Bonds and Bond Funds

[Finster]

Re: Bonds and Bond Funds

You're an adherent of the efficient market hypothesis, ehh Finster? Even in the face of overwhelming contrary evidence?

Yes, collectively all investors are the market, but some will consistently do better than others. Perhaps they are just part of the bell curve or perhaps it is because they have special knowledge.

I subscribe to a few newsletters and I do a little homework (not a whole lot.) I watch my stocks and believe in each one. When something changes that affects that stock's story and I believe it will be adverse, I sell and replace it with another stock.

I am convinced that stock picking like this can result in returns that are consistently superior to the overall sector.

Just avoiding the high cap miners and going for quality juniors has meant a big return over what it would have been had I purchased an index weighted heavily (as the HUI and XAU are) towards the big miners.

I can't understand why people still believe in the Efficient Market Hypothesis. I no longer believe that I can trade well. I know I can't. But I do believe that I can make a competent long term investor and achieve a return above that of the index. Silly me

Just remember that for every investor that beats the index there is another who won't. It's not a function of the efficient market hypothesis (which incidentally, I don't believe in), though, it's merely mathematical fact. An index representing the sector as a whole reflects the aggregated experience of all those investing in it.

Moreover, in the last great bull market for gold, not only did the stock investor need to outperform the index, but he needed to do double the performance of the index just to match the performance for just owning the real thing. Even if he had done so, with a great deal of careful research and effort, to merely match the results of one decision ownership of bullion, he would nevertheless be subject to criticism for a lot of wasted effort. The simple thesis he started out with - that gold was in a bull market - and nevertheless he subjected his portfolio to all sorts of other influences; management risk, political risk, labor unrest, cost escalation, multiple contraction...

What escapes most enthusiasts in this field is that stocks were in a bear market. It takes a conscious effort to look at things in the proper perspective, because for most of the past quarter century we have lived during the greatest bull market in stocks ever. Our whole mind set is shaped by that experience, and we instinctively approach investing from the perspective of stocks. And we need to remember that last time, by the time that phase of financial history was over, that attitude had changed so much that Business Week magazine asked on its cover whether we had permanently seen the "Death Of Equities".

As a result, the first inclination of gold bulls this time around has been to think in terms of stocks. But if their thesis that stocks have entered a secular bear market is correct, by the time it’s over they will be rushing to bullion. That’s the way it was last time, too.

A little graphic history, first especially for those who think that stocks are vulnerable to a sharp downdraft.

Q: How does gold mining stock perform when the stock market at large crashes?

A: It crashes harder.

Crash Of 87 - XAU versus S&P


Crash Of 02 - HUI versus S&P


Okay, what about the whole secular bull market in gold last time around?

As I said, mining stock was up ten times. Here’s the BGMI since 1970. But remember, gold itself was up twenty times. Just imagine, all the careful stock research and clever stock picking it would have taken to double the index, and still you’d only be on par with the simple bullion owner.

BGMI - 1970-2007

[spunky]

Re: Bonds and Bond Funds

Simple bullion owner ---- he he he . Just like pop says, "my son is smart like tractor and strong like bull "

[Finster]

Re: Bonds and Bond Funds

Simple bullion owner ---- he he he . Just like pop says, "my son is smart like tractor and strong like bull "

I don't want to convey the impression of a generalized indictment of precious metals mining stocks here. I just run into too many investors that either are overenthusiastic and load their portfolios disproportionately with them, or that mistakenly think of them as a form of gold and neglect to own the bullion.

Gold bulls - especially those that are also stock bears - would do better to follow the K.I.S.S. principle and own the real thing. Treat the mining stocks like any other, and follow the time-honored approach of sizing up assets, liabilities, management, competition, financial statements, and doing the hard work of estimating an intrinsic value of the shares. That last step - and doing it free of emotional bias - is crucial, as illustrated by the folly of the dot-com crowd - that eventually allowed itself to use such metrics as eyeballs to assess corporate prospects ... to the extent it was even looking at valuation at all. Otherwise, like those investors, you simply have no way of assessing when the wind is no longer at your back and whether the market is putting a far higher value on your shares than they are worth and that it's time to get out.

So no reason not to have some of these securities in one's portfolio. Just keep them to a reasonable proportion of your nest egg, don't overlook valuation and diversification, and don't fail to own some real gold.

