Scott Burns is investing in Gold

[steve r]

.....

Here is my attempt to answer your questions: Using this calculator: http://www.dinkytown.net/java/AnnualReturn.html punching in $35 for 1/1/1971 and $1655 for today, I come up with a 9.616% nominal annualized return from 1971 to today. Taking inflation into account, calculated so many different ways, I'm not sure what the real return is, but perhaps 4% annually?

In regard to the time prior to 1971, I don't know why people would argue we only can measure the real return of gold during the current period. I think we can measure with some qualifications, the real return of gold before that period. We would have to keep in mind that gold was $20.67 per ounce in 1802 and then went to $35 in 1935. Using the same calculator this is a nominal return of .385% annually through 1935. Was there a general deflationary tendency during that period, I believe so...nisiprius posted about this period...I really don't have the specifics, but let's say there was an average 2% deflation over that time...

+1
A few observations.
1. Gold does have a long term positive real return.
2. Deflation did occur in the 1800s ... but probably only about -1 percent per year (estimate of CPI by Fed http://www.minneapolisfed.org/community_education/teacher/calc/hist1800.cfm?)
3. Gold's fluctuations are large.


Holding gold for diversification purposes makes sense given points 1 and 3, but only in moderation. I think this is Scott Burn's realization.

[Clive]

The 1800's had zero inflation (some small deflation overall), gold remained fixed at around $19 across those years.

1900 up to the mid 1930's there was around 1.8% average inflation. Gold rose to $20 in the 1920's and then to $34 after the 1933 'confiscation' - where $20.67 (market rate) was paid by the Federal Reserve for that gold, after which the price of gold was raised to $34 i.e. an uplift of 1.8% annualised from 1900 price levels and where it remained until the late 1960's/early 1970's.

From 1933 to the early 1970's there was around 3% average inflation, so in concept the price of gold should have risen around 2.9 times to $98.6. In 1973 the price of gold was $97. Since 1973 there's been around 4.4% inflation up to 2012. So gold should have risen from $98.6 to around $556. In 2004 gold was $445, in 2005 it rose to $603, but has since risen to recent $1700 levels.

I suspect that part of the 1933 confiscation was to inflate the price of gold (somewhat akin to Quantitative Easing). i.e. collect it all in and then adjust the price upwards.

The saw-tooth type progression of the real value of gold is a consequence of uplifting its price at particular points in time rather than allowing it to free float upwards more gradually.

The more recent $1700 price levels is a fear/negative real yield induced anomaly, and perhaps once fear subsides the price of gold might mean revert back down to $900/$1000 levels.

All back of a napkin calculations/approximations.

[steve r]

The 1800's had zero inflation (some small deflation overall), gold remained fixed at around $19 across those years.

The Fed study I posted found the price level was cut in half during those years. Perhaps that is viewed as "small" on an annual basis.

The saw-tooth type progression of the real value of gold is a consequence of uplifting its price at particular points in time rather than allowing it to free float upwards more gradually.

The more recent $1700 price levels is a fear/negative real yield induced anomaly, and perhaps once fear subsides the price of gold might mean revert back down to $600/$700 levels.

+1



One last point Clive ... you speak often of levered ETFs (including on this thread). The math behind these things suck regardless of the item being levered or the ETF company. As you know the leverage occurs daily. A back of the envelop calculation with 100 days up 1 percent and 100 days down 1 percent loses nine percent because of this. Excel formula "=(1.03)^100*.97^100" In my view, these are day trading vehicles ... Perhaps another thread.

[Browser]

Many governments hoard gold, but to my knowledge don't hoard salt, coconuts, or other commodities. I wonder why they do that if gold isn't unique in some way that might be worth understanding? I recently read that they do it to provide a means "to defend their currency" if needed. That sounds like a meaningful explanation, but I don't actually understand how that would actually work; perhaps someone does and can explain it. If that is the correct explanation, then does it translate down to the individual? Is it useful to hold gold to "defend my currency-based investment?" I guess that would include things like money market and fixed-income investments based on the USD. So if you hold those, should you also hold a little hair of the yellow dog too?

[umfundi]

And so,

What is the theory (not the prediction) for the price of gold going forward?

Keith

[steve r]

And so,

What is the theory (not the prediction) for the price of gold going forward?

Keith

My personal theory.
Demand for gold increases with nominal gdp. As people get richer (even in nominal terms) they want more gold. This is sort of the max that gold prices should rise in the long run. This is offset somewhat by new gold finds. Increases in gold supply puts downward pressure on price. Since gold finds are usually relatively small, gold prices will rise near economic growth rates.

