Buying Gold

I made the decision to buy gold last week. At the close on Friday gold had come off its highs to be at $1091.50. In British pounds gold was off its November peak by about 5%. The buy was not big. I nibbled by transferring about 0.6% of my total retirement investing assets from cash held in British pounds.

So when weighing up the buy what were the pro’s that I could come up with:

1. My desired low charge portfolio has an asset allocation dedicated to commodities and more specifically to gold of 5%. As I highlighted on Monday my current low charge portfolio mainly through contributing around 60% of my gross earnings towards my retirement investing strategy had seen my actual gold holdings reduce to 2.6% portfolio. This was too low.

2. Gold in 1980 reached a real monthly average price of $1,728.

3. It looks as though inflation may be among us with the RPI leaping to 2.4%. My personal feeling is that the Bank of England will not raise interest rates to counter this so I am thinking I may need more inflation protection than I already have.

The con’s that I could come up with were:

1. I hadn’t bought gold for some time as my analysis showed that if gold was following the trend line it would have a real price of $630.

2. The average real (after inflation) price for gold since 1968 has been $599. This suggested that gold had a good chance of returning to trend in the long term.

As always DYOR.

Why I Hold National Savings and Investments (NS&I) Index Linked Savings Certificates

My retirement investing strategy asset allocation currently consists of 18% worth of National Savings and Investments (NS&I) Index Linked Savings Certificates. I have been buying these for quite a few years now and on average they are now providing me with an average headline return of 1.01% plus the Retail Prices Index. The big advantage they bring to me though as a 40% tax payer is that they are tax free.

I would like to buy more Certificates however you can only invest a maximum of £15,000 into each Issue which is currently Issue 19 for a 3 year and Issue 46 for a 5 year. These current issues are currently offering Index Linking plus 1% tax free which is pretty close to my average.

I think these are now really starting to provide me with some advantages and I would like to buy some more 3 years if they became available. Let me demonstrate with an example.

Let’s say that on the 22 January 2009 I purchased £15,000 worth of 3 year Index Linked Savings Certificates. Using the calculator on the National Savings and Investments (NS&I) website reveals that if I sold those certificates today they would be worth £15,279 which is a 1 year return of 1.9% tax free. However as a 40% higher rate tax payer the fact that they are tax free means that I would have had to earn a 1 year return of 3.1% in a taxed bank account for it to be equivalent.

If however I had bought on the 22 January 2008 then today they would be worth £15,985.50. Again, selling today would be a total tax free return for the 2 years of 6.6% or after factoring the tax free status a taxed bank account would have had to have provided a 2 year total return of 11%.

Finally, if I had bought on the 22 January 2007 then today they would be worth £16,830. Again, selling today would be a total return for the 3 years of 12.2% or after factoring the tax free status in a taxed bank account would have had to have provided a 3 year total return of 20.3%. That’s a Compound Annual Growth Rate (CAGR) of 3.9%. A taxed bank account for a 40% tax payer like me would have had to provide a CAGR of 6.4%.

I’m happy with that for “100% security for your money” as detailed on the NS&I home page.

Please note that this is a very simplistic example and there are a number of terms and conditions for these investments that I made myself aware of before I invested.

As always DYOR.

Australian Stock Market – January 2010 Update

To try and squeeze some more performance out of a retirement investing strategy that is heavily focused on asset allocation I am using a cyclically adjusted PE ratio for the ASX 200 to attempt to value the Australian Stock Market. The method used is based on that developed by Yale Professor Robert Shiller. I will call it the ASX 200 PE10 and it is the ratio of Real (ie after inflation) Monthly Prices and the 10 Year Real (ie after inflation) Average Earnings. For my Australian Equities I will use a nominal ASX 200 PE10 value of 16 to equate to when I hold 21% Australian Equities. On a linear scale I will target 30% less stocks when the ASX 200 PE10 average is ASX 200 PE10 average + 10 = 26 and will own 30% more stocks when the ASX 200 PE10 average is PE10 average -10 = 6.

Chart 1 plots the ASX 200 PE10. Key points this month are:
ASX 200 PE10 = 18.8 which is up from 18.7 last month. My target Australian Equities target is now 19.2% which is down from 19.3% last month.
ASX 200 PE10 Average = 22.9
ASX 200 PE10 20 Percentile = 17.3
ASX 200 PE10 80 Percentile = 27.7
ASX 200 PE10 Correlation with Real ASX 200 Price = 0.82

Chart 2 plots further reinforces why I am using this method. While the R^2 is low at 0.1358 there appears to be a trend suggesting that the return in the following year is dependent on the ASX 200 PE10 value. Using the trend line with a PE10 of 18.8 results in a 1 year expected real (after inflation) earnings projection of 12.5%. The correlation of the data in chart 2 is -0.37.

Chart 3 plots Real (after inflation) Earnings and Real Dividends. Dividends and Earnings are below the trend line. In fact Earnings are now very close to that of Dividends. What this means is that currently Australian companies are using nearly all their Earnings just to fund the Dividends. Yet the trend line suggests typically clear distance between the two with the trend lines running almost parallel. Where is the money for investments going to come from?

As always DYOR.

