Asset Allocation Ahead of the Algo Apocalypse

Gold, softs, small caps, hedge funds

Cutting to the chase, if I were a CFA I would recommend a portfolio with 10% in gold, 10% in soft commodities (agricultural products like wheat, corn, coffee, cacao, sugar etc.), 20% in a trusted global small cap fund, and 60% in a basket of different hedge fund strategies.

Disclaimer: Nothing on my site is to be construed as recommendations to buy or sell anything. All my writing is for educational and entertainment purposes, so be a responsible adult and consult a professional financial consultant before putting any money at risk, anywhere. Again: I don’t make recommendations. Never. Ever.

My own asset portfolio currently consists of an apartment, ten private companies, and various fixed income streams (loans and obligations). And precious metals.

Oh, and my girlfriend manages a little money for me, a portfolio that currently is exposed to, e.g., Spotify, Hennes & Mauritz, Gran Colombia Gold, Azelio and various soft commodity ETFs.

FAQ

I’m often asked what to invest in. It’s a hard question to answer. It depends on who’s asking, how much risk they can take, i.e., if they’ll freak out if they lose 5%, 10% or 50% in the interim, what their investment horizon is, and not least how active they will be.

By the way, did you know I’ve learned everything I know about strategy and perseverence by Adrian at TQM? Okay, not everything, but he has added a lot of value regarding not least mindset through his 30 Challenges, newsletters and more (affiliate link – the reason I have one is that we approve of each other’s material).

There are several categories of answers, including the following:

  • Don’t invest at all. Just live it up as you get your hands on the money, or keep a buffer at the bank. The strategy is called: invest everything in your personal experience while you still have the time and energy.
  • Set aside a fixed amount every month and buy a global stock index for the money. Don’t look at the result for 40 years. Zero time and resources wasted.
  • Buy precious metals for 90% of your wealth. I’ll help you re-allocate when it’s time in a few years or so. Highly contrarian, zero income-generating, advice-contingent strategy.
  • Go for the Dogs Of Dow, with annual weight adjustments, i.e., a stocks only, slightly sophisticated strategy, with medium level maintenance
  • Invest everything in your own education, skills and business
  • Just buy a basket of hedgefunds and go back to sleep
  • Create and maintain a true asset allocation strategy with medium-frequent adjustments: stocks + fixed income + real assets (real estate, precious metals, commodities) + businesses (own, private equity).

The last bullet point warrants its own full text book, but I’ll try to break it down in just a few paragraphs.

Asset Allocation

First, some would advocate fixed weights for the various asset classes; 25% each if you choose four different pizza slices, 20% each if five and so on. I think you should be way blder than that. Risky assets like certain categories of listed stocks and private equity perform much better than the others during equity bull markets, as well as in total over time. Take advantage of that by on average allocating more than a “fair” share to equities.

Second, the weights shouldn’t be static, but dynamic and dependent on A) absolute valuation metrics, B) relative valuation metrics, C) recent performance (in particular stock market crashes that last 2 years).

Third, we are different, and thus there is no way you could invest the same way I do. I can make new assessments and investment calls every day if I’d like, and you don’t have access to information about when I change my mind.

When I describe a good portfolio allocation, I consider how I think the investor will manage the portfolio when I’m not looking, as well as how I think they’ll react to paper losses.

Fourth, as a general rule, over the very long term some kind of exposure to the general profit making part of growing economies is warranted. Ergo: over time most people should load up on stocks, perhaps even with a little leverage on average.

Leverage

I hesitated over that last statement, since most people aren’t equipped to decide when to use leverage, what kind of leverage and how much leverage. Consequently, most people use too much at precisely the wrong time and end up permanently destroying their capital.

On an economy-wide level this tendency is apparent in NYSE margin loan statistics, corporate indebtedness statistics and not least buyback and insider buying data series. Loans, leverage, buybacks and insider buying always peaks right before serious market downturns.

That tragic historic fact aside, there are times to use smart leverage, and it’s right when the mentioned data series are near their lows. Unfortunately loans can be hard to get just when you want one, so you have to secure your loan earlier but hold off using the money until you get a fat enough pitch.

Alright, back to the portfolio allocation decision. This is what I told a friend earlier today:

  • 10-20% gold
  • 10-20% (soft, agri) commodities
  • 20% global small caps managed by a trusted and experienced PM
  • 40-60% a basket of various hedge funds with uncorrelated strategies

Why gold?

Gold and commodities are very cheap compared to stocks and the amount of currency in circulation, not to mention the vast quantities of outstanding credit and derivatives. In addition to all that government welfare promises require inflation or money printing of hitherto unheard of proportions.

