Gold Aversion

[ThisDinosaur]

Haven't read Rowland's book yet, but its on the list.

I've definitely noticed that the portfolio finder favors GB-like portfolios, and I have also considered that international exposure should give you inflation protection through varying exchange rates. But building a four fund portfolio with international stocks in place of gold is, indeed, sub optimal. I did see that your link above talked about gold positively correlating with non-US currencies like the euro. This seems to show that gold's correlation with USD inflation should NOT be expected to continue, and its utility in the 1970s after we came off the gold standard was unique. The fact that International stocks didn't do as well as gold maybe is because those other markets were then fixed to the dollar or that gold's correlation to the euro is transient??? I know, Tyler, you've argued against the significance of Nixon coming off the gold standard elsewhere, but I am still unconvinced.

Point of clarification: your Total International and International Developed EXCLUDE the US, correct?

[Tyler9000]

Point of clarification: your Total International and International Developed EXCLUDE the US, correct?

Correct.

The repeal of Bretton Woods was certainly significant for gold. It's just that 1) when looking at tools that allow you to bypass the bubble years, gold still helps portfolios (the benefit is not isolated to the early run-up), and 2) the repeal coincided with a decade of massive inflation -- how exactly would you expect gold to perform? (Some percentage of the spike is due to BW, but not 100%).

The important thing I take from the article is that the idea that gold is driven solely by inflation is clearly false. And the meme that it's just a shiny greater fool metal is also false. It's a complex financial instrument with deep ties to the global economy and human history. Whether that makes it a good part of your personal portfolio is completely up to you.

[ThisDinosaur]

So, suppose someone was sold on the rationale of the PP as originally laid out by Harry Browne (four quadrant allocation for the market cycle's prosperity, recession, inflation, and deflation) but wasn't convinced about the particular assets he laid out. What set up would work better?
After all, STT has already replaced cash in the modern equivalent.

When I use the portfolio finder and X out gold, some of the results I get :
6%CAGR ISML,TBM,LTT,REIT (-)19.8%
5%CAGR I-EM,LTT,5T (-)15.7%
4%CAGR SCV,TBM,LTT,5T,COM (-)10.7%
4%CAGR IEM,TBM,LTT,5T,STT (-)11%

The first one resembles PP superficially, but clearly depends on the high past returns in ISML and REIT. Is this reproducible? I don't know.
The third one looks a lot like PP but doesn't perform as well or as consistently. And the second and fourth look like my understanding of other antifragile portfoios like swedroe's min fat tails, with only a small allocation to one volatile, hopefully high performing asset.

Any opinion on these portfolios?

Also, when you put in a MIN return of 5% with all assets on the table, the most consistent pair of stocks is SCV and MCB, yet you chose Large caps instead of mid cap for your Golden Butterfly portfolio. Any thoughts on this?

[Tyler9000]

Any opinion on these portfolios?

Also, when you put in a MIN return of 5% with all assets on the table, the most consistent pair of stocks is SCV and MCB, yet you chose Large caps instead of mid cap for your Golden Butterfly portfolio. Any thoughts on this?

I personally have an aversion to emerging markets much like others have to gold. They've sharply fallen off of their historical high averages and continue to set new lows, and I guess I don't trust them. At least not in significant percentages.

Remember that my post on the Golden Butterfly was written six months before I created the Portfolio Finder. I originally thought of the GB as a simple permutation of the PP that rolled in Bill Bernstein's large/small stock barbell to mirror the PP bond barbell, with a nod to Swedroe's preference for small value. I really liked the results, but it was not purely data mined for maximum performance. The Portfolio Finder independently verifies that it's very hard to beat in terms of risk-adjusted return (with passive asset allocation), and points out that other versions are in the same ballpark. Some a little better, some a little worse. I like to talk about the GB not as a specific recommendation of individual funds but as an example of a class of portfolios that people should consider.

For full disclosure, I personally switched to a GB-style portfolio with a total stock market fund (VTI) and small cap blend fund (VB), and the split is not perfectly 20/20. I already had VTI in my portfolio, I personally punted on the value premium debate, and I intentionally decided against a full rebalance to avoid unnecessary capital gains. Every situation is different.

