The Year of Easy Wins

This will be my last post of 2017. My next post will be in January starting with our regular monthly updates.

The Year Everything Goes Right

Let's be honest, 2017 has been another amazingly easy year to make money investing. It seems just about everything has gone up, even in Canadian dollar terms (our dollar rose a few cents on the year which reduces the gain on international investments).

U.S. stocks are up around 15%, developed markets are up 19%, Canadian stocks are up over 7.5%, emerging markets are up 21%, even bonds are up 2-3% in our rising rate environment. To top it all off, volatility has been incredibly low with the VIX below 20 for the entire year. That's unprecedented stability!

If you were starting out this year and simply bought XAW.TO, taking a stake in over 8,100 companies around the globe, you would have made an easy 17% this year! It would have been free to purchase if you used Questrade as your low-cost online brokerage.

We’ve also been hit by crypto-mania. You could have bought any number of “currencies” like Bitcoin, Ethereum, Litecoin, Bitcoin Cash, Bitcoin Gold, Ripple, NEO, Zcash, Stellar, Waves, Qtum, and a myriad of other names and tripled or even 10x your investment in mere months. (Yes, these all and many more have market caps over $1 billion). You can't make this stuff up.

Millions of people who can barely keep their iPhone properly updated and their laptops virus-free are putting their life savings into fictional digital money. Some boldly pretend to understand the ins-and-outs of this technology and justify its value; most are just blindly chasing the crowd.

A Reality Check

All this investment dreamland stuff calls for a bit of a reality check. I don’t mean to scare people from investing, taking smart risks, or saving aggressively for retirement. But realize that it isn’t going to stay this easy.

Stock markets and bond markets go through cycles which average out to a long-term return of around 3% to 7% depending on the investment mix and corrected for inflation. It’s impossible for the broad market to give returns much higher than that for an extended period of time. A few years in a row of +10% or +20% returns are always followed by a year or more of -20% or -40% returns.

Given that we’ve had a wicked good run since the beginning of 2016, and really since spring 2009, it’s only reasonable to believe this bull market will come to an end and stocks will undergo another severe correction at some point. Right now a return to average valuations for U.S. stocks requires a 60% drop!

I’m not saying it will be in 2018. In fact, the numbers are looking so good that many “experts” are already suggesting 2018 will be another banner year. We’ve got Trumpian tax cuts, big government spending, record corporate profits, inflation and wage gains, and public legitimized trading of cryptos to propel the markets forward forever.

Of course, the experts also saw no risk investing in mortgages for bankrupt, jobless people in 2007, or investing in perpetual money-losing tech firms in 1999 based on website eyeballs.

Socioeconomic Problems

Despite having some of the lowest unemployment rates in modern history, with historically low unemployment for some time now, many are suggesting we have just entered a new economic boom. As if things were so terrible from 2011-2016.

Some are still under the illusion that we need to have growth rates of 4% or more in the developed world. This despite low birth rates, the economic drag of an aging population, out-of-control spending, and a voting public that expects super-low tax rates but blindly dives into debt.

From the beginnings of time, parents and grandparents demanded a better future for their children. Now they put the burden of their selfish desires on the next generation. Insane public health care services, social security, OAS, CPP, tax cuts, and lucrative pensions are enjoyed by older generations today.

Meanwhile the adults of tomorrow are saddled with record student debt, over-priced housing, and trillions in government debt and future social obligations. Historically these things tend not to shake out too well.

If you are young and contributing to a defined benefit pension plan today, don’t foolishly count on it being there for you in its promised form when you are ready to retire yourself. Even the most coveted government pensions are in deep trouble. After nearly a decade of incredible investment returns, there is hardly a pension out there which is fully funded in actuarial terms. A large drop in global asset valuations would do incredible damage.

Investing With Caution

Now more than ever is a good time to invest with caution. This isn’t being fearful; it’s being smart.

Follow a disciplined investment strategy that has proven to perform in down cycles. Trend investing and Dual Momentum strategies are reasonable choices.

You should hedge against the downside risks that are always very real. This means putting in wide stop-limit orders or tracking stops yourself to get out of your investment positions methodically if prices fall.

