Efficient Frontier
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William J. Bernstein

The Longest Discipline

I’m getting a lot of phone calls these days about one of my oldest friends—gold. The two of us, you see, go way back. About a decade ago, I began to notice that when rebalanced back to policy, the internal rate of return of a precious metals equity portfolio clocked about five percent per year more than that of the underlying asset. The funny thing was, it didn’t seem to matter how often the rebalancing was done; frequently or infrequently, a bit at a time or all at once. Five percent, more or less, it was.

The underlying reason for the bonus was obvious enough to me, even then: rebalancing enforces a rough and ready buy-low/sell-high discipline. But why five percent? After several thought experiments and a few dozen lines of canonical math, the answer emerged: five percent was half the variance of this very volatile asset class, which is the rebalancing bonus of an asset class with a zero correlation with the rest of the portfolio. In other words, rebalancing precious metals equity allows one to extract the arithmetic return out of the geometric return. A neat trick, that.

Of course, back in the 1990s, five percent more than a low or negative return was nothing to write home about. Not many people wanted to talk to me about the asset class. But this worm has turned, and with a vengeance—after a few years of barn-burning returns, the glittering yellow has become the asset class du jour. So I figure it’s time to take a few steps back and look at its behavior.

Thanks to Ken French’s wonderful industry-specific database, we can now do that. His precious metals equity series goes back to July 1963, yielding a 41.5 year baseline, long enough to get some idea of its long-term return and risk:

Annualized Return


Precious Metals Equity


S&P 500 Stock Index


Long-Term Treasuries


30-Day T-Bill




Too good to be true, really—a long-term real rate of return of nearly five percent, within shouting distance of industrial stocks—and that’s before the five percent "rebalancing bonus." One doesn’t need to fire up an optimizer to realize that this asset class, with its 0.29 correlation with the S&P, belongs in every portfolio.

As you might suspect, there’s a price to be paid. You think that value and small-stock exposures were a tough row to hoe in the 90s? Have Japanese stocks given you fits for the past 15 years? You ain’t seen nothin’: since 1963, the precious metals equity (PME) series has lost more than 35% five different times and, on one occasion, nearly 70%. Between October 1980 and August 1998, it lost a total of 53.8%, or 4.2% annualized—a 7.7% annualized loss after inflation. For the more than 24 years between October 1980 and December 2004, the real return of PME was –0.3%.

That’s nearly a quarter century of zero real returns, pilgrims. How hard was it hard to keep the faith? To quote Klaus von Bulow, You’ve No Idea. What with central banks divesting themselves of their reserves, the permanent demise of inflation, and the dwindling industrial usefulness of the metal, some very smart people went on record that this particular hard asset was as welcome in your portfolio as Hillary Clinton on the op-ed page of The Wall Street Journal.

Not that I’m a gold bug. Far from it; anyone who rebalances this asset class (and, dare I say it, overbalances it) is actually an anti-gold bug, hibernating when these little creatures are most frenzied, and coming out to prowl only when interest has waned.

What percentage of investors has the discipline to stay the course with an asset capable of withering away for an entire generation before reverting to its mean? (If indeed the past 41.5 years have given us a realistic picture of its mean.) I wouldn’t even venture a guess, but I’m pretty sure that the answer is not too far above zero.

I don’t know how much further or longer this asset class has to run. Maybe a decade, maybe two, or maybe ten minutes. But I can tell you the disenchantment that will follow the inevitable next period of underperformance will make the flight from tech stocks in the 1990s look like an infant’s post-bottle burp.

Make no mistake about it: over the very long term, precious metals equity should provide your portfolio with a mean-variance boost. Just be sure that you’re prepared for the long term—the very long term—behavior of this asset class.

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