Gold as diversifier

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konik
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Gold as diversifier

Post by konik »

Hi all!

Until recently I thought that since gold has long term expected return of 0% it has no use in portfolio theoretically. I thought that recent history results where it improved returns are just artefact.

Now I understood that its average compound return is expected to be 0, i.e. geometric mean of returns. Arithmetic mean is larger, especially since gold has high volatility, so gold has positive expected annual return.

Since Sharpe ratio takes into account arithmetic returns, it will be improved when adding gold if we simplistically accept that correlations with stocks and bonds are zero.

Am I generally correct?

Similar effect I think is described in this article https://www.nber.org/system/files/worki ... w10595.pdf table 1, where there is diversification bonus to real negative returning basket of commodities.
petulant
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Re: Gold as diversifier

Post by petulant »

You are starting to reach conclusions that others have thought as well. You can search for other threads on BH about the topic; it has been debated at length between user willthrill81 and others. Suggested search terms would be "willthrill81 gold" and similar things. You can also look for threads on the golden butterfly and permanent portfolios.
secondopinion
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Re: Gold as diversifier

Post by secondopinion »

konik wrote: Fri Jan 27, 2023 4:37 pm Hi all!

Until recently I thought that since gold has long term expected return of 0% it has no use in portfolio theoretically. I thought that recent history results where it improved returns are just artefact.

Now I understood that its average compound return is expected to be 0, i.e. geometric mean of returns. Arithmetic mean is larger, especially since gold has high volatility, so gold has positive expected annual return.

Since Sharpe ratio takes into account arithmetic returns, it will be improved when adding gold if we simplistically accept that correlations with stocks and bonds are zero.

Am I generally correct?
Technically if we assume zero correlation, we can achieve lower standard deviation. This, however, does not mean that the Sharpe Ratio will be improved since we have not stated how expected returns will be for stocks and bonds.

I think gold has some merit as a diversifier; I just am not sold on it as to start a position.
Passive investing: not about making big bucks but making profits. Active investing: not about beating the market but meeting goals. Speculation: not about timing the market but taking profitable risks.
Logan Roy
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Re: Gold as diversifier

Post by Logan Roy »

konik wrote: Fri Jan 27, 2023 4:37 pm Hi all!

Until recently I thought that since gold has long term expected return of 0% it has no use in portfolio theoretically. I thought that recent history results where it improved returns are just artefact.
A real return of 0%, at least when averaged over long periods.. So in years in which inflation's 3%, you'd say gold effectively has a return of 3%, and in years when inflation's 15%, gold could be a very high returning asset.. When and how these returns come along, etc. etc. But when bonds were only available on 1% yields (or TIPS on negative), gold would be a comparatively high returning asset (as in the other cases, you're buying a negative real return).

The perfect diversifier would have some optimum balance of return and low correlation with equities (being that equities are the only things that really grow wealth). Gold's 0% real return isn't all that bad compared to things like bonds and alternatives – and may be especially good when we've got very high global debt (as it's likely there'll be an incentive to keep real yields very low or negative).

But gold's low correlation with equities (and the dollar) is a lot stronger than bonds, especially over long periods (where stock and bond valuations tend to track). So I think even on paper, gold is perhaps as close to a perfect diversifier as you'll get. At least at weightings from 10-20%, which don't tend to subtract significantly from returns, so long as they reduce drawdowns. But gold even at 30%, historically, has done well. Not quite addressed your post, but I think the perfect diversifier would be equity-like returns with negative medium-term correlation with equities. Gold is maybe closer to that ideal than bonds and most other alts.
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konik
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Re: Gold as diversifier

Post by konik »

petulant wrote: Fri Jan 27, 2023 4:45 pm You are starting to reach conclusions that others have thought as well. You can search for other threads on BH about the topic; it has been debated at length between user willthrill81 and others. Suggested search terms would be "willthrill81 gold" and similar things. You can also look for threads on the golden butterfly and permanent portfolios.
Thanks, I read some of that. Still I thought its kinda historic artefact. Now I start to feel there is at least some theoretical basis for that
seajay
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Re: Gold as diversifier

Post by seajay »

UK data for stocks (price only), gold and T-Bills

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Owning a home yields imputed rent benefit, stocks yield dividends, are productive assets, like buying a farm and working the land; Cash (T-Bills) and gold are unproductive assets, similar to buying a farm and leaving it idle.

Varying correlations, where one might inversely correlate to the others, gold did well in the 1970's when stocks and bonds declined. But may all correlate, WW1 years (around 1918) when all three declined. Even when they correlate however they will do so to varying magnitudes and the average of multiples will be better than the worst alone.

If assets don't compound to broadly 0% then they will either rise to being exceptionally expensive, or exceptionally cheap.

Is gold a barbaric relic? Well for centuries gold/silver were money (coins). Investors lent their gold to the state in return for interest (more gold returned). In the 1930's the US convinced others (international trade) to instead use the US dollar, promising to peg the dollar to gold. Which held until the late 1960's (President Nixon who decoupled as a means to pay down the cost of the Vietnam war). But even today, Yellen since 2013 for instance, and gold still is used as a guide to which policies are set to align the dollar with gold (gold price in US dollars since 2013 to recent has broadly been flat).

Multiple assets with the same geometric/compound reward (stock price only, gold, T-Bills ... 0% real) with varying correlations/volatility and rebalancing conceptually captures a higher reward than each/any alone. However in the above case for UK data since 1896 for over the first half of those years 50/50 yearly rebalanced stock (PO) and gold didn't improve rewards, just lowered volatility. Since the 1970's however rebalancing did yield a positive slope. Rebalancing is trading using a automated method/system, where following rebalancing if the prior trend continues it would have been better to not have rebalanced, if the prior trend reverses it was better to have rebalanced. Broadly, across all 30 year periods for instance, and the outcomes of rebalancing versus non rebalanced washed. With non rebalanced you just ended up with a higher weighting in the asset that was the more rewarding asset.

Sharpe Ratio assumes volatility to be risk, whereas volatility can be a benefit/reward - such as if there's high volatility to the upside. If after 30 years yearly rebalanced and non rebalanced achieve the same outcome/reward, but rebalanced did so with less yearly volatility, then some might consider that to be the safer/better choice, however yearly rebalancing requires trading ...cost and tax events. You can reduce costs by minimizing trading, such as by just drawing income from the asset most above target weighting at the time (or adding new savings to the asset most below target weighting), a form of partial-rebalance.

The question should perhaps be do you need to improve the Sharpe Ratio/interim period volatility? Generally that only matters if you're lumping in and out at individual points in time whilst most investors average-in and average-out over many years.
seajay
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Re: Gold as diversifier

Post by seajay »

Assume, as historic measures since 1871 suggest, 50/50 stock/gold (T-Bills pre 1934) lags all-stock by 1% annualized. Similar to 50/50 stock/bonds. In bad case 30 year outcomes the two tending to compare in final portfolio values. In good cases stocks doing significantly better, but where those cases typically started following deep stock price declines. For the average investor 30 year outcomes work out much the same either way. Stock heavy is a lottery ticket that provides much better outcomes for a relatively small set of investors. But that ignores the optionality benefits. In 20% of months the S&P500 price since 1871 (Shiller's data), was at or below 50% down from former inflation adjusted highs. That's a relatively high probability of such a occurrence during each investors investment lifetime. Whilst gold and bonds as the paired asset to stocks generally yielded similar outcomes, at times of when stocks are down a lot, typically when inflation and fear are high, gold is more inclined to have moved counter-direction than bonds. 50 initial stock value that declines to 25, 50 gold value that doubles to 100, and selling gold to buy stock increases the number of shares being held five-fold, where the majority of those shares were bought at discount price. Contrasted with 50 stock halving to 25, 50 bonds remaining unchanged, and selling bonds to buy stock increases the number of shares held three-fold.

