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.

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Why My “Gold-Plated” Government Pension Sucks

That's right. The pension plans that every socialist drools over and the right-wing anarcho-capitalists love to hate are really not an outsized deal.

Mediocre returns, high administration costs, bad investment strategies, political dabbling, I don't know... but when I do the math the numbers tell the same story over and over. I would be much better off investing on my own in a matching contribution-based plan than contributing to my supposedly gold-plated, defined-benefit government pension plan.

How Government Pensions Work

Government pension plans—or at least the ones that the media world tell you are so brutally unfair—are defined-benefit plans. You and your employer pay into the plan according to advanced calculations. Regardless of how the investments contained within the plan perform, you get a guaranteed pension benefit that's based on a percentage of your working income and your years of service under the pension plan.

Periodically, government pension authorities evaluate the sustainability of their pension plan and set contribution rates. These rates fall into two main categories: 1) a certain rate for employees and employers up to the CPP contribution limit [called YMPE - Yearly Maximum Pensionable Earnings], and 2) a higher rate for employees and employers above the YMPE limit.

The CPP limit—or YMPE—is factored into the calculation because once you turn 65, your pension benefits will be lowered according to your estimated CPP payments. For example if the plan calculates you will earn $1,000 a month from CPP, they will reduce your monthly pension benefit by about $1,000.

In my pension, one can retire and collect a benefit as early as 55 years old as long as they meet the "85 factor" (Age + Years of service >/= 85). This means you would have to start your career contributing to the pension plan at 25 years old to get the full benefit at 55 years old.

My Future Pension Estimate

Under the current rules, my pension benefit calculation goes like this: Average of Best 5 Years Salary x 2% x Years of Service = Best Annual Benefit.

At age 65 this is changed to a two part calculation for the CPP adjustment: (YMPE x 1.4% x Years of Service) + (Balance of Salary x 2% x Years of Service) = Total Pension Plan Benefit.

Assuming my salary goes up with inflation (it has been lower than inflation for the past decade now), at age 55 I will get a taxable benefit worth about $53,000 in today's dollars. After paying taxes at 19%, my net income will be around $42,900 if I retire in Alberta.

At age 65 when I get CPP, the pension benefit will be adjusted down to $23,219 + $20,560 for a total taxable benefit of $43,679 in today's dollars. I should note once I start collecting my pension the benefit only increases each year by 60% of the posted inflation rate so over time my real purchasing power goes down. Also, when I die my wife only gets 66% of the total benefit for the rest of her life. Our estate gets zilch when we both die.

Not bad at first glance considering I earn around $85,000 a year before a bit of overtime (overtime/extra pay is not included in the pension calculation). However, I should point out the benefit is fully taxable as regular income and I have zero control over my income mix, tax saving strategies, or coordinating my withdrawals with my actual expenses.

What If I Invested Myself?

The contribution rates to my pension are pretty high. About $420 biweekly comes directly from my salary plus $455 biweekly from my employer. That's a total adjusted contribution of $875 bi-weekly.

If I invested through Questrade according to a Growth Portfolio—which should return 6% annually after inflation over the long term—after 31 years my portion of contributions would be worth about $970,000 and my employer's contributions would be about $1,050,000 for a total value of a bit more than $2,000,000.

Following my 25x Rule (which gives me more than 92% chance of success when retiring at 55 years old), I would be able to withdraw $80,000 in my first year of retirement and adjust up each following year at the full rate of inflation. Plus I get no clawback at 65 years old for CPP. My wife would still get the full amount when I die. When we both die, our estate would get the total value of the portfolio which is very likely to be worth more than $2 million.

With a self-directed portfolio, I also am able to tax-optimize my withdrawals. Drawing some fully taxable income from RRSPs, tax advantaged Canadian dividend income from my Cash/Margin Account, tax advantaged capital gains income from my Cash/Margin Account, and non-declarable income from my TFSA, I could realistically pay a blended tax rate of 16% (or less) for a net income of $67,300.

Outcome

Although my pension is pretty much guaranteed, it certainly isn't as lucrative as many believe it to be. To me a 92% guarantee with full adjustment for inflation, no CPP clawback, and a remaining balance for my estate is about as valuable as the 99% guarantee the government pension gives with only 60% inflation adjustment.

Using the same contribution rates in a self-managed, low-fee, index based Growth Portfolio, I would realistically be able to achieve almost 60% higher net income in retirement.

If the pension plan was able to follow the 25X Rule, the total value of my pension at age 55 should be $1.325 million ($53,000 x 25). The administrators should be able to achieve that with total biweekly contribution of $600 over 31 years instead of the current $875. It's almost certain that anyone contributing to a defined-benefit pension plan today is subsidizing the under-funded pension payments enjoyed by current retirees of those plans.

I realize it's definitely a controversial topic, especially considering many Canadians are about as financially literate as my fluffy and ever-so-cute pooch. "Guaranteed pensions" courtesy of the government is probably a decent deal for the average Canadian who would fall apart financially if their interest expenses went up a few hundred bucks a month.

I for one would not be upset if "the swamp was drained" and my fallaciously esteemed government pension was changed to a contribution based indexing plan open to all working Canadians. One can only dream.

Despite the large contributions I make to my government pension plan, which ultimately shrink my paycheque, I don't add my pension value in our Net Worth Updates. I feel it would throw off our true accomplishment: building a great investment portfolio out of what's left of our paycheques after taxes and those massive contributions.

Comments & Questions

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