Mostly Voices [0:00]

A foolish consistency is the hobgoblin of little minds, adored by little statesmen and philosophers and divines. If a man does not keep pace with his companions, perhaps it is because he hears a different drummer. A different drummer.

Mostly Mary [0:19]

And now, coming to you from dead center on your dial, welcome to Risk Parity Radio, where we explore alternatives and asset allocations for the do-it-yourself investor. Broadcasting to you now from the comfort of his easy chair, here is your host, Frank Vasquez.

Mostly Uncle Frank [0:37]

Thank you, Mary, and welcome to episode 40 of Risk Parity Radio. Today on Risk Parity Radio, we are going to follow up on episode 12, which was an analysis of gold, and we are going to follow up using a suggestion that came from one of our listeners, Joseph K. Now, Joseph K. Writes, hi Frank, thanks for this great website and informative podcast. I thought you'd be interested in this article. And he refers to an article on the website Early Retirement Now, which is part of the Safe Withdrawal Rate Series, Part 34. and we'll link to that in the show notes. Then he writes further, I'm curious regarding your thoughts on the conclusions Earn, that's the author of the website, reached regarding the golden butterfly, Ray Dalio all weather portfolio, etc. Feel free to shoot me an email, perhaps even do a podcast episode regarding this. Thanks and take care, Joseph. Now, I'm assuming this Joseph K. is not the same Joseph K. who was the protagonist in the Franz Kafka novel the Trial for an obscure reference for you. But it's a very interesting article that he pointed out and we're going to talk about today. Now, just in case you're not aware, early retirement now is a very well-regarded website about early retirement and portfolios and in particular the safe withdrawal rate. Big Earn has written an entire series of at least 40 articles now, I believe, about various aspects of the safe withdrawal rate and analyses of various portfolios that is well worth reading. The best way to read it is to look at the list of topics and read the ones that you'd be interested in, because it would take you many hours to read through the entire series, at least if you're going to do it all at once. So what Part 34 of the Safe Withdrawal Rate series was is a blog post entitled Using Gold as a Hedge Against Sequence Risk. SWR series part 34. And again, I'll link to that in the show notes. So not to bury the lead, let me go straight to the conclusions that Big Earn reached with respect to this. And here we go, and I will just read it to you. It's not that long. He writes, Just for full disclosure, except for a quarter-ounce gold American Eagle coin I got from my late uncle Carl, I own no gold. So with a little bit of confirmation bias, I set out to prove that gold has no place in a retirement portfolio. The average return over time is simply too low. But gold shines, pardon the pun, when all other asset classes are hurting. And that's a huge benefit. Not so much in the pre-1920s era, but at least during the last 100 years, and during some of the well-known bear markets and recessions. I particularly like the fact that gold seems to work well both during inflationary recessions, 1970s, but also during the bad demand shocks with that conjured up fears of a deflation scenario 2008 slash 9. So am I going to increase my gold holdings? Probably not, at least not right now. Right now, when he wrote this was January of 2020, earlier this year. Here are two reasons. One, procrastination. Yeah, I admit it. I'm a bit of a procrastinator, but there is even a good rationale to stick with equities. Let's just ride the equity momentum a little bit longer. I don't see any imminent risk for a recession around the corner. and I hope that the music doesn't stop playing in this financial version of musical chairs anytime soon. 2. Inertia Making a major change is hard. For me to go from 0% gold to 10-15% gold allocation would be a major shift and I need to see evidence almost beyond a reasonable doubt to make that move. But with the lingering doubts about whether gold will perform well as in the past, see the disclaimer and the caveat about gold ownership restrictions and government fixing prices above, I'm still on the fence about putting a six figure sum into some useless metal just sitting around and not generating any dividends. But likewise, if you currently do own 10 to 15%, you probably don't see any clear and convincing evidence to move out of gold either. So much for today. Maybe readers can convince me to shift from equities into gold now. It was a little bit prophetic that he wrote this in January of 2020 since we did have a recession a couple months later and gold is up 25% or so this year. But as we say, hindsight is 2020 with respect to any holding that you might hold. In the earlier part of the article, he did a lengthy analysis of a number of portfolios involving gold, essentially going back 100 years with some also analysis back to as far as 1871. And his bottom line conclusion was that adding 15% gold to a stock bond portfolio would decrease the safe withdrawal rate. I'm sorry, would increase the safe withdrawal rate because it would reduce the drawdowns in that portfolio. And this is essentially the same conclusion that we reached back in episode 12 of this podcast. Now, why he did not take his own advice? Well, he explained it as best he could there. That procrastination issue really does affect us. And if you listen to the preamble of this podcast, you'll hear from Ralph Waldo Emerson about our foolish consistencies being the hobgoblin of our little minds, which tend to make us cling to what we knew before and be unable to incorporate new information, no matter how good it is. into our future selves. And that is something we need to get over for ourselves. But there were a couple other portions of this article that Joseph K wanted me to address and we will address those. In this analysis, Big Earn also analyzes the all-weather portfolio and the golden butterfly portfolio. along with a permanent portfolio. Now the all-weather portfolio or all-seasons portfolio, as we've named it in the Golden Butterfly, are sample or reference portfolios that are also on our website, www.riskparriyradio.com