Gyroscopic Investing

During the early eighties the inflation in my country (Israel) was raging and it hit about 400% in 1985. However, the world spot price of gold remained rather calm during that year compared to the gains of the seventies.

I realize that Israel's economy is very small and hardly affects the world price of gold, but this has got me thinking, can gold really save me if a similar crisis hits in the future?

In other words, if gold price only follows inflation rates of the largest economies, maybe it is not a suitable asset to own for investors living in smaller countries?

Maybe I'm just missing something important here.

The price of gold in USD may have stayed the same, but what about gold denominated in old shequels? Could someone  in 1985 have sold an ounce of gold and received far more shequels than they could have in 1984?

Catacomb,

I think you are entirely correct. I don't think international PPs in small countries should be expected to work. If I lived in a country other than the US I personally would pursue a different solution, or at the very least lower my expectations about how it would fare in a local inflation.

Pointedstick wrote: The price of gold in USD may have stayed the same, but what about gold denominated in old shequels? Could someone  in 1985 have sold an ounce of gold and received far more shequels than they could have in 1984?

They would still be losing money in real terms from their gold position in a time period where they are counting on it to be their only winning investment. I don't think gold can be expected to react the way small country investors need it to.

Catacomb,

You are correct, gold is an international asset, and doesn't care about individual countries.  However, if the value of your currency falls then the price of gold will increase relative to your currency, even though it may remain unchanged in USDs.  Now this is also true of assets denominated in other currency, such as stocks and bonds.

My general thoughts on this is to hold an equal amount of international assets and gold.  Here's an example:

20% Gold
20% World Stocks
10% Domestic Stocks
50% Domestic Bonds

The gold and world stocks balance each other, and in addition protect you from your currency weakening against the major currencies.  The domestic bonds protect you from a strengthening domestic currency, and will typically provide a real return in your own currency.  If your country has a history of defaulting on its debt then consider buying some international bonds, although this increases the risk from a strengthening domestic currency.

Thank you all very much for your insights, I really appreciate it and learn alot from it.

Gosso,

that post is pure GOLD (no pun intended). Your suggestion is extremely interesting to me as an Israeli investor. The question is if it is not "heretic" in terms of over-tinkering with the 25x4 method. 

It got my mind thinking and I have a few more question if you will:

1. Would you define funds like VEA, SPY, VTI (or any other fund that is not Israeli for that matter) to be "world stock"? Or should I for the sake of simpllicity just stick to purely global indices such as VT?

2. What purpose do the "domestic stocks" serve in the portfolio you outlined? The more I think about it I realize the Israeli stock market is not large enough to merit 10%, let alone 25% of the entire portfolio! It's just too risky and not diversified enough in my view. 

3. Could you explain exactly how do domestic bonds protect me from a strengthening domestic currency? This is actually the case in recent years, the Israeli currency is becoming stronger and stronger and the central bank artificially buys more dollars to keep it at bay.

4. When you say 50% bonds, you mean 25% long term and 25% short term?

5. Finally, I'm worried that this portfolio is not reflecting the concept of changes to one single economy as recommended in this forum. What do you think?

Thank you again

Catacomb,

My answers:
1.  VT is fine.

2.  Domestic stocks protect you from your economy outperforming the global economy.

3.  Basically if your currency strengthens then all your global assets (gold, world stocks) will fall in value.  So by holding domestic bonds you limit this risk.  Plus domestic bonds will generally compensate you for your local inflation, expected real returns in the domestic stock market, and risk of default -- at least they should.  If you hold international bonds then you are at the mercy of the currency markets to provide you a real return.  Just imagine a US investor holding Japanese Bonds over the past 20 years; the yen has strengthened against the USD, but has it been enough to compensate for the lower yield, I don't know?  And imagine if the Yen hadn't strengthened, not good.

4.  The barbell is fine.  Although I'd argue that anything with an average bond duration between five to ten years is acceptable.

5.  You could look at it from a currency perspective.  You hold 40% of your portfolio in global assets (gold, world stocks), so if your currency falls in value then these assets will increase in value, and vise versa.  Your domestic assets then act to anchor you to your home country.

Added:  Also, all my comments assume one lives in a reasonably stable country with its own central bank and currency.

What about to put only the cash part in locally short term bonds or I Bonds?
In my view the long US Treasuries are essential to offset the losses of the stocks (VT for example). Because I don´t see that other countries bonds generally moves in the opposite direction as the US do.

escafandro wrote: What about to put only the cash part in locally short term bonds or I Bonds?
In my view the long US Treasuries are essential to offset the losses of the stocks (VT for example). Because I don´t see that other countries bonds generally moves in the opposite direction as the US do.

But for a non-US investor we have to factor in the impact of currency fluctuations.  If VT falls and investors flee to the USD, then the USD will increase in value.  This will cause your gold and VT to increase in value relative to your currency. 

For example during 2008 the Canadian dollar fell by 20%, and therefore providing gold and US stocks with a 20% bonus.

So while a US investor relies on falling interest rates to protect during a down market, we foreign investors can rely on our currency weakening and therefore boosting our global assets.  We can also have the added benefit of our interest rates falling, but they likely won't move as much as the US.

Basically what I am saying is that any benefit from TLT would be overwhelmed by currency fluctuations.  That is why I recommend placing ~60% of your assets in your home country, otherwise your portfolio will be dominated by the currency markets. 

The caveat here is that you need to be living in a reasonably stable country with its own central bank; if not then I would increase my holdings of USD (as escafandro suggested) and simply accept that this will result in a more wild ride, but at least there is a good chance your assets will be protected.

I believe there are many factors that affect gold price

a. US Dollar value and inflation  as pointed out by several others
b. General perceived uncertainty - fear of war, financial armageddon etc.
d. Jewelry market - especially during marriage season in India and China (impact is Oct onwards till about March)
e. US Interest rates