The tragedy of Bernie Madoff’s Ponzi scheme that ruined so many lives, led to suicides and wiped out a mindboggling $60 billion was not the enormity of the fraud. It was that the scheme was so obvious that even the most superficial of reviews set off alarms. In 2000, 2001 and 2005 the SEC was warned by investors of the impossibility of Madoff’s returns, yet regulators never responded. If you’re a taxpaying citizen, this is maddening. All of the useless, never-ending regulations that spew from an overreaching bloated government – and no one followed up when handed a massive Ponzi scheme that was their job to discover in the first place? Worse still, the SEC never figured out Madoff’s scheme – he turned himself in when the obvious conclusion became society’s problem.
Today, we are witnessing a similar tale of gross negligence unfold in the investment world that is far larger in scale, potentially impacting all pensions throughout the country. On this go-round, however, the incompetence flows from lettered professionals who consult for retirement plans. Pension consultants oversee an estimated $10 trillion while drawing hundreds of millions in fees from pensioners. This despite recusing themselves from the same transparency of performance they demand of managers. In the opinion of numerous studies, such as those done by Oxford, pension consultants are “useless” – save for one purpose. In theory, the pension consultant gives legal protection to the boards of pensions, often made up of hard working individuals such as policemen, firefighters and carpenters. However, this theoretical legal protection begins to break down when it threatens the ability for many baby boomers to retire safely.
What is the prime negligence within the actions of these pension funds? The diversification of risk management, which is the fundamental cornerstone of investment consultation. While no pension consultant would be naive enough to argue this reality, in practice pension consultants do not routinely put this fiduciary duty in play.
Portfolio diversification does not come from owning a magic number of equities, public or private. As the number of equities in a portfolio moves beyond 25, the impact on a portfolio diminishes asymptotically. Moreover, the greater the number of equities in a portfolio, the greater the portfolio correlation is to market direction. This is particularly true during periods of falling markets when diversification is most critical. Even more alarming is the reality that bonds, an asset that pension consultants point to as diversification and the second biggest asset dominating American pensions, are uncomfortably correlated to equities and don’t come close to adequately diversifying portfolios.
Chaves et al. looked at other assets utilized by pension consultants and sounded the alarm bell: even the assets pensions place around their bloated equity and fixed income exposures are correlated. It was this same reality that led Michael Burry, who correctly saw the ’08 meltdown and was profiled in The Big Short, to say, “The incredible correlation … is problematic.” Pension consultants’ timing couldn’t be more perilous, as equity markets are at or near all-time highs with valuations that suggest the ensuing performance will be very poor at a time when aging pensioners can least afford such recklessness.
So what exactly should pension consultants be doing to protect their retirees? They should follow these three key points necessary to rebuild confidence by ensuring that their allocations:
1) Are uncorrelated to the massive allocations they hold to stocks and bonds
2) Are liquid and time-tested with proven records
3) Are not vulnerable to excess systematic leverage
Pension consultants will argue this is impossible. Yet the solution has been around since the dawn of time. Could it be that the answer is so simple it threatens the relevance of pension consultants?
The answer is physical gold. Gold has traded freely for 46 years, a statistically significant data set. Over that time, gold has returned 8 percent annually, a very respectable number compared to equities and bonds, even with those markets at all-time highs. Consider, too, that central banks have invested over $10 trillion in the stock and bond markets, artificially inflating the returns of equities and fixed incomes on a global scale, which artificially suppresses gold’s returns. This distortion, admitted by all central banks, makes gold’s strong performance more noteworthy. Gold’s returns are even more impressive when one considers how superior the risk profile of gold is compared to equities and bonds. What risk really entails is the potential permanent loss of capital. That risk applies to stocks and bonds, but not gold, which has never defaulted and never hit zero. Gold carries no liabilities. Keep in mind that in the great market sell-off of 1929 and each major market correction in our own lifetimes – 1987, 2000 and 2008, gold markedly outperformed stocks by an average of 30 percent and over 50 percent if one includes the 1929 crash.
Also worth noting: Physical gold is protected from cyber attacks that pose threats to electronic wealth, providing further critical diversification for retiree assets.
Consultants profess to be all about data, but discrimination for investing in physical gold is so prevalent that not one pension in America owns it.
Pension consultants’ prejudice against gold’s performance is even more difficult to ignore when data so clearly demonstrates it as an uncorrelated solution so desperately needed by retirees. From 1971 through 2016, gold’s correlation to stocks and bonds was -.24 and -.33 respectively. Thus, what gold does for a portfolio’s performance is even more important than its price. Digging deeper, many pension boards dismiss gold’s performance over the last half century as “ancient history.” Yet how many pension boards have been made aware that since the year 2000, the return on gold has accelerated even further to 8.4 percent through 2016? Even more troubling is the search to find a consultant informing any pension board member that gold has handily outperformed equities since the start of this century 17 years ago.
Beyond the uncorrelated benefits, while pension consultants refuse to include physical gold into their allocations, investors have observed that gold enhances the sustainability of portfolios through market gyrations. Specifically, portfolios that have included 10 percent allocations since gold began freely trading outperformed portfolios of 60/40 stocks and bonds by more than 35 bps annually. While past performance never guarantees future returns, 20/20 hindsight shows a gold allocation would have theoretically netted investors an incremental $1 million on a $100,000 starting portfolio versus a portfolio that only held stocks and bonds. Yet despite all this hard data, pension consultants suggest zero percent as an ideal allocation of gold? Would you want to legally defend the choices of these consultants or their boards?
