Gold continues to fall

[STC]

...If you choose a single currency (whether it is zero duration cash or 20 year duration treasuries) then you subject yourself to the default/inflation risk of that country. The way around this is to hold a currency basket (e.g. 10% allocation of 10 different currencies for example). This is not easy to implement, so one solution is to hold Gold bullion instead.

This is not a new concept. Many Bogleheads reduce risk by allocating a percent of their portfolio to "safe" assets such as cash/bonds. This helps reduce volatility. A popular way to do this is by holding U.S. bonds (corporate or government). If you think about it, cash is really a zero-duration bond which makes bonds not unlike long-duration cash. So currency, bonds, and cash are all really a similar asset class.

Gold is not the same thing as cash, but it can serve the same role as a basket of currencies held as short-to-long term sovereign bonds.

So the strategy now is to use gold as a currency hedge against bonds denominated in a currency other then your personal currency of consumption? Why own those bonds, and invent the need for a currency hedge to begin with? And if the 80/20 equities/gold is your goal state, where do these foreign bonds fit?

[athrone]

So the strategy now is to use gold as a currency hedge against bonds denominated in a currency other then your personal currency of consumption? Why own those bonds, and invent the need for a currency hedge to begin with? And if the 80/20 equities/gold is your goal state, where do these foreign bonds fit?

STC,

The 20% Gold portion is not a "currency hedge" any more than 80% Stock portion is an "equity hedge." Each serve a distinct role: productive assets generate real gains, and a savings medium stores purchasing power for use at a future time.

If you are answering the question "What vehicle can I use to store purchasing power over long time frames?" You might come up with the following choices:

1. Cash in a checking account
2. 1 month to 30 year tbills
3. Gold
4. Currency basket of sovereign bonds (e.g. USD, INR, JPY, CNY, AUD, CAD, BRL, CHF)

Each has a different profile of risk, ease of implementation, tax implications, and ability to successfully preserve purchasing power. However, all of these things have one thing in common: they are a medium for savings.

[STC]

So the strategy now is to use gold as a currency hedge against bonds denominated in a currency other then your personal currency of consumption? Why own those bonds, and invent the need for a currency hedge to begin with? And if the 80/20 equities/gold is your goal state, where do these foreign bonds fit?

STC,

The 20% Gold portion is not a "currency hedge" any more than 80% Stock portion is an "equity hedge." Each serve a distinct role: productive assets generate real gains, and a savings medium stores purchasing power for use at a future time.

If you are answering the question "What vehicle can I use to store purchasing power over long time frames?" You might come up with the following choices:

1. Cash in a checking account
2. 1 month to 30 year tbills
3. Gold
4. Currency basket of sovereign bonds (e.g. USD, INR, JPY, CNY, AUD, CAD, BRL, CHF)

Each has a different profile of risk, ease of implementation, tax implications, and ability to successfully preserve purchasing power. However, all of these things have one thing in common: they are a medium for savings.

So gold is...
- not a currency hedge
- not cash
- has an expectation of real returns, and paradoxically, a history of tracking inflation ... Or 0 real return WITH high volatility
- has equity-like volatility
- kicks off no cash flow

Awesome! We agree. Only my conclusion is different then yours. Good luck

[wshang]

"Don't fight the Fed" is a common refrain. I think we might also consider why central banks and now, emerging country banks seek to buy gold, vidi infra:

The world’s central banks collectively bought 374 tons of gold in the first nine months of this year. That’s higher than last year’s 343 tons for the same period.

Diversification of reserve assets remains the driving force behind gold demand by central banks and purchases of a similar order of magnitude are expected for the fourth quarter.

Until about 2009, central banks as a group have been net sellers of gold of about 500 tons a year on average, according to Grubb. During that 15-year period going back to the 1990s, the sellers were almost always the Western central banks, while any buyers were almost always central banks from developing countries.

Grubb said two things happened around 2008-2009: Western central banks ceased to sell gold. And with the increasing foreign exchange reserves in surplus countries in Latin America, Asia and Far East, their central banks started buying gold because they had very low weightings in gold in their reserve portfolios.

Developing countries started to diversify their reserve portfolios as they continued to build up large currency reserves by exporting goods to Europe and North America. Then came the 2007-2008 credit crunch, the large-scale monetary easing actions and widespread economic issues.

As a result, central banks have continued diversifying away from the dollar, the euro and the sovereign debt because of the higher risks associated with those currencies and asset classes.

“Emerging country central banks are now buying gold like they never have done before to increase the weightings in gold in their reserve asset portfolios and to protect against the effects of unconventional monetary policy, which is now being implemented on an international scale like we’ve never seen before,” Grubb said.

