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Update #2 - Asset Allocation Explained and Why I Hold Gold
Posted on: 17 / 07 / 2018
Last month I briefly covered my current asset allocation.
But what is asset allocation? Sometimes I forget that a lot of the terms I use are jargon. 

Basically, its dividing your investment monies into different types of investments  - making sure you don't "put all your eggs in one basket". 

The linchpin to the theory is this: different assets perform differently at different times. 

As an example, in 2015/2016 BHP Billiton was hated by the market. A tailings dam which failed in Brazil causing disaster to the surrounding villages was still a recent event. The resource industry was stalling. Everyone was dumping BHP shares. Flash forward to 2018 and the resource cycle is back into full swing and the revenue is flowing.
On the flipside, Telstra was a market darling in 2015 hitting new share price highs. But then the NBN network was sold, earnings decreased, dividends were cut, and the shares have been on a slow train ride to hell ever since. 
bhp share price
tls share price telstra
I own both of these and while it is sad to see Telstra shares which were around $6 a share cut down to under $3, on the flipside BHP Billiton and similar company, Rio Tinto, have increased in value over the same time to counteract this loss. 

Individually, different types of assets can fluctuate in value. The general hope and view is that over a long period of time, the average value will increase. You can reduce your risk and volatility by spreading your cash out over different assets which aren't related.

This is the basis of diversification and portfolio allocation – it aims to reduce wild swings to the positive or negative side in your portfolio.
my asset allocation
Why Hold Gold?
One of the asset classes I have invested in is Gold and Silver. I consider these a special type of investment and hold them for a number of reasons.

Usually when you put money into something you do so with the hope that it will make you more money (yield); buying an investment property for rental income and capital growth, buying shares for dividends and capital growth.

But gold just sits there. It doesn't generate more money. So why hold it? 

For me, it is an insurance policy against a few special scenarios. 
A crash course in gold
Money is essentially an IOU. A gift card for a store where the store happens to be everything in the Australian economy. 

If I do some work for a friend by helping them move house, they might return the favour by forking out a carton of beer instead. All good - A favour for a favour.

But this doesn’t work well outside of your friend circle. Enter; money.

Money allows the exchange of services/goods to be scaled across society, we just use dollars instead of imaginary IOUs and favours.  
Unless you like dealing in favours...
But someone needs to overlook this system and prevent it from being abused. The Reserve Bank of Australia (RBA) currently does this in modern times, but previously gold used to perform this duty indirectly. 

How? Gold was the perfect material; it was rare enough that people couldn’t just create it out of thin air, it doesn’t corrode or rust over time so it stays the same over centuries, it is small and can be smelted and minted into easy to carry pieces (coins and bars), it has few industrial uses, and is safe to handle (i.e. not radioactive). 

The fact that gold is a pretty shiny yellow is merely a bonus. These practical reasons are why it has been the universal sign of value and wealth for so many centuries. 

Gold is often seen as the money prior to the existing money system we have (paper notes, debit cards). The existing money system used to be tied to gold (until 1932 in Australia, 1971 in the US) - this is where the term "The Gold Standard" came from - where for every bit of cash printed, there was gold held in the treasury for it.

The way it is viewed, gold is the great constant in the financial system which isn't affected by inflation (theoretically - if you take out the short term changes in price). If you had an ounce of gold 100 years ago, you could probably buy roughly the same thing with it now. 

This makes it perform well in times of very low inflation (or deflation) as well as extreme inflation (hyper inflation). 
Just in case....
Australians my age (see; the so-called ‘lazy’ millennial generation) have never really experienced a recession (the last one was early 1990's).  We have no idea what one would be like. 

Australia is a lucky country, but eventually we will fall into a recession. It may not be for some time (my guess is 8-10 years), but when it hits, it is going to hit our economy like a freight train. 

If there is a recession, people flock to cash and if it is more severe, gold. These are seen as assets which preserve capital and thus, are safer. 

Put it this way, if everyone wants to sell their shares or houses and there isn't enough money to go around, cash becomes scarce and thus, valuable. If faith in Australia's economy drops, other currencies may be more appealing.

If you've ever been to a country where they have a weak currency, you may see that they accept and even prefer US Dollars (or AUD) over their own currency.

