Anyone else have a bad feeling about gold?

[TripleB]

I've been having bad feelings towards gold recently. It's not actionable to me, and I'm maintaining my PP. Makes me glad I have a bit of a VP. I wonder if having a modest VP (10% to 20% of total portfolio) helps to maintain PP in the long term because I can make minor moves as I feel appropriate, while having the bulk of my money isolated from what could be a stupid decision.

[Reub]

The beauty of the PP is that one asset can tank and the overall portfolio will do well. If gold were to seriously depreciate, say by 50%, the most that this could affect your overall portfolio would be by 12.5%! And that would be an extreme case and would probably be accompanied by a rise in some of your other assets.  

Does anyone happen to have a graph of how the PP has performed when gold has underperformed over the years?

[TripleB]

I'm concerned that gold and bonds went up together very highly over the last few years, and will fall together over the next 18 months. I'm worried stocks won't be able to absorb the hit. If both gold and bonds fell 50% each, then gold would have to do 100% gains just to maintain an even portfolio. I don't see that happening.

I can very easily imagine bonds dropping 50% as it would simply require a 2.5% rise in interest rates. A 5.5% 30 year interest rate doesn't seem absurd. Eventually the Fed will run out of ability to keep the rate down.

I can also imagine gold dropping 50%. Perhaps partly due to gold going out of favor as people and countries struggle to keep up with rising agriculture costs. And partly due to a strengthening of the USD against other paper currencies.

I can't possibly imagine stocks doubling over the next 12 months.

On the bright side, I could argue the 25% cash portion will be worth more if gold drops and the USD strengthens, and thus while my nominal value goes down, my purchasing power improves with a smaller portfolio.

Either way, we can't know what will happen, which is why we are in the PP to begin with. If I had to bet (and I do in my VP), we're going to see a 12% to 17% gain in stocks in 2012, and a 5% to 8% drop in the PP.

My VP for 2012 is going to be 25% REITs, 25% Index Stocks and 50% "Free Money" Cash which is things like IBonds and some high rate CDs offered as promos that are NCUA/FDIC insured. I call it free money cash because it's interest that is above the level of comparative risk. i.e. it's hard to argue that a 3% 12 month CD that is backed by NCUA/FDIC isn't "a free lunch" right now even if you feel the FDIC is insolvent. Compared to the risk you are taking, you are getting a steal. Of course, the promo CDs have low maximum amounts so your ability to juice them is limited, as are IBonds, which are essentially 3% 12 month bonds right now.

[amp]

I've had similar thoughts lately, but with bonds vs. gold, and have traded on them fairly profitably.  Sure, I realize rates can go lower (TLT go higher), but is that the most likely scenario in the long run (10+ years)?  So far I've been pretty lucky and bumped my overall PP return by about 1% this year by doing so, but know deep down that I got lucky and it could've gone against me.  EDV is up 50+% this year and I've jumped in and out a couple of times as it's bounced around to bump my return even more... and I know it's mostly luck.

To your point, I am now placating my need to tinker, experiment, and test my wits against the market by using almost 20% of my investable (did I create a new word there?) funds in a VP and the other 80% in PP.  I've promised myself not to F*CK with the PP and to give the VP a 5-year window to measure results.

I'm not very successful at viewing the PP as a basket of goods, because it's not.  I should (per HB and everyone here), but I don't.  We buy them independently, they move independently.  It's hard to resist the urge to avoid something that appears to be high risk... perhaps like TLT or gold at current levels. At the same time I can admit to having no inclination whatsoever as to what the stock market will do next year.

On another note... one other thing I've been contemplating is if there is some sort of optimal rebalancing strategy vs. 25% in each asset.  For example, if an asset hits 35% should you rebalance to 25% or would 20% (thereby increasing the percentages in the relatively underperforming assets) be more advantageous.  I don't know how to test this, it might not do anything to returns, and it may not even be a reasonable question to ask, but I just can't accept that 25% is always the "right" PP answer.

[jediclampet]

I can very easily imagine bonds dropping 50% as it would simply require a 2.5% rise in interest rates. A 5.5% 30 year interest rate doesn't seem absurd. Eventually the Fed will run out of ability to keep the rate down.

