How gold bubbles affects PP performance

[Arturo]

Hi everybody,

i just want to ask two question. From the point of view of people, actually investing in PP, how the actual gold bubble we are experiencing nowdays, affects the PP performance? particulary:

1. How the raising gold prices affects to actual PP performance. Every year, because of the actual global crisis, the price is raising to abnormal values. How does it affects to the 4 x 25% ? as far as i understand the system, because of the raising prices, this years of crisis, everybody applying PP, are selling gold to rebalance the 4 x 25%, right? it means that is not necessary a negative phenomenom that we are experience a gold bubble, since we are just selling ETFs gold stocks when they are expensive, and buying cheap stocks in other ETFs, like BONDs or CASH. Is it right? Any studies or book references talking about this subject?

2. My second question is about how it could affect to people like me, thinking seriously about jumping in PP, when the market is experiencing a gold bubble. Any studies or book references talking about this subject?

looking at the charts from 2007 to 2011, i have the feeling that i already have the answer (the PP charts gives positive returns), but i would like to ask it to this forum to get a double check.

By the way, like always, thank you very much for your interest and time to answer my questions.

Regards.

[stone]

I think everyone looks at the PP and sees at least one asset that looks to be a terrible choice at the present time. The point is that with hindsight people typically can see that in actual fact it was one of the other assets that ended up being the loser.
I also think it is important to remember that you setting up a PP is no more foolish or wise than someone else choosing not to sell off a PP that they have held for decades. The assets will perform tommorow just the same whether someone has bought them today or fifty years ago.
Gold may look to be in a bubble from the perspective of someone grounded in USD, GBP or Euro- BUT if you compare gold over the past decade to the total returns (interest reinvested) from some emerging market currency cash holdings then it becomes more understandable. The amount of gold that can be bought for a months wages for someone in Asia is something that really matters for supporting the gold price. Also negative (after inflation) real interest rates in major currencies cause a flight to gold. Those factors could well drive gold even higher.

[moda0306]

Has gold ever truly been in a bubble since 1970?  For the record, I'm the first guy who would ever be skeptical of the "intrinsic value" of a shiny yellow useless (sarcasm) metal, but assuming real interest rates are the true price-setting mechanism of gold, it seems to me that it's price has maybe been much more sound over the last 40 years.  In 1980, there was a fundamentally sound reason gold was so high.  Unlike the housing market in 2007.  Maybe the predictions of negative real yields going forward were foolish, but it seems to me that judging the bubble-ness of a hedge asset like gold using the standard measures is flawed.  Housing has always made up gobs and gobs of the collective US balance-sheet.  Gold's volatility is much more a trait than a flaw in terms of where it lies and its role on the typical American's balance sheet.  In that role, it's done almost exactly what it should have done for decades.  

We don't call insurance policies "in a bubble" for the couple of decades before they pay out, do we?  :)  No.  It's not insurances job to be a savings account, but to hedge against a specific event.  In gold's case, that's negative real interest rates on risk-free debt.  If gold was a bubble in 1980, then I think we can safely say that it's the role of gold to bubble up on us when we need it to.  If it didn't bubble, we wouldn't hold it.

[MediumTex]

If you look at a chart of asset bubbles throughout history, it is clear that there was a bubble as the price of the asset appeared to shoot straight up.

When you look at gold starting in about 1999, however, you don's see anything like that.  It's just a steady upward drift. 

It's possible that gold may turn into a bubble at some point in the future where its steady upward trajectory begins to spike violently, but we're not there yet.

I think that gold is probably the most appealing PP asset right now.  I guess that just shows that two people can look at the same thing and see something completely different.

[craigr]

Keep in mind also the idea of capital flow in a portfolio. Meaning that where is the money going when an asset is tanking? If gold is in a bubble and deflating, where are the sellers putting that money? Stocks? Bonds? Cash? Odds are something else you hold in the portfolio will be a net gain as the money is moving around between assets. This is why I constantly remind investors to not look at assets in isolation. It may be that Asset X falls by 50% one day. But what happens to Assets Y and Z as a result? Did they go up enough to offset or even eliminate the losses? This is commonly what happens.

[Arturo]

Keep in mind also the idea of capital flow in a portfolio. Meaning that where is the money going when an asset is tanking? If gold is in a bubble and deflating, where are the sellers putting that money? Stocks? Bonds? Cash? Odds are something else you hold in the portfolio will be a net gain as the money is moving around between assets. This is why I constantly remind investors to not look at assets in isolation. It may be that Asset X falls by 50% one day. But what happens to Assets Y and Z as a result? Did they go up enough to offset or even eliminate the losses? This is commonly what happens.

So following your words and PP system, if gold raises as a bubble right now, is not a big consideration, because is an uncorrelated asset related to the other assets.  So i can also understand that is not a big issue if i start doing PP right now, understanding that i will have to buy 25% of GOLD when the price rised incredibly high (actually, buying gold right now is very expensive).

best regards,

Arturo

[craigr]

So following your words and PP system, if gold raises as a bubble right now, is not a big consideration, because is an uncorrelated asset related to the other assets.  So i can also understand that is not a big issue if i start doing PP right now, understanding that i will have to buy 25% of GOLD when the price rised incredibly high (actually, buying gold right now is very expensive).

