Asset Allocation for Today’s Financial Reality
How a gold mindset can help investors adapt to changing times
By Nick Barisheff
Asset allocation is one of the most crucial aspects of building a diversified and sustainable portfolio that not only preserves and grows wealth, but also weathers the twists and turns that ever-changing market conditions can throw at it. However, while the average advisor or investor spends a great deal of time carefully analyzing and picking the right stocks or sectors, the basic and primary task of asset allocation is often overlooked.
Asset allocation is usually taken for granted as being a mix of the three main asset classes: stocks, bonds and cash. Many investors believe that a broad mix of equities (financials, healthcare, utilities and telecoms), an exposure to foreign stocks, some emerging market plays, some bonds and a foundation of cash, equals diversification.
The Canadian Banks Forum correctly defines asset allocation as a process whereby an investor diversifies his or her portfolio with different classes of assets such as stocks, bonds, cash investments, foreign currency, real estate, collectibles, precious metals, natural resources and life settlements. It notes that, because markets are constantly changing due to the unstable global economic climate, investors should examine and, if necessary, rebalance their asset allocation annually.
Long-Term Trends
The Dow has experienced several cyclical up and down trends throughout the last century. Identifying which trend the market is currently experiencing is of paramount importance. For example, a 60-year-old investor allocating to stocks in 1968 would have been 87 before breaking even, adjusting for inflation, in 1995.
The bond portion of a portfolio faired just as poorly during the 1970s. Bonds are decimated during periods of rising inflation, and in the 1970s inflation rose to over 13 percent. A mutual fund bond investment fared even worse during that decade; the net asset value of a bond fund drops as inflation takes hold and subsequent interest rate rises eat into the purchasing power, and then the price, of the fund.
Perhaps more crucially, a portfolio limited to stocks and bonds during the 1970s would have missed one of the greatest commodity booms ever experienced. From 1971 to 1980, gold rose by 2,300 percent, silver by 2,400 percent and platinum by 900 percent, while oil rose 900 percent.
Changing Times Require Changing Mindsets
Most investors' experience with investing is based only on the last cycle. They find it difficult to rebalance their portfolios in order to align them with changing trends, having become entrenched in one mindset. Savvy investors today need to adopt a gold mindset.
Today’s investors are convinced that equities will continue to provide superior returns during the next 20 years. Many feel the financial turmoil of 2008 is behind us, that the worst is over, and are blindly looking forward to further gains on the stock market. This mindset fails to acknowledge today’s financial reality.
In fact, economic conditions today are much worse than in the 1970s. Government spending around the world has exploded and continues to do so. Fiat (paper) currency supply, along with government debt in the world’s major economies, is spiraling out of control. The situation is worsening daily, and burgeoning inflation can be the only result. Crucially, the world’s debt will inhibit governments from substantially raising interest rates– today’s economies couldn’t withstand a high interest rate environment.
These are the reasons gold has risen constantly, year after year for nine years, and will continue to do so. In truth, gold isn’t just rising; fiat currency values are falling through debasement by their governments. The more dollars created, the less each one is worth. Gold protects investors against inflation, because it is a non-depreciating asset.
Equity markets are topping. From a purely analytical point of view we can see that equity valuations are high, and there is more potential risk than reward. It is time to rebalance portfolios.
The Dow:Gold Ratio
The Dow:Gold Ratio, which measures trend changes in the price of gold versus a basket of stocks as represented by the Dow, supports the idea that investors today should have an allocation to precious metals. Essentially, the Dow:Gold Ratio divides the Dow by the US-dollar gold price. Figure 1 shows that when the ratio is rising, as it did in the 1920s, 1960s and 1990s, portfolios should be overweight equities. When the Ratio is falling, as it did in the 1970s and is doing today, portfolios should be overweight precious metals. Currently the Ratio is 8.18:1 and, equally important, it is falling, meaning there is still plenty of time for investors to rebalance into gold and precious metals.
