Rocky never provides investment advice. But for once he’ll violate this rule and offer some advice to Congressman Ron Paul.
Members of Congress must file financial disclosure forms which show all of their assets and investments. Rocky studied Rep. Paul’s portfolio from 2003 to the present. http://www.legistorm.com/memberdisclosure/413/Rep_Ron_Paul_TX.html
Ron Paul’s portfolio violates every principle of sound money management. It is not prudent. It is not sensible. It is volatile. It is speculative. And it may give a window into Ron Paul’s perspective on the economy and free enterprise.
From 2003 to the present, Ron Paul’s stock portfolio owned only gold stocks. He owned some real estate. He had some cash. And he owned mutual funds that make money ONLY WHEN the stock market declines. He did not own any gold bullion. And more recently, he purchased more gold mining stocks and added to his bearish bets on the stock market using leveraged bearish funds.
In 2003, the value of his portfolio was between $860,000 and $2,300,00. (The disclosure form only provides a range of values.) In 2010, his portfolio grew to $2.4 million and $5.5 million. (Gold stocks have declined between 15% and 30% in 2011, so his portfolio has declined commensurately. He will declare that loss next year.)
So, over an an 8-year period his portfolio has appreciated by about 12%/year. (And after this year’s losses for gold mining stocks, it will be a bit less than that.)
Not so bad, eh?
If, instead of being such a wiseguy, he had instead just purchased gold bullion, his return would have been 55% better — returning an impressive 18.5% per year! (It’s very strange that Ron Paul doesn’t own any bullion. And a skeptic might wonder whether he owns bullion, but failed to disclose it.)
[Disclosure: If one extrapolates the profile of his portfolio, one must conclude that he either nailed the bottom of the gold market, or he has really lousy long term performance. Remember that (even after this 10 year old rally) gold has appreciated at only about 5% for the past 30 years, while stocks have returned about 11%, and long bonds have returned high single digits. More troubling, however, is the notion that a President of the United States would personally profit from a DECLINING stock market and a declining economy! Even Barack Obama’s assets include some S&P Index Funds….]
Knowing that he’s been a gold bull for years, Rocky’s friends keep asking: “What you do think of gold, NOW?” (These people actually think that Rocky and certain other TV commentators can predict the future.)
Rocky’s answer: “I have no idea, and have NEVER had any idea about what the price of gold will do tomorrow.”
But does he still own gold?
“Yes, and I also own some stocks. And I own some real estate. And I own some bonds. And I own a copy of last week’s People Magazine. And I have no idea what the price of these will do tomorrow either. My experience has been that pundits who claim perfect knowledge of the future are generally either liars or idiots. (Whoopi Goldberg is the exception to this rule.) What I’m doing is called diversification.”
But when will he sell gold?
“The PRICE of gold is irrelevant. As I’ve written on this blog, I will sell gold when the gold story (or more accurately, the market’s perception of the gold story) changes! Gold’s ascent is a confluence of negative real interest rates; undisciplined central bank behavior; a growing loss of confidence in government policies and financial systems; loss of Swiss bank secrecy; an accumulation of economic wealth by individuals in parts of the world without stable property rights and rule of law. Can gold drop $100 tomorrow? Sure it can! Can gold drop $300 next week? Sure it can! Can gold drop $1000 next year? Sure it can! But so long as these FUNDAMENTAL factors remain in place, the underpinnings and demand for hard assets that are beyond the reach of governments will remain.”
“Almost all of my really smart friends are very bearish right now. They all think this move is idiotic. Many think this is a bubble. And eventually they will be right. But eventually could be a really really long time. And it could include a trip to unimaginably higher prices first. Their skepticism is not predictive of anything. And importantly, they are not betting that gold will decline either. All it tells you is that they aren’t long gold and missed this move. I’ll admit that I get nervous when prices rise quickly. And historically, buying after a sharp rally isn’t a good idea. But why should any of this market chatter affect my long-term porfolio construction/diversification? After all, I’m not afraid to admit that I have absolutely no idea what prices will do tomorrow.”
[Disclosure: Rocky NEVER gives investment advice. He’s owned gold for a long time. And he owns some hedges that will protect him if gold drops sharply while he’s asleep. And some day, he will sell his gold. But whether it’s at $2,000/oz or $10,000/oz is out of his control. It’s in the control of millions of other investors around the world, and how they react to the policies of their central banks and governments.]
Rocky just approved his employee paychecks for the first pay period of 2011. He noticed that everyone’s paycheck increased by almost 2%.
“I don’t remember approving any raises!” Rocky grumbled to his CFO. “Especially not for Bosley in the mailroom. That’s the guy who nodded off while sitting in front of the postage meter — and his forehead wasted a few hundred dollars in postage stamps!”
“Rocky, it’s the tax cut,” explained the CFO. “Congress passed a one year holiday on Social Security and Medicare taxes. Everyone’s paycheck went up by about 2%.”
