Suggestions on Building a Serious Portfolio
by Robert B. Gordon, Sc. D.
June 14, 2004

EXPERT COMMENTS ON OUR ECONOMY

These are the concluding words in a long Gary North article which quoted British expert Andrew Smithers:

"I am convinced that Smithers is correct. The end of the compound rate of return in the American stock market, 2000-2004, is a herald of things to come -- if things go well. But he does not think things will go well. He thinks the stock market will decline. So will the bond market. He isn't even optimistic about gold. I am more optimistic about gold than I am about stocks and bonds. Gold is little more than a blip in the overall economy. A tiny increase in demand, worldwide, will push up its price. But the overall trend of the American capital markets is unfavorable, because saving and investment are slowing in America. There has also been enormous misallocation of capital because of decades of monetary manipulation, all over the world. This has led to a vast increase in debt. The problem that we are now facing, worldwide, is the fact that the free market will eventually find a way to reallocate this capital and also reallocate the ownership of debt and its underlying capital assets. How can this be done without suffering a cataclysm? No one knows. But Austrian economists know this much: the likelihood of an inflationary cataclysm is more likely in a world of central banking than a deflationary cataclysm. The alternative to this market-imposed re-allocation of capital and ownership and prices is a continuation of the present misallocation: the steady erosion of the value of money and the steady increase of debt. This process is sometimes called "pouring good money after bad." In the case of central bank policy, however, it's more like "pouring bad money after slightly less bad money" until there is no monetary value at all. It is a world in which, to quote John Schaub, "nothing down" becomes "nothing left." When the re-allocation comes, you had better be out of debt for anything that can easily be repossessed. If you can't afford to lose it, own it debt-free. But remember this: you can afford to lose most things if you can repurchase similar things with cash in the secondary markets. Also, if you can make your monthly payments, a lender will not repossess your home. There will be too many repossessed homes on his books. Just meet your payments. This means that you had better keep your job. Conclusion: keep improving the skills that enable you to keep your job. Then start accumulating cash. Buy some re- possessed homes. Creditors will be anxious to sell them. As to beating the market, I recommend Smithers' opening words: Unlike most articles about investment, which tell people how to make money, this one will try to persuade you not to lose it."

BUILDING YOUR FIRST MULTI-ASSET PORTFOLIO

Of course it's always wise to build every portfolio from your first to your last with care. Early in your investing lifetime, it's good to be a little timid, but not too timid. It is important to learn quite broadly about investing opportunities and to make all your big learning mistakes early with small amounts of money rather than later with larger amounts. Ideally, a novice investor should learn about common stocks (equities) and interest-bearing bonds, both taxable and non-taxable (municipals). This experience should come first from reading followed by experiments in modest amounts with a number of classes of equities and several maturities in bonds. You need to learn about the wide spread in quality and safety with both stocks and bonds. There is a time early in a bull market to own lower quality stocks and, when interest rates are falling, to own lower grade bonds of all types. However, and I cannot stress this point too heavily, in the fifth year of a major bear market in stocks and a time of very low interest rates in bonds, it is very dangerous for any inexperienced investor to be exploring unknown areas to gain experience. This is a time to follow the advice of those who have made mistakes much earlier and learned from them. And if guidance is not available from an experienced living investor, neophyte investors should go to a large library and read the exciting books about previous market crashes from London in 1720 to Tokyo in 1989. From all these amazing stories, we learn the same truth, namely, that every one of these manias was followed by a major economic depression. Japan�s is now in its 14th year and they have not found a way to get out of their depression. Their struggling government will not be helped by the fact that the rest of the major nations are about to join in their economic misery.

