Gold Holdings During Lagging Interest Rates

[moda0306]

One of the big reasons for gold to do well, it seems commonly perceived on this board, is when short-term interest rates are lagging inflation.  A return to real returns on your cash showed that it could give gold quite a wollup back in 1981 when it fell 36% in the face of still-heavy inflation.

Does this imply that maybe, as our cash holdings lag inflation more-and-more, that we should maybe pare back our gold holdings?  When (and if) real interest rates rebound, our cash may jump 3%, long-bonds could stay relatively stagnant while our gold drops 20%.  The "1981 scenario" appears to be the PP's weakest link so far, and I wonder (though I doubt I'll act on my curiousity) whether it warrants holding less gold in our PP in times like this.

I am not saying I think this will happen... nothing like 1981 anyway... maybe a "soft 1981" where gold only drops 10-15%.

If one wanted to act on this idea, maybe they'd set up a 30% rebalance cap on their gold portion, or even sell some gold for I-bonds until rates maybe come back up. 

Just food for thought.

[MediumTex]

moda,

Remember that what hurt gold in the scenario you cite was not 3% t-bill yields, it was 13%+ t-bill yields.

If t-bills were yielding 13% I would be tempted to sell my gold too, but at 3% I'm not sure if that is even tracking current inflation in light of the recent increases in food and energy prices.

Anything much above 0% in short term interest rates seems unlikely anytime soon.

This economy is SICK.  Even at 0% interest rates it's sick.  It's SICK, I say!

[Lone Wolf]

I certainly agree that gold responds to real interest rates and that it would suffer if these rose.  The trouble is that you never know whether interest rates will rebound any time soon.  High interest rates would place a huge burden on an extremely weak recovery as well as our national debt situation (since we roll so much short-term debt), so the Fed may be inclined to work hard to keep them low for a very long time.

Then again, rates could go nuts tomorrow.  It's just that right now I'm not getting a very strong signal from The Bernank that he's ready to strap on his plate mail and sally forth to defend the dollar a la Volcker.  But who knows?

Whatever the case may be, I'd avoid actual selling of gold.  It's best to avoid realizing gold gains if you can avoid it.  I'd say just keep buying the assets as needed and stay close to 4x25.  For me, predicting the future is For Entertainment Purposes Only. 

[moda0306]

13% interest... in 10% inflation though... now we do have commodity inflation, but that's only so much of the story and quite volatile (as you've said about demand destruction)... maybe 6% would have been a better example.

I really don't think we'll see rising rates any time soon either... nor do I know what will happen if the Treasury MM rates went to 3-6% tomorrow, in terms of gold.  I just figured that a decent part of the frustration driving people into gold has to be awful short-term interest rates today, and it could take quite a hit if people could get 4% from a savings account.

I agree with most of what you're saying, though.

LW,

I'd only sell within a tax-deferred fund... and your points are agreed with by me.

It'd be interesting to see what happens if Ron Paul's candidacy takes off within the Republican primary.  He'd probably nominate one "loony" (in terms of status quo) fed chairman.

[cowboyhat]

If you look at a simulated PP using the last 40 years of actual historical returns using annual rebalancing only when 35% or 15% bands are reached, the 15% rebalancing triggers come from gold and there aren't many of them. The 15% gold triggered rebalancing doesn't help return. If gold getting trashed is a big concern you could decide ahead of time to ignore the 15% band on your gold allocation and just rebalance when something else hits 35%.

Personally I wonder about ignoring the 15% band for the long bond allocation a situation where they are getting crushed. Ignoring the 15% band slows down the frequency of rebalancing and increases the chance your trades happen after the dust has settled.

[AdamA]

If gold getting trashed is a big concern you could decide ahead of time to ignore the 15% band on your gold allocation and just rebalance when something else hits 35%.

Personally I wonder about ignoring the 15% band for the long bond allocation a situation where they are getting crushed. Ignoring the 15% band slows down the frequency of rebalancing and increases the chance your trades happen after the dust has settled.

Definitely "tinkering" but very interesting. 

Curious to hear what others think. 