Paying (sacrificing) 1%/year as portfolio insurance has a relatively high probability of a claim potentially being made at some point by most investors and where gold as that insurance has the potential to yield a higher insurance claim payout amount than bonds. Central Banks are aware of the need to have such insurance (excepting Canada who have opted to not insure (sold their gold)) as the chances of such insurance being beneficial increases with time.

50/50 stock/gold is too much gold for most, applying the same concept however and 80 stocks halving to 40, 20 gold doubling to 40, and after a 50% decline in stocks you might sell gold to double-up on the number of shares being held. Whilst also reducing the ongoing portfolio insurance cost to zero PV
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firebirdparts
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Re: Gold as diversifier

Post by firebirdparts »

Lots of other threads on this you might enjoy.

Personally I don’t like relying on platitudes to deal with gold (which is what you are doing here) and I really don’t think you should backtest it in dollars starting in 1972 either. I don’t like either of those. I do think it’s okay as a diversifier (good post above), I just don’t go around telling people “gold is [insert platitude here].” I don’t trust that. Gold is “popular” that’s as far as I’ll go. People like it.
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NiceUnparticularMan
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Re: Gold as diversifier

Post by NiceUnparticularMan »

So suppose every year you take 5% of your portfolio and bet it on a coin flip--heads you double, tails you lose it all.

This "investment" will have a 0% expected return. It will have very high volatility of returns. Finally, it will have zero correlation to stocks/bonds.

So, is this "investment" necessarily a good idea?

Figuring out why not was an important exercise in one of the courses I took on finance. I continue to think it is a good exercise.

By the way, I note there is nothing special about gold in these respects. Again, gambling has the same structure. Commodity spot prices generally have the same structure. Collectibles generally have the same structure. There are lots and lots of different things beside gold that could serve the same purpose--if it was a good idea to begin with.

And in fact, there is a possible case for using diversified collateralized commodities futures, captured in this paper:

https://static.vgcontent.info/crp/intl/ ... t-tips.pdf

Vanguard does NOT make the claim there that CCFs will generally improve the efficiency of portfolios as measured by things like Sharpe Ratios. But, they could potentially serve as an unexpected inflation hedge, which is a different concept. That is specific to commodities futures, versus commodity spot prices, because of the much higher Beta to unexpected inflation.

Note gold futures could be a part of the CCF futures basket. But there would be no particular reason to ONLY use gold futures. And as studied in that paper, gold spot prices only would not be a remotely good substitute.

OK, so, no, this is not a good argument for specifically speculating on gold spot prices.

But there is a different argument for CCFs, and gold futures could be in such a basket.
seajay
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Re: Gold as diversifier

Post by seajay »

NiceUnparticularMan wrote: Sat Jan 28, 2023 7:42 am a coin flip--heads you double, tails you lose it all. This "investment" will have a 0% expected return
Martingale - applied to a major stock index. $100 share price, if it falls to a $50 share price (tails) you double up the number of shares you hold, if the share price continues to fall down to a $0 share price (tails again) you lose all, but so has everyone else.

Stake 1 heads outcome, you win (stake 1, returned 2, +1 up).

Stake 1, tails outcome, double up your stake to 2 (double up the number of shares held), followed by a heads outcome (share price recovers back from having declined to $50 to a $100 share price) ... and you're ahead (staked 3, returned 4, won 1).

Tails, Tails ... and the major stock index (S&P500) has failed.

80% in stock, 20% in gold and the circumstances that induce stocks to halve (80 falling to 40) such as high inflation/interest rates/weakened currency/fear, are inclined to have seen the price of gold move counter-direction (20 doubles to 40), facilitating gold being sold to double up on the number o stock shares being held).

d'Alembert devised a less aggressive approach, increase the stake by 1 after each losing play, but in the context of the above, defined with finite losing runs, they're the exact same.

With d'Alemberts ...

Stake 1, lose
Stake 2, lose
Stake 3, win ... in total staked 6, won back 6, break-even despite having 2 losing flips, just 1 winning flip.
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burritoLover
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Re: Gold as diversifier

Post by burritoLover »

If you really wanted to invest in precious metals, why would you restrict yourself to gold exclusively? A diversified basket of precious metals would make more sense (say equal weighted and rebalanced periodically).
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Watty
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Re: Gold as diversifier

Post by Watty »

You need to be very careful about reading about gold on this message board or other places on the internet. The problem is that people with a reasonable case against gold will see threads like this and just think, "Another gold thread." and skip over it. The people who agree with owning gold are more likely to respond. You may see that 90% of the people that respond agree that owning gold is a good idea and think that is the consensus when it is not. Some people who think owning gold is a good idea are also very vocal about it which also tends to prevent there being a balanced discussion about it.
konik wrote: Fri Jan 27, 2023 4:37 pm Until recently I thought that since gold has long term expected return of 0% it has no use in portfolio theoretically.
Just a quibble but owning gold has costs so the expected long term return is negative.

For example the GLD ETF had an expense ratio of 0.4% or if you own physical gold you will pay for someone to store it or if you store it yourself you will need to pay for insurance or at least adjust for the risk that it could be stolen or destroyed in a house fire.

There will also be a spread between what you can buy gold for and what you can sell it for. For example you might buy physical gold at a bit more than the spot price, when you sell it you might sell it at a bit less than the spot price. Even when you buy a gold ETF there is a small spread in the buying and selling price too.

If gold exactly keeps up with inflation then when you sell it from a taxable account you will also need to pay capital gains taxes on the increase due to inflation. For example if you buy $1,000 worth of gold and hold it until it sells for $2,000 in inflated dollars then you will pay the capital gains taxes on the $1,000 gain.

There are lots of ways these numbers can work out but it would be easy to be in a situation where you buy gold and hold gold for 20 years then sell when the price of gold has just kept up with inflation but still find that it costs you 20% or more to have owned it for 20 years.

Many of the backtests of owning gold in a portfolio are based on the spot price of gold which does not include these costs so watch out for that.

I do not own any gold as an investment but the best argument I have seen for it is more for insurance for financial collapse or to use physical gold to flee as a refugee. In prior threads about gold people have posted stories of relatives who used gold to help flee Nazi Germany or Vietnam.

If you are tempted by gold because it has a long term return that is 0% so it can be used as a diversifier then run the same math with individual TIPS which might work better at least in a retirement account where taxes are not an issue. Depending on the maturity date they have a real yields of around 1.2%.

It would also be good to be cautious when looking at gold since it has a lot of natural appeal which can cloud your judgement. Not that I think it would be a good idea but if you are looking at gold as a commodity then there are dozens of other commodities you could invest in so you need to ask yourself why you are attracted to buy gold and did not even consider buying something like zinc for diversification.
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konik
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Re: Gold as diversifier

Post by konik »

NiceUnparticularMan wrote: Sat Jan 28, 2023 7:42 am So suppose every year you take 5% of your portfolio and bet it on a coin flip--heads you double, tails you lose it all.

This "investment" will have a 0% expected return. It will have very high volatility of returns. Finally, it will have zero correlation to stocks/bonds.

So, is this "investment" necessarily a good idea?
In your example arithmetic mean is 0, not geometric one - thats the big difference. Assets with 0 arithmetic mean return and 0 correlation indeed do not add anything useful to portfolio.
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konik
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Re: Gold as diversifier

Post by konik »

Watty wrote: Sat Jan 28, 2023 9:03 am You need to be very careful about reading about gold on this message board or other places on the internet. The problem is that people with a reasonable case against gold will see threads like this and just think, "Another gold thread." and skip over it. The people who agree with owning gold are more likely to respond. You may see that 90% of the people that respond agree that owning gold is a good idea and think that is the consensus when it is not. Some people who think owning gold is a good idea are also very vocal about it which also tends to prevent there being a balanced discussion about it.
konik wrote: Fri Jan 27, 2023 4:37 pm Until recently I thought that since gold has long term expected return of 0% it has no use in portfolio theoretically.
Just a quibble but owning gold has costs so the expected long term return is negative.