The average weighting of the European and American central banks in gold is between 50 percent and 100 percent. But for a developing country’s central bank generally has less than 5 percent of its reserve portfolio allocated to gold.

http://www.ibtimes.com/central-bank-gol ... dip-881004
So, where do you think most of the global growth will be coming from in the next decade?

[Joe S.]

If you want to hold savings you have to choose a currency. If you choose a single currency (whether it is zero duration cash or 20 year duration treasuries) then you subject yourself to the default/inflation risk of that country. The way around this is to hold a currency basket (e.g. 10% allocation of 10 different currencies for example). This is not easy to implement, so one solution is to hold Gold bullion instead...

...What I am suggesting is that Gold can be an acceptable approximation / replacement to a currency basket. Again, the purpose of a currency basket is to diversify your currency (bond) allocation between foreign and domestic assets. The U.S. dollar may seem safe at the moment, but any currency has risk (at the very least, long periods of negative real rates).

I do not now of any mathematical analysis that shows that it makes sense to add a "currency basket" to asset allocation. I don't know of any Boglehead that owns a "currency basket." You are suggesting we replace a "currency basket" with gold, but nobody I know of believes in currency baskets.

If there were any significant number of people that believed in currency baskets, some one would create a mutual fund that invested in a basket of 50 currencies and you could buy the mutual fund. It would be easy. However, since it is a concept next to no one believes in, there is no market for such a mutual fund.

There are many arguments in favor of gold, but this "currency basket" argument does not impress me. However, if you have some links about currency baskets, I would be happy to read about them. Maybe I need to know more about the subject.

[Clive]

Gold is not the same thing as cash, but it can serve the same role as a basket of currencies held as short-to-long term sovereign bonds.

Matching the amount of gold held with a similar amount of domestic stocks appears to be generally bond like. For instance 1973/1974 UK stocks declined around -70% real/after basic rate tax. A 3 fund portfolio comprised of a third each in UK stocks, US stocks and bonds declined around -40%. Replacing the third in bonds with a stock/gold barbell and the dip was much the same, as was the subsequent recovery compared to holding a third in bonds on a gross basis. Add in taxes however and the bonds lagged during the recovery whilst in contrast stocks/gold as bonds might have been more tax efficient.

Conceptually a 60-40 stock/bond might be replicated with a 60% stocks and 40% stock/gold barbell i.e. 80% stocks, 20% gold. 1979 to 2011 Simba's data comparing 60/40 TSM/Total Bond with 80% TSM/20% gold had very similar progressions.

UK mid 1970's when inflation, cash etc. were all up at 15% type levels isn't good when you're perhaps paying 33% tax on income/interest/dividends. i.e. rolling up (deferring) capital gains and holding stocks paying low/no dividends combined with gold (no dividends) might at times be a more tax efficient choice compared to bonds.

50-50 stock/gold as a bond proxy isn't however consistent. The Permanent Portfolio for instance might be considered as 100% bonds comprised of half in a stock/gold 50-50 proxy for bonds and a STT/LTT bond barbell for the other half. The PP however didn't track total bonds closely. Whilst it has done so moderately closely since 1979, in the earlier 1972 to 1978 years following the IPO of gold so-to-speak the PP performed better than bonds.

[nisiprius]

You are suggesting we replace a "currency basket" with gold, but nobody I know of believes in currency baskets.

I looked into this once. I was too lazy to calculate purchasing power, because it is instantly clear at a glance that, far from protecting against inflation during the period 1978-1984, a basket of non-U.S. currencies was sharply losing dollar value and would have just made things worse.

One has to look beyond abstract theory and ideology. Maybe the deficit ought to have created runaway inflation over the last decade, but it didn't. Maybe inflation should have been lower during the days of the surplus, but it wasn't.

The big thing is that nobody touting "inflation hedges" will guarantee them. If gold were a reliable stable store of value, then I ought to be able to buy gold together with a dirt-cheap insurance policy that guarantees to pay me the difference in the unlikely event that it ever loses real value. As it is, I doubt that any dealer will even promise to buy gold back at the dollar price for which it was sold.

[Clive]

Isn't QE (printing money) a round trip to nowhere. A hope to inflate away a debt that's been negated. Start with $100 owed, of which $50 owed to foreign, $50 owed domestically. Print $300 more money of which half is owed domestically, half to (bought by) foreign and now the debt stands at $400, $200 owed domestically, $200 owed to foreign. When $300 more was printed, other countries also printed similar amounts of their own currency in lock-step to buy more of the US debt (treasury's). There's no inflation as everyone still has similar amounts of money printed and it all balances out overall.

1993 to 2011, gold has pretty well universally risen around 4 times in price, beit in Pounds Sterling, US, Australian or Canadian dollars, Euros, Chinese renmimbi, United Arab Emirate dirham, Saudi riyal ...etc. Since 2007 gold has universally risen around 2 times in price. (As ever there are exceptions (Russian ruble, Turkish lira both had way above average gold price increases up to 2007 (high inflation), but have since fallen more into alignment with others).

