Gold Within My Retirement Investing Strategy – January 2009 Update

Within my Retirement Investing Strategy I currently hold 3.1% (up from 2.6% at the last gold update due to a buy decision made this month) of my portfolio in gold with a targeted holding of 5%. Gold is the only portion of my portfolio that does not provide a yield (dividends, interest etc).

The first chart shows the real price of gold since 1968, with the wild ride that comes with gold obvious. This month the real (after inflation) price of gold has fallen by about 3.2% to $1,096.00 per ounce. The trend line however suggests a price today of $631.00 up from $630.00 at the last update. The historical average real gold price from 1968 to today is $600.52. So by both of these measures gold appears overpriced.

The correlation between the real S&P 500 (also displayed on the first chart) and real gold lowers slightly from the last update which was -0.34 to -0.33. The second chart provides the ratio of the S&P 500 to gold demonstrating just how far apart the two can vary. Today this ratio is 1.00. The trend line however suggests a ratio today of 2.6 and the historical average ratio from 1968 to today is 1.63. So this measure would suggest that if you were looking to choose to buy the S&P 500 or gold then the S&P 500 might be the better option.

The final point to make however is that while both the first and second charts suggest gold is overpriced on historic measures I cannot forget that in 1980 gold reached an average real monthly price of $1,728 which is a long way above where we are today.

I made the decision to buy gold. Largely this is because I have set myself mechanical requirements that bring little to no thought process or emotion into the decision. Only time will tell if the decision was correct.

As always DYOR.

Assumptions include:
- Gold and S&P 500 January prices are that at time of writing 25 January 2010.
- All other prices are month averages.
- Inflation data from the Bureau of Labor Statistics. December ‘09 & January ‘10 inflation is extrapolated.

Buying Gold

I made the decision to buy gold last week. At the close on Friday gold had come off its highs to be at $1091.50. In British pounds gold was off its November peak by about 5%. The buy was not big. I nibbled by transferring about 0.6% of my total retirement investing assets from cash held in British pounds.

So when weighing up the buy what were the pro’s that I could come up with:

1. My desired low charge portfolio has an asset allocation dedicated to commodities and more specifically to gold of 5%. As I highlighted on Monday my current low charge portfolio mainly through contributing around 60% of my gross earnings towards my retirement investing strategy had seen my actual gold holdings reduce to 2.6% portfolio. This was too low.

2. Gold in 1980 reached a real monthly average price of $1,728.

3. It looks as though inflation may be among us with the RPI leaping to 2.4%. My personal feeling is that the Bank of England will not raise interest rates to counter this so I am thinking I may need more inflation protection than I already have.

The con’s that I could come up with were:

1. I hadn’t bought gold for some time as my analysis showed that if gold was following the trend line it would have a real price of $630.

2. The average real (after inflation) price for gold since 1968 has been $599. This suggested that gold had a good chance of returning to trend in the long term.

As always DYOR.

Why I Hold National Savings and Investments (NS&I) Index Linked Savings Certificates

My retirement investing strategy asset allocation currently consists of 18% worth of National Savings and Investments (NS&I) Index Linked Savings Certificates. I have been buying these for quite a few years now and on average they are now providing me with an average headline return of 1.01% plus the Retail Prices Index. The big advantage they bring to me though as a 40% tax payer is that they are tax free.

I would like to buy more Certificates however you can only invest a maximum of £15,000 into each Issue which is currently Issue 19 for a 3 year and Issue 46 for a 5 year. These current issues are currently offering Index Linking plus 1% tax free which is pretty close to my average.

I think these are now really starting to provide me with some advantages and I would like to buy some more 3 years if they became available. Let me demonstrate with an example.

Let’s say that on the 22 January 2009 I purchased £15,000 worth of 3 year Index Linked Savings Certificates. Using the calculator on the National Savings and Investments (NS&I) website reveals that if I sold those certificates today they would be worth £15,279 which is a 1 year return of 1.9% tax free. However as a 40% higher rate tax payer the fact that they are tax free means that I would have had to earn a 1 year return of 3.1% in a taxed bank account for it to be equivalent.

If however I had bought on the 22 January 2008 then today they would be worth £15,985.50. Again, selling today would be a total tax free return for the 2 years of 6.6% or after factoring the tax free status a taxed bank account would have had to have provided a 2 year total return of 11%.

