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PRESERVING PERSONAL WEALTH

By Nick Barisheff
October 2008

“I’m not so much interested in the return on my money as I am the return of my capital.” – Will Rogers

Driven by low interest rates and easy credit, businesses and consumers have been taking on excessive leverage and ignoring downside risk. That same leverage is now being unwound and financial asset prices are falling dramatically. In this extraordinary environment, preserving your personal wealth becomes priority one. There are three key courses of action available to those who wish to safeguard their portfolios from further damage. The first is to bolster portfolio diversification beyond stocks, bonds and cash (the three traditional asset classes). The second is to understand the true size and cost of inflation and fully hedge against it. The third is to recognize where we are in the investment cycle so as to take advantage of a generational opportunity.

KEY 1: TRUE DIVERSIFICATION

If you’re like most sophisticated investors, you know your portfolio should be fully diversified. But it is hazardous to your wealth to include only three asset classes. Cash may seem to be a safe haven, but it won’t protect against rising inflation and as we have seen with money market funds, it can actually lose money in nominal and real terms. Adding bonds to your portfolio does not provide true diversification because according to Ibbotson Associates, a leading authority on asset allocation, stocks and bonds have been positively correlated since 1969.

Modern portfolio theory tells us that having the right mix of uncorrelated assets reduces risk and improves return. Yet few investors take advantage of all the available asset classes, and fewer still realize that precious metals are the most negatively correlated asset class to stocks and bonds. That’s why truly diversified portfolios should always include these additional three asset classes: real estate, commodities, and precious metals.

KEY 2: TRUE INFLATION

Inflation has always been an important element in financial planning, but now it is moving to centre stage. The Consumer Price Index, the most common measure of inflation, has risen to a startling 5.6%. But many experts, including Bill Gross, manager of PIMCO, the world’s largest bond fund, say America’s CPI understates true inflation. If we were to recreate the CPI using the original 1980s formula, we would discover that inflation is running above 13%. In Canada, there is a similar understatement of inflation.

Personal WealthIntelligent investment decisions can’t be made without knowing if we are in a high or low inflation environment. In a 5% inflation environment, bonds paying 5% won’t lose money to inflation. But what if real inflation is running closer to13%, as many experts think? Then that 5% return bond is a guaranteed 8% loss. (For a detailed comparison of holding bonds for income vs. taking systematic withdrawals from BMG BullionFund, please visit www.bmginc.ca/bondsvsbullion.)

In recent years, the money supply issued by central banks globally has been growing at an alarming rate. Most people think of inflation as a rise in the price of goods and services, but in actuality price rises are the effect, not the cause, of inflation. The increase of the amount of currency in circulation is the cause of inflation.

KEY 3: THE INVESTMENT CYCLE

A good way to understand the investment cycle is to look at what is called the Dow: Gold ratio. It calculates the number of ounces of physical gold bullion it would take to ‘purchase’ one share of the Dow Jones during any given time period. When the ratio rises, as it did in the 1920s, 1960s, and 1990s, it tells us that portfolios should be overweight stocks. When the ratio slumps, as it did in the 1970s and today, it tells us that portfolios should be overweight precious metals.

The three major stock market bubbles ended with the Dow:Gold ratio above 18:1, while the two major bear markets in 1933 and 1980 ended with the ratio at 1:1 At the height of the equities bull market in 1999, the Dow: Gold ratio peaked at nearly 40:1.

As of September 30, 2008, the Dow: “I’m not so much interested in the return on my money as I am the return of my capital.” – Will Rogers Gold ratio is 12.3:1 and falling. Th is means that now is the time to increase your portfolio allocation to gold and other precious metals. The current trend favouring hard assets such as gold, silver and platinum is expected to last another 10 years.

CONCLUSION

Deleveraging is devastating the financial markets right now and, unfortunately, it is likely to get much worse. For example, a financial institution with a net worth of $30 billion and assets of $600 billion can become insolvent if the value of its assets fall by only 5%. Without doubt, these are extraordinary times.

Today, preserving wealth should be priority one and to accomplish this you should:

  1. Bolster your portfolio by adding other asset classes, especially precious metals
  2. Understand and hedge against true inflation
  3. Recognize where we are in the investment cycle

Bullion preserves your wealth in both deflationary and inflationary cycles and is the only asset class that protects wealth from a systemic financial crisis. A modest allocation of 10% to 15% into precious metals bullion not only diversifies, but adds assets that keep their value because they are unaffected by the explosive growth of continually depreciating printed money from the world’s central banks. Finally, the investment cycle, as indicated by the Dow:Gold ratio, is telling us to be overweight precious metals because true inflation is not only rising, but is substantially higher than officially reported numbers suggest.

Nick Barisheff is president and CEO of Bullion Management Group Inc., a bullion investment company that provides investors with a costeff ective, convenient way to purchase and store physical bullion. Widely recognized in North America as a bullion expert, Barisheff is an author, speaker and financial commentator on bullion and current market trends. For more information on Bullion Management Group Inc. or BMG BullionFund, visit: www.bmginc.ca

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