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business newsGold for the Long Run
By
Drew Mason
May 07, 2010 10:00 am
Refuting "Stocks for the Long Run" and advocating gold and silver for a long term portfolio.
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The idea of me rebuking a cornerstone of finance, Stocks for the Long Run by Wharton’s Jeremy Siegel, will bring smiles to the faces of my Wharton classmates as I was an undistinguished student during my days at Steinberg-Dietrich Hall. But sometimes the smartest people can miss the biggest icebergs -- just consider Ben Bernanke, who missed the financial crisis of 2007, apparently pinned under mountains of data that blinded his views of ridiculous leverage and excess.
The bottom line is that Stocks for the Long Run, like most financial textbooks, is myopic and does readers an injustice. It's built upon some assumptions that are questionable at best and focuses virtually all of its guidance on the extrapolation of those assumptions, ignoring other key tenets from what is really “the long run” of investing history. Siegel concludes what may be the most important section of his book for the next 10 years:
The message of this chapter is that stocks are not good hedges against increased inflation in the short run. However no financial asset is…Fortunately for shareholders, central bankers around the world are committed to keeping inflation low…and they have largely succeeded.
Such a statement is inaccurate, and as it relates to bankers, is also naïve. One would be hard pressed to argue that bankers are committed to anything other than their own self interests and to say that they are committed to low inflation is ludicrous given their actions. Furthermore, to say that no financial assets are a good hedge versus inflation speaks from the myopia of Wall Street, which only seems to consider “assets” as being paper instruments that can be created for a fee from their syndicate desks. This narrow and flawed perspective permeates Siegel’s work, and in his defense, most tomes written on investing that have been popular in recent years borne from years of declining interest rates.
One imminent danger of following Siegel’s advice is that we are heading into an inflationary period thanks to the untested lab experiment central bankers are playing with currently. To build a portfolio upon Siegel’s findings ignores that the tenets he uses as building blocks are not valid in many cases. A more sage approach would be to make no assumptions about the skills and interests of bankers and to have a diversified plan designed to ride through any storm rather than naively betting one’s future on domestic and global governments looking out for your family’s best interests.
In constructing such a portfolio, investors need to quickly understand that gold and silver are time-proven excellent hedges from inflation and both are financial assets. Not only are they financial assets, gold and silver belong in the cash portion of every portfolio as they were ordained by the Constitution of the United States as our only legal cash (Article I, Section 10). Indeed, it's “dollar cash” rather than “gold cash” that is the fleeting currency impostor and it's “dollar cash” that was the focus of the death penalty in the Coinage Act of 1792. Why did our founding fathers make such a radical law? Because they saw firsthand that if individuals saved in an asset (think any fiat currency, especially US dollars today) that became worth less than its holders expected, it would be devastating. The source of our fathers’ concern? Every paper currency in history has failed. Despite this abysmal fiat track record, Siegel makes no mention of the insanity of having nearly all of one’s safe money in one fiat currency, aka checking and savings accounts, CDs, etc.
This is a disservice to readers because even Siegel wouldn't suggest 100% of a portfolio be allocated to stocks, and the divergent performance of the dollar versus gold over time has been dramatic and needs to be addressed. Although Siegel doesn't discuss it at all, his data set of real returns from 1802-2006 shows that gold cash went from $1 to $1.95 while dollar cash went from $1 to $0.06. This divergence proved the difference between wealth and poverty for many, and holds true when looking only at the last century as well. Indeed, in contrast to simplistic models you may have been taught, checking and savings accounts belong in the high-risk, low-reward quadrant of risk/return charts given the consistently negative performance of dollar cash.
We make no bones about how horribly gold performed from 1980-2000. Investors need to realize though that the key input in valuing hard and paper assets, namely interest rates, went from 20% to near 2% over that period. Such a move is generational that mathematically can't be repeated from current levels. That move provided a brutal headwind for gold and was the afterburner for paper assets. Now that we are poised to see rates move higher rather than lower, the headwinds will reverse, providing the fuel for hard assets and a multiple compressor for equities. The fundamental landscape is more like 1970 than 1980 so investors may be well served to recognize the period from 1980-2000 bears few similarities to today’s markets.
No positions in stocks mentioned.
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