[DemonD]

Re: Bonds and Bond Funds

Gold bulls - especially those that are also stock bears - would do better to follow the K.I.S.S. principle and own the real thing.

there is nothing simple about taking possession and responsibility for physical gold.

[Finster]

Re: Bonds and Bond Funds

there is nothing simple about taking possession and responsibility for physical gold.

What's so complicated about going to your local coin shop? Or hitting one of the online dealers like Kitco, Monex, Tulving, or Fidelitrade?

Some of the latter will even store it for you if you don't want to take possession.

Compared to opening up a brokerage account, researching stocks, and figuring out which of the scores of them warrant your attention ... when your main thesis was simply one of being bullish on gold ... and then for the odds that you will underperform bullion by half?

[jk]

Re: Bonds and Bond Funds

there's something both worrisome and symptomatic about the fact that a thread titled "bonds and bond funds" turns into a discussion of gold and mining stocks.:rolleyes:

[Finster]

Re: Bonds and Bond Funds

there's something both worrisome and symptomatic about the fact that a thread titled "bonds and bond funds" turns into a discussion of gold and mining stocks.:rolleyes:

Oy.

On the other hand, we could always retain topical integrity thusly...



(...thanks to Bart...)

[bart]

Re: Bonds and Bond Funds

...
To anyone who might say "buy gold please" I will kindly tell you folks that in my 401k I have no option for any precious metals play.
...

One off the beaten path possibility I've heard about but never checked out. Most 401k's have a facility for borrowing your own funds - you might be able to get "legally creative".

Let's say you have a child about to start college and you already have allocated funds, and your 401k allows borrowing for educational purposes. Just use it for the education, and your other funds to choose from a broader range of investment opportunities. That's just an example - do your own due diligence, as always.

[DemonD]

Re: Bonds and Bond Funds

the purpose about asking about bonds was originally a decision on bonds v. savings. tax-free CA muni bond fund is gaining a little over 5%/year. I want to keep a relatively liquid reserve. Online savings accounts are around 5% apy so i would be trading a little bit of liquidity for tax savings if i go with bond fund vs. savings account.

I was wondering about bonds as a safe haven - are they really safe in terms of defaults. I know bonds will not beat inflation, and I know all the arguments about gold and PM's. The question I have is about bonds as a class themselves without comparison. If there are massive loan defaults what happens to bond markets? If the US Dollar goes to 50 cents/euro, what is the effect on bonds? Those types of things. I'm not looking at bonds as a long-term investment right now I'm just trying to figure out the safety of bonds on their own merits.

[bart]

Re: Bonds and Bond Funds

I was wondering about bonds as a safe haven - are they really safe in terms of defaults.

Some are, some aren't - too many variables to give a generic answer. In the Great Depression, few besides Treasuries were safe from defaults and losses.

If there are massive loan defaults what happens to bond markets?

They'll tank as people get scared and switch to Treasuries or foreign bonds, depending on the scenario and what the US Gov't and Fed do.

If the US Dollar goes to 50 cents/euro, what is the effect on bonds?

If they're denominated in dollars, as a class they will lose significant value and global purchasing power.

Finster - your doorbell is ringing...

[Finster]

Re: Bonds and Bond Funds

I was wondering about bonds as a safe haven - are they really safe in terms of defaults.

Some are, some aren't - too many variables to give a generic answer. In the Great Depression, few besides Treasuries were safe from defaults and losses.

If there are massive loan defaults what happens to bond markets?

They'll tank as people get scared and switch to Treasuries or foreign bonds, depending on the scenario and what the US Gov't and Fed do.

If the US Dollar goes to 50 cents/euro, what is the effect on bonds?

If they're denominated in dollars, as a class they will lose significant value and global purchasing power.

Finster - your doorbell is ringing...

Pretty much copasetic, El Bartos. Bonds are too variegated as an asset class to make a monochromatic statement about all of them. And yes, Treasuries have been and likely will continue to be default-proof.

Of course (and you know this as well as anyone ) that doesn’t mean you aren’t subject to losses. You can think of the failure mode of Treasuries as default-by-inflation. Sure, you’ll get your money back, but don’t expect it to be worth the same as the money you loaned the Treasury in the first place.

Even TIPS ("Treasury Inflation Protected Securities") are not protected from default-by-inflation. They are indexed to the CPI - not to inflation. Any shortfall of the CPI relative to true inflation represents just a subtler and more insidious form of default-by-inflation.

