Portfolio Allocation - Part 1

I am going to suggest four plans for managing your portfolio from which you may choose. The first three are suggested by Richard Maybury in the April, 2008 issue of his Early Warning Report. They involve use of Harry Browne’s Permanent Portfolio (PPF) concept. If you have read carefully the first three letters, you should understand that concept, and you may already have decided to what extent you want to employ it. The fourth plan I will suggest is to simply follow what I am doing for however long I am able to share it with you. That length of time will be uncertain at best considering my age. Obviously, you always have a fifth choice, which is “none of the above.” Here are Richard Maybury’s three plans.

My Allocation Plan
My allocation plan is a variation of the PPF concept. It seeks to accomplish the main objectives of PPF, but changes from time to time based on what I learn from the master investors whom I have confidence in (primarily Maybury, Rogers and Russell). I approach allocation of my portfolio from three perspectives: major categories, sub-categories and specific investments.

First Perspective For Allocation
Currently my portfolio has three major categories:

• Physical commodities – 47%
  [Commodities are tangible substances or items, like gold, silver, aluminum, lead, iron ore, property (land, home, car, etc.), crude oil, ethanol, coal and agricultural products (sugar, soybeans, rice, wheat, etc.)  They are interchangeable with other products of the same type, and investors buy and sell them, often through futures contracts.]
• Common stocks (of companies that produce commodities) – 35%
• Cash and Bonds – 18%
• No debt

Here’s the logic behind this major allocation. 

ADDITIONAL ROGERS WISDOM: Several studies have shown that over time, physical commodities significantly out-perform the stocks of companies that produce them (see Hot Commodities book). When you buy the actual commodities, you don’t have to worry nearly as much about big sell-offs in the stock market, which will bring down almost all stocks, including those related to commodities. You don’t have to worry as much about management failures, bankruptcies, adverse political developments, tax changes, natural disasters, etc. There’s no way gold and silver can go bankrupt, or default. They are no one else’s liability. They are pure wealth, and have been for 5000 years, outlasting thousands of paper currencies (which have gone to zero value) through history. Twenty years ago, all three experts forecasted destruction of the purchasing power of the US dollar. At that time, such an idea was hardly on the radar screen of the average US citizen. As people wake up to this reality, they will accelerate the transition from depreciating dollars to tangible assets.

So, why own any commodity stocks at all? Because they can be great investments for periods of time, because they give you built-in leverage to the commodity prices without having to borrow money and pay interest. But today I don’t want more than about one-third of my portfolio in common stocks of any kind, and as we realize profits from that leverage, we’ll modify our allocation to stocks (more later on that).

Why have 18% in cash and bonds? Because they are our deflation protectors (hedges). Note their place in the Permanent Portfolio allocation in Letter 2. And they are a reserve waiting for super bargains which may come along.

Second Perspective for Allocation – Sub-Categories
Asset classifications within the three broad categories. Here are mine at present.

• Physical gold (Kruggerands) – 10%
• Physical silver (pre-1964 junk coins) – 23%
• Misc. physical commodities – 14%                  47%
    
• Gold shares – 3% 
• Silver shares – 11%
• Energy shares – 13%
• Misc. commodity shares – 8 %                   35%
    
• Cash and Bonds – 18% 

Here are my current parameters for these secondary classifications. I want to be near 10% in gold coins, and 20% in silver coins. Right now I’m a little over in silver. If you want to read up on why I want twice as much in silver as gold, read Theodore Butler’s archives on www.silverseek.com, especially his essays entitled “Silver versus Real Estate,” and “The excellence of Silver.”)

At any point in time, I am willing to go up to 10% in gold mining shares (at the moment I’m only 3%), up to 10% in silver mining shares, and up to 15% in energy shares. The reason for the energy shares allocation is that Jim Rogers has 35% of his Commodity Index in energy commodities. We’ll discuss the other categories more as we get to the third allocation perspective.

Third Perspective for Allocation – Specific Investments
Now we’re down to specific investments. I’ve already given my “limits” for physical gold and silver. Regarding individual stocks, I usually invest no more than 3%-6% initially in any given stock. If it increases in value to the point it becomes 10% of the total portfolio, I will usually sell off part, but not sell out until I believe the bull market is over. The same rule applies to individual commodities I might buy (except gold and silver). For example, my 11% in silver mining shares is in just two stocks, the two I consider the best. My 3% gold share allocation is in a mutual fund, the one I think is the best. My 13% energy allocation is in 4 different stocks. In fact, my major allocation of 35% common stocks consists of just 7 individual stocks, one mutual fund. Diversification is an important principle of portfolio management, but over-diversification will lower your performance. We’ll have much more to say about all this later, and it will become much clearer. Here we have to get the basics.

So Far - Three Balls in the Air
I want my portfolio to fit three different allocations at the same time (I don’t worry about being exact, or varying a little from my allocations). I want no more than about one-third in common stocks. I want somewhere near half in actual commodities (principally gold and silver at this time), and I want 15% to 20% in cash and bonds, mostly cash in T-bills or money market. I want my individual stock positions, and commodity positions other than gold and silver to be in the 3%-6% range.

Very Important – My allocations will change in the future
I conclude this letter with some investment wisdom from Jim Rogers (it is pretty much confirmed by the other experts).

ROGERS WISDOM: I have heard him say (in at least 7 or 8 different interviews) these words: “I am the world’s worst trader, and the world’s worst market timer.” I think a lot about this statement and recommend you do the same. Intuitively, I know this is not entirely true (I know he’s not a worse trader than I am), but it communicates incredible wisdom. I won’t burden you with all the studies, which show that most traders lose, and most eventually go broke. I did in the 1970s. A few years ago I read a book written by one of the greatest traders in the world, and a reputable man, by the way. Two years after he published the book, he went completely broke. When I refer to trading, I’m not talking about occasional re-allocations as mentioned above, I’m referring to short term, day to day trading. I’m not judging or criticizing traders, nor making it a moral issue (unless you are in violation of 1 Tim 6:9 - Those who desire to be rich fall into temptation and a snare, and into many foolish and harmful lusts which drown men in destruction and perdition - NKJV). What I’m saying is that the above quote from Jim Rogers is all I needed to hear to decide what part trading would have in my strategy. That being the case, here’s another important ball we want to keep in the air.

This is exactly where commodities were in 1998. The prices were at 60-year lows (down 80% to 95% from their inflation-adjusted highs). The major brokerage firms had closed out their commodity departments years ago. Nothing in the media, etc. Someday, maybe in 2017 or thereabouts, commodities will be wildly popular, making the magazine covers. Every newsletter will have a commodity section, every firm a commodity department. That’s when we will want to sell. Can you believe, as I write this, there are 70,000 mutual funds that deal in stocks and bonds, and ten (that’s right, 10) commodity mutual funds!

Many questions come to mind, such as, what if I missed the beginning of the commodity bull in 1998? What if I’m starting a new portfolio now? How do I buy low and sell high? I hope to be of help in answering these questions in future letters. For today, try to get a good grasp of Rogers’ concept just stated.

Select from the four plans outlined above. If you select the fourth (my allocation plan), you will want some way of keeping up with your allocations. I have an Excel spreadsheet which does all this, and updates the market values of everything with the click of a mouse. Some of you are users of excel and can do this. I will be glad to share my excel spreadsheet with you, and any computer expert can get you up and running in an hour or so. It should begin to make more sense after you have worked with it a few months.