Ideal cash/PM allocation for inflation/deflation hedge

12 posts / 0 new
Last post
switters's picture
switters
Status: Platinum Member (Offline)
Joined: Jul 19 2008
Posts: 744
Ideal cash/PM allocation for inflation/deflation hedge

I'm up to my ears in the inflation/deflation debate and, while I'll continue to follow it because it's interesting to me, I long ago reached the conclusion that there's really no way to know for sure how it will turn out.  The only prudent course of action, therefore, is to prepare for both.

To that end, I've been thinking of what the ideal allocation of cash to gold might be.  It seems to me that there is potentially more downside in the dollar than there is in gold (i.e. I can imagine the dollar losing more than 50% of it's value in an inflationary environment, while I think it's less likely that gold would lose more than 30% in deflation), and more upside in gold than in the dollar (i.e. it's hard to imagine the dollar appreciating more than 30-40% in deflation, but not difficult to imagine a 200-300% increase in gold in an inflationary/hyperinflationary environment).

Therefore it seems to me that even if one is leaning towards deflation for the short term (as I am), a 50/50 cash/PM allocation makes more sense than a 75/25 cash/PM allocation.  If I'm 50/50 cash/gold, and the dollar goes up 30% and gold loses 30% I haven't lost any money.  But if I'm 75/25 cash/gold, and the dollar tanks and loses 50% of it's value and gold doubles in price, I lose money.  

Curious to hear your thoughts on this.  If you're leaning towards deflation, what is your current investment strategy/allocation and why?

codeblue's picture
codeblue
Status: Member (Offline)
Joined: Apr 21 2009
Posts: 13
Re: Ideal cash/PM allocation for inflation/deflation hedge

My gut is telling me 30% Gold; 30% Silver; 40% Cash.  I like the fundamentals of silver and this approach diversifies the metals.  Also, if the deflationists are correct (which I think they are in the short-term), I think this time the metals may actually hold their own.  The world has never been seen this situation before.  Deflation or not, people and countries will continue to buy metals and the manipulation can only go on for so long.

cedar's picture
cedar
Status: Bronze Member (Offline)
Joined: Oct 7 2008
Posts: 96
Re: Ideal cash/PM allocation for inflation/deflation hedge

I have concluded that 50% PM (50/50 gold/silver) and 50% cash (short term government debt) is best mix. I agree that short term is deflation followed by longer term high inflation. However I also think there is a reasonable probability of some black swan crisis that will surprise us all and make PM a good place to be.

crazyhorse's picture
crazyhorse
Status: Bronze Member (Offline)
Joined: Nov 16 2008
Posts: 56
Re: Ideal cash/PM allocation for inflation/deflation hedge

One must also consider investments in hard assets and commodities that may be useful in a post SHTF scenario.  You can't eat gold or greenbacks!

switters's picture
switters
Status: Platinum Member (Offline)
Joined: Jul 19 2008
Posts: 744
Re: Ideal cash/PM allocation for inflation/deflation hedge
codeblue wrote:

My gut is telling me 30% Gold; 30% Silver; 40% Cash.  I like the fundamentals of silver and this approach diversifies the metals.  Also, if the deflationists are correct (which I think they are in the short-term), I think this time the metals may actually hold their own.  The world has never been seen this situation before.  Deflation or not, people and countries will continue to buy metals and the manipulation can only go on for so long.

While I agree that gold could hold its value during deflation, I'm far less certain about silver.  It still seems to behave more like a commodity and hasn't yet resumed it's role as money.  Perhaps I'll regret it, but I recently sold my silver and am now 50/50 cash/gold.

switters's picture
switters
Status: Platinum Member (Offline)
Joined: Jul 19 2008
Posts: 744
Re: Ideal cash/PM allocation for inflation/deflation hedge
crazyhorse wrote:

One must also consider investments in hard assets and commodities that may be useful in a post SHTF scenario.  You can't eat gold or greenbacks!

I couldn't agree more.  I'm just referring to surplus funds available for investment.

JAG's picture
JAG
Status: Diamond Member (Offline)
Joined: Oct 26 2008
Posts: 2492
Re: Ideal cash/PM allocation for inflation/deflation hedge

Based on excessive bullish sentiment for gold, and extreme bearish sentiment for the USD, my non-invested capital allocation is 75/21/4 cash/gold/silver. My invested capital allocation is 5% cash, 18% gold etf / miner stocks, 0% silver, 20% Treasuries, 50%+ stocks/commodity stocks (hedged).

PM allocation of total capital=roughly 10% ("Barter money" just in case the very unlikely (IMO) economic collapse occurs)

As market sentiment changes, my allocation will change accordingly...always overweighting the more feared or disliked asset and underweighting the favored asset as things unfold. 

cedar's picture
cedar
Status: Bronze Member (Offline)
Joined: Oct 7 2008
Posts: 96
Re: Ideal cash/PM allocation for inflation/deflation hedge

JAG, you will probably make a lot more money than I will but I can't stand the thought of investing in a stock market that makes no sense, even if it does go up. And I am really worried about many instabilities for which there is no way to predict the outcome.

JAG's picture
JAG
Status: Diamond Member (Offline)
Joined: Oct 26 2008
Posts: 2492
Re: Ideal cash/PM allocation for inflation/deflation hedge
cedar wrote:

JAG, you will probably make a lot more money than I will but I can't stand the thought of investing in a stock market that makes no sense, even if it does go up. And I am really worried about many instabilities for which there is no way to predict the outcome.

Hi Cedar,

I agree the market makes absolutely no sense, I cannot believe that equities are up so much today....total bizarro-world. But then again, if the market made sense, there would be no opportunity for profit.

Believe me, everyday I wake up and think I should convert everything to PMs and just say "adios" to the equity markets....but then I would go crazy from the gold and silver markets. If I hold 100% cash, then I go crazy from the currency markets. So I'm just diversified in my craziness.

Preserving one's capital in this environment is a like playing big game of chicken. 

"All we have to fear is fear itself...."

JAG's picture
JAG
Status: Diamond Member (Offline)
Joined: Oct 26 2008
Posts: 2492
Some Numbers...

I quickly ran a few numbers to backtest the 50/50 cash/gold allocation to see if it really did protect purchasing power. First, some charts:

The time scale on these charts is off of course, but it gives you an idea of how Gold and USD interact.

Now for some numbers. In each time period we assume we start with 5K cash and 5K gold.

For example, in the first time period the cash allocation lost 12% of its value. I represent this loss in cash value as  $4,400, as this assumes that 5k will only buy you 4.4K worth of goods at the end of this time period.

When I get time, I will do another backtest that incorporates market sentiment as a guide for re-allocation/balancing...Jeff

 

cedar's picture
cedar
Status: Bronze Member (Offline)
Joined: Oct 7 2008
Posts: 96
Re: Some Numbers...

Thanks. I should have clarified that my cash is Canadian. I expect a bounce in $US followed by a big drop. Personally would not touch $US. Canadian may follow but I hope no where near as bad.

switters's picture
switters
Status: Platinum Member (Offline)
Joined: Jul 19 2008
Posts: 744
Re: Some Numbers...

Jeff,

That is very helpful.  I appreciate you taking the time to do it, and I look forward to seeing the same comparison with market sentiment as the guide.

After the first big deflationary wave last Fall came a period (12/18/08 - 3/03/09) where gold and the dollar rose together.  I can't help wondering if that will happen again if we have another deflationary spiral. 

 

Comment viewing options

Select your preferred way to display the comments and click "Save settings" to activate your changes.
Login or Register to post comments