Is the Permanent Portfolio in a Bubble?

[EdwardjK]

I am concerned that the rapid increase in the price of gold has created a potential "bubble".  It appears to me that gold is now being bought by "everyone and their brother" and the price is being driven by speculation more so than economic fundamentals.

If true, then the price of gold will decline.  But will it decline more or less than the hoped for/expected increase in money market accounts, equities and long-term Treasuries?

Does anyone share my concerns?  What is the best way to measure the historical relationship between gold and the other asset classes to determine if these relationships still hold over the past, say, 3 years?

Thanks.

[craigr]

I am concerned that the rapid increase in the price of gold has created a potential "bubble".  It appears to me that gold is now being bought by "everyone and their brother" and the price is being driven by speculation more so than economic fundamentals.

If true, then the price of gold will decline.  But will it decline more or less than the hoped for/expected increase in money market accounts, equities and long-term Treasuries?

Does anyone share my concerns?  What is the best way to measure the historical relationship between gold and the other asset classes to determine if these relationships still hold over the past, say, 3 years?

Thanks.

The best data we have so far would be to look at the last speculative gold bubble in the late 1970s/1980s where gold hit an inflation adjusted price of $2300 an ounce or thereabouts.

Gold dropping by 50% at this point would cause a -12.5% loss in the portfolio. Not great. But consider that it's likely another asset would absorb that loss. Then again, the -12.5% loss would still be better than the pounding stock-heavy portfolios took in 2008 and 2000-2002.

The portfolio doesn't overweight any one particular asset so there is a firewall of sorts as to the total amount of damage that can be inflicted if one of them should go horribly bad. Even if gold were to drop to $0 tomorrow, it would be a -25% loss. Again, not great. But it's not catastrophic if you stop to think about the total losses even in this very unlikely condition or the sustained losses stock investors took the past decade that didn't diversify.

But we don't know what the future will do. A drop in gold will hurt the portfolio if nothing rebounds to offset the losses. But the same could happen to a portfolio heavy in stocks or heavy in bonds. You just have to diversify as best you can and try to not look at asset classes in isolation. Only total portfolio value matters. A big drop in gold that is totally offset by rise in stock prices can still result in a net profit.

[pplooker]

The PP, like any strategy that's not devoted to market timing (primarily, technically even the PP times the market with its rebalancing bands), isn't going to post winning numbers every year.  Nothing in the investing world does that.  Lots of people I know have asked me how to reliably get a 5 or 6% nominal return without risking anything and never losing money, and are incredulous when I tell them it can't be done, all that can be accomplished is the probability of that can be improved upon.

I have to admit as I learn more about it, I'm more intrigued how simple it really is and how it simply uses the very basic ideas of finance I picked up in grad school.  It's not that the correlations between each of the four slices are negative or anything, they're just much lower than they are in my VP.

The point I'm trying to make is that a complete catastrophic event is, well, bloody unlikely.  Yeah you could have a bum year, or two, maybe even three, but eventually something has got to take off or at least hold still.  The four pieces are just too different from each other.  Nothing short of complete social collapse could really destroy the portfolio, and if that happens we got bigger things to worry about.

If it hits a "bubble" and has a bum year, well that's the nature of the beast.  When you "sign up" for the PP, you know good and well you're buying into at least one asset class that's overvalued and thus likely to drop in value, possibly a lot, and the odds are actually random, in my estimation, which one it will be.  It's just how the game is played.

[bdahl01]

If you are doing the PP then it does not matter if there is a bubble or not.
Just make sure you re-balance when the thing pops.