Scott Burns is investing in Gold

[umfundi]

I've been re-reading Dr William Bernstein's "The Four Pillars of Investing".

More and more, I am coming to the opinions that first, there is no gold standard for monetary policy any more. Get over it. Second, there is no rational theory for gold as an investment vehicle.

As Nisiprius so elegantly points out, the supposed attributes and "tendencies" of gold investing fall down when evaluated in the context of the recent historical record, the last 70 years or so. (After the abandonment of the gold standard.)

Keith

[dnaumov]

I've been re-reading Dr William Bernstein's "The Four Pillars of Investing".

More and more, I am coming to the opinions that first, there is no gold standard for monetary policy any more. Get over it. Second, there is no rational theory for gold as an investment vehicle.

If gold is not money, as people so often like to point out, how come the world's central banks to continue to be net BUYERS of gold?

[Joe S.]

With regard to "tends," to me that's just qualifying your wording and making the statement unfalsifiable. To repeat my point. Whenever I look at what has actually happened in the past, I usually find that things didn't do what they are said to tend to do. That's not singling out gold advocates, others are just as bad. It's really important to try to verify these things yourself. Usually, you can't. But you can't disprove an alleged "tendency."

I will have to say I don't have good statistical data on relationships between interest rates and gold prices. It is something that is alleged in the economic literature, but I would like to see more data on the subject. It should be noted that the relationship is felt to work in the gold standard days as well. When gold dropped in value during the gold standard days, the dollar would drop with it, causing inflation. It is alleged when interest rates rose, we would have inflation, the so called Gibson's paradox. I don't have data backing that up either.

I would point out that it is alleged that Gold rises when there is inflation, that Gold rises when stocks drop, and that gold rises when there is a crisis, and nobody has shown that there is a good correlation coefficient for any of these things. It may well be if anyone does a correlation coefficient between gold and interest rates, they will find the correlation is low as well.

[umfundi]

I've been re-reading Dr William Bernstein's "The Four Pillars of Investing".

More and more, I am coming to the opinions that first, there is no gold standard for monetary policy any more. Get over it. Second, there is no rational theory for gold as an investment vehicle.

If gold is not money, as people so often like to point out, how come the world's central banks to continue to be net BUYERS of gold?

I did not say "gold is not money". I am not "people", I am Keith.

how come the world's central banks to continue to be net BUYERS of gold?

Why don't you tell us? There must be a rational economic explanation, if gold really has a role to play in monetary policy.

Keith

[athrone]

Second, there is no rational theory for gold as an investment vehicle.

$10,000,000,000,000 in worldwide wealth disagrees with you.

[steve r]

... the supposed attributes and "tendencies" of gold investing fall down when evaluated in the context of the recent historical record, the last 70 years or so. (After the abandonment of the gold standard.)

Keith

70 years ago gold was priced at 33.85, today it is 1650. That is a nominal return of 5.7%. Inflation was no way near this a
http://www.nma.org/pdf/gold/his_gold_prices.pdf CPI inflation was well less than 4% per year during this time period. So much for the false zero return argument (unless markets are not efficient). It would appear it tracks nominal GDP growth, not just inflation. That said (punching a hole in my own argument), gold price data pre-1971 is pointless to look at.

[umfundi]

Second, there is no rational theory for gold as an investment vehicle.

$10,000,000,000,000 in worldwide wealth disagrees with you.

I don't disagree with the value. Why is that more important than, say, the total value of productive farmland on the planet. Or of oil production?

You quoted what I said. Let me ask a few questions:

1. What is the expected return on gold? Why?

2. If global economic growth in 2013 is at 2%, with no change in interest rates, what is the short term outlook for gold?

3. The US long term outlook for inflation is less than 2%, dropping to 1% within 10 years. Given that estimate, what is the outlook for gold over the next decade?

If you ask each of those questions for stocks and for bonds, there is a pretty good answer. Is there a comparable theory for gold?

Keith

[steve r]

I cannot speak for others ... but I own gold primarily for diversification. Gold will do poorly under the above scenario. But, what the economy does next quater is uncertain, let alone in ten years.

[brick-house]

dnamouv wrote:

If gold is not money, as people so often like to point out, how come the world's central banks to continue to be net BUYERS of gold?

According to the Bernank, it is tradition

http://www.youtube.com/watch?v=2Dj9v9s9buk

[brick-house]

umfundi wrote:

2. If global economic growth in 2013 is at 2%, with no change in interest rates, what is the short term outlook for gold?

What is the short term outlook for stocks?

William Bernstein quote from Efficient Frontier article titled The Returns Fairy…Explained

http://www.efficientfrontier.com/ef/403/fairy.htm

For starters, let’s be clear what we’re talking about. Nobody knows what the market is going to do tomorrow, next month, or even in the next five years. And in the final analysis, what the market does over such relatively short periods is irrelevant to the average investor. What is important is return over the next few decades, and we do have a pretty good idea of what’s going to happen over such long time periods. We don’t want to tip our hand too early, but we’ll warn you, you’d better be in a good mood before you read this because you won’t be by the time you’re done.

As for expected returns on gold, there are no dividends, interest, or earnings to discount. Gold is a wild card...

[umfundi]

umfundi wrote:

2. If global economic growth in 2013 is at 2%, with no change in interest rates, what is the short term outlook for gold?

What is the short term outlook for stocks?

As for expected returns on gold, there are no dividends, interest, or earnings to discount. Gold is a wild card...

I think then the short term (1 year) outlook for stocks is mildly positive. That is not a prediction, but I think that sentiment has some basis.

For bonds, pretty flat.

For gold, I have no idea. In your words, it is a wild card.

Keith

[brick-house]

umfundi wrote:

I think then the short term (1 year) outlook for stocks is mildly positive. That is not a prediction, but I think that sentiment has some basis.

For bonds, pretty flat.

For gold, I have no idea. In your words, it is a wild card.