The only winner is gold during QE. Sooner or later however it will occur to those with their fingers on the money printing machines that they're just wasting effort. 4 times or whatever larger debts, paying 4 times less interest, still with half the debt owed to foreign and half domestically. There's been no solution of inflationary erosion of debt by those owing and the lenders will still get their money bar a default, except receiving larger piles of lower valued (relative to gold) money/notes. If that QE game persists, gold continues to rise. Stomping around and banging a table demanding others not to print money in lock-step and allow the debt to be eroded will just be met with a wry smile. If they stop printing, gold levels. If they decide to reverse back down again (Quantitative Tightening) gold declines. The only way out of the debt is to either default or pay it down. For larger economies open defaults are a no-no and instead defaults occur more via stealth - higher taxes, inflation etc.

The last time gold soared and bought a lot more dollars was back in the 1970's. Over the 1980's those gains were given back again. Whilst gold can preserve purchase power over centuries, over decades it can be highly volatile. As and when a region appears to be transitioning to stability and paying modestly safe real rewards (yields), gold might be dumped in favour of such alternatives - initiating QT and/or forcing treasury yields higher. 5% weighting in a 3x gold ETF IMO is better than 15% in physical (or whatever 1:3 ratio of weighting you prefer), rebalanced at most once each year - that way you're maximum loss over any one year is limited to that 5% amount.

[HenryPorter]

Why shell out ~$1700 for a one troy ounce gold coin when you could buy $1700 of pennies that will have a spot metal value already at ~ $1850 and retain face value of coins? Go to your local bank and dollar cost average into $25 boxes of circulated pennies. Buy an occasional $100 box of nickels that has about $103 worth of metal in it.

[athrone]

I was too lazy to calculate purchasing power, because it is instantly clear at a glance that, far from protecting against inflation during the period 1978-1984, a basket of non-U.S. currencies was sharply losing dollar value and would have just made things worse.

nisiprius,

I am using 3 mo T-bills and 30 year T-bills interchangeable. The duration of a bond one chooses is a personal choice. Unless you think bonds (in general) are a losing proposition, why would a currency basket (basket of bonds) lose to inflation? Unless the entire planet is in financial repression (negative real rates) shouldn't the interest paid on a bond exceed the inflation in that currency?

The principle is the same as anyone who holds a traditional 80/20 stock/bond portfolio as advocated commonly on this board. If you are comfortable with a single currency, then yes US Total Bond market is just fine. Others do not live in the US or are not comfortable with that level of diversification. Gold can be an alternative for those wishing to diversify their savings (not investments).

As Clive mentions above, Gold historical has risen in all currencies so it is one way to approximate a currency-basket (bond-basket, if that makes it more clear).

-athrone

[athrone]

Why shell out ~$1700 for a one troy ounce gold coin when you could buy $1700 of pennies that will have a spot metal value already at ~ $1850 and retain face value of coins? Go to your local bank and dollar cost average into $25 boxes of circulated pennies. Buy an occasional $100 box of nickels that has about $103 worth of metal in it.

You could, you could also just buy shares of Total Bond Market. There are countless ways to save money. Some are better than others, depending on your personal situation.

For my personal situation, I am not strong enough to carry 170,000 pennies at once. I can however, easily slip a 1oz Gold coin into my pocket.

[athrone]

I don't know of any Boglehead that owns a "currency basket." You are suggesting we replace a "currency basket" with gold, but nobody I know of believes in currency baskets

Almost all Bogleheads own a currency basket. In fact I'm guessing you do is well. Let me guess:

Number of currencies = 1 ($USD)
Duration = 5 years

How close am I?

[athrone]

The only winner is gold during QE. Sooner or later however it will occur to those with their fingers on the money printing machines that they're just wasting effort. 4 times or whatever larger debts, paying 4 times less interest, still with half the debt owed to foreign and half domestically.

QE maybe explains the rise of Gold from 2008-2012. How do you explain the rise in Gold from 1999-2008?

[HenryPorter]

You could, you could also just buy shares of Total Bond Market. There are countless ways to save money. Some are better than others, depending on your personal situation.

For my personal situation, I am not strong enough to carry 170,000 pennies at once. I can however, easily slip a 1oz Gold coin into my pocket.

I hope that gold coin goes up in value.

