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.