Gyroscopic Investing

Hi
I'm kind of confused, especially about the bond part of the portfolio once more and the future of the Euro, as always. I don't want to keep all my assets within the Eurozone, it is a disaster waiting to happen in my opinion. ECB QE just started, they want to print about 10% of GDP and they drive government bond yields to all time historic lows. The safest long-term bond, which I own, is the 30 yr German federal government bond (ISIN DE0001135481). It yields about 0.66%. Its price shot up from 139 to 148 in a matter of days because of ECB bond buying.

1 year term deposit I can get for 0.5% without the duration risk. How can I justify to myself buying a 30yr bond at 0.66%? Pure insanity. German government bond yields negative up to 7 years now. Even if there is a deflationary depression and a sharp upward revaluation of the EUR, the yield of 0.66% does not compensate for the duration/rate risk.

Here's what I want to do, sell my German bonds, shift to 30yr US Treasuries and somehow reallocate the whole portfolio towards a world portfolio.

Portfolio now:
A) 25% Stocks: German DAX ETF
B) 25% Gold: physical coins
C) 25% Bonds: 30yr German government bond, yield 0.66%
D) 25% cash: 1/2 EUR deposit, yield 0.5% + 1/2 USD Treasury note 2016, yield 0.66%
(this 1.5 year USD bond yield matches the German 30 year rate, pure insanity IMO)

Portfolio re-allocation:
A) 25% Stocks: 1/2 German DAX ETF, 1/2 MSCI World ETF (which contains roundabout 60% USA)
B) 25% Gold: physical coins
C) 25% Bonds: 30yr US Treasury bond, yield 2.69%
D) 25% cash: 1/2 EUR deposit, yield 0.5% + 1/2 USD Treasury note 2016, yield 0.66%


Anyone having any opinion on this?
30yr Treasury offers not only rate risk, but also foreign exchange rate risk to me as not residing in the USD area.
I wonder if I should up the cash portion of the portfolio or buy more short term USD bonds to mitigate FX/duration risks without investing in German government bond yields.


Have a look at the German yield curve - this is pure central banking folly, not free market capitalism anymore:
http://pigbonds.info/Staatsanleihen/Deutschland

Hello

I am not sure if that new portfolio works well.

I would prefer to have X% in a EUPP and Y% in a USPP.

This is what I concluded from my readings.

Pfanni wrote: Anyone having any opinion on this?
30yr Treasury offers not only rate risk, but also foreign exchange rate risk to me as not residing in the USD area.
I wonder if I should up the cash portion of the portfolio or buy more short term USD bonds to mitigate FX/duration risks without investing in German government bond yields.


Have a look at the German yield curve - this is pure central banking folly, not free market capitalism anymore:
http://pigbonds.info/Staatsanleihen/Deutschland

Pfanni,

On that yield curve link you posted is the column labeled "Veränderung" showing what percentage yields have dropped, what percentage bond prices have gone up, or neither? Assuming it's one of these two, the performance just seems to be totally random. I get that "Verändern" means "to change" in German. I just cant make sense of the numbers because the chart doesn't seem to have any connection to reality, i.e, longer term bonds should have way bigger price moves one way or the other as compared to shorter term bonds.

LTTs are normally held in the PP for two reasons. 1) Primarily they are your hedge agains inflation, and 2) Their interest payments give your portfolio some yield along with stock dividends and (usually) cash. It seems to me that including German Bunds in a portfolio doesn't do much of either at this point unless I am missing something. And I for one don't like the idea of adding more exchange rate risk to a portfolio. Sure it would have worked great recently but the demise of the Euro is not guaranteed. You already are sensitive to exchange rate risk with gold, correct? Adding to that just would seem to put you in a position of speculating on currencies, not investing.

Not sure what the solution is but if we assume that stocks are good for you in the event of prosperity, and gold will protect you during inflation or a (further) loss of confidence in the Euro, then holding extra cash would seem to be the solution. It would give you more deflation protection and a more stable portfolio, I think.

I'll be curious to see what others think on this.

pigbonds.info, you cannot read the numbers? I suppose you are not used to negative rates on bonds.
It is

Duration - Yield - Rate of change since yesterday

Yields (the middle column) are negative up to seven years duration.

