Crazy days and what to do about them

What in the world was that?

Stocks, gold/silver, and bonds all rally in unison, with the precious metals as the clear winner on the day.  Gold finished the North American trading day up almost $55 in what I believe is the largest intra-day nominal gain ever.  Silver fared even better, finishing up almost 8% at over $26 an ounce.  What in the world does it all mean, and how do you take advantage of it.

Let’s be very clear:  This is a broken market.  At no other point in history have all three asset classes experienced such strong performance simultaneously for such a long period of time.  They can’t all be right.  Stocks are pricing in a strong and continued rebound in earnings, meaning they’re banking on consumers to step back up to the plate.  Gold is pricing in massive instability of some kind, likely significant inflation.  Bonds are pricing in strong deflation.  How can this be?

Conspiracy theory?

Chairman Ben gave us some clear indication that they are quite happy seeking to boost equity prices in order to achieve that marvelous wealth effect and associated consumer spending.  From the Washington Post, quoting Ben Bernanke:

“This approach eased financial conditions in the past and, so far, looks to be effective again. Stock prices rose and long-term interest rates fell when investors began to anticipate the most recent action….higher stock prices will boost consumer wealth and help increase confidence, which can also spur spending. Increased spending will lead to higher incomes and profits that, in a virtuous circle, will further support economic expansion.”

Without getting too conspiracy theory-ish, it wouldn’t shock me one bit if in five year’s time we find out that the Fed was indirectly providing a floor under the stock market by bidding up the price of SP500 futures or some other instrument.  This may well explain the massive correlation among all asset classes of late.  I’m just saying…

So how does one approach investing and saving in this market?

First of all, make sure you are crystal clear about your time horizons and intended future use.  I have two separate investing accounts; one for my retirement and one for my house fund (there are more actually: emergency account, RESP, etc….but we’re not going there today).

Saving for a house:

If you are planning on taking advantage of falling home prices, you HAVE to stay conservative in your savings portfolio, a point I wish Garth Turner would emphasize more on his site.

Although I agree that preferred shares are a great investment instrument and I own some myself, I do NOT own them in this portfolio.  The reason is that they can experience a decline in the face value of the shares, though they will mature later at full price.  If you do decide to hold preferreds in your house fund, make sure the maturity lines up with your expected timeline.  In other words, if you plan on buying within 5 years, make sure your prefs mature within that time frame or you COULD experience loss of capital.

In my own house portfolio I own a mix of corporate debt, government debt, and cash with the bulk of my portfolio in short term debt.  Some of my main holdings are XSB, CLF, and CBO.  You’ll note that these are all ETFs.  Although I just mentioned above that you need to match maturities to your timeline, and though bond ETFs have no maturity date, you can match them up using the average weighted maturity of the holdings in each ETF, easily found on the fund website.  Though theoretically you could see a decline in the nominal value of the ETFs, I feel that the extra yield over a savings account and the inexpensive diversification (particularly important with your corporate bonds) more than makes up for the added risk.

The other main component of this portfolio is plain cash, held in a high interest savings account.  Holding cash is as boring as watching drying paint, but it provides the ultimate in security and the true return on your cash is amplified by its purchasing power in a falling market.  Furthermore, it is a near-universally despised asset class, telling me that at some point in the future it is quite likely that cash will become extremely valuable.

Saving for Retirement:

Now although I preach that we will experience broad monetary deflation, meaning that leveraged assets will be hammered, I am still fully on side with the inflationists over the long term.  There can be no sustained inflation without an expansion in credit.  Period.  So the craziness we are seeing in commodity prices right now are quite likely due to the perceived threat of inflation, which in a round-about way becomes a self-fulfilling prophecy when measuring inflation as the change in price of a basket of goods.

But inflation cannot persist without the expansion of credit.  Until then, all we are seeing is speculation driving up prices.  They may just as easily fall back to earth tomorrow.  And for those believing that QE2 will lead to an expansion in the monetary aggregate, please tell me who the borrower will be and how that money will get into the broader economy.  Until we see credit picking back up, QE2 will do nothing but stoke inflation fears leading to temporary price (but not monetary) inflation and add to unwanted bank reserves.

All that being said, once the consumer has run through their deleveraging phase, there is a VERY real chance for significant inflation.  As such, my retirement portfolio is diversified with an emphasis on strong yield plays and inflation hedges.

If you are unsure of how to construct an appropriate asset allocation, consult a financial advisor.  In general, here are the broad asset classes I think everyone should be exposed to as well as some suggested vehicles for achieving that exposure.

NOTE:  Unlike other financial pundits, I am a big fan of using broad market ETFs for diversification, particularly for international exposure.

Canadian Equity:  XIC (broad market etf), overweight reits (XRE) and individual utilities.

US equity:  XSP (broad market etf), overweight healthcare

International equity: XIN

Emerging markets:  EEM (on NY stock exchange, broad market etf)

Precious metals:  Physical gold and silver, stocks that hold independently audited physical gold holdings and do not participate in securities lending such as CEF.A, SBT.UN, PHYS, etc.

Preferred shares:  I’m still leery on bank shares, but there are some other strong contenders out there.  If you don’t want to wade through them, CPD is not a bad choice, but watch for the nature of the distributions.  You want them to be distributed as dividends, not return of capital.

Bonds:  You could keep things simple with a domestic bond etf like XSB and a real return bond fund like XRB.

Closed-end funds:  Some of my best buys during the market panic were closed-end funds selling at massive discounts to their net asset values.  I particularly like some of the international dividend funds as they add to my international exposure.  Some can be very illiquid and you have to watch the nature of the distributions as they are notorious for paying out return of capital, but they are often an overlooked investment instrument.  You can research them here. Avoid anything structured as a split share.  They weird me out.

Speculative short-term plays: Keep this to a minimum…no more than a couple percent of your overall portfolio.  This is where you get to make short term bets like playing volatility (VXX) or an overlooked commodity like nat. gas (GAS) or anything else.

Bottom line: diversify!  Get a grasp on your risk tolerance and time horizons.  Make sure that your ‘vulture fund’ does not look like your retirement fund.  Keep any one asset class within reasonable bounds, INCLUDING GOLD!  I have 20-25% of my retirement fund in physical bullion and gold stocks plus additional exposure via Canadian ETFs.  I wouldn’t advocate too much more than that.

Be wise.  Be reasonable.  Don’t gamble with your retirement fund or with any money you need in the short term.

Email me if you have any questions.  I’m happy to help.



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8 Responses to Crazy days and what to do about them

  1. Steve says:

    Ben, in the last 6 months or so, I’ve been reading blogs like yours and Garth’s. I do indeed have questions, and I would like to email you. However, I don’t see your email address in an obvious place on this page >_< am I just blind? … or does the email chain go through these comments?

  2. Sorry….posted under the ‘About’ section


  3. DancinPete says:

    Hi Ben, love your site,
    Was just wondering if this was a typo:
    “US equity: XSB (broad market etf), overweight healthcare”
    as I can’t find reference to XSB in the us markets, only the canadian bond fund.


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  6. seo link says:

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  7. Pingback: Inflation, Hyperinflation, Deflation, Stagflation, Screwflation……what’s in store for Canada? | Financial Insights

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