Finally, if I had bought on the 22 January 2007 then today they would be worth £16,830. Again, selling today would be a total return for the 3 years of 12.2% or after factoring the tax free status in a taxed bank account would have had to have provided a 3 year total return of 20.3%. That’s a Compound Annual Growth Rate (CAGR) of 3.9%. A taxed bank account for a 40% tax payer like me would have had to provide a CAGR of 6.4%.

I’m happy with that for “100% security for your money” as detailed on the NS&I home page.

Please note that this is a very simplistic example and there are a number of terms and conditions for these investments that I made myself aware of before I invested.

As always DYOR.

Australian Stock Market – January 2010 Update

To try and squeeze some more performance out of a retirement investing strategy that is heavily focused on asset allocation I am using a cyclically adjusted PE ratio for the ASX 200 to attempt to value the Australian Stock Market. The method used is based on that developed by Yale Professor Robert Shiller. I will call it the ASX 200 PE10 and it is the ratio of Real (ie after inflation) Monthly Prices and the 10 Year Real (ie after inflation) Average Earnings. For my Australian Equities I will use a nominal ASX 200 PE10 value of 16 to equate to when I hold 21% Australian Equities. On a linear scale I will target 30% less stocks when the ASX 200 PE10 average is ASX 200 PE10 average + 10 = 26 and will own 30% more stocks when the ASX 200 PE10 average is PE10 average -10 = 6.

Chart 1 plots the ASX 200 PE10. Key points this month are:
ASX 200 PE10 = 18.8 which is up from 18.7 last month. My target Australian Equities target is now 19.2% which is down from 19.3% last month.
ASX 200 PE10 Average = 22.9
ASX 200 PE10 20 Percentile = 17.3
ASX 200 PE10 80 Percentile = 27.7
ASX 200 PE10 Correlation with Real ASX 200 Price = 0.82

Chart 2 plots further reinforces why I am using this method. While the R^2 is low at 0.1358 there appears to be a trend suggesting that the return in the following year is dependent on the ASX 200 PE10 value. Using the trend line with a PE10 of 18.8 results in a 1 year expected real (after inflation) earnings projection of 12.5%. The correlation of the data in chart 2 is -0.37.

Chart 3 plots Real (after inflation) Earnings and Real Dividends. Dividends and Earnings are below the trend line. In fact Earnings are now very close to that of Dividends. What this means is that currently Australian companies are using nearly all their Earnings just to fund the Dividends. Yet the trend line suggests typically clear distance between the two with the trend lines running almost parallel. Where is the money for investments going to come from?

As always DYOR.

Assumptions include:
- All figures are taken from official data from the Reserve Bank of Australia.
- January price is the 21 January ’10 market close.
- January Earnings and Dividends are assumed to be the same as the December numbers
- Inflation data from October ’09 to January ’10 is estimated.

UK Inflation – January 2010 Update

During my previous UK inflation entry I showed concern at what I saw in the data and predicted that inflation could very quickly get out of hand. That concern was justified today. Firstly let’s look at the data. The Office for National Statistics (ONS) reports the December 2009 UK Consumer Price Index (CPI) as 2.9% up from 1.9% and the UK Retail Price Index (RPI) as 2.4% up from 0.3%.

The first chart is tracking the CHAW Index which is the RPI including All Items. I focus on the RPI as my National Savings and Investments Index Linked Savings Certificates use the RPI to index from. This shows a big dip when the Bank of England dropped interest rates to historic lows however the chart shows that all the dip did was compensate for the big kick upwards that was seen from 2007. The current level of the Index has now risen above the trend line and is disturbingly starting to point more and more upwards.

The second chart is again based on the CHAW Index. This chart shows annual figures based on the previous 3, 6 and 12 month’s worth of data. As of December the 12 month figure is 2.4% (as published by the ONS) however disturbingly the 6 month figure is 4.3% and the 3 month figure is 5.0% annualised.

The Office for National Statistics reports:
“The increase in the CPI annual rate of 1.0 per cent between November and December 2009 is the largest ever increase in the annual rate between two months. This record increase is due to a number of exceptional events that took place in December 2008:
- the reduction in the standard rate of Value Added Tax (VAT) to 15 per cent from 17.5 per cent
- sharp falls in the price of oil
- pre-Christmas sales as a result of the economic downturn”

That explanation is all fine and well except the Bank of England knew all this months ago. Why then did they keep the Official Bank Rate at record lows and continue with plenty of Quantitative Easing which continued to devalue the GBP further forcing inflation into the system through increased import prices. Additionally, next month (January data) we get another big kick in inflation as the VAT increase back to 17.5% hits the data set.