Only quibble is with the dollar/euro exchange rate. If we assume the dollar goes to 50/euro, we don’t know from that premise alone whether the dollar fell in broad market value or the euro gained, or even whether they both gained, but the dollar gained less. As a practical matter though, it’s unlikely that either currency would gain much for long, so chances are your take on dollar (and dollar-denominated bond) losses would turn out to be correct.

We just don’t know for sure without checking with the FDI …

[Jim Nickerson]

Re: Bonds and Bond Funds

We just don’t know for sure without checking with the FDI …

Finster,

I noted last week what appears to me to be a "discrepancy," I hope that isn't too harsh a word, in your FDI rate of change charts. I didn't bring it up because I thought it would be "corrected" this week.

In the one covering 32 years inflation seems to be about 5%.

In the one since 1915, it seems to be about 1%.

Is that not a discrepancy, or am I missing something?

[Finster]

Re: Bonds and Bond Funds

Finster,

I noted last week what appears to me to be a "discrepancy," I hope that isn't too harsh a word, in your FDI rate of change charts. I didn't bring it up because I thought it would be "corrected" this week.

In the one covering 32 years inflation seems to be about 5%.

In the one since 1915, it seems to be about 1%.

Is that not a discrepancy, or am I missing something?

I don't recall your having noted the "discrepancy", Jim; sorry I missed it. But the two charts have different purposes. One is a shorter term, more detailed, chart and the other is a longer term, less detailed chart.

The "since 1915" is an annual chart meant to give a birds-eye historical view of the level of inflation over nearly a century. The "32 year" is a weekly chart meant to give a much more detailed and accurate close-up of more recent times. Use the annual chart for an overview of how inflation has evolved historically. Use the weekly chart for the most accurate current and recent data.

Keep in mind something I pointed out before - the rate of inflation at any given point in time is not a unique number. It depends over how long an interval you are looking at. The same thing applies to any rate of inflation measure, including the familiar CPI. If you wanted to state the rate of inflation as of the middle of last year, for example, you could start by dividing the CPI as of the end of the year by the CPI as of the beginning of the year. Or you could instead use the CPI figures for June and July. You will get different figures for the rate of inflation. This even though the raw price index data are exactly the same.

Make sense now?

To make things complicateder yet, conventionally the stated rate of inflation is backward-looking - that is, people will state the "current" rate of inflation by comparing the current CPI with that of one year ago. This is commonly done, but misleading - all it really tells you is what CPI inflation has averaged over the past year. To interpret it as a rate of inflation as of some particular date, the best you could infer is that it gives the rate of inflation as of six months ago.

So in order to give a current rate of inflation at all, we actually have to introduce an element of forecasting into the equation. And this is in addition to selecting a time period over which to calculate the change. So in practice the rate of inflation is only finalized once the entire time period has passed. So if you use a one-year time period over which to measure inflation, the last rate that is actually nailed down is the one given for six months ago.

In sum, the rate of inflation charts are inherently "soft" data. If you want only "hard" data, use the raw FDI figures. Then, if desired, you can apply your own time frame preferences to arrive at your own conclusion regarding the rate of inflation.

[jk]

Re: Bonds and Bond Funds

finster, i don't understand why you say inflation must vary according to the interval over which is measured. why not take a price index and look at its derivative? then you get an instantaeous measure which is not subject to the vagaries of choosing a base period and base duration.

[Finster]

Re: Bonds and Bond Funds

finster, i don't understand why you say inflation must vary according to the interval over which is measured. why not take a price index and look at its derivative? then you get an instantaeous measure which is not subject to the vagaries of choosing a base period and base duration.

Think about it, JK, recalling first semester calculus. The taking of a derivative involves taking differences over an infinitesimal interval. And the operation is only defined on continuous functions. No one (not even me! ;)) actually has continuous data.

The upshot of this is that you have to work with a finite interval. And that means you have to make an arbitrary choice. If your data happen to be (as with the CPI) monthly in frequency, you can in the limit select a month for that choice, but that only means someone else (the BLS) made an arbitrary choice. And for reasons of limiting randomness and noise from your result, you might even choose a longer interval, and perhaps invoke frequency-selective (low pass) filtering. My rate-of-change figures do that, using digital-signal-processing methods.

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