For example the GLD ETF had an expense ratio of 0.4% or if you own physical gold you will pay for someone to store it or if you store it yourself you will need to pay for insurance or at least adjust for the risk that it could be stolen or destroyed in a house fire.

There will also be a spread between what you can buy gold for and what you can sell it for. For example you might buy physical gold at a bit more than the spot price, when you sell it you might sell it at a bit less than the spot price. Even when you buy a gold ETF there is a small spread in the buying and selling price too.

If gold exactly keeps up with inflation then when you sell it from a taxable account you will also need to pay capital gains taxes on the increase due to inflation. For example if you buy $1,000 worth of gold and hold it until it sells for $2,000 in inflated dollars then you will pay the capital gains taxes on the $1,000 gain.

There are lots of ways these numbers can work out but it would be easy to be in a situation where you buy gold and hold gold for 20 years then sell when the price of gold has just kept up with inflation but still find that it costs you 20% or more to have owned it for 20 years.

Many of the backtests of owning gold in a portfolio are based on the spot price of gold which does not include these costs so watch out for that.

I do not own any gold as an investment but the best argument I have seen for it is more for insurance for financial collapse or to use physical gold to flee as a refugee. In prior threads about gold people have posted stories of relatives who used gold to help flee Nazi Germany or Vietnam.

If you are tempted by gold because it has a long term return that is 0% so it can be used as a diversifier then run the same math with individual TIPS which might work better at least in a retirement account where taxes are not an issue. Depending on the maturity date they have a real yields of around 1.2%.

It would also be good to be cautious when looking at gold since it has a lot of natural appeal which can cloud your judgement. Not that I think it would be a good idea but if you are looking at gold as a commodity then there are dozens of other commodities you could invest in so you need to ask yourself why you are attracted to buy gold and did not even consider buying something like zinc for diversification.
Thanks for all the points, all of them are perfectly reasonable. If I would invest in gold (which i do not now) I would buy some ETFs, not physical one. The reason to choose gold and not zinc is just availability to retail investor.
NiceUnparticularMan
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Re: Gold as diversifier

Post by NiceUnparticularMan »

seajay wrote: Sat Jan 28, 2023 8:13 am applied to a major stock index.
Stocks are ownership shares in businesses where the ultimate source of returns is a share of business profits. Over the short term, the price of stocks can vary due to changes in expectations about future profits, expected risks around future profits, general discount rates, and so on. Over the long term, the returns on stocks will be determined by actual business profits.

An individual business faces all sorts of risks, but when you own shares of many businesses in the same industry you end up exposed only to the risks systematic to that industry. Like, if Business A in this industry fails for some specific reason, that just means more market opportunities for Businesses B through Z.

If you then own shares of many businesses in many industries, you end up exposed only to the risks systematic to the industrial economy as a whole, aka market risk.

Modern stock theory suggests that the risk associated only with an individual business, or only a specific industry, or so on, is uncompensated by a risk premium precisely because it can be eliminated through diversification. That is sometimes called idiosyncratic risk, and the idea is you get risk premiums only for systematic, aka undiversifiable, risks, and not idiosyncratic, aka diversifiable, risks.

Diversification is therefore a type of "free lunch" in that given these assumptions, you can increase the risk-adjusted returns of your portfolio with diversification, as long as diversification is reducing and not increasing your exposure to idiosyncratic risk.

OK, so commodities producers are represented in broad stock indices, and so if you invest in broad stock indices you already have some investment in commodity production.

Again if you want to hedge against unexpected inflation, you might consider CCFs too.

Selecting out some one commodity would be taking on idiosyncratic risk specific to that commodity. Since you could diversify across commodities instead, there is no reason to expect that sort of risk-taking would be compensated.

This analysis applies to gold. But also to silver. Or copper. Or sugar. Or crude oil. Or whatever single commodity you might choose.

A diversified investment in commodity producers as part of a diversified investment in stocks in general is very likely a good idea. A diversified investment in commodities futures as a hedging strategy might be a good idea. But a concentrated bet on some one commodity isn't justifiable as a diversification strategy.
Logan Roy
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Re: Gold as diversifier

Post by Logan Roy »

NiceUnparticularMan wrote: Sat Jan 28, 2023 7:42 am So suppose every year you take 5% of your portfolio and bet it on a coin flip--heads you double, tails you lose it all.

This "investment" will have a 0% expected return. It will have very high volatility of returns. Finally, it will have zero correlation to stocks/bonds.

So, is this "investment" necessarily a good idea?
'Real return'. If it keeps track with inflation over long periods, its average return will be something like 4%.

The average yield on 10 year bonds has been something like 5% – although for about 70% of the past century, you haven't been able to buy 10yrs on yields that high.

So you give up a bit of return, but you get more of a diversification benefit. That's the way I'd look at it. Stocks and bonds often have a useful inverse relationship around recessions, but longer-term, their valuations tend to track (Bond Equity Earnings-yield Ratio). So bonds are very good for smoothing out volatility, but they're not great diversifiers. The best time to buy bonds (e.g. 1982-ish) is usually an even better time to buy stocks. But that was also the worst time to buy gold. That's partly why gold works so well in practice.
Morik
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Re: Gold as diversifier

Post by Morik »

My thoughts on various things related to gold:
- Why gold and not other precious metals: Cost. Many other metals take up a lot more volume/weight per unit of value. The exceptions are Rhodium/Palladium/Iridium.
- What form to hold: Physically backed gold ETFs in my opinion: you probably pay less in transaction costs than buying/selling physical gold yourself, you do have to pay them for admin/storage but it is fairly cheap if you pick the cheaper ETFs. Not a fan of gold futures because various events can cause significant deviation between the futures contract prices and the underlying price. I.e., futures seem to have more tracking error, sometimes significantly so, compared to physically backed gold ETFs. Of course there is some risk with the physically-backed ETFs that the vault is robbed/destroyed, and risk of fraud/failure of the trustee to act appropriately. On balance though I think physically backed ETFs are the way to go. If worried about the trustee consider diversifying across several different gold ETFs that have vaults in different locations & use different trustees. Personally I don't currently do this (I just hold IAUM), but might consider doing so in the future.

I think gold is a useful diversifier, especially during decumulation.

Some further reading:
https://portfoliocharts.com/2021/12/16/ ... ortfolios/
https://portfoliocharts.com/2020/08/21/ ... e-of-gold/
https://portfoliocharts.com/2021/03/02/ ... he-matrix/
NiceUnparticularMan
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Re: Gold as diversifier

Post by NiceUnparticularMan »

konik wrote: Sat Jan 28, 2023 9:39 am In your example arithmetic mean is 0, not geometric one - thats the big difference. Assets with 0 arithmetic mean return and 0 correlation indeed do not add anything useful to portfolio.
That is actually a bit complicated because you are not wagering a fixed amount, you are wagering 5% of your portfolio.

But generally, I am aware of long-term studies suggesting diversified commodities futures might have an arithmetic mean expected return that is greater than 0% real, and in fact a geometric mean expected return that is also greater than 0% real but less than the arithmetic mean. Unfortunately, their correlation is not a reliable zero-to-negative with stocks/bonds, and an unexpectedly large positive correlation with stocks/bonds over a recent period (but not the most recent period) helped depopularize CCFs as an asset class. But they might have zero or negative correlations in certain circumstances where it would be helpful, as in fact we just saw in the very most recent period.

