You Can’t Eat Asset Allocation Either

–Alas, poor Europe has not yet embraced its common debt future. The French and the Germans met overnight to talk about collectivising Europe’s liabilities. The deal was not consummated. Markets were lethargic.

–What is the price action telling you? To answer that, we refer you to the latest YouTube update from Slipstream Trader, Murray Dawes. Murray records a market overview on Wednesdays to give non-Slipstream subscribers a peek at how his analysis works. The individual recommendations that follow from his analysis of the price action are reserved for paid-up subscribers.

–Murray makes sense. And he thinks clearly. That’s what we like about him. Let us balance his good analysis with some awful analysis of gold, courtesy of Wells Fargo Bank. Perhaps channelling their inner Michael Pascoe, the bank’s analysts told clients, “Interest in gold investing has reached the level of a speculative bubble.”

–Having thus be-clowned themselves, they went on to elaborate: gold prices are volatile, gold doesn’t pay a yield, it depends on a “greater fool” for capital gains, central banks are net sellers, it doesn’t beat inflation, Warren Buffett hates (and does not understand) it, and you can’t eat it.

–Oh dear. The gold price in dollars is volatile because the US dollar is volatile. An ounce of gold has almost always bought you a nice suit at any time in history. The volatility in the gold/dollar exchange rate is all on the dollar’s end. And that’s because the supply of dollars is always increasing. Also, the futures exchanges have been pretty active boosting margin requirements on gold contracts. That’s made for some larger-than-normal price moves. But the value? Rock steady over time, baby.

–And that’s the point. Gold isn’t really an investment. It’s money. And it’s money that holds value well over time. You only worry about capital gains if you’re investing in gold. If you’re buying money, you’re more focused on preserving purchasing power.

–Gold doesn’t have a yield? Someone should tell the boys at Wells Fargo that 10-year US Treasury yields went negative in real terms this week (see chart below). Investors are so terrified of the debt super volcano upon which asset prices are built, they are paying rent to Uncle Sam in order to park their money in bonds.

–By the way, this willingness to lose some of your capital in exchange for the illusion of safety and liquidity, in the short term, is probably going to be the catalyst for a violent stock market rally. All that money will come out of bonds and into stocks. After all, you have to beat inflation somehow, don’t you? This is how artificially low interest rates destroy savings (negative real yields) and encourage speculation in equities.

–The claim that central banks have been net sellers “in recent years” isn’t backed up by any facts. But in any case, the Bank of England sold all its gold in May of 1999, near the bottom of a 20-year bear market in gold. Peter Costello, who was Australian Treasurer at the time, beat Brown to the punch when he sold two-thirds of Australia’s gold reserves in 1997 for the handsome price of $306.60 an ounce.

–This was at the height of political efforts to eliminate gold’s role in the financial system. Costello said as much. He said gold, “no longer plays a significant role in the international financial system.”

–You’d expect politicians to say that. You’d expect them to want it to be true. A gold standard was the only check on the permanent expansion of government debt in the early 20th century. That’s why it was abandoned. With a gold standard, the Warfare State and the Welfare State are not possible. Get rid of the gold standard and discredit gold as money and you can expand the role of the State to your heart’s delight.

–Central banks are the largest holders of gold bullion in the world. Politicians sold gold because they’re stupid, ignorant of monetary history, and think only in terms of election cycles. Most central bankers, Ben Bernanke notwithstanding, recognise that gold is money. Its role in the world’s financial system is growing, not shrinking.

–Warren Buffett doesn’t like gold? So what. Buffett is an investor. Gold is money.

–You can’t eat gold? Is that so? Well, you can’t eat dollar bills either. You can always sell gold and silver for local currency and buy food, which you can eat. Being a medium of exchange is only one property of money. Just because you can’t yet use gold coins to buy a Big Mac doesn’t mean gold isn’t money or isn’t useful. Claims to the contrary are ignorant.

–We asked Diggers and Drillers editor Dr. Alex Cowie what he thought of the Wells Fargo report. He wrote back:

“They forgot that you can sell gold and buy a room, a hot meal, or an ‘efficient’ jacket, hat and gloves with the proceeds.