If you’re a more advanced buy-and-hold investor, use 0.5% of your portfolio to pick up some six-month forward out-of-the-money SPY or QQQ puts and roll them every quarter. They’re as cheap as they’ve ever been right now and a good form of portfolio insurance costing 1% or less of your total portfolio.

Having A Moose Mentality

All this said, I don't spend a lot of time worrying about these risks; you shouldn't either. It's easy to follow a plan where you check your brokerage account only once or twice a month and go on living your life for the rest with an eye to a promising future. I do it, so can you.

I believe in the importance of looking after myself first. That means being financially responsible, cutting out the frivolous crap in life, and slowing life down wherever possible. It means looking after my physical and mental well-being. Stress is a choice and I choose 'No'.

In a world where money is the biggest cause of chronic stress, hopefully the nuggets of info every week on this site have helped you say 'No' to money stress as well.

This season, commit to being generous to those you actually care about—family and friends. I challenge you to pick up the phone and cancel your regular donation to that faceless charity who knocked on your door years ago. I bet you don't know where your money actually goes and the accountability is often shaky.

Instead, look around to the people that matter to you and see where you can help. It might be a grocery gift card to the friend that was laid off, a few weekends of your time helping someone save thousands repairing their house or vehicle, bringing a warm meal to someone who is sick, or sharing a cup of coffee at home listening to a friend's concerns and showing them your love. That's the best kind of charity. Use your talents to form the community you want to be a part of.

This Christmas season my wife and I will be trekking a few thousand kilometers to be with our families. We'll share laughs and squabbles, eat like kings and regret it, drink too much and wake up lousy, be active but still gain a few pounds, enjoy the outdoors and relax.

Wishing you and your family a Merry Christmas and fantastic holiday season!

- Daren

Comments & Questions

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I Like Gold; You Should Too

Since I started The Rich Moose, I have been positive about gold. I've included gold miners in a simple model portfolio. I believe gold (and silver) are great protection assets because history tells us they are.

We are at a weird point in history in currency terms. Never before has the entire world been transacting primarily with fiat currencies—money not backed by any hard assets. But that doesn't mean fiat currencies are new, it has been tried and failed many times before.

Save for a few blips of excitement, gold and silver have been largely an afterthought since the 1970's. Precious metals as an investment have been heavily criticized in recent years, just as they were in the 1990s and early 2000s.

Why not buy bonds that pay interest, or safe stocks that actually rise in value? Isn't it safer to be in bank stocks that have paid dividends for over a hundred years than to invest in a gold miner? Even Warren Buffett has slagged on gold several times, emphasizing its uselessness.

Gold or Bonds

Bonds—the safe go-to asset du jour—are debt instruments: a loan with an attached promise. The only confidence in a bond is the ability of its issuer to pay it back in full with interest as specified. Issuers of commercially available bonds are governments (at all levels) and corporations.

Governments have historically been the safest bond issuers, but history tells us even governments don't pay their debts as they should. There have literally been hundreds of defaults, partial defaults, effective defaults, or forced debt restructurings by governments in the last 500 years. This includes the most trusted governments of their day, such as the United Kingdom, France, Germany, Spain, and yes... even the United States.

Corporations are even worse and it's reckless to hold long-term corporate bonds as a safe investment asset. It's almost laughable that Apple Inc., in the notoriously volatile tech sector, is issuing 30-year bonds at rates just 1% above government debt. Remember Eastman Kodak or Nokia's cash hoard? I don't either.

The dangerous part about bond investing today is that we are nearing a crisis point in government debt for the largest bond issuers. The U.S., the U.K., Japan, Italy, Ireland, and Spain have very high debt levels. Since bonds are denominated in fiat currency terms, not gold or hard assets, it's easier than ever for governments to crank open the printing presses, devalue the debt, and pay it back in full—technically speaking.

I would be surprised if major governments didn't try to "stimulate" the economy next down-cycle by going through a massive devaluation.

Even the U.S., the greatest country of the 20th century, effectively did this twice in the last hundred years: in 1933 and 1971. The government printed more money, devalued the currency relative to hard assets, and met their obligations. Of course a large bond holder in 1932-1934 or 1971-1974 would eagerly tell you they were cheated.