I am not aware of a good reason to consider investing in anything other than diversified commodities futures for this purpose. Although this can also vary in different periods, generally spot returns net of storage costs are lower than comparable futures returns. And generally diversification of commodities strategies seems to improve portfolio results.
smooth_rough
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Re: Gold as diversifier

Post by smooth_rough »

Gold is erratic. Might want to consider 3 ETFs, gold silver platinum. They will all peform differently. Invest equal amounts for 10 years, and see what happens? Or Aberdeen ETF gltr will do that for you.
halfnine
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Re: Gold as diversifier

Post by halfnine »

Across countries gold has mitigated the disastrous effects of the far left tails. The fee one pays for this "insurance" are the far right tails. At this point in my investing career it's insurance I am willing to pay for.
seajay
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Re: Gold as diversifier

Post by seajay »

Watty wrote: Sat Jan 28, 2023 9:03 amthere are dozens of other commodities you could invest in so you need to ask yourself why you are attracted to buy gold and did not even consider buying something like zinc for diversification.
Because states more commonly base their currency on gold. Pre 1930's and gold/silver were money - coins. Individuals lent that gold to the state in return for interest (more gold). From the 1930's the US managed to convince others to trade in dollars instead of gold, on the promise that it would peg the US dollar to gold. That faltered in the late 1960's when President Nixon was struggling with paying down the cost of the Vietnam war. More recently however Yellen, since 2013 has again attempted at least in part to broadly peg the dollar to gold. In the absence of such trust/faith is inclined to be lost. The British Pound started back in the 700's as a Saxon pound weight of silver, for larger amounts however and it was easier to carry/move lighter amounts of gold around than silver. Warren Buffett’s Berkshire Hathaway 1997/1998 purchased 129,710,000 ounces of silver bullion.

Nowadays states don't accept gold as loans, instead you are expected to sell gold into dollars and lend those dollars to the state, where the interest is taxed, costs are involved and where inflation is just another form of taxation. In so doing there's a risk that upon maturity of the loan the total amount of dollars returned may not even buy as much gold as when you started the loan. Indeed states don't need to borrow your dollars/pounds/whatever, as they can just print/spend them. Even banks no longer need to match depositors with lenders - they can just create debt out of thin air.

Gold is a non-fiat monetary metal, and has been for millennia. Zinc is a commodity. The reasoning for gold being a monetary metal is down to its scarcity, and its qualities of not rusting, being solid rather than liquid/gaseous, and not inclined to kill you - unlike some other possible alternative elements. As a non-fiat money the tendency is for it to maintain its purchase power even if buried for centuries. Unlike fiat money where unless you invest and compound those gains purchase power is more inclined to be lost over time. The purchase power however has been volatile, such as how many Dow stock index shares gold might have bought - Dow/Gold ratio since the 1930's ...

Image

At times little over a single ounce of gold bought a Dow stock index share, at other times it cost 40 ounces. Given such volatility a reasonable choice is to hold some of both and periodically rebalance.
seajay
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Re: Gold as diversifier

Post by seajay »

halfnine wrote: Sat Jan 28, 2023 11:25 am Across countries gold has mitigated the disastrous effects of the far left tails. The fee one pays for this "insurance" are the far right tails. At this point in my investing career it's insurance I am willing to pay for.
The far right tails tend to arise out of start dates following/at far left tail dates. Unless you bought in at such times then all-stock will just ride the up's/down's and tend to compound to similar overall rewards as less aggressive asset allocations. When holding gold and stocks dive during ones investment years then the option of being able to sell gold and buy stock at least in part directly captures that potential bought at left tail - right tail case outcome that a all-stock'er in the absence of additional new capital misses. At 80/20 type stock/gold levels, the insurance price can be zero (free)

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Re: Gold as diversifier

Post by Anon9001 »

I recently done a Monte Carlo Simulation where I assumed Annual Returns of all Assets I compared were following Log-Normal Distribution (To be more Precise Annual Gain Factors or Annual Return Relatives i.e. (1+Returns) instead of the Returns Directly as Logs cannt be taken of Negative Values which Returns can sometimes be). The correlations I assumed for Gold, Bonds in relation to Stocks was 0 and the Real Geometric Mean or Real Arithmetic Mean of Log Returns I entered for Gold and Bonds was 0% and 1.5% respectively. I used the Historical Standard Deviation of Log Returns as the Standard Deviation of the Log-Normal Distribution for all Assets.

Not suprisingly the Portfolios with Gold done worse than the Portfolios with Bonds. If I were to assume though similar real returns for Gold and Bonds I suspect there would be no difference between the two.
Last edited by Anon9001 on Mon Jan 30, 2023 11:23 am, edited 3 times in total.
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konik
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Re: Gold as diversifier

Post by konik »

Anon9001 wrote: Sat Jan 28, 2023 2:34 pm I recently done a Monte Carlo Simulation where I assumed Annual Returns of all Assets I compared were following Log-Normal Distribution. The correlations I assumed for Gold, Bonds in relation to Stocks was 0 and the Real Geometric Mean or Real Arithmetic Mean of Log Returns I entered for Gold and Bonds was 0% and 1.5% respectively. I used the Historical Standard Deviation of Log Returns as the Standard Deviation of the Log-Normal Distribution for all Assets.

Not suprisingly the Portfolios with Gold done worse than the Portfolios with Bonds. If I were to assume though similar real returns for Gold and Bonds I suspect there would be no difference between the two.
What about all three combined?
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Re: Gold as diversifier

Post by seajay »

Anon9001 wrote: Sat Jan 28, 2023 2:34 pm I recently done a Monte Carlo Simulation where I assumed Annual Returns of all Assets I compared were following Log-Normal Distribution. The correlations I assumed for Gold, Bonds in relation to Stocks was 0 and the Real Geometric Mean or Real Arithmetic Mean of Log Returns I entered for Gold and Bonds was 0% and 1.5% respectively. I used the Historical Standard Deviation of Log Returns as the Standard Deviation of the Log-Normal Distribution for all Assets.

Not surprisingly the Portfolios with Gold done worse than the Portfolios with Bonds. If I were to assume though similar real returns for Gold and Bonds I suspect there would be no difference between the two.
From 1791 (and earlier) gold was pretty much 20 USD right up to 1932 and was legal tender (gold coins as currency, alongside silver). Was cash-in-hand. Investors might have invested it, such as lending it to the state/holding bonds, for the interest that provided.

The US compulsory purchased all gold in 1933, and later set up international agreement to adopt the dollar for international trade and that it would peg the dollar to gold. As such investors might have continued to have held bonds. In the late 1960's/early 1970's there were indications that the gold backing of dollar was coming to a end. Investors had two choices, continue to hold bonds, or to buy gold. But gold is somewhat like T-Bills, which instead of being held alone might be barbell'd with long dated treasuries - where a T-Bill and 20 year Treasury barbell is similar to a 10 year treasury bullet, but for gold a reasonable partner to that is stocks, 50/50 stock/gold barbell.

For much of history bonds and gold were the same, at least from a investor perspective and as such might have assumed same/comparable rewards (1.5% in your case). From the late 1960's/early 1970's however and its reasonable to assume a 50/50 stock/gold barbell versus 1 and 20 year Treasury barbell as the comparison indicator, which yielded 1.7% annualised more for stock/gold compared to TBM (log linear regression), but with higher volatility, might broadly be considered as again being comparable.
I suspect there would be no difference between the two.
Generally I concur - when combined with other assets. 50/50 TSM/TBM versus 75/25 TSM/Gold for instance. However the latter of those two is more inclined to see higher volatility and as such potentially yield a higher reward in reflection of that 'higher risk'. Dialling down the risk, thirds each stock/gold/bonds is more comparable to 50/50 TSM/TBM in both risk (volatility) and reward.

