Gyroscopic Investing

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Right, this is an important point.  What this "universal devaluation" scenario would mean is that while paper currencies remain (relatively) stable compared to one another, they would likely decline in value in relation to "real stuff".

It's why you can see the dollar remaining a decently strong currency at the same time that you see many prices rising.

Let's say that $100 and 100 Yuan (to use your mathematically convenient exchange rates) buy one barrel of oil in 2011.  Imagine that you can buy 10 barrels of oil with one ounce of gold.

If in 2013, that same barrel of oil costs $10,000 or 10,000 Yuan, both the dollar and the yuan are worth less in comparison to "real stuff" although neither has fallen in value relative to one another.  Ultimately at some point, though, the purpose of all "money" is to be traded for this "real stuff".  I don't really save up my dollars in hopes of one day buying a big pile of yuan to lounge around in.

I will likely still be able to buy the same 10 barrels of oil with that same ounce of gold.  With the kind of inflation picture I painted above, I could probably get a heck of a lot more.

Furthermore, fast forward several decades into the future and that ounce of gold will still have its purchasing power.  Nobody can make any reasonable predictions as to how much purchasing power (if any) those dollars or yuan will have, though.  This is the value of gold in "stabilizing" the Permanent Portfolio.

Clive,

What you are saying is that gold can't go up forever and maybe it would be good to bank today's gains rather than bet on further gains in the future.

The problem is, when you are dealing with a bubble who knows when it will pop?  People said the same thing about stocks in the mid-1990s (including Alan Greenspan with his "irrational exuberance" comment), and missed out on some huge gains as the bubble entered its blow off top phase.

With the PP, you can receive the benefit of an entire secular bull market cycle in an asset (whether it's stocks, gold or LT bonds) without assuming any of the risk of holding that asset in isolation.

Even during secular bear markets for an asset, cyclical bull markets can buoy the overall PP.  In looking back at the year by year returns for each PP asset during gold's secular bear market from 1982-2000, there were a few years in which gold led the other PP assets, and during those years it was gold that kept the portfolio afloat.

I fully agree that gold has come a long way and nothing goes up forever.  The problem is I don't know if gold will stop at $1,500, $2,500, $3,500 or some other number.  Therefore, I hold it without judgment or speculation about the future.  I take what the market gives me, often remarking to myself "hmm, I didn't think THAT was going to happen."

I have no idea if gold is in a bubble.  I'm inclined to say yes.  As an investor who has just recently discovered the concepts of the PP, I've made a couple of decisions.  

1) For the time being, PP will only be 50% of my total portfolio.  That means gold will only be 12.5%  The other 50% of my portfolio will remain my current 70/30 equities/bond allocation.

2) To achieve that 12.5% gold allocation, I'm going to buy into gold at approximately 0.5% every month for 25 months.  I figure that if gold is indeed in a bubble, it will have dropped over that 25-month period.  And if gold hasn't dropped by then, then maybe it's not in a bubble.

3) Even if it is in a bubble and it doesn't do anything over that 25 month period, but then suddenly drops like a rock after my 12.5% allocation is built up, it's still only 12.5%.

4) If gold really drops substantially... like 50% or more, then I might consider moving all in to a PP.  But I certainly won't be doing that when gold is so high.

MediumTex posted while I was writing this, and I agree with what he said.  That's exactly why I'm going to start buying in now, but do so gradually.

chrikenn wrote: To achieve that 12.5% gold allocation, I'm going to buy into gold at approximately 0.5% every month for 25 months.  I figure that if gold is indeed in a bubble, it will have dropped over that 25-month period.  And if gold hasn't dropped by then, then maybe it's not in a bubble.

Now THAT'S what I call caution--sort of a Kevlar belt and suspenders approach, hedged with out of the money falling pants options.

I like it.

The picture you are painting is one in which there's an increase in confidence in the dollar (and paper currencies in general) as a permanent, secure store of value... so what do we need this "gold" stuff for?  You're right that this would absolutely be bearish for gold, since acting as a stable source of value is gold's "home turf", so to speak.  On the other hand, it would be very bullish for long-term bonds, the cash portion, and could pave the way for strong stock market performance.

Gold provides one primary value: permanently securing wealth regardless of what comes.  If the market perceives that dollars can fulfill that role in an ongoing way, gold will lose value.  This implies a positive real interest rate, relative stability, and a belief that the way the currency is being managed will not significantly endanger its value.  Think of how badly gold cratered when Volcker slammed the brakes on inflation and aggressively raised interest rates.  The market took note when the Fed said, "We will do anything to defend the dollar, including doing something that is certain to cause a recession."

Now let's look at it from the other side.  When this much printing goes on, what happens when all that money gets into circulation and begins bidding up real assets?  Nobody has any clear idea on when this might happen but in a world awash with liquidity, there are real and growing concerns that there will be very painful levels of inflation worldwide when it does.  We simply don't know.  We'd feel better about the whole thing if we did, but we just don't.

Clive wrote: A house/land is a real stuff and that has more use. House/land prices have remained stable or even declined.