and he ran some back tests using the data that he had assembled that are really from about the 1920s to the 1970s. and essentially concluded that neither one of those portfolios would be a good portfolio to hold. I won't go through all of the numbers on that because you can read them for yourself. And Joseph K was wondering what I had to say about that. Well, in a nutshell, what I have to say is what I've said before about those two portfolios. I think the All Seasons portfolio is probably a bit too conservative. Generally because it's only got 30% stocks in it and then has a very large component of bonds and that if you really wanted to run a portfolio like that you would probably have to apply some leverage to it to make it really work. And Big Earn seems to agree. If you look in the comments, particularly the one on February 16th of this year, he notes that if you were to hold one static portfolio, it would look a lot like that all-weather portfolio, though that's not what he would recommend. Now, as for the golden butterfly, this is a little more controversial for Big Earn, and there are some references, I think, to other discussions, and especially in the commentary, that my opinion of the golden butterfly is that it's a very good portfolio, but perhaps it has a bit too much gold in it. And what Big Earn has to say about it is more focused on the stock components because he believes that the outperformance it has had in the past 50 years is largely due to its allocation to small cap value stocks. And he's not sure that small cap value stocks are likely to perform as well. in the future, whether they will or won't, I'm not sure, but that's his opinion and he's entitled to it. They have, oddly enough, since I implemented these portfolios, small cap value has been one of the best performers over the past six months and they're up something ridiculous, like 35%, but that has not been indicative of their performance over the past 10 years, certainly. lagged the markets considerably. As I mentioned, I do think that it's a little bit overweight in gold. So where big earnings comes out is he thinks that it should have more stocks in it instead of the 40% that it holds. And if you did that, you end up with things that look more like the Golden Ratio portfolio or the Risk Parity Ultimate portfolio that you see as the sample portfolios on our website. which are looking at 50 to 60% in stock funds or things that are correlated with stocks like REITs and preferred shares. The other issues you see raised about his analysis of these portfolios has to do with the problems inherent of trying to analyze a portfolio that held gold between 1933 in the early 1970s because it was illegal in the United States to hold gold during that time period. And gold was also pegged specifically and exactly to the dollar at a fixed rate, which means that it really would not have performed in the same manner as it does today or prior to that period. and so a number of the commenters have raised that issue. And there's really not a whole lot he could have done about it, given the constraints that you have, but I think it is a legitimate issue. I don't know what the answer to it is. I suppose you could have substituted something like gold miners for a proxy or something of that nature, but really, The dollar itself was almost a proxy during that period. So you could have also tried to substitute cash for that period. Regarding gold miners, there is an interesting history to that sort of analysis. He did not do this, but just anecdotally, when the US was on a gold standard, owning gold miners could be extremely lucrative in deflationary environments. And so what you saw from 1929 to say 1933, during the onset of the Great Depression, the best performers in the stock market were actually the large gold mining companies, especially Homestead Mining Company. Homestead Mining Company went up something like 500 or 600% in those three or four years while everything else was crashing around it. And so if you held that at that time, that certainly would have saved you a lot. What I find also coincidental or interesting about Homestead Mining is its future. It was acquired by Barrick Gold earlier in this century, around in 2002, I believe. And Barrick Gold is in fact the company that Warren Buffett has bought recently. in this year for whatever reasons he had, although I think he's sold a bunch of it recently, but I just thought that it was funny that the number one performer in that horrible deflationary environment of the Great Depression was in a way, shape, or form something that was bought by Berkshire Hathaway earlier this year. And no, that doesn't mean you should go out and buy a lot of Barrick Gold right now. Or sell it if you have it. I don't have any opinion on that. The other issue that comes up in the discussion and in the comments is the anomaly that occurred when the US came off the gold standard and closed the gold window in 1971, and there was a huge spike in the price of gold in 1972. And so, Big Earn questions using that data as useful for future prognostications or predictions as to what gold may do or how it may behave in the long term in the future. And that is an issue that comes up in the data that you find in portfolio charts in particular, because it does go back and start around that time in about 1970. What I get from this is that you really should try to use as many data sets as you can and that are available, but you should recognize the limitations that they might have and might have in certain circumstances. Obviously, data that occurred in the past 30 years is probably going to be a little bit more relevant than something that is ancient history under a different monetary system. But you never know on that score. If you look at the kinds of data that we have in the data sets, Portfolio Visualizer is the data set that has the broadest list of assets and things to analyze, is what we use frequently here. Portfolio Charts goes back a little further in time. to the 1970s. Now what Big Earn uses and has constructed and is available on his website is a much longer time series, but a much more narrow time series that basically for the most part covers a stock bond portfolio where the bonds are 10-year treasuries. And he's got that