Tuesday, July 17, 2012

PRPFX and Silver

I have written about the recent performance of PRPFX.  Yesterday I wrote about the stock holdings in PRPFX.  Today, I will discuss the silver portion.

One of the main reasons to invest in the permanent portfolio as described by Harry Browne is that it provides diversification in almost any economic environment.  It tends to do the poorest during a recession, but these are usually short-lived and there is also a tendency for stable or even declining prices during those times.

The primary protection for the permanent portfolio in an inflationary environment is the 25% devoted to gold and gold related investments (but preferably not gold stocks).  There is some additional protection with stocks, but even stocks did not hold up too well in the 1970's when there was high price inflation in the U.S.

The mutual fund PRPFX does things a little different.  It holds approximately 20% in gold and 5% in silver.  While the overall percentage in metals is the same as the regular permanent portfolio, the mutual fund deviates with silver.  The regular permanent portfolio does not have silver at all.

This is a fairly small percentage (five percent), so a major drop in silver isn't going to completely crush the mutual fund.  However, it can make a little bit of a difference, and it can be good or bad.

Silver is far more volatile than gold.  In a boom of precious metals, silver is likely to outperform gold.  In a bust period of precious metals, silver is likely to fall much further than gold.

Another difference is that silver is used more as an industrial metal.  While silver has some history of being used as money and gold has some uses outside of being money, gold is heavily favored over silver when being used as a form of money.  In a recession, silver is more likely to go down due to its uses as an industrial metal.

Another interesting aspect is that central banks and governments hold gold.  They don't usually hold silver.  In the past, this could have actually been a reason to prefer investing in silver over gold because central banks had more of a tendency to sell gold, thus driving down its price.  Today, I would say the opposite.  Central banks all over the world are actually increasing their gold reserves, probably because of the shaky financial system and the growing mistrust of fiat currencies.  This has seemed to put a floor on the price of gold.

As far as PRPFX, what does this mean?  It means that it will tend to be more volatile.  One of the great attractions about the permanent portfolio setup is that it tends not to move in wild swings.  You don't feel like you are on a roller coaster the way pure stock market investors have felt over the last 4 years.  By adding a little silver to its fund, PRPFX can potentially be a little bit more volatile than the regular setup.  In a high inflationary environment, it will probably pay off.  In a recession or depression, it will probably mean bigger losses, or at least less gains, assuming that precious metals take a big hit.

In conclusion, while it would seem that having 5% in silver would add diversification, it actually makes the fund more volatile.  This may not be a bad thing for younger and more aggressive investors, but you should at least know that there is a slight amount of increased risk due to this allocation.

2 comments:

Anonymous said...

I've been reading your blog for a while now and greatly appreciate your composed, well reasoned thoughts on economic matters. I've become interested in the idea of the permanent portfolio, but I'm not sure the best way to implement it given my situation.

I'm in my early 30's with a stable job. I participate in my company's 401k plan up to the limit that they match. That currently makes up 44% of my savings.

About 17% percent of my savings is in cash. Some in my checking account and some in a safe at home. I also have a high yield savings account (0.85% APR) where I can keep some cash, but even that seems like such a paltry rate.

I have about 13% in physical precious metals (gold and silver).

And finally, I have a brokerage account where about 26% of my savings is held. Of this, 28% is in a gold ETF. The remainder is in foreign funds that have not been doing too well lately.

I'm confused by all the various ways of saving and investing. I'm not sure if I should have an IRA or Roth IRA, or what I should do with all the cash i'm sitting on that isn't earning anything. I don't necessarily want it tied up in an account for a long period of time. Do you have any general recommendations for a person in my situation? Am I on the right track?

LIBERTARIAN INVESTMENTS said...

Since I thought my comments might be beneficial to others, I decided to answer it as a separate post.