In your words, stocks sound like a wild card as well…

[Clive]

I would point out that it is alleged that Gold rises when there is inflation, that Gold rises when stocks drop, and that gold rises when there is a crisis, and nobody has shown that there is a good correlation coefficient for any of these things.

US Dollar Bearish (basket of currencies) generally correlates with US stocks





Australia and Canada are commodity like currencies (Australia exports a lot of gold) - sometimes considered as a gold type play, but as with others also correlate with stocks





So perhaps AUD/USD (and/or CAD/USD) are somewhat stock and gold exposure like combined.

USD/JPY tends to track US treasury yields, the inverse JPY/USD will therefore tend to rise when yields decline, fall when yields rise - so somewhat treasury bond like.



A combination of AUD/USD and JPY/USD FX positions might be somewhat Permanent Portfolio like - having some stock like exposure, some gold like exposure, some treasury bond like exposure. Interest is paid daily and FX has 24 hour trading, churning $4T+/day trading activity compared to $250B/year that the S&P trades.

Wherever there are good consistent pattern/correlation effects evident, there are those with much deeper pockets and better resources that are prepared to bet the other side. One of the easiest ways to wealth transfer is to see the target highly convinced that something will happen such that they bet big, only to see that expectation turn against them.

You wont find a consistent stable correlation. Any correlations that you do find will fail sooner or later.

[hazlitt777]

... the supposed attributes and "tendencies" of gold investing fall down when evaluated in the context of the recent historical record, the last 70 years or so. (After the abandonment of the gold standard.)

Keith

70 years ago gold was priced at 33.85, today it is 1650. That is a nominal return of 5.7%. Inflation was no way near this a
http://www.nma.org/pdf/gold/his_gold_prices.pdf CPI inflation was well less than 4% per year during this time period. So much for the false zero return argument (unless markets are not efficient). It would appear it tracks nominal GDP growth, not just inflation. That said (punching a hole in my own argument), gold price data pre-1971 is pointless to look at.

Steve, I would just modify this by pointing out that when we were on a gold standard in the 19th century, although it wasn't a perfect and true gold standard, there tended often to be a mild deflation in prices...without this being a bad economic issue as so many think deflation to be these days.

Therefore, it isn't pointless to look at pre 1971 gold behavior, it is just that it was at that time more or less synonymous with the dollar. So if aggregrate prices were falling, then your gold/dollar made money just sitting there!

This is why I am not of the school of thought that argues over time gold just gives a zero rate of return. For example, from 1869-1879 there was an average deflation of 3.8%. This means your gold/dollar just sitting there getting no interest, was increasing in value every year by 3.8%. Not bad. And the economy was booming in those years.

[umfundi]

For example, from 1869-1879 there was an average deflation of 3.8%.

Two of Bill Bernstein's Pillars are the theory and the history of investing. What he has to say about the abandonment of the gold standard and the subsequent inflation of the 20th century is quite interesting.

Deflation in 1875 is absolutely irrelevant in today's context.

Keith

[brick-house]

umfundi wrote:

Deflation in 1875 is absolutely irrelevant in today's context.

The Fed's actions since 2009 suggest they do not think deflation is irrelevant.

Quote from Ben S. Bernanke 2002 speech titled Deflation: Making Sure "It" Doesn't Happen Here

http://www.federalreserve.gov/boarddocs ... efault.htm

The conclusion that deflation is always reversible under a fiat money system follows from basic economic reasoning. A little parable may prove useful: Today an ounce of gold sells for $300, more or less. Now suppose that a modern alchemist solves his subject's oldest problem by finding a way to produce unlimited amounts of new gold at essentially no cost. Moreover, his invention is widely publicized and scientifically verified, and he announces his intention to begin massive production of gold within days. What would happen to the price of gold? Presumably, the potentially unlimited supply of cheap gold would cause the market price of gold to plummet. Indeed, if the market for gold is to any degree efficient, the price of gold would collapse immediately after the announcement of the invention, before the alchemist had produced and marketed a single ounce of yellow metal.

What has this got to do with monetary policy? Like gold, U.S. dollars have value only to the extent that they are strictly limited in supply. But the U.S. government has a technology, called a printing press (or, today, its electronic equivalent), that allows it to produce as many U.S. dollars as it wishes at essentially no cost. By increasing the number of U.S. dollars in circulation, or even by credibly threatening to do so, the U.S. government can also reduce the value of a dollar in terms of goods and services, which is equivalent to raising the prices in dollars of those goods and services. We conclude that, under a paper-money system, a determined government can always generate higher spending and hence positive inflation.

[Clive]

...Now suppose that a modern alchemist solves his subject's oldest problem by finding a way to produce unlimited amounts of new gold at essentially no cost. Moreover, his invention is widely publicized and scientifically verified, and he announces his intention to begin massive production of gold within days. What would happen to the price of gold? Presumably, the potentially unlimited supply of cheap gold would cause the market price of gold to plummet. Indeed, if the market for gold is to any degree efficient, the price of gold would collapse immediately after the announcement of the invention, before the alchemist had produced and marketed a single ounce of yellow metal.

1981 - 1984 gold declined at -20% annualised real (-15% nominal) after Glenn Seaborg transmuted Bismuth into gold in 1980

[steve r]

umfundi wrote:

Deflation in 1875 is absolutely irrelevant in today's context.

The Fed's actions since 2009 suggest they do not think deflation is irrelevant.

The boom to bust cycle of the 19th century was viewed as so problematic that governments around the world created central banks like the Fed in the first place. Others (like W.J Bryan) wanted to add silver to the monetary mix. Farmers in particular hated deflation. The deflation was solved by large gold finds in the 1890s. Gold finds were not happening in the previous decades.

Think of it this way - you want to buy a $25,000 car that will cost $24,000 in few months ... you postpone the purchase ... when everyone does this it hurt the economy. Think Japan in recent decades and U.S. in the 1930s (and to a lesser extent in 2008).