If you own real stuff like gold, silver, uranium, real estate or a business, you only sell if the money you get in return will buy you some other real stuff you want in a reasonable quantity. When the amount of money in circulation doubles, you can expect prices on all tangibles to double too. Don’t sell for less, nobody else will.

Liqudity sloshing

So far mainly stocks have been on the receiving end, but the liquidity sloshing around the system is bound to reach metals and food sooner or later.

In any case, most governments have taken on more debt than they can handle with the current monetary system, and when they perform a re-set, it will most likely be against a basket of various moneys — including gold. It’s around that time, shortly after the re-set, a gold owner makes the switch from gold to stocks.

However, since you never know how far a bull market can go, or how far the madness of central bankers can push the system to avoid a crash on their watch, you’re more or less forced to hold some stocks at all times.

Right now, I advocate a minimum of stocks in relation to your average strategy, since we are within the 5% most expensive, euphoric, overbought and long-lived bull markets of all time. For some, like me, that means close to 0% listed stocks, or even outright net short stocks! In practice, however, I’m actually around 1% net long listed stocks. In addition, my private equity holdings amount to maybe 50% of my net worth, although it’s pretty hard to estimate their value at this point.

And then there is gold/silver, loans and real estate.

Well, that’s me. And you’re not me. Neither is my friend. I told him I like (Swedish) Robur’s global small cap fund that’s managed by Jens Barnevik. And as a basket of hedge funds I always mention Brummer Multi Strategy with 2x built-in leverage.

I have all my private pension money in BMS2xL, and I estimate that alone would be enough to carry me from retirement to the grave in a reasonably comfortable way.

However, that’s how things look now, when gold and commodities are cheap, P2P loans yield 7-10%, some corporate bonds even more, not to mention my private loans where the range is truly huge, and stocks are at their most expensive in 200 years right at the top of a record long expansion and the build-up of more leverage than ever at record-speed.

Algo-apocalypse or U-zombie

After what could either be an algo-apocalypse, a 75% crash in record time, or a drawn out, slow zombie death by a thousand cuts, U-formed profit recession, the tables will most likely have turned completely.

In the latter case, imagine impotent but vengeful central bankers spewing helicopter money over everone and everything they can shake a stick at, while companies fight tooth and nail to make their bond holders whole, and consequently having to cut back on investments, employees and growth. One company’s cutbacks and slow growth means less sales for another.

Thus the zombie disease of investment cutbacks spreads to the whole system. Nervous bond holders keep counting coupons and return of capital, while business owners constantly stare Chapter 11 in the face.

When stock market valuations have normalized, started to normalize, or possibly are going through a period of undershooting, it’s time to overweight equities, while underweighting all other asset classes. Maybe you should even go as far as consider going more than 100% long equities, if you have access to controlled and reliable financing and are dead sure of a secure line of income.

But which equities? Well, once again the Dogs Of Dow could be a place to look. Or stalwart cyclicals. Banks usually perform well after a (financial) crash. But beware of highly indebted companies, if I’m right that the downturn will be drawn out. Some of the latter might default given long time enough to recovery.

Too hard

If you realize this simply is too much work for you, perhaps somebody else should manage your money for you. Or you should aim for one of the simpler strategies.

That’s why I always come back to a portfolio of gold, fixed income, stocks and hedge funds.

Gold is your insurance against systemic risks and rampant inflation, and your source of purchase resources after a stack market crash. Fixed income takes care of your most urgent everyday needs. Stocks makes sure you get some of the upward drift of the world economy (although I really think everybody should try to at least perform some market timing, like buying much more after two negative years, or sell most when stocks are 100% more expensive than the historic average).

And finally, a basket of hedgefunds puts hundreds of brilliant absolute return focused asset managers to work, doing their best to create decent performance in both bull and bear markets in a wide range of uncorrelated asset classes. If you want risky assets-like performance but don’t want stock market crash-like downside, products like Brummer Multi Strategy (2xL) should form the basis of your portfolio.

Please note that I used to work at Brummer & Partners (2000-2014), but don’t have any affiliation with the group today. I just happen to like the product.

So, where did all of this put us?

Avoid stocks now and focus on gold, agri and a diversified basket of hedgefunds. Be prepared to allocate your money the other way around after a crash, but keep in mind it might be a U-shaped recovery that takes more than the usual 2 years before a clear uptrend is established. Look to Japan and some European indices for guidance. How should you best have played the Nikkei between 1990 and 2010?