Thanks for the replies. I think you pointed out the conundrum very well.
In Permanent Portfolio theory or Harry Browne's line of thought, the long term government bonds are supposed to give one some kind of yield in a deflationary environment and the possibility of capital appreciation when yields go down further.
However, German government bonds yield the following:
1 year: -0.18% (negative yield - one pays the government)
5 year: -0.11% (negative)
30 year: 0.7% (positive yield for the investor).

All that makes no sense, since EUR has lost about 30% purchasing power within one year.
So, it's not rational investors buying these bonds - it is the central bank suppressing yields to save bankrupt governments.

This is where permanent portfolio breaks down because it assumes the market place to be populated with rational investors or individuals investing for their own benefit. Rational investors would not accept negative yields in a currency that tumbles 30% within a year (and we are talking about western industrialized currency block, not some South American banana republic).

Pfanni wrote: This is where permanent portfolio breaks down because it assumes the market place to be populated with rational investors or individuals investing for their own benefit. Rational investors would not accept negative yields in a currency that tumbles 30% within a year (and we are talking about western industrialized currency block, not some South American banana republic).

But does it really break down? Has it in practice broken down for European PPers over the last year? Seems to me that this is just another stress test for the PP and that the "insane" 25% allocation to gold has saved purchasing power of the European PP, no? For those that think gold is in the dumps right now I would say that what a German or Russian has actually experienced recently is that one of the four assets has done really well. I am happy to be corrected if I am wrong. Not trying to promote the PP, just understand it better.

My focal point was not 25% gold, I'm fine with that.

It's the bond portion that gives me the headache. A 30yr bond yielding 0.7% has basically zero upside and lots of duration risk. It is by far the worst bond in the world, surpassing even Japanese government bonds by a mile.

I see no other option for European investors than to bite the bullet and buy a 30yr US treasury bond, preferrably with the lowest convexity available (making it less price-sensitive to changes in the fed funds rate).

(Sorry if I repeat myself over and over again).

Hello PP-friends,

as remember you should not mix the assets.

They will not work.

From a bond valuation perspective in general, when yields go lower, your duration exposure should decrease.  When yields are negative, that almost seems like an invitation to go all in cash because there's NO CONFIDENCE of economic growth in the future.  If you do that then it seems like the prudent thing to do is also replace your stocks with stocks hedged against the Euro.  The bonds (and gold) are there primarily to hedge against equity declines.

You need to think ahead and decide what is going to happen when the ECU implodes.  Are German bonds going to remain sovereign or only as a convenient location of last resort until the EU splits and then all capital flees to the USA?  Or do you want to get ahead of the panic curve.  Germany may be "Rome" relative to the EU but it is not "Rome" for the planet.  How confident are you Germany will survive when France is already in trouble?

But I like frugal's approach.  Just have two separate US and German PPs with a shared gold kitty and shift your contributions accordingly depending on how the weather is blowing.

Pfanni wrote: Rational investors would not accept negative yields in a currency that tumbles 30% within a year (and we are talking about western industrialized currency block, not some South American banana republic).

That is actually a rational response.  In lieu of any confidence about expected future economic growth, people will pay the safest place to park and hold their capital.  That is what deflation literally is.  Gold will only respond when that NO CONFIDENCE spreads to the sovereign debt issuer.

OK, I see what you are saying Pfanni... the bond portion of the PP is broken for you.

I'm still digesting MG's posts but I don't like the idea of a European holding US Treasuries. If you load up on them at 2.7% and the yield goes up considerably (say to 4% or 5%) AND the Euro starts moving up against the USD, then you really get hammered. To me additional cash is enough of a deflation hedge. IMHO, the long duration bond issues have already done their heavy lifting when yields get as low as they now are in Europe. At that point you want to preserve wealth relative to others in your economic zone (normally we would say "country" but that's not what is going on in Europe at the moment).

I am no expert at this and my question may reveal my ignorance but here's 3 things that stick out in my mind.

1:

MachineGhost wrote: But I like frugal's approach.  Just have two separate US and German PPs with a shared gold kitty and shift your contributions accordingly depending on how the weather is blowing.

For me, this seems like a terrible approach. Who's really to say how the weathers blowing? In my mind, this would be trying to predict the future. If a German and US PP would be your goal, I'd imagine the most sensible way would be to divide contributions to each equally. Otherwise you'd engage in market timing big time. And where is it to stop? I guess sooner or later you'd do yourself more harm than good by switching funds (too) frequently.