So what do we learn and must learn to survive the coming depression? It is to protect your principal above all else, because it may take a very long time to earn it back. Now, let's remind our readers of one more important fact from all previous stock manias in recorded history from 1722 in London. When I read this fact ten years ago, it made a big impression on me and I hope it does on you, my readers. Here it is, and it is true as I have personally checked the records. All major completed stock manias in world history have bottomed with their stock price below where they started. The 1920s bull market started with the Dow at 100, rose to a 1929 top at above 390 and ended at a bottom of 41. The current bull market mania started in the mid 70�s with the Dow at about 500 and will close many years from now, if history is replayed, at below Dow 500. Did you ever hear this prediction from the Bulls on Wall Street? You can be sure that if the Dow eventually goes below 500, it will be many years away under very gloomy market conditions. I hope that my readers will be able to recognize that bottom as a wonderful buying opportunity. That future stock market bottom will be unrecognized by most experts and there will be very few buyers. It will represent a great opportunity for a few wise investors.

PLEASE CHOOSE SAFETY FOR YOUR ASSETS

It may not be in a bank CD. It may not be in a Treasury bill or note. It may not be in a conventionally diversified mutual fund portfolio. It may not be in a portfolio of typical municipal bonds. It might be in a well secured hoard of gold and silver, if it can be safeguarded until you need it. However, it might be a little hard to buy food with precious metals.

We are living in difficult times, even though probably no more than 1% of our population realize it. What follows in this essay is a discussion on safety in investing from the standpoint of wise selection and diversification of major asset classes. I will leave it to others to cover safety from suitcase bombs and other possible perils. I am making an assumption that there are duplicate safeguarded records of our mutual fund ownership that will survive most hazards. I would appreciate hearing from any reader who has factual information on this subject.

A MINIMUM STARTING PORTFOLIO

In a tax-free account, most of the funds we favor have a minimum purchase of $1000, but the two Hussman funds for Growth and Income can be purchased for only $500 each. So a young investor could follow the two very different Hussman funds with just $1000. An even better starting portfolio at this particular time would be to pair the Hussman Growth fund HSGFX with BEARX, the Prudent Bear fully managed short fund.

Although starting with two quite different asset classes would be one good way to start, an even better way would be to start with 4 funds, one each from our 4 main asset classes:

Stable: Hussman Growth Fund
Stable Long Term: Permanent Portfolio Fund
Volatile: ASA gold stock NYSE
Short: Prudent Bear Fund

This 4 asset portfolio, with equal percentages of four funds, will be very good for studying the quite different fund performances, but would not be recommended for a larger portfolio. We would suggest a balanced portfolio as shown below:

40% Hussman Growth Fund
30% Permanent Portfolio Fund
15% ASA gold stock NYSE
15% Prudent Bear Fund

This portfolio could be started in a tax free account for $6,667. It is moderately conservative with 55% stable and 45% volatile assets, splitting the 30% long-term stable equally between stable and volatile. It would be the smallest portfolio that would provide a well-balanced education for an inexperienced investor. This portfolio, for optimum performance, should be rebalanced at the peak values of the two volatile components, probably about every two years.

A SMALL DIVERSIFIED PORTFOLIO

My preferred starting portfolio has 8 asset classes and can be assembled for just $6,500 in a tax-free account. The 3 stocks can easily be bought at any broker in the low quantities.

SMALL DIVERSIFIED PORTFOLIO Performance from 11/21/2001 to 06/09/2004
Allocation	$ Amount	Fund	Weighted %
Stable Assets
Hussman Strategic Growth	$1000	15.6%	2.4%
Hussman Total Return*	$1000	6.4%**	0.9%
Prudent Global Income*	$1000	14.6%	2.2%
Total Stable	$3000		5.5%
Long-Term Stable Assets
Permanent Portfolio*	$1000	11.4%	1.8%
WTR Water (NYSE)	$500	12.8%	1.0%
PCL Timber (NYSE)	$500	11.5%	0.9%
Total Long-Term Stable	$2000		3.7%
Volatile Assets
ASA Gold Stock (NYSE)	$500	23.8%	1.8%
Total Volatile	$500		1.8%
Short Funds
Prudent Bear Short Fund*	$1000	15.9%	2.4%
Total Short Funds	$1000		2.4%
Portfolio Grand Total	$6500	14.2%	13.4%
* holds gold ** from 9/18/2002

