A Balacing act

[mrdch]

Hello,

First - I apologise for writing in English. I live abroad (UK) and I don't have the keyboard (nor the typing skills) to write in Hebrew. I am an avid reader of the Blog and while much of the specific investment discussion is rightly around Israeli capital market - the principals are universals.

Now to the subject matter.
Investment in precious metal(s). In building my portfolio I decided that I will apply the PRINCIPLES (as I understand them) to this section of my investment. The PRINCIPLES are:
1. You can't tell and should try to guess the future direction of any investment.
2. You should balance your portfolio so that you will gain maximum or lose minimum in ANY eventuality.

So, in that spirit, I decided to invest not just in GOLD, but in ALL four precious metals (gold, silver, platinum and palladium) and to do so in EQUAL measures.
To test this I have run a simulation that checks the behaviour of a GOLD ONLY investment for the last 25 years vs a portfolio that has the four metals AND is being rebalanced when the share of any investment deviates by 5% or more from the original 25% allocation. the RESULTS: Over that period a GOLD ONLY investment would have returned 330% while a BALANCED METALS would have returned 430%. This is not surprising. After all, the REBALANCING act means that you are selling when an investment has gone up - and buy the one that is now low. Doing it repeatedly increases the value of the portfolio over time.

I don't know if there are ETFs in Israel that deal with all precious metals. Even in the UK it is relatively new phenomenon.

I also have a question, should anyone read my post to this point and want to help me.

Dorin advocates the idea of investment in shares that is weighted geographically PER the percentage of the region in the world wealth. Thus, for example, investment in the US would be of 50% of the portfolio. I was wondering if that does not violate the rules above. After all, if the US economy just sneezes, the whole portfolio catches cold! would it not be wiser to allocate EQUAL share of investment between, say, US, UK, EUROPE, JAPAN, FAR EAST and DEVELOPING COUNTRIES?

Please convince me of the folly of my idea!

Thanks

Mordechai

 

[daat99]

Dorin advocates the idea of investment in shares that is weighted geographically PER the percentage of the region in the world wealth. Thus, for example, investment in the US would be of 50% of the portfolio. I was wondering if that does not violate the rules above. After all, if the US economy just sneezes, the whole portfolio catches cold! would it not be wiser to allocate EQUAL share of investment between, say, US, UK, EUROPE, JAPAN, FAR EAST and DEVELOPING COUNTRIES?

Think about it this way.
Most of the companies traded in the US stock exchanges derive a lot (if not most) of their income from international business.
If the US economy drops to the ground than PM for example will barely get effected because they derive over 80% of their revenue from abroad.
By purchasing the US market you are actually purchasing stakes in the entire world.
Adding to the mix the geo allocation which Dorin referred to only adds exposure to the smaller companies trading in the smaller geographical areas and haven't grown enough to reach international level yet (mostly).

In practicality this means that when you buy with 50% of your capital the SP500 index (or ETF that tracks it) than you are getting closer to 35-40% exposure to the US economy and 10-15% exposure to the rest of the world.

If we'll look at Israeli companies than you get Teva both from SP500 and from TA100.

 

[mrdch]

First - if that was not clear - I am happy to read in Hebrew - I just can't write it from here
Thanks for the reply. I am still unclear about the principle, but perhaps it would help me if you were to explain what is 'PM' in your sentence:
If the US economy drops to the ground than PM for example will barely get effected ...

 

[הסולידית]

I don't know if there are ETFs in Israel that deal with all precious metals. Even in the UK it is relatively new phenomenon.

בבורסת ת"א נסחרות תעודות סל שעוקבות אחר מחיר הזהב בבורסת לונדון, אבל הן די גרועות לענייננו (כלומר, לשמש כפוליסת ביטוח לתרחיש של קריסת המערכת הפיננסית) משום שהן לא מתכסות בזהב פיזי.

So, in that spirit, I decided to invest not just in GOLD, but in ALL four precious metals (gold, silver, platinum and palladium) and to do so in EQUAL measures.