I can also imagine gold dropping 50%. Perhaps partly due to gold going out of favor as people and countries struggle to keep up with rising agriculture costs. And partly due to a strengthening of the USD against other paper currencies.

Lately gold and treasuries have been inversely correlated so I'd be surprised if both plummeted simultaneously.

[Storm]

I'm concerned that gold and bonds went up together very highly over the last few years, and will fall together over the next 18 months. I'm worried stocks won't be able to absorb the hit. If both gold and bonds fell 50% each, then gold would have to do 100% gains just to maintain an even portfolio. I don't see that happening.

Really?  What you said just doesn't make sense.  How could gold and bonds fall 50% and stocks go nowhere?  Where does all that money go?  Do you seriously think everyone in the investing world will just go to cash?

[clacy]

With rates near zero in most of the developed world, money has to go into one or more of: stocks, LTT's, or gold.

[moda0306]

I would be very surprised to see 5.5% long bond rates and/or $775 gold.

Keep in mind, during this deliberating there is a very high amound of supply of loanable funds, but very little demand.  These are fundamental market making trends that are not simply some fed concoction.

That said, we are about to end two consecutive years of double-digit pp performance in a time of record-low interest rates and inflation expectations.  I think the pp is ripe for a pullback, and now is time to rebalance into your lagging cash, IMO.  

If you look at the history of the PP, the performance tends to revert to a mean.  Only twice has the pp carried double digit gains into the third consecutive year.  Those two periods were in the 1970's, and one was preceding the PP's 1981 loss.

I tend to think if one wanted to tinker moving into and out of the more volatile pp assets as they under/over-perform as a group.

[TripleB]

With rates near zero in most of the developed world, money has to go into one or more of: stocks, LTT's, or gold.

I dont believe it's a zero sum game. Just because money is moving doesn't mean the prices have to go up. For example, stocks are valued based on the present value of their future earnings. If their future earnings drops due to new government regulations, a permanently lagging economy, a natural disaster that kills 20% of the global population, etc, then the stock market will drop, even if few people sell their positions.

Also, if food prices go up substantially, which I believe they will, then money will be dumped into food and eaten. Will those farmers then turn around and buy stuff to stimulate the economy? Maybe. Or will the farmers simply have to pay their workers more money for their time, so they can afford food, and the farmers aren't really making a bigger profit, even though more money is being spent on food.

[clacy]

With rates near zero in most of the developed world, money has to go into one or more of: stocks, LTT's, or gold.

I dont believe it's a zero sum game. Just because money is moving doesn't mean the prices have to go up. For example, stocks are valued based on the present value of their future earnings. If their future earnings drops due to new government regulations, a permanently lagging economy, a natural disaster that kills 20% of the global population, etc, then the stock market will drop, even if few people sell their positions.

Also, if food prices go up substantially, which I believe they will, then money will be dumped into food and eaten. Will those farmers then turn around and buy stuff to stimulate the economy? Maybe. Or will the farmers simply have to pay their workers more money for their time, so they can afford food, and the farmers aren't really making a bigger profit, even though more money is being spent on food.

The bottom line is if people are hitting the bid for one of those three assets, prices will go up.  In your first scenario, money would rush into treasuries.

In your second scenario, gold would likely go up along with commodity prices.

[FarmerD]

I can very easily imagine bonds dropping 50% as it would simply require a 2.5% rise in interest rates. A 5.5% 30 year interest rate doesn't seem absurd. Eventually the Fed will run out of ability to keep the rate down.

I can also imagine gold dropping 50%. Perhaps partly due to gold going out of favor as people and countries struggle to keep up with rising agriculture costs. And partly due to a strengthening of the USD against other paper currencies.

I can't possibly imagine stocks doubling over the next 12 months.

I have a hard time imagining bonds and gold both dropping.  To get bonds to drop 50%, expectations of high inflation would have to dramatically increase.  If that happens, gold should go up, not down. 

Of greater concern should be the threat of deflation.  Stocks would get killed in a deflationary scenario, but there is a cap on how low yields can go.  Therefore, TLT gains may not be able to protect the PP from big stock losses.  Gold is an unknown in this scenario though I doubt it will rise.  That's why I'm considering moving most of my cash to some intermediate term bond funds.   These have the potential to appreciate some if yields fall and help TLT rescue the PP.   