We used dollars instead of percentages above because that is what you use to buy the portfolio. This is a conservative portfolio with 62% of stable assets using our usual rule that half of the long-term stable is added to the stable amount. The gold is 7.7% and the short fund is 15.4%, both on the conservative side, but high enough to provide a good experience. This portfolio has 31% of long-term stable components, each of which will probably have periods when they will have moderate temporary price declines. These declines will increase future profits, if the portfolio is rebalanced at each price dip. Rebalancing will add appreciably to the long-term returns of this portfolio. This highly diversified portfolio could be purchased at reasonable cost from brokers such as Scottrade or Brownco. If desired, it could be purchased over time in this order: Stable, Long Term Stable, Volatile and Short. But remember that it will not be an effective, working portfolio until it is complete as shown above.

TIME TO BUY GOLD AND SILVER?

According to recent Elliott Wave reports, both gold and silver are descending in price from their recent highs and they are anticipating much lower price over the next year or two. The mining shares have also declined considerably in price. Many gold bugs are in denial over the gold and silver price declines, which are making very standard Elliott waves in their declines. I have received several e-mails using strong words to object to my sale of gold positions with the expectation of rebuying at lower prices. They seem to feel that selling precious metals at any price is a grave mistake.

I think it is a mistake to consider precious metals as being in a special category. Some of these "gold bugs" seem to have developed a sort of "religious" affection for their hoards. Well, they can do do this if they wish, but I will continue to buy and sell gold and silver as I would any other metals. Of course they may play a special monetary role someday, but their prices still obey the laws of supply and demand. If anyone wants to worship their gold and silver, I am happy to let them do it.

I have no objection to any reader buying a small quantity of precious metals or mining stocks right now. I especially like at this time a plan of dollar cost averaging accumulation of gold and silver during the time they are falling in price and continuing back to their old levels. This could be the very best time to purchase a large quantity of gold, silver and their stocks. Both metals are in well defined declining Elliott Waves having much further to go to their normal completion.

THE CURRENT PICTURE IN STOCKS

Although the major stock indices made their tops quite a few weeks ago, they are proving very reluctant to complete an Elliott Wave 2 up. This has presented a wonderful opportunity to sell risky stocks before an expected major wave 3 decline. I do not know whether this is the result of a "plunge protection" team at work or of millions of ignorant buyers. Clearly most investors and advisors are still bullish and Wall Street will be advising buying all the way down for that is their major livelihood.

If you have friends or relatives who are still bullish and in denial of the true facts about the market or economy, please make one more attempt to help them as once their money is gone, there will be no way to bring it back. Interest rates are rising and may take a big jump soon. This will not be good for the economy. Bond prices, except for very short-term bonds, will be dropping and should be sold. I do not like municipal bonds of the states, because I expect them to go broke and be unable to pay the bond interest.

INFORMATION SOURCES

Excellent sources on the econmy, markets, governments, world affairs can be found at: financialsense.com, freebuck.com, fiendbear.com, safehaven.com, prudentbear.com

Information on stocks and funds financial data and charts can be found at:
morningstar.com, bloomberg.com, yahooo.com, bigcharts.com

For an interesting five year real time trading history, view the Cornerstone Model Portfolio on www.cornerstoneri.com displayed in colors for each portfolio asset class. I would be interested in learning whether any reader knows of any other portfolio record available to the general public.

THERE ARE NO GUARANTEES

Although we have our own money in portfolios like that described above, we cannot assume and do not assume responsibility for any other investor's portfolio. Uncertainty in the stock markets and in managing individual portfolios are far too great for me to accept responsibility for any other portfolio. We wish our readers the best of success in managing their portfolio. We will be happy to answer questions to the best of our ability.

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© 2004 Robert B. Gordon, Sc. D.

Contact Information

Dr. Robert B. Gordon
c/o Roger Gordon
1488 Cynthia Lane
El Cajon, CA 92019