The economy did well in the 1870s because of the industrial revolution, railroads, oil, steel and rebuilding post civil war America ... not because of the deflation / gold standard. The economy then would have in all likelihood done even better had it not been for deflation (a smoother ride). While I am no fan of Bernankee - he has been right in fearing deflation.

1981 - 1984 gold declined at -20% annualised real (-15% nominal) after Glenn Seaborg transmuted Bismuth into gold in 1980

I wonder what happened to the price of Bismuth

***************
As far as Scott Burns investing in Gold - I suspect Gold will likely get hammered if deflation is around the corner. I could be wrong (though I doubt it) if deflation causes unrest/uncertainly that will mute or even offset gold's price decline ... so, I am uncertain about deflation occurring or not occurring and uncertain how gold will react if deflation occurs ... like noted earlier ... gold is a wild card. In my view, this is good for diversification purposes, in the view of others it is foolish to invest gold with no way to measure or predict its value.

[Browser]

Nice to know that Ben Bernanke provides the rationale for exchanging your fiat currency for gold. There is a currency alchemist but no gold alchemist has yet appeared. I'm surprised most people just don't get it yet.

[nisiprius]

Deflation in 1875 is absolutely irrelevant in today's context.

It's not at all irrelevant. If the dollar is the same as gold, then the stability of prices tells you about the degree of stability of the value of gold. It would be silly to ignore the difference in pre- and post-gold-standard price behavior, but it would be misleading to suggest that gold, and thus the dollar, was a stable store of value before then.

After all, the first inflation-indexed bonds were issued in 1780. In "A Connecticut Yankee in King Arthur's Court," Mark Twain has a chapter, transposed to Camelot but obviously referring to contemporary inflation rates in the North and South, on inflation and the impossibility of getting people to think in real dollars.

Gold is a volatile asset, with zero long-term real return, whose fluctuations last for periods of time that can be long in the context of an individual investor's holding time.

The fact that gold quadrupled in real value during a period of unprecedentedly mild and stable inflation, just as the fact that it halved in real value from 1910 to 1920, show that it does not really behave the way people say it "tends to" behave. And it's not fair to throw out data before 1971; we have to judge gold by what it did, not what it might have done in some ideal world where governments do not regulate anything.

Gold's recent wonderful appreciation in real value should not dazzle us and prevent us from seeing it for what it is: a failure of stability and an illustration of unpredictability.

[hazlitt777]

Deflation in 1875 is absolutely irrelevant in today's context.

It's not at all irrelevant. If the dollar is the same as gold, then the stability of prices tells you about the degree of stability of the value of gold. It would be silly to ignore the difference in pre- and post-gold-standard price behavior, but it would be misleading to suggest that gold, and thus the dollar, was a stable store of value before then.

After all, the first inflation-indexed bonds were issued in 1780. In "A Connecticut Yankee in King Arthur's Court," Mark Twain has a chapter, transposed to Camelot but obviously referring to contemporary inflation rates in the North and South, on inflation and the impossibility of getting people to think in real dollars.

Gold is a volatile asset, with zero long-term real return, whose fluctuations last for periods of time that can be long in the context of an individual investor's holding time.

The fact that gold quadrupled in real value during a period of unprecedentedly mild and stable inflation, just as the fact that it halved in real value from 1910 to 1920, show that it does not really behave the way people say it "tends to" behave. And it's not fair to throw out data before 1971; we have to judge gold by what it did, not what it might have done in some ideal world where governments do not regulate anything.

Gold's recent wonderful appreciation in real value should not dazzle us and prevent us from seeing it for what it is: a failure of stability and an illustration of unpredictability.

I certainly do not encourage a diversification into gold because it is stable. "Stability" is over emphasized, certainly short term stability. Only broad diversification gives one any type of real stability. This is one of the permanent portfolio's charms. Any asset, whether stocks, bonds or gold, by itself, can be very volatile, short term for sure.

[Browser]

Stability is in the eye of the beholder, I guess. Is gold unstable in dollar terms, or is currency unstable in gold terms? If we were paying for stuff with gold would prices be in permanent flux? My understanding is that when the dollar was pegged to gold, prices were stable. When the peg was changed and finally eliminated we have modern "inflation", an invention of the Central Bank.

[brick-house]

nisiprius wrote:

The fact that gold quadrupled in real value during a period of unprecedentedly mild and stable inflation, just as the fact that it halved in real value from 1910 to 1920, show that it does not really behave the way people say it "tends to" behave. And it's not fair to throw out data before 1971; we have to judge gold by what it did, not what it might have done in some ideal world where governments do not regulate anything.

What "people" say it "tends" to behave in a certain way? The people with the tin hats who do not want government to regulate anything or the strawman???

Gold has been a wild card since the early 1970s. Prior to the early 1970s, gold was not a wild card. Once we went fiat, gold was allowed to float. Straight poker prior to 1971 and poker with wild cards (deuces can be dangerous...) after 1971...

Gold's recent wonderful appreciation in real value should not dazzle us and prevent us from seeing it for what it is: a failure of stability and an illustration of unpredictability.

Many Roads to Dublin - The recent failure of stability and illustration of unpredictability provides this tin hat a wonderful appreciation of a wild card asset that can be dealt many times in the context of my brief time at the investing poker table.

[steve r]

....

Gold is a volatile asset, with zero long-term real return, whose fluctuations last for periods of time that can be long in the context of an individual investor's holding time.

This statement is only half true. I (personally) question the half that gold has zero real return. I know it is well talked about by those who write investment books (including those I read and believe in). Seems to me gold is price based on supply and demand, and demand is largely determined by income (nominal GDP and global GDP) and investment purposes (fear of inflation).

According the the Federal Reserve - the CPI has increased 35 fold since the 1830s.
http://www.minneapolisfed.org/community_education/teacher/calc/hist1800.cfm?

Since the same time, gold has increased nearly 90 fold.
http://www.nma.org/pdf/gold/his_gold_prices.pdf

This implies either Gold prices will crash soon or the zero real return argument has flaws. Not sure yet. At this time I am only questioning this common belief.

