FSO Editorials: A Safer, Saner Way to Acquire and Hold Gold by Robert B. Gordon 01/11/2004

A Safer, Saner Way to Acquire and Hold Gold
Using Periodic Portfolio Rebalancing
by Robert B. Gordon, Sc. D.
January 11, 2004

This promising idea has been generated by building on our prior work on balanced asset portfolios using and benefiting from periodic or irregular rebalancing. It is just as applicable to a lump sum purchase or to one intended for periodic or irregular dollar cost averaging purposes. It should be of special interest to all investors who do not have the time or interest in becoming a gold trader.

There are many internet web sites devoted to all aspects of gold and silver trading which can be visited for further information. We are simply going to discuss how to design portfolios that will do a good job without requiring a lot of management attention by the investor. It will get its conservatism from following the principles of balancing the stable and volatile components and, further, by carefully selecting and diversifying both the stable and precious metal assets.

Since 1970, pure gold and silver prices have soared as high as $800 and $50 dollars an ounce and are now somewhat over $400 and $6 per ounce. Prices of individual mining companies are extremely volatile and catch the attention of professional traders and rank amateurs. Prices of gold mutual funds occupy a price volatility range between the base metals and the stocks. We are not aware of any silver mutual fund since most silver is produced as a by-product of other metals such as copper.

So with three distinct forms of gold and silver, it is easy to design portfolios with a wide range of volatility. The biggest and hardest question for most individual investors is to choose a portfolio with a level of volatility they can sleep with. We have received letters from individuals who have sold their house and put all the proceeds into precious metals, a practice we could not recommend for anyone.

Fortunately, by using portfolios designed to be balanced between stable asset classes and precious metals, we can present portfolio ideas suitable for every investor except a wild speculator as mentioned above. We will now proceed to present a several portfolio examples which could be adopted either as shown or combined as investors may desire to match their desired risk level.

This portfolio would be a good way for very conservative investors to acquire both gold and silver bullion stored in the vault of a very large bank in western Canada, thus saving the investor from concerns over storage. We will use just two funds, one quite stable and the other with low volatility but still holding 100% gold and silver bullion. We will discuss a combination with moderate price fluctuations. Each investor can readily shift the percentages of the two funds to suit their own temperament.

Stable Component	PSAFX	60%	$6,000
Volatile Component	CEF	40%	$4,000
Total		100%	$10,000

PSAFX is the Prudent Global Income fund and is a sister fund of the Prudent Bear fund, both of whom are managed very competently by David Tice. At the last report it held about 84% short term foreign government bonds and about 16% of gold shares. Assuming that percentage still remains, the 60% position would hold about 50% bonds and 10% precious metals. So with 40% of CEF, the portfolio would contain about equal percentages of foreign bonds and gold and silver bullion. This is an attractive allocation for a portion of your total assets.

I have owned CEF for about five years and in that time it's price has risen from about 3.5 to 5.33 which makes it about as exciting as watching grass grow. In contrast, PSAFX has risen from 10 to over 18 in just 3 years. Below, we will present the 3 year performance for this simple portfolio, both with and without rebalancing. CEF is a Canadian closed end fund that is traded on the Amex exchange and is readily available thru any broker. In my opinion, it is a very good place to start acquiring gold and silver.

We arbitrarily started the portfolio with $10,000, $6,000 in PSAFX and $4,000 in CEF. Because these two funds had somewhat similar growth in the past 3 years, re-balancing, made very little difference in the growth of this simple portfolio. But it did do a much better job of holding the 60-40 ratio.

Portfolio Without Rebalancing			Portfolio With 3 Re-Balancings
PSAFX	$8,581	55.7%	PSAFX	$9,190	59.0%
CEF	$6,833	44.3%	CEF	$6,380	41.0%
Total	$15,414	100%	Total	$15,570	100%

We can recommend this very simple portfolio for anyone wishing to start an easily managed and effective gold/silver portfolio. The annual rates of return on this portfolio were 11.5% without and 11.7% with rebalancing. Based on these three years experience, It would appear that rebalancing every two years would be adequate unless the precious metal prices really take off in a wild price climb. In that event, rebalancing should be speeded up because it is well to remember that the prices can fall even faster than they rise.

Gold and silver mining, measured by total industry sales or stock market values, is relatively small. but it is fairly complex. At the top are several large companies with market valuations of billions of dollars. Then there are about 50 smaller companies mining and selling precious metals. These stocks have been in a strong bull market for the last 3 years with many shares showing price increases of 5x or more. But on my computer screen, the stocks appear to be making a third sharp price peak that may end in a sudden decline like two such earlier peaks.

There are about 30 precious metals mutual funds all trying to beat the others by buying and selling the same small group of mining companies. The smallest mutual funds buy the same small number of better gold stocks but, as they grow in size, their performance drops into the range of all large funds. There are only a few funds still small enough to be at the top of the performance list. But, as investors send them more money, they eventually will drop into the group of large funds with mediocre performance.

There is another large group of mining companies, that are exploring for gold and producing little or none. Their prices start at a penny a share and are boosted by stories of gold strikes issued by their management or others with a vested interest. I do not play in this area and suggest my readers follow suit.