Arturo,

First understand that nobody can guarantee anything. I'm just talking about my own experience in how this works. In general, an asset that is diving in price is often offset by one that goes up in price. It may not be immediate as people sometimes expect, but over time. The other factor is that you have 25% in an asset split four ways. So even if you had a massive drop in the price of (gold, stocks, bonds, cash) that would be a -12.5% impact to the portfolio. This assumes no other asset goes up to offset it. That may not be a great scenario, but it's not a disaster the way you may find in other portfolios that concentrate their bets.

For instance I see people advocating 100% gold/gold mining stocks. If gold crashes those investors will be crushed. Same for investors doing 100% stocks. I don't want to see heavy bets in any particular asset just in case something bad were to happen.

We could also see potentially losses in 2 or even 3 of the assets in the portfolio (it's happened). But this is usually short lived and one asset will normally get its feet under it and recover quickly.

For interest, below is a chart I made from the highest gold price ever (August 2011 about $1900 per ounce) and what the assets did after that. You can visualize here that gold fell, but the bonds and stocks went up. The net effect was no loss to the portfolio even though the gold price dropped quite sharply from the high at one point. Even if you bought 100% everything on that very day you still are profitable right now. Again it's not instantaneous, but over time the losses usually give way to the gains in the portfolio.



In general when I talk about these assets moving in the portfolio I'm referring to this idea of intra-portfolio capital flow (a phrase I just made up). I blogged about the concept today in fact to explain what I mean better:

https://web.archive.org/web/20160324133 ... ital-flow/

[murphy_p_t]

Arturo,

Why do you feel that gold is in a bubble?

[Pointedstick]

There's some evidence that gold becomes popular and rises in value when the real rate of return is below 2%. Right now the real rate of return is negative for short-term debt and very close to 0 for long-term debt. Since the Fed has committed itself to keeping interest rates low for at least the next few years, I would expect gold to continue to appreciate unless there's some really bad deflation (which I doubt).

There's a whole paper on this somewhere but I can't remember where it is. I think Gumby posted it last time.

[MachineGhost]

2. My second question is about how it could affect to people like me, thinking seriously about jumping in PP, when the market is experiencing a gold bubble. Any studies or book references talking about this subject?

When taxi cab drivers and shoe shine boys are talking about buying gold, then and only then is gold in a bubble.

But if you want to see what happens to the PP when a gold bubble pops, look at 1981.  The portfolio drawdown was about 22% I believe.

[Arturo]

@Craigr

i don't want to believe you wrote a new blog post based on my thread :-).

As i said before,when investing on PP,you really have to make the effort of not looking at the assets isolated,because is the natural tendency of human behaviour. And you have to add the detail that when we talked about "wait for the market to get adjusted naturally" (let the assets rebalance by itself), we are talking about years, not months. And as you know, human being is a little bit impatient and easily to disturb when you have to wait years until you see your investment is safe again :-).

@murphy_p_t

Just because how it raised up in less than 3 years. Here where i live, in less than 2-3 years, the number of shops for second hand gold buyers has grown up like i have never seen in my life ..

[craigr]

@Craigr

i don't want to believe you wrote a new blog post based on my thread :-).

As i said before,when investing on PP,you really have to make the effort of not looking at the assets isolated,because is the natural tendency of human behaviour. And you have to add the detail that when we talked about "wait for the market to get adjusted naturally" (let the assets rebalance by itself), we are talking about years, not months. And as you know, human being is a little bit impatient and easily to disturb when you have to wait years until you see your investment is safe again :-).

What I find is if you concentrate only on *total portfolio value* you will do a lot better as a human than looking at the assets in isolation. If looking at the assets in isolation is really going to bug you, then you should strongly consider using a fund like PRPFX or PERM which will hide the internals from you and you just see the combined yearly gains.

This is a very difficult thing for the vast majority of investors to do. It really takes a serious mental shift in how you look at your wealth.

[Arturo]

@Craigr

i don't want to believe you wrote a new blog post based on my thread :-).

As i said before,when investing on PP,you really have to make the effort of not looking at the assets isolated,because is the natural tendency of human behaviour. And you have to add the detail that when we talked about "wait for the market to get adjusted naturally" (let the assets rebalance by itself), we are talking about years, not months. And as you know, human being is a little bit impatient and easily to disturb when you have to wait years until you see your investment is safe again :-).

I totally understand what you mean. Thank you very much for your time.

What I find is if you concentrate only on *total portfolio value* you will do a lot better as a human than looking at the assets in isolation. If looking at the assets in isolation is really going to bug you, then you should strongly consider using a fund like PRPFX or PERM which will hide the internals from you and you just see the combined yearly gains.

This is a very difficult thing for the vast majority of investors to do. It really takes a serious mental shift in how you look at your wealth.

[murphy_p_t]

@murphy_p_t

Just because how it raised up in less than 3 years. Here where i live, in less than 2-3 years, the number of shops for second hand gold buyers has grown up like i have never seen in my life ..

I would interpret those observations differently. In US$...gold has been in basically an 11 year bull market...with some corrections along the way. It appears we are just, in the past weeks, leaving the consolidation of the past year as the uptrend resumes with haste. (Thank you B. Bernanke.)

Regards the gold-buying shops....when these fly-by-night operations are SELLING gold with urgency...that would signal to me that the top is near.

If you wish to get a totally different view of the metal from your current view...spend some time @ kingworldnews.com