Adaptive gold allocation rule

[Libertarian666]

You have come up with an excellent way to avoid the one (relatively rare but not unknown) situation in which a person of relatively modest means can become immensely wealthy without taking a lot of risk.

Doesn't sound like a good tradeoff to me. On the other hand, I survived the 1980-2000 gold slump without bailing out, so maybe I'm just weird.

[MachineGhost]

That is exactly the problem MG, finding a way to make any one of the assets not totally dominate the mix. Very hard since gold goes up and down by a factor of ten over the span of thirty years. That's why zero coupon bonds are not in the PP... too volatile, because of no coupon interest.

It's not a diffcult problem to resolve: http://gyroscopicinvesting.com/forum/pe ... #msg110588

[Kbg]

Anyone that has back tested moving averages can tell you they are deceptive...

[ochotona]

This is morphing into a bigger discussion. Does anyone have a table 1972-2014 of the calendar year returns for the four PP components?

[sophie]

Xan's comment was spot on.  At this point, I think its time for a brief excerpt from Fail-Safe Investing by Harry Browne.  I've edited the text for brevity, keeping the original meaning.

Rule #6:  Don't Expect a Trading System to Make You Rich

If someone were to tell you he'd discovered a foolproof way of picking lottery numbers or beating the football pools, you'd be wondering how to remove yourself from the conversation.  You'd know the story was too good to be true.

But the investment world is full of sure-fire ways to beat the markets.  You can be offered more hot trading systems in a week than you'll come across in a lifetime at the race track.

Trading systems are automatic signals that tell you explicitly when to buy and when to sell - without your having to make any decisions on your own.  Each comes with the assurance that it's been tested scientifically, and it will already have a fabulous track record. 

But somehow the systems never come through when your money is on the line.  So please remember the first principle of trading systems:

The system that has worked perfectly up to now will go sour when you stake your money on it.

Human activity, human values, and human intentions can't be measured and quantified as though you were weighing a sack of apples.  There's no way to translate any truism into a mathematical formula that can tell you accurately when to buy or sell. 

If a trader looks hard enough, he's bound to find some amazing correlations simply because there are trillions of possible combinations of events.  Whatever he finds, he'll treat as a law of nature.

No it isn't.  Whatever the reason for the past correlation (if there was a reason), the future is a different story.  The exact same conditions won't prevail in the future, because the participants won't be the same and all participants will be working with different knowledge from what they had in the past.

Trading systems are based on the unstated assumption that the world doesn't change.  But the world is in constant change.  History doesn't flow from a Xerox machine.  History never repeats itself, because people learn from experience, they change, and they change events.  Otherwise there would be no price movements for investors to try to profit from.  And these changes mean that, even if B followed A five times in the past, there's no assurance A will lead to B in the future.

A long and elegant way of saying...I'll stick to my 25% gold allocation, thank you very much.

[ochotona]

Sophie, I don't want to trade either. That's a recipe for disaster. I just want to buy less of expensive things, and buy more of bargain things. That's what the rebalancing bands do, but personally I just could not rebalance 25% all the way around when sitting on one of those once-in-a-generation gold price spikes. Those are easy to recognize, my gosh. It's big news when it happens, and the gold bugs go nuts! And then in the years following they go into hard denial.

I think the problem is that it's really hard to wait years for something to go on sale. We are right now possibly, maybe in a leg downward from a generational price spike, it will perhaps take us to a bottom of unknown magnitude at an unknown date... or not.

FWIW, I'm still technically balanced... I have 15% gold, 25% cash, 30% stocks, 30% long bonds as of right now. Because I fundamentally can't forecast the future, but I do know where we've just recently come from... a 2011 gold price spike.

Xan's comment was spot on.  At this point, I think its time for a brief excerpt from Fail-Safe Investing by Harry Browne.  I've edited the text for brevity, keeping the original meaning.

Rule #6:  Don't Expect a Trading System to Make You Rich

A long and elegant way of saying...I'll stick to my 25% gold allocation, thank you very much.

