Friday, May 31, 2013

You Have to Be in Gold

Weston Wellington
Down to the Wire
Vice President

All of us could benefit by examining our inclination to invest with our hearts rather than our heads—especially when it comes to gold.

“We are living in a world of money printing. … That is why I have to recommend gold again. ... Once gold surpasses $1,800 an ounce, it will run to the low-to-mid $2,000s.” Quotation attributed to Felix Zuelauf, Zuelauf Asset Management. “Here’s What’s Cooking for 2013,” Barron’s, January 21, 2013.

“Investors can choose between artificially priced financial assets or real assets like oil and gold, or to be really safe, cash. … My first recommendation is GLD – the SPDR Gold Trust.” Quotation attributed to Bill Gross, PIMCO. “Stirring Things Up,” Barron’s, February 2, 2013.

“I am recommending gold, as I have done for many years. I will continue to do so until the gold price hits the blow-off stage, which is nowhere in sight. … The environment for gold couldn’t be better. … Gold could go to $5,000 or even $10,000.” Quotation attributed to Fred Hickey, The High-Tech Strategist. “Stirring Things Up,” Barron’s, February 2, 2013.

Each January, a group of prominent investment professionals gather in New York as members of the Barron’s Roundtable to trade quips, stock ideas, and the outlook for markets and economic trends worldwide. Barron’s—a weekly financial newspaper with a small but devoted following of professional and do-it-yourself investors—publishes a transcript of their remarks over three successive issues. The quotations above are excerpts from this year’s panel discussion, and to the best of our knowledge they represent the only occasion that three of the nine participants have highlighted gold-related investments among their choices for capital appreciation during the year ahead.

Although the year is far from over, it’s off to a rough start for gold enthusiasts. A sharp selloff in mid-April sent bullion prices to $1,395 on April 15, down 15.7% for the year to date and 26.4% below the peak of $1,895 reached in early September 2011. (Prices are based on the London afternoon fix.) For the 10-year period ending March 31, 2013, gold enthusiasts have a more positive story to tell: The annualized return for gold spot prices was 16.83%, compared to annualized total returns of 8.53% for the S&P 500 Index, 10.19% for the MSCI EAFE Index, 17.41% for the MSCI Emerging Markets Index, and 2.34% for the S&P Goldman Sachs Commodity Index.  

Taking a somewhat longer view, for the 40-year period ending March 31, 2013, gold performed in line with many widely followed fixed income benchmarks, while lagging behind most equity indices. We find it ironic that the return on gold over the past four decades is essentially indistinguishable from five-year US Treasury notes, often scorned by gold advocates as “certificates of confiscation.”

Considering the volatility of gold prices, even a 40-year period is too short to provide conclusive evidence regarding gold’s expected return. And the issue is further clouded by shifts through time in the legality of gold ownership and its changing role in various monetary systems worldwide. In his book The Golden Constant, published in 1977, University of California, Berkeley Professor Roy Jastram examined the behavior of gold in England and America over a 400-year-plus period—and suggested that the long-run real return of gold was close to zero. Even with centuries of data to study, however, he couched his conclusions in cautious language.

When we last commented on gold in February 2012 (“Who Has the Midas Touch?”), the mysterious metal was changing hands at $1,770 per ounce. We directed readers’ attention to the Berkshire Hathaway 2011 annual report, which presented an engaging discussion by Chairman Warren Buffett on the long-term appeal of gold—or, in his view, the lack of it. Since that time, the role of gold in a portfolio has provoked vigorous debate in the investment community, with thoughtful, articulate, and successful investors lining up on both sides of the issue, including at least three billionaire hedge fund managers making the case for gold.

Some might argue that gold’s price behavior will never succumb to rational analysis. For those seeking to try, a recently updated paper by Claude Erb and Campbell Harvey offers a useful framework for discussion without necessarily resolving the debate. Along the way, it provides the reader with a few nuggets of historical interest, including a comparison of military pay between US Army captains of today and Roman centurions under Emperor Augustus. (Apparently, little has changed over 2,000 years.)