Naturally if the government devalues their currency undermining bond values, corporate bond issuers benefit the same way. They will raise the prices of their goods and services to match inflation, but you can bet they won't offer to pay more for their bonds when it's time to cash them in.

If you must hold bonds because it makes you feel better, focus on short-term government bonds, even if the interest rates are not as good. It's also smart to choose good issuers. A country like Switzerland, Singapore, Norway, Canada, or Australia with very low debt levels is far more likely to uphold their bond and currency values than highly indebted countries.

Gold is not a bond and it never will be. Critics correctly point out that gold doesn't pay interest and that's okay. Gold is just a representation of a store of value. It's something that's tangible, quite rare, and makes a great asset that can be used as a medium for exchange without losing it's value. For thousands of years man has recognized this use for gold and I don't think that's going to change.

Gold is a great hedge to a monetary crisis or other forms of similar government stupidity. It performed fantastically in the 1930s and 1970s and will likely do so again when currencies are intentionally devalued.

Gold has also done well in other periods where monetary supply was expanded through debt, such as the 2000s and 2009-2012.

Gold or Gold Miners

In my portfolios I use gold miners to represent gold. This isn't a must—a gold trust or real gold will do just as well. They might even do better if you believe there will be a full loss of confidence in government, currency systems, and financial markets in the next monetary crisis.

I'm personally a little more optimistic than that and I'm very optimistic about the prospects of gold mining companies. In 2008 when gold prices briefly collapsed with the Financial Crisis, gold miners were heavily indebted after years of aggressive expansion during the resource boom and teetered on a liquidity crisis. Gold miners were punished with the rest of the market although they recovered months earlier and much more aggressively than the wider market.

Now we are in very different circumstances. Thanks to the gold bear market since 2012, many gold miners have low debt levels, they've significantly trimmed their costs, and have been typically cautious in deployment of capital. Without debt and liquidity problems holding them back, they are likely to do very well if the price of gold increases.

Miners are quite levered to precious metal prices. If all-in sustaining costs for a miner are $900/oz and gold is selling for $1,200/oz, the miner makes $300/oz of gold mined and sold. If gold prices jump 25% to $1,500/oz, the miner's profits will increase 100% to $600/oz.

Miners like Goldcorp, Pan American, Agnico Eagle, Kinross, and First Majestic have very low debt levels. Franco Nevada, the big streamer, has no debt, while Wheaton has very little debt. These companies are not likely to fail and are nicely levered to precious metal prices.

Gold or Silver

In history gold or silver could often be used interchangeably as a store of value, for transaction purposes, and as a hedge against currency devaluations. Typically when gold does well, silver does well too. Silver also has industrial use as a great conductor of heat and electricity and as a anti-microbial material.

That said, there are differences in the value of gold and silver. Historically, the ratio of silver to gold has varied between 15:1 to 100:1. It's currently trading 75 grams of silver to 1 gram of gold, implying that silver is cheap relative to gold.

While gold might do well in the next bear market, silver could do even better.

Limitations on Precious Metals

All this said, there are clear limits to the use of gold or silver as an asset in your portfolio. If all your money is 100% invested in gold and silver bullion, you might always have a nice hedge to government stupidity, but that doesn't make you rich, it just makes you Chicken Little.

One ounce of gold isn't going to grow another ounce every 10 years, but we know that productive growth assets like stocks often double in value in a single decade.

You want to have the bulk of your assets invested in something that is productive and grows in value, like shares in a good business (stocks), productive farm land or timber land, or profitable rental real estate. Preferably a bit of each if your net worth allows for it. Reasonable diversification across assets is always a good choice.

I personally choose 10% of investment net worth as a nice round number for precious metal assets. It's enough to do what it does without having a significant downside on returns.

Need evidence? In the last 100+ years, a portfolio consisting of 90% stocks and 10% gold would have outperformed a portfolio of 90% stocks and 10% bonds by nearly 0.5% per year while having lower drawdowns. And that's in an environment where currency was pegged to gold for the first 70 years.

Comments & Questions

All comments are moderated before being posted for public viewing. Please don't send in multiple comments if yours doesn't appear right away. It can take up to 24 hours before comments are posted.

Comments containing links or "trolling" will not be posted. Comments with profane language or those which reveal personal information will be edited by moderator.