[buddtholomew]

Sophie, I don't want to trade either. That's a recipe for disaster. I just want to buy less of expensive things, and buy more of bargain things. That's what the rebalancing bands do, but personally I just could not rebalance 25% all the way around when sitting on one of those once-in-a-generation gold price spikes. Those are easy to recognize, my gosh. It's big news when it happens, and the gold bugs go nuts! And then in the years following they go into hard denial.

I think the problem is that it's really hard to wait years for something to go on sale. We are right now possibly, maybe in a leg downward from a generational price spike, it will perhaps take us to a bottom of unknown magnitude at an unknown date... or not.

FWIW, I'm still technically balanced... I have 15% gold, 25% cash, 30% stocks, 30% long bonds as of right now. Because I fundamentally can't forecast the future, but I do know where we've just recently come from... a 2011 gold price spike.

Xan's comment was spot on.  At this point, I think its time for a brief excerpt from Fail-Safe Investing by Harry Browne.  I've edited the text for brevity, keeping the original meaning.

Rule #6:  Don't Expect a Trading System to Make You Rich

A long and elegant way of saying...I'll stick to my 25% gold allocation, thank you very much.

So now is a perfect time to allocate to gold. We've experienced a 40% retracement. It sounds like you are attempting to pick a bottom in the metal based on some charting analysis. If anything is undervalued at present, isn't it precious metals?

How about a once in a generation bull market in equities and interest rates so low that they are negative in many countries. You hold 30% in each of these investments. In my opinion, that is the risk in under-weighting one of the assets - you expose yourself to undue risk in those assets that are beyond a 25% allocation. Granted you are slightly over, probably immaterial, but the point is the same nonetheless.

[Mark Leavy]

ochotana,

I applaud your desire to understand more about the various assets that make up the PP - and your efforts to explore ways that you might benefit from any inefficiencies.  I hope you never stop exploring.

As a caution, though, you should understand that many many people with powerful resources have prodded the avenues you are currently pursuing.  You are not likely to discover anything novel going down the route you are taking.

Much of what you are doing falls under what I would call "optimizing the small" or "picking up pennies in front of a steam roller".
Market timing will likely gain you a small advantage for many years.  Until it costs you a large sum one year.

Do keep testing and challenging the conventions.  I sincerely think you have the right mindset.  But think long term.  Worst case scenario.  What if the improbable goes against you?

Best wishes,
Mark

[ochotona]

We've had two gold cycles in a row where the price went, in constant 2014 Dollars, from a very low level (1970) up by factor of ten (1980), way back down (2001), and then by a factor of four (2011). 40% in my view isn't gold on sale, 40% could be the opening chapter of a one or two decade long mega-correction all the way back down to the basement again... the kind we've just had during 1980s-1990s... unless we're in a new era, or an old (pre-1970s) era.

I've been in the oil business, a commodity business, since 1986, and I am fond of saying, particularly at this time in the oil price cycle, "I have seen this movie before". Whenever someone says we're in a "new era" in commodities, that oil is going above $200 (2008 Goldman Sachs) or below $20 (2015 Citigroup), AND STAY THAT WAY INDEFINITELY, you need to hold on to your wallet, plug your fingers in your ears, and run in the opposite direction. Follow the money - people say stuff like that for a reason, to manipulate others, to bolster their own position.

I know, oil isn't gold, but my point is... look at the graph. Look at the gigantic waves from 1970 - 2011. The past does not predict the future, but I sure would hate myself if I bought a lot of gold at too high a price. That's not a technical trading system, that's just being thrifty.

Nevertheless, I am in gold, 15% allocation. Still within the orthodox band limit. Right on the paint stripe. If gold falls a few dollars I'm in violation.

So now is a perfect time to allocate to gold. We've experienced a 40% retracement. It sounds like you are attempting to pick a bottom in the metal based on some charting analysis. If anything is undervalued at present, isn't it precious metals?