The deflation of the 1800s often occurred during decades when nominal GDP rose and no gold (monetary base) was found. Think of it this way, if the number of goods made in the economy double, but the amount of money/gold stays constant, prices must fall (in half).

It is possible that gold demand increases a little more or a little less than changes in nominal GDP. That is to say I can think of no reason why it should be exact.

This is akin to the quantity theory of money in economics.

Again, my personal theory.

[Clive]

The Fed study I posted found the price level was cut in half during those years. Perhaps that is viewed as "small" on an annual basis.

I was going from memory and UK inflation. Something like flat/gradual decline for the first three-quarters of the 1800's, and then a spike back up again in the last quarter of the century.

I see what you mean for the US figures.

One last point Clive ... you speak often of levered ETFs (including on this thread). The math behind these things suck regardless of the item being levered or the ETF company. As you know the leverage occurs daily. A back of the envelop calculation with 100 days up 1 percent and 100 days down 1 percent loses nine percent because of this. Excel formula "=(1.03)^100*.97^100" In my view, these are day trading vehicles ... Perhaps another thread.

That's not a good calculation to use - proof is in the pudding. Go to etfreplay.com and select the backtest/ETF portfolio drop down and enter SSO 50%, TIP 50% and compare that to SPY for multiple SINGLE years. Or try 33.3% in UDOW, 66.7% TIP compared to DIA, or UGLD 33.3%, TIP 66.7% compared to GLD ...etc. Make sure you only look at single years at a time, not multiple years (i.e. you have to rebalance back to target weightings once each year to maintain reasonable tracking).



Beat TIP and you potentially beat the index This is one method I've recently started to adopt to potentially do that.

[nisiprius]

The 1800's had zero inflation (some small deflation overall), gold remained fixed at around $19 across those years.

There was no inflation between the start and end points, but, despite being on the gold standard, there were two episodes of very high inflation.

[steve r]

Beat TIP and you potentially beat the index This is one method I've recently started to adopt to potentially do that.

"Over the 12 months ending June 30, 2009, the S&P 500 was down nearly 30%. The SSO behaved pretty well and was down about 60%, as you would expect. The SDS, however, was down about 20%, when it should be expected to be up 60%! "http://www.investopedia.com/articles/exchangetradedfunds/09/broken-leveraged-etfs.asp#axzz2Ga85YKCh

I can find other examples.

Just be careful my friend - these things may not perform as expected under stressful situations (when needed most).
I might add that you found (and shown me) other creative ways to beat TIPS w/o levered ETFs.

[nisiprius]

Many governments hoard gold, but to my knowledge don't hoard salt, coconuts, or other commodities.

C'mon, the United States "hoards" petroleum and helium, to name two off the top of my head. I'm sure everyone knows about the petroleum reserve, it becomes a political football whenever gasoline prices rise.

Although I think I read that they're selling off the helium. (Anyone know any good helium ETFs?)

Google, click, click... also: wheat, uranium, and antibiotics.

Canada has a strategic maple syrup reserve.

[Clive]

There's a widespread tendency to look at how the 1x (non leveraged) compared to the leveraged versions when 100% loaded into both. That will exhibit differences as you're in effect borrowing the same amount again as invested in the 1x to double-up exposure (twice the gains, twice the volatility over shorter periods of time compounds out totally differently). Better IMO to compare how 100% in the 1x compares to 50% in the 2x (or 33.3% in a 3x).

Trading the VIX (volatility) can be relatively expensive. Selling Options when volatility is high, buying when volatility is low, combined with hedging (arbitraging) using leveraged ETF's is one way to potentially trade volatility more cost effectively.

Leveraged ETF's also provide a means to limit the downside. 5% in a 3x gold, 10% TIP for instance left as-is for a year has a maximum downside risk of that 5% only ignoring TIP risk.
I will be careful - thanks

[brick-house]

umfundi wrote:

And so,

What is the theory (not the prediction) for the price of gold going forward?

2% real interest rates is one theory offered in the second link below by Eddy Elfenbein. If higher than 2%, gold's price falls. If lower than 2%, then gold's price rises. The first link is a graph showing gold's price and real interest rates since 1970.

http://seekingalpha.com/instablog/98115 ... s-and-gold

http://www.crossingwallstreet.com/archi ... model.html

In my view, there are a few key takeaways.