“That’s great,” said Rocky. “Allowing people to keep their own money is always a good thing. But what should we do with all those wasted postage stamps? Maybe we should hand them out as holiday bonuses?”
[Disclosure: Reducing taxes is the most efficient way to stimulate an economy.]
Inflation, says Rocky, are rising prices for the things that you WANT to buy. Deflation, says Rocky, are declining prices for the things that you DON’T WANT to buy.
Although it uses a more analytically rigorous definition, there are many problems with the government’s Consumer Price Index (CPI).
It’s exciting to announce that MIT has gone live with it’s “Billion Price Project” (BPP) — which monitors daily prices of 5 million items sold by 300 online retailers!
Here’s the link to the Billion Price Project: http://bpp.mit.edu/
[Disclosure: It costs the Labor Department $234 million each year to calculate the CPI, and it’s only reported once each month. For more details, see: http://www.slate.com/id/2278623/ ]
For long-term investors with a dedicated portion of their portfolio in bonds, Rocky believes that there’s currently an opportunity to reduce exposure — without reducing return.
The “trick” is to extend maturities with a portion of their bonds, and to put the balance of their exposure in cash. This is called a bar-bell trade (named after the exercise equipment) — and the steepest yield curve in 30 years (see chart) provides a rare opportunity to do this trade.
Here’s an example of the mechanics.
An investor has $100,000 in the Vanguard Intermediate Term Investment Grade Bond Fund. This fund yields 3.1% and has an average duration of 5.3 years.
If the investor sells that fund, and buys $58,000 of the Vanguard Long Term Investment Grade Bond Fund which yields 5.4% with a duration of 12.9 years and puts the other $42,000 in FDIC insured money market funds yielding 1.0%, a number of virtuous things can happen:
1) If nothing happens, the cash yield of his portfolio has increased by a little bit. Before the re-allocation, his portfolio was producing $3100 in income, and now it’s producing $3500 in income.
2) The investor has increased his cash balance, and since no one really knows what the future will hold, it’s always good to have lots of cash. If interest rates rise , the investor will be able to put the cash to work at higher yields.
3) If interest rates rise, the yield curve is likely to flatten (based both on history and standard economic theory). That is, short-term rates “should” rise more than long-term interest rates. So, even though the re-allocation results in a longer duration (7.48 versus 5.3), in most scenarios this risk is overstated. Also, the risk is lessened due to the 42% cash cushion. So the practical increase in duration should be less than the theoretical increase.
4) The investor has sold the portion of the bond market that is being levitated by the Federal Reserve and purchased a portion of the bond market which is being set by market forces. (Most of the Fed’s purchases are under 7 years in maturity.) So, when the Fed stops buying or reverses its purchases, the re-allocation should have less market risk in the short maturities that usually rise the most during tightening cycles.
5) With short rates at zero, there’s nowhere for rates to go except up. However, if the USA is in a Japanese-style depression, the only yields that can still decline are the ultra-long maturities, and one might experience a “bull market flattener”. (This is a low probability event.) Due to its modestly increased duration and position on the yield curve, the re-allocation would likely outperform nicely during a bull market flattener. Additionally, the stock market will be weak in this scenario, and the 48% cash balance might be useful for purchasing some stocks at much lower prices.
Where does this strategy look worse? If all interest rates across the yield curve move higher by the same amount , then the modestly increased duration can cause an underperformance, and if the yield curve steepens even more, there can be an underperformance. Remember: Rocky isn’t suggesting to just move out the yield curve with the same amount of money… It’s important to tuck about 48% of the portfolio away in safe money market funds . Remember also that when rates rise, bond prices decline. So if interest rates rise a lot, all bond investors will lose money. The underlying theme to this re-allocation is “less exposure — same return.”
[Disclosure: This is NOT investment advice…see the Disclaimer at the top of this page! It’s just something that Rocky noticed and investors should think about. It’s also an observation that the yield curve is steepest its been in 30+ years. If the 30-year bond keeps rising in yield — and the Fed keeps rates at 0%, then this strategy will not be attractive. There’s no reason to think that today marks the maximum steepness. Lastly, Rocky doesn’t have an opinion about when rates will rise; but they eventually will. But as Keynes supposedly said, “In the long run, we’re all dead.” ]
Rocky’s read a lot of information and mis-information regarding Quantitative Easing. This may be the best and clearest discussion of the issues and is worth a read:
[Disclosure: Rocky rarely agrees with Professor Landsburg, and finds some of his philosophies to be morally objectionable. Nonetheless, the Professor does a good job explaining the pros and cons of QE2 in his article.]
Rocky noticed that his friends see bubbles in bonds, in gold, in stocks, in cotton, sugar and grain prices. In fact, his friends see bubbles EVERYWHERE!
It appears that there may be a bubble in bubbles. And a look at “Google Trends” confirms this bubble. However, this bubble-in-bubbles popped early in 2010 — on the 50th Anniversary of Bubble Wrap!
[Disclosure: Rocky never gives investment advice. When asked if or when the current “bubbles” will burst, he started foaming at the mouth.]