[wshang]

Why shell out ~$1700 for a one troy ounce gold coin when you could buy $1700 of pennies that will have a spot metal value already at ~ $1850 a

I actually discussed this with a friend who was contemplating a machine which sorts copper from copper clad pennies. The metal weight, labor and storage volume makes this untenable. Copper while used since the Bronze age as a precious metal when smelting reigned, fell with present methods of electrolysis. Gold by contrast, has largely been mined and demand is growing with each nuevo rich Indian and Chinese. . . . . Not to mention when Western central banks are racing to the bottom devaluating their fiat currency.

[nisiprius]

I was too lazy to calculate purchasing power, because it is instantly clear at a glance that, far from protecting against inflation during the period 1978-1984, a basket of non-U.S. currencies was sharply losing dollar value and would have just made things worse.

why would a currency basket (basket of bonds) lose to inflation?

I don't know "would" and "wouldn't." I just plotted what actually happened.

[STC]

I don't know of any Boglehead that owns a "currency basket." You are suggesting we replace a "currency basket" with gold, but nobody I know of believes in currency baskets

Almost all Bogleheads own a currency basket. In fact I'm guessing you do is well. Let me guess:

Number of currencies = 1 ($USD)
Duration = 5 years

How close am I?

You still fail to describe the practical uses of a "currency basket" when expenses are denominated in dollars. You fail to describe how your 80/20, equities/gold, portfolio is the risk equivalent of an 80/20, equities/fixed income. All theory and no application of that theory to portfolio theory is about as useful as me trying to get a job as a major league pitcher because I theorize that I should have a 100mph fastball. Ridiculous.

[STC]

I was too lazy to calculate purchasing power, because it is instantly clear at a glance that, far from protecting against inflation during the period 1978-1984, a basket of non-U.S. currencies was sharply losing dollar value and would have just made things worse.

nisiprius,

I am using 3 mo T-bills and 30 year T-bills interchangeable. The duration of a bond one chooses is a personal choice. Unless you think bonds (in general) are a losing proposition, why would a currency basket (basket of bonds) lose to inflation? Unless the entire planet is in financial repression (negative real rates) shouldn't the interest paid on a bond exceed the inflation in that currency?

The principle is the same as anyone who holds a traditional 80/20 stock/bond portfolio as advocated commonly on this board. If you are comfortable with a single currency, then yes US Total Bond market is just fine. Others do not live in the US or are not comfortable with that level of diversification. Gold can be an alternative for those wishing to diversify their savings (not investments).

As Clive mentions above, Gold historical has risen in all currencies so it is one way to approximate a currency-basket (bond-basket, if that makes it more clear).

-athrone

If you own treasuries in the currency of your expenses, it is NOT the same as owning a "currency basket." The purpose of a currency basket is either:

a: Bet on Forex/QE/Devaluation of currency/ETC - all stuff priced into the market already
b: Hedge currency risk, most likely the ownership of fixed income denominated in currencies other then the currency of your expenses.

If Gold is a proxy for a "currency basket," then its purpose is one of those two things. Your argument has continually shifted and been proven wrong. Please, shift again.

Gold is
- not a currency hedge
- not cash
- has an expectation of 0 real return
- has equity-like volatility
- kicks off no cash flow

[athrone]

You still fail to describe the practical uses of a "currency basket" when expenses are denominated in dollars.

Expenses aren't denominated in shares of stock either, but people seem to hold those as well.

[STC]

You still fail to describe the practical uses of a "currency basket" when expenses are denominated in dollars.

Expenses aren't denominated in shares of stock either, but people seem to hold those as well.

Shares of stock are denominated in a currency. If you own shares in USD, then the currency risk of the holding is relatively minor and contained to un-hedged foreign earnings of the underlying companies.

So, there is minimal to no currency risk in holding something like TSM.

[Clive]

QE maybe explains the rise of Gold from 2008-2012. How do you explain the rise in Gold from 1999-2008?

Dot com, Fredie and Fannie...etc

Back in 2001 Congress were forecasting a $5.6T surplus for 2002 - 2011 compared to a $6T deficit actual. Wars, lower taxes ...etc.

The gold rise didn't really start until 2002 (when stocks were still diving from dot com bursting) and has more or less been adding 20% yearly since.

As the US creates new debts (sells treasury's), so others print and buy those treasury's in order to maintain balance (fair value of IOU)

[STC]

Athrone - I am going to move your notes to me here to help others understand. Let me help you out. Currency risk is: "A form of risk that arises from the change in price of one currency against another." If both currencies are the same, there is no currency risk. If you compare USD against USD the delta is always 0.

This is why the currency of your consumption (expenses) is an important part that you NEED to understand. Comparing a USD fixed income against the ultimate USD consumption does not require any currency hedge or basket. It is only when investment and consumption are denominated in different currencies that currency risk is an issue.

Again, within TSM there are likely some un-hedged earnings in non-USD terms. But that is so minor as to make it moot.