הייחוד של הזהב בהקשר הזה הוא שלא מדובר במתכת תעשייתית, בשונה מכסף ומתכות אחרות.

would it not be wiser to allocate EQUAL share of investment between, say, US, UK, EUROPE, JAPAN, FAR EAST and DEVELOPING COUNTRIES

השאלה האמיתית כאן היא אם יש לך סיבה טובה לפעול בניגוד לשוק. השוק (כלומר, כל המשקיעים בעולם, בממוצע), החליט להשקיע את כספו בחברות אמריקניות. אם אתה יודע משהו שהשוק לא יודע - לדוגמה, שחברות באינדונזיה צפויות להניב רווחים גבוהים יותר מחברות אמריקניות - אתה יכול להגדיל את משקלן היחסי בתיק ולהקטין את משקלו של השוק האמריקני. לי באופן אישי אין ידע כזה, ולכן אני לא מנסה "להמר" על חברה ספציפית. בשורה התחתונה - EQUAL WEIGHT, בתכל'ס, זה לתת משקל גדול יותר לחברות או מדינות עם שווי שוק קטן יותר, ולתת משקל קטן יותר לחברות או מדינות עם שווי שוק גדול יותר.

I am an avid reader of the Blog and while much of the specific investment discussion is rightly around Israeli capital market - the principals are universals.

אם אתה מעוניין בפרספקטיבה בריטית על השקעה פסיבית, ממליצה מאד מאד להתחיל מכאן.

Please convince me of the folly of my idea!

לא ייעוץ, לא המלצה, אתה נושא באחריות בלעדית להחלטותיך.

 

[Yevgeny]

Adding back the link to the UK blog that talks about passive investment and financial independence, with some UK-specific advice (should be fixed now):
http://monevator.com
​

 

[mrdch]

Dear Dorin,

Many thanks for taking teh time to reply - much appreciated.!

I think I have identified at least one major difference between us - which is simply in the weight we give to various principles.
For me, I am mostly concerned with finding investments that would protect the portfolio in (almost) all eventuality. So, if we look at the GOLD element, I don't care if it is a metal that is used mostly for industry or not, what I care about is that it is a finite resource and it is in demand. The s\me is true for other precious metals. However, there is no correlation between the demand for one and the other and thus having them all protects me from flactuations that can happen. If you are holding physical gold as insurance in case of a total collapse, as you say, what will it be worth if, say, a new and vast gold mine will be discovered in Siberia? Or chine will decide to get rid of the extremely large gold reserves they hold? Seems to me that having it balanced between several precious metals gives the portfolio better protection. I agree though that having physical possession of them may have been superior still

As to the markets - the same argument applies. Let's see if my logic holds: There are two options: Either the WORLD economy acts in unison (i.e. when markets are up they are up everywhere etc.) or they don't. Clearly the latter is the case, as is exemplified by Japan. If so - can we imagine a Japan-like recession hitting the US? If that happens and we are invested 50% there - the imapct can be quite devastating. If, on the other hand, we are equally invested - the impact would be much smaller.

Finally - it goes without saying that I am NOT looking for financial advise. This is a purely theoretical discussion about the logic behind different investment strategies.

 

[Yevgeny]

Mordechai,

Any deviation from a market-cap weighted stock allocation requires an active decision (prediction) of which countries you think should perform better or worse, and which countries you should or should not invest in. Will you give israel (0.2% of world market cap) the same equal weight as japan or us? Why or why not? This leads you down the rabbit hole of trying to outguess the world markets, which is what passive investing seeks to avoid.

Gold is considered a separate investment vehicle compared to all other commodities, because most of it's value is not derived from industrial demand (which would peg its value much lower) but purely from market psychology. It reacts very differently to markets compared to any other commodity.​

 

[daat99]

First - if that was not clear - I am happy to read in Hebrew - I just can't write it from here
Thanks for the reply. I am still unclear about the principle, but perhaps it would help me if you were to explain what is 'PM' in your sentence:
If the US economy drops to the ground than PM for example will barely get effected ...