The first and perhaps the most significant is that gold isn’t tied to inflation. It’s tied to low real rates which are often the by-product of inflation. Right now we have rising gold and low inflation. This isn’t a contradiction. (John Hempton wrote about this recently.)

The second point is that when real rates are low, the price of gold can rise very, very rapidly.

The third is that when real rates are high, gold can fall very, very quickly.

Fourth, there’s no reason for there to be a relationship between equity prices and gold (like the Dow-to-gold ratio).

Fifth, the TIPs yield curve indicates that low real rates may last for a few more years.

The final point is that the price of gold is essentially political. If a central banker has the will to raise real rates as Volcker did 30 years ago, then the price of gold can be crushed.

[Clive]

There was no inflation between the start and end points, but, despite being on the gold standard, there were two episodes of very high inflation.

There were also periods of high inflation in the 1900's whilst on the gold standard. 1917 and 1918 had inflation at around 18% yearly levels. 1919 and 1920 that declined a little down to 15% levels. All whilst gold was fixed - they did however opt to raise the fixed price a little from around $18.99 to $20.65 in 1920 (8.7% increase).

[Clive]

2% real interest rates is one theory offered in the second link below by Eddy Elfenbein. If higher than 2%, gold's price falls. If lower than 2%, then gold's price rises.

Umfundi wasn't asking at what point does holding gold become appealing - but what you've highlighted seems reasonable. In some cases however it might be a little lower, in other cases maybe higher. If for instance inflation is 2% and a safe investment earns 3% and is taxed 33.3% then net real = 0%, so gold becomes more attractive at around a 1% gross real level. If however inflation is 6% and a safe investment earns 9% and is taxed 33% = 0% net real when gross real = 3%.

[Clive]

Craig just highlighted how those two spikes coincided with significant events

Episode 1: War of 1812. Among other things, large parts of Washington D.C. were set ablaze by British troops.

Episode 2: The Civil War where Lincoln broke the gold standard by printing greenbacks to pay for wartime expenses. The country (and dollar) almost ended as a unified entity.

Looking at a somewhat similar chart for the 1900's posted earlier



There were dips around both World War I and World War II. i.e. if you turned gold into cash that cash bought you less - gold didn't hedge wars that well. I would have thought that when the future looked uncertain as to whether your current government/sovereignty/currency might not even exist that gold would have been highly prized as something to hold - but due to being price "fixed" it wasn't beneficial to do so. I'd suspect that since being "free-floated" it might do a better job of hedging such crises?

[Browser]

Many governments hoard gold, but to my knowledge don't hoard salt, coconuts, or other commodities.

C'mon, the United States "hoards" petroleum and helium, to name two off the top of my head. I'm sure everyone knows about the petroleum reserve, it becomes a political football whenever gasoline prices rise.

Although I think I read that they're selling off the helium. (Anyone know any good helium ETFs?)

Google, click, click... also: wheat, uranium, and antibiotics.

Canada has a strategic maple syrup reserve.

Is Canada intending to defend the Loonie with Maple Syrup? If I decide to invest in Loonie bonds, perhaps I should hold more maple syrup in my kitchen cabinet to hedge?

[umfundi]

Canada has a strategic maple syrup reserve.

Is Canada intending to defend the Loonie with Maple Syrup? If I decide to invest in Loonie bonds, perhaps I should hold more maple syrup in my kitchen cabinet to hedge?

In that case, I have the deal done. In the park across the street, there are four very large maple trees. Each spring, we tap them for about 40 gallons of sap, rendered into a few pints of maple syrup.

It's like a personal gold mine!

Fortunately, I live in the USA. It is unlikely that the Canadians will be able to seize my maple syrup and "compensate" me with some loony fiat currency.

Keith

[stemikger]

I didn't read all the replies, but I was wondering if Scott Burns still stands by the original Couch Potato Portfolio 50/50 Total Stock Market and Total Bond Market. I have a variation of it in my 401k at 60/40. Mine really is a two fund portfolio that is similiar to the Vanguard Index Balanced Fund which I also own in my IRA.

[hazlitt777]

Clive and Nisiprius,

The spikes in prices which you referred to, during the war of 1812, the Civil War and WWI, were times we actually, practically speaking, went off the gold standard. This is why prices spiked during those times. We either lowered the reserve ratio of gold to dollars, or printed greenbacks. (Civil War) If a person actually had gold coins, or gold certificates, you were protected.

[hazlitt777]

I didn't read all the replies, but I was wondering if Scott Burns still stands by the original Couch Potato Portfolio 50/50 Total Stock Market and Total Bond Market. I have a variation of it in my 401k at 60/40. Mine really is a two fund portfolio that is similiar to the Vanguard Index Balanced Fund which I also own in my IRA.