[Clive]

Stability is in the eye of the beholder, I guess. Is gold unstable in dollar terms, or is currency unstable in gold terms?

Second chart below indicates the former

This is one of the permanent portfolio's charms. Any asset, whether stocks, bonds or gold, by itself, can be very volatile, short term for sure

The Permanent Portfolio however does seem to leave a gold residual i.e. mostly treasury like reward, but with some gold volatility on top.

[nisiprius]

According the the Federal Reserve - the CPI has increased 35 fold since the 1830s.
http://www.minneapolisfed.org/community_education/teacher/calc/hist1800.cfm?

Since the same time, gold has increased nearly 90 fold.
http://www.nma.org/pdf/gold/his_gold_prices.pdf

This implies either Gold prices will crash soon or the zero real return argument has flaws. Not sure yet. At this time I am only questioning this common belief.

It could also imply that gold has fluctuations that last a really long time like real estate, which has secular bulls and bears that can last for a century:

Measure from the early 1800s to today and it looks like it has a long-term positive real return. Measure from the early 1700s to the early 1800s and it looks like it has a long-term negative real return--and notice that the late-1700s downturn lasted a century. Look at the whole thing and I'd say "zero long-term real return," mentally assuming a post-2005 decline although I don't have an updated chart.

I'm willing to bet that for all four of those centuries, every move upward was thought to be a persistent trend and that the peak of every bubble was thought to be a "permanently high plateau." In perspective it just looks like a huge amount of random low-frequency noise around a steady midpoint of about 200.

[Browser]

I ran across a commentary in which the author asserts that, within a portfolio context, gold should be viewed as a way to protect or "hedge" the income stream provided by bonds. The idea being that rising interest rates impairs bond returns and that this is offset by the price increase of gold when there are rising rates. This is similar to Larry Swedroe's point about commodities allowing you to extend bond maturities because there are offsetting risks. The author claims that a 9:1 ratio is about right historically; 90% bonds to 10% gold. I'm playing around with this in Simba's spreadsheet and it seems about right - somewhere in the 10% - 15% gold range vs. intermediate treasurys seems to generate the fewest and lowest magnitude annual real return drawdowns. I find this viewpoint interesting, since I'm one of those with a large fixed-income holding in retirement who is worrying about selling and putting it all in CDs or ST bonds for safety. Perhaps another approach would be to allocate about 10% or so to gold or commodities to help hedge rising rates and just hold onto the bonds I've got. I also have found that equities actually have a positive correlation with interest rates, so a small amount of equities can help to inoculate a bond-heavy portfolio against interest rates. Something like 10% stocks, 80% intermediate treasuries, 10% gold looks pretty good historically in Simba as far as annual real drawdowns go. If you go to 15% equities, 70% treasurys, 15% gold it looks even better.

[Joe S.]

For example, from 1869-1879 there was an average deflation of 3.8%.

Two of Bill Bernstein's Pillars are the theory and the history of investing. What he has to say about the abandonment of the gold standard and the subsequent inflation of the 20th century is quite interesting.
Deflation in 1875 is absolutely irrelevant in today's context.
Keith

I have not read Bernstein's book. However he presumably discussed what things were like before we abandoned the gold standard. Presumable he discussed the deflation that frequently occurred. Presumably he thought discussing these matters would help today's investors better understand today's problems. So I highly suspect that Bernstein thought that discussing the deflation in 1875 (and other years) was relevant in understanding today's context. Hazlitt777 also thinks that discussing the deflation in 1875 is relevant in today's context. It's you who think otherwise.

[umfundi]

For example, from 1869-1879 there was an average deflation of 3.8%.

Two of Bill Bernstein's Pillars are the theory and the history of investing. What he has to say about the abandonment of the gold standard and the subsequent inflation of the 20th century is quite interesting.
Deflation in 1875 is absolutely irrelevant in today's context.
Keith

I have not read Bernstein's book. However he presumably discussed what things were like before we abandoned the gold standard. Presumable he discussed the deflation that frequently occurred. Presumably he thought discussing these matters would help today's investors better understand today's problems. So I highly suspect that Bernstein thought that discussing the deflation in 1875 (and other years) was relevant in understanding today's context. Hazlitt777 also thinks that discussing the deflation in 1875 is relevant in today's context. It's you who think otherwise.

You are correct, it is my opinion. I did not mean to imply it is Bernstein's.

I also do not mean to say there is not an historical lesson to be learned. There is.

What I am saying is that gold is no longer tightly (or even weakly) coupled to the monetary system. The interplay of the gold price with inflation / deflation and interest rates 150 years ago is not relevant today.

Keith

[Clive]

somewhere in the 10% - 15% gold range vs. intermediate treasurys seems to generate the fewest and lowest magnitude annual real return drawdowns. I find this viewpoint interesting, since I'm one of those with a large fixed-income holding in retirement who is worrying about selling and putting it all in CDs or ST bonds for safety. Perhaps another approach would be to allocate about 10% or so to gold or commodities to help hedge rising rates and just hold onto the bonds I've got. I also have found that equities actually have a positive correlation with interest rates, so a small amount of equities can help to inoculate a bond-heavy portfolio against interest rates. Something like 10% stocks, 80% intermediate treasuries, 10% gold looks pretty good historically in Simba as far as annual real drawdowns go. If you go to 15% equities, 70% treasurys, 15% gold it looks even better.

Try 10% to 15% Small Cap Value with 10% to 15% gold Browser. SCV tends to be more volatile and is perhaps more volatility balanced with gold.

A few years back I noticed how a 50-50 Permanent Portfolio/cash worked relatively well. Whilst the PP has stable nominal gains, its real gains are more volatile and blending with STT's helps. I also noticed how a Fat Tail Minimisation and PP 50-50 also worked well. Another observation I made was that the Permanent Portfolio STT/LTT barbell could be replaced with 5 year T with near identical overall results. (15% is the lower rebalance band level for the Permanent Portfolio).