I prefer to write in English and you gave me the excuse to do so and I intend to use it
PM is Phillip Morris
An american company that sells Cigarettes mostly outside the United States.
The US economy can come down crashing and people outside the US will keep smoking Marlboro like nothing happened pushing PG profits even higher due to weak dollar.

 

[mrdch]

Any deviation from a market-cap weighted stock allocation requires an active decision (prediction) of which countries you think should perform better or worse, and which countries you should or should not invest in. Will you give israel (0.2% of world market cap) the same equal weight as japan or us? Why or why not? This leads you down the rabbit hole of trying to outguess the world markets, which is what passive investing seeks to avoid.​

This is a very valid argument. There as so many choices out there - so how do we decide? Having the yardstick of market-cap weighted stock allocation is a very good rule, which has the big advantage of having some logic behind it, which Dorit explained very clearly. However, I do not think that it is devoid of ACTIVE thinking as it is implied by you.
If we start from the very first step, any investor must decide how to allocate his assets between shares/bond/gold/cash - we all accept that. Now, what is the RIGHT ratio between those assets and what is the justification for it? You can use the 'equal distribution' formula, or use such example portfolios as shown here: https://www.bogleheads.org/wiki/UK_investing#Sample_portfolios (Thanks Dorit - good resource!) . In any case, my view is that the guiding principle is that your investments would be such that it sustain any economic period (inflation, deflation, growth, stagnation - etc.) and your precious savings would be least impacted - and most profitable. The reason for selecting those investment venues is that they have historically been non-correlated or negatively correlated.
The question now comes to the allocation of shares. Perhaps, then, I can suggest a different formula for choosing the geographical areas for the share allocation. Quite simply, find those markets that have been either negatively correlated to each other or not correlated and invest in them in equal amounts. Thus, for example, if we find that the Israeli share market has a 'life of its own' and flourishes when other tumble or vice versa - why should I care if it is 0.2% or 10% - it would be a good balance to have it in my portfolio. If, on the other hand, it is strongly correlated to, say, the FTSE 100, - I shouldn't be bothered to deal with it.

 

[Yevgeny]

find those markets that have been either negatively correlated to each other or not correlated and invest in them

This is the general argument in favor of investing in different asset classes - and this is the truly "active" decision even a passive investor must make, as to what asset class allocation fits their goals and risk preference.
It is less helpful within an asset class, as the correlations between stock markets for example are very high. Worse, as with perfomance, past correlations are not an indicators for future correlations. Said another way, there's a saying - "during a market crash all correlations go to 1".​

 

[mrdch]

הייחוד של הזהב בהקשר הזה הוא שלא מדובר במתכת תעשייתית, בשונה מכסף ומתכות אחרות.

I appreciate that only 10% of Gold goes to industry (http://en.wikipedia.org/wiki/Gold#Consumption) and Platinum http://en.wikipedia.org/wiki/Platinum#Applications and certainly Silver - but from my perspective (fanatical balancing act) - do I care? Here is a small excerpt from Wikipedia that illustrates my point:
During periods of sustained economic stability and growth, the price of platinum tends to be as much as twice the price of gold, whereas during periods of economic uncertainty,[58] the price of platinum tends to decrease due to reduced industrial demand, falling below the price of gold. Gold prices are more stable in slow economic times, as gold is considered a safe haven. Although gold is used in industrial applications, its demand is not so driven by industrial uses.

