If you go to almost any source for reasons to invest in gold, one of the first reasons it cites is for an inflation hedge.  A quote from the World Gold Council (one of the most reputable sources of information about gold) is typical, “Investors often rely on gold to counter the effects of inflation.”

In the spirit of challenging embedded assumptions, I decided to probe deeper to determine just how effective gold is as an inflation hedge.  Just because every purveyor of precious metals cites this “fact” and many market pundits echo this assumption, it does not mean that their assumption is based on accurate data or reflects an accurate interpretation of history. Read the rest of this entry »

Don asks an excellent question:

The basic principle of your book, as I understand it, is to invest in uncorrelated securities and periodically rebalance them. We can’t know which investments will go up and which will go down. But it really doesn’t matter as long as, over the long run, the investments make uncorrelated “up and down” fluctuations. Rebalancing will force you to sell high and buy low.

I believe in this principle with one reservation. If a particular class of investment is already “pegged” at one extreme of its viable range (that is, it is up against some fixed limit), then that investment can only move in one direction. For an example, consider long-term bonds, which are sensitive to interest rates. The Federal Funds Rate is approximately zero, which means it can only go higher. Therefore, for now, long-term bond prices can only go down, not up. In order for bonds to fluctuate “up and down” to generate rebalancing opportunities, interest rates need to be higher than zero, to give some room on the “up” side.

It seems to me that long-term bonds can play an important role in a rebalancing strategy when the Federal Funds Rate is in a “normal” range–at least, greater than zero. This gives bond prices room to move in both directions. But for now, there’s only one way they can go. Therefore a wise investor would not invest in bonds until the Funds Rate rises a little.

I expect that you will disagree with this, and I would be interested to learn why.
-Don

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