The Bank of England meets on the 04 February. I think this meeting will be crucial and will really show their hand. Will they sell some debt that was bought through Quantitative Easing to support the GBP? Unlikely as who’s going to buy all that in addition to the regular record monthly amounts that the Debt Management Office is trying to get rid of. Will they raise the Official Bank Rate? I’ll be watching this carefully as if they don’t then I believe they will have chosen the inflation route to ease the pain. This would obviously only ease the pain on those who are in debt. That is the government and the public who on average have over extended themselves. Those prudent savers will of course be punished as the value of their assets is reduced.

All I can say is that I’m glad I own Index Linked Savings Certificates and Index Linked Gilts.

As always DYOR.

My Current Low Charge Portfolio – January 2010

Another month passes.

Buying: As always I contributed about 60% of my gross salary towards my retirement investing strategy. Of this 60% the allocations I made are 64.7% Cash, 5.3% UK Equities, 7.4% International Equities, 1.4% Index Linked Gilts and 21.2% Property.

Selling: Nothing this month.

Dividends: My Australian Equities paid dividends of about 1.5% of the total value of the Australian Equities. I have taken these dividends off the table and put them to Cash as I was overweight Australian Equities.

Current UK Retail Prices Index: 0.28%

Current Annual Charges: 0.60%

Current Expected Annual Return after Inflation: 4.2%

Current Return Year To Date (from 01 January 2010): 0.1%

How close am I to retirement: 41.3%

The following are the highlights for the month:

- Desired Cash portion moves from 11.6% to 12.4%. This month I have moved further from the desired by going from 12.7% to 13.5%.

- Desired Bonds portion moves from 17.2% to 17.4%. This month I have moved closer to the desired by going from 20.7% to 20.1%.

- Desired Property stays constant at 10.0%. This month I have moved closer to the desired by going from 7.7% to 7.9%. With the poor exchange rates to the GBP I have been reluctant to buy outside the UK and so these purchases have been all UK Commercial Property.

- Desired Commodities stays constant at 5.0%. This month I have moved further from the desired by going from 2.8% to 2.6%. With the poor exchange rates to the GBP I have been reluctant to buy gold. However this asset class is now the furthest from the desired percentage of any asset class. I may buy here soon.

- Desired International Equity portion moves from 13.3% to 12.9%. This month I have moved further from the desired by going from 13.1% to 13.3%.

- Desired Emerging Market Equities stays constant at 5.0%. This month I have stayed constant at 2.9%. In GBP terms Emerging Market Equities are at a near high since May ’08. I have tried to compensate by holding extra UK Equities which earn a reasonable portion of their revenues in International and Emerging Markets.

- Desired Australian Equity portion stays constant at 19.3%. This is because the Reserve Bank of Australia is yet to publish its data yet meaning I am unable to calculate the ASX 200 PE10. This month I have moved closer to the desired by going from 20.9% to 20.5%. It is almost impossible for me to get out of this class tax effectively other than by dividends and by eroding the percentage by not investing in the asset class. Not an ideal situation to be in.

- Desired UK Equity portion moves from 18.6% to 18.0%. This month I have moved further from the desired (partially to compensate for Emerging Markets) by going from 19.2% to 19.3%.

A History of Severe Real S&P 500 Stock Bear Markets

Looking at the first chart which shows the real (inflation adjusted) S&P 500 (or its predecessor) stock market I have identified three historic severe stock bear markets. These I am defining as stock markets where from the stock market reaching a new high, they then proceeded to lose in excess of 60% of their real (inflation adjusted) value. These are best demonstrated by the second chart which shows each of these stock bear markets and the fall in percentage terms from the peak. So what were these bear markets.

The first severe stock bear (marked in purple on the chart) market started with a new real high being reached in September 1906. This period incorporated the 1907 Bankers Panic which was caused by banks retracting market liquidity and depositors losing confidence in the banks. This occurred during an economic recession and there were a number of runs on banks and trust companies. Additionally many state and local banks were bankrupted. All sounds a bit familiar doesn’t it? So from the high it took until January 1920 for the stock market to reach a real loss of 60.9% and then until December 1920 to reach its real low of -70.0%. That’s a period of 14 years and 3 months.

