Note that they recommend investing in gold and related assets.

Link: The Boeckh Investment Letter

Pensions have been devastated and people’s appetite for risk has declined dramatically. The return on safe liquid assets ranges from 0.60% to 1.20% depending on term and withdrawal penalties. Reasonable quality bonds with a five-year maturity provide about 4%. Bonds with longer maturities have higher yields but are vulnerable to price erosion if inflationary expectations heat up. As for equities, people now understand that blue chip stocks carry huge risk. GE, once considered the ultimate “bullet proof” stock, dropped 83% in the panic, and Citigroup lost 98%. Revelations of massive fraud schemes have further damaged trust and confidence in markets.

Against this backdrop, we offer a few thoughts. First, an increase in price inflation as reflected in the CPI is a long way off. The degree of excess capacity in the world is probably the greatest since the 1930s, although excess capacity does get scrapped during recessions. Western economies will remain depressed for years and China will also be important in keeping inflation down. Its capital investment is larger than the U.S. in absolute terms. It is currently 40% of GDP and growing at 30% per annum. Profit margins in China will probably get squeezed, which, together with the huge amount of underemployed labor means that the Chinese will keep driving their export machine at full throttle, continuing to flood the world with high-quality, inexpensive goods. Therefore, investors who need income are probably safe holding reasonably high- quality bonds in the five-year maturity range. A bond ladder is a very useful tool for most people. Holdings are staggered over say, a five-year time frame and maturing bonds are invested back into five-year bonds, keeping the portfolio structure in the zero-to-five year range. In this way, some protection against a future rise in price inflation and falling bond prices can be achieved.

Second, massive monetary stimulus is good for asset prices in the near term (e.g. stocks, bonds, houses, commodities) in a world of very weak price inflation and a soft economy. That is true as long as the economy does not fall apart again, which is very unlikely given all the stimulus present and more to come if needed. Therefore, investors who can afford a little risk should own some assets that will ultimately be beneficiaries of the wall of new money being created and thrown at the economy.

There is a major risk to our relative near-term optimism, and that is the U.S. dollar. Foreign central banks hold $2.64 trillion, overwhelmingly the largest component of world reserves. The U.S. role as the main reserve currency country is compromised by its persistent inflationary policies and current account deficits, a subject high on the agenda at the recent G-8 meeting in Italy and referred to frequently by China, Russia, Brazil and others. Foreign central banks fear a large drop in the dollar, which would cause them potentially huge losses on their reserve holdings. They don’t want more dollars, and yet they don’t want to lose competitive advantage by seeing their currencies go up against the dollar. To preserve their competitive position, they have to buy more when the dollar is under pressure. On the other hand, since the 1930s, the U.S. has never subjugated domestic concerns to external discipline. Officials may talk of a strong dollar policy, but their actions always speak differently. Their attitude towards foreign central banks is, “we didn’t ask you to buy the dollars”. The U.S. has typically seen such buying as currency manipulation to gain an unfair trade advantage.

The most likely outcome is a nervous dollar stalemate or, as Lawrence Summers once described it, “a balance of financial terror.” The most important central banks will continue to hold their nose and buy dollars to keep it from falling too sharply. However, this is a fragile, unstable situation and the dollar must fall over time.

Investors need to diversify away from this risk. There are three obvious ways.

The first is investing in high quality U.S. equities that have a majority of their earnings and assets in hard currency countries.

The second is investing in gold and related assets. Gold will probably remain in a tug of war for some time.

Third, most foreign currencies will also be a beneficiary of these fears and hence investors can also protect themselves by diversifying into non-dollar assets in the best- managed countries. On the negative side, it is faced with non-existent global price inflation, even deflation, and a sharp decline in jewelry demand. On the positive side, concerns over U.S. monetary and fiscal debauchery will almost certainly heat up. As the odds of the latter increase, gold will be a major beneficiary and investors should have a healthy insurance position in this asset class. Some of these are emerging markets like China, which are liquid, in surplus, fiscally stable, and still growing well in spite of the global economic downturn. If and when the world economy begins to recover, and should price inflation stay low, asset bubbles are likely to recur. Where and when is always hard to tell in advance. Good prospects are in emerging market equities, commodities, and commodity-oriented countries.

