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The Lombra Report 2010 Update

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The 2010 Lombra Report shows the return of bullion and rare coins vs. other asset classes over the past 30 years.

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The Investment Performance of Rare U.S. Coins By: Raymond E. Lombra, Ph.D. An independent study of the investment performance of rare U.S. coins for the period January 1979 to December 2010. Analysis by R L Associates, Penn State University, February 2011. Raymond E. Lombra, Ph.D., Professor of Economics and Senior Advisor to the Dean at Penn State University, has authored numerous economic and financial books, publications and periodicals. Professor Lombra has been a consultant to the House Banking Committee of the U.S. Congress, the Federal Reserve System, the Congressional Budget Office, the Joint Economic Committee, Morgan-Stanley, the International Monetary Fund and the U.S. Treasury. His many honors and awards include election to Whos Who in Economics.
Overview This study updates and extends several of my earlier studies, the first of which was prepared for the Joint Committee on Taxation of the U.S. House and Senate. It focuses on the longer run performance of gold and rare coins, both relative to each other and to the more typical array of assets comprising most portfolios stocks, bonds, and money market instruments, specifically, Treasury bills. 2
Risk and Return on Broad Asset Classes In collecting, arraying and analyzing the data, I assume that the typical investor has at least a one-year holding period or investment horizon; this assumption is reasonable in a study that takes as given that frequent trading by typical investors, particularly within their retirement accounts, will yield inferior returns, especially when transaction costs are factored in. Table1 shows the average annual rate of return on stocks, bonds, gold and rare coins over the last 32 years (1979-2010 inclusive). While any particular sample period is somewhat arbitrary, I wanted a period long enough to cover several economic cycles. As can be seen, high-quality coins and stocks had the highest returns over the past three decades, despite the strong performance of gold over the past nine years. 3
Table 1 Evaluating the Performance of Individual Asset Classes Over Time Average Annual % Returns 1979-2010 Stocks 12.6% Treasury Bonds 8.8% Gold Bullion 6.7% Coins (all types MS65) 12.9% Coins (all types MS63-65) 10.8% 4 Source: R L Associates, Penn State University
Volatility Next, I extend the analysis of performance to include the historical fluctuation or volatility of the annual returns, typically measured by the standard deviation of the returns. I also provide a simple count of the number of years each asset type registered positive and negative returns; this calculation provides a sense of the challenges facing those who might think that timing the ups and downs in the returns on various assets is a viable investment strategy. The data in Table 2 show that the returns on stocks, gold and coins were the most volatile, while, not surprisingly, those on Treasury bills were the least volatile. 5
Table 2 Investment Returns, Risk and Timing A Long Term View: 32 Years, 1979 - 2010 Average Years Years Best Year % Worst Year Standard Annual % Up Down Return %Return Deviation Return Gold 6.7 19 13 100.2 -26.4 16.0 Stocks 12.6 26 6 36.8 -37.3 13.1 3 Month T-bill 5.5 32 0 14.3 0.8 2.5 Treasury Bond 8.8 27 5 34.8 -9.3 8.2 Coins (all types MS65) 12.9 19 13 198.8 -40.6 22.7 Coins (gold type- MS63-65) 10.8 21 11 198.8 -42.7 21.8 6 Source: R L Associates, Penn State University
Market Timing In roughly five out of six years over the last 32, the returns on stocks were positive; however, the -37.3% for 2008 (Russell 3000) was the worst over the period. In contrast, annual gold and rare coin returns were positive in each of the last eight years, but were positive in only 60 % of the 32 years covered. These data are again suggestive of both the difficulties of implementing a successful market timing strategy and of the benefits of investing in a diversified portfolio over the longer run. The data in Table 3 provide additional perspective on market timing. The best years for coins and gold were indeed very good, especially for coins, with average annual returns in excess of 100% for the best three years. In contrast, the worst three years for stocks, gold and coins were significantly negative, while in the remaining 26 years returns were, on average, respectable. 7
Table 3 Market Timing 1979 2010, Average Rate of Return Stocks Treasury Coins Coins Gold Bonds MS65 MS63-65 Bullion Best 3 Years 33.2 29.5 107.4 101.3 53.0 Worst 3 Years -13.5 -6.2 -27.9 -34.7 -23.9 Other 26 Years 14.4 8.5 6.7 5.6 4.8 Total 32 Years 12.6 8.8 12.9 10.8 6.7 8 Source: R L Associates, Penn State University