2:

Pfanni wrote: 1 year term deposit I can get for 0.5% without the duration risk. How can I justify to myself buying a 30yr bond at 0.66%? Pure insanity. German government bond yields negative up to 7 years now. Even if there is a deflationary depression and a sharp upward revaluation of the EUR, the yield of 0.66% does not compensate for the duration/rate risk.

I don't know anything about fixed income, so could you please explain to me why this 0.66% is so bad?
Last year ComStage iBoxx EUR Liq. Sov. Div. 25+ TR UCITS ETF I ended the year with a 29.42% net asset value gain. So far this year it's up 16%. Why should I care with nav gains like these?

3: Posts like these worry me. I am  not yet that engrained yet in the PP and posts like these leave me wondering whether the PP is flawed, whether it's your psychology or the weather.
The Core components (stocks, bonds, cash, gold) either work like they are supossed to or they don't. It's as simple as that really.

Hi iLoveMoney

why is a return of 0.66% on a 30yr bond bad?
Because the underlying currency collapsed by 30% within a year. EUR went from 1.40 USD to 1.05 USD.
Capital gains of 20-30ish percent on these bonds are a look in the rearview mirror - not repeatable.
In real world terms, physical plane terms, measured in Harley motorcycles, or trips to Dubai, Big Mac menus or whatever you would want to buy, you probably didn't gain 30%. It's a bit like the Zimbabwe stock market, it might be up 35%, but when the underlying currency goes down 30%, you didn't gain all that much.

To repeat this stellar performance the bonds would have to be priced for negative yields of -3% to -7%.

So here is what I did and how my portfolio looks now:

A) Cash (EUR): 26%
B) Stocks (DAX ETF, EUR): 26%
C) Gold (coins): 24%
D) Bonds (USD): 24% (split half between US Treasury 30yr and 1.7 yr maturity)

But of course, I understand and actually share the criticism as this being a EURUSD currency speculation to some degree.
Contributions will now go into creating a balanced 50%/50% US-German Permanent Portfolio, but on the German one, replacing the 30yr bond with cash.

The fundamental schism here between the US and European view is that US citizens have engrained the Great Depression-point of view, which US citizens seem unable to leave behind and adjust to a changed landscape.

US view/explanation of low yields: the yield on long-term government bonds goes down because there seems to be no other viable business opportunity, so instead of risking too much, market participants perceive it is better to hang on to ultra-low, even negative yields.

European/real world explanation: the central bank wants to drive down the exchange rate to spur inflation and growth at the cost of its trading partners (beggar thy neighbour), but since the EUR is a free-floating currency, they cannot revalue the currency directly and additionally, exchange rates are not part of the ECB's official policy mandate.
So they print money to buy bonds to drive down yields to lower the exchange rate. So these low and negative yields do not reflect actions of rational market participants, as in the Great Depression in regards to safe bonds, but buoyant central bank manipulation.

---
I hope I don't get criticism for spamming the forum with my point of view.
It is meant to be an exchange of ideas, and I don't want to insult anyone.
I like this particular forum because people seem to have a deeper insight into finance than in most other forums.

I understand your concern.
However I still do have my €/$ LT Bond-allocations: 75 % iShares € Government Bond 15-30 & 25 % ZROZ
And of course the capital gain at the moment is foolish.
I just hope the rebalance point will arrive before the game is over.

Your allocation at the moment implies in fact a 38 % cash allocation (although different currency). That means your reblance strategy is "gone". Or your future allocation becomes 40 % cash, 10 % Bonds etc.. That's okay but a low yield I guess.
The most important part of investing is stick to your strategy otherwise you get mixed up with: when, if then else, how etc..
And we know the future isn't predictable.

Hello,

a) I can't understand your problem about Euro decline against Dollar, isn't it the same for your portfolio ?

b) You believe in PP in US and not in EU?

PP seems to work in every big market, like Japan, Singapore, Iceland ... historically.

This is what I remember from the BOOK.

ILoveMoney wrote: The Core components (stocks, bonds, cash, gold) either work like they are supossed to or they don't. It's as simple as that really.

They all work in the long-run, but you must keep in mind they all require certain economic environments to function best.  The transition when everyone is panicing up or down in the short-term can be painful since you're not market timing with the PP.

Pfanni wrote: US view/explanation of low yields: the yield on long-term government bonds goes down because there seems to be no other viable business opportunity, so instead of risking too much, market participants perceive it is better to hang on to ultra-low, even negative yields.