Get it?

athrone's PM

I'm sorry but your statements disprove themselves, nothing outside is needed. How do you go from statement 1 to statement 2? I would love to see that logic, maybe you will win a Nobel prize for coming up with a new form of logic nobody has ever used.

1. "Shares of stock are denominated in a currency."

2. "there is minimal to no currency risk in holding something like TSM"

[athrone]

Please name a person who only buys items manufactured in a single country.

[Clive]

If you own shares in USD, then the currency risk of the holding is relatively minor and contained to un-hedged foreign earnings of the underlying companies.

So, there is minimal to no currency risk in holding something like TSM.

Exposure to multiple foreign currencies will tend to counter-balance each other, some up, some down, generally neutral overall - but with some volatility as per nisiprius' earlier chart. Excepting if your domestic currency performs relatively strongly in isolation, or exceptionally poorly in isolation. The former is perhaps a lot less likely than the later, and when the later those foreign currencies (earnings etc.) become much more valuable.

A foreign stock holding after all is just the stock price change + currency price change, which may make that stock either rise (fall) more if both the stock and currency changes move in the same direction, or have some of the stock price changed dampened down if the stock and currency changes move in opposite directions.

For example in 2008 whilst both UK and US stocks were down around -30%, a UK holder of US stocks saw near enough a 0% change in the value of those US stocks in GB Pounds due to the Pound declining relatively more than the USD. UK bonds rose around 7% in 2008 (gold rose 40%), such that a 3-fund portfolio of a third each in UK stocks, US stocks and bonds declined around -7.7% in total from a UK investors perspective. Substituting a 50-50 domestic stock and gold combination for bonds and the 2008 3-fund decline was around -8.3%.

[Clive]

Please name a person who only buys items manufactured in a single country.

Mr Extremo Patriot

[STC]

Please name a person who only buys items manufactured in a single country.

Consumption athrone. I know you love to wander. First that gold is cash, then its a perfect equity hedge, then it a currency basket... now its... I dont know....

If you want to start yet ANOTHER different point about where manufacturing occurs in a globalized economy, central bank strategies to debase currencies to get more competitive, and how that relates back to your silly proposal of an 80/20 equity/gold portfolio - I would expect a well supported opinion. Not a question.

On the current point of currency risk: DO YOU UNDERSTAND THAT CURRENCY RISK DOES NOT EXIST WHEN INVESTMENT AND CONSUMPTION ARE DENOMINATED IN THE SAME CURRENCY? YES/NO?

[athrone]

Please name a person who only buys items manufactured in a single country.

Mr Extremo Patriot

Okay, I concede.

Mr. Extremo Patriot who lives in the hills and only purchases goods stamped with "made in the USA," never intends to eat mangos out of season, sources all his building materials locally, and does not fill up his Chevy with foreign Oil is safe from foreign exchange risk.

Unfortunately he may still be susceptible to other forms of currency risk such as default, hyperinflation, or financial repression (negative real rates) which could significantly impact his shares of TSM.

[Clive]

Assume that your living standard depicts that your expenses go 50% on domestically produced goods/services and 50% on foreign goods/services (directly and/or indirectly). If your domestic currency hits a crisis in isolation likely you'll adjust your living standard to buy a much larger proportion of domestic goods/services and a lot less foreign/imports. Whilst gold or a foreign good might double in domestic currency terms, domestic inflation might rise 20%. Some gold or foreign currency/earnings in a portfolio would help mitigate the collapse and help towards maintaining a similar level of living standard as before the domestic currency crisis.

[STC]

.....

[athrone]

Back to actionable investing:

In this global market we live in, you are exposed to currency risk every day. When you buy coffee with beans made in Columbia, when you eat your salad with fruits grown in Chile, when you are shopping for a new smartphone made in China, when you get in your Japanese car and drive home. Earning a paycheck in $USD and spending it in $USD does not isolate you from global trade.

The U.S. comprises less than 20-30% of Global market cap in both equities and bond markets. So is it smart to diversify out of the dollar? Maybe. That is a personal decision and depends only on your personal situation. For those who wish to diversify out of the dollar, and already hold enough equities (productive assets) Gold may be a viable alternative to holding a basket of foreign and domestic bonds, both for ease of implementation and for increased tax efficiency.

[STC]

Back to actionable investing:

In this global market we live in, you are exposed to currency risk every day. When you buy coffee with beans made in Columbia, when you eat your salad with fruits grown in Chile, when you are shopping for a new smartphone made in China, when you get in your Japanese car and drive home. Earning a paycheck in $USD and spending it in $USD does not isolate you from global trade.

The U.S. comprises less than 20-30% of Global market cap in both equities and bond markets. So is it smart to diversify out of the dollar? Maybe. That is a personal decision and depends only on your personal situation. For those who wish to diversify out of the dollar, and already hold enough equities (productive assets) Gold may be an easy alternative to holding a basket of foreign and domestic bonds, both for ease of implementation and for increased tax efficiency.

