Chris M.,
Thanks for your usual on-point breakdown here. For a second I thought I was at the wrong website.
I’m late to the thread, what about DRIPS as a safe haven?
machinehead
Compound Annual Return ........ 7.62% Standard Deviation ..................... 4.82% Sharpe ratio ................................. 1.58 $100,000 grows to ............ $218,872That's a very interesting analysis of the PP—thank you for doing it.
The remarkable thing about the PP, to me, is its stability over a very long period (e.g., see 36 yearly returns here: http://crawlingroad.com/blog/2008/12/22/permanent-portfolio-historical-returns/). I suspected that the PP might be less volatile (than 5MM or 5MM/2) , but it’s nice to see it confirmed in the Sharpe ratio. All things being equal, I’d prefer the slightly lower returns for the ~2x lower volatility—but that’s just me. I might make up some of the difference in lower transaction fees because there are fewer elements to rebalance.
I’d urge you to try and come up with some proxy for the elements in your 5MM that would allow you to back-test to 1972 (the year when gold ownership was allowed in the USA, I think), just to see how it stands up over a broader range of economic conditions and stresses.
If I am right about the poor prospects for long-term bonds going forward, then the weak returns from that 25% component of the Permanent Portfolio would need to be made up with continuing solid gains in gold.You might be right. Long-term bonds might take a beating—indeed, people have been expecting and predicting that for years. However, for example, Vanguard's Long-Term Bond Index Fund VBLTX has average returns of over 8%/yr over the last ten years. Not as good as GDX's +10% but still not bad.
By the same token, what happens to the REITS if entities were no longer allowed to “extend and pretend” with respect to the value of the CRE on their books? What happens to the energy MLPs if the government, “for national security reasons” intervenes in the oil and gas market and installs price controls, as Eric T posited a few months ago? What happens to the mining stocks if the government (hello Australia), to “simulate” the economy (and increase government revenue), institutes a heavy “windfall profits tax” on miners?
Ah, if only we knew the future…but that’s what annual rebalancing is for.
There are many investment uncertainties ahead, and the old warning: “Past Performance is No Guarantee of Future Results” was never truer than it is today.
I am not an economist.I am a small business owner in an industry that has been under attack from the government for decades.My industry is not the exception.Most businesses are can no longer afford employees,transportation costs,equipment maintenence,taxes,or any number of fees,licenses,or permits to conduct business.I have been investing for awhile,but it is becoming increasingly difficult to find safe investments.The bottom line is this:your money is only safe in your pocket.gold is money,silver is money,a truckload of firewood is money.paper is not money,it is I.O.U.s from a wasteful,corrupt government.
Politics aside,the facts are clear:
1-Our country is broke.
2-Our politicians and the businessmen that hire them are desperate.
and do not forget the most important one.
3-They control ALL paper assets with the stroke of a keyboard key.
I think i’ll keep my funds in useful,tradeable goods for now.
In a rising interest rate environment, fixed-income investments should be as short-term as possible. Stocks in commodity-oriented economies and sectors will do better than others, whose rising earnings will be offset by P/E contraction. REITs and physical commodities should do well when interest rates and inflation are rising.
I searched for farmland REITs, but there aren’t any. This comment appeared in an article about the prospects for farmland:
There are not any farmland REITs due to corporate farming laws. Our parent company, Colvin & Co. LLC, manages a limited partnership focused on investing in farmland in the Midwest.http://farmlandforecast.colvin-co.com/2009/02/12/why-invest-in-farmland.
All of the calculations mentioned are total returns, including reinvestment of dividends.
DRIPS are a convenient mechanism for reinvesting dividends, but do not provide any safe haven if stock prices fall.
The low volatility of Harry Browne’s Permanent Portfolio is indeed impressive. At the time Harry Browne published it in 1981, he had nine years of history available. Because of the 20X rally in gold during 1972-1980, the Permanent Portfolio’s compound annual return was a stunning 15.4% over his test period. In the 30 years since, it has settled into a remarkably stable 8% compound annual return.
