“Our last report dealt with the characteristics of a bubble as seen through a technology stock, Cisco, and the sentiment surrounding the choice of that asset.  We thought it would be even more interesting to revisit the issue across a broad array of asset classes during the period from 1978 to 1980. 

That period seemed to be the culminating phase for the various factors that shaped the late 1960s through the beginning of the 1980s.  The table below shows the totals returns for these asset classes both before-and-after-inflation.


It is important to take a look at both to give us possible clues as to how the current situation might unfold, and to see how well broadly diversified portfolios fared, and most importantly, which class performed the task of wealth preservation that we all hope to achieve in these chaotic and potentially catastrophic markets....

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“It is easy to answer the third question.  Gold was the clear winner both before-and-after-inflation by a staggering margin.  It is particularly impressive as there were strong competitors for that crown.

Unlike today, interest rates were allowed to rise.  If you owned Treasury bills, you had a chance to offset the inflation driving higher rates.  Before taxes, Treasury bills were flat.  Given the 70% marginal Federal income tax bracket that many paid, it was decidedly negative, but that topic is for another day.

If you owned longer-dated fixed income, it was a devastating period.  The data is for 30-year Treasury bonds, but the destruction was spread across all fixed income.  It was the worst performing asset class, a stomach-churning compound annual decline of about 16%.

Equities did fairly well, even after adjusting for inflation.  High growth technology companies and non-U.S. equities showed solid compound returns.  Real estate stocks, as measured by a broad index of real estate trusts also provided wealth-enhancing returns, although not in the same league with the winner, gold.

The second question is how well broad diversification performed going into this period.  The truth is not well.  The equal-weight returns were good, but fell far short of making the correct call, gold.

Consultants have been advocating a “60%/40%” split between equities and fixed income for 30 years.  While it was appropriate in a 30-year, historic decline in interest rates and when asset showed little correlation, it is not advisable when correlations converge as we saw in 2008. 

If and when interest rates are allowed to rise again, we will return to that late 1980s period when rising rates devastated the 40% allocation to fixed income. Most forms of equities, other than those related to precious metals, become a drag on overall performance and preservation.

How this plays out in the short-term is a difficult call.  Our global markets are being impacted by a wide array of powerful forces such as central bank interventions on interest rates as well as high-frequency trading.  History strongly suggests that markets will eventually prevail.  Instead of the bond vigilantes of the 1970s, it could be the oil, gold and food vigilantes in this period.

Along the way, there is potential for great volatility.  As investors, we need to work from history and as well as an overall strategy.  We believe that those investors with a heavy allocation to real assets and very short-term fixed income will be best positioned to adapt to what comes next.

Energy, precious metals, high quality precious metals mining companies and food are the areas in which to concentrates one’s focus given what we know today.  Equities in general might also get a significant boost, even from these levels if the major countries do engage in coordinated, massive printing. 

If that is the chosen path, however, it will ensure that gold will be once again grabbing the crown as the top performer and the top wealth-preserving asset.”

© 2012 by King World News®. All Rights Reserved. This material may not be published, broadcast, rewritten, or redistributed.  However, linking directly to the blog page is permitted and encouraged.

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Eric King

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© 2012 by King World News®. All Rights Reserved. This material may not be published, broadcast,

rewritten, or redistributed.  However, linking directly to the blog page is permitted and encouraged.

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