That isnt currency risk. Thats inflation. And there are better ways to manage inflation then gold. Please at least use terms correctly.

http://www.investopedia.com/terms/c/currencyrisk.asp
http://en.wikipedia.org/wiki/Currency_risk

http://en.wikipedia.org/wiki/Inflation
http://www.investopedia.com/terms/i/inflation.asp

And just one more thing. The US is ~44% of global market cap: http://seekingalpha.com/article/80998-p ... by-country

[athrone]

Some gold or foreign currency/earnings in a portfolio would help mitigate the collapse and help towards maintaining a similar level of living standard as before the domestic currency crisis.

I view it like this. Denominating all your bonds in a single currency is kind of like owning an individual stock -- something this board does not recommend. Yes it could work out but it might also end up horribly. This board gives good advice to "hold the entire market" and while the focus is certainly on the U.S, at least with regards to equities many people do allocate 50% foreign / 50% domestic.

Why is this not true for the bond side?

[STC]

Some gold or foreign currency/earnings in a portfolio would help mitigate the collapse and help towards maintaining a similar level of living standard as before the domestic currency crisis.

I view it like this. Denominating all your bonds in a single currency is kind of like owning an individual stock -- something this board does not recommend. Yes it could work out but it might also end up horribly. This board gives good advice to "hold the entire market" and while the focus is certainly on the U.S, at least with regards to equities many people do allocate 50% foreign / 50% domestic.

Why is this not true for the bond side?

Its not true because you are misunderstanding that what you are talking about is inflation, but defining it as currency risk. By misunderstanding what it is you are solving for, your solution is likewise off-base. This is why you can not understand why the collective wisdom of this board disagree's with you. They understand what it is they are solving for, inflation. You think you are solving for something else, currency risk.

[athrone]

What factors impact foreign exchange rates?

[STC]

What factors impact foreign exchange rates?

Inflation, REGARDLESS OF CAUSE, is what matters. Can currency exchange rates LEAD to inflation? Yes. But the problem is INFLATION not currency risk.

And there are better ways to manage inflation.

[Clive]

For those who wish to diversify out of the dollar, and already hold enough equities (productive assets) Gold may be a viable alternative to holding a basket of foreign and domestic bonds, both for ease of implementation and for increased tax efficiency.

As I suggested before, 50-50 matching stocks and gold as a synthetic bond is perhaps a better choice IMO. Instead of 60-40 stock/bonds, 80-20 stock/gold for instance. At times historically when dividend yields, cash, and inflation were high, taxes on income were also relatively high. By holding accumulation funds/stocks that paid no dividends combined with gold the tax drag effects would have been considerably lower.

In the UK tax efficiencies are still similar for both choices, from what I've seen in the US however it looks like the US might be moving more toward higher taxation of income streams (dividends). Reaching for yield as has been the more recent tendency, might start drifting more towards lowering portfolio yield in favour of taking periodic capital gains.

with regards to equities many people do allocate 50% foreign / 50% domestic.

Why is this not true for the bond side?

Some countries take 35% withholding taxes out of income streams (dividends, bond interest) and depending upon any tax treaties investors may also have to pay domestic taxes on top (double taxation). The bond market is still somewhat behind the times and bid/ask spreads can be wide/blind. I suspect that generally its easier and more tax efficient to diversify via foreign stock and capital gains than it is to diversify via foreign bonds/income.

[HenryPorter]

I actually discussed this with a friend who was contemplating a machine which sorts copper from copper clad pennies. The metal weight, labor and storage volume makes this untenable. Copper while used since the Bronze age as a precious metal when smelting reigned, fell with present methods of electrolysis. Gold by contrast, has largely been mined and demand is growing with each nuevo rich Indian and Chinese. . . . . Not to mention when Western central banks are racing to the bottom devaluating their fiat currency.

That is the Ryedale machine. Those could be rented someday if you have enough copper penny ore to harvest. How did coins fare in Zimbabwe? Consider copper a component of the blue-collar version of a permanent portfolio. I bet Bill Gross and Warren Buffett and John Bogle hate copper pennies. LOL.

[NoVa Lurker]

What factors impact foreign exchange rates?

Why are you asking? The short answer is: many many many things.

Off the top of my head: relative inflation rates, relative current account surpluses/deficits, relative interest rates, relative productivity, and - probably most importantly - the market's perceptions of all of the previous factors.

[Clive]

Inflation figures at best are only a guide. A weighted increase in an 'average' basket of goods. My basket of goods often differs significantly from that 'average' basket of goods.