[Gumby]

there is a cap on how low yields can go.

The cap is meaningless. You can halve a yield over and over and over again until infinity. It's possible to have micro yields or even negative yields.

[craigr]

I've been having bad feelings towards gold recently. It's not actionable to me, and I'm maintaining my PP. Makes me glad I have a bit of a VP. I wonder if having a modest VP (10% to 20% of total portfolio) helps to maintain PP in the long term because I can make minor moves as I feel appropriate, while having the bulk of my money isolated from what could be a stupid decision.

In 1981 gold lost -31% in a single year and stocks also did about -5%. Bonds were basically flat. The portfolio took a -5% loss that year (about -12% in real terms).

As I always say, we just don't know what will happen. But I've looked at a ton of other strategies and they all have much worse weaknesses than what I see in the Permanent Portfolio. So while it may be that it takes a loss, it probably will be less than other approaches over the long run. The four core assets are bought by people for very different reasons and it is unlikely that two or more of them are going to go down in price together very long before things correct.

And even in the 1981 scenario, what would have been a better approach? We know now what the right answer was (just sit in cash), but back then you'd have been hard pressed to guess what was going to occur with prime rates in the 20% range.

Markting timing the assets in the portfolio has proven to be a bad idea in the past. Earlier this year many said LT bonds had nowhere to go but down. Now that the year is over LT bonds are posting almost +30% gains.

I again encourage investors not to look at assets in isolation and to not watch their portfolios very closely. I say again that most people on this forum would be absolutely shocked at how little I watch my portfolio, how very little I trade in my account or how little I pay attention to financial news. I eat my own dog food and I am very happy with the results.

[FarmerD]

there is a cap on how low yields can go.

The cap is meaningless. You can halve a yield over and over and over again until infinity. It's possible to have micro yields or even negative yields.

Long bonds tend to move inversely with stocks (at least in volatile markets anyway).  But when yields get too low, I think you begin to lose that uncorrelated portfolio protection.  There is a real risk investor attitudes begin to change so that they don't automatically run to treasuries when stocks tank.  More and more people may begin to have  real trouble with the risk/ return aspects of LTT should yields for LTT drop to say, 1%.  Why take the risk of big losses on long term treasuries - why not just put your money into cash.

Over the past ten years Japanese long bonds have been miserable protecting the Japanese PP from stock losses.  Gold is the asset that saved the Japanese PP. Going forward, Japanese long bonds will, at best, have a near zero return, and in the worst case, suffer huge losses

I wonder if long Japanese bonds even move inversely with the japanese stock market anymore.

[stone]

At a high enough price, 30year treasuries will have a yield to maturity of zero. Isn't that the maximum price?

[stone]

Clive, you explain the rebalancing gain phenomenon of the PP better than anyone. To me that seems so dissonent with you posing the idea, "Is continually holding 25% in each of the PP assets any better or worse than repeatedly (and sequentially) holding 100% in each single asset for a year at a time?"

You are throwing away any chance of rebalancing gains by holding the assets sequentially aren't you? DM hopes to counteract that sorry fact by correctly guessing the market.

[stone]

Clive, that idea is like saying that when playing roulette, if you lose betting on red for ten spins, you can reduce your risk by betting on black for ten spins. It doesn't make sense to me unless you aknowledge that DM is purely predicting the future. Predicting the future can work sometimes with some assets (not with roulette ).
PP is not using relative values to time the market IMO. If it were then you would just go 100% into the leading asset. It is hedging. Hedging is not prediction. It is the opposit of prediction. It is based on the idea that you do not know what will hapen.

[stone]

Clive, sorry you are completely right, I agree that the wide rebalancing bands do mean that the PP is using relative value to time the market as you say. Is it fair to say though that very tight rebalancing (daily) only cuts <1% off the CAGR? So to some extent the relative value timing approach from the wide rebalancing bands is just offsetting a loss of hedging style rebalancing gains. The wide bands reduce transaction costs and that is the clincher.