An 8% compounded return, while very adequate, took a back seat to the 10%-12% returns that stocks delivered during the long secular rally of 1982-2000. It was during the recent rocky decade for stocks that the Permanent Portfolio, which never missed a beat in delivering gains in each and every year, really shone.
I’d like to backtest the 5MM portfolio farther, but I don’t know of any proxies for the energy MLPs before 1997.
Regarding REITs, banks may be ‘extending and pretending’ on the book value of real estate loans. But their questionable loan valuations apparently are taken into account in their stock prices. The BKX bank index languishes at a pitiful 31% of its early-2007 peak. Chart of BKX:
http://bigcharts.marketwatch.com/quickchart/quickchart.asp?symb=bkx&sid=0&o_symb=bkx&freq=2&time=11
Similarly, if the carrying value of commercial real estate on REITs’ books is unrealistic, presumably their prices have been marked down accordingly. I assume that the stock prices of both banks and REITs reflect investors’ informed assessment of the market value, rather than the claimed book value, of their portfolios.
Thanks for the informative chart. Substituting LINN into the portfolio, with its higher volatility, would increase the standard deviation and reduce the Sharpe ratio. So there’s a price to be paid in terms of risk, although it may be rewarded by superior returns.
The midstream MLPs derive a majority of their income from revenues that are not sensitive to energy prices. From the original logic of the portfolio – replacing bonds with a source of high, stable income – I chose Kinder Morgan and Enterprise for that reason, the lack of volatility related to energy prices.
A more risk-tolerant investor who wants more upside exposure to energy prices would prefer LINN.
MH
First let me say that I have a great deal of respect for you intelligence & knowledge, especially in the world of investing - thanks for your detailed & thoughtful post – I do have a comment …
I think we agree that the next 20+ years will be MUCH different than the last 20 years. If this is so, then projections for the future based on past experience are, in my opinion, suspect to say the least. We may find ourselves in a situation that is far more serious than flat of slightly negative growth. Try on for size the idea of 20 or 50+% inflation combined with having to operate on 50% of our current consumption of oil. Not that the insiders can’t still make a lot going forward, because some will do well, however the average investor is left out in the cold. The idea that there is any sort of guaranteed security in the years ahead by so called “investing” seems to me to be an illusion at best. Our economic system is more a system of manipulation and is on the edge of collapse, About the only real security left will be in one’s own abilities, community, farmland/water and assets that enable people to stay alive - maybe some value in a little gold & silver, but even that is questionable given that we are looking at a worldwide crash and not just another USSR or Japan that has/had the rest of the world still charging forward. This is a gloomy picture in some ways no doubt, but is most certainly a distinct possibility - you won’t catch me investing in/with some fund manager that in all likelihood has had a part to play in the mess we find ourselves in now. Personally, I will continue to work towards hands on holdings and lifestyle that gets as close to sustainable as possible
Jim
Broadly, I share your views. That’s why bonds and stocks constitute only 40% of the 5MM portfolio, versus 100% of a typical 60/40 balanced portfolio. So why include them at all?
The reason is that uncorrelated assets can still do a wonderful job of taming the volatility of a portfolio. Here’s an example from 2008 and 2009, involving TLT (a long Treasury ETF) and VTI (a total stock market ETF).
2008 – TLT: +31.07%; VTI: -36.99%
2009 – TLT: -22.31%; VTI: +28.28%
Long Treasuries popped like crazy in the late 2008 smash, nearly offsetting stocks’ collapse. In 2009, the pattern was reversed – stocks roared back from their panic low, while Treasury prices backed down from their panic high.
In setting out a long-term portfolio, one needs to take advantage of uncorrelated markets. The fallacy of Wall Street’s ‘buy and hold’ philosophy is that stocks, as an asset class, are just too distressingly volatile for most people to hold them during the dips. This is true of most asset classes which offer high returns – now and then, they’re going to bite you. Multi-asset class portfolios do a surprisingly good job of damping volatility while still delivering acceptable returns.
