Investment Commentary, Q3 2011

At the time of this writing, on the forefront of every one’s mind is the US debt debacle. Through weeks of political wrangling, months of failed budget proposals by the President, and years of overspending on both sides of the isle, investors today worry for good reason that the US debt crisis may end badly. By the time you read this, the August 2 deadline will have passed and it is quite likely that more will have been said than done; however, we continue to urge our clients to remain invested in their diversified, well-managed, and sometimes insured portfolios. It is our view that the simple act of dealing with the debt question will invariably increase the attractiveness of the investment landscape in the US, as spending will be cut irrespective of the magnitude, and tax reform will be had, regardless of the overall direction of tax rates or other concerns. While the uncertainty between now and then may cause volatility in the financial markets, investors who properly account for the broad conditions and expectations and identify this time as an opportunity rather than a threat will be well served.

As for financial markets, not much has changed from our last writing in Quarter 1 of 2011.

Bond yields have fallen slightly since the beginning of the year: the 10-year Treasury Note yield has declined from 3.39% to 2.99% as of 22 July#. At this point, our interest rate outlook is one of relative stability. We do not expect a huge increase in interest rates in the next 1-2 years, but rather we expect 10-year yields oscillation similar to the last year or two. As in our last writing, we believe fixed income should be used sparingly, and any exposure should focus on high-quality, short-duration securities to hedge against any rate fluctuation and to mitigate default risk. High yields should not be pursued at the expense of principal security.

Real estate prices have increased marginally, but not significantly. Green Street Advisors reports that publicly traded REITS are currently trading at a 13.3% premium to net asset value,# putting them in line with most non-traded REIT offerings. (Investors generally pay in the neighborhood of 13% over net asset value for non-traded REITs; this overage covers administration and distribution expenses associated with each individual offering.) At this point in time, we believe much of the deep value opportunities in real estate have subsided, although deals may still be found by the diligent manager. Moving forward, success in the real estate sector may be found by astute managers who are able to patiently await the right buying opportunity, for the right property in order to ensure adequate occupancy to provide sufficient investment income.

Equity valuations have remained largely unchanged, with the Shiller CAPE10 (10-year Cycically-Adjusted Price to Earnings Ratio published by Prof. Shiller of Yale University) at 23.77 vs. 22.97 at the beginning of the year.# We continue to recommend that clients lean towards value managers who purchase stocks of companies with good growth prospects at reasonable prices.

All That Glitters Is Not Gold

A recent publication by the New York Times cites some interesting statistics on our metal de jour. About 166,000 tons of gold has been mined in recorded history, about 29,000 tons of which is held by the world’s various central banks. Over 8,000 tons of gold are held in reserve by the United States, making the US the largest official holder of gold stock of any other nation. The Wall Street Journal reported that gold held by Exchange Traded Funds is up to 2155 tons from 2106 one year ago.

We’ve had many clients continue to ask us about the efficacy of holding gold as an investment. We are diametrically opposed to viewing gold as an investment. Gold does not produce cash flow, yet has associated expenses for storage and exchange. Gold may thus be considered a speculation. In fact, large run-ups in the price of gold have historically been driven by speculators in times of uncertainty. However, despite seemingly strong U.S. investor demand, the most dramatic accumulation of new gold has been by Asian countries for reserve purposes: the Wall Street Journal reports that China and India accounted for 58% of gold demand in the first quarter of the year.

We view the current run up in gold prices as largely unsustainable. While gold prices may not be considered a “bubble” subject to a near-term precipitous decline in price, substantive investor demand and demand by Asian central banks cannot and likely will not continue ad infinitum. We urge clients to view gold in its utilitarian form: as a component of jewelry, and potentially as a currency substitute–that is, a precious commodity used for a store of value. One cannot eat gold, one cannot trade gold bars for useful necessities of life, and one generally cannot use gold as a productive metal. For clients who wish to hold gold, we recommend an amount not to exceed 1-2% of total investment dollars, to be held in small denominations in coin form. Thus gold would serve as an adequate store of value along with a certain amount of cash, and could easily be used with denominations of silver coinage for trade or posterity if needed.

As always, we value each one of our clients and wish to help you make the most of your wealth. Feel free to contact us at any time with any questions you may have about the markets, economy, or your investments with our firm.


Jeremy S. Mitchell, CFP®

Posted in Current Events, Economics, Investing, News and Views.