going back to the 20s with really good data or pretty good data. and back to as far as 1871 with some other data that he's been able to construct. What you get out of that is a very deep set of data that's not very broad. And the problem you would have with that is it can't tell you a whole lot about other alternative assets and how they might perform in a portfolio, for instance, REITs or preferreds or even gold since he had to come up with a construction to make this particular analysis for that. So we are stuck with some uncertainty, as we always are, and we must do the best we can with the data that we have available and the tools we have available. But whenever I look at someone else's site, what I come back to, what I'm always most interested in is what do they actually invest in themselves? and what big earns got is extremely interesting from a risk parity perspective. And he writes about this in a series where he talks about options trading because this is part of what has become probably the most active part of his portfolio and is generating the most steady returns out of it. So what does this options trading portfolio look like? I will link to this in the show notes in part three of this particular series. But what he's got here is essentially what you would think of as a barbell portfolio where you have some very inert portions of it and then some very risky portions of it. So he's got 30% in municipal bond funds and 40% in municipal closed-end funds. Now those are also investing in municipal bonds, but they carry leverage and they are managed and more volatile than ordinary muni bond funds. And then he's got 25% in preferred shares and then he's got 5% in cash. Now the question then becomes, well, where are the stocks? Well, the stocks are part of the option trading strategy that is overlaid on top of this and that this Portfolio of more static income generators is supporting. And so what he is doing is actually selling puts on the S&P 500 and doing that for two day periods. So he'll sell one on Monday to be closed out on Wednesday that expires on Wednesday, one on Wednesday that expires on Friday, and another one on Friday that expires on Monday. And he's found that this generates a fairly steady return for it. What I find interesting about this is it is a kind of risk parity style portfolio. If you're taking a portfolio that is largely bonds or bond equivalents and income generators and then superimposing upon it or having the section with stocks as a driver of the total returns for the portfolio. what he ends up with, with something that looks like he thinks it'll generate a 9% total return on average. And so that's probably around 7% after inflation. And he's worked this thing, and it's worked very well for a period of years. I really won't get into the option trading strategy he's got because he explains it very well, and I don't understand it very well, or as well as I'd like to, to be trying to implement something like that. Man's got to know his limitations. But he has done some other analyses on there, particularly part five of this, looking at how it performs overall. He did note that during March it did do very well. The stock portion of it actually was making money because the puts he was buying were so far out that they weren't even caught by the fall in the stock market at the time or were only caught a few times. Basically what happens is most of the time he makes money on this trade and then a few times he loses money on the trade, but it results in a more steady income. I did note reading it that his one dismay was that during March the bond or income portions of these portfolio was actually losing in money because it was down 4%. And my observation is that if he were to substitute some of those munis and preferreds and instead put a little gold and some long-term treasuries in there, as you might in a risk parity style portfolio, his results probably would have been better and a little bit more stable, if a little bit more complicated. But I think this is really interesting food for thought. Obviously, he's a lot more sophisticated than me or most of us. And so I would not recommend trying to trade any kind of option strategy without studying it in detail and probably having some back and forth with him about how it all works. Man's got to know his limitations. From my perspective and the perspective of this show, it just is another example of something that looks like a risk parity style portfolio where you are taking leverage in a portfolio that has lots of income generators and a smaller proportion of stocks. than you would find in something like a 60/40 portfolio or a 70/30 portfolio. And the fact that he's got a big slug of preferreds in there, I also find interesting because a lot of our risk parity style portfolios do use those as ballast and to generate some income for them. But now I see our signal is beginning to fade. I would like to thank again Joseph K. for making this suggestion. I thought it was an excellent topic for discussion and would invite our listeners to go look at those articles and not only read through that article I'm going to link to on his gold analysis, but also all of the comments after that because he was very diligent about responding to various issues that were raised about the analysis and about these portfolios. And it was a lot of work he did, a lot of excellent work on analyzing this situation. If you have comments or questions or suggestions, you can send them to frank@riskparityradio.com that's frank@riskparityradio.com Or you can go to the website and fill out the little contact form there and your message will get to me that way. Our next episode will be our weekly portfolio review, which should come out this weekend after we have a full week to review. In the meantime, thank you for listening in.

Mostly Mary [24:07]

This is Frank Vasquez with Risk Parity Radio, signing off. The Risk Parity Radio Show is hosted by Frank Vasquez. The content provided is for entertainment and informational purposes only and does not constitute financial, investment, tax, or legal advice. Please consult with your own advisors before taking any actions based on any information you have heard here, making sure to take into account your own personal circumstances.