Ray Dalio, founder of the world’s largest hedge funds, once advised consultants: “If you do not own gold you know neither history nor economics.” Dalio’s knockout punch has been echoed by an overwhelming percentage of a very select group of managers who all notably outperformed the markets and profited from past corrections. Consider the words of Bill Gross, who ran one of the world’s largest bond funds. He recently said that the risks are higher now than any time since ’08 and that pensions “instead of buying low and selling high, [are] buying high and crossing [their] fingers.” Gross speaks positively about the benefits of utilizing gold allocations within a portfolio.
Paul Singer, founder of the $20 billion Elliott Management Corporation, said, “It makes a great deal of sense to own gold … the world’s central bankers are completely focused on debasing their currencies.” Singer explicitly said that post-QE, the bond market is “broken” and sees uncomfortable similarities with 2008. He feels it is obvious that central banks have created bubble after bubble and that bankers have taken exactly the wrong action, all the while putting pension boards to sleep at precisely the wrong moment. And while pension consultants predict that inflation will remain low for a protracted period of time, Singer suggests that the opposite is highly likely. When inflation does return, he cautions it could be swift and impossible to stop. Singer continued, “What we have today is a global financial system that’s just about as leveraged—and in many cases more leveraged—than before 2008, and I don’t think the financial system is more sound.”
How can pension consultants and boards close their eyes to these realities and simply pine for extremely low inflation in the years ahead? With rates at recent levels, just a one percent rise in inflation suggests over a 15 percent collapse in value to long-duration bonds. Furthermore, realize statistically that a one percent inflation increase is highly likely from current levels, when one observes the cyclical swings in rates –particularly as we are coming off levels where bonds are more expensive than they have been in 500 years. If history is a guide, the pending inflationary cycle will be intense. Given how high he thinks inflation may rise, Jim Grant, chief editor of Grant’s Interest Rate Observer, quipped, “If inflation were a stock you would want to own it.” This would pummel pension portfolios even further, given their lack of exposure to assets that thrive in inflationary times. Grant’s view was also echoed by Jeff Gundlach, another of the world’s most successful fixed income investors, who stated, “Duration has never been this long in my career. With rates near the lowest levels ever and duration at literally the highest level ever, it is the worst possible setup [in] history.”
Today, with investor complacency at extreme highs shown by numerous metrics such as put/call ratios on stocks and bonds, global debt up nearly 50 percent since the ’08 debt crisis at an unfathomable $200 trillion and gold near inflation-adjusted lows – how will pension boards withstand the gross negligence test in the event of a true market correction? When such a correction occurs, just imagine board members and pensions defending the following questions amidst what will surely be outrage and bitterness from an aging workforce once again hosed while Wall Street consultants raked in millions. Here is an apt and telling preview – you must answer each of these questions in the affirmative or advisors/fiduciaries will be deemed grossly negligent…
Mr. Pension Board Member:
1) Did you know that in July 2017 stock and bond markets were near all-time highs, and that valuations in private equity and debt markets were also historically very rich?
2) Did you know that since the ’08 crisis, debts had exploded nearly 50 percent higher and stood in excess of $200 trillion, levels never seen in modern history?
3) Were you aware that there was never a debt crisis like ’08 that ended by dramatically increasing debt, a clear harbinger in the summer of ’17 that exposure to uncorrelated assets was critical?
4) Did you understand that a certain percent of your pensioners were at or beyond retirement age, meaning it would be very difficult for these hard-working Americans to make up for another major correction?
5) Did you not know that bonds and stocks are correlated and that the environment was replete with warnings from history that your portfolio was heinously diversified?
6) Did you realize that the ECB and BOJ balance sheets alone added more than $1 trillion in assets to their balance sheets in 1H17, an absolutely unsustainable pace and major reason why stock markets kept rising?
7) Then why did you have a zero percent allocation to physical gold, knowing that gold has protected working Americans from every major U.S. market downturn, and it was negatively correlated to your bonds and stocks?
The publicly available data is clear: Gold is not just an asset – gold is the antidote to debt that pensions cannot ignore.
This is not to say that pensions must sell everything and buy only gold – but the evidence will be clear that pension consultants and their boards that held zero percent gold allocations were grossly negligent, failing to protect the retirement assets of America’s workers as they were charged and paid to do.
The urgency of this issue is reaching a crescendo. Just this month, big money investors became more bullish on gold than they have been in over a year, as big money bets against America’s pension consultants. Pension consultants should do the same. We don’t have to repeat the Madoff tragedy and recklessly risk the retirements of firefighters, nurses and the men and women who make America work. Pensions can fix this mess now, but not if their consultants and boards continue to turn a blind eye toward a glitteringly obvious solution.
About the Author
Drew Mason worked on Wall Street for 15 years and is a founding partner of A Palos Harbor Fund L.P., a physical gold advisory firm. He has written about precious metals via numerous media channels and focuses on family office estate planning in conjunction with T&E, accounting and financial specialists. He authored Victory from Defeat, graduated from Wharton and can be reached at [email protected].
© St. Joseph’s Partners, LLC
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