Make sure you sleep well. The point of all wealth is well-being

Loans, including P2P loans, will probably be honored over time, which at the same time will be an important reason for the slow recovery. Size your exposure intelligently so you can sleep well at night when thinking about the individuals that might or might not be able to meet the payments due to you. Just don’t rely on them to provide ample liquidity when you want to go levered long the stock market in 2026. For that you’ll need gold.

P.S. Remember that guy Adrian at TQM that I mentioned above? Check out his 30 Challenges here (affiliate link), if you’re interested in a method to establish surprisingly effective habits. As an investor you’ll need it, since your hardest job is keeping yourself in check.

Have you ever been shocked by your own behavior?

That’s how Robert Sapolsky begins his book “Behave”.

“No”, I thought, before I realized you were supposed to say “yes” and thus be enticed to read the book to find out why humans do things they can’t explain or feel ashamed of.

I just don’t see it. Why would you do things that shock yourself?

Pull the trigger if you want to. Go to the gym if it’s good for you. Party if you like, but don’t do it if you feel bad afterward — that is, bad-er than you expected.

HOW DO YOU TRADE?

Talk about being shocked, some stock traders surprise themelves – and me – again and again, when they keep trading on emotional impulse during reporting season instead of according to set parameters within a proven strategy. If you were that guy or girl the last four weeks, don’t be in April.

I hope this doesn’t come as a shock to you, but since daytraders create exactly zero value (negative even, due to the false liquidity they provide, and the exaggerated price swings they cause as they react to other people’s moves), a trader without a superior strategy will lose money over time. That’s before commission and fees.

In the corporate world, profit is of course created by providing goods and services to the client that have a higher value than they cost to produce. A daytrader is only trying to do one better than his or hers counterparty. It’s a zero sum game less commission for them, and a negative for the market and society in general. The more people engaging in non-research based trading the less real products and services are made available, and the poorer the society.

—-
Completely off topic, I caught the song Bloodline when partying about a week ago, and I just had to listen to it A LOT OF times.

However, when a song is that good and instantly catchy, it’s almost bound to fall out of favor just as quickly. Not completely unlike the current stock market rally for cyclicals, based on explosive credit in China and The Fed’s sudden dovish U-turn. Well, with the best start to the stock market in 30 years behind us, you know it’s not time to buy shares.

On the other hand, gold is really picking up some speed, despite s strong dollar and a stock market rally. I’m happily holding on to all my types of gold, including Nueva Granada and Gran Colombia. If you’re Swedish, you really should listen to my and Anna’s talk with gold and precious metals investor extraordinaire Eric Strand here.

Anti-elite clicks at your peril

Topic: gold, societal unrest, Davos, the credit cycle, macro reasoning

Summary: grab your gold and run for the hills when you see the Yellow Vests gathering

Reading time: 5 minutes? 10?


Kan du svenska? Är du intresserad av de praktiska tips om värdebaserade investeringar som jag sammanställt från mina 20+ år som analytiker och hedgefondförvaltare? Då är mitt veckovisa nyhetsbrev Finansbrevet värt att kolla upp. Ja, det är gratis.


When the Fed turned dovisher-er again last week, in order to stimulate the supposedly weak economy, expectations for economic growth in the US strengthened and the dollar consequently strengthened. A stronger dollar means cheaper imports and a lower trade deficit, and yet a stronger economy, reinforcing the stronger currency.

Alternatively, in the little longer run, the massive monetization of US deficits and debt leads to increasing inflationary pressures. More money chasing fewer goods in a stagnating economy, where the focus is turning toward finance instead of production, gradually leads to higher consumer prices and demand for higher wages.

It all comes to a head when the Yellow Vests of the world have had it with “the elite” leaving ordinary people behind.

Reasoning vs. the real world

Macro reasoning can take you in any direction you like. Financial market reasoning is even worse. There the logical jump from good is good to good is bad due to eventual overheating to good is good since the bad that comes from over-gooding will lead to policy measures that will turn all things good again is done in an instant.

The real world, however, doesn’t care about your reasoning, reflexivity be damned.

A Lööf in the eye of the storm

For now, we are enjoying a pause of sorts. We are in the eye of the storm, with more or less sensible political leaders like Trump, Macron and Löfvén-Lööf (the Swedish socialist leaning government that took five months of bickering to form) at the helm. Yes, sensible, moderate. Relatively speaking.

Just you wait and see what comes after if these boys and girls next door were to fail. Well, with “were to” I mean “when they will fail”. A deeper, more disturbing, nuance of populism is bound to color the political landscape in the wake of an increasing sense of injustice, where the crony-elite is perceived to be living off of the backs of ordinary citizens.

