I finished James Rickards’s latest book Death of Money this weekend, which I found provocative, informative, and scary, but ultimately lacking in terms of investment advice. Rickards knows his stuff, and I recommend the book for all the great information it contains and because it will get you thinking. I plead ignorance on most of the books topics, save the final one: how you should position your portfolio to defend against what Rickards thinks is an inevitable global financial meltdown. His suggested portfolio has some serious flaws.
The Death of Money Portfolio
At the very end of the book, Rickards recommends the following portfolio allocation: 20% gold, 30% cash, 20% alternatives (long/short equity, resource funds, etc.), 10% fine art, and 20% undeveloped land. Rickards suggests that this portfolio will protect against all of the scary potential outcomes: deflation, hyperinflation, the return to a gold standard, and even social unrest.
His basic rationale is as follows. Gold, land, and art should hold their value and protect against inflation/hyperinflation. Cash protects against severe deflation and gives you optionality to move into whichever other asset makes the most sense depending on how the collapse plays out. Alternatives (he specifies resource based funds, or long/short equity) should do well in any environment. A few thoughts on this portfolio:
It is incredibly unproductive. Aside from whatever yield you’d earn from the alternative category, this portfolio is dead weight that produces no income (and, because he recommends physical gold and undeveloped land, it also has significant carrying costs).
It is all but impossible for a typical investor to build. Unless you’ve got a multi-million dollar portfolio, how the hell could you invest in museum quality fine art, hedge funds, and undeveloped land? Even the part of the portfolio for which I have the most sympathy (alternatives) is easier said than done: finding the right hedge fund managers is very hard to do—and the best ones are often closed to new investors.
It should hedge against the severe outcomes he foresees. Rickards is clear that he can’t predict how the international monetary system will melt down, only that it will. This portfolio—which emphasizes hard assets—would hold up well in a severe deflationary scenario, hyperinflation, and maybe even during social unrest. In discussing the importance of hard assets, Rickards makes an interesting observation on Warren Buffet’s acquisition of Burlington Northern:
Buffett described this purchase as a “bet on the country.” Maybe. A railroad is the ultimate hard asset. Railroads consist of a basket of hard assets, such as rights of way, adjacent mining rights, tracks, switches, signals, yards, and rolling stock. Railroads make money by transporting other hard assets, such as wheat, steel, ore, and cattle. Railroads are hard assets that move hard assets. By acquiring 100 percent of the stock, Buffett effectively turned the railroad from an exchange-traded public equity into private equity. This means that if stock exchanges were closed in a financial panic, there would be no impact on Buffett’s holdings because he is not seeking liquidity. While others might be shocked by the sudden illiquidity of their holdings, Buffett would just sit tight. Buffett’s acquisition is best understood as getting out of paper money and into hard assets, while immunizing those assets from a stock exchange closure. It may be a “bet on the country”—but it is also a hedge against inflation and financial panic. The small investor who cannot acquire an entire railroad can make the same bet by buying gold. Buffett has been known to disparage gold, but he is the king of hard asset investing, and when it comes to the megarich, it is better to focus on their actions than on their words.
The invocation of Buffett brings me to my next point…
No global equities?! Rickards has a 0% allocation to history’s most successful and remunerative asset class. As he himself explains many times in the book, forecasting outcomes in complex adaptive systems like the global financial/monetary system is very hard to do. It is odd, then, that his portfolio assumes a 0% chance that some global markets will weather the coming storm. A global equity portfolio has stood up remarkably well since 1900 through a wide variety of calamitous events. In my book, I have a chapter on the importance of “going global,” because while a German equity investor between 1900 and 1948 (or a Japanese investor between 1990 and the present) would have realized awful returns in their home country equity markets, they would have done just fine in a global portfolio. Of course, there were no cheap, global ETFs in 1900 so the German investor would probably have still been screwed, but things are different today. Even if the U.S. were to collapse or significantly falter, a global portfolio should provide some protection.
Rickards believes that anything that is a derivative or an electronic claim on an asset is dangerous and should be avoided. But if we are going to be in a situation where stocks markets are all shut down and our stock holdings are worthless, then the best investment might be a go bag! Rickards even suggests keeping your gold somewhere other than a bank safety deposit box, which brings me to my final huge concern…
Gold. One of my main issues with owning gold is the fact that I don’t command an army. Most people forget that FDR—one of our most respected and popular presidents—confiscated the country’s gold in 1933 through Executive Order 6102. Americans had to turn over their gold in exchange for $20.67 an ounce. If they didn’t, would have had to pay a fine and might have been sent to jail for 10 years. With the confiscated gold secure in vaults at the newly built Fort Knox, FDR re-priced gold at $35 an ounce, giving the U.S. extra dollars to fight off the Great Depression. Americans weren’t allowed to own gold again in significant quantities until the 1970’s. If Rickards is right, then why in the world couldn’t (or wouldn’t) a similar confiscation happen again?? Maybe we’d get a somewhat fair price for our gold, but if things were as bad as Rickards suspects they may be in the future, the government might just flex its muscles and take it all. They’ve got an army with guns. Individuals would be bringing knives to a gun fight.
The bottom line is that the Death of Money portfolio is not really an investment portfolio, but a big hedge against the Chicken Little, sky-is-falling, scenario. Zero equity exposure makes no sense to me. Owning some hard assets is a reasonable suggestion (I buy some gold jewelry for my wife!), but in the event that the world weathers the coming storm, and global stock markets don’t cease to function, you should have a large allocation to global equities. Sometime soon, I will write a more data driven post on the importance of global equities—which are very important given current valuations in the U.S. In the meantime, check out Meb Faber’s latest book Global Value.