I prefer to consider inflation as just another form of tax. That should be summed with more conventional taxes to derive a total taxation overhead. Only if my investments have returned in excess of costs, taxes and personal rate of inflation have I made any real gain.

Symantics.

[STC]

Inflation figures at best are only a guide. A weighted increase in an 'average' basket of goods. My basket of goods often differs significantly from that 'average' basket of goods.

I prefer to consider inflation as just another form of tax. That should be summed with more conventional taxes to derive a total taxation overhead. Only if my investments have returned in excess of costs, taxes and personal rate of inflation have I made any real gain.

Symantics.

I am not talking about CPI. I am talking about the economics concept of inflation. What you and athone keep talking about is "currency risk" and its impact on the buying power of the currency of consumption - say USD. What you both keep missing is that changes in exchange rates is a FACTOR that influences inflation. So you are building investment strategies to attack the WRONG problem. The REAL issue is maintaining your assets purchasing power over time. That is to say, manage inflation.

Now, If you want to make an argument for gold as an inflation hedge, go right ahead. But PLEASE, understand the real problem you are trying to solve for.

[Barry Barnitz]

Hi:

From Dimson, Marsh, and Staunton, and the 2012 Credit Suisse Yearbook Asset class real returns in USD from 1900- 2011:

Code: Select all

Asset          Geo mean       Arithmetic mean      Std dev.      Sensitivity to inflation

World equities    5.40%         6.90%              17.70%            -0.52
US bonds          1.70%         2.30%              10.40%            -0.74
US bills          0.90%         1.00%              4.70%             -0.62
Gold              1.00%         2.40%              12.40%             0.26
Housing           1.30%         1.50%              8.90%             -0.20

[nisiprius]

When I was challenged as to what I would bring with me if I knew I were going to be dropped into a human civilization at a truly random time and place, if I wanted to be sure I had something that would be valued by the society I landed in, I answered, not-so-jokingly, "Salt and pepper." This has gotten me on a not-yet-successful quest to find long-term data for the real value of salt.

I did find values from 1900 to the present, and they show something interesting. I saw this on the web here literally minutes before I was about to plot it myself. I'm going to show my own plot anyway, just to show that I verified the data. I still have not found out how to make Excel plot a decent log scale, so my apologies for that. There are two points I want to make. I have data only for the first, but the second is more important.

The first point is from 1900 to the present, the real value of salt has been much more stable than that of gold. Gold has, of course, been a much better buy if you bought it at the right time--and a much worse buy if you bought it at the wrong time.

The second point is the one for which I don't have data. It is that salt was awfully valuable for a very long time, and then became so much cheaper that the idea of salt as valuable now seems like a joke.

The obvious riposte to the idea of salt as a store of value is that it is not worth enough. But cheap salt is a very recent phenomenon. For millennia it was a prized and expensive luxury. Salt cellars were made of gold because the valuable salt deserved to be displayed ostentatiously, and simply having an open container of salt on the table was a status symbol. Salt has had at least as much mystique surrounding it as gold, and we are paid a salary, not an aurary.



I'd love to know how the value of the salt in a salt cellar compared with the value of the gold in its container. Yes, I'm sure that the gold was worth much more, but I'm equally sure that portable quantities of salt were valuable enough to be a practical medium of exchange. Whether the value of salt was as stable over the millennia before 1900 as in the century afterward would be nice to know.

If you dropped me into a time-and-space-machine to emerge at a random society in human history with as much salt and pepper as I could carry on me, I'd be OK any time up to, I don't know, I'm thinking maybe 1700. Obviously after 1900 I'd be in deep trouble.

And that's the point. One can imagine a 16th-century saltbug making a good case for the special characteristics, universality, and long-term safety of investments in salt. But something can be universally and cross-culturally valuable in time and space for centuries and centuries--and then become so cheap they dump it out of trucks onto the roads in wintertime.

[Joe S.]

I don't know of any Boglehead that owns a "currency basket." You are suggesting we replace a "currency basket" with gold, but nobody I know of believes in currency baskets

Almost all Bogleheads own a currency basket. In fact I'm guessing you do is well. Let me guess:

Number of currencies = 1 ($USD)
Duration = 5 years

How close am I?

When talking about a "currency basket" I put it in quotes because I was referring to your first definition of currency baskets.

If you want to hold savings you have to choose a currency. If you choose a single currency (whether it is zero duration cash or 20 year duration treasuries) then you subject yourself to the default/inflation risk of that country. The way around this is to hold a currency basket (e.g. 10% allocation of 10 different currencies for example).

You clear stated that a currency basket is something that contains more than 1 currency. You stated that you shouldn't hold a single currency, but rather a "currency basket."

You are now changing your definition of a "currency basket." You are now just playing word games with me rather than discussing the underlying investing philosophy.

[athrone]

Joe S.