But, if the crisis happens to be worldwide (like the GFC was) and faith in the US dollar drops as well, gold is the next stop. 

This is also why gold tends to increase in price if there is an uncertain event approaching i.e. when North Korean war looked inevitable, or just before Trump became US President. Gold is in demand when there are too many unknowns. 
On the Chinese and Russians...
One of the theories out there is that the US dollar will fade in importance when the next major crisis hits. With the amount of national debt they have, this is could be the case.

The US spent a lot of its financial arsenal fighting the GFC when this occurred in 2008. If another worldwide financial crisis were to strike again, the International Monetary Fund (IMF) may be the one to do the bailing out through special assets known as a Special Drawing Rights (SDRs).

SDRs are a ‘basket’ of currencies issued by the International Monetary Fund (IMF) and is comprised of the following makeup:
sdr, yuan
Note the recent inclusion of Chinese Yuan. 

It is no secret that the Chinese and Russians governments have been buying gold by the truckload for the last few decade and a half. 

China 'officially' had 400 tonnes of gold in 2001. The last report was early 2017 which had them at around 1800 tonnes. At a guess, this would be over 2000 tonnes now, the same as Russia.

To compare, the US government only has around 8000 tonnes of gold (FYI Australia has a measly 72 tonnes).
Russia and china gold
Are these two economies positioning themselves to be bigger players in the world financial system by stocking gold? 

I'm not sure, but it all seems to be too much to be a coincidence. If they're planning something, i'd rather be holding onto some gold than not. 

As the saying goes – who has the gold makes the rules.
How to own gold
So if one were inclined to hold gold, there are several ways to do it. The main ones that come to mind are:

- Physically posses coins or bars, this means you need to safely store them yourself
- Own coins/bars but have a third party manage the storage and security of them
- Buy an exchange traded fund (ETF) which tracks the price of gold
- Buy companies which mine gold. 

Each are viable and depend on your choice. There are some advocates who swear that "If its not in your hands, you don't own it".

To buy coins or bars, there are several exchanges in Australia which you could use. ABC Bullion and Perth Mint come to mind. There are definitely plenty more, and if you live in a capital city there are usually places where you could buy coins or bars from. You may want to do a bit more research into it if you plan to physically possess gold - things like purity, authenticity and how you will store it are factors you need to consider.

Several exchanges also offer to store the gold for you. They usually charge a fee for this. You would still want to look into it a bit more though, as some exchanges will allocate a specific bar to you (i.e. it has a serial number tied to you) where as others may not allocate a specific bar and just assign you a weight of gold (usually in grams or troy ounces).

Exchange traded funds (ETFs) that follow the gold price are out there. These are traded on the ASX. Some are physically backed by gold, some are not. There are also some that are a mix of gold mining companies. 

Finally, buying gold producers is a way to expose yourself to gold indirectly. My view is that gold companies are a leveraged bet on the gold price and as such will react more severely to changes in the gold price. They are also at heart, companies, so things like debt, underground reserves, growth potential, what the Australian Dollar is doing, etc all come into play as well as the gold price.

Also, its interesting to note that an ounce of gold is not very big and this is something that blew my mind. To give you an idea, the piece in this stock photo below is 1 ounce (oz) and worth around $1600 AUD.
Final Note
So that is my view as to why gold has its own special place in a portfolio. 

It definitely isn't something to bet the farm on, but a small portion set aside as a ‘just in case’ is fine for me. Its kind of like portfolio insurance.

While I didn't mention silver much, it is considered similar enough to have its own minor allocation as well as it is viewed as being the cousin of gold.

I like to keep the total combination of gold and silver at around 7.5%. It is currently around 7%. 

In my shares I do own a few gold producers; Northern Star Resources (NST), Evolution Mining (EVN), Saracen Minerals (SAR) and Millenium Minerals (MOY). 

These typically fluctuate with the gold price and are more sensitive to changes in the price so this actually makes my reliance on gold a bit heavier than it may appear. 

That's all for now.
I was hoping to go into this month's investments but that may have to wait til next time. A quick hint though, i've cut my losses in some shares and decided to move some of that capital into some uranium stocks. I'm also considering starting to build a larger cash position.
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