The second severe stock bear (marked in blue on the chart) market started with a new real high being reached in September 1929. This is obviously the well known period of the Great Depression. I won’t go into the history here as I’m sure it’s well known by all readers. What is interesting however is that the markets passed through -60% on a number of occasions. So from the high it took until January 1931 for the stock market to reach a real loss of 62.0% and then until June 1932 to reach its real low of -80.6%. That’s only a relatively short period of time however it really wasn’t over then as the market never really recovered and kept dipping back below -60% in real terms. This occurred in January 1933, July 1934, April 1938, June 1940, February 1941 and was back at -73.1% in May 1942. That’s a period of 12 years and 8 months. Even 20 years later the market was still below the real -60% mark.

The third severe stock bear (marked in olive on the chart) market started with a new real high being reached in December 1968. This period incorporated the stock market crash of 1973 to 1974 which came after the collapse of the Bretton Woods system and also incorporated the 1973 Oil Crisis. So from the high it took until March 1982 for the stock market to reach a real loss of -60.9% and then until July 1982 to reach its real low of -62.6%. That’s a period of 13 years and 7 months.

So that brings me to the last line on the chart marked in red which shows the real bear market that we are currently in. This period began in August 2000 with the Dot Com Crash however we were unable to reach a new real high before the Global Financial Crisis took hold. In this real bear stock market we were unable to break through -60% ‘only’ reaching -58.6% in March 2009. That is a period of only 8 years and 7 months. Even today we are still -38.1% which is a period of 9 years and 5 months which is a relatively short period of time compared with the bears shown above.

My question is once the governments of the world are forced to stop stimulating the economies through borrowing (for example a bond market strike) or quantitative easing (for example excessive inflation) could we yet see that real -60% bear? History suggests there is still plenty of time for it to occur.

Assumptions include:
- Inflation data from the Bureau of Labor Statistics. December ‘09 & January ‘10 inflation is extrapolated.
- Prices are month averages except January ‘10 which is the 11 January ’10 S&P 500 stock market close.
- Historic data provided from Professor Shiller website.

US Inflation – January 2009 Update

The above chart shows the Consumer Price Index (CPI-U) up to December 2010 courtesy of the Bureau of Labor Statistics. Year on year inflation has risen from 1.8% in November ’10 to 2.7% in December ‘10. This index is going to be interesting to watch because month on month the index has actually fallen -0.2%.

I have taken the liberty of dividing the chart into two sections. The first red section runs from 1871 to 1932 and the second blue section runs from 1933 to present day. I chose this break point as during 1933 the US officially ended their link to the gold standard. I think this chart demonstrates a point that government will always choose to inflate debt away at the expense of savers if given the chance. They could not do this under the gold standard.

To demonstrate this arithmetic mean inflation rates have been:
1871 to 1932 CPI = 0.5% with deflation being a regular occurrence.
1933 to Present CPI = 3.7%

The CAGR CPI from 1871 to 1932 has been 2.1%.

Further Reasons Why I Use the Shiller PE10

Regular readers will know that to try and squeeze some more performance out of a retirement investing strategy that is heavily focused on asset allocation I use a cyclically adjusted Price / Average 10 Year Earnings (PE10) ratio for the S&P 500 to value the US stock market. The method used is that developed by Yale Professor Robert Shiller. My latest update is that for January ’10.

The first chart today shows the chart that I show each month which reinforces why I use this method. The R^2 value is low at 0.0566 and the correlation is also low at -0.15. That said however these values, along with a look at the trend line, suggests that some advantage may be able to be taken of the relationship. I must point out here how the x and y axes are calculated for this chart.

The x axis should not be an issue for any regular reader. It is simply the monthly PE10 ratio which is the real (ie inflation adjusted back to 1871) price of the S&P 500 divided by the real monthly average of the previous 10 years earnings. The y axis is the real price in 13 months time minus the real price in 1 months time plus the real dividend all divided by the real price in 1 months time. Hope that makes sense... It is also important to note that I then calculate these values every month to form the scatter chart that I show.

