Gold Vs. Inflation of the dollar

Discussion of the Gold portion of the Permanent Portfolio

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brylig

Gold Vs. Inflation of the dollar

Post by brylig » Wed Apr 28, 2010 12:23 am

Ok, a critical part of the portfolio's function is that when the cash portion gets mauled by inflation the gold portion more than makes up for it.  In theory this is beautiful and I know in practice it has held true, but will it always?  Would the portfolio still work if the dollar were no longer the dominant currency in the world?  As I see it, if the dollar is replaced by the Euro or Yuan as the worlds preferred reserve currency the portfolio will stop functioning properly.  Gold would move as an inverse to one of the other currencies or even with no relationship to any of them.  Am I right about this or am I missing something? 

If I for example built a permanent portfolio right now with 25% Rupees for cash, 25% shares of INP or IFN for stocks, 25% Indian Bonds, and 25% Gold would it perform similar to our "Standard" permanent portfolios?  I'm guessing no.  If not, how can we be sure that the portfolio will remain as successful as it has been?
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craigr
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Re: Gold Vs. Inflation of the dollar

Post by craigr » Wed Apr 28, 2010 12:57 am

Interestingly, some people have looked at this issue. I have one blog post here about a UK version of the portfolio that was posted on the Motley Fool website:

https://web.archive.org/web/20160324133 ... -uk-style/

There is an error in their returns numbers posted (one year gold returns were way off if I recall), but it doesn't affect overall returns dramatically and the theory held up fine for UK investors even when the Pound was doing much worse than the dollar.

Then there is Marc DeMesel's analysis of what the portfolio would have done in Iceland's currency collapse in 2008 here:

http://europeanpermanentportfolio.blogs ... eland.html

The synopsis is that while it may not have saved you outright, it put you well ahead of standard portfolios. Not just this, but an Icelander who was rebalancing the entire time (as they should have) probably did even better as they would have been selling out of their inflated stock market and buying gold at the time just before things blew up.

Also, Marc tracks a portfolio made up of Eurozone assets and it appears to do well over there for him.

I don't believe gold is going away any time soon as a form of money (probably not in our lifetimes at least). Virtually every major central bank on the planet holds tons of the stuff and it's recognized as wealth in virtually every society and major religious text. Culturally, gold is considered wealth just about everywhere going back a long time in human history. It will be around well after the Dollar, Euro or Yuan are long forgotten. IMO.
Last edited by craigr on Wed Apr 28, 2010 1:03 am, edited 1 time in total.
Roy
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Re: Gold Vs. Inflation of the dollar

Post by Roy » Fri Apr 30, 2010 9:41 am

brylig wrote: Ok, a critical part of the portfolio's function is that when the cash portion gets mauled by inflation the gold portion more than makes up for it.  In theory this is beautiful and I know in practice it has held true, but will it always? 
Even though it performed well in hyperinflation, I don't think Gold can really be considered an inflation "hedge," though the portfolio is.  I think the role of Gold embraces panic protection of many sorts.  For example, on average, in years when Stocks have declined, Gold outperformed Stocks, usually producing positive returns. 

Another quality of portfolio-as-whole is that the powerful protection 25% Gold provides has not harmed the PP.  Since 1972, Gold had 17 down years averaging -7.84%  In those years the portfolio averaged +6.75%

Roy
brylig

Re: Gold Vs. Inflation of the dollar

Post by brylig » Sun May 02, 2010 10:57 pm

Roy wrote:
Even though it performed well in hyperinflation, I don't think Gold can really be considered an inflation "hedge," though the portfolio is. 
I beg to differ.  Harry Browne frequently said on his radio show that gold was placed in the portfolio specifically because of it's inflation performance.  Gold For inflation, bonds for deflation, and stocks for prosperity.  Gold was chosen for this purpose because it's function in the world is monetary, and it cannot be devalued like any other currency can(i.e. using the Euro to hedge the Dollar's inflation only works if the Euro isn't inflating too).  During bad inflationary periods the "flight to safety" investors take will lead to huge price increases for gold, far beyond the price change directly caused by inflation.

Also, craigr, thank you for those links, I truly appreciate all your hard work!  They do present another question though.  Considering the performance of the Icelandic portfolio, should we diversify internationally with multiple permanent portfolios setup in different countries?  Would you rebalance those against each other periodically or would you let them run independently?  Maybe I should just buy PRPFX and stop worrying about it!
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Re: Gold Vs. Inflation of the dollar

Post by craigr » Sun May 02, 2010 10:59 pm

brylig wrote:Considering the performance of the Icelandic portfolio, should we diversify internationally with multiple permanent portfolios setup in different countries?  Would you rebalance those against each other periodically or would you let them run independently?  Maybe I should just buy PRPFX and stop worrying about it!
If I was in a tiny country like Iceland with an extremely small stock market I would consider more the idea of intl. stock diversification. The biggest thing though again is to be widely diversified even within your own country and to make sure you rebalance. The damage to an Icelander, even if they had 100% of their portfolio in the country, would have been significantly reduced if they were rebalancing out of stocks the entire time and into the other assets (especially the gold).