 

[mrdch]

It is less helpful within an asset class, as the correlations between stock markets for example are very high.".​

That's true to a certain degree. While most markets will fall at the same time - they would NOT recover at the same time... For example, see this graph
http://stockmarketalmanac.co.uk/wp-content/uploads/2014/01/FTSE-100-v-SP-500£-v-GOLD£-1984-2013.png
Also, as Dorin has shown, there is some balancing that needs to be done when it comes to the BOND side of the investment - so one has to look into the asset class itself and decide what to do within it. Finally, to exemplify why I think balancing is proper in the METAL asset class - see here: http://d1w116sruyx1mf.cloudfront.net/ee-assets/gsd/critical_reads/PM Growth Chart_1.gif

 

[Yevgeny]

Here's my thinking on this:

I understand stocks as an asset class. You buy ownership in most major world companies. You assume future economic growth, and you expect them to grow long term along with the economy with occasional hiccups. Long term (decades+) this is in my mind also the way to preserve 'real' value and hedge from inflation.

I understand bonds as an asset class. You lend money to govs and corps to fuel their growth. You also participate in future economic growth, but get limited upside, together with being better protected from the downside (since when a company defaults, the owners = stockholders are wiped out and bond holders divide the remains among them).

I understand cash as an asset class. It's about immediate (short-term) financial safety and ability to use liquidity in times when no one else has it and other assets are cheap.

I somewhat understand gold as an asset class - beyond negligible industrial value, it's a repository of human fears from "economic armageddon", although the end-of-the-world scenario changes with each iteration. Zero expected future returns, but may spike occasionally during economic shocks that hurts the other assets. Another approach to capital preservation, even if provides no growth.

I have little idea about the rest, and thus past performance tells me nothing about future behavoir and expectations.

I may expect world economic growth and "reversion to the mean" for stocks , but I have no such expectation for any commodity, be it a precious metal, oil, agricultural products, etc. Changes in science, industry and society can change the supply and demand of any of those commodities in the future, and I have no basis on which to extrapolate past prices into the future - so past perfomance is useless to me here.​

 

[mrdch]

Many thanks for the detailed reply - and explaining your thoughts - that helped me a lot clarifying my own
On a slightly philosophical path, I have explored in my mind the accepted wisdom of 'past performance is no indication to the future'. I realised that, as a rule for governing BEHAVIOUR (as opposed to a statement of fact), it is absolutely false - certainly for me and I would argue that this is so for every human being. ALL my actions and all my decisions, in any possible area of my life, are heavily impacted by my PAST experience and extrapolation to and expectations from the future. But let's just talk about investment. When I read the Fail Safe investment book http://en.wikipedia.org/wiki/Fail-Safe_Investing, which is the cornerstone of the investment philosophy here, I realised that the author has arrived to his recommendation after thorough consideration of the PAST and extrapolating it into the FUTURE. There is simply NO OTHER WAY - unless you are a prophet, of course

So now the REAL question is: WHICH elements from the past I choose to take into account - and which I choose not to? The answer to that is an interesting subject, perhaps for another post, but for now I'll come back to our specific issue.
!Selective quoting!

s:
I somewhat understand gold as an asset class - beyond negligible industrial value, it's a repository of human fears from "economic armageddon", although the end-of-the-world scenario changes with each iteration. Zero expected future returns, but may spike occasionally during economic shocks that hurts the other assets.
I have little idea about the rest, and thus past performance tells me nothing about future behavoir and expectations.

I may expect world economic growth and "reversion to the mean" for stocks , but I have no such expectation for any commodity, be it a precious metal, oil, agricultural products, etc. Changes in science, industry and society can change the supply and demand of any of those commodities in the future, and I have no basis on which to extrapolate past prices into the future - so past performance is useless to me here.

You clearly have a notion about the PAST of gold and the way it behaved in times of crisis as well as in times of prosperity and you assume that it holds true for the future. You don't have such expectations for any commodity - including precious metals, as 'changes in science, industry and society can change etc.'. There is an apparent contradiction here. My question is - why does one assume that Gold is exempt from such possible changes? Any answer must be related to how gold was used in PAST - and the assumption that it would hold true for the future. Personally, I think that one can apply the same logic to other precious metals too: Having noticed the behaviour of precious metals in the last few decades, I am assuming that the same pattern (of non correlated appreciation/depreciation) will hold true in the future and I use those investments as a diversification method. Moreover, unlike you/Dorin/Harry Browne I prefer to treat it as a part of the portfolio that is designed to appreciate with time, not just a passive defence mechanism. ..
So, in summary, my point is that (in my very humble opinion) I have replicated the same thought process that had led Harry Browne to devise his asset allocation formula to my dealing with precious metals. My strategy is probably not as good as his in terms of defence against 'total economical collapse', but my thoughts on that subject are fully encapsulated in your sentence:
the end-of-the-world scenario changes with each iteration.
so I am not trying to predict what form it will take next time - and trust myself to cope with whatever life throws at me.