“Their mixed salad of an argument was full of holes, and didn’t mention the epic growth in Chinese gold demand that is completely reshaping the market. China is the biggest importer of gold now, and these imports are about to double.

“The reason China and the rest of the world is buying gold is that the financial system is corrupted with debt, bailouts and defaults.

“And who is Wells Fargo’s number one share holder?

“None other than Mr Warren Buffett: the world’s biggest gold hater. Interesting that the bank’s analysts are now quoting him, like lovesick schoolgirls.

‘Do something for me,’ and [the gold] says, ‘I don’t do anything. I just stand here and look pretty.’

“Damn right. It does look pretty.

“It also does something that Wells Fargo hasn’t done too well in the past. It preserves wealth.

“There’s no one to stuff things up with gold. No bungling bankers, no corrupt politicians, no bail outs. And this is why it doesn’t need to pay interest – there’s no counter-party risk to compensate for.

“As the Octogenarian of Omaha points out – there is very little gold in the world. It would in fact fit into a couple of full size swimming pools. This scarcity is exactly what makes it valuable.

“So as the European and US debt crises continue to unravel in the coming months and years, and more and more Euros and Dollars are printed to plug the shortfalls, gold’s scarcity will be more and more valuable.

“So next time you are saving money up to buy some ‘shelter, food or efficient clothing’, buy some gold to do it with.

–The Wells report concludes that:

“Gold is a commodity that should be held as a part of a larger, diversified allocation to commodities that is frequently rebalanced. We do not believe that gold should be utilised as a cash-equivalent, no matter how enticing the price returns have been in recent months.”

–It’s clear Wells thinks gold is an investment speculation. That’s why they think it’s in a bubble. If the Wells’ bankers treated gold like money, not a financial asset, perhaps they’d allocate a lot more of their cash to it. But oh well.

—On the subject of asset allocation, we return to yesterday’s question of whether the Australian funds management fraternity is prepared for an era of lower Chinese growth. The answer is a resounding “No!”, according to what we’ve found so far. But you decide for yourself.

–Our premise is that there are two big drivers of share market returns. The expansion of the global credit bubble – which has driven capital to the Aussie investment market. And China – the source of real earnings growth for the bulk of the non-financial companies on the ASX. The equity market grows when credit expands and China grows. (China’s rise itself also being a by-product, in a roundabout way, of global credit growth.)

–Australians are probably over-invested in growth assets. But you wouldn’t have seen a problem with that in the last two years. According to a recent study of global assets under management by the Boston Consulting Group (BCG), global assets under management (AuM) by financial firms have grown by $9 trillion since the end of 2008 to hit $121.8 trillion.

–BCG concluded that:

“[T]he strong performance of the financial markets accounted for the lion’s share (59 percent) of the growth in AuM. Its impact was amplified by the ongoing reallocation of wealth. From year-end 2008 through 2010, the share of wealth held in equities increased from 29 percent to 35 percent.”

–Ah yes. In 2007 and 2008 investors fled to cash. But once the smoke cleared from the rubble of the Lehman Brothers collapse, investors did about the only thing they could with interest rates low, they bought stocks and risky investments.

–Australia did okay because of this. But not as well as you might expect. “Total wealth grew in Australia at a slower pace than anywhere else except Western Europe last year but the number of millionaire households surged”, according to an article in the Australian, which quotes the BCG study.

“Australian wealth increased by only 5 per cent to $US2.34 trillion last year, compared to the global average increase of 8 per cent…BCG’s head of financial services practice in Australia, Matthew Rogozinski, said Australians’ high exposure to equities through superannuation meant wealth fluctuated more than in other countries.”

–Ah yes! The high exposure to growth assets via super. The trouble, as near as we can gather, is that the default super fund option has a very high allocation of assets to shares, both Australian and global. We’d argue that this is a general bias toward growth in the default asset allocation of most Australians that exposes them to a big decline in growth. And a big credit depression in Europe in America coupled with much slower growth in China is the “big decline” we’re talking about.

