The

VOL. 1, No. 16

Real Returns Report

Non-Consensus, Data-Driven Analysis
MAY 7, 2012

Contents This Week Value Map U.S. Equities Value Map Precious Metals

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Contents From the Archives License/ Disclaimer

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This Week
Last week, I promised extended coverage across asset classes and, this week, I'm making good on that promise, by adding two Swiss Franc-denominated series for gold and two dollar-denominated series for silver (see page 3). In staying true to our name at The Real Returns Report, all price and return series are inflation-adjusted. My headline pitch for this week's issue was "Definitive proof gold is a bubble." Let's be clear whenever anyone tells you they have definitive proof of anything in the financial markets, your first reaction should be to put your hand to your pocketbook. This is practical finance, not formal logic; there is no such thing as "definitive proof" of a financial bubble only judgment and likelihood (even in formal logic, Gdel showed that some statements are undecidable.) 11% real! Nevertheless, the Swiss Franc-denominated series provide strong confirmation that gold is a bubble by shattering the notion that gold's price ascent in dollars simply reflects the greenback's debasement. The Swiss Franc remains a safe haven and a strong currency despite that, gold has produced a 10.9% annualized return on an inflation-adjusted basis in that currency. That figure is inconsistent with a plain store of value. A 'store' retains its value, it does not compound it at 11%. I remain comfortable asserting that gold is in a bubble now. It's possible to argue that the series I have put together aren't representative I admit that but I don't find those arguments compelling enough. On the balance of probabilities, I believe that gold is significantly overpriced. Enjoy your week and, as always, I welcome your feedback you can reach me at the e-mail address above. AD 1

Alex Dumortier, CFA alex.dumortier@gmail.com

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May 7, 2012

The Real Returns Report

Value Map - Equities

U.S. - Broad market/ Large-caps/ Small-cap stocks
Current value (05/04) Aggregate U.S. equities, Equity q ratio Russell 1000, P/E 10 0.99 % Above (below) geometric mean 49% % Above (below) arithmetic mean 39%

Series length 1945 2011

Percentile rank 88%

Standard deviation 0.26

18.7

2004 - 2012

33%

(9%)

(11%)

4.0

S&P 500, Equity q ratio

0.72

1871 2012

53%

13%

5%

0.25

S&P 500, P/E10 Small-caps: 2000, P/E10 Russell

21.1

1881 2012

81%

38%

28%

6.6

29.6

2003 - 2012

32%

(2%)

(3%)

5.0

Source: Federal Reserve Board of Governors, Robert Shiller, Russell Indexes, Standard & Poor's, The Real Returns Report Notes Equity q = Market value / Net worth (estimated at market prices) This is a variation on Tobin's q. When it is calculated over all U.S. equities, it is a quarterly series since it depends on data from the Federal Reserve's Flow of Funds report. However, it's possible to calculate the ratio mid-quarter, as I have done, by adjusting the market value to reflect changes in equity market indexes. Here, I used the Wilshire 5000 full capitalization index, which is the broadest measure of U.S. equities' market capitalization and performance. P/E10: Also known as the cyclically-adjusted PE (CAPE) or "Shiller PE" after Robert Shiller of Yale. The P/E10 uses the average of the prior ten years' earnings, on an inflation adjusted basis, as its earnings input. The rationale behind this is the observation that earnings are too volatile on a year-to-year basis to provide reliable information on a company's (or a market's) true earnings power. By using a ten-year average, the P/E10 smoothes out earnings volatility and allows investors to better identify legitimate changes in risk premiums. The figures in this table are derived from Professor Shiller's data (available from his web page), which include series of monthly average prices for the S&P 500/ S&P Composite Index.

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May 7, 2012

The Real Returns Report

Value Map Precious Metals

% Above (below) geometric mean % Above (below) arithmetic mean

Current value (05/04) GOLD Real price, USD $1,675.2

Series length

Percentile rank

Standard deviation

1970 2012

97%

162%

135%

$339.9

Real price, CHF Trailing 10-yr real return, USD Trailing 10-yr real return, CHF SILVER Real price, USD Trailing 10-yr real return, USD

CHF 1,507.1

1970 2012

94%

95%

80%

CHF 357.4

15.4%

1979 2012

90%

1,393 bps

1,362 bps

812 bps

10.9%

1979 2012

92%

1,034 bps

1,011 bps

686 bps

$29.9

1970 2012

93%

139%

100%

$11.3

17.2%

1980 2012

90%

1,773 bps

1,734 bps

893 bps

Source: Kitco, The Real Returns Report, The World Gold Council

Nota bene: As far as the statistics for the trailing 10-year return series are concerned, the '% Above (below) geometric mean' and '% Above (below) arithmetic mean' refer to the amount by which the current trailing 10year real return exceeds the geometric/ arithmetic mean in percentage points, rather than on a percentage basis. For example, if we take the third line in the table below, we see that gold's trailing 10-year inflation adjusted return in dollar terms is 15.4%. That return, according to the figure in the cell corresponding to '% Above (below) arithmetic mean' is 1,393 bps higher than the average trailing 10-year return over the entire series [1 basis point, or 1 bps, equals one hundredth of a percentage point.] In other words, the average trailing 10-year return is equal to 15.4% - 13.9% = 1.5%.

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May 7, 2012

The Real Returns Report

From the Archives

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May 7, 2012

The Real Returns Report

The Real Returns Report by Alex Dumortier is licensed under a Creative Commons AttributionNonCommercial-NoDerivs 3.0 Unported License. Permissions beyond the scope of this license may be available at longrunreturns.blogspot.com.

Disclaimer: This research is based on current public information that we consider reliable, but we do not represent it is accurate or complete, and it should not be relied on as such. This research does not constitute a personal recommendation. The price and value of the investments referred to in this research and the income from them may fluctuate. Past performance is not a guide to future performance, future returns are not guaranteed, and a loss of original capital may occur. Certain transactions, including those involving futures, options, and other derivatives, give rise to substantial risk and are not suitable for all investors.

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