[MediumTex]

Perhaps gold was the 15% rebalancing asset during that period because that period covered a 19 year bear market in gold.

I would say any period that included a 19 year bear market in anything would be likely to see multiple 15% type rebalancing events in that asset.

Before the current secular bear market in stocks is over, we may see some 15% equity-triggered rebalancing events.

The overall portfolio has done well enough that I'm comfortable just sticking with the recipe.  In any case, in the current gold market, I think we are unlikely to see any 15% rebalancing events triggered by gold anytime soon.

[Roy]

Perhaps gold was the 15% rebalancing asset during that period because that period covered a 19 year bear market in gold.

I would say any period that included a 19 year bear market in anything would be likely to see multiple 15% type rebalancing events in that asset.

Before the current secular bear market in stocks is over, we may see some 15% equity-triggered rebalancing events.

The overall portfolio has done well enough that I'm comfortable just sticking with the recipe. 

I think Clive once posted a chart showing all the rebalancings in the last 40 years, and there were surprisingly few, if I recall correctly.  Would like to see that again.

The more I study the HB PP the more I'm struck by the absurdly-effective simplicity of the thing.  It stands in its monumental constancy like one of those giant Easter Island heads against every element.  All this in contrast to every piece of "news" or analysis, or even the various postings from forums, that apparently works against it, or seeks to improve it.  That I can still say that—wholly un-jaded by its familiarity—after all the time I spent over the last years looking at the thing and reading the comments, and engaging in presentations and private meetings over it, is something to which I don't have words as of this typing.  It might just be that the biggest problem with any "grail quest" is not its discovery, but its acceptance once revealed—and for many reasons, including good reasons.  And I include myself in that.

[MediumTex]

It might just be that the biggest problem with any "grail quest" is not its discovery, but its acceptance once revealed.

Yep.

It's right there.  All you have to do is see it and take a few simple steps in light of what it says.

How many will do it?  Very few. 

We are not conditioned to be able to effectively cope with something like this.

As an analog, think about the typical peaceful alien encounter storyline.  What do the humans do?  They typically kill the alien and begin dissecting the body, which is what I am reminded of when the latest iteration of PP tinkering is offered. 

[moda0306]

Killing and disecting the friendly alien.... I like the analogy, MT.

I get a little creative, moreso to get the tinkering out of the way in my mind and have you guys poke its flaws and hopefully prevent me from making a dumb mistake in the future.

[MediumTex]

The more I study the HB PP the more I'm struck by the absurdly-effective simplicity of the thing.  It stands in its monumental constancy like one of those giant Easter Island heads against every element.  All this in contrast to every piece of "news" or analysis, or even the various postings from forums, that apparently works against it, or seeks to improve it.  That I can still say that—wholly un-jaded by its familiarity—after all the time I spent over the last years looking at the thing and reading the comments, and engaging in presentations and private meetings over it, is something to which I don't have words as of this typing.

If you let it, history can really tickle the imagination.

One thing that sort of gives me the chills no matter how many times I think about it is the pyramids in Egypt and the ugly urban sprawl sitting right next to them.  I always imagine how in 1,000 years all of that urban sprawl might be in ruins or gone completely, while the pyramids will still be sitting there, almost infinitely patient with the passing of time.

The PP in many ways has that same Sphinx-like quality to it, outlasting less sturdy forms of thought and market strategies, grinding on as most other strategies eventually tire and finally give way to the market entropy that seems to empty everyone's pockets when given enough time.

[Roy]

As an analog, think about the typical peaceful alien encounter storyline.  What do the humans do?  They typically kill the alien and begin dissecting the body, which is what I am reminded of when the latest iteration of PP tinkering is offered. 

Lovely analogy.  Then we wonder why when, finally, the priest delegation goes out to make friends, it gets incinerated via laser.

This tinkering of the HB PP used to annoy me to the point I'd just want to visit folks and ask them to stop.  But I was younger then.  Greater understanding of human behavior with investing (and aliens) has created some space in me for tolerance.  And lord knows folks have tolerated my stuff...