The authors cite a number of reasons advanced in support of gold ownership, including a hedge against inflation, a safe haven in times of stress, an alternative to assets with low real returns, and its “under-owned” status across investor portfolios. Although the inflation hedge argument is likely the most frequently cited attraction for gold investors, the authors find little evidence that gold has been an effective hedge against unexpected inflation. They go on to poke holes in the assertion that gold qualifies as a genuinely safe haven or presents an appealing alternative in a world characterized by low real yields.

The most interesting argument, they believe, is the claim that gold is under-owned in investor portfolios and that a small shift in investors’ allocation strategy could lead to a significant rise in the real price of gold. Putting aside for a moment the ambiguity of the “under-owned” statement (all the world’s gold is already owned by somebody), the authors suggest it is plausible that individuals or central banks could choose to have greater exposure to gold. If they are insensitive to prices, this choice could cause the real price of gold to rise, particularly if gold producers are unwilling or unable to increase production. (On that note, it’s also conceivable that a significant real price increase would encourage development of electrochemical extraction of the estimated 8 million tons of gold contained in the world’s oceans, dwarfing the existing gold supply.)

INDEX                    ANNUALIZED         GROWTH
                                   RETURN (%)            OF $1            
Dimensional Large
Cap Value Index     12.89                       $127.75

Dimensional US
Small Cap Index     12.67                       $117.96

S&P 500 Index     10.18                       $  48.30
Index (gross div.)       9.05                       $  31.96

Barclays US
Credit Index               8.31                       $  24.33

S&P Goldman Sachs
Commodity Index       8.21                       $  23.51

Barclays US Gov't
Bond Index               7.85                       $  20.53

Five-Year US
Treasury Notes      7.69                      $  19.40

Gold Spot Price       7.63                       $  18.95

One-Month US
Treasury Bills               5.29                       $    7.86

Consumer Price
 Index                       4.30                        $    5.39
*40-year period ending March 31, 2013.

The “gold is under-owned” argument has been advanced by a number of thoughtful investors, and only time will tell if such a shift in allocation strategy takes place with the consequences they expect. While acknowledging the bullish implications for gold prices under this scenario, the authors point out that gold prices relative to the current inflation rate are roughly double their long-run average since the inception of gold futures trading in 1975. They suggest $800 per ounce is a suitable target when applying this metric.  Which is more plausible—that prices will gravitate closer to their historical average or that a new world order is emerging that calls for a sharply different valuation approach? No one can be sure; hence, the title of their paper, “The Golden Dilemma.”

What should investors make of all this? In our view, long-run investment results for any individual reflect the combination of available capital market returns and the investor’s behavior and temperament. As Warren Buffett has observed, excitement and expenses are the enemy of every investor, and all of us could benefit by examining our inclination to invest with our hearts rather than our heads. The decision to own gold often  is motivated by an emotional response to current events, leading to abrupt shifts in asset allocation strategy and a failure  to achieve capital market rates of return there for the taking. If adopting a permanent 5% allocation to gold encourages  investors to maintain a buy-and-hold strategy for the remaining 95% of their portfolio, perhaps that is the most sensible solution for some. Many other investors undoubtedly will be just as content to stock their portfolios with securities offering interest and dividends—and let gold fulfill their innate human desire for rare and beautiful objects of adornment.

Jastram, Roy W. The Golden Constant, John Wiley & Sons, 1977.

Erb, Claude B., and Campbell R. Harvey. “The Golden Dilemma.”

Barclays data, formerly Lehman Brothers, provided by Barclays Bank PLC.

Stocks, Bonds, Bills and Inflation Yearbook. Chicago: Ibbotson Associates.

MSCI data copyright MSCI 2013, all rights reserved.

S&P data provided by Standard & Poor’s Index Services Group.

Dimensional Index data compiled by Dimensional.

London gold fix prices: London Bullion Market Association. Accessed April 24, 2013.

Gold spot prices: Bloomberg returns from composite prices.

For more articles, visit Dimensional’s client site at
Indices are not available for direct investment; therefore, their performance does not reflect the expenses associated with the management of an actual portfolio. Past performance is not a guarantee of future results.
This information is for educational purposes only and should not be considered investment advice or an offer of any security for sale. All expressions of opinion are subject to change in reaction to shifting market conditions.

S&P data are provided by Standard & Poor’s Index Services Group.

