Gyroscopic Investing

Sorry if someone has already posted, but I thought this was interesting.  In short, the author finds that T-Bills have actually been a great inflation hedge, energy and real estate were so-so, and TIPS and gold weren't very effective.

http://papers.ssrn.com/sol3/papers.cfm? ... id=2161124

Gold does exactly what we want it to do, when we want it to do it... it's just hard to see it through all the noise.

I certainly didn't appreciate it at one point in my life.

Real estate is interesting... usually valued most by those who want something "real" and tangible of value and often that don't trust government, except the goverment often regulates land use and sometimes even confiscates land.  The government could make the value of my property drop in half without batting an eye just by signing a few laws into place.

moda0306 wrote: Real estate is interesting... usually valued most by those who want something "real" and tangible of value and often that don't trust government, except the goverment often regulates land use and sometimes even confiscates land.  The government could make the value of my property drop in half without batting an eye just by signing a few laws into place.

In addition to the bad things government does for real estate, they also protect it. If it catches fire they come over and put it out. If someone breaks in your house, they come over and shoot them. If someone squats there, they come by and force them out.

Thus, for someone who is suspicious of government, that makes RE investing even stranger, because without government, you wouldn't want to invest in RE (you'd simply just take someone else's house for free, or on the flip side, you'd have to sit in front of your house 24/7 with a shotgun to protect it).

And again I will say to the paper author that comparing gold on price to determine how it worked as an inflation hedge, when gold was price controlled over much of the analysis period, is worthless. This paper seems to make the same exact mistake. Maybe I missed something?

Cash in tbills certainly can keep pace with inflation, but only for itself. It has no explosive growth power to offset damage to the rest of a portfolio like gold has.

Also, "real" assets are more than just about inflation protection. What makes an asset a real asset is that it is not a financial asset. Financial assets are promises and sometimes promises are broken.

Gold doesn't promise you anything, it just sits there, being gold.

When tons of other promises are being fulfilled, gold becomes less desirable because it is worth trusting others with your capital. However when promises are being broken (especially in real terms) that is when gold becomes more attractive.

The fact that gold doesn't promise interest or dividends is what makes it such an awesome diversifier.

melveyr wrote: Gold doesn't promise you anything, it just sits there, being gold.

Beautifully put.

MT,

When you retire from the Internets please hand your position to melveyr.

He might be old enough to drink by then...

Dets wrote: Sorry if someone has already posted, but I thought this was interesting.  In short, the author finds that T-Bills have actually been a great inflation hedge, energy and real estate were so-so, and TIPS and gold weren't very effective.

http://papers.ssrn.com/sol3/papers.cfm? ... id=2161124

Surprisingly good paper re. the data it presents.

Ang makes some surprising assumptions if you aren't expecting a Keynesian background.  (I just love his commodity case where he follows the traditional approach in assuming that because the real world doesn't match the model, it is because of what was intentionally left out of the model rather than any invalid assumptions behind the model or causes/effects not even considered by the model.)

The other major flaw is related.  The entire paper seems to assume that other factors affecting prices (of e.g. commodities or gold) are insignificant and thus they can be ignored when calculating the correlation with inflation, or else the effect of those factors ruins the correlation with inflation.  I'm not sure which.  Maybe I missed it, but it sure would have been nice to see spelled out which mistake he was making.

And I draw very different conclusions.

His conclusion is that because the return on T Bills correlates with inflation better than the other things he compared, even though that return lagged, that T Bills are a better hedge against inflation.  He even identifies why -- inflation causes expectation of inflation and that causes investors to seek higher returns from their T Bills and the market, driven by investors, complies.  He doesn't bother to point out the general trend of declining interest rates which give an advantage to T Bills, nor does he point out the problems with increasing authoritarian interference in the T Bill market which has resulted in negative real returns in 10 year bills even tho he pointed out similar in TIPS.

I would only make his conclusion in regards to one asset -- cash.  For anything else, you should go after the better return.  Why?  The correlation he found is what I expected.  It makes sense that the most liquid asset he tested, with the most direct and easy relationship to cash and inflation returns, has the highest (most direct) correlation with inflation.  Any time you reduce liquidity compared to the ideal you are going to reduce correlation by an amount proportional to the change in liquidity.  This is why closed-end funds trade at a premium or discount (see GTU) to their underlying securities and why ETFs typically do not.  And when ETFs do trade offset, it is due to liquidity differences.

Edit:  Got distracted, didn't finish my thought there.  The correlation he found is the basis behind his conclusion.  In other words, he assumes that higher correlation means a better hedge.  But you had to expect that correlation just knowing the nature of the markets and assets he compared.  So to go deeper than the obvious, you have to ask yourself, better hedge than what?

Edit continued:  Obviously better than cash which has no hedge at all.  But once you are talking about other assets with better returns, correlation suddenly becomes less important even if it has any relevance at all.  Why would you wait months or years to be compensated for inflation (as in T Bills with their better correlation) when you could be compensated more, or sooner or even in advance by better returns?  I'm not as interested in exactly offsetting inflation by a known amount as I am in generating a better return.  And in Ang's model, a better return is worse because the correlation is less -- it does not move the same direction by the same amount as inflation.

Anyway, good data.  Good overview of traditional economic thought.  Scholarly papers that go beyond presenting data are always such a load of crap.

TripleB wrote: In addition to the bad things government does for real estate, they also protect it. If it catches fire they come over and put it out. If someone breaks in your house, they come over and shoot them. If someone squats there, they come by and force them out.

Ever heard of private contractors?

All those things were done by private contract long before gov't stepped in to supposedly do them cheaper and better.

TripleB wrote: Thus, for someone who is suspicious of government, that makes RE investing even stranger, because without government, you wouldn't want to invest in RE (you'd simply just take someone else's house for free, or on the flip side, you'd have to sit in front of your house 24/7 with a shotgun to protect it).

Or how about hiring someone like this...

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