[ochotona]

Worst case is I rebalance at $1500 gold and it goes to $500 over the next few years. That's what I'm trying to stay away from; a head fake, a bull trap. I love to have gold in my portfolio, I am convinced the non-correlatedness is valuable. I won't overpay for each unit of that service. Would you pay your car insurance premiums if they doubled or tripled over a period of time?

Gold has been in the basement twice in my lifetime, it's not "improbable". It's very possible.

Do keep testing and challenging the conventions.  I sincerely think you have the right mindset.  But think long term.  Worst case scenario.  What if the improbable goes against you?

[buddtholomew]

The thing is...maybe you're right and so what if you're wrong. What's the price of piece of mind? That is the mental state you should adopt when considering a specific asset. One or more will go up and one or more will go down with higher highs than lows to produce a modest, inflation adjusted return. All other analysis is secondary.

[sophie]

I just could not rebalance 25% all the way around when sitting on one of those once-in-a-generation gold price spikes. Those are easy to recognize, my gosh.

I guess your crystal ball must be a new and improved model that I don't have.  The thing is, this statement is pure market timing, and this thread probably belongs in the "variable portfolio" section.  At any given moment in time, how would you know whether gold is about to go down, or continue going up?  The only possible way for you to argue in favor of one or the other is necessarily based on predictions arising from analyses of past performance.  This is a flawed line of reasoning from the word go.

That said, market timing may be very interesting as a VP strategy - check out Decision Moose, for example.  I'm just saying that it doesn't have any place in the Permanent Portfolio, which was devised specifically to counter market timing strategies.  I certainly don't have the extensive knowledge that Harry Browne did about investing, but it's worth also knowing that he believed strongly that market timing is a futile exercise.  Read my post again with the HB quote...it's quite an elegant explanation of this view.

[MachineGhost]

Gold went down 50% before reaching its ultimate high in 1980.  How much will gold go down if it bottoms at significant support at $1000 or major support at $680?  Point being, you need to come up with a better strategy than "pants on fire".  The one asset you do not want to be wrong on is gold.  It's your apocalypto insurance.

[ochotona]

Thanks for your concern, but I'm not sure that being 15% gold right now instead of 25% gold will be a portfolio breaker. Just think of that missing 10% as being "negative shares in my variable portfolio".

[Pointedstick]

I predict that when stocks take beating for a couple of years (ex. 2000-2002, 2007-2008) people start devising "adaptive stock allocation" rules.

[Kbg]

I think there may be some value in a timing mechanism between LTTs and bonds, by PP definition they are polar opposites. Why hold both at the same time (notionally)? I also like MGs thoughts of LTTs, $ and gold as forms of cash as well. Perhaps increase cash above 25% and time the other two. Momentum is philosophically PPish in that it doesn't attempt to predict.

[MachineGhost]

I think there may be some value in a timing mechanism between LTTs and bonds, by PP definition they are polar opposites. Why hold both at the same time (notionally)? I also like MGs thoughts of LTTs, $ and gold as forms of cash as well. Perhaps increase cash above 25% and time the other two. Momentum is philosophically PPish in that it doesn't attempt to predict.

I used to think that but it is a flawed assumption in assuming that bonds will always rally in response to an equity downturn.  Sometimes gold does that.  Sometimes even both.  There's really no need to jiggle the strategic weights other than to normalize the risk.  If you want to use tactical, then make it a binary 25% or 0% and that is far superior to anything else you can come up with.  But you have to do this on ALL of the assets because you have broken the built-in hedging; you can't pick and choose.  And you can never, ever fall asleep.

[4x4]

Xan's comment was spot on.  At this point, I think its time for a brief excerpt from Fail-Safe Investing by Harry Browne.  I've edited the text for brevity, keeping the original meaning.

Rule #6:  Don't Expect a Trading System to Make You Rich

If someone were to tell you he'd discovered a foolproof way of picking lottery numbers or beating the football pools, you'd be wondering how to remove yourself from the conversation.  You'd know the story was too good to be true.

But the investment world is full of sure-fire ways to beat the markets.  You can be offered more hot trading systems in a week than you'll come across in a lifetime at the race track.