So, to sum up, in the next six to 12 months, we look for a weak but recovering U.S. economy, continued deflationary price environment, pretty good asset and commodity markets, and continued narrowing of credit spreads. This view is based on the assumption that the new money created has to go somewhere, a stable to modestly falling dollar and anemic world economic recovery next year.

A buy and hold strategy has been bad advice for the past 10 years. The S&P is down 45% from its peak in early 2000. The investment world is likely to remain very unstable in the face of the difficult longer-run problems discussed above. Investors, whether they like it or not, are in the forecasting game and forecasting is all about time lags. The exceptional circumstances of the current environment make any assessment of time lags extraordinarily difficult and mistakes will continue to be costly. For that reason, holding well above average liquidity, in spite of the paltry returns, is sensible for most people who don’t have deep enough pockets to absorb another hit to their net worth. They are in the unfortunate position of having to wait until the air clears a bit and more aggressive action can be taken with higher confidence. Warren Buffet has properly reminded us on numerous occasions that a price has to be paid for waiting for such a time, but then most of us aren’t as rich as he is.

If you believe that we will return to a stable financial system where the stock market delivers steady, sustained growth, the Buy and Hold investment strategy is for you. If you have some doubts, read on.

Keith Fitz-Gerald at Money Morning describes how Buy and Hold failed during the financial crisis of 2008.

It was supposed be a simple proposition. Consistently put money to work in the markets, let it ride – and laugh all the way to the bank. The thinking was that you couldn’t go wrong because the markets would go up 10% to 12% a year – each and every year (It’s actually more like 4% to 6% – on average – but that’s another story for another time.

What’s important to understand is that “Buy and Hope” is the greatest myth foisted upon the American public in the last 200 years – the need for American International Group Inc.’s (AIG) retention bonuses, notwithstanding. As millions of investors have found out the hard way, the markets can – and do – frequently go through tremendous periods of readjustment.

This means that timing, as they say, really is everything. And “they” – the brokerage firms, hedge funds, ratings agencies and others that together make up “Wall Street” – don’t want you to know that. Wall Street wants you all the way into the game all the time. It doesn’t care whether you win or lose, just as long as you keep playing. So the collective “they” work together to pitch you whatever’s hot, and then move on when that investment has run its course.

And don’t even get me started about the conflicts of interest. The supposedly independent ratings agencies that rubber stamped everything from derivatives to high-grade debt have been in bed with the companies they’re supposed to be regulating for years. Consequently, millions of investors thought they had the “green light” to invest in supposedly safe institutions that have proven to be anything but during the past 24 months.

Where the rubber meets the road – especially during the down years like we’re living through now – is that the risks of outliving your money go up dramatically if you have to get out. In fact, if you achieve annualized returns of zero or less for the first five years after you retire, your odds of running out of money in the next 30 years more than double from 26% to 57%, a study from T. Rowe Price Group Inc. (TROW) reported recently.

And that’s proving to be a tough reality for millions of investors who thought they had this handled. Which is why I was not surprised to see data from the Employee Benefit Research Institute quoted in Money Magazine showing that more than 30% of near-retirees, or those in the early years of their retirement, had more than 80% of their money invested in stocks at the onset of this crisis.

Many of those investors have undoubtedly sold off assets to finance living expenses while waiting for the market to reverse. And that’s created a “double whammy” of sorts: Not only did they lose money on the way down; but those losses and the subsequent forced sales could well mean that their portfolios won’t be big enough to benefit from the next upturn when it does arrive.

Losses from Buy and Hold in a bear market reduce your potential to take advantage of an upturn. That is why every investor needs an warning system when stuff hits the fan. Investors that I know who moved to cash in the summer of 2008 are feeling very grateful now.

Almost everything I ever learned about investing turns out to be wrong. I learned that buying and holding a diversified portfolio of stocks was a sure winning strategy in the long run. So far, my lifetime stock investments are negative. I learned that the safest investment is real estate, especially in California, because “they aren’t making any more land.” That theory hasn’t worked out too well.

I learned that investing in California municipal bonds was extra safe because they were insured. That’s great until the insurance companies themselves become insolvent. 

So if everything that was good is now bad, is there any investment that we all assumed to be bad that is now good? (Other than stuffing cash under the mattress. Too obvious.)