If you read his article, the link can be found in the original post, he is just proposing a modification of it via the inclusion of gold.

[Clive]

Clive and Nisiprius,

The spikes in prices which you referred to, during the war of 1812, the Civil War and WWI, were times we actually, practically speaking, went off the gold standard. This is why prices spiked during those times. We either lowered the reserve ratio of gold to dollars, or printed greenbacks. (Civil War) If a person actually had gold coins, or gold certificates, you were protected.

Not sure about 1812, but for the other dates you didn't get more hard cash in exchange for gold at those times. The price of gold remained fixed. 1860 for instance when the cost of living was around 8, you might have exchanged a gold coin for $18.93 cash. Later in the 1860's when the cost of living had jumped to 16, exchanging a gold coin for $18.93 cash bought you only half as much as it did in 1860 ???

[Joe S.]

My personal theory.
Demand for gold increases with nominal gdp....

This is an interesting theory. Why was the real value of gold approximately the same in 1802 and 1971?

[umfundi]

My personal theory.
Demand for gold increases with nominal gdp....

This is an interesting theory. Why was the real value of gold approximately the same in 1802 and 1971?

Demand for gold increases with nominal gdp....

As does demand for sugar, salt, gasoline, ...

I would actually argue that gold is a less essential commodity, so demand is more (inversely) sensitive to price than for, say, gasoline or sugar.

Keith

[steve r]

My personal theory.
Demand for gold increases with nominal gdp....

This is an interesting theory. Why was the real value of gold approximately the same in 1802 and 1971?

Good question ... two answers come to mind. 1) increases in gold supply 2) the nominal price was fixed. Nixon was basically forced to take the U.S. off the gold standard. Other industrialized countries were forced likewise. Owning gold was problematic and at times illegal. This had to have some impact. In hindsight, the gold spike of the 1970s makes sense.

Demand for gold increases with nominal gdp....

As does demand for sugar, salt, gasoline, ...

I would actually argue that gold is a less essential commodity, so demand is more (inversely) sensitive to price than for, say, gasoline or sugar.

Keith

+1 (had not thought about it). I think that it is more than 1 to one sensitive related to wealth/income. A luxury good that you buy more of at an increasing rate as your income goes up (like rare art).

[umfundi]

A luxury good that you buy more of at an increasing rate as your income goes up (like rare art).

Or, that you buy less of as the price goes up, like Kobe beef?

Or, gold?

Keith

[Clive]

...Gold would have served as insurance. The only asset allocation strategy that addresses this in modern era that I am aware of is the Permanent Portfolio strategy of Harry Browne

Due diligence - DYOR et al.

Since 1972 a UK Permanent Portfolio total gains, income reinvested looked similar in risk/reward to that of a US Permanent Portfolio - better overall results for the UK likely due to the UK having higher inflation.

1972 to 2011 inclusive 11.6% annualised, -5.6% worse year nominal; 5.2% annualised real. Smooth nominal growth over those years etc. as per the first chart in the image below.

A problem however is that back in the 1970's in the UK we didn't have tax efficient investment options. Most investors who worked would be in the basic rate tax bracket - unless they had a good job in which case they'd likely be in an even higher tax bracket.

When you account for basic rate tax on dividends and cash/bond interest etc, and account for inflation, the Permanent Portfolio gains were far less impressive - as per the second chart in the image.



Since the 1990's there has been a tendency towards more tax efficient investment options. There is a risk however that they could be a target for lock-down - perhaps as part of a 'deficit reduction' policy.

The second chart didn't include costs, and gold (silver) were gross figures as we have 0% tax options available on gold. The high interest rates in the 1970's/1980's were a burden as 15% inflation, 15% yield, 30% income tax meant that net real cash deposits and gilt (treasury) yields were more like -5% rather than the 0% gross real indicated by total nominal gain figures. The chart also excludes any capital gains taxes that might have applied i.e. assumes any rebalancing or selling resulted in no capital gains taxes being due.

I'd be interested to see a similar net real (of basic rate tax, after inflation) figures for a US Permanent Portfolio. Or even just an indication of what taxes/costs an average US investor might have typically paid over those years.

[Ricola]

I am very leery about purchasing gold since hearing Warren Buffet's comments on gold and the stories about talk radio's hype-it and pump-n-dump schemes. Gold is starting to sound like Tulip Mania to me and if that is case I want to be on the shorting end.