[ThisDinosaur]

Yeah, your site mentions EM as declining in returns in the last few years, but that unusual decline in returns combined with their low valuations make it one of my few investments I'm actually comfortable with right now. Vanguard published a paper favoring emerging markets (in spite of flaws in the popular narrative about future growth prospects in a world with global-conglomerates). But I know valuations and market timing are anathema to your way of thinking. Even if it underperforms for a while, it seems that the high volatility in that single asset is a good thing in this type of portfolio because of rebalancing. Or maybe not because you are frequently harvesting capital gains? And, since you mentioned capital gains, do you think friction is a big concern in adding a fifth asset to your portfolio? (I'm also considering a merriman ultimate type portfolio with 10% in all of the assets I've ever read anything good about, only selling off the winners year by year.)

[Tyler9000]

Regardless of my personal preferences, my warnings regarding Emerging Markets don't at all mean they can't play a nice role in certain portfolios. The whole point of the site is that there are many good options for different types of people. They're more a response to the many emails I get from people excited about the very high returns of EM who don't necessarily understand just how volatile they really are. Sometimes the message meant to provide balance can come across as a bit one-sided.

Friction depends very heavily on the individual situation. Low tax brackets can reduce the impact, tax planning can eliminate it if done smartly (volatile uncorrelated assets are particularly helpful for tax-loss harvesting), and using a tax-deferred account can make it a complete non-issue.

[bryan]

It makes more sense to use a basket of other national currencies than bitcoin to hedge US inflation, as bitcoin is kind of a bet in favor of the popularity of that particular cryptocurrency over others.

Absolutely. Except, I never mentioned gold (or Bitcoin) as inflation/deflation hedges:
> but really, gold just has this mindshare, perception worldwide (throughout human history) that it is nearly a universally accepted/useful/valuable money. That's all.

Gold is the most commonly regarded as a valuable "money" (even if it's not as practical any longer with credit cards or digital payments or cash) in the world. There will always be money changers which will give you close to market rate (closer than other mediums like guns, foreign currencies, electronics) in local currency (paper/polymer notes, mpesa, cigarettes, detergent, baby formula, drugs, alcohol).

Bitcoin indeed is a totally different sort of "investment." Or money for that matter. But it is strikingly similar (limited supply, convenient to secure) and better (digital/math based which gives it great capabilities like access anywhere, store anywhere, more capable of being hidden/secured, fast settlement for non face-to-face transactions (f2f gold is better, unless "trusted computing" becomes prevalent), auditable and capable of proving you have access to funds, and many, many more) than gold. Yet it is minuscule still in the minds of most people (it's market cap of $9B instead of $7T for gold) and still in the experimental stage.

I would advocate diversifying among new intriguing or growing crypto-currencies. You don't want to be all in with myspace when facebook takes off.

The beginning and end of Bretton Woods led to the rising popularity among nations of fiat currency. I don't foresee the government use of monetary policy manipulation becoming less common in the future. It gives them way too much control.

Agreed. The realistic way this could change is basically (quite, free market type of) revolution (crypto-currencies) or practical collapse (Venezuela, Egypt). (economic/monetary warfare fits into either of those, too, I think).

And central bank gold reserves strikes me as banks behaving like doomsday preppers; hedging against their own currency. I don't mean to condescend to preppers BTW, I just think gold reserves would be worth more to banks than to individuals in a doomsday situation.

If it's good enough for banks?

In a SHTF scenario, I think you'd be better served with a rifle and a large garden than some gold coins.

From experience (interesting read, of people that actually went through SHTF):
http://www.metafilter.com/137458/In-war ... er#5461243 (specifically http://ask.metafilter.com/76997/Where-t ... da#1144184)
http://www.rapidtrends.com/surving-arge ... -part-1-3/

Thermodynamically, you have to put energy/material (value) into the system, and that HAS to come from the stocks. Gold produces nothing, bond principle either goes up or down with money supply, but neither add value to the system. Try backtesting a version of the PP with a steadily declining stock allocation. It will not end well.

What do goods in general produce? They are all worthless and only have value in so far as humans think they are valuable and can be used to some purpose (even if it means making a swimming pool filled with gold coins), hence a price is determined.

I would be interested in the opposite backtesting, steadily declining the less volatile (or rather, least anticipated growth) asset percentages. AKA glide path.

So, again, the gold works awesome in those cycles where bonds, cash, and stocks all decline simultaneously (constructive interference), but I don't see why gold ALONE should be so good at this. And you still need to have predicted the correct stock blend for it to work at all.

My best guess is again that gold has
> this mindshare, perception worldwide (throughout human history) that it is nearly a universally accepted/useful/valuable money.
and it's a place of stability, which humans like and may prefer over trying to make returns in certain environments.

Agree with everything FBeyer just said, especially that first paragraph. But, before I can even think about whether I should put a quarter of my life savings in a vault in my house, I need a damn good reason for owning it at all.