Too Risky? Taken together, these data suggest that yearly returns vary quite a lot over time. Is this sufficient to conclude that asset classes with large standard deviations and a non-trivial number of low or negative return years are too risky to be included in a typical investors portfolio? The simple answer, of course, is no. The data presented so far show the performance of each asset in isolation from other assets and from the economic environment, particularly the rate of inflation. 9
The Economic Environment Table 4 shows the correlation of asset returns with inflation over the disinflation period 1979-2010. The contention that gold is a better hedge against inflation than, say, rare coins, is not supported by the data. The same result holds if we calculate the correlations between gold and a measure of GDP volatility and between rare coins and such a measure. Looking ahead, with the amount of monetary and fiscal stimulus still flowing into the world economy, we know that at some point talk of deflation will give way to the reality of inflation. Given the considerable uncertainly about timing and duration, the longer term relationships embedded in Table 4 are relevant for those with longer term investment horizons. 10
Table 4 Correlation with Inflation 1979-2010 A Long Term View Stocks .19 Treasury Bonds -.20 Gold .23 Coins .59 NOTE: +1.00 is a perfect correlation, meaning moves exactly in tandem. -1.00 is a perfect negative correlation, meaning moves exactly opposite. To hedge against inflation, highest positive correlation best. 11 Source: R L Associates, Penn State University
Rare Coins: Can they help hedge against stock market fluctuations? The beta coefficient can tell us how the return on a particular asset is correlated with the return on stocks overall; but beta is not simply correlation, it also tells us about direction and magnitude. If, for example, when the stock market is up 5% a particular asset is always up 10%, the correlation is 1.0 but the beta is 2.0. Over the turbulent 1987-2010 period, covering the 1987 and 1989 crashes, the dot-com collapse, 9/11 and the subsequent recession, and the 2008 financial crisis, the beta for rare coins is 0.06. The lower the beta, the more effective the particular asset will be in improving a portfolios overall performance, that is, reducing volatility without sacrificing return. Given the low beta it should not be surprising that hypothetical portfolios containing stocks, Treasury bonds, Treasury bills and proportions of gold and rare coins that vary between 0 and 10% show that, in general, average returns over the challenging 1987-2010 period are improved and portfolio volatility is reduced by augmenting standard stock, bond and bill portfolios with about 5% rare coins. 12
Summary of Findings 1.Over the last 32 years, high quality coins and stocks had the highest average annual returns. 2.At the same time, the annual returns on stocks, gold, and coins were the most volatile. 3.Taken together, these findings suggest that those holding stocks and coins were rewarded for bearing the extra risk thought to be associated with larger fluctuations in annual returns. 4.The correlation of the return on coins with inflation over the last 32 years is well above that of other assets considered, and twice that of gold; thus, the contention that gold is a better hedge against inflation than, say, rare coins, is not supported by the data. More generally, hypothetical portfolios containing stocks, Treasury bills and bonds, and a modest proportion of rare coins, generally perform somewhat better than those without coins or with a modest proportion of gold over the past two decades. 5.The results continue to suggest that including rare U.S. coins within an existing portfolio could improve investment performance. 13

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The Lombra Report 2010 Update

  • 1. The Investment Performance of Rare U.S. Coins By: Raymond E. Lombra, Ph.D. An independent study of the investment performance of rare U.S. coins for the period January 1979 to December 2010. Analysis by R L Associates, Penn State University, February 2011. Raymond E. Lombra, Ph.D., Professor of Economics and Senior Advisor to the Dean at Penn State University, has authored numerous economic and financial books, publications and periodicals. Professor Lombra has been a consultant to the House Banking Committee of the U.S. Congress, the Federal Reserve System, the Congressional Budget Office, the Joint Economic Committee, Morgan-Stanley, the International Monetary Fund and the U.S. Treasury. His many honors and awards include election to Whos Who in Economics.
  • 2. Overview This study updates and extends several of my earlier studies, the first of which was prepared for the Joint Committee on Taxation of the U.S. House and Senate. It focuses on the longer run performance of gold and rare coins, both relative to each other and to the more typical array of assets comprising most portfolios stocks, bonds, and money market instruments, specifically, Treasury bills. 2
  • 3. Risk and Return on Broad Asset Classes In collecting, arraying and analyzing the data, I assume that the typical investor has at least a one-year holding