Trading systems are automatic signals that tell you explicitly when to buy and when to sell - without your having to make any decisions on your own.  Each comes with the assurance that it's been tested scientifically, and it will already have a fabulous track record. 

But somehow the systems never come through when your money is on the line.  So please remember the first principle of trading systems:

The system that has worked perfectly up to now will go sour when you stake your money on it.

Human activity, human values, and human intentions can't be measured and quantified as though you were weighing a sack of apples.  There's no way to translate any truism into a mathematical formula that can tell you accurately when to buy or sell. 

If a trader looks hard enough, he's bound to find some amazing correlations simply because there are trillions of possible combinations of events.  Whatever he finds, he'll treat as a law of nature.

No it isn't.  Whatever the reason for the past correlation (if there was a reason), the future is a different story.  The exact same conditions won't prevail in the future, because the participants won't be the same and all participants will be working with different knowledge from what they had in the past.

Trading systems are based on the unstated assumption that the world doesn't change.  But the world is in constant change.  History doesn't flow from a Xerox machine.  History never repeats itself, because people learn from experience, they change, and they change events.  Otherwise there would be no price movements for investors to try to profit from.  And these changes mean that, even if B followed A five times in the past, there's no assurance A will lead to B in the future.

A long and elegant way of saying...I'll stick to my 25% gold allocation, thank you very much.

I think it is interesting that you chose this Rule #6 passage as I too was thinking of it.  Thank you for reminding, posting it for review.  I do however have to admit that when I read the passage, I feel that it in some ways is advocating AGAINST the permanent portfolio. 

I believe I understand its original intended meaning, but in some ways couldn't the PP be considered a "Trading Strategy" executed in slow motion?  It too has, "automatic signals that tell you explicitly when to buy and when to sell - without your having to make any decisions on your own.  Each comes with the assurance that it's been tested scientifically, and it will already have a fabulous track record."

I still am not aware of a better portfolio, asset allocation or "System" than the PP, but sometimes this passage makes me ponder...

[ochotona]

I am very skeptical whenever I hear "turn your brain off and follow this simple system and everything will be great". That's why I am poking, prodding, questioning, and tweaking. I do want to get to the 25% gold allocation, but it may take a series of gold buys on dips over the next years to get there.

I think it is interesting that you chose this Rule #6 passage as I too was thinking of it.  Thank you for reminding, posting it for review.  I do however have to admit that when I read the passage, I feel that it in some ways is advocating AGAINST the permanent portfolio. 

I believe I understand its original intended meaning, but in some ways couldn't the PP be considered a "Trading Strategy" executed in slow motion?  It too has, "automatic signals that tell you explicitly when to buy and when to sell - without your having to make any decisions on your own.  Each comes with the assurance that it's been tested scientifically, and it will already have a fabulous track record."

I still am not aware of a better portfolio, asset allocation or "System" than the PP, but sometimes this passage makes me ponder...

[4x4]

I understand your sentiment completely. I myself have been "unexcited" about the long bond position for some time. To play the advocate, I must admit many market turns, and subsequent effect on $, Stocks, Long Bonds or Gold, were not necessarily predictable by myself at least.  I think this hang up of your/ours is something that one must choose to internalize and accept as a known limitation along with the other advantages or not.  In other words every strategy has advantages and weaknesses.  If the set of strengths and  weaknesses in the PP is of your liking, go for it!  If not reevaluate something more appropriate, a BH portfolio has its down sides as well, all equities, etc.  I think the key selling point is the asset allocation limiting losses, passive nature, and admission that one can not predict the future investment horizon BOTH accurately AND consistently.  Yes at times, 2008/9 equities bottom, one can see the direction.  But of course others were selling low..  There was a sarcastic quote I used to like, something along the lines of "Investment advice can be considered successful (or accurate or good I forget), if one is able to predict either the direction OR timing of a market event.  Hope that isn't too cryptic, in other words predict when something is going to happen but get the direction wrong, or predict the move but get timing wrong; both are equally "successful" and both might be essentially considered worthless and unactionable.  I think cash might be the strongest asset during the next phase myself, but I thought that a year ago too...  Staying out of gold last year might have been good, staying out of stocks last year might have been bad.