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Re: Gold as diversifier

Post by DesertDiva »

Watty wrote: Sat Jan 28, 2023 9:03 am
I do not own any gold as an investment but the best argument I have seen for it is more for insurance for financial collapse or to use physical gold to flee as a refugee. In prior threads about gold people have posted stories of relatives who used gold to help flee Nazi Germany or Vietnam.
Thus, the recommended amount of gold to own is “no more than you can swim with” :twisted:
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Re: Gold as diversifier

Post by GRP »

William Bernstein’s take:
…the return of both bullion and PME has a zero correlation with almost any other asset you might want to name. It is a superb hedge against inflation, which cannot be said of almost all other reasonably liquid assets.
http://www.efficientfrontier.com/ef/197/preci197.htm

Buy gold.
Almost nothing turns out as expected.
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Re: Gold as diversifier

Post by enad »

To me it only makes sense to buy gold when it's low. If you're buying near or at the top of the current cycle it could be years before you can sell again just to break even but you'll have still lost purchasing power.

Chuck Woolery did a commercial pushing the purchase of gold back in 2020 (these commercials come out in large numbers whenever the stock market is having an off year) and contrasted a contestant named Lee who won $12,800 in cash back in 1976. He showed that if the money were held in a safe for 45 years it'd still be $12,800 but have much less purchasing power than it had in 1976, but the $12,800 worth of gold would be worth $135,000. The problem is that people probably would not keep the money in the safe (or mattress) but in a bank earning interest over all these years. Contrast the $12,800 in cash, to $12,800 in Gold to $12,800 in a US Stock (mutual) fund and the results would show that holding the US Stock Market would be a far better investment over the last 47 years. Since 1976 gold returned 5.375% interest but for many of those years "cash" was better, but the US Stock Market was truly the way to go for long periods
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Re: Gold as diversifier

Post by petulant »

enad wrote: Sat Jan 28, 2023 6:40 pm To me it only makes sense to buy gold when it's low. If you're buying near or at the top of the current cycle it could be years before you can sell again just to break even but you'll have still lost purchasing power.
Don't gamble; take all your savings and buy some [gold] and hold it till it goes up, then sell it. If it don't go up, don't buy it. - Will Rogers
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Re: Gold as diversifier

Post by Anon9001 »

konik wrote: Sat Jan 28, 2023 4:51 pm What about all three combined?
I havent tested this as I wanted to see if Gold could substitute for Bonds if the Return Assumed was lower than Bonds. I will do this later if I have the time.

I forgot to mention that even at max the benefit was only a 18% higher Ending Portfolio Balance than the Portfolios which contained Gold. The Gold Allocation in the Portfolios was 30% same as the Bond allocation in the Portfolios.

Also the simulations are done for me Indian Investor so they contain a sizeable (50%) exposure to Indian Equity which I am assuming are having a 0.6 correlation with US Equities and 0.7 correlation with Global Equities. For Bonds and Gold like I stated earlier correlation assumed is 0. The volatility I assumed for Indian Equities is the Historical Volatility of Annual Log Returns of Sensex TRI from 2001-2022. The Real Return I assumed for Sensex, USA and Global are 3.2%, 3.8% and 3.7% respectively.
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Re: Gold as diversifier

Post by Phyneas »

What are the allocation bandwidths for gold in a portfolio that make it useful? There must be lower and upper limits, and proportionality to the relative stock/bond mix of the particular portfolio.
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Re: Gold as diversifier

Post by Northern Flicker »

konik wrote: Fri Jan 27, 2023 4:37 pm Hi all!

Until recently I thought that since gold has long term expected return of 0% it has no use in portfolio theoretically. I thought that recent history results where it improved returns are just artefact.

Now I understood that its average compound return is expected to be 0, i.e. geometric mean of returns. Arithmetic mean is larger, especially since gold has high volatility, so gold has positive expected annual return.

Since Sharpe ratio takes into account arithmetic returns, it will be improved when adding gold if we simplistically accept that correlations with stocks and bonds are zero.

Am I generally correct?
You would do well to ignore arithmetic means of return. It is not a useful concept. It gets used as an artificial, straw man approximation for annualized return for little purpose other than to critique it, and pretend that instead computing annualized return correctly is some revelation and enlightenment.

Gold has a long term expected real return of zero. But it also has high volatility.
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Re: Gold as diversifier

Post by konik »

Northern Flicker wrote: Sun Jan 29, 2023 1:51 am
You would do well to ignore arithmetic means of return. It is not a useful concept. It gets used as an artificial, straw man approximation for annualized return for little purpose other than to critique it, and pretend that instead computing annualized return correctly is some revelation and enlightenment.

Gold has a long term expected real return of zero. But it also has high volatility.
Except that its's arithmetic mean that is used in all kinds or return/risk ratios, like Sharpe, Sortino, Omega, etc. Compounding is not important when you construct a portfolio. To find the most risk-rewarding asset allocation you need to use arithmetic means.
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Re: Gold as diversifier

Post by seajay »

Northern Flicker wrote: Sun Jan 29, 2023 1:51 am Gold has a long term expected real return of zero. But it also has high volatility.
Ditto house/land and stock prices, and artworks etc. If the longer term real (price only) returns were negative the assets value would fade towards zero. If real returns were positive then the assets value would rise to extreme levels. Generally buyers buy such assets for similar reasons to why the seller originally purchased the assets.

Take a period when money was gold (coins), early 1890's up to the early 1930's. S&P500 (Shiller's data) indicates stock nominal price only was broadly flat, but with high volatility. As was CPI broadly flat but volatile. The price of gold remained perfectly flat. With finite gold money (gold) isn't inclined to inflate (devalue). People however would have been less inclined to hold large amounts of gold coins/money in-hand however, and instead might have lent that gold/money to the state in return for interest. Arithmetic average for Treasuries 3.7%, whilst stock dividend yields averaged 5.1%. Investors around that time might have concluded that 50/50 stocks/money (Treasuries/bonds) yearly rebalanced to be a reasonable choice of asset allocation - as a combination of both high and low volatility assets.

From the early 1930's the US (and UK) decoupled direct convertibility between gold and money (cash/notes). The US also incited others to adopt the US dollar as the international trading currency instead of gold, agreeing to peg the US dollar to gold as part of that. Easier to transfer/balance notes than moving gold (London being the global hub physically moved bars of gold between individual cages allocated to each country). But that promise to keep the dollar pegged to gold faltered, and by 1968 each of inflation, treasuries and the price of gold had around doubled. In effect the price of gold still remained generally flat.

From the late 1960's to early/mid 1970's, the dollar was completely disconnected from gold, the promise to peg it to gold was ended. Faith/trust was broken and inflation soared such that interest rates also spiked sharply upwards. Stocks and bonds declined. But following that 'reset' faith/trust started to return, things calmed down and from such low 1970's/1980's prices (high interest rates) for the next couple of decades was a great time for investors in bonds and stocks. However as with all fiat currencies, sooner or later faith/trust is brought into question. 2004 through 2010 (dot com and 2008/9 financial crisis) and gold in US dollar soared. As of 2013 Yellen started pushing for the US dollar to be more aligned with gold, such that since 2013 the price of gold in US dollars has broadly remained relatively flat.

Gold in part is a non-fiat commodity currency that plays-off against fiat currency. Whether you consider gold or fiat-currency to have high volatility is just a matter of perspective. Oil for instance priced in dollars has been very volatile historically, priced in ounces of gold and the price has been much less volatile.

Pre 1930's and savers/investors might have been perfectly content to just hold gold (coins), deposited with the state that paid interest and where broadly inflation was flat. Bond yields were in effect real rates of returns, stocks were for speculators. But states opted to remove that stability/benefit. Investors/savers might subsequently looked to hedge that risk, such that 50/50 US dollars - claimed to be pegged to gold and actual gold might have been a reasonable choice, but given you couldn't hold gold in the US by law, bonds were the next best alternative, a continuation of historical preference. From the late 1960's/early 1970's however and with no alignment of the US dollar to gold remaining at all, a reasonable choice would have been to opt for 50/50 US dollars (invested in stocks) and gold fiat/non-fiat currencies. Up to 2013 and 50/50 stock/gold broadly compared in total return to 100% stock.

