking a big risk because you can have the company stock go down in price and also find yourself out of a job at the same time.

Now I don't know the specifics though of your case. If you are a principal or executive in the company you may have good reasons for not diversifying. But generally I recommend that if the stock is publicly traded that you do diversify for safety's sake. I can give you all sorts of horror stories from the tech boom of people concentrating their wealth in company stock and losing everything in options value as they went underwater. But it sounds like you have your reasons...

If anything, instead of holding more gold only I'd be inclined to hold less equity because of your large allocation to stocks and the associated risk of owning stocks. Company stock can move in sync with the market or move for its own reasons relating only to your industry or company. So there are many ways for the risks to show up (both good or bad). In this case, I'd be more inclined to use my earnings at the company to diversify more heavily towards the cash, bonds and gold together and not overweight any particular asset.

Just my take though. Personally if it were me I'd diversify out of the company stock based on past experience. But I don't know your situation and can't provide a good answer other than generalities on what I've see happen in the past. If the gamble pays off you can make a lot of money. But if not, well then you at least have the salary to work with and the non company stock savings you accumulated.
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Re: Gold, History and Diversification

Post by Pkg Man » Thu May 06, 2010 9:47 pm

Thanks for the advice.  My reasons for holding the stock are that it is expected for management folks to hold a certain amount of company stock, based on your level and salary.  I did not purchase the stock, it was given as part of my compensation over the years in annual awards.  While technically I am allowed to sell, it can in some cases be a career limiting move.  I am hoping for a promotion soon so I don't want to do anything that might lessen that possibility at this time.

An additional incentive to hold onto the stock is that we are given an annual "bonus" based on how close we are to the recommended amount held. In my case that works out to be close to one-month's pay.  Although half of this "bonus" is provided in cash, and the other half in stock.  FWIW, the company is a low-beta stock and AA rated (it just recently moved from being AAA due to an increase in debt to do stock buy-backs).  It also pays a relatively high dividend, which is in effect bleeding off my holdings. The dividends and extra bonus will be plowed into the PP.

I know black swans happen, but barring something like that I am confident the company will be around for a while.  I plan to sell off some each year, but the bucket also keeps filling up with the annual stock awards.  As I get closer to retirement I will reduce my holdings much more substantially.

It seems your advice is to underweight stocks, but I am thinking that I should keep the PP "pure" and not consider the company stock as a part of that?  I guess if nothing else I should reduce my other stock holdings in the VP, which I have already done to some extent, and put that to work in the PP.

thanks
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Re: Gold, History and Diversification

Post by craigr » Thu May 06, 2010 10:10 pm

Pkg Man wrote: Thanks for the advice.  My reasons for holding the stock are that it is expected for management folks to hold a certain amount of company stock, based on your level and salary.  I did not purchase the stock, it was given as part of my compensation over the years in annual awards.  While technically I am allowed to sell, it can in some cases be a career limiting move.  I am hoping for a promotion soon so I don't want to do anything that might lessen that possibility at this time.
Understood. Companies like having employees with skin in the game. One place I worked for would fire you if it was discovered you shorted the company stock for instance.

Yet, a company can go south for many reasons not related to a specific employee. Yet the employee gets punished by the fall in price and maybe getting laid off at the same time after the fallout.

I'm assuming these are stock options and not actual stock shares. If it's actual exercised shares you could theoretically build a collar to insure against losses if you wanted to take on the added expense. But many company option plans specifically prohibit promising shares in this way so it may not be a real possibility unless you actually do hold shares of stock.
It seems your advice is to underweight stocks, but I am thinking that I should keep the PP "pure" and not consider the company stock as a part of that?  I guess if nothing else I should reduce my other stock holdings in the VP, which I have already done to some extent, and put that to work in the PP.
The advice really is if you are running a VP and consider your company stock part of it I would not go out and specifically overweight gold over anything else. I'd just keep funding the PP and if I want to add more to the VP, I'd be more inclined to buy the three other non-stock assets for the allocation. I wouldn't go out specifically looking to boost my stock holdings. You have a lot tied up in stock as it is.
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Re: Gold, History and Diversification

Post by Roy » Sun May 30, 2010 11:03 am

craigr wrote: I generally advise people not doing the PP to have at least 10% of their portfolio in gold. Take it from the stocks if they over-represent the allocation. Take it from the bonds if they over-represent the allocation. But 10% is the minimum for insurance purposes. Anything less and it won't do much good when needed. IMO.
Hi, Craigr,

Understood and makes sense. 

If someone already using a conventional portfolio wanted to go that 10%, would you advise they go all-in, or pay any mind to valuations near historical highs, as they are now, and enter incrementally over time?  (Most folks in this category have stocks and intermediate bonds, I suppose.)  Talking tactics here, not emotions and am aware there is no right answer.  Of course, with Gold, not sure how to assess properly its valuations anyway.  But HB himself seemed mindful of Gold valuations in some of his comments that advised when to sell, so just asking...

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Re: Gold, History and Diversification

Post by craigr » Sun May 30, 2010 11:38 am

This is an age old question as you know. Certainly at some level valuations matter. But I have just seen through the years that nobody can really call valuations right.