The other thing to remember is that the Permanent Portfolio, imho, is meant to be used in conjunction with a Variable Portfolio once one has progressed to a certain level of wealth in relation to living standards.  While we are likely focusing to find "the one right approach."  There is advantage combining these two paradigms, that of the PP w/ VP. While the PP is meant to be safe, possibly limiting returns, the VP allows one to speculate with money that can be lost and tolerated.

I think the original intent of the passage was to steer one away from a trading system designed to make those selling it $ claiming a definite ability to consistently predict the future without error.  First rule, don't lose money 

PS There is an interesting recent post regarding on Ray Dalio of Bridgewater.  He also advocates an diverse asset allocation admitting the difficulties of knowing the future for the average person (and he according to some readings still keeps his trust in his version called "All Weather Portfolio"  sounds similar no?)  His asset allocation is tweaked slightly.  http://gyroscopicinvesting.com/forum/pe ... rdseen#new

[barrett]

Nevertheless, I am in gold, 15% allocation. Still within the orthodox band limit. Right on the paint stripe. If gold falls a few dollars I'm in violation.

Haven't seen anyone try to poke a hole in this yet. If 15/35 bands are considered acceptable, then we have to think that 15% is enough of an asset to get a lot of the upside when it moves. Otherwise we'd need to narrow the bands, no?

[Kbg]

I think there may be some value in a timing mechanism between LTTs and bonds, by PP definition they are polar opposites. Why hold both at the same time (notionally)? I also like MGs thoughts of LTTs, $ and gold as forms of cash as well. Perhaps increase cash above 25% and time the other two. Momentum is philosophically PPish in that it doesn't attempt to predict.

I used to think that but it is a flawed assumption in assuming that bonds will always rally in response to an equity downturn.  Sometimes gold does that.  Sometimes even both.  There's really no need to jiggle the strategic weights other than to normalize the risk.  If you want to use tactical, then make it a binary 25% or 0% and that is far superior to anything else you can come up with.  But you have to do this on ALL of the assets because you have broken the built-in hedging; you can't pick and choose.  And you can never, ever fall asleep.

MG,

My thoughts are just gold and LTTs and not mess with cash or stock. I'm working a couple of things we'll see if I find anything interesting

[MachineGhost]

I still am not aware of a better portfolio, asset allocation or "System" than the PP, but sometimes this passage makes me ponder...

You have to understand Browne was targeting his message to ordinary Joe Sixpacks.  Back in 1987 behaviorial finance and economics were very underground, so this was Browne's way of cautioning against getting ensnared in the emotional impulses that cause the best laid plans to fail.  It's true the PP is an active investment strategy but it is the easiest one you are ever going to find.

[sophie]

Ah, but the main difference with the PP is that it's got way more in common with buying and holding a stock index fund, than it does with a plan to buy and sell based on some kind of mathematically derived signal.  That's because the PP is not trying to do anything more than capture broad market returns, while the signal-based traders are trying to BEAT the market.  That's the difference.  The point is that no matter how good you are, you can't consistently beat the market.  Well except Warren Buffett maybe.

To use my standard analogy:  Think of the PP as a pigpen with four feeding troughs.  When food disappears from one trough, the pigs will run to one of the other troughs.  Since there aren't any other feeding troughs, you know that most of the pigs are going to eat out of one of the four - you just don't know which one ahead of time.  Over time, the "food supply" increases only because of overall population and economic growth; the food (i.e. money) comes into the system and has to go to one of the four troughs.  That's what the PP captures:  "the return the market gives you", to quote HB.

The proposal to time gold purchases according to whether it's "high" or "low" amounts to trying to guess when food will become more plentiful in the gold trough...argh, I can't take the analogy any further but you know what I mean, I hope.

[4x4]

OINK OINK!