Right.  There are some very specific reasons that real estate declined in value but beyond that also note that the fact that gold is primarily monetary is a "feature not a bug".  If gold had a lot of industrial use, its price would less purely reflect its monetary utility.  You can see this by considering silver or platinum.  In stable times when a silver-using industry is thriving, we won't be able to buy it as "cheaply" as we want to for monetary purposes.  Likewise, in very rocky times, what if the industries that use silver collapsed, collapsing industrial demand for silver with them?  This would have the effect of "muddying" the price.

Clive wrote: If that is the case then the large gains in gold could be a decade+ long bubble (so far) formation in a similar manner to how shares bubbled in the 1990's, only to snap back down again.  That's fine for a PP investor who rode the low to high, sold some and then rides the high to low full cycle - buying back the gold he/she original sold for a lower price, but for anyone more recently buying perhaps there is a risk comparable to having been buying stocks in the later part of the 1990's ?

Sure, this kind of thing is always possible.  However, we simply have no idea when this might happen.  What if we are headed into a period of sustained, worldwide uncertainty and inflation?  Gold could be the only big winner.

Gold will eventually be a big, big loser.  There's simply no doubt.  But I feel that trying to time that moment is futile.  It's better to consider what else must be happening in the world that would make gold a loser and attempt to profit from it.  That's what the Permanent Portfolio tries to do.

Clive wrote: I can see the potential of holding gold across the full cycle, but equally I can see that prior to 2000 when gold had been flat/low for a couple of decades few investors actually held any gold. Those that bought some gold in the early noughties have done well, but 2011 could turn out to be a stock 1999 type high such that many gold investors since say 2009 might have buying near a peak as did stock investors in the 1999's.

It's a good analogy.  It was during these times that gold protected the rest of the portfolio.  When gold falters, the other asset classes will have to step up to the plate.

Clive wrote: The question I ask myself therefore is whether just to totally skip holding any gold whatsoever, holding perhaps 25% of funds in a diverse range of stable foreign currencies/investments just in case a domestic currency crisis occurs in isolation, and leave it at that. An investment blend of 33% foreign currency denominated stocks, 33% LT and 34% ST so to speak.  According to Simba's backtest spreadsheet from 1972 to 2009 such a blend (using International Developed for the 33% stock part) has provided much the same annualised, standard deviation (risk) and real (after inflation) gains to that of the PP (and is somewhat similar to a Larry Swedroe's Fat Tail Minimisation blend).

I'd be extremely worried about worldwide inflation in this scenario.  Stocks struggle horribly during inflation, LT bonds get annihilated as interest rates shoot up, and the cash portion will only just keep up (its interest payments getting eaten by taxes the whole way.)  I'm afraid that if worldwide inflation caught fire, that portfolio could take a horrific beating.  I think that the gold plays a critical role here.

MediumTex wrote: Now THAT'S what I call caution--sort of a Kevlar belt and suspenders approach, hedged with out of the money falling pants options.

I like it.

Haha.  Yeah.  I guess you could say I'm convinced that the PP is for me, but I'm simultaneously pretty certain that gold is due for a drop.  Problem is, I have no idea if it will drop this year, next year, or in 5 years.  I'm not willing to wait 5 years to implement the PP, but I'm also not willing to go all-in at a time when gold might be/probably is due for a drop.  So after giving it a lot of thought, building up my gold allocation over a period of 2 years was ultimately the plan I knew I could stick to.  Of course, if gold drops 50% next week, I'll probably go all in then =P  I just don't want to go all-in at the peak.  Now, if only I had started this at the beginning of 2010... I'd already be up to 6% gold

I'm also 26 years old, so even at my snail's-pace-entry to the PP, I will only be 28 when I've achieved my target gold allocation.  So that's 35-40 years for the PP to do its magic---likely through several bull and bear markets---before I start withdrawing.

You're right, Clive.  That silver backtest was quite cool.  I still say that gold is the more "theoretically sound" PP play, but it was very interesting to see silver make up what you might call a "Pretty Permanent Portfolio".

I like the analysis you've done Clive.  I plan to stick to gold for the PP but am quite fond of silver for the VP.

Clive wrote:

Pkg Man wrote: I like the analysis you've done Clive.  I plan to stick to gold for the PP but am quite fond of silver for the VP.

Just to clarify, I wasn't suggesting silver should replace gold in the PP Pkg Man, rather I just used silver as a proxy for gold for backtesting prior to 1972. As the 1972 onwards comparison between a PP with gold and a PP with silver were somewhat similar overall, a backtest from 1926 using a PP with silver provides a general feel for perhaps how a PP with gold might have performed over that period had the price of gold not been fixed.

My mistake Clive, thanks for the clarification.  Guess my speed-reading course didn't deliver all it promised 

I think the reason I like silver is that it at least has the potential to benefit during periods of prosperity, inflation, and currency blow-ups.  For me it is the perfect VP complement to the PP as I still find LT Treasuries the least-comfortable component to hold (although I hold them just the same).

I think that there are a few very interesting implications to what Clive discovered.  The first is that those who have built their PP with a slice of silver in there should definitely expect very PP-like results.  (This includes PRPFX, although IMO they've still got the obvious holes in their LT bond coverage.)

Another implication is that if for whatever reason gold became unobtainable or unusable (due to general confiscation or because the alchemists finally figure out how to turn lead into gold), a silver PP might be a good backup plan to consider.  I don't see this happening (although you never know when those crafty alchemists might finally nail it) but it's always good to have options.

It's all good news.