This is not a crisis of capitalism

There is nothing wrong with capitalism, nothing wrong with adults willingly agreeing to sell goods and services to each other, nothing wrong with the best producer, best satisfyer-of-wants, amassing huge wealth.

What is wrong, however, is when the banking elite is first allowed astronomical gains from risking other people’s money, and then after the inevitable crash are saved by the political elite in return for political funding in the next round. We are not experiencing a crisis of capitalism, what we’re seeing is a particularly nefarious brand of of socialism.

Crony central banking at the center

It may sound conspiratorical but it’s all the central bankers’ fault. Without their wanton manipulation of interest rates blowing bubbles in the economy and on the financial markets, and their setting the stage for subsequent crashes, politicians and central bankers wouldn’t be able to play the game they do.

Politicians want to win elections, so they promise more than they can keep. Central bankers willingly fund the difference between dreams and reality. The unrestricted money printing drives asset prices, which drives borrowing, which drives lending, which drives bank profits.

It doesn’t take many decades before the debts are too high to allow for a normal correction. Politicians and central bankers (as if they weren’t all politicians) then vow to do whatever it takes to salvage the situation they themselves created. And their solution is always the same: keep doing exactly what caused the problem — just at a bigger scale.

After longer time than a single human investor usually can or do care, the system re-sets. A new power, a new currency regime, new relative positions and prices. It’s not that the cycles are aeons, but half a human life is long enough to be forever on the financial markets.

You’re much too young boy

I personally know people who haven’t seen a single market crash and yet consider themselves market veterans. Imagine having only invested in stocks since 2009. You’d look upon ten years as a long time in the market, and twenty as looking back toward a completely and irrelevant era.

I first started talking about stocks sometime in 1985 when a friend told me about his investments. Around then I actually inherited a stock portfolio with some really old holdings: Aga, SKF, Asea, Sandvik and similar stocks. That’s 33 years ago. I have to look back an additional 33 years, to 1952, in order to feel what today’s newbies feel about the turn of the millennium.

Oz wizardry a case in point

Australia hasn’t seen a recession for 26 years. The continent has been riding the rising tide that is China, but that era might be coming to en end now. Imagine the unpreparedness of investors, banks and house buyers when a recession finally hits.

Try to imagine the repurcussions when one panicky domino hits another. Overleveraged consumers and house owners losing their jobs, banks failing, dividends being cut, pension funds falling underwater, selling begetting selling on the stock market, and cost cuts causing unemployment, in a vicious cycle not seen in more than a generation.

Try to imagine the policy response and the saving of the elite on unprecedented scales. Try to imagine the populism that ensues. That’s one more geographical win for the Yellow Vests.

The credit cycle is a cycle

Artificially low interest rates and money printing create a seemingly benign feedback loop over a handful of decades. But it’s just as misleading as the inflation leads to a stronger dollar narrative mentioned at the top of this article. Sooner or later the credit cycle shows why it’s called a cycle.

Healthy growth that was turned into a speculative boom and followed by stagnation and monetary magic morphs into deflation. Deflationary impulses are met with increasingly desperate fiscal and monetary policies that lead to a combination of populism and inflation. The latter wreak havoc with living standards and justice, not to mention financial markets, exchange rates and asset prices until a strong enough leader can set things “right” again.

Right meaning high enough interest rates to force fiscal prudency and a stop to rampant inflation.

At that point risk aversion peaks and liquidity (cash availability and willingness to lend and borrow) troughs.

At that point assets might be “cheap”, but only because you 1) truly can’t know how it will end, and 2) you don’t have any cash to buy assets for, and 3) banks won’t lend it to you. That’s the meaning of “it’s not your father’s market but your grandfather’s”. No matter, that‘s the starting point of another bull market, not the current multi-year topping process.

I hope. You never know. Perhaps buying stocks at 5x earnings won’t work. Perhaps social and political reasons force them to 3x before it’s over. Perhaps dividends will be illegal.

As Grant Williams pointed out in the latest Macro Voices podcast episode, what garners the most journalistic clicks these days are articles from Davos pointing out how much richer the elite has become since before the financial crash of 2008.

Pitchfork time

It’s all fun and games as long as the money illusion makes everybody feel rich. But when the wheels stop turning and you realize your increase was but a fraction of the increase in true prices, not to mention the multiples of that that befell the elite, then it’s pitchfork time.

The anti-elite clicks are accumulating. Populism is rising. You may not like what you see today, or support Trump, Macron and Lööf. But if they fail, Mordor and the winter of the seven kingdoms would be preferable outcomes to what’s in store.

The question is: will your holdings of physical gold (and mine) be a good or a bad thing in that environment?