[LonerMatt]

The PP however also isn't as stable as many might believe. Recently for example I've been updating/correcting historic Australian PP figures and as examples that saw real (after inflation) losses of -2.5% in each of 1974 and 1975 followed by a -5.8% in 1976. Had you also been taking 4% as income each year for living expenses then that would have been something around -6.5%, -6.5%, -10% down years (-23% down in total). Similarly 1980 +3%, 1981 -19% 1982 +2.5%, with 4% income withdrawals had -1%, -23%, -1.5% down years (-25% down in total).

To be fair, I'm not sure how many PP proponents are taking 4% out for living expenses - having a look at the reasons people are interested in the PP, there aren't many who are living off it. Of course, it is valuable to consider such possibilities.

Also, I don't know that, in a 38 year time period, seeing four years of loss - total - means that the portfolio is unstable, or pretending to be something its not (although some of those losses are not great). Let's not forget, that same data saw 21, then 28% growth in 85 and 86, 45% growth in 79 and plenty of double digit growth throughout the years.

Similarly, with looking at those same figures Clive is discussing, I'm wondering if this hesitation with gold might not have occurred at earlier points in history. There have been times when gold was $200 AUD, and rose to $600 within a few years. Such an increase might have warranted the same "It's risen so high, what to do next?" attitude, but as we can see with hindsight, gold has risen much more highly. If global uncertainty = rising gold prices, and the future is anything but certain (in regards to Europe at the moment) maybe it will go higher.

Please continue the discussion, I'm learning a great deal.

[stone]

Clive, isn't it true that the key aspect of the bookmaker's craft is to have a bet on EVERY horse? To my mind that is what the PP tries to do. As you have pointed out loads of times, a 50% loss needs a 100% gain to recover. That property of the arithmetic seems the heart of the PP to me. Each asset sort of alternates between 50% losses and 100% gains. The PP mixes the opposing assets to transfer some of that 100% gain onto new holdings bought by selling an asset that hasn't fallen.

[stone]

I guess it all depends on whether the pack of cards you think you are counting is what you think it is.

[Storm]

I eat my own dog food and I am very happy with the results.

Hi Craig,

I'm looking forward to your 2011 PP performance blog post.  Do you plan on posting it next week sometime?

[craigr]

The PP however also isn't as stable as many might believe. Recently for example I've been updating/correcting historic Australian PP figures and as examples that saw real (after inflation) losses of -2.5% in each of 1974 and 1975 followed by a -5.8% in 1976. Had you also been taking 4% as income each year for living expenses then that would have been something around -6.5%, -6.5%, -10% down years (-23% down in total). Similarly 1980 +3%, 1981 -19% 1982 +2.5%, with 4% income withdrawals had -1%, -23%, -1.5% down years (-25% down in total).

To be fair, I'm not sure how many PP proponents are taking 4% out for living expenses - having a look at the reasons people are interested in the PP, there aren't many who are living off it. Of course, it is valuable to consider such possibilities.

I do. I withdraw between 3-4%. I chose this portfolio because I do use it for living expenses and wanted to diversify my risks further than stocks and bonds do. It was one of the most stable portfolios I had seen that provided real returns in the 3-5% range over 5-10 year rolling periods. Most other portfolios I'd seen advocated (in fact basically all of them) didn't do that.

Now what would I do if the Permanent Portfolio had an especially bad year? I'd go on a tight budget. Just as anyone would do with a portfolio that took a big loss.

But I've not seen a portfolio work better in various environments so I've seen no reason to change the strategy.

[craigr]

I eat my own dog food and I am very happy with the results.

Hi Craig,

I'm looking forward to your 2011 PP performance blog post.  Do you plan on posting it next week sometime?

For sure.

[MachineGhost]

I posted a simple gold timing system in another thread.  The biggest risk of the "adolescent" HBPP is that it is very suspectible to real interest rates rising.  If gold is in a bubble that is only halfway done but decides to tank 50% as we go into the double dip recession (as during 1974-1976), then the LT bonds will still go up to compensate.  But everything will tank and the pressure will be on the ST bonds if real rates start rising.  That is the risk at the ultimate end of the gold bubble.

MG

I've been having bad feelings towards gold recently. It's not actionable to me, and I'm maintaining my PP. Makes me glad I have a bit of a VP. I wonder if having a modest VP (10% to 20% of total portfolio) helps to maintain PP in the long term because I can make minor moves as I feel appropriate, while having the bulk of my money isolated from what could be a stupid decision.