At it's current price ($1240/oz) and assuming a $1M portfolio and 20% PP allocation, it means you have 4.57kg (10lbs) of gold. Seems exceptionally value dense and one reason it has been considered a good money throughout history and why we make jewellery out of it. So, you are just placing your risk/trust in yourself/environment instead of others if you chose to hold it in your home.

Inflation hedging with a hard asset makes sense, but it would have to be something that people would conceivably buy from you during stagflation,

Like... gold.

even after the world realizes that gold is nearly useless

I guess this is the crux of the aversion, you somehow think gold is not correctly priced at $1240/oz, or that in a future time (in present dollars) it will be (worth)less?

Maybe you prefer other commodities like silver (or timber, fresh water, medicine, etc) over gold, which may just have too much human psychology baked into it's price? I would probably agree there of course (and don't think I could bring myself to do 20% gold. Bitcoin maybe.), but it's very hard to go against the domination/maximalism of gold throughout human history, especially when investors are fleeing away/into certain assets. Maybe the next iPhone will actually be decorated with pokemon trading cards on the back instead of gold. And of course I can't put my timber land in my pocket (or dissolve it into acid) while I flee one region to another (or find a buyer before I flee, unless I can reasonably predict the future much better than others).

I personally have an aversion to emerging markets much like others have to gold. They've sharply fallen off of their historical high averages and continue to set new lows, and I guess I don't trust them. At least not in significant percentages.

Interesting. I am very much a bull for emerging markets in the long run. Eventually the Californians will migrate there (South America, Canada (jk)) instead of TX/WA/CO Bull on Russia, South America at least. Though I'm not convinced if the emerging market indexes will capture the growth in value. Probably better to be more intelligent about how to capture the value.

[BRUTE]

brute finds that bryan makes many good points. brute thinks along similar lines both regarding gold and long-term emerging markets. latin america, asia, are just gold mines in the long term. anyone who's been there can see that. now will it take 2 years or 200? hard to say. will the indices capture this? who knows, but he's on first base.

brute finds it strange that so many humans like to draw an arbitrary distinction between "productive" assets like stocks and "greater fool" assets like gold. all trades involve a degree of "greater fool", not just gold. cash, bullets, drugs, stocks: if no other humans want to buy them, they don't have value. this is true for anything, yet somehow, gold always gets the ugly duckling treatment.

asset classes seem to brute not inherently productive/unproductive. stocks are not productive. machines with resources and workers are productive, and only if what they make turns a profit. stocks are a claim to those profits. if brute has a claim to gold and gold increases in value, how is that less productive?

[ThisDinosaur]

Chenda's article from livescience is a very satisfying explanation for the origin of gold use as money. Maybe this is just one of those times where my thinking differently is to my detriment, but bryan's SHTF articles point out that a farm or garden (which I plan to have as well) is far more useful in those situations. If you've got eggs, you can exchange them for gold and then buy medicine. But what if things are so bad that your neighbor with medicine only wants eggs, and you've only got gold? People will always need food.

BRUTE is right that there is a subjective aspect in stock prices just like there is with gold, but those paper promises are at least in principle connected to a right to shared profits from making things and providing services. Gold does not have that at all and is therefore not valuable during times of prosperity or worst case scenario crisis. Portfoliocharts can show that if you x out stocks, you can't make any real profit.

[bryan]

If you've got eggs, you can exchange them for gold and then buy medicine.

For fun: the 10lbs of gold equates to almost 1M eggs, based on some numbers pulled from NerdWallet for cost of a dozen eggs in LA. Can't fit 1M eggs on my person but 10lbs of gold could work.

[jacob]

stocks are not productive. machines with resources and workers are productive, and only if what they make turns a profit. stocks are a claim to those profits.

I appreciate you making this distinction because it seems that a lot of the investing world are completely blind to the assumptions underlying what being a shareholder actually implies. It's potentially a massive black swan lying in wait. The idea that stocks and by extension profit should benefit the shareholder is a somewhat recent sentiment. Every shareholder should understand/have read/google/look up "Friedman's shareholder primacy". Indeed, it could easily be that popular/government/market sentiment switches once again and instead of maximizing shareholder value, corporations will start focusing on paying out more in wages or reduce their revenue (imputed oil anyone?) so as to render profit more or less zero.