MH,
Thanks for the direct response. I appreciate it.
jpitre,
Spot on (x 10). Since peak oil = peak food = peak people, the only thing that makes sense to me is community, farmland, water, and the ability to perform tasks or provide services that are absolutely needed.
Nate
MH – Thanks for all your hard work. I was one of the earliest posts advocating – call me crazy – partly tongue in check – an all precious metals portfolio. Your analysis used a portfolio of all gold stocks rather than gold itself. Would your analysis of an all gold portfolio be significantly different? The reason I am half serious about an all precious metals portfolio is because we are in a crisis period & being in precious metals – bullion not the stocks – is like going to all cash when the stock market appears risky. The crisis period I refer to the period from late 2007 through the present through to somewhere between 2012-2015 depending upon when the government gives up on its efforts to stimulate which are instead destroying the economy. Thanks again for all your work. By the way are you a financial advisor?
Ah…
In the bolded sentence a major source of discomfort I have with the current market structure has been uncovered and it centers on correlation.
Let me be clear; this is a relatively recent discomfort of mine, having first been detected by me as a minor burr under my investing saddle which I couldn’t quite dislodge (first noticed circa 2004 because I missed the early signs; I think the actual rise began in 2003 but that was difficult to detect) but which eventually wriggled out, germinated, and is now a well developed weed patch that is thoroughly unavoidable. At least I have to wade right through it.
A recent repost of somebody else’s material on Zerohedge (sorry, I forgot to preserve the link to provide here, but the article was within the last two weeks and should be relatively easily located) by a money manager who came up with this next hair raising image (among other goodies).
Ponder this one for a few, I’ll wait:
During the period roughly in question for your 5MM portfolio (barring the last two years), the degree of correlation of stocks with bonds/commodities/gold/oil/dollar has roughly remained within a +/- band of 15%, give or take. It is only within the last two years that we breached first the 30% mark, then the 40% mark, and even the 50% mark. Zounds. I don’t have access to the base data, but by eye I would be surprised if the mean plus a second standard deviation has not been put in the rear-view mirror.
The above chart confirms my personal trading experience; correlations are now so tightly - what … managed? … part of the ‘new’ reality?? - that they must be reconsidered from any historical perspective to include the possibility that prior safety zones of ‘negative beta’ (i.e. inverse correlation) no longer exist to the same degree as they did in the past.
Said more simply, the above chart suggests that reversion to the mean (a return of correlation) is a distinct possibility and that a period of ‘devolution’ from high correlation to low(er) correlation might, possibly, maybe, blow a model or two out of the water.
The question, then, is what happens to the 5MM model if/(when) the correlations revert to the mean? Is the 5MM a helpful place to be or the opposite? Do returns increase or decrease?
I ask these questions with an open mind, and in the spirit of inquiry and learning.
Chris -
Given that the major asset classes seem to now be much more correlated vs historical norms, if there were to be a substantial correction in the equity markets while we are in this abnormal state, would you expect the other asset groups - including PMs - to decline along with it? (at least initially)
From the article:
This is the unfortunate result of markets where governments and central banks try to truncate risk and algos determine marginal prices based on short-term patterns. In the real economy, price signals have become distorted, thus causing capital to be inefficiently allocated. In the financial economy, the environment has become riskier than ever. The farther prices are pushed away from their true underlying value, the greater the adjustment will be. And one thing the algos don’t do - adjust slowly.
Excellent MH - you couldn’t buy this analysis from any money mangler. I do however have similar questions as Chris. At this stage of the game, the only era we have for comparison is the 1930s - the only other time in relatively modern history that has witnessed a severe credit contraction. That era too was fraught with massive interventions from all quarters - to no avail as the credit bubble then was no more immune to total deflation from the gaping hole and insufficient additions demanded by the Ponzi-esque nature of fractional reserve lending.