But no, I wouldn't want to run a portfolio in a bunch of different countries. For all you know the country you diversify into could be the next Iceland!
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Re: Gold Vs. Inflation of the dollar

Post by Roy » Mon May 03, 2010 6:40 am

brylig wrote:
Roy wrote:
Even though it performed well in hyperinflation, I don't think Gold can really be considered an inflation "hedge," though the portfolio is. 
I beg to differ.  Harry Browne frequently said on his radio show that gold was placed in the portfolio specifically because of it's inflation performance.
The type of inflation envisaged by Harry Browne, and anticipated by his 25% Gold allocation, was rampant inflation.  This was accomplished so brilliantly (in the 70s, say), that it had the intended effect of lifting the entire portfolio into positive REAL during times when almost all portfolio types got crushed.  But in perception, many think Gold is therefore a steady "hedge" against inflation.  In REAL terms—over a long period—Gold is not a "hedge" (which means, in investing terms, to work against, offset, or contrariwise).

Over a very long period, Gold—in isolation—has provided around 0 REAL return vs. inflation.  And for long periods (2-3 decades), it actually lags inflation in REAL terms (by several percent). Therefore, it can not—by itself—be considered a "hedge".  I do not think this can be disputed in data.  Obviously, this is not a criticism of Gold in the PP.  It is a problem for those who buy Gold, will-nilly, thinking that any amount is going to counter inflation in all situations. 

The important thing is that the PP—as a portfolio—has provided positive REAL returns steadily over most if not all its history (a tremendous achievement).  The 25% Gold component has made that possible during runaway inflation.  The portfolio—as a package—made it possible for 4 decades. 

Roy
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Re: Gold Vs. Inflation of the dollar

Post by craigr » Tue May 04, 2010 6:45 pm

I always wondered why I can't write off the losses in the dollar against my taxes.
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Re: Gold Vs. Inflation of the dollar

Post by Quasimodo » Wed May 05, 2010 7:58 am

According to this article:

http://www.goldstockbull.com/articles/c ... -own-gold/

"Ian McAvity, founding director and advisor to CEF, said there are definite tax advantages to CEF as opposed to an open-ended ETF. Long term gains in the gold ETFs (and presumably Barclays’ silver ETF) would be taxed as collectibles at 28%, according to the Gold ETF prospectus. As a passive foreign investment company with shares not convertible into bullion, CEF is believed to qualify as a PFIC to enable the 15% capital gains tax treatment, which can be an important factor for investors with long-term ambitions and taxable accounts, said McAvity."

Presumably this would also apply to the all-gold fund GTU.

John
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Re: Gold Vs. Inflation of the dollar

Post by Roy » Wed May 05, 2010 9:06 am

Thanks for the info, Quasimodo.

Huge difference in returns:  GLD (and other ETFs) around 7.05 and CEF 25.85.  I assume there can also be swings just as broad in the other direction.  I don 't mind small differences but there seems a lot of risk in the choice there.  What's up with that difference?

Here is one of the quotes from a linked article:  "...GLD and SLV appear impotent in reducing inflation or counter-party risk.  "


Also see this piece:  http://www.runtogold.com/2009/02/anothe ... e-gld-etf/

"Under the GLD prospectus and latest 10-K it appears that the Trust neither needs to own actual physical gold that constitutes atomic number 79 nor allow their auditors to see and touch the undefined ‘investment in gold’."

Is there as much risk here as believed?  And is GLD less likely to help vs. Inflation?

While the ETFs weren't around in Harry's day, I suppose he'd still hold Gold physically and never recommend the ETFs.

Also, is ALL the PRPFX Gold physical?  It seems to be.  If these risks to the ETFs are real (lack of Inflation protection esp.) Maybe PRPFX + 10% EDV (as Tex advises) is the safer play.  Would hate that to be true but am open to that possibility.

Roy
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Re: Gold Vs. Inflation of the dollar

Post by Quasimodo » Wed May 05, 2010 9:21 am

Hi Roy;

CEF holds physical gold and silver (about 55%/45%). GTU is 100% gold. CEF underperformed gold during the time period cited in the article because of the silver holdings. Sometimes it goes the other way. GTU would be more of an apples to apples comparison.

I don't have PRPFX's prospectus with me here at work, but as I recall they hold physical bullion.

John
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