 

[Yevgeny]

My question is - why does one assume that Gold is exempt from such possible changes?

Very simple answer - I dont
I just summarized my understanding of what are the assumptions defining this asset class as being different from all others. I personally don't trust this assumption (also known as "The Greater Fool" theory). I also don't like gold as an inflation hedge - as this role is filled by stocks for me (interesting reading on this).
My personal portfolio, based on my goals, circumstances and time horizon is mostly stocks, with a small portion of relatively short term bonds.

To your more general point, a non-blind extrapolation of the past into the future requires some assumptions (model) about the world.
As long as I'm aware of my assumptions, and I believe that long term world economic growth will continue, for example, I feel safe extrapolating into the future regarding the growth of stocks for example.
For asset classes which I don't understand, or don't agree with their underlying assumptions, - I don't bother extrapolating into the future, and don't invest in them.​

 

[mrdch]

Very simple answer - I dont
I just summarized my understanding of what are the assumptions defining this asset class as being different from all others.​

Phew! All is well then I also came across some interesting reading - much shorter than yours, which exemplifies my point... http://www.morningstar.co.uk/uk/etf/snapshot/snapshot.aspx?id=0P00008UKV&tab=11
I am sure one can find such comments on almost anything - but hey - I was looking for that...

 

[Yevgeny]

The link is inaccessible (behind a paywall).
What point would that be?​

 

[mrdch]

Sorry. It is free if you are registered, but here's the quote
Role in Portfolio
Palladium has historically demonstrated low- to negative- correlations with equity and fixed income securities, making it a potentially attractive portfolio diversifier. However, the palladium price has in the past exhibited a large degree of volatility and is intrinsically more cyclical than both the gold and the platinum prices, given that its primary uses are largely in automotive catalysts and electronics. An investment in palladium should be approached with caution. The metal’s volatility may create tactical trading opportunities at various points during an economic cycle, while its low correlation with other asset classes and potential inflation-hedging characteristics may make it suitable for a portion of a broader long-term commodity allocation.

 

[Yevgeny]

Well, my point is that I, personally, have no basis to assume this past behavior will continue into the future (while for stocks - I do).

 

[mrdch]

OK - so some update and further analysis...
It's all to do with my idea of having 4 precious metals - not just Gold.
The following is the table that shows the performance of those metals in the last 4 full calendar years2013-2016)
(The figure nearest to the name is for 2016 and the furthest is for 2013...)
Platinum 23.57% -24.07% -5.73% -12.84%
Palladium 46.82% -27.77% 18.74% -0.57%
Gold 29.83% -6.53% 5.76% -29.31%
Silver 39.61% -8.82% -13.36% -36.36%

I run some sample scenarios, all assuming that I invested 10,000 at the beginning of the 2013 in all the 4. At the end of that period, (assuming I did not do ANYTHING for the whole 4 years), I would have the following profit/loss
result / metal:
Platinum -2291
Palladium 2520
Gold -928
Silver -2981
Or a total LOSS of 3579. - slightly above 9%
On the other hand, if I review the portfolio ONCE a year, and balance it to maintain 25% allocation for each, the end result after four years would be:
Platinum 421
Palladium 2381
Gold 949
Silver 1773
Or a total GAIN of 5524, nearly 14%.

The moral, as I see it, is that the four precious metals do not move in tight correlation and by balancing a portfolio even as infrequently as once a year one can gain significantly over the years.