Taking that a bit further and using LEFT's : 6% UVT (2x Russell 2000 Value as a SCV proxy) and 4% in UGLD (3x gold) for instance instead of 12% stocks, 12% gold, falls within a Nassim Taleb type mostly safe, a little highly speculative approach. TIPS seem to be a good partner for LETF's. i.e. 6% UVT, 6% TIP will track 12% SCV relatively well. 4% UGLD, 8% TIP will track 12% GLD relatively well. Try using etfreplay.com ETF/Backtest option to compare 50% SSO, 50% TIP with SPY for a range of individual years (i.e. use the drop down top right box to select individual years). If you look at multiple years you'll see more tracking error i.e. you have to rebalance back to 50-50 (for 2x, 33.3/66.7 for 3x) once year year or so. A benefit of using 3x LEFT for gold is that if you're only holding 4% in gold and rebalancing once yearly, then the most you might lose in that year should gold crash in price is 4%.

http://images.investorshub.advfn.com/im ... of_tip.png

A 5 year TIP and/or conventional bond ladder is a reasonable choice when concerned about rising yields. You'll have 20% of bonds maturing each year with no capital risk and potentially rolling into higher yields.

Assuming you bought a 5 year conventional each year with a coupon yield the exact same as the market yield at the time, you'd pay $100 for each such bond and be certain of a $100 capital return 5 years later. Intermediate changes in yield/price become irrelevant and the gain each year simplifies to the average of the current and past four years 5-year-yields.

Code: Select all

   
US
Year_end_5_year yield   5_year_ladder
1962   3.56   
1963   4.06   
1964   4.12   
1965   4.88   
1966   4.8   4.284
1967   5.78   4.728
1968   6.33   5.182
1969   8.22   6.002
1970   5.98   6.222
1971   5.5   6.362
1972   6.26   6.458
1973   6.83   6.558
1974   7.36   6.386
1975   7.5   6.69
1976   6.13   6.816
1977   7.54   7.072
1978   9.32   7.57
1979   10.38   8.174
1980   12.59   9.192
1981   13.97   10.76
1982   10.09   11.27
1983   11.57   11.72
1984   11.08   11.86
1985   8.49   11.04
1986   6.81   9.608
1987   8.33   9.256
1988   9.14   8.77
1989   7.86   8.126
1990   7.68   7.964
1991   5.93   7.788
1992   6.04   7.33
1993   5.2   6.542
1994   7.84   6.538
1995   5.39   6.08
1996   6.2   6.134
1997   5.7   6.066
1998   4.52   5.93
1999   6.34   5.63
2000   4.98   5.548
2001   4.33   5.174
2002   2.73   4.58
2003   3.22   4.32
2004   3.61   3.774
2005   4.36   3.65
2006   4.7   3.724
2007   3.45   3.868
2008   1.55   3.534
2009   2.69   3.35
2010   2.02   2.882
2011   0.83   2.108
2012   0.61   1.54


In practice you don't have to be precise about which bonds are actually bought as you'll either pay below $100 and receive less income, some capital gain at maturity; Or pay above $100 and receive more income during the term and a capital loss at maturity. Generally that all washes.

[Joe S.]

For example, from 1869-1879 there was an average deflation of 3.8%.

...Deflation in 1875 is absolutely irrelevant in today's context.
Keith

I have not read Bernstein's book...

You are correct, it is my opinion. I did not mean to imply it is Bernstein's.

I also do not mean to say there is not an historical lesson to be learned. There is.

What I am saying is that gold is no longer tightly (or even weakly) coupled to the monetary system. The interplay of the gold price with inflation / deflation and interest rates 150 years ago is not relevant today.

Keith

I think the main point Hazlitt777 was making is not that there was deflation in 1875, but that deflation meant than gold was rising in price. Similarly, in 1917 there was inflation, which meant gold was dropping in price. Gold did fluctuate in real value during the gold standard. There are some people who allege that gold did not vary in value during the fixed gold standard, but that only refers to nominal value, not real value. These people then claim gold couldn't rise in value during the gold standard, but since we are now off the gold standard, gold is at last able to rise in value. Therefore only the data from 1971-present should be used to evaluate gold's expected return. I just don't buy this argument. Maybe it needs explained better to me.

[Clive]

Nisiprius posted this in another thread



Bit of a saw-tooth. Spike in early 1930's - Wall Street Crash, again in the 1970's UK bailed out by IMF and again in 1980's high yields. Again in 2000 dot com and 2008 financial crisis.

Oddly however, during World War's the opposite seems to hold and the real value of gold seems to have gone down!

All taken with a pinch (2500 tons) of salt.

Thanks Nisiprius

[Epsilon Delta]

According the the Federal Reserve - the CPI has increased 35 fold since the 1830s.
http://www.minneapolisfed.org/community_education/teacher/calc/hist1800.cfm?

Since the same time, gold has increased nearly 90 fold.
http://www.nma.org/pdf/gold/his_gold_prices.pdf

This implies either Gold prices will crash soon or the zero real return argument has flaws. Not sure yet. At this time I am only questioning this common belief.

It could also imply that gold has fluctuations that last a really long time like real estate, which has secular bulls and bears that can last for a century

Or that gold has short term fluctuations. In 2006 the data clearly showed "zero long term real return". It's hard to draw conclusion when a 4% change in end points has such a big effect. If I had to guess I'd suspect that this is one of those processes with out a central tendency.

[nisiprius]

If I had to guess I'd suspect that this is one of those processes without a central tendency.

Actually, an asset whose value is an almost pure social construct would be just the sort of asset for which that might well be true.

[umfundi]

If I had to guess I'd suspect that this is one of those processes without a central tendency.

Actually, an asset whose value is an almost pure social construct would be just the sort of asset for which that might well be true.

So,

I've been trying to find any plausible theory that would justifiably position gold as a candidate in an investment portfolio or strategy. I can't find one.