I could say that gold is too high right now, but if the Euro keeps having problems then it could go much higher. Or if the spending the US Govt. is doing catches up with it that could cause it to go higher. It's hard to say. We just can't predict these things and gold is going to be worth what people think it's worth so there is no formula that can be applied to it.

Now we do know the high of gold in the early 1980s was around $800 an ounce which adjusted for inflation is over $2000 today. So there is an argument that could be made that it's still undervalued. I don't know if I personally believe this, it's just another perspective you hear from people.

Overall though investors need to do what they feel comfortable with. I'm personally an all-in kind of guy because dollar cost averaging can hurt as much as it could help. But if someone isn't comfortable with the prices of gold but wants to own some I can't fault them for buying in over time as long as they aren't doing it for market timing reasons.

Meaning that I think they should tell themselves "I'm going to by X$ a month/quarter/whatever no matter what until I hit my allocation."

But I've seen that this is hard for many people to really do. Reason being is that each time they are supposed to buy it gives them another chance to second guess their decision.
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Re: Gold, History and Diversification

Post by Roy » Sun May 30, 2010 1:02 pm

craigr wrote: Overall though investors need to do what they feel comfortable with. I'm personally an all-in kind of guy because dollar cost averaging can hurt as much as it could help. But if someone isn't comfortable with the prices of gold but wants to own some I can't fault them for buying in over time as long as they aren't doing it for market timing reasons.
Ha!, this time the question is exclusively for market timing reasons!  And, of course, there is no answer, as the crystal is always cloudy, or rather, multiple answers that may also conflict—like the Magic 8 Ball (my favorite source of divination), being a child of the 60s. 

I think, as discussed recently on Bogleheads, that the PP is a better bet (better than conventional ports) for not regretting if you lump the four asset classes simultaneously.  The reason is that three of its asset classes are high-velocity capable, and rarely do they decline together for extended periods—and just once on a yearly basis in 4 decades.

The emotional management issue is separate and needs be adjudicated on an individual basis.  Just wondered if you thought the circumstance of already being fully invested in a conventional port. warranted any different approach.  And thought through, I guess the answer must be no.

Am going to a Memorial Day party tonight so I'll need answers better than "Reply hazy, try again"!

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Re: Gold, History and Diversification

Post by Quasimodo » Sun May 30, 2010 4:01 pm

Here's a post I made on the Bogleheads forum:

"In 1970 there was a book called "How You Can Profit from the Coming Devaluation" by Harry Browne, which suggested buying gold and silver coins, Swiss francs and South African gold mining stocks. After reading that book I followed the suggestions from the book for the decade of the 1970s and those investments did pretty well for most of the decade, with one major sinking spell in 1975/76 when the stock market came roaring back from a big decline in 74. The Permanent Portfolio mutual fund is modeled on the suggestions in that book.

During 1979 gold really spiked upward, and when it hit $400 an ounce I thought "Holy Cow, this is crazy" so I sold my Krugerrands. The price of gold doubled after that within about six months.

Maybe a rule of thumb about gold prices is "Cyclical peak price of gold = Holy Cow x 2". That sure resonates for me. "

Some additional comments I would make are that "... The Coming Devaluation" book was focused on self defense against bad inflation, and PRPFX is I believe based on one of Harry's later books that I didn't read that has a more complete iteration of the PP concept which includes stocks and fixed income.

Whenever I have tried to time gold purchases, it has almost always turned out badly for me because I lose heart and sell at a bad time. Casino Mentality Regret might be a term for it.

Reading the Hussman Funds weekly commentary, I'm inclined to agree with his view that '70s-style inflation is some years down the road and gold will probably undergo a steep price correction before we see anything like the late '70s price action again.

My history of being drastically wrong and mistaken has never stopped me from having an opinion.

The great thing about the Permanent Portfolio idea is that you don't have to predict or have an opinion about the direction of this or that market.

John

edited to include last sentence...
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Re: Gold, History and Diversification

Post by Roy » Mon May 31, 2010 8:09 am

Quasimodo wrote: Maybe a rule of thumb about gold prices is "Cyclical peak price of gold = Holy Cow x 2". That sure resonates for me. "
Hi, John,

See, that is what I was asking for.  Finally a predictive model that can rival PE/10!  As it turned out, they were too drunk at the party last night to discuss portfolio nuances (adding Gold to conventional ports.), hence this gift went wasted.
Quasimodo wrote: Reading the Hussman Funds weekly commentary, I'm inclined to agree with his view that '70s-style inflation is some years down the road and gold will probably undergo a steep price correction before we see anything like the late '70s price action again.
I greatly enjoy reading Hussman's commentaries and understand most of his rationale, though never act on any of his views.  I think he is a better investor on the fixed income side—his HSTRX (his take on different vehicles, valuations, and shifting maturities are much like Swedroe's)—but he too mistimes guesses with PMs (Swedroes prefers CCFs and dislikes Gold) and likely incurs too many transactions costs which contribute to the high expense ratio of his fund (.75 or so).  His scholarship and overall knowledge of economic history are impressive, and though he speaks rarely (I mean, they would not want him on CNBC!), is a good speaker.

Gold will correct, I suppose, and before inflation becomes a problem, I suppose.  But this depends on the endurance of some global problems, and new ones, that might keep the "holy cow" variable from weakening too much.  Another possibility, rarely mentioned, is that Gold remains in a tighter trading range for much longer than expected.

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