Year-End Comments 2010 and Outlook 2011
Liberty Valley Investors
January 6th, 2011
As we leave the year 2010 behind us, the following comments summarize our 2010 year performance and contemplate strategies for 2011. In typical money manager fashion, we have to offer good news and bad news.
The good news is, that 2010 was a very successful year for us. Libertyvalley's portfolio earned 25.9%, far outperforming the Vanguard Balanced Index (13.3%) and the S&P 500 (14.4% for SPY). Most of the gains were driven by our precious-metals holdings (up 42.9%) and our oil-related equities (up 34.8%), which we have held for many years in anticipation of such an eventual outperformance versus the general market. Gains in our industrials were 30.3%, international bonds gained 14.7%, and consumer-staples and food equities returned 3.3%. These are all simple returns (not annualized), since several holdings in the precious-metals and industrial sector were sold during the year.
The bad news is, that it will not be expected that this absolute performance can be extended into the new year. The general stock market and the commodities sector did both far better than what we consider sustainable rates, and that leaves us with the dilemma that even less value can be found in these markets than at the beginning of the past year. Moreover, markets that have underperformed, such as real estate and bonds, are still high by long-term historical standards, and we will only slowly enter these markets as their valuations come down.
The precious-metals sector has truly been stellar in the last decade. Gold has now turned in 10 years of consecutive gains, and the gains were much larger than the inflation rate. With this we are committed to do what our asset allocation model prescribes. We will continue winding down our precious-metals positions as prices increase further. As this process of selling our positions continues, there will be a point sometime in the future where we will hit a minimum holdings percentage as insurance, so even in the event of a runaway inflation, there will be some (albeit small) protection provided by precious metals against total real erosion of capital. In addition, we will strive to allocate the freed-up capital to other real assets. These are for example real estate (globally) and consumer staples (also globally) which have both underperformed lately. Both will not provide as great of a real outperformance of inflation as the commodity sector, but they are expected to provide better safety through yield income, and they will still provide a protection against total loss of purchasing power in an inflationary event. Should precious metals fall sharply in the year ahead, we will accordingly increase our position again if relative value assessments call for it.
Sharp falls in various assets could happen if we enter another period of deflation. While this path is less likely than inflation, it is possible due to a continuing large credit contraction. Only two asset classes come to mind for true good performance in a deflation: long-term bonds on the one hand, and put options on various markets on the other hand.
Long-term bonds need to be issued by entities that in a severe deflation also have the means to pay, which are generally only the governments and central banks. So we will most likely only consider sovereign bonds. Countries of consideration could be the ones where temporary crisis put the repayment or stability of currency in question, while strong forces among the population towards economic revival or debt repayment will ultimately make the bonds profitable.
Put options have not been bought by us due the limitations of many of the underlying investment accounts. Yet, Premiums are historically low and the markets overbought at the beginning of 2010. If these trends continue during the beginning of the year, put options on SPY, QQQQ, and SLV could be considered as worthwhile hedges.