As I mentioned once before, I have presented to 3 money managers (clients via other means else they never would have seen me).  One time on Wall St. with pics of the founding fathers (I kid you not) on the boardroom walls of the Mutual Fund shop they owned. 

One (the eldest) did not believe it was real (though could have had an assistant check it). 

The youngest really loved it, worked diligently on it for a week, and then tried to show me how adding HY Bonds and Oil (in place of some Gold) would have been better—til he realized what happened in moments of simultaneous asset class flight. 

The last smiled like a boy and said he needed to be able to "manage things from time to time as needed".  But that otherwise it was great.

They all gave me nice lunches.  Free lunches.  I was trying to show how they might avoid losing their shirts, but they are really all focused on obtaining their own free lunches.  But hey, that's why they pay them the big bucks.

[Roy]

I think Clive once posted a chart showing all the rebalancings in the last 40 years, and there were surprisingly few, if I recall correctly.  Would like to see that again.

Thanks, Clive.  I think this is an extraordinary chart.  Even less is actually required than imagined—11 technical rebalancings since 1972, with a bunch of "almosts".  Is there a human that can actually do just that from an emotional perspective?  Who can tolerate that much...less?  Amazing...

Clive, how would the returns of this compare to auto-rebalancing once per year—no matter what the bands were.  I think you had a chart on that too, but this time I'm archiving them.

Thanks.

[Roy]

how would the returns of this compare to auto-rebalancing once per year—no matter

That would just be a bunch of 25% all the way down Roy

I dug that table/image out from some archives. I can't locate the spreadsheet I used to create that at present (my poor housekeeping), but I do recall that midway rebalancing, was the best choice overall as that's the most neutral stance. Historically the difference between that and conventional rebalancing however was a fractional percentage amount something like 10.6% versus 10.3% if memory serves.

PS Just found this http://www.jfholdings.pwp.blueyonder.co ... -15-35.xls that might be of use if you have Excel

Yes, what I meant was what was the difference in RETURNS between hard-and-fast 25/15 bands and a yearly rebalance (where all assets were brought to 25% on a set day)?  What is "midway rebalancing"?  And here too, if there are no large differences, I'd just as soon do a yearly rebalance and be done with ever monitoring bands. (as your chart seems to indicate won't matter much anyway).

And just so I am clear, ST bonds are something like 2-year Treasuries and not Cash, yes?

[6 Iron]

I have a theory that MediumTex and Roy are like young and old Spock, brought together on the forum by a wrinkle in the space- time continuum. Easter Island heads and aliens... I love this place.

[Roy]

I have a theory that MediumTex and Roy are like young and old Spock, brought together on the forum by a wrinkle in the space- time continuum. Easter Island heads and aliens... I love this place.

Wait a minute...Who is "old Spock"?  Only kidding.  Of course, your theory is correct.

Also, can never be said enough that Tex and Craigr have provided a quality of leadership that is almost impossible to find on any forum on any topic.

And if when speaking about investing, we are NOT talking about Easter Island Heads, Sphinxes, and Aliens, then we are necessarily talking about things like valuations, fundamentals, psuedo-diversity, and other falderal.  And then we become wholly screwed, yet earn the right to get a CNBC spot. 

[rickb]

What is "midway rebalancing"?

And just so I am clear, ST bonds are something like 2-year Treasuries and not Cash, yes?

Midway rebalancing is rebalancing not to 25/25/25/25 but halfway to that from wherever the allocation currently is.  For example, if one asset increased to 35 and another decreased to 15 with the other two staying even you'd hit a rebalance band at 35/15/25/25.  Rather than rebalance to 25/25/25/25 you'd rebalance to 30/20/25/25.  Clive's thought is that this is more "neutral" in the sense that you don't know whether the increasing asset is still increasing (in which case you want to let it run) or not (in which case you want to rein it back to its nominal 25%) - the same principle applies to a decreasing asset.

Yes, ST bonds are like 2-year Treasuries (e.g. SHY) and not Cash, which is like 30-day Treasuries (e.g. SHV).

