How to Apportion a Larger Portfolio

My brother called a couple of days ago. His wife has $100,000 to invest and he wanted to know where I thought I should put it. I’ve made recommendations in the past and they’ve always made money; which I feel puts a bit of pressure on me because each time I feel I’ve got to live up to my own record.

It’s also tough because the investment market is so screwed up with the recent actions of the Federal Reserve. In the 1800s, investing was pretty simple, you just put your money in bonds and forgot about it. Since consumer prices went down for most of the 1800s (with the notable exception being the war-time inflation of the Greenback fueled Civil War) the return you received on bonds would be in addition to the additional purchasing power the money itself possessed. Few people invested in the stock market in those days; it was seen as a shady place where individuals like Jay Gould, Cornelius Vanderbilt, and Nathan Rothschild could use their deep pockets and insider information to force a stock price to be whatever suited them at the time. A stock exchange was more casino than sober investment house. Bonds were where the common man should put his money.

Of course, the advent of the Federal Reserve changed all that. The Federal Reserve was an inflation engine that has successfully destroyed some 97% of the value of the dollar since it’s inception. Concurrent with that, it has manipulated interest rates so that the inflation adjusted yield people get on bonds tends to be rather miniscule. Over the last century, people have adjusted to this changing landscape by shunning bonds and embracing stocks. Conventional investing wisdom can be summed up by Dr. Jeremy Siegel’s book “Stocks for the Long Run,” and conventional wisdom was on quite a tear from the 1982 through 2000 bull market. The bear market that followed it has, however, suddenly awakened people to the risk present in the stock market. It has also spawned studies that bonds can perform comparable to stocks, or even outperform them, for fairly long periods of time.

Today’s market represents the logical termination of the era of the Federal Reserve. For the last century, it has manipulated interest rates and the money supply in order to give the illusion of prosperity. Now staring in the face of the massive deflationary wave that logically must follow all of this inflationary meddling, the Fed governors are once again going back to that same inflationary well yet again. The power of the Federal Reserve in the last century has largely stemmed from the fact that the common man has simply not understood inflation. Inflation was whatever the government said it was, and most people seem to have taken them at their word. This given the Federal Reserve privilege to print virtually limitless quantities of money whilst the population at large was none the wiser.

Recent events have pushed the Federal Reserve to the limits of its inflationary power. Ben Bernanke has slashed interest rates to zero and announced that the printing presses would run as long as necessary to provide “liquidity” to the market. This has produced the expected inflation (see my last post on the 10+% annual increase in the Christmas Index), but has done little to put people back to work.

Enter the latest tactics to be tried by the Federal Reserve, QE2. Some are speculating that the Ben Bernanke is trying to increase “inflationary expectations” in the hopes of forcing people to put their money to work. I’m reminded of Alan Greenspan lowering interest rates in the early 1990s to combat recession. It lowered the rate of return of savers and those on a fixed income and lured these people into the stock market. Later, Greenspan found that he was not able to raise interest rates without causing a decline in the assets he had lured these people into. Thus we got the roaring 90s and the resulting crash of 2000.

Now we see Bernanke trying to repeat the same trick, but he’s not seeing the stock market boom he wanted to see. So now he’s really trying to make anyone holding US dollars rather nervous by engaging in QE2 and giving a 60-Minutes interview where he says additional bond purchases may be necessary. This has made the investing landscape increasingly bizarre. I don’t see how any rational investor can really want to purchase bonds yielding 2% or less while the Federal Reserve is in a money printing storm and the Christmas Index has gone up 10% in the last year. It’s not a case where income investors are being lured out of bonds like they were in the early 1990s, they’re getting forced out. As my father likes to say, “If you standing under the spigot and the crap’s pouring down on you, stop screaming for someone to turn it off- move.” That’s exactly the situation that income investors currently find themselves.

Given this situation, I’ve taking to putting all my available cash that’s not currently tied up in Gold investments into the royalty trust Great Northern Iron (ticker symbol GNI). A royalty trust is a shell company that has the rights to some income producing assets. By buying shares in the company, you receive a share in the cash distributions. Great Northern Iron holds mineral rights to a great deal of iron ore, and receives royalties from mining companies that are taking this iron out of the ground and converting it to steel. When I purchased GNI a couple of months ago it was paying out $15 a share and selling for $120 or so. The simple math worked out to a annual yield of 12% or so. It didn’t take a lot of thought to make this investment choice given that this is an inflation protected return. After all, as inflation causes the cost of iron to go up, more royalties are generated. It certainly beats the hell out of bonds or preferred stock.

Of course, many others are discovering royalty trusts. They are a natural investment choice for the income investor. So GNI has appreciated a great deal in the past couple of months. Currently, it’s selling for $150 a share, which is a yield of 10% or so. Still not a bad deal. Personally, I think it’s going to keep going up until yields get to the 5% to 6% range, which means the value of the investment could double in the next year or two. Not only is it a great growth opportunity, it’s paying 10% or so in the meantime.

But if your apportioning a large portfolio, I can understand why you wouldn’t want to put all of it in just one investment- particularly one that has appreciated 20% or so in the last month alone. So let’s try to spread the risk out through the traditional route of diversification. I really like gold. Gold has been a tremendous investment over the past decade, and it’s really just getting started. The largest holders of bonds are foreign central banks, such as the Chinese and Japanese. They have been forced so suffer and watch the value of their US dollar holdings have plunged due to the actions of “Helicopter Ben.” I understand that everyone the world over is engaging in the new sport of competitive currency devaluation, and that perhaps over the next few years, the dollar will continue to be the recipient of much foreign love as they vainly continue to try to force the dollar higher versus their own currency, but sooner or later something’s gotta give. When that happens, gold is going to be a natural choice for foreign central banks to gravitate towards, and that would mean that the best days for gold lie ahead of it.

I like to do my gold investing through gold mining companies. They’re easy to trade, should be a nice leveraged return on a rise in the gold price, and pay dividends while you hold them. Traditionally, Barrick gold has been my mining company of choice, but these’s also Newmont Mining (NEM) which is one of the S&P 500 and trading at a PE discount to Barrick (15.5 versus 21) and, at current prices, has a slightly higher yield. In terms of other diversity, something in oil seems a prudent choice. A quick look at oil related royalty trusts, don’t really excite me. Sabine Royalty Trust (SBR) is currently yielding 6.5%, which seems a little pricy to me given that Exxon Mobile is yielding 2.5% in dividends for a company that’s got considerably more going for it that just oil and gas rights.

Lastly, I thinking of silver. It historically trades at a ratio of 12-15 to 1 versus gold. Right now silver is at $30 an ounce and gold is at $1400, which is a ratio of 46 to 1. If gold has a bright future ahead of it, that silver even more so. Not to mention, it’s a very liquid investment. Of course, one can hold physical silver, but that makes it harder to trade when the time comes. Not to mention it takes up a great deal of space when you’re investing larger amounts of money. So I’m going with the iShares Unit Investment Trust, SLV.

So let’s see, the securities I’ve picked are: SLV, NEM, GNI, and XOM. Apportioning 25% of your portfolio to each will definitely protect you from inflation while (hopefully) avoiding any gut wrenching downside potential. Note that I follow my own advice, so I already own SLV, GNI, and XOM.

Leave a Reply

Your email address will not be published. Required fields are marked *