In hindsight, it was great to buy gold, silver or gold shares five years ago but now, with prices at what to me seems like a temporary peak, I recommend caution in buying large quantities. I definitely prefer a dollar cost averaging approach in an attempt to buy at lower prices. In our next portfolio example, I strongly urge that the positions be built over a period of time like one or two years in an effort to buy at lower average prices.

It's time to tell the story again of the advantages in buying closed end precious metals funds. The first advantage is that they are relatively unknown and have a fixed number of shares so they do not have the disadvantage of open end funds growing rapidly from new purchases. Second, they do not trade on their NAV at the end if the day. Their shares trade all day long at the price set by the auction between buyers and sellers. When precious metals are in demand, they trade at a premium over NAV, occasionally as high as two times. When the demand is low, their price will drop below the NAV and provide bargains for wise investors.

Stable Assets
Hussman Strategic Growth	30%	$3,000
Prudent Global Bond	25%	$2,500
Total	55%	$5,500
Volatile Assets
ASA Closed End Gold	25%	$2,500
CEF Gold/Silver Bullion	10%	$1,000
Small Mining Company	10%	$1,000
Total	45%	$4,500

We have given the names of four of the funds in this portfolio because they are one of a kind with no duplicates available. As in recent essays, we start with at least 50% in stable assets. The goal is to provide a moderate risk plan for building a sizable portfolio because we want the odds for success to be in your favor. To provide a little excitement, we have included a small mining stock which has had a spectacular price increase over the past 3 years. By printing out a listing of gold stock performance at www.yahoo.com, you can find other mining stocks with spectacular price gains over the past three years.

Portfolio Without Rebalancing			Portfolio With 3 Re-Balancings
HSGFX	$4,105	13.9%	HSGFX	$9,607	29.5%
PSAFX	$3,575	11.3%	PSAFX	$8,259	25.4%
ASA	$7,234	22.8%	ASA	$7,763	23.8%
CEF	$1,708	5.4%	CEF	$3,379	10.4%
XYZ	$15,089	47.5%	XYZ	$3,553	10.9%
Total	$31,711	100.9%	Total	$32,561	99.8%

The annualized gains of this portfolio were extremely high, 47% for the unbalanced and 48% for the balanced case. Most of the gain came from the huge15-fold increase in the small mining stock. Note, however, how these gains were reapportioned to the stable asset classes which more than doubled in the right hand case above. These profits are now extremely safe, while in the left column, the huge gains in XYZ are almost totally exposed to a huge price drop in a very volatile stock. Please remember this lesson for the rest of your life.

Please study this data closely as it is the most spectacular example we have ever shown of the benefits of portfolio rebalancing. Note, in the left column, that the two stable funds had their dollars and percent reduced to much less than half of the original amounts. Then, note at the right that, with 3 re-balancings the percentages are close to the original portfolio values 3 and a half months after the last balancing in September 2003. Without any rebalancing, all of the original conservatism built into the portfolio design has been lost, with all of the capital gains at risk of a severe price drop in the small mining stock.

If this portfolio were to be continued into the future without any rebalancing, it could end with most or all of the profits lost in a declining phase of the precious metals market. History proves that this market is extremely volatile, so keep your portfolio balanced throughout a long lifetime and enjoy the great benefits therefrom.

In the two portfolios presented above, we have emphasized two approaches to building wealth from precious metals. If this is your first venture, we suggest you try the first two fund portfolio for a while. It can very easily be converted into the five fund portfolio at any time you choose. And, of course, the five fund plan could easily be expanded based on your own learning experience. There is no need to rush as gold and silver will probably be attractive investments for many years to come. Just remember their prices will be going both up and down.

I know from my mail that the great majority of my regulars readers are interested in building wealth surely and safely. To do this with precious metals, you really need to isolate yourself from as much of the public press and brokerage hype as possible. If you are not now being flooded with precious metals mail of all types consider yourself lucky. The general public is still not aware of opportunities in gold but, when they do, you will need a safe and sound plan to guide you.

I expect that the tremendous price volatility of gold and silver in the past will be further increased when the investing public hops on the gold bandwagon. In the three years covered by this study, there were three price peaks at which we chose to rebalance the portfolios. They came at the end of June 2002, early January 2003 and mid September 2003. A fourth price peak is forming at the present time, so gold's historic volatility is continuing as we write.

One of the future gold and silver price peaks is going to lead to a rather severe price decline. I do not know when but consider it's occurrence is inevitable since a number of stocks have risen ten-fold in recent years. Unless you are an experienced trader, we suggest that you adopt a periodic purchase plan for accumulating either the two or five fund portfolios. It will sure contribute to less worry and better sleep.

The two component portfolio does not need rebalancing more often than every two years based on the experience over the last 3 years For the larger portfolio, we suggest rebalancing at least once every year at major price peaks or on a regular calendar date.

I have recently discovered that www.bigcharts.com offers free charts that can give at least 1 to 5 years of data on at least 5 stocks or funds. I suggest that readers check this service out as these charts will a big help in analyzing securities to buy and manage.

I deeply appreciate all your letters and regret that I cannot respond as fully as I would like. It would help me in reply if you enumerate your questions at the start or end and not bury them in a long paragraph. I read every word but need your help in finding the questions among the comments.