If you put an apple into a basket, you would have a fruit basket. Wouldn't be much of a fruit basket really, mostly just an apple basket. This is what most Bogleheads do if you replace apples with dollars.

Point is, better to include euros, yen, yuan, dollars, francs, rupees, etc. if you want to impress guests with your currency basket. Not everyone likes apples, ya know.

Sorry for the terrible analogy...

[athrone]

nisiprius,

I really enjoyed your post about Salt. Quite interesting that you were able to track down the data, and the link you provided is pretty useful. The parallel you draw between Salt going out of favor is certainly possible with Gold, but I would be careful in drawing too much of a link. Another interesting aspect of Gold (aside from it's ability to grow tax free, as Clive mentions) is that it is created mainly through the collision of neutron stars or very large supernovae. Very rare events.

From a truly universal perspective, Salt was always destined to be cheap.

-athrone

[Browser]

Gold is a bad investment -- except for the alternatives. Jumpin into those stocks and bonds are ye?

[hazlitt777]

Gold is a bad investment -- except for the alternatives. Jumpin into those stocks and bonds are ye?

They are all bad investments, if you are not diversified into all of them, and rebalancing.

[mephistophles]

Bought some gold awhile back, just for diversification, and paid about $400 an ounce for it. Sure was a bad investment. That said, I also own, real estate, mutual funds and many other things. Some things go up in value, some things go down in value and other things stay about the same. I also own a dog, but really the dog owns me. P.S. I also got some salt.

[Clive]

Hi:

From Dimson, Marsh, and Staunton, and the 2012 Credit Suisse Yearbook Asset class real returns in USD from 1900- 2011:

Code: Select all

Asset          Geo mean       Arithmetic mean      Std dev.      Sensitivity to inflation

World equities    5.40%         6.90%              17.70%            -0.52
US bonds          1.70%         2.30%              10.40%            -0.74
US bills          0.90%         1.00%              4.70%             -0.62
Gold              1.00%         2.40%              12.40%             0.26
Housing           1.30%         1.50%              8.90%             -0.20

Hi Barry

UK figures from Credit Suisse/Forst Boston Equity-Gilt Study 1999

Gilts 1918 - 1999 2.3% average real return, 15.2% std dev. So a similar average to US bonds, but with more volatility (higher std dev.).

One data series in that paper shows yearly data from 1945 to 1999 and indicates

1945 100
1999 137

inflation adjusted gross income reinvested values for Gilts (around 20 year maturity treasury's).

Another data series shows the same but with net of basic rate tax income reinvested values of

1945 100
1999 36.6

I have a physical paper version of that document, so can't just cut and paste the data here, but as a guide the real net income reinvested progression values at each decade were :

1950 72.7
1960 39.5
1970 26.3
1980 12.8
1990 17.4

More tax efficient options for investments (PEP's, ISA's, Roth's? etc) are relatively new (since mid 1980's/1990's ?), so average investors prior to such tax efficient options wouldn't have seen actual rewards anywhere near to the gross figures.

The same also might be said for stocks and cash. Ball park around half of stock total gains historically arose from dividends. If inflation averaged say 3.1% (guess) stock total gains 10% nominal = 6.9% average real (as per your 6.9% figure), and 5% of that 10% nominal gain were dividends that were taxed at 25% = 1.25% tax drag perhaps (5.4% geometric might be more like 4% after dividend taxes).

Fund fees and trading costs were also higher pre 1990's. Some funds even today still charge a couple of percent yearly fee - which was much more common back then. Which excludes any foreign withholding taxes that might have been applied to foreign holdings (http://www.dits.deloitte.com/DomesticRa ... atrix.aspx 'Withholding Tax' tab shows a list of recent values).

[STC]

Joe S.

If you put an apple into a basket, you would have a fruit basket. Wouldn't be much of a fruit basket really, mostly just an apple basket. This is what most Bogleheads do if you replace apples with dollars.

Point is, better to include euros, yen, yuan, dollars, francs, rupees, etc. if you want to impress guests with your currency basket. Not everyone likes apples, ya know.

Sorry for the terrible analogy...

Most bogleheads hold only the currency of their personal consumption because they understand that the problem they are solving for is inflation. What is more likely? that you have some new brilliant notion that the folks here haven't evaluated OR you don't understand the real problem to solve for to maintain the purchasing power of your assets?

From your PM to me:

I am not interested in preserving my purchasing power for goods manufactured in other countries. I said gold is one alternative to domestic+foreign bonds as means of preserving [real] purchasing power. Real meaning the real things real people buy today, which includes goods from other countries.

This is of course an interest in managing inflation. If you continue to try to solve for currency risk where there is none, while refusing to address inflation - the thing your examples all say you WANT to address - your investment strategy will remain misguided.