Over the most recent decade and internationally TINA ... there is no alternative to trading using the US dollar, has been more brought into question. The BRIC's for instance along with others (Arabia, Europe etc.) are looking at possible alternatives, special drawing right and other baskets. In awareness of that Yellen has sought to broadly peg the dollar to such baskets, that include gold.

Whilst owning land or a home, or stocks have additional benefits, worked land/imputed rent/dividends, gold like bonds is more like buying a farm and leaving it idle, a tendency to see just the price appreciation (inflation) offset along. Unlike land, or bonds however, gold has the tendency to spike when stocks/bonds/land prices are in sharp decline, and that is where gold tends to provide 'dividends'. 2008 for instance, when stocks dropped 37% nominal total return whilst gold gained 5%, 50/50 stock/gold where that gold was sold to buy stock shares - increased the number of shares being held to 2.7 times more shares being held. Call that what you like, hedging, insurance, optionality the cost can be low for that insurance, maybe even zero. 1972 to recent for instance and 50/50 stock/gold yearly rebalanced yielded the same total return as all-stock, whilst there were a number of opportunities across those years to make-a-insurance-claim (sell gold to buy shares) which if so made would have tended to result in higher total returns overall.
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Re: Gold as diversifier

Post by firebirdparts »

Phyneas wrote: Sun Jan 29, 2023 1:42 am What are the allocation bandwidths for gold in a portfolio that make it useful? There must be lower and upper limits, and proportionality to the relative stock/bond mix of the particular portfolio.
For sure, there is a big line in the sand at 25% set by original simple concepts of “all weather”. However, Up to 40 or 50 is not really bad in my opinion if somebody just didn’t have any bonds at all and just had stocks and gold. To each his own there. If you have more gold than stocks, I would say that is fringe.

The lower bound to me is 10. That’s just me. Any less and it’s not doing anything.
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Re: Gold as diversifier

Post by petulant »

Anon9001 wrote: Sat Jan 28, 2023 11:34 pm
konik wrote: Sat Jan 28, 2023 4:51 pm What about all three combined?
I havent tested this as I wanted to see if Gold could substitute for Bonds if the Return Assumed was lower than Bonds. I will do this later if I have the time.

I forgot to mention that even at max the benefit was only a 18% higher Ending Portfolio Balance than the Portfolios which contained Gold. The Gold Allocation in the Portfolios was 30% same as the Bond allocation in the Portfolios.

Also the simulations are done for me Indian Investor so they contain a sizeable (50%) exposure to Indian Equity which I am assuming are having a 0.6 correlation with US Equities and 0.7 correlation with Global Equities. For Bonds and Gold like I stated earlier correlation assumed is 0. The volatility I assumed for Indian Equities is the Historical Volatility of Annual Log Returns of Sensex TRI from 2001-2022. The Real Return I assumed for Sensex, USA and Global are 3.2%, 3.8% and 3.7% respectively.
From your previous post, it's not clear how you modeled bonds and gold. Did you model them with purely real returns, or did you model them with nominal returns and a separate inflation parameter?

Did you model them as completely alternative options, i.e. stocks+gold and stocks+bonds? Or did you allow the model to select among all three?
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Re: Gold as diversifier

Post by Anon9001 »

petulant wrote: Sun Jan 29, 2023 6:23 am From your previous post, it's not clear how you modeled bonds and gold. Did you model them with purely real returns, or did you model them with nominal returns and a separate inflation parameter?

Did you model them as completely alternative options, i.e. stocks+gold and stocks+bonds? Or did you allow the model to select among all three?
Pure Real Returns. Not sure what is the need for a seperate inflation parameter? I have seen people do that in their MCS and I am not sure what is the logic there.

As per the second question completely alternative options. I wanted to see if Gold could replace Bonds in the Portfolio. I might see later if it adds value if added to a Portfolio containing both Stocks and Bonds.
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Re: Gold as diversifier

Post by rockthisworld »

"Gold is money, everything else is credit"
-JP Morgan to congress in 1912

JP Morgan was not stating an opinion but a monetary fact. Gold is the ultimate diversifier due to having no counterparty risk and the broadest base of buyer. It has been money for thousands of years. All central banks hold gold in reserves and it is a tier 1 asset as defined by basel III.

Having a percentage of wealth held independent of the fiat system seeing as the purchasing power continues to decline in fiat currency and that the usd strength as seen in usd index is due to relative strength vs other declining fiat currencies.
Some experts reccommend 5-10% in gold. Some feel etf is diversification others will say it must not be paper derivitives but physical.
Others have full faith and credit in this debt based system and dont believe gold as being a long term store of value.
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Re: Gold as diversifier

Post by petulant »

Anon9001 wrote: Sun Jan 29, 2023 7:19 am
petulant wrote: Sun Jan 29, 2023 6:23 am From your previous post, it's not clear how you modeled bonds and gold. Did you model them with purely real returns, or did you model them with nominal returns and a separate inflation parameter?

Did you model them as completely alternative options, i.e. stocks+gold and stocks+bonds? Or did you allow the model to select among all three?
Pure Real Returns. Not sure what is the need for a seperate inflation parameter? I have seen people do that in their MCS and I am not sure what is the logic there.

As per the second question completely alternative options. I wanted to see if Gold could replace Bonds in the Portfolio. I might see later if it adds value if added to a Portfolio containing both Stocks and Bonds.
In real life the incidence of inflation and nominal returns will be different, which will affect the value of both gold and bonds differently based on their correlation with inflation (if any) and their different respective volatility characteristics. There are also implications for how you define the volatility parameters in the simulation. Most volatility data assumes a nominal return series. If this was not adjusted, you could be getting wrong results (using nominal volatility but real returns).

To illustrate, I got onto the simba backtesting spreadsheet (mine is still version 18b) and added new columns of data for "real intermediate treasuries," "real gold," and "real (S&P 500) stocks." For the data, I used a formula in the cells to divide the nominal return for each asset class by the inflation to get a real return. (If inflation is CPI and nominal return is NR, since the returns are given in single digit numbers rather than percentage values, the formula would be ((100+NR)/(100+CPI)-1)*100.) The simba spreadsheet always reports standard deviation in nominal terms, so this allows me to compare the nominal standard deviation for these asset classes with the real standard deviation (since by using a real return series and making no adjustment to the standard deviation, it should turn out to be the "real" standard deviation). The standard deviation for S&P 500 stocks for 1970-2018 is 16.93 nominal and 16.8 real. For intermediate treasuries, it's 7.25 nominal and 7.85 real. For gold, it's 27.64 nominal and 24.15 real. So you can see, the adjustment didn't change stocks much at all, but it actually makes bonds more volatile and gold less volatile, all with different magnitudes.

One also wonders about the asset class correlations you assumed (if you made an assumption).
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Re: Gold as diversifier

Post by Northern Flicker »

konik wrote: Sun Jan 29, 2023 3:17 am
Northern Flicker wrote: Sun Jan 29, 2023 1:51 am
You would do well to ignore arithmetic means of return. It is not a useful concept. It gets used as an artificial, straw man approximation for annualized return for little purpose other than to critique it, and pretend that instead computing annualized return correctly is some revelation and enlightenment.

Gold has a long term expected real return of zero. But it also has high volatility.
Except that its's arithmetic mean that is used in all kinds or return/risk ratios, like Sharpe, Sortino, Omega, etc. Compounding is not important when you construct a portfolio. To find the most risk-rewarding asset allocation you need to use arithmetic means.
Don't use any statistic in absolute terms if it uses arithmetic mean of return. Garbage in, garbage out.

