Is gold in your permanent portfolio?

Posted MAY 9 2012 by JAN SKOYLES in 

In a week where we have seen the gold price plummet and return to levels below $1600, investment decisions are feeling as confusing as ever. No-one knows if the Eurozone will make it to the end of next week and the markets are responding to various elections and announcements in a reflective manner.

For gold investors it is particularly confusing especially when Warren Buffet and his Merry Men continue to trot out the ‘gold is stoopid’ line. We have written so many times in regard to how gold will protect its investors in times of financial difficulties, but at present we are sitting in a bit of limbo in regard to the markets and the gold price does not seem to be enjoying it.

Earlier this week the FTSE 100 fell to its lowest level this year by 1.78 per cent to 5,554.55. Other indices fell around the globe on the back of fears that Greece may be forced to leave the Euro and concerns that faith in major parties in Europe has disappeared.

How has gold responded? It has fallen below $1600 in a similar pattern to its fall just before Christmas. Understandably, some investors are feeling wobbly about their gold bullion and wonder if they should sell before they lose more money.

Should investing be so stressful?

The reason Warren Buffet and his friends don’t like gold is because they don’t understand its value. Because it doesn’t pay any dividends, because it does not have a clear revenue stream, or a clear business model it is, in comparison, not as easy to value as it is with stocks and shares.

But perhaps savers, gold bugs and loyal Berkshire Hathaway fans should meet in the middle and appreciate the value which lies in a portfolio which is balanced between all major asset classes.

Gold investment was never supposed to be a short-term game. It was always there for the long-haul, to guide you through the good times and the bad. Is it better than other investments? As the Daily Reckoning recently pointed out, if it makes up part of a balanced portfolio you will see the benefits.

In 1981 investment guru, Harry Browne, developed a ‘set-it and forget-it’ portfolio strategy. The portfolio consisted on four main elements.

As the Daily Reckoning reports, the portfolio was laid out as follows: ‘25% cash, 25% bonds, 25% stocks, 25% gold.’

The idea behind the portfolio was to sit back and allow each element to perform when its time came according to the current economic environment.

The Permanent Portfolio’s proven success is due to its wide and true diversification across asset classes. As its managers argue, ‘You have exposure to assets that can grow you money safely at all times without having to predict the future. You also have protection in the diversification against losing large amounts of money which can cause you to abandon the strategy in bad markets.’

Between 1972 and 2008 this set it and forget it strategy was able to achieve 9-10% compound growth per year (CAGR). The CAGR for the entire period was 9.7%.

For evidence of the value of investing in gold alongside other investment classes (such as those in the Berkshire Hathaway portfolio) we can look at how gold has performed in the portfolio and kept it balanced during times of major financial turmoil.

In the 1970s, when inflation was rife, and stocks, bonds and cash were all down the portfolio was still able to generate positive returns. This was thanks to the inflation-proof asset of gold.

Having 25% of your investment portfolio in gold sounds like a hefty amount. Particularly in a world where, according to the World Gold Council, as recently as the end of 2010 gold holdings accounted for approximately 1% of global assets under management.

But if you are of the Warren Buffet mind-set then, according to the World Gold Council, you don’t even need to commit 25% of your portfolio to gold. The WGC finds that by adding an allocation of gold of between 3.3% and 7.5% the investor can ‘obtain a desired expected return while incurring less risk than on an equivalent portfolio which does not include gold.’

But was gold a success in the Permanent Portfolio because times were different then? Is gold no longer a modern enough investment for market-savvy investors?

 

The naughty noughties

Warren Buffet is open about the huge gains gold has made since the 1960s, however stocks have made similar, if not higher, gains. The issue gold investors should remember however is that Mr Buffet chooses to forgo the protection gold offers in order to enjoy the upside of stocks. Gold investors invest in the yellow metal in order to enjoy the protection of gold and still enjoy some upside.

The success of gold investment, and reasons for it, are highlighted by investment decisions made by legendary investor Jim Rogers. He has made one decision about allocating his capital to an asset class every ten years in order to enjoy higher returns than one would with a diversified portfolio.

Mr Rogers invested in gold during the decades of 1970s and the 00s. In both decades he saw huge returns, 1,363% and 391% respectively. This is reflected in the Permanent Portfolio’s performance in during each of these periods.

Since 2000, inflation has steadily been creeping up on the markets. In the last decade alone, gold has increased by 500%. The noughties is the second period where gold has shone and proved its worth. Namely since 2001 gold has provided a significant positive return.

But is this just a reflection of the seventies, will things get better; will we see a drop in the gold price once again?

According to Bill Bonner, it’s not likely:

In the seventies, the US was on top of the world…and headed higher. It was owed more money by more people than any nation ever had been. It was the leading energy exporter. It was the world’s leading capital investor. Its people were earning more and more money — in real terms. Total consumer and government debt, as a percentage of GDP, was barely a fifth of today’s level.


The Permanent Portfolio’s golden success

Whilst both Warren Buffet and Jim Rogers have made huge amounts of money from their investment strategies, their investment decisions are their careers. For the average investor, a diversified portfolio, and one which does not require over-active management suits the modern investor looking for somewhere to first preserve, then grow, their wealth over the long-term.

The success of Mr Browne’s Permanent Portfolio was down to its stability and growth, both of which can be attributed to its breadth of diversification across different asset classes. Unlike other popular investors he is not just focused on one asset class, or one country. People talk about the US, Japan, China,  Brazil, without remembering that they are investing in equities in all these geographies. Other people talk about having exposure to the dollar, the euro, the pound, or other currencies, whilst forgetting that these exposures are all to fiat currencies. The Permanent Portfolio went beyond this. In line with the advice from the Swiss banking tradition, Mr Browne’s portfolio has a significant holding of gold. This acts as an anchor during times of stormy economic downturns and threats of hyperinflation.

Unlike the decade of the seventies we do not appear to be coming to any sort-of quick fix solution, nor does anyone seem to know which authority or country to turn to in order to guide us out of this mess. We can’t even agree on whether we should be tightening our belts or digging deep into our pockets.

No one has a crystal ball, not even billionaires such as Warren Buffet. Therefore, perhaps we should take a leaf out of Harry Browne’s book and not worry too much about what may happen, balance your portfolio with the ‘civilised’ and (apparently) not so civilised investments. Place gold on the other side of the scales and sit back as it balances you out during the rough and the smooth.

 

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Please Note: Information published here is provided to aid your thinking and investment decisions, not lead them. You should independently decide the best place for your money, and any investment decision you make is done so at your own risk. Data included here within may already be out of date.

 

About the Author

Jan SkoylesJan first became interested in precious metals and sound money when she met Ned Naylor-Leyland whilst working at Cheviot Asset Management in the summer of 2010. Jan then went on to write her undergraduate dissertation on the use of precious metals in the monetary system. After graduating from university Jan joined The Real Asset Co research desk and now contributes to the Cobden Centre, The Commentator, The Renegade Economist and Market Oracle.