Let's please disregard the data mining and back testing. And the Armageddon theories. So far, all I have is:

Expected return: Zero.
No matter what.

I cannot find a theory that says why gold is or is not correlated with interest rates, inflation / deflation, stock returns, stock p/e ratios, ...

So far as I can see, even for inflation, salt has a much more reliable correlation. I would pick sugar, at least I could be making rum.

I am really not anti-gold. I am just an engineer / applied mathematician looking for a plausible theory.

Keith

[hazlitt777]

Measure from the early 1800s to today and it looks like it has a long-term positive real return. Measure from the early 1700s to the early 1800s and it looks like it has a long-term negative real return--and notice that the late-1700s downturn lasted a century. Look at the whole thing and I'd say "zero long-term real return," mentally assuming a post-2005 decline although I don't have an updated chart.

I'm willing to bet that for all four of those centuries, every move upward was thought to be a persistent trend and that the peak of every bubble was thought to be a "permanently high plateau." In perspective it just looks like a huge amount of random low-frequency noise around a steady midpoint of about 200.

This is interesting...measured from the early 1800s to today it looks like it[gold] has a long term positive real return....from the early 1700s to 1800s...long term negative.

[OT comments deleted by admin alex]

I don't know how this can apply to ones investment/diversification decisions. But I have a hunch that if the economy continues to make gains through greater efficiences, then gold will tend to have a positive real return. But if not, if we go backwards, and productivity goes down, it could have a long term negative return again. Just stuff to think about. I frankly find it fascinating.

[hazlitt777]

Let's please disregard the data mining and back testing. And the Armageddon theories. So far, all I have is:

Expected return: Zero.
No matter what.

I cannot find a theory that says why gold is or is not correlated with interest rates, inflation / deflation, stock returns, stock p/e ratios, ...

So far as I can see, even for inflation, salt has a much more reliable correlation. I would pick sugar, at least I could be making rum.

I am really not anti-gold. I am just an engineer / applied mathematician looking for a plausible theory.

Keith

Keith, take a look at my prior post. Maybe it will be thought provoking if nothing else.

Joe

[umfundi]

Keith, take a look at my prior post. Maybe it will be thought provoking if nothing else.
Joe

Yes, I was about to reply: It is very interesting stuff. I will look at your reference.

It was coincidental I was re-reading Bernstein at the time this thread arose. I think he does a great job, in not many pages, of explaining the history and why, and then discussing what does and does not apply today. Lessons learned from history.

Keith

[brick-house]

Joe s wrote:

I think the main point Hazlitt777 was making is not that there was deflation in 1875, but that deflation meant than gold was rising in price. Similarly, in 1917 there was inflation, which meant gold was dropping in price. Gold did fluctuate in real value during the gold standard. There are some people who allege that gold did not vary in value during the fixed gold standard, but that only refers to nominal value, not real value. These people then claim gold couldn't rise in value during the gold standard, but since we are now off the gold standard, gold is at last able to rise in value. Therefore only the data from 1971-present should be used to evaluate gold's expected return. I just don't buy this argument. Maybe it needs explained better to me.

Big difference between an asset that's price was fixed by the government (until 1971) and for many years illegal to own (1933-1975). Since 1975, U.S citizens can own gold and the U.S. government no longer fixes the price. Thus, the data since 1975 matches today's situation (not price fixed and available to own). This does not mean that gold did not change in real value while its price was fixed. It did, but it changed in a manner more like cash - Inflation hurt gold and deflation helped its value.

Here is an article from Seeking Alpha (March 2012) with a bearish outlook for gold. It provides a good review of historical inflation adjusted gold prices.

http://seekingalpha.com/article/410391- ... elp-decide

There is an explanation: While gold carries the aura of being a (the) value standard, it has become "simply" another investment choice. Rather than consumers using gold as a medium of exchange, investors are using it as a medium of investment.

[Clive]

I've been trying to find any plausible theory that would justifiably position gold as a candidate in an investment portfolio or strategy. I can't find one.

So far, all I have is: Expected return: Zero. No matter what.

More often you'll see nominal asset gains being published - and portfolio's might be constructed based on those figures. Some publish real (after inflation) rewards. Rarely do you see net real (after taxes and inflation) figures.

I'm UK so I have more reliable British net real figures. Condensing down to decades for respectively Gilts (similar to 20 Year Treasury) and Building Society deposits (government insured (within limits) cash deposit accounts) the annualised net real gains were (assuming BASIC RATE i.e. more common tax rate) :

1950's -4.95 -1.14
1960's -4.31 0.24
1970's -7.73 -5.82
1980's 3.83 0.79
1990's 7.06 0.87
Averages of -1.2% and -1%

Which makes a net real of 0% look more appealing. A problem is however that is gold doesn't provide 0% net real consistently, but rather in a highly volatile manner (over decade+ long periods). Buy and later sell at the right times and the rewards can be outstanding. Buy and sell at the wrong times and the results can be devastating.

For the same decades, annualised real Gold gains (in GBP)

1.79
5.05
8.35
-12.10
-3.48
Average -0.08

Note how when gilts/cash were more negative net real, gold was more positive net real - and visa-versa.

Also note however that certain types of gold isn't taxable in the UK - being legal tender, so those gold gains are just inflation adjusted only (no taxes/costs included).

It's only sensible that if investors are receiving a negative net real reward from their 'safe' investments, that they'll switch to a 0% net real potential alternative during such times, but then move back again once net real returns become positive.

You might say that the Permanent Portfolio allocates a third each to Gilts, Building Society and Gold for a more stable 'bond' like combination, and then opts to hold 75% in that bond set together with 25% stocks. Why 25% stocks? Perhaps because 50-50 stocks and gold (and/or 25% stocks, 25% LTT) also tends to balance relatively well. Harry Browne however was an astute investor who was heavily into gold during the 1970's up-run and after having made a fortune from that helped to devise an early version of the Permanent Portfolio (PRPFX like) as a means to diversify (profit take) those gold profits. He later revised that in the later 1980's towards the 4x25 type Permanent Portfolio.