If this happens, stock ownership will change from having profit as its primary goal for its owners and likely back to where it once was some 50-75 years ago, namely, control and a seat at the board/voting rights at the annual meeting. This will be interesting, because unlike before, ownership in many companies is now so diluted that the practical value for most people will be a free cup of coffee at the annual meeting. One can only imagine what such a shift would do to share prices or when Joe Average shows up at FedEx HQ with his 52 shares and demands control over the front wheel of a delivery truck.

[ThisDinosaur]

Jacob, I've never seen you say anything one way or the other about gold. But if we are to differentiate "means of production" ownership from stock ownership, does that imply you only like private equity? Ive never seen you say anything about that either (save maybe a question about owning a Laundromat.) Wrt shareholder vs stakeholder, yes the incentives for a CEO don't necessarily line up with an investor in company stock. Especially when tax law favors "reinvesting" earnings into manager's pockets rather than giving dividends. But is it not still true that a stock is paper ownership of a productive asset with some price volatility, and gold is ONLY the price volatility alone?

[jacob]

Two exercises:
1) How would you classify/valuate a gold mining company? (If it was currently operating? If everybody went on vacation?)
2) Will/did your thinking change and if so how if your portfolio was denominated in troy ounces of gold instead of dollars?
(Try plotting your portfolio value in gold and compare to the same plot in dollars for a bunch of different periods, e.g. YTD, 3yr, 15yrs)

[stayhigh]

Gold is one of very few assets you can have control on. You cannot do nothing about:
- vanguard, they can switch off their website and go to Vegas any time
- your broker, same as above
- index, and how it's managed, how private company select holdings for you
- bonds and government who issue them. Let's say, they announce in 5 minutes time that they won't accept them anymore? What you can do about it?
- cash, remember 1933 and 1971? inflation? QE? Greenbacks? Fiat money have it's expiration date
- stocks, how company is run and how much money it make
- your bank, remember Lehman, remember Cyprus in 2013?

You can't do nothing about it at all. When you own gold (I mean when you keep it in you hand), nobody but you can control it. Real, tangible, historically and globally recognized hard asset.

[BRUTE]

"only the government could take a valuable commodity like paper and turn it into something useless, like FRN"

polemic, but it made brute laugh

[ThisDinosaur]

@ jacob
Not sure I understand the exercises, but here goes:

Its clear that I am very skeptical of gold's future prospects, but if I were less so, I would look first at the company's history of profits. I'd be interested in how consistently they were above operating costs including debt payments over the last several years. I would look at the value of their mining equipment and land. I would look at estimates for how productive there mines are likely to be in the future and whether competing mining companies have more productive mines than the company I am evaluating.
If everyone went on vacation(?) unexpectedly(?) and it wasn't operating? Do I know why? Are the workers on strike? As a shareholder, can I vote to sell off the land and equipment? Again, not sure I get the question.

If my portfolio were denominated in units of gold, I would convert to my local currency and compare that to my recurring expenses (since I still think in terms of SWR/multiples of fixed costs.)

[JL13]

@ThisDinosaur

1.) If everyone went on vacation then the mining company still owns all the gold in the mine, even if it's not extracting it right now.
2.) Does it matter how many dollars your mine gets for each oz of gold it sells (say the price of gold doubles) if your portfolio is quoted in gold?

[JohnnyFactor]

So, suppose someone was sold on the rationale of the PP as originally laid out by Harry Browne (four quadrant allocation for the market cycle's prosperity, recession, inflation, and deflation) but wasn't convinced about the particular assets he laid out.

This is the question I've been asking myself since I discovered the PP earlier this year. I'm absolutely sold on the concept of investing based on economic states, but the assets Harry chose at the time may not be appropriate anymore. I was reading his book "Why the Best-Laid Plans Usually Go Wrong" and noticed this passage from chapter 2 (the bold highlighting is mine):

"There are many economic relationships that you can use for guidance in making investment decisions. While not certainties, there's good reason to expect them to hold up. For example: lower interest rates encourage higher stock prices; greater inflation leads to higher gold prices; an increase in bank failures should widen the difference between yields on Treasury bills and bank CDs, and so on.
For each of these notions, there's a reason-- based on what we know about the way human beings act-- for it to be true. You may disagree with the explanation, you may want to qualify it, the relationship may even change in time-- but there is an explanation that separates it from coincidence."

He acknowledged that no asset will necessarily serve the original purpose indefinitely. He discussed assets often on his radio show and was still sticking to the four choices (stocks, bonds, gold, cash) as of 2005. It's been 10 years since he could provide input on the PP, so it's up to us to determine what the best assets should be. The pdf you linked to, https://scs.fidelity.com/common/applica ... proach.pdf is an excellent example of examining assets in relation to economic conditions.

