Wednesday, March 4, 2009
The best portfolio might well be half dollars and half gold.
The Case for Dollars
As horrible as the economy in the U.S. is, Europe and the rest of the world is crashing also. America's economy may be in the toilet, but everyone else's is also, so people view the traditional reserve currency as a safe haven.
In addition, institutions and individuals are trying to raise cash to ride out the depression. Many have debts in dollars, and so have to get dollars to pay back their debts.
And during periods of deflation, every dollar can buy more, and so is worth more.
Sure, the dollar will eventually be worth about the same as toilet paper. And it is in many ways illogical for the dollar to strengthen given America's financial woes and the trillions in bailouts and stimulus; but that is what is actually happening in the real world right now.
The Case for Gold
Gold does well during periods of instability. We are entering a period of massive global instability.
How Can We Place Opposite Bets?
Gold and the dollar have traditionally moved in opposite directions: when the dollar strengthens, gold goes down and vice-versa. If the value of a fiat currency is destroyed, gold will soar. If the fiat currency is revived, gold will go down.
So shouldn't we place our bets on one or the other? How can we back two horses?
That's exactly the point of diversification. Even in the middle of a depression, you don't want to put all your eggs in one basket.
Note 1: Dmitry Orlov, the engineer who lived through the collapse of the Soviet Union - and who now advises Americans on how to weather the collapse of the U.S. - provides a contrary perspective, counseling against holding too much gold. Orlov said the following in an email to me:
What I generally tell people is that, during the collapse, most people will lose most of their money. No matter how you represent it, money just won't be worth nearly as much in a post-collapse economy, because the resource base from which money takes its value will no longer be the same. The important thing is to avoid losing all your money at once, but to coast down gently, while coming up with ways to survive without money, by relying on personal connections and relationships, home production of various kinds, barter, favors, gifts, and so forth. Gold should be about 10% of any portfolio, 20% if you are adventurous, but you have to keep in mind that a hoard of gold is hard to defend, and redeeming gold in a high-crime environment is a high-risk proposition.
Note 2: I am not an investment advisor and this should not be taken as investment advice.