Being a tweaker (prepared to modify his choices) and value player (buying low, reducing high), I'm far from certain that he'd be sticking with the 4x25 Permanent Portfolio based on more recent valuations of gold and LTT's. For instance a Permanent Portfolio comprised of a 50% weighting into a barbell of STT/LTT has since the 1970's provided a similar result to that of holding 50% in 5 year Treasury's instead. And as gold is approaching the purchase power levels that it had back at the peak of the 1970's/early 1980's when he previously reduced his gold exposure - he might not be suggesting that 25% weighting to be appropriate around more recent times.

[wesleymouch]

David Ranson of Wainwright economics has done the calculations and a 15-18% allocation to gold protects either a bond portfolio or stock portfolio from high inflation. I know that gold is anathema to most Bogleheads but if you study history and see what has happened to investors in Argentina and Iceland in recent times their portfolios would have been decimated by the events in those countries. An allocation to gold would have allowed investors in both scenarios to survive. We are blinded by normalcy bias where we assume that the current economic conditions will continue. They may not. Gold is a good hedge against the insanity of Central banks and politicians. History is full of many prior calamitous economic events including the John Law era and the French assignant collapse. 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 of which there is a thread on this site and which has been well researched by Craig Rowland at crawlingroad.org.

[Joe S.]

Joe s wrote:

I think the main point Hazlitt777 was making is not that there was deflation in 1875, but that deflation meant than gold was rising in price. Similarly, in 1917 there was inflation, which meant gold was dropping in price. Gold did fluctuate in real value during the gold standard. There are some people who allege that gold did not vary in value during the fixed gold standard, but that only refers to nominal value, not real value. These people then claim gold couldn't rise in value during the gold standard, but since we are now off the gold standard, gold is at last able to rise in value. Therefore only the data from 1971-present should be used to evaluate gold's expected return. I just don't buy this argument. Maybe it needs explained better to me.

Big difference between an asset that's price was fixed by the government...

First almost every gold enthusiast I read in the 70's claimed that the price of the dollar was fixed to gold, not that gold was fixed to the dollar. At any rate that is the only the nominal value that was fixed.

Furthermore an open government cannot control by fiat the real value of gold. If they set the value too low, people will sell it overseas. If they set the value to high, gold will flow in from overseas. The government does affect the price of gold by such things as interest rates, but this is still done after we went off the gold standards.

So this is my big question that no one has been able to answer:
From 1802-1971 the real value of gold showed no trend. Alleged the U.S. Government was preventing gold from growing exponential in real terms. When we went off the gold standard, gold finally was able to rise exponentially. Please explain the mechanism.

[Clive]

If you assume 4% net real from stocks, -1% net real from bonds, 0% real from gold, investors might derive totally different asset allocations than when using 5% gross real from stocks, 2% gross real from bonds, 0% real from gold average longer term gain assumptions.

Stocks and LTT's tend to move similar over the longer term (but maybe with an inverse correlation over shorter periods of time), but with LTT's rewarding less. 50-50 stocks and gold can be a longer term potentially more tax efficient proxy for a bond like holding. For instance, compare 80% stocks, 20% gold as a proxy for a 60% stocks, 40% bond type holding and you'll see somewhat similar general reward to that of the Coffee House portfolio (60-40 stock/bond type asset allocation), but with more volatility.

As you say Wesley, gold can be a hedge against instability. A stock and gold asset allocation is potentially more protective when income streams are taxed at punitive levels. When looking back, 15% inflation, 15% treasury yields in the 1980's looked OK for investors, but deduct perhaps a third in taxes from those treasury yields and its a totally different story. Punitive taxation on income streams can be mitigated by holding stocks that pay no dividends (provide rewards via capital gains alone), combined with gold that pays no dividend and is portable enough to be moved to mitigate punitive taxation.

Buying any asset after it has been putting on around 20% annualised gains for the last 5 to 10 years is however a risky venture. Look back at most of the big-down events, Wall Street Crash, 1980's gold decline, Japan post 1990 stock decline ...etc. and in the lead up to those there were a decade or so of outstanding upside gains.

[Clive]

Broadly speaking, if 50-50 stocks/bonds were assumed to be generally similar to 75/25 stocks/gold or 40/60 small cap value/TIPS - what would be the better choice for a new investor lumping into the market today (generally an existing investor should also do likewise - i.e. no different to if you liquidated into cash today, would you still buy the exact same assets back again).

With gold having run up strongly and LTT's having also performed well, and TIPS in negative yield territory, perhaps the more conventional 50-50 stock/bond choice might be the better option at the present time - but perhaps looking to hold shorter dated bonds (more stock/cash like than stock/intermediate bond like).

That choice however has to be made with taxation also in mind. With dividend yield/income taxes likely to rise rather than decline (in order to pay down large debts) it would be wise to minimise that tax liability - perhaps by investing via tax efficient accounts.

Another factor to consider is the reduction in a domestic currency hedge if holding cash like assets rather than gold. Which might be addressed by holding some foreign currency based assets/exposure.

Scott Burn's might have the balance about right. Not too much gold being bought that if it turns it would weigh heavily upon the whole, but a little just in case its strong up trend continues yet further. A variation of that might be to invest perhaps 5% in a 3x gold ETF and review/rebalance no more frequently than once yearly. That way your downside is limited to the 5% invested, whilst any upside might be more like had 15% of gold been held. There are however other risks with that (counter-party default risk etc.). Note that 33% UGLD (3x Gold), 67% TIP might generally compare to 100% GLD (1x gold) over any single one year long period.

Whether that proves to be better or worse than holding 50% of total funds in gold and long dated bonds as the Permanent Portfolio does ???