Myself, I'm sticking to the original four horsemen, at least until I find compelling evidence that they no longer work.

[ThisDinosaur]

@JL13 and Jacob,
I think the point you're making is that any stock purchase is essentially an unreliable promise to the company's future profits. That I have no say if the staff of my company decides to stop its moneymaking activity the moment I purchase the stock. So, I "own" the gold in the mine, which does me no good if it stays there, since I'm not allowed to go fetch my share for myself any more than shareholders are allowed to walk into Apple's warehouses and start selling phones from the back of a car.

Am I close? Isn't this uncertainty about future profits inherent in all forms of investing?

@JohnnyFactor
The PP has consistent performance and a solid rational explanation, which is why I like it. As you said, correlations change over time. And lots has been written about gold's price variability being more complicated than simple inflation tracking. Tyler9K explains this as gold having a "double role" as an inflation hedge and a negatively correlated asset with stocks. On the face of it this explanation should be a selling point, but it also seems to be part of what concerns me. It means the "story" is inaccurate. The appeal of the PP is its "four investments for four recurring scenarios" logic. If gold doesn't track other inflation metrics, but is better described as a fear purchase when people stop trusting their businesses and governments, then the rationale needs a better explanation. Okay, so, fear is a recurring event just like inflation is. So, I should hedge it right? But doesn't it just make sense to wait out the stock drop and buy more of it with inflation-matching commodities instead? Some will say that that is exactly what PP is doing with gold. And maybe it is. But since I don't fully *understand* the appeal of gold in and of it self, it makes me think I don't understand the PP as well as I want to. And, again, it still seems to me that the value-adding business stocks are the driver of positive returns in this allocation, just like every other. Even government bonds could be considered indirect value-adding, because at least some of my coupon comes from taxes on productive people and companies (money-printing aside.) Governments might be thought of as corporations in the business of taxation.

So, gold clearly has no value in and of itself beyond the fact that fearful people will trade their REAL resources for it *sometimes*. And it makes me feel like I'm buying into a system of ignorance if I participate in the charade. The only reason I'm engaged in this discussion, though, is that people like Tyler consistently publish compelling evidence that this system works. Proving there's something flawed in my thinking. Its blindingly obvious to all of you, but I just don't see it.

[jacob]

@ThisDinosaur - Once upon a time I had a summer job in a stockroom for industrial parts. One of the very first tasks I got was to take a shovel and a broom out back; then use the shovel to spread a big pile of sand on the cobble road that led to the back loading port; and then sweep the sand off the road and onto the embankment; and keep going until the pile was gone.

Wanting to impress my new boss, I go out back and figure out that the job would be much faster if I just tossed the sand directly from the pile to the embankment as this got rid of the sand much quicker.

About 45 minutes later, the CEO comes storming out of his office asking my boss what I'm doing with the sand. The boss (having not observed me working) explains what I'm doing or rather what I'm supposed to be doing to the CEO. I explain that I've been getting rid of the sand in what I figured would be the fastest way.

After a little bit back and forth, it dawns on me that the goal of the task was not to get rid of the sand but to get it into the cracks of the newly laid cobble. I had completely missed the context of the task and because I didn't understand the context of the instructions I had left out the most important step.

Luckily, they both thought "the failure to communicate" was hilarious. For the tuition cost of half a pile of sand, they learned that my "sphere of competence" didn't include 'road building'. The CEO consequently reassigned me to unpacking boxes of parts and driving a forklift around to move the parts to the bulk storage under the supervision of boss #2. The bulk storage had a particular labelling system for the parts and boss#2 explained it to me. Ok, it's similar to color coding resistors, got it. Ten minutes later, he comes back and has me explain the labelling system back to him. I do. He lets me know that nobody who has ever worked there has ever understood the labelling system that fast.

A few days later he comes back to me to ask about some of the new labels I've made. I explain how I've improved the current system in a way that retains backwards compatibility with the old system. He understands the optimization but tells me to change it back to the old inefficient system because as obvious we agreed the new change was, none of the other guys would understand it. At the end of the summer boss#2 offers me a permanent position to replace his #1 guy, whereas boss#1 only ever again trusted me with the simplest tasks, e.g. "paint this engine part blue", after that first episode with the sand. The CEO still talks about me almost twenty years later.

Edit: PS: There are some possible profound observations about adult learning, different levels of understanding, management and creative thinking in this anecdote. Or in any case, if not profound, at least observations that took me many years to learn and/to appreciate.