Assumptions include:
- All figures are taken from official data from the Reserve Bank of Australia.
- January price is the 21 January ’10 market close.
- January Earnings and Dividends are assumed to be the same as the December numbers
- Inflation data from October ’09 to January ’10 is estimated.

UK Inflation – January 2010 Update

During my previous UK inflation entry I showed concern at what I saw in the data and predicted that inflation could very quickly get out of hand. That concern was justified today. Firstly let’s look at the data. The Office for National Statistics (ONS) reports the December 2009 UK Consumer Price Index (CPI) as 2.9% up from 1.9% and the UK Retail Price Index (RPI) as 2.4% up from 0.3%.

The first chart is tracking the CHAW Index which is the RPI including All Items. I focus on the RPI as my National Savings and Investments Index Linked Savings Certificates use the RPI to index from. This shows a big dip when the Bank of England dropped interest rates to historic lows however the chart shows that all the dip did was compensate for the big kick upwards that was seen from 2007. The current level of the Index has now risen above the trend line and is disturbingly starting to point more and more upwards.

The second chart is again based on the CHAW Index. This chart shows annual figures based on the previous 3, 6 and 12 month’s worth of data. As of December the 12 month figure is 2.4% (as published by the ONS) however disturbingly the 6 month figure is 4.3% and the 3 month figure is 5.0% annualised.

The Office for National Statistics reports:
“The increase in the CPI annual rate of 1.0 per cent between November and December 2009 is the largest ever increase in the annual rate between two months. This record increase is due to a number of exceptional events that took place in December 2008:
- the reduction in the standard rate of Value Added Tax (VAT) to 15 per cent from 17.5 per cent
- sharp falls in the price of oil
- pre-Christmas sales as a result of the economic downturn”

That explanation is all fine and well except the Bank of England knew all this months ago. Why then did they keep the Official Bank Rate at record lows and continue with plenty of Quantitative Easing which continued to devalue the GBP further forcing inflation into the system through increased import prices. Additionally, next month (January data) we get another big kick in inflation as the VAT increase back to 17.5% hits the data set.

The Bank of England meets on the 04 February. I think this meeting will be crucial and will really show their hand. Will they sell some debt that was bought through Quantitative Easing to support the GBP? Unlikely as who’s going to buy all that in addition to the regular record monthly amounts that the Debt Management Office is trying to get rid of. Will they raise the Official Bank Rate? I’ll be watching this carefully as if they don’t then I believe they will have chosen the inflation route to ease the pain. This would obviously only ease the pain on those who are in debt. That is the government and the public who on average have over extended themselves. Those prudent savers will of course be punished as the value of their assets is reduced.

All I can say is that I’m glad I own Index Linked Savings Certificates and Index Linked Gilts.

As always DYOR.

My Current Low Charge Portfolio – January 2010

Another month passes.

Buying: As always I contributed about 60% of my gross salary towards my retirement investing strategy. Of this 60% the allocations I made are 64.7% Cash, 5.3% UK Equities, 7.4% International Equities, 1.4% Index Linked Gilts and 21.2% Property.

Selling: Nothing this month.

Dividends: My Australian Equities paid dividends of about 1.5% of the total value of the Australian Equities. I have taken these dividends off the table and put them to Cash as I was overweight Australian Equities.

Current UK Retail Prices Index: 0.28%

Current Annual Charges: 0.60%

Current Expected Annual Return after Inflation: 4.2%

Current Return Year To Date (from 01 January 2010): 0.1%

How close am I to retirement: 41.3%

The following are the highlights for the month:

- Desired Cash portion moves from 11.6% to 12.4%. This month I have moved further from the desired by going from 12.7% to 13.5%.

- Desired Bonds portion moves from 17.2% to 17.4%. This month I have moved closer to the desired by going from 20.7% to 20.1%.

- Desired Property stays constant at 10.0%. This month I have moved closer to the desired by going from 7.7% to 7.9%. With the poor exchange rates to the GBP I have been reluctant to buy outside the UK and so these purchases have been all UK Commercial Property.

- Desired Commodities stays constant at 5.0%. This month I have moved further from the desired by going from 2.8% to 2.6%. With the poor exchange rates to the GBP I have been reluctant to buy gold. However this asset class is now the furthest from the desired percentage of any asset class. I may buy here soon.

- Desired International Equity portion moves from 13.3% to 12.9%. This month I have moved further from the desired by going from 13.1% to 13.3%.

- Desired Emerging Market Equities stays constant at 5.0%. This month I have stayed constant at 2.9%. In GBP terms Emerging Market Equities are at a near high since May ’08. I have tried to compensate by holding extra UK Equities which earn a reasonable portion of their revenues in International and Emerging Markets.

- Desired Australian Equity portion stays constant at 19.3%. This is because the Reserve Bank of Australia is yet to publish its data yet meaning I am unable to calculate the ASX 200 PE10. This month I have moved closer to the desired by going from 20.9% to 20.5%. It is almost impossible for me to get out of this class tax effectively other than by dividends and by eroding the percentage by not investing in the asset class. Not an ideal situation to be in.

- Desired UK Equity portion moves from 18.6% to 18.0%. This month I have moved further from the desired (partially to compensate for Emerging Markets) by going from 19.2% to 19.3%.