[moda0306]

Rickb,

If most of my funds were in taxable accounts, I'd definitely use midway rebalancing... the whole idea of rebalancing is getting yourself back within a reasonable risk-tolerance zone.  If 30/20 is well within that zone, why not just rebalance to that if you're going to take a tax hit.

Most of my stuff is in tax-deferred, though... so I don't worry as much about it.

[MediumTex]

And if when speaking about investing, we are NOT talking about Easter Island Heads, Sphinxes, and Aliens, then we are necessarily talking about things like valuations, fundamentals, psuedo-diversity, and other falderal.  And then we become wholly screwed, yet earn the right to get a CNBC spot. 

If I had a CNBC show the theme song would be "Dirty Laundry" by Don Henley and the format would be me making fun of all of the times each guest had been wrong in past market predictions.

When Cuggino came on, I would say "Well, Mike, normally we make fun of our guests' past market predictions but we can't do that with you because you never make any predictions.  Instead, we are going to make fun of those Harry Browne platform soles on your shoes that for some reason you refuse to acknowledge you are wearing."

[Roy]

When Cuggino came on, I would say "Well, Mike, normally we make fun of our guests' past market predictions but we can't do that with you because you never make any predictions.  Instead, we are going to make fun of those Harry Browne platform soles on your shoes that for some reason you refuse to acknowledge you are wearing."

Yeah.  Ridicule is the only way to truth here.  Voltaire would be helpful. 

Of course, nobody interviewing Cuggino ever asks why it's called "Permanent" even as his 5-star brand—on the very named poster he stands before—survives better than, well, everything else.  Far more important to ask Cuggino his views on the direction of oil, for example.  I guess Cuggino figures he'll just answer the questions and get more investors.  Or, something else, far scarier, is happening within his brain.  And I fear if the greater evil is possible, it is almost certainly happening.

(I'm thinking much of this thread probably should be under "PP Discussion," but such is the nature of the dynamic.)

[Pkg Man]

I think Clive once posted a chart showing all the rebalancings in the last 40 years, and there were surprisingly few, if I recall correctly.  Would like to see that again.

Seems odd to me that LT never hit a rebalance point.  I would have thought that at least during 2008 that would have happened (it did get close).

The other oddity is that stocks only hit a band twice.  Gold is what drove nearly all the rebalance points.

[WildAboutHarry]

Clive,

Great chart, thanks.

I was also struck by no rebalance for the LT Bonds and the general infrequency of rebalancing.

I was also surprised that widening the bands (e.g. to 10% and 40%) increased returns.

[Roy]

Seems odd to me that LT never hit a rebalance point.  I would have thought that at least during 2008 that would have happened (it did get close).

The other oddity is that stocks only hit a band twice.  Gold is what drove nearly all the rebalance points.

I agree.  Based on the bands, while things got close, there was precious little to do, even with all those volatile classes.  I'd be comfortable with a once per year rebalance, barring any crazy year where I suspected things got out of whack fast, and then I'd rebalance at the bands.  Ideally, I'd never look much at all.  The problem is you can't be un-knowing and be a steady reader of an investing forum where the daily news is regularly discussed.  Of course, once one becomes desensitized to the horror, news and opinions really do become noise, or entertainment.  So I believe the Colonel Kurtz approach is better than the Bogle no-peek rule for that reason.

[MediumTex]

Since virtually any investor is going to be adding to his portfolio over time, it seems like in practice there might be even fewer rebalancing events, depending upon how new contributins are allocated (i.e., if new money is put into the lagging asset there would be fewer rebalancing events than if new money was put into cash, as HB recommended).

[Roy]

Since virtually any investor is going to be adding to his portfolio over time, it seems like in practice there might be even fewer rebalancing events, depending upon how new contributins are allocated (i.e., if new money is put into the lagging asset there would be fewer rebalancing events than if new money was put into cash, as HB recommended).

Yeah, and then there's that.  I think the assumption (including mine) had been a lump-sum management, but that isn't the way most unretired folks who dynamically utilize the PP (or any portfolio) are likely to do things.  Though, to save on transaction costs, even a frequent contributor might shunt the money to cash first and then re-distribute to the laggards only every so often.  But even so, there would be yet fewer rebalancing events.