Welcome to Finance and Fury, the Say What Wednesday edition

Today’s Question is from Gabriel

With the latest news around trade wars, inverted yield curve and EU collapse, I would love to hear your thoughts on how to protect a portfolio, is it worth using hedging instruments or changing the assets mix? Do you use options? What do you think about using them as a hedge?

 

Wealth Preservation –

  1. Concerns to account for – Most asset classes aren’t looking good
    1. Share market collapse – many things that can trigger it – Hyper Synchronicity – Event occurs all at the same time without any apparent event – herd behaviour – governing dynamic which underlies the whole of human experience and history — social, emotional, psychological, and spiritual – probability transitions between emergent states of order and nonlocality –thought of long bull run makes people for different reasons sell off assets to profit and reinvest –
      1. If the EU breaks apart – I think is inevitable – when? No idea – Covered EU in 3 ep series Nov last year – Brexit over another few eps in April this year – go back to the eps then go into a lot of detail – ramifications – not the biggest concern by itself – but given the debt/financial systems interconnection – may cause a spark – in a sane world it wouldn’t
      2. Trade wars – This is already weighing on markets in my opinion – Things could get worse if things that aren’t expected occur –
      3. Bank failures – fragility of financial system – gets worse with lowering interest rates
  1. Fixed Interest – Inverted yield curve – which occurs when the coupon rates on short-term bonds are higher than the rates paid by long-term bonds – shows investors are so worried about the near-term future that they are piling into safer long-term investments – Switching out of 5 year into 10, or 15
    1. Government Bonds – high price and low yields due to that – risks if rates rise –
    2. Corporate Credit – Catch provisions of bail-ins – for banks
    3. Seems to be a trend for most countries where 5 year bonds are lower yields than 2 years – except Germany and Japan – negatives

  1. Cash – Low interest returns – if any – plus if negative rates come
  2. Property as well – in most capital cities Aus is one of the most expensive fuelled by credit expansion and concentration of urbanisation
  1. Can’t invest in shares, property, FI or cash – basically all asset classes

But are alternative Options –

  1. Options (no pun) – used in Hedging – if you own shares – use it to reduce portfolio risk by lock in the right to sell the market at a certain price – shares you hold crash, then you can exercise the option and sell shares at the strike price. These securities are intended to move in a different direction than the rest of the portfolio. They tend to appreciate when other investments decline.
    1. A put option on a share or index is a classic hedging instrument – if your shares decline – your put can help cover losses –
    2. I don’t – personally not a fan of them – something that is far too hands on and risky for me – Unless you are constantly monitoring – can lead to ruin – say market goes up a bit – and doesn’t move much – paying premiums
    3. Relies a lot on timing – Everyone can see that a volcano is likely to erupt – but anyone’s guess on the time and day when it will happen – Or avalanche – Talk about investment options a bit more in next Monday episode about negative rates and investing or holding cash

First – Lessons from conservation – listening to book from James Rickards 

  1. Talks about Conversations with family members and representatives – what it takes to preserve wealth over centuries and not just short-term cycles – frequent reply is “a third, a third, and a third.”
    1. Stands for dividing one’s wealth into one-third land, one-third gold, and one-third fine art
    2. Obviously some liquidity (cash) is needed for day-to-day expenses – along with allocations to speculative portfolios
    3. Not about gains with capital reserves – but that the investment will be around in 100 years –
      1. Looking at centuries timeframes for investments – land, gold, and art outperform riskier assets such as shares, bonds, and cash – sound weird but a viewed from the perspective of centuries and not just years or decades
    4. Objections/issues –
      1. Share and bonds can perform well for long periods – but they and also cash all involve some claim on a third party
        1. Contain credit risk in addition to the underlying market risk – volatility
        2. Credit risk is what ruins a lot of investments – investor is always at the mercy of the issuer
          1. Shares – Company go bankrupt and Bonds can default (no money to return for your loan)
          2. Paper currency in the history of the world has eventually proved worthless eventually – so why is it different this time?
        3. No income or yield – Warren Buffett disparages gold because it has no yield. The reason it has no yield is that it has no risk. Yield is what you earn when you take risk. Gold has no credit risk, no currency risk, no maturity risk, indeed no risk of any kind. It is just gold.
          1. In contrast, Buffett’s Berkshire Hathaway stock when priced not in dollars but in ounces of gold has declined in value by about 75 percent since 2000 from 280 ounces per share to 70 ounces per share.
          2. someone who bought gold rather than Berkshire in 2000 could today buy four times as much Berkshire stock using the same gold.
          3. There has been similar appreciation in the value of fine art. Admittedly this is a selective example.
          4. Yet it is true that over centuries it is the hard assets not the paper assets that retain value through collapse and catastrophe. The old money knows this—they have seen it all before.
  1. Alternatives – value of land, gold, and art is intrinsic – beyond valuations – If you own it, you own it
    1. no issuer who can suddenly make your land disappear or turn your gold into confetti
      1. Possible that a totalitarian regime or an invading army might confiscate tangible wealth – why I don’t like legislation
    2. Gold can also be confiscated if in bank institutions – held personally stuffed in a saddlebag or sewn into the lining of a coat and moved. Art can be removed from frames, rolled up, and carried in one’s luggage –
    3. Admittedly land cannot be moved, but with good title and patience a family can reassert its claim even generations later once interlopers have been ousted
  2. No portfolio is perfect or without risk – too often we think of risk narrowly and ignore the greatest risks of all
    1. Due to short term focus – normally only happen once in a lifetime, if that – but looking through history – do happen
    2. In the form of monetary collapse, social disorder, regime change, and emergency edicts
  3. The question comes back to – how much of your wealth do you need to preserve – and at what cost?
    1. Depends on how big the next crash will be – who knows?

 

Lessons to take away –

  1. Intrinsic Values – Wealth preservation –
    1. Shares are fine to invest in – especially after the market collapses – but only if you have confidence in them – would you use their products in a recession? Intrinsic values can become zero
    2. Gold – physical metals – silver as well
  2. Investing in fine art – can’t be done by everyone? Well not really – ETFs available
    1. Personally – I am a not suggesting this – but greater lesson – that alternative assets that have confidence in a crisis may be a place to start
    2. Have to do some research and look at this further – there are fine art ETFs available – haven’t properly researched and backtested their place in portfolios – if there is something to this – do a separate ep
  3. Monday ep – finish running through investing in Gold, precious metals and other alternative asset classes

 

Thanks Gabriel for the question!

If you want to get in contact you can at financeandfury.com.au on the contact page

episodes mentioned in this podcast:

What Happens if the EU collapses? – https://financeandfury.com.au/furious-fridays-what-happens-if-the-eu-collapses/

Will the EU fall apart? – https://financeandfury.com.au/furious-friday-will-the-eu-fall-apart/

Tax scams and the Brexit mess – https://financeandfury.com.au/tax-scams-and-the-brexit-mess/

Bullish Shares vs Bearish Bonds – https://financeandfury.com.au/bullish-shares-versus-bearish-bonds-which-one-is-correct/

Where to invest in preparation for the next financial collapse? – https://financeandfury.com.au/where-to-invest-in-preparation-for-the-next-financial-collapse/

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