ASSET ALLOCATION
30 October 2010 by Boeckh Investments
5 Comments
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Comments
most equity centered FA’s do not really understand gold….they do not get it and i am not surprised. its more than just the anticipation of inflation. and no, i’m not talking about trading it for bread someday….geeez.
it is THE fear trade.but not anymore irrational than the DOW going up on QE 2 rumors n winks n nods from the FED.
when El-Erian says greece will default within 3 years-i’m listening..the other PIIGS will go like dominoes…if you don’t think there is a currency time bomb ticking over there, don’t buy gold.
So this investment letter is telling me that gold is a “terible investment” over the next 5 – 10 years. A few paragraphs later it is telling me that the inflation argument for gold investment doesn’t hold over the next “few” years. You can’t have your cake and eat it, too.
Cough it up, Boeckh, which is it?
TPC, thought I would share a story with you about market psychology.
I have a friend, a successful trial lawyer, who just recently opened an on-line brokerage account. He does not trust financial advisors, but his market knowledge is dangerously thin. So he calls me Friday morning (yesterday) at 7:30 AM, Eastern Time, with a question… “is the market closed?… I’m trying to buy XXX because I just read an article that it’s going to go nuts in the emerging countries”. His buys are likely to be in the 6 figure category.
To me this fits in the “unintended consequences” category. Our government is manipulating and distorting market risk assessments, and growing a new bubble. Of course, my friend is an extreme case, but he’s a megaphone for what’s going on in risk markets… PANIC. We are living in an investment “twilight zone”.
What I take away from this article is the belief that the markets are extreme but normal. What they don’t take into account is this is not a normal recession but a once in “100 year” storm. My view is that the instability of the financial system is so great and is being distorted by the Federal Reserve so dramatically that the normal investing routine is worthless. I believe in the deflationary scenario. I believe “the market can destroy money faster than the Fed can print it”. I believe that there are times you cannot reliably make money in the markets and this is one of them. All one can do is to hold cash, hedge with a short position and some gold, and pray. When the tipping point is reached those with liquid resources will prevail.
Great reading. Even though I do not agree with it everything in the letter, it is well written and the rationale for the views presented is detailed well enough so that one can easily develop a counter argument if there is something one does not agree with.
The thing that jumps at me the most in this letter and in a lot of the investment advice stuff that I read is that the level of risk out there in terms on what is likely to happen is, IMO, as high as it has ever been in the last 20 years. Many MMs recognize this, but the they go ahead and ignore this when making asset allocation recommendations (this letter is a good example). The key risks I see out there are as follows:
1. The uncertainty about QE and the possible consequences of the extreme liquidity it creates. Are we gonna be the next Japan or are we gonna take off?
2. The consequences of the financial crisis and a recession that was almost a depression, coupled with a housing market that is very likely to go into a second dip; and the best most economist can do is say that housing is such a low percent of GDP already that it can no longer have a significant effect on GDP. Ignoring the unknown consequences (the behavioral stuff that cannot be put into equations) that can make a housing double dip have an impact in the economy that is much larger than most would predict is, IMO, the largest downside risk in most forecasts out there.
3. The high correlation among asset classes which intensifies short term swings in the valuation of risky portfolios.
4. The current rich valuations in all asset classes, coupled with the fact that many actually say all risky market are cheap due to QE; leading most MMs to make the exact same recommendations, e.g., buy large cap high dividend stocks, stay away from investment grade bonds, buy commodities, etc.
The combination of the items above leads me to believe that investors may make an 180 degree turn in the not too distant future and decide to cut down in risk. This would result in a lower, more appropriate, valuation of risky assets; end if you do what the MMs are telling you you will be caught with your pants down.
Thus, I believe that the allocation to risky assets most MMs recommend is significantly higher than it should be, and that trying to seek alpha by making small bets on low probability, negative events that may materialize (using, e.g., puts going long volatility) are sensible strategies that are missing in most investment advisor recommendations that I read.
Thanks TPC, once again for your valuable posts.