I think trying to optimize risk-adjusted return based on past data is a fool's errand due to sample bias of historical data. I assume that the market has priced risk well for efficient markets, and future return is unpredictable. (Whether the gold market is efficient is debatable). If I use portfolio optimization techniques, they exclusively will be minimizing a risk measure.
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Re: Gold as diversifier

Post by konik »

Northern Flicker wrote: Sun Jan 29, 2023 2:24 pm
konik wrote: Sun Jan 29, 2023 3:17 am
Northern Flicker wrote: Sun Jan 29, 2023 1:51 am
You would do well to ignore arithmetic means of return. It is not a useful concept. It gets used as an artificial, straw man approximation for annualized return for little purpose other than to critique it, and pretend that instead computing annualized return correctly is some revelation and enlightenment.

Gold has a long term expected real return of zero. But it also has high volatility.
Except that its's arithmetic mean that is used in all kinds or return/risk ratios, like Sharpe, Sortino, Omega, etc. Compounding is not important when you construct a portfolio. To find the most risk-rewarding asset allocation you need to use arithmetic means.
Don't use any statistic in absolute terms if it uses arithmetic mean of return. Garbage in, garbage out.

I think trying to optimize risk-adjusted return based on past data is a fool's errand due to sample bias of historical data. I assume that the market has priced risk well for efficient markets, and future return is unpredictable. (Whether the gold market is efficient is debatable). If I use portfolio optimization techniques, they exclusively will be minimizing a risk measure.
Maybe i did not clarify my thesis well enough. What I'm saying (and want to be critised):
1) Long-term gold geometric mean real return is zero, which is reasonable either way u look at gold like currency or commodiity. Yes, history supports this view, but its actually theoretical very reasonable.
2) It's mathematically inevitable then that arithmetic mean is positive due to gold's non-zero volatility.
3) An asset with positive arithmetic mean real and zero correlations to stocks and bonds is useful part of portfolio if risk-adjusted returns are considered.

Only two assumptions are made here: zero long-term compound return and zero correlation to stocks and bonds. While they both can be challenged, my initial question was whether the logic in this 3 bullets correct, if we assume these assumptions are true.
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Re: Gold as diversifier

Post by Northern Flicker »

I believe what you are trying to get at is that while gold has an expected real return of zero, because it is volatile and has had low correlation with equities, it may contribute to a rebalancing premium as a source of real return in a portfolio.
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Re: Gold as diversifier

Post by konik »

Northern Flicker wrote: Sun Jan 29, 2023 5:53 pm I believe what you are trying to get at is that while gold has an expected real return of zero, because it is volatile and has had low correlation with equities, it may contribute to a rebalancing premium as a source of real return in a portfolio.
Yes, I think so
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Re: Gold as diversifier

Post by seajay »

firebirdparts wrote: Sun Jan 29, 2023 6:10 am
Phyneas wrote: Sun Jan 29, 2023 1:42 am What are the allocation bandwidths for gold in a portfolio that make it useful? There must be lower and upper limits, and proportionality to the relative stock/bond mix of the particular portfolio.
For sure, there is a big line in the sand at 25% set by original simple concepts of “all weather”. However, Up to 40 or 50 is not really bad in my opinion if somebody just didn’t have any bonds at all and just had stocks and gold. To each his own there. If you have more gold than stocks, I would say that is fringe.

The lower bound to me is 10. That’s just me. Any less and it’s not doing anything.
+1

90/10 stock/gold (as a alternative to Buffett's stock/T-Bills), and if stock prices have halved, gold doubled, you have the option to sell gold to add 44% more shares than already held, whilst the general drag of 90% stocks compared to 100% stocks will tend to be negligible.

Up to 50%. Such as home/land value a third of total wealth, another third in stocks, another third in gold (50/50 stock/gold for liquid assets). Historic imputed rent of 4.2% = 1.4% if proportioned to a third of total wealth; 2% of total wealth SWR to make 3.4% total (with imputed rent) = have cake and eat it ... return of your inflation adjusted money via 30 years of 3.33% SWR, and a very high probability of having at least your inflation adjusted start date wealth still available after 30 years. Same as 3% SWR drawn against 50/50 stock/gold. Once loaded there's no need to rebalance, just draw the 3% SWR each time from whichever of stock or gold has the higher value at the time, which is a form of partial rebalancing. The tendency historically was to compare to having rebalanced each year, but is lower cost/taxed, is inclined to end with a higher weighting in whichever of stocks or gold yielded the higher reward across the 30 years. Also considerably reduces early years bad sequence of returns risk. And has lower counter-party risk (initial thirds each in house and physical in-hand gold leaves just the third stock weighting having counter-party risk).

50/50 stock/gold up to 100/0 will tend to more often end 30 years with similar outcomes. Stock heavy periodically does much better but that outcome is inclined to be fixed by the start date valuations, if you start after large stock price declines have occurred the 30 year outcome tends to be very good, otherwise overall rewards tend to be much the same whether you held all stock or a stock/gold blend. With 50/50 however you have the option at any time to migrate that gold over to stocks - such as when stocks have declined a lot, which is a high probability event at some time during a 30 year window. 50 stock halve to 25, 50 gold doubles to 100, and you can sell gold to buy stock and increase the number of shares held to five times the number of shares previously held, and where the majority of the shares held were bought at relatively low prices and inclined to subsequently do very-well/great.

There's no need for bonds. States/banks no longer need to borrow your gold (money) - as was the case in pre-fiat millennia (money = gold/silver coins and where banks/state needed to borrow that gold (money)). Under fiat the state can just print/spend, banks can just create debt, they have no real need for lenders/depositors. In non-fiat era the tendency was for the state/banks to pay a real return against loans made to them (investors buying treasuries). In the absence of needing to borrow the inclination is to pay less in return for loans made to them, maybe even levy a cost (negative real yields after costs/fees/taxes/inflation (where inflation is just another form of taxation). And where the state can direct inflation (print/spend), adjust interest rates, adjust taxation rates, change the rules - i.e. the table is stacked heavily in its favor.
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Re: Gold as diversifier

Post by cbox »

What's the P/E ratio of gold these days? Dividend?

What's the difference between investing in gold and gambling?
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Re: Gold as diversifier

Post by seajay »

BRK pays no dividends, its left to each individual investor to create their own, at times and to the amounts of their own choosing.

Dividend : A resultant reward.

Not necessarily a regular payment. Two investors, one buys 20,000 stock index shares at $1/share. Another buys 10,000 shares and invests $10,000 into gold. Less than 18 months later and selling gold to buy stocks adds a further 23,994 shares to the 10,000 shares that they already held, Making 33,994 shares in total. A 70% dividend in the way of 13,994 more shares than the other investors 20,000 shares.

Image

Yes a contrived example, but a ongoing option when you hold both stocks and gold and where at any time the spread between the two can widen sufficiently to entice 'paying a dividend'.

At what cost? 1972 to recent and 50/50 stock/gold total return = 10.05%, all stock 10.23%, and that's assuming you never opted to 'pay a dividend' such as the above.

Gold is money finite/tangible/in-hand, fiat currency is a gamble - a spin of a wheel for how much there is of it today.