I have been thinking about the fact that I am only analysing the historical return on investment from the S&P 500 that can be expected for a period of 1 year. I am certainly not a 1 year investor and so I wondered what these charts would look like for 5 or even 10 year periods.
To do this easily I am going to switch from monthly data points to one data point for each year which I have chosen to be January for no other reason than it is the first month of the year. This is because before I can run the real return calculations I first have to calculate a total return for the S&P 500 going back to 1871 and this is easiest done with yearly data.

Now to the interesting bit. Firstly, as a comparison to the monthly chart above my second chart shows the 1 year real total return versus the PE10. Charts three and four then show the 5 and 10 year real total return versus the PE10. Examining the R^2 and correlations shows:
1 year, R^2 0.0462, correlation -0.21
5 year, R^2 0.1554, correlation -0.39
10 year, R^2 0.2725, correlation -0.52

This for me is really interesting. It suggests that the longer the period of time you hold the stocks or equities the more the Shiller PE10 becomes a useful measure for predicting future expected real returns. This reinforces why I am using the PE10 ratio as part of my retirement investing strategy.

As always some assumptions:
- Q1 ’09 & Q2 ’10 earnings are estimates from Standard & Poors.
- Inflation data from the Bureau of Labor Statistics. December ‘09 & January ‘10 inflation is extrapolated.
- January ‘10 dividend is estimated as December ‘09 dividend.
- Prices are month averages except January ‘10 which is the 11 January ’10 S&P 500 stock market close.
- Historic data provided from Professor Shiller website.

The Recession and Global Financial Crisis is Over. Back to the Boom in House Prices.

You’d be forgiven for thinking that it’s all over if you caught page 19 of the London Evening Standard which has the headline ‘London house prices surge past the pre-recession peak of 2007’. Apparently the suburbs of Mayfair, Knightsbridge, Belgravia, Pimlico, Chelsea, Kensington, Holland Park, Notting Hill and Regent’s Park have risen in price by 51% from their lowest point in March of 2009. As an added bonus they are now 3% above the previous high.

Can you spot a theme with the suburbs? It’s amazing what bailing out the banks, the Bank of England dropping the Official Bank Rate to 0.5% and around £200 billion of Quantitative Easing can achieve. It’s certainly helped some however I don’t think we’re out of the woods yet. Let me provide some further evidence.

I don’t have to look far. Firstly, page 31 leads with ‘More bank losses feared after SocGen writedown’. Society Generale have issued a surprise profit warning stating they have to write down a further EUR1.5 billion on is Collateralised Debt Obligations on residential Mortgage Backed Securities after deciding to take a “stricter assessment” on their value. Now where have I heard those words before?

Until banks face up to their losses and clear their balance how can we move onto the next business cycle. At this rate we’re going to end up just like Japan. A further sobering thought is that this is all still going on and the peak of the Alt-A resets in the US are just starting now.

Secondly, page 33 tells us that ‘Flat manufacturing triggers talk of recession’s return’. Manufacturing output has failed to grow for a second month in a row leaving manufacturing output 5.4% lower than a year earlier.

That doesn’t sound like a boom to me. To me it sounds like it’s going to get worse before it gets better.

Australian Property Market (Alternate Data) – January 2009 Update

The Brisbane and Australian Eight Cities (Sydney, Melbourne, Brisbane, Adelaide, Perth, Hobart, Darwin & Canberra) House Price Index published by the Australian Bureau of Statistics catalogue 6416.0 suits my requirement to track Australian house prices as part of my retirement investing strategy. It however seems to have two flaws. Firstly the housing data is only published quarterly and secondly this housing data is then published over a month after the quarter ends.

I’m therefore looking for something that helps me keep my finger on the pulse a little more. Certainly monthly figures are desirable. I am going to therefore use housing data published by RPData and in particular I will monitor the Brisbane and Logan City numbers.

The above chart shows the figures to November 2009. With the Reserve Bank of Australia now over their global financial crisis panic and apparently in an interest rate raising cycle plus the government removing housing stimulus by reducing first home buyers grants I ask is the Australian housing market slowing. Brisbane median prices this month have only increased by $100 ($510,000 to $510,100) which is only 0.2% annualised and Logan City median prices by $1,000 ($370,000 to $371,000) which is still 3.2% annualised.

Is the property boom running out of legs?