We as mere mortals cannot know the true extent of the contraction as we are not privy to an honest analysis of holdings of our fine upstanding financial institutions. We can only get glimpses of some of it such as this piece from a WSJ blog
In short almost all of the debt reduction by consumers over the last 2 years (including mortgages) has been by default. And how many times was debt leveraged and releveraged? We do not know but the size of the derivatives tower in comparison to total global debt is a pretty good clue.
I doubt there’s too much we can project into the future based on the past - unless we look way back and skip right over about 70 or 80 years. Even that may be of little value since the monetary system back then at least gave lip service to a species backed money and frankly too much time has past. Those who might have served as guides are dead and much has been lost to history or suffered “revision”.
This game may turn out not answering the question of who made the most, but who lost the least. The average 401K holder with his $40,000 invested and $225,000 mortgage on a house now worth $150,000 is already road kill.
This thread and much of this site talks/argues about so-called “investments”. I submit that somewhere along the way in the last 30 years are so, nearly all investments within the mainstream meaning have become speculative gambles. Markets are so manipulated that pricing has become so removed from true value, that typical investors are no longer tied to actual wealth and the means of creating it – rather to the current scam of the day perpetrated by the Corporatocracy colluding with the banksters and big government,
Chris has been careful to describe the source of all wealth as coming from basic resources coupled with human effort & ingenuity including manufacturing. We have now moved into a virtual world where derivatives with unknown value form the majority of our wealth. Paper shufflers who pretend to create wealth but create none – do the manipulation by means of false markets and our debt based monetary system. Most of us have come to accept that Wall Street somehow is an indicator of real wealth when in fact nothing could be farther from the truth. We make major decisions based on the Dow and/or some index and where we guess the speculators will push them.
Difficult if not impossible to survive without a seat at the table with those who call the shots when their only aim is selfish control with no regard to our country, our people or any moral guideline.
Jim
I don’t understand most of the derivatives and forecasting and soforth.More than one great investor has warned not to invest in something that you do not understand.I am in my late 20’s,self employed,blue collar as they come.All my long term stocks are in DRIPS.I think the idea is great,I invest my “excess human energy”(money)into a company I believe in and if they make even more excess human energy from it then I get a portion which I can send straight back to them for even more profits.
The poison in the kool-aid for me is this:In the last couple of years I have learned about fiat currencies and us gov money policies.
I worked damned hard for some paper which could be devalued because my representatives are less responsible than me?A single,high taxation of my hard earned money always pissed me off,but when I realized they will tax it multiple times without a vote by quantitative easing(isn’t that one of the complaints in the declaration of independance?) I stopped buying Stocks and started holding gold and silver.
I have often thought about a bank that only loaned gold or silver(to be repaid in only gold and silver).Is it legal?
Dr. M,
Perhaps I have misunderstood your query here, but what I think your saying is that all asset classes are tightly correlated and diversification is not possible in this market. If this is the case, how is owning gold any different from owning (or renting) any other asset? Many here believe that owning gold effectively takes them “out of the game” and is therefore a safe investment relative to stocks and bonds. As you know, I think idea that gold is a market safe haven is very short-sighted. Its price is not derived from the average Joe exchanging bullion with his dealer, its derived from the same market as every other asset.
But the mean reversion that we should really be concerned about is not in the stock, bond, real estate, or commodity markets: its in the credit market. Without the explosion in credit over the last decade, none of these assets would have appreciated to the degree that they have, gold included. And without that credit these assets are going to depreciate in purchasing power.
The only asset that is not correlated to the markets is physical cash. When the demand for cash rises, all other assets depreciate in value. And with a mean-reversion in available (private) credit taking place, the demand for cash will only increase in our future. Besides, its the ultimate contrarian play, after all, what fool would hold (or desire) physical cash in the face of unprecedented “printing” by the Fed? The “fool” that needs to feed his family would.
Best…Jeff
About 8 of the 10.67 years of data used in the 5MM featured relatively uncorrelated markets, which are the preferred condition for a multi-market model – otherwise market diversification doesn’t offer as much protection as it should.
The 5MM model performed just fine during the highly correlated markets of 2009 and 2010. But it’s really the uncorrelated markets that it is designed for.