PE's are dynamic, just a indicator. Irrelevant n the case of gold. The price of gold in fiat currency will tend to increase - broadly maintain its purchase power, savers/investors have to invest fiat currency (and incur costs/taxes/fees ..etc. in the process) in the hope of maintaining the purchase power.
petulant
Posts: 2739
Joined: Thu Sep 22, 2016 1:09 pm

Re: Gold as diversifier

Post by petulant »

konik wrote: Sun Jan 29, 2023 5:12 pm
Northern Flicker wrote: Sun Jan 29, 2023 2:24 pm
konik wrote: Sun Jan 29, 2023 3:17 am
Northern Flicker wrote: Sun Jan 29, 2023 1:51 am
You would do well to ignore arithmetic means of return. It is not a useful concept. It gets used as an artificial, straw man approximation for annualized return for little purpose other than to critique it, and pretend that instead computing annualized return correctly is some revelation and enlightenment.

Gold has a long term expected real return of zero. But it also has high volatility.
Except that its's arithmetic mean that is used in all kinds or return/risk ratios, like Sharpe, Sortino, Omega, etc. Compounding is not important when you construct a portfolio. To find the most risk-rewarding asset allocation you need to use arithmetic means.
Don't use any statistic in absolute terms if it uses arithmetic mean of return. Garbage in, garbage out.

I think trying to optimize risk-adjusted return based on past data is a fool's errand due to sample bias of historical data. I assume that the market has priced risk well for efficient markets, and future return is unpredictable. (Whether the gold market is efficient is debatable). If I use portfolio optimization techniques, they exclusively will be minimizing a risk measure.
Maybe i did not clarify my thesis well enough. What I'm saying (and want to be critised):
1) Long-term gold geometric mean real return is zero, which is reasonable either way u look at gold like currency or commodiity. Yes, history supports this view, but its actually theoretical very reasonable.
2) It's mathematically inevitable then that arithmetic mean is positive due to gold's non-zero volatility.
3) An asset with positive arithmetic mean real and zero correlations to stocks and bonds is useful part of portfolio if risk-adjusted returns are considered.

Only two assumptions are made here: zero long-term compound return and zero correlation to stocks and bonds. While they both can be challenged, my initial question was whether the logic in this 3 bullets correct, if we assume these assumptions are true.
Like I said in the first reply, you have stumbled on a theoretically plausible view of gold in a modern portfolio. The reason I pointed you to other threads is that I think you are more likely to learn useful things by reviewing quality responses, if any, in those older threads. You may not catch any fish with this thread.
dcabler
Posts: 3036
Joined: Wed Feb 19, 2014 10:30 am
Location: Austin, TX

Re: Gold as diversifier

Post by dcabler »

This is one of several topics that come up pretty often on the forum, much like "international or no", and "tilt or no"? I confess to reading them each time, or at least before they become 10's of pages long. :D

Anyway, in a backwards-looking analysis, not all portfolios see any sort of benefit to adding gold. When I did this analysis years ago with my own portfolio, anything more than 5% made things worse and anything >0 and <5% did pretty much nothing. And, as always, there will never be enough data to know what the future will bring.

So far on the HBO series "The Last of Us", nobody is talking about the need for gold as the fungus ridden zombies attack. :D

Cheers
seajay
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Joined: Sat May 01, 2021 3:26 pm

Re: Gold as diversifier

Post by seajay »

In a era of when gold (and silver) coins were money, that money was finite and the tendency was for broad zero inflation. In England the Sovereign gold coin was currency, a Pound value. Go into a shop and buy something, receive silver coins in change. Those with surplus money (gold) would save, such as lending that gold to the state or banks in return for interest (more gold). That interest was like a real rate of return, say 4% average interest. Stock prices lagged that rate of return, typically just paced inflation (broadly flat-lined), but also paid dividends, say around 4%. Both forms of investing in effect yielded similar rewards.

Whilst direct convertibility between dollar and gold ended in 1933, the dollar was pegged to gold up to 1968, a pledge made by the US in order to get international trading performed in dollars rather than gold.

When that system, that had lasted for centuries ended the tendency was to have stocks retain more of earnings, pay out less in dividends. Taxation policies were introduced to direct that in the US. 2% was a appropriate choice in that balances/matches inflation, dividends, price appreciation and stock/gold rebalance factors. The situation/rewards haven't changed, just the elements of those rewards have become more opaque. Gold alone might be expected to earn 2% annualized real, stock prices rise by 2% real and pay a 2% dividend (combined 4% real). Blend 50/50 stock/gold and that averages 3% real, but where rebalancing (trading) adds a further 1% (difference in OP's arithmetic and geometric) to make 4% real.

Fiat has really only been running since 1968, and even then since 2013 Yellen has somewhat put the US dollar back onto a form of gold standard (pegging). For centuries holding gold with surplus to requirements amounts deposited for interest was all that many savers/investors might have needed (earned a positive real return).

Source data from https://papers.ssrn.com/sol3/papers.cfm ... id=3805927 (Edward F. McQuarrie. Santa Clara University - Leavey School of Business) for stock and bond data since 1793 and compare the total return of both of those (i.e. gold as money deposited to earn interest into bonds), for 1793 to 1932 (the year before the UK and US ended direct gold convertibility) ... and you'll see near-as the exact same rewards.

Use PV to compare 50/50 stock/gold to 100/0 stock since 1972 and the two yielded near-as the exact same rewards.

The 1933 to 1971 in-fill between those is pretty subjective. For one that was a start date following large declines (Wall Street Crash), from where typically subsequent reward tend to be above average. For another the US was a right-tail great case economy (so stock heavy benefited). Also you couldn't legally invest in gold in the US between the 1930's and 1970's. 50/50 stock/gold if you could have still did OK, just not as well as all-stock. As the US dollar was pegged to gold, 50/50 stock/bonds perhaps, that yielded 5% real compared to 9% for all-stock for 1933 to 1971. If you could have invested in gold however and shifted the start days a few years either side, 1929 to 1974 for instance and 50/50 stock/gold compared in reward to all-stock.
NiceUnparticularMan
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Joined: Sat Mar 11, 2017 6:51 am

Re: Gold as diversifier

Post by NiceUnparticularMan »

seajay wrote: Sun Jan 29, 2023 4:26 am
Northern Flicker wrote: Sun Jan 29, 2023 1:51 am Gold has a long term expected real return of zero. But it also has high volatility.
Ditto house/land and stock prices, and artworks etc.
Durable consumer goods like houses, collectibles like art, natural resources like land, and ownership shares in companies are all different things and not in fact amenable to the same analysis.
If the longer term real (price only) returns were negative the assets value would fade towards zero. If real returns were positive then the assets value would rise to extreme levels.
For example, this is a very poor analysis of stocks specifically because stock prices are not simply tied to the value of the company's depreciating assets. Instead, companies typically take some amount of the profits from their businesses and use them to upgrade old assets or acquire new ones. The stock's price over time will then reflect the evolving assets over time, not just what is happening with the assets that the company owned at T=0.

A given company can grow its businesses this way in pace with general economic growth indefinitely. If it is growing its businesses faster than general economic growth, it is true this cannot continue to infinity because at some point that would mean this one company was the only company. Of course, companies can grow in relative size for long periods of time, but it is true in practice that eventually they must reach a phase where their relative growth stabilizes (or indeed starts going down).

Functionally, that typically means the company starts paying out more profits in the form of dividends (or possibly buybacks) and devotes less profits to upgrading or acquiring new assets. But the stock can then continue providing positive real returns indefinitely: as much as the general economy in terms of appreciation, and then an additional amount from dividends/buybacks.
gold like bonds is more like buying a farm and leaving it idle
I agree buying and holding gold is like buying a farm and then leaving it idle.

Bonds, of course, are not. Bonds are loans, not equities at all. Loans/bonds give some other entity your capital to use for some period of time, in exchange for the promise they will return that capital plus more by the end of term of the loan/bond.

Nothing equivalent is happening when you buy a farm and then leave it idle. Nor when you buy gold.
Unlike land, or bonds however, gold has the tendency to spike when stocks/bonds/land prices are in sharp decline
There is in fact no such reliable negative correlation between free-floating gold and stock or bond prices.
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