European/real world explanation: the central bank wants to drive down the exchange rate to spur inflation and growth at the cost of its trading partners (beggar thy neighbour), but since the EUR is a free-floating currency, they cannot revalue the currency directly and additionally, exchange rates are not part of the ECB's official policy mandate.
So they print money to buy bonds to drive down yields to lower the exchange rate. So these low and negative yields do not reflect actions of rational market participants, as in the Great Depression in regards to safe bonds, but buoyant central bank manipulation.

Actually, it's some of the rest of the world (i.e. EU) with the Great Depression-mindset as reflect in their yields going below negative.  There must still be some economic optimism in the USA despite years of QEternity (the Fed literally bought 30-year Treasuries) for yields to remain so relatively high.

I think you misunderstand the situation within the EU.  They 1) did not deal with the pre-existing sovereign debt before forming the EU so that the old debt was inflated away; 2) all of the EU central banks have used trash-grade sovereign debt (i.e. Southern Europe) for reserves on their balance sheets, so likewise they cannot afford for any of the EU members to inflate away their debt by defaulting or leaving the EU in what would start a contagion of dominos falling; 3) The whole situation was exacerberated by interest rate differentials that did not reflect the true nature of the risks of the trash-grade countries, i.e. they got a free ride of easy cheap credit bubble money which contributed to both governments and civilians issuing debt and spending like drunken sailors.  Here we are!

In other words, the EU is in the grips of a massive deflationary headwind with no way out since none of the EU members are currency issuers which was a power explicitly given up for the purposes of joining the EU.  The ECB has been desparately trying to acquire that power to save the EU, but kingmaker Germany which does not exist in the real world anymore but that of the misunderstood hyperinflationary 1930's, refuses to pull its head out of the sand.  So what the ECB is attempting to do is take some of the trash-grade debt off its members' balance sheets and onto its own.  In the meantime, the built-in structural stupidities of the EU as outlined above remain a deflationary head chopping block that will continue to doom the real EU economy (along with excess socialism and overregulation that severely constricts "Creative Destruction" from cleaning up decades of chronic and crony malinvestment), because after all, there is no transmission mechanism from central banks to the real economy.  The ECB is BAILING OUT its member central banks, Brussel technocrats, national bureaucrats, etc. at the expense of everyone else.  Nothing will change for the non-ruling elite citizen.  Whoever wises up and leaves the EU first (Greece?) and reasserts its rights as a currency issuer will be the winner.

My US PP YTD

in USD -1.75%
in EUR +13.21%
in gold +0.88%

Pfanni wrote: I hope I don't get criticism for spamming the forum with my point of view.
It is meant to be an exchange of ideas, and I don't want to insult anyone.
I like this particular forum because people seem to have a deeper insight into finance than in most other forums.

I think a lot of what people post on here has to to do with whether or not the PP is set up to withstand different stress tests. We all want to know that because it's our hard-earned money that we are talking about.

A lot of PPers both here in the US and in Europe are concerned about how the portfolio will hold up in this really low-rate environment. I personally don't like LTTs at this level but they still have some potential juice left here in the US. With a yield of .66% I think that juice is mostly spent. At a certain point the interest rate risk is just too great. Or another way to look at it is that they no longer have the potential upside volatility as stocks and gold, so the risk parity aspect of the portfolio has to be questioned.

Many of us here in the US could be in your shoes in a year or two. We just don't know what will happen but we have to at least accept that as a possible scenario. To me you are betting against the Euro with your US LTTs, so it's a bit of a speculative play, but I do think you have to do something besides buying 30-year issues with such low yields.

Thanks for sharing your thoughts. I spent the whole Saturday with research in regards to interest rates & historical rate differentials, allocation strategies, etc. etc.
The central dilemma for EUR PPs boils down to the fact that the currency cannot be trusted as a stable savings device, not even for an intermediate 3-5 year term. A currency devaluing 30% within months is not worthy of an industrialized, first world economy. Look at a EURUSD chart over 3yrs - without labeling one could guess it's an African trash currency.
Negative real rates are common historically, but negative nominal rates for a German 7yr government bond in a nominally growing economony blow up all asset allocation strategies.
EUR PPs had to leave the original allocation pattern behind with 3yr rates at -0.1% (now at -0.22%), replacing the short term bonds with cash.
I refuse to be part of that EUR scam / farce / hustle / lie - whatever cuss word one might consider appropriate
30yr UST yield around 2.6% has enough "juice" left to fall further, plus USD being the cleanest of all the dirty shirts seems to be the only currency worth to be even considered as a denominator for the bond allocation.

