People sometime have a problem sitting on cash. They might feel like they are not working if they are not deploying cash and that cash if not deployed is not really working for them. An investor would usually keep a portion of his portfolio in cash just in case he/she is confronted with a fat pitch. But how much cash should one keep in the portfolio? The answer is..it depends! Here, I will address the time when the investor is usually feeling pessimistic about the markets prospects or when the markets seem high. There are usually two positions people take when confronted with this:
(1) Increase their Cash holdings(2) Speculate with Gold.
Let me get the gold issue out of the way first and let me tell you why I said speculate. Benjamin Graham said, "An investor calculates what a stock is worth based on the value of its business. A speculator gambles that a stock will go up in price because somebody else will pay more for it". Do you know what the intrinsic value of gold is? I sure don't! A lot of value investors including Jean-Marie Eveillard of the First Eagle funds have large positions in gold. Now on the other hand Warren Buffett has talked about gold as having no use, no utility. According to him we dig a hole to take it out, and then dig another hole to store it! Gold in the markets trades as other commodities trade - supply and demand. Gold however, is different from other commodities as gold is seen as money; more specifically the ultimate form of money. The demand for gold is mostly psychological and comes from the perceptions of investors depending on their views on the macroeconomic conditions at that time and in the future. Since the gold standard was ended on August 15, 1971, the U.S. government has been free to print as much money as they choose, and recently they have been printing a lot of it (M3 supply has risen to 9,873 billion in 2005 from 288 billion in 1959). So when the world around you is getting bubbly, the argument goes buy gold, as it is the only sure thing.
Now cash. The problem here is that when there is uncertainty in the markets (as is the case now), government bonds yield too little, they don't even yield enough to dampen the dilutive effects of inflation! Here my answer to that, so what? Warren Buffett sat on his cash reserves for most of 2002-2007 (and many other periods), he did take stakes in some rail stocks and bought a few companies, but he sure did not go on a spending spree. Now, look at his Goldman Sachs and General Electric purchases, he is getting some of the best deals of his life! I think the underperformance of his cash holdings would be more than offset by the performance of his investments going forward. We must not look a year ahead and think that the yield is not high enough, we should think about the opportunities we can have if we have 103% of the money we started with as opposed to 50%! As Jessy Livermore said, "Big money is made in the waiting". Charlie Munger has talked about sitting on 10-20 million at a time in T-Bills just waiting. He further elaborated, "It takes character to sit there with all that cash and do nothing. I didn't get to where I am by going after mediocre opportunities".
Coming back to Benjamin Graham's point, the problem with gold is that it can be too psychological dependent! I don't know what the "real" value is! I don't know if I bought too soon, too late or when I should sell. I rather have my money in T-Bills, just sitting there so that when Mr. Market throws a fat pitch in a security I really understand, I have enough power to swing hard and let that fat pitch take care of the underperforming years.
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