MSCI data copyright MSCI 2013, all rights reserved.

Indices are not available for direct investment; therefore, their performance does not reflect the expenses associated with the management of an actual portfolio. Past performance is not a guarantee of future results.
This information is for educational purposes only and should not be considered investment advice or an offer of any security for sale. All expressions of opinion are subject to change without notice in reaction to shifting market conditions.

Dimensional Fund Advisors LP ("Dimensional") is an investment adviser registered with the Securities and Exchange Commission.
All expressions of opinion are subject to change without notice in reaction to shifting market conditions. This article is provided for informational purposes, and it is not to be construed as an offer, solicitation, recommendation or endorsement of any particular security, products, or services. 
©2012 Dimensional Fund Advisors LP. All rights reserved. Unauthorized copying, reproducing, duplicating, or transmitting of this material is prohibited.

Tuesday, May 21, 2013

My Problem with the Morning News

Pathways Advisory Group, Inc.
Jeff Karst, CFP®

Each morning my wife and I watch the news as we get ready for work.  Towards the end, there is a segment on the stock market.  They always talk about what’s moving the market and highlight a specific stock or two.  What bothers me the most is when they say something like “Investors are concerned about new numbers coming from insert just about anything here.”  As an investor, I am not concerned about the daily ups and downs of the market.  You shouldn't be either.

Who is concerned about this stuff?  Traders and speculators.  There are the ones hoping to make a quick buck or beat the market.  Playing the market is not investing.

Investors shouldn't worry about lower or higher than expected numbers from XYZ company.  You can’t control what the market does each day.  You can control your savings/spending and keeping investment costs low.

If I asked the media, do you think they would say “Traders and Speculators” instead of “Investors”?  I doubt it.

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Thursday, May 9, 2013

Tax Form 5498

Pathways Advisory Group, Inc.

Have you received a tax form in the mail recently? If not, then disregard this post. If, however, you did receive a 2012 IRS Tax Form 5498 recently, do not panic. Form 5498 is generated by investment custodians every May for Traditional or Roth IRAs with activity during the previous tax year and usually does not lead to an amended tax filing. Tax Form 5498 is informational. The IRS reconciles this activity with your Tax Return. If you received this form, ask yourself: "Did I contribute to a Roth or Traditional IRA last year? Did I roll money into an IRA last year? Did I convert IRA money to a Roth IRA last year?" If any of this activity applies to you, you received Form 5498. Contribution information is typically requested on an accountant's questionnaire. Rollovers and conversions generate a 1099-R. Either way, your accountant should already be aware of the activity. Then what should I do with my copy? In most cases, simply add it to your freshly started tax folder for 2013. As your accountant reviews next year's tax file, he or she can confirm that the activity was addressed.

The above explanation is summarized and generic. Please consult your tax professional with any specific questions.

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Wednesday, May 1, 2013

National Mortgage Settlement

Pathways Advisory Group, Inc.
Dustin J. Smith, CFP®

February of last year the 49 state Attorney Generals, including California’s Attorney General, reached a settlement with the five major banks (Wells Fargo, Citibank, JP Morgan Chase/Washington Mutual, Bank of America/Countrywide and Ally Financial).  It made some headlines, but seemed to fly under the radar.  And, to this point, the “actual” benefits of the settlement have been difficult to quantify.

Was the settlement simply overshadowed by the relative success of the federally subsidized refinance program HARP 2.0?  Perhaps.  But the National Mortgage Settlement is a year old and remains mysterious.   Some argue that the banks have not complied.  Others believe transparency is the problem.  I don’t know which borrowers have been targeted but some qualified borrowers may still be eligible for settlement benefits.  And apparently some money is earmarked for the Central Valley.  The settlement description originally mentioned principal reductions, cash settlements, refinances and/or modifications.  It’s a long shot, but, if 1) you, or someone you know, have been searching for a refinance/restructure unsuccessfully and 2) the loan was owned/serviced by one of the five banks mentioned above, it may be worth an inquiry.  They may not be diligently searching for qualified borrowers!

If interested in an inquiry, the following websites may be a starting point: Wells Fargo. Citibank.  JP Morgan Chase. Bank of America. Ally Financial. And this is the Official National Mortgage Settlement Website.

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