I see no other way:
A) 25% cash: 1/2 EUR deposit as long as yield is not negative, 1/2 USD 3 yr UST
B) 25% bonds: USD 30yr UST
C) 25% gold
D) 25% stocks: 1/2 EUR German index DAX (ETF), 1/2 S&P500 ETF (or MSCI World, but TER is way lower on S&P 500)

Look at the German DAX in USD terms:
http://www.dax-indices.com/DE/index.asp ... 000A1EXLZ4

It hasn't moved all that much this year in real money (USD) terms. All my fellow Germans frantically buying a nominally rising stock index don't seem to grasp that these gains are an optical illusion - it does not make them richer in physical plane terms (cars they can buy, whatever).

I don't think the Dollar has gone parabolic yet but if the 10 year chart for DXY is examined, there might be a time for a 5% correction.  Early April, maybe?

If that happens, the Dollar then just may resume its merry romp.

If US Treasuries are paying 2.6%, does that mean there is capital gains potential as rates sink toward zero?  As MG suggests, the distortions could be frustrating.

barrett wrote: Many of us here in the US could be in your shoes in a year or two. We just don't know what will happen but we have to at least accept that as a possible scenario. To me you are betting against the Euro with your US LTTs, so it's a bit of a speculative play, but I do think you have to do something besides buying 30-year issues with such low yields.

Could you compare these low rates like a decline in the stock market of say:  -70% to -80%? Or is this more a Japan type situation, where the economic environment isn't inducive to the homes countries stock market. (I guess bond market in this case.)

If it's the latter I guess diversifying a portion of your portfolio would make sense, although I would want it to be Euro hedged though.

Pfanni wrote: It hasn't moved all that much this year in real money (USD) terms. All my fellow Germans frantically buying a nominally rising stock index don't seem to grasp that these gains are an optical illusion - it does not make them richer in physical plane terms (cars they can buy, whatever).

Some Apple products got €200-€300 more expensive, over here, but that's the only thing I know that did. As long as you are not going abroad/spending your money abroad, right now I don't see why I should be overly concerned about what the EUR/USD is doing. But please feel free to enlighten me in a quick sentence or two.

I will list the ETFs for an European Permanent Portfolio:

*Stocks: SPDR MSCI EMU UCITS ETF (IE00B910VR50) or db x-trackers Euro Stoxx 50 UCITS ETF (DR) 1C (LU0380865021)
*Bonds: Deka Deutsche Boerse EUROGOV Germany 10+ UCITS ETF (DE000ETFL219) or iShares eb.rexx Government Germany 10.5+yr UCITS ETF (DE) (DE000A0D8Q31)
*Gold: Xetra-Gold (DE000A0S9GB0) or db Physical Gold ETC (EUR) (DE000A1E0HR8)
*Cash: iShares eb.rexx Money Market UCITS ETF (DE) (DE000A0Q4RZ9) or  Deka Deutsche Boerse EUROGOV Germany Money Market UCITS ETF (DE000ETFL227)

The rationale for this picks is explained here (in spanish):

http://www.carterapermanente.es/cartera ... -con-etfs/

New person here...

I am getting towards a PP, I would suggest different Bond ETF with E20Y, its a new listing covers 20 year durations, no PIIG countries in it. Or, if you want a rally broad bond market ETF, look at IEAG.

There is a interesting post from the same Spanish blog linked by chalimac which analyses the performance of the different country bonds in the last years and according to the results the bonds that offer the best results are those from Germany, the Netherlands and Finland.  And E20Y has about a 30% of French bonds.

http://www.carterapermanente.es/bonos-europeos/

German 10yr now at 0.18%.
Looks like the best deal in the world.

Lend your money, say 1 million for a return of 18.000 (before 26% taxes), so for a German investor net return would be something like 15.500 (max. annual personal exemptions included) -  you only have to lock away the money for 10 years. Whooowooo!!

The interest does not compensate for the duration as well as rate risk, even at the utmost deflation.
If I put banknotes in a safe desposit box, at least I have instant access to my money all the time.

This lunatic policy will by the way kill all European pension plans within 5-10 years.