Gyroscopic Investing

A mid-2012 paper I read on SSRN about 18 months ago has hit the "pop" investment-economic media (with all-to-typical click-bait headline):

[url=http://Opinion:%20Two%20reasons%20why%20gold%20may%20plunge%20to%20$350%20an%20ounce]Opinion: Two reasons why gold may plunge to $350 an ounce[/url]

Hypothetically, if Messrs. Erb and Harvey are onto something, and gold continues a reversion to their "fair value" (roughly $825 by their calculation) or, worse, overshoots to the downside, what does it bode for the PP when stocks are already at historically high valuations (almost 2 standard deviations above mean by some analyses http://www.advisorperspectives.com/dsho ... uation.php) and the Fed is widely expected to start returning interest rates to something more historically "normal"?

The prospect of another 20 percent (or more) decline in gold, if accompanied by a reversion toward the mean in stock valuations and the negative impact on long-term bonds of the Fed starting to raise interest rates toward something more historically "normal" would seem likely to push the PP toward out-of-character negative performance. Seems like this triple whammy would simply be too much load for the cash to carry.

Does the history of the PP suggest that simultaneously declining gold, stock, and long-term bond valuations are simply implausible? Is at least one among the gold, stock, and bond bears wrong? Since the money will want to go somewhere, will at least one of the three be buoyed when circumstances suggest all should trend toward the downside?

cnh wrote: The prospect of another 20 percent (or more) decline in gold, if accompanied by a reversion toward the mean in stock valuations and the negative impact on long-term bonds of the Fed starting to raise interest rates toward something more historically "normal" would seem likely to push the PP toward out-of-character negative performance. Seems like this triple whammy would simply be too much load for the cash to carry.

Does the history of the PP suggest that simultaneously declining gold, stock, and long-term bond valuations are simply implausible? Is at least one among the gold, stock, and bond bears wrong? Since the money will want to go somewhere, will at least one of the three be buoyed when circumstances suggest all should trend toward the downside?

Well, certainly all three of those assets could go down at the same time. I'm having trouble figuring out how to insert a screen shot but go to peaktotrough.com and put in the start date of 1/21/1980. Use 1/1/1981 as the end date. That is the harshest example of that rare event in action. The PP was down almost 17% in about 65 days. Not pretty. It's worth noting - though a repeat of this is not guaranteed - that nearly all of those losses were erased in April, May and June of that year.

Just my opinion but... I think stocks are overvalued but not ridiculously so. They could just sit at these levels for a while as earnings catch up to price. Bonds are high by historical standards but the current price is a prediction by a lot of investors that interest rates will be low in the coming three decades. So far The Fed is all bluster with regard to tightening. Whatever numbers they are looking at are telling them that the US economy is not even strong enough to raise short-term rates to 1/4 of 1%.

On this forum we have resident deflationists and inflationists alike. We even have some that see prosperity as a good bet going forward. In short there are folks who like and dislike all of the assets at their current levels.

The PP can get hit and hit hard but has historically bounced back quickly as well.

There was a three-asset question like this about a year ago which was essentially "Then what?" The best answer, I believe, was "Then nothing. We might have to actually go out and do work that people will pay us for."

The 25% in cash at least gives you the option of buying some shares/bonds/ounces at lower prices.

Thanks, barrett, for the reply and your comments. I'm sorry I missed the "three-asset question" from a year ago you describe. Before posting, I searched the forum and didn't find anything similar; I suppose I didn't input the right keywords.

Hey cnh,

I probably couldn't find that thread myself. It was just one of the many "PP angst" threads. The question was essentially "what happens if gold, stocks and bonds all drop in value at the same time?" At the heart of the answer was really the admission that holding a PP is no guarantee that one won't lose money.

But do check out the 1980 & 1981 period on peaktotrough.com. That was a pretty wild ride with gold all over the place, cash yields sky high, and the 18-year stock boom just getting started.

The monthly view tells much of the story, but if you set it to the daily view you'll see how volatile everything really was. From 1/22/80 to 1/28/80, a PP would have been down 9.7%. Of course Harry Browne hadn't even settled on the 4X25 allocation at that time, but it is still instructive.

good reminder not to check portfolio every 20 minutes