–A chart courtesy of Australian Super will illustrate the point nicely. This is how assets are allocated the default “balanced growth” fund most Australians are automatically put in. It allows for some variability depending on the reading of other factors. But for the most part, it’s heavily biased toward shares, and shares are quite naturally heavily biased toward growth.


Source: Australian Super

–Our point is that there’s nothing really balanced about this, given the current global conditions. Another pie chart from an ASX article on the subject makes the point even more dramatically. In the example below, shares make up 47% of a “balanced” portfolio while “fixed interest and high yield income” make up 30%.



–Now, portfolios and asset allocation strategies are highly personalised affairs. They vary depending upon your age, your income, your objectives, your tolerance for risk, and many other factors. But surely one of those factors would be the macro-economic environment. Wouldn’t it?

–We’re working on a model assets allocation strategy that correlates with our despairing world view. It will probably have a much higher allocation to cash and precious metals. It won’t get rid of an allocation to aggressive growth stocks (especially precious metals and energy stocks). But we wouldn’t call it balanced.

–In fact, that’s part of the problem. The idea that you can build wealth in a balanced way through a uniform asset allocation strategy is crazy. A sound portfolio would rebalance assets annually. That’s a nod to the fact that none of us can predict the future and you don’t want to have all of your wealth concentrated in one asset class, or in one risk.

–But what assets should you really have in your portfolio if we’re entering a credit depression? Will stocks generate the same returns over the next 20 years as they have for the last 20 years? You’d think not, given that global credit is due to contract in the years ahead, not expand like it did for the last 20. Stay tuned…


Dan Denning
Markets and Money Australia

Dan Denning
Dan Denning examines the geopolitical and economic events that can affect your investments domestically. He raises the questions you need to answer, in order to survive financially in these turbulent times.

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9 Comments on "You Can’t Eat Asset Allocation Either"

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Time to check the Baltic again. 1 toe over the cliff


Liked the bit about Wells Fargo. 12months ago i bought sovereigns at gbp 200, and just sold for gbp 250, that’s 25% return in 1 year, no brokers fees cgt or any other cost, sort of puts it into perspective does it not. I bet Wells Fargo or WB don’t make that kind of profit, well, not legally anyway.I am rather suspicious about those two. Pascoe and Buffett is there an hidden agenda somewhere, i’m long retired and no longer in touch but alarm bells are ringing.Maybe MM can do some sniffing around and see whats in the wind.


Liked the bit about Wells Fargo. 12months ago i bought sovereigns at gbp 200, and just sold for gbp 250, that’s 25% return in 1 year, no brokers fees cgt or any other cost, sort of puts it into perspective does it not. I bet Wells Fargo or WB don’t make that kind of profit, well, not legally anyway.I am rather suspicious about those two. Pascoe and Buffett is there an hidden agenda somewhere, i’m long retired and no longer in touch but alarm bells are ringing.Maybe DR can do some sniffing around and see whats in the wind.

Gold Rate
Thanks for this. One of the best overall articles on gold I’ve read recently. For some reason I notice its mainly the stock value investors that hate gold. Some of the brokers I know and some of famous ones like Warren Buffett always regurgitate the can’t eat gold line and every other cliche you listed here. It’s as though they all learned it at a financial conference 10 years ago. They know stocks. They just don’t understand the history of money. They don’t understand gold’s utility as a wealth reserve and don’t seem to comprehend the complexity of the global… Read more »

I do own some gold, but we must still realise that it is at the end of the day gold is an asset and thus vulnerable to speculation like any other asset, or even currency for that matter.


Following is a free intelligence source on commodities and energy using a transport and logistics take.

What a great article! I have some friends who are in banking who are always telling me the same reasons stated by Wells Fargo Bankers about investing in gold. However, during recent stock market correction, some have congratulated me on holding gold/silver and for selling out of stocks in June 2011. So it just goes to show, bankers are just humans, just people like us, who may not know everything. I read UK Daily Reckoning and I must thank them for making those sound recommendations. My wealth is preserved for now so thank you for your great reporting and keep… Read more »

A short video that you might like.An oldie but it says it all.

bob wetmore

Wells F. will probably rehash the same garbage 5 years from now when gold is $5,000 or so an ounce and the Dow is at $4,500.

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