Blog | CB Investment Management

Widespread Advisor Misallocation In Gold And Bonds.


Gold has risen 89% in the past five years, compared to 85% for the S&P 500 and a disappointing 0.7% for the US aggregate bond index (as of May 17, 2024, according to Bloomberg).

Financial assets are reflecting the evidence of currency destruction. Equities and gold soar; bonds do nothing. It is the picture of governments using the fiat currency to disguise the credit solvency of the issuer.

Once we understand that inflation is a policy and that it is an implicit default of the issuer, we can comprehend why the traditional sixty-forty portfolio does not work.”

Daniel Lacalle

 Selective history can be a very misleading basis for your allocation assumptions.

The 1970s produced the highest interest rates and inflation ever seen in the US. Just looking at a 60/40 (equities/bonds) allocation returns from 1982, the bottom of that experience, suggests 60/40 is a brilliant portfolio construction, why bother with anything else?

However, this conclusion would be highly selective cherry picking from what has been an  unusual and llkely unrepeatable historic period. Look below at the real value of the 15 year period before. 60/40 had a negative return for 15 years.

What was the difference between these two periods? In the earlier period inflation was rising. In the latter period inflation was falling. Inflation started rising in 2021, and it is still above target and rising again. Worse, as we have described, the Federal Reserve has just downgraded its inflation priority.

No surprise, 60/40 lost 15% in 2022, and in compounding terms has not recovered. Yet allocation behavior has not yet changed. Investors are still being put into a stock/bond allocation model. They are likely in for a rough ride if inflation is now on a rising trend.

Finding the optimal allocation has become a crucial issue. Advisor allocations suggest that this is not being adequately addressed.

As we have described recently, Powell has downgraded the Fed’s inflation objectives at a dangerous time. Just as inflation has started rising again, and money supply too.

Paul Volcker says inflation is all about money supply, good thing money supply is up $1 trillion in 7 months since Nov 1, 2023. No wonder there’s a speculative orgy in financial markets as well as reaccelerating inflation.

“It is clear Fed leadership is desperate to ease and keep flipping the narrative to justify a cut. Hence, in Oct, Powell told us that financial conditions are how monetary policy works and today, Waller dismissed that thesis. Is it any surprise gold is outperforming treasuries?

We believe #bonds are in a structural bear market that, absent intervention, will see yields rise for the next +20yrs and you need a new hedge. Note that on a total return basis ie plus interest, Treasuries have broken 35yr support vs #gold, and the next target is 20% lower!”

Julian Brigden

International investors, including central banks have and continue to reduce their dollar investments in favor of gold. Not just bonds are underperforming, but the US dollar is too. The policy changes over the last 6 months have downgraded the dollar against gold, at an accelerating rate.

Gold keeps on appreciating versus the dollar. Around 8x since 2000!

The big question is why haven’t US investors abandoned or downsized bond allocations too? Most likely this is a poorly understood allocation issue across the advisor industry.

The problem for investors is that failing to avoid a substantial allocation to both stocks and bonds in 2022 was a fatal allocation error. A 15% loss in 2022 cannot easily be recovered if you want to positively compound your account value. Just trying to compound at just 4% you would require a 30% return in 2023 just to get back on track. Very few investors were able to do that! Most investors are still behind their compounding rate over the last 2 1/2 years!

Clearly, these are circumstances where a stock/bond allocation carries far more risk than is appropriate, or even understood.

 A structurally higher interest rate level requires a reassessment of investment strategies and an adjustment of portfolios. We have recently witnessed the substantial vulnerability of equities and bonds in an environment of higher inflation and rising interest rates. Commodities, on the other hand, proved to be an excellent hedge in 2022, with a positive annual performance of 16.1%, while adding gold to the portfolio would have at least significantly cushioned the losses.

Gold and commodities hold a significant advantage over equities and bonds because they carry no default risk, a benefit that is particularly relevant in the current challenging interest rate environment. The integration of alternative asset classes therefore offers sensible diversification of the portfolio, not least due to their low correlation to equities.

Not only that but in times of rising inflation, bonds are positively correlated to equities as they were in 2022. This caused the outsize losses. As you can see in the table below, that is much less the case for gold and commodities.

Quite simply, a long term allocation only to stocks and bonds is an incompetent misallocation in a rising inflation environment. Be aware that this is very often still recommended as the basis for portfolio allocation! A stock/bond allocation was a disaster for around 15 years through the 1970s, and it has already been so again for the last five years. It should be clear why.

Yet US investor advisors have an astonishingly low allocation to gold. Having studied performance over the last 50 years, including the work of many others, my opinion is that many investment advisors are making an error in maximizing long-term risk adjusted returns. The latest research indicates that around 15% in gold would be more appropriate as an average. There is a similar problem with commodities in general, and of course bonds.

The chart below shows that advisor gold allocation is broadly insignificant.

The Treasury already has a challenging job of finding investors for record bond issuance as far as the eye can see. Yet in current conditions bonds are becoming an increasingly unattractive investment. The Treasury is scrambling to get the funding done!

This must have been a factor in the recent retreat of the Fed in its selling down of its bond portfolio. At least if things get bad the fed can stop selling and become a buyer to fill the gap. Wait! Doesn’t monetizing debt increase inflation which increases bond yields?

 International perspectives about US Treasuries relative to gold have clearly changed

 Increasingly, the Chinese market is a dominant force for the price of gold. The chart below show that the recent rally in the price in Yuan certainly contributed. It shows the continued urgency for Chinese investors to own gold.

Clearly, US investors have a completely different view. The outstanding shares of gold ETFs have even been declining! US investors have completely missed the current move in gold. In the video below, the demand for gold is now driven 70% by China, India, the middle east, and central banks.

(Almost) everybody in the Western world still seems to hate gold.

If US investors have to shift their allocation to gold by just 1% that will be significant new buying support for gold.

The US needs more investment but international investors increasingly prefer gold to US Treasuries, as described above. We have also shown before that central banks have been directly selling Treasuries to buy gold in their reserves.

Clearly there are different perceptions.

There are two reasons behind this development. The first is massive demand from China, and the second is a growing realisation that the dollar’s fiat days are numbered. It amounts to the end of paper pricing in London and Comex.

Don’t underestimate the scale of just Chinese savings, and now gold has become a favored investment allocation.

The estimate for the annual rate of household savings is 35% of GDP, according to OECD data. This means that households are putting aside $6.3 trillion annually, in addition to their existing holdings of assets. For households, the choice is broadly limited to property, the stock market, bank deposits, and gold.

Property is less popular because that bubble has recently been lanced. The stock market has risen 7% this year so far after recent losses, so presumably a small proportion of total savings might be invested there. That leaves bank deposits and gold. So far this year, the most popular investment medium is certificates of deposits offered by banks, which with a three-year term give a yield of 3%. These are regarded as the safest form of investment, some of which can be cashed in at short notice.

Investors’ preoccupation with bank CDs reflects deep pessimism. Burned by the Evergrande property disaster, they know that backed by the state their bank deposits are at least safe. Their memories of stock market performance are informed by the losses of the last three years, and they are yet to be convinced buyers. But as long-term buyers of gold, it appears that they have latched onto its rising trend.

Don’t miss the most complete gold research that comes out once a year. It is a remarkable collection of information and analysis, and an invaluable reference.

Or click on the video below for a shorter video version.

Best Practice is a matter of your Best Interest.

Education and a Commitment to Informed Consent is an Obligation.

Chris Belchamber is an IRMAA Certified Planner

Medicare’s IRMAA impacts every retirement plan. Learning how to mitigate it is available via IRMAA Certified Planners designation.

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