Year to date

50% stocks
5% UGLD, 10% TIP, 15% stocks as a 50-50 stock/gold bond type proxy
20% SHY

was up 10.4% total gain versus 6% for PRPFX whilst from the start of 2009 to the end of 2011 the two had tracked quite closely (using 7.5% UGL 2x gold and 7.5% TIP for those years as UGLD 3x gold wasn't available back then).

[hazlitt777]

So this is my big question that no one has been able to answer:
[/b]From 1802-1971 the real value of gold showed no trend. Alleged the U.S. Government was preventing gold from growing exponential in real terms. When we went off the gold standard, gold finally was able to rise exponentially. Please explain the mechanism.

Joe, could you clarify your question for me? I want to make sure I am understanding you.

[Joe S.]

So this is my big question that no one has been able to answer:
[/b]From 1802-1971 the real value of gold showed no trend. Alleged the U.S. Government was preventing gold from growing exponential in real terms. When we went off the gold standard, gold finally was able to rise exponentially. Please explain the mechanism.

Joe, could you clarify your question for me? I want to make sure I am understanding you.

Some people argue that when you measure the real return of gold you must only use the period we were off the gold standard 1971-present. This period suggests a positive real return for gold. By this theory, we should ignore the period 1802-1971, since government controls somehow prevented gold from rising exponentially in real value.
Please explain the economic mechanism or theory that explains why gold should rise exponentially. Explain how the government could keep down the value of gold during the gold standard, when it has a "natural tendency" to increase exponentially in value.
Also please realize that I completely understand that government controls could prevent it from rising in nominal value. I am talking real value.

[nisiprius]

Please explain the economic mechanism or theory that explains why gold should rise exponentially.

Just for laughs, (and remember, Joe, I'm a gold skeptic...) assume that the amount of gold in the world is constant (no mining). Assume that gold is the only medium of exchange. Assume that the amount of real wealth in the world rises with population, exponentially, because each person contributes to the total world economy. Then: quantity of gold is constant, total wealth = total value of gold rises exponentially, unit price of gold rises exponentially.

Perhaps some of those assumptions might be challenged

[Epsilon Delta]

Please explain the economic mechanism or theory that explains why gold should rise exponentially.

Just for laughs, (and remember, Joe, I'm a gold skeptic...) assume that the amount of gold in the world is constant (no mining). Assume that gold is the only medium of exchange. Assume that the amount of real wealth in the world rises with population, exponentially, because each person contributes to the total world economy. Then: quantity of gold is constant, total wealth = total value of gold rises exponentially, unit price of gold rises exponentially.

Perhaps some of those assumptions might be challenged

Arguments about the demand for a quantity of a medium of exchange always avoid the issue of velocity of circulation. If we still used physical gold as a medium of exchange many of the historical anomalies would not exist, since we could air freight hundreds of tons in a few hours instead of waiting months for a mule train or ship.

[umfundi]

Arguments about the demand for a quantity of a medium of exchange always avoid the issue of velocity of circulation. If we still used physical gold as a medium of exchange many of the historical anomalies would not exist, since we could air freight hundreds of tons in a few hours instead of waiting months for a mule train or ship.

In a world where the proposals to slow down electronic trading involve inserting a delay of a fraction of a second?

Keith

[hazlitt777]

Some people argue that when you measure the real return of gold you must only use the period we were off the gold standard 1971-present. This period suggests a positive real return for gold. By this theory, we should ignore the period 1802-1971, since government controls somehow prevented gold from rising exponentially in real value.
Please explain the economic mechanism or theory that explains why gold should rise exponentially. Explain how the government could keep down the value of gold during the gold standard, when it has a "natural tendency" to increase exponentially in value.
Also please realize that I completely understand that government controls could prevent it from rising in nominal value. I am talking real value.

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...(aggregrate prices in terms of gold falling at that rate) then your gold/money would have appreciated annually 2.385%. The problem with these calculations will be that the goods of 1802 are very different from those of today, so trying to compare the gold and goods of 1802 to those of today could be a bit problematic. Not sure. Would we equate horses and equipment to tractors and equipment? We have to keep these limitations in mind.

Also, I'm not sure somebody should argue gold will rise exponentially, either when on a gold standard, or off a gold standard, in real terms. I think that at best, in a progressing economy, like from the 1800s to today, yes, we would have a mild deflationary environment if on a strict gold standard (one in which a dollar is simply a unit of weight in gold). In such a case gold or cash, would maybe give one a 2-3% maximum real return.

Now in a inflationary period like we are in now, would the return be that good in real terms? Depends on how you define inflation. If the economy can still become more efficient in spite of the economical harmful inflating of the currency, then I would say gold could go up in real terms around the same in real terms. But if it gets destructive, and goods and services start to shrink broadly in the economy, my hunch would be that gold could lose purchasing value. You would have relatively the same amount of gold chasing fewer goods. The goods would become more expensive in relation to gold/money.

In regard to how the government could keep down the value of gold, perhaps short term. Nixon was able to do this by selling gold at $35 dollars/ounce no matter what. The problem was we printed so much money for the guns and butter of the 1960s that there was more dollars than gold. So we would have run out if he kept selling to the French and Germans at that rate. So we went off any semblance of the gold standard August 15, 1971. And then the dollar adjusted downward from 1/35 an ounce of gold to 1/850th, settling imho at an average of 1/350th till around 2001. Nixon could have kept the price at $35 till we ran completely out of gold, but I imagine the shock to the dollar would have been even greater, so he broke the link before that. This is my understanding of how governments can temporarily influence the price. And I'm sure there are others even more complex, but it can't go forever.

Good questions. Those are my best attempts at answering them.

I would just add, people shouldn't have any delusions of getting rich off of gold, and I think most of us who want to use it as a part of a well diversified portfolio take the same approach. It's just gives some conservative ballast to a portfolio...but only if held for the long term as part of a diversified portfolio. You still have to follow the traditional wisdom of the Boglehead philosophy: watch costs, rebalance, don't time the market, save, and so forth. What say you?