september 24, 2012

The case for gold

That’s the title of a nice book written by my favourite politician (oxymoron?) Ron Paul. The book is one of the first books written by Rep. Paul and it is a strong defense of the gold standard. It was written 30 years ago, in 1982, and at the time it seemed more obvious than ever that the replacement of gold backed money with paper money was a terrible decision. In just ten years’ time the US economy (the book is very US-centric since it is a politically motivated report) had almost collapsed (falling stock prices, high inflation, high unemployment etc.). Only gold (Au) thrived.

I like the book and I suggest anyone interested in the concept of money to read it. I find at least two reasons for doing that:

1) The book is sometimes a bit detailed and perhaps overly political (you won me over many years ago, Ron.....) but if you skip those passages there are some very nice bits where the history of commodity-based monies and 19th and 20th century monetary economics is discussed. I use the word “discussed” because sometimes I am not completely sure that the opinions are backed by facts and/or chosen in an unbiased way. Regardless, I think the author should be complemented for his convincing defense of gold money and for keeping this opinion unchanged for more than thirty years!

2) The book is written in 1982 and it is interesting to see (ex post) how even the best of minds sometimes so clearly are wrong about the future. In 1982, the world economy seemed doomed to permanent hyperinflation, unemployment and stagflation. And the root cause of this was paper money printed by populist governments with the sole aim of being re-elected. Interestingly, even if Paul and his compadres probably were right in their critique of fiat money they were wrong in their predictions of the (near) future. Even if gold money most likely one day will replace paper money again this has still not happened thirty years after Paul’s fierce critique. And even if inflation probably has been one of the greatest evils in the world even in the post-“Talking Heads” years it has not crippled the wider economy (yet). As an investor I think that is a sobering fact. Even if you think you “understand” the economics it is difficult to understand it better than the market.... I think this should be a lesson for anyone who sees everything in black and white and for those who think they know everything. Read the book and see for yourself.

september 03, 2012

The Norwegian Petrolium Fund

For those of you who want to learn more about the Norwegian oil fund, formally named Norway’s Government Pension Fund Global, perhaps the paper “The Norway Model” by Dimson et. al. (2011) could be of interest.

The paper discusses the oil fund and compares its investment mandates, dubbed the Norway model, with that of Swensen’s Yale model. While the Yale model focuses on alternative investments such as private equity, infrastructure and real estate the Norway model instead focuses on a widely diversified portfolio of traded fixed income and public equity. If you like, the Norway model tries to harvest beta while the Yale model tries to generate alpha.

The Norwegian oil fund is the largest sovereign wealth fund in the world with more than $600billion in assets. As a rule of thumb the fund owns roughly 1% in each publicly traded firm in the world. The fund is supposed to spread the oil-fortunes accumulated over a million years across several generations and it makes every Norwegian close to a millionaire (in NOK).

Now, I like the Norway model. However, there are two things I think I would change if I were in charge of the fund:
1) The real return expectations! Currently, the Norwegians expect the fund to generate 4% return in real terms every year. To me, this sounds a bit optimistic and it seems dangerous to build the state budget around these numbers (in the long run, they plan to spend roughly the real return each year). Particularly since the mean real return over the last 15 years is only 3% and the standard deviation is close to 8%....
2) The “war” risk! I would allocate a significant share of the fund to concentrated investments that will keep generate cash flows also if total Armageddon strikes. If the financial system suffers a complete meltdown, perhaps caused by a global war or something similar, it would be good to rely on other things than pieces of paper giving you the right to 1% of a firm in Asia or Latin America... I would allocate 5-10% to gold. I would buy protectable land and real estate that can be guarded. I would buy entire firms at home and in neighboring countries. I would also build up close relationships and make concentrated investments in certain countries in Africa and the like (like China).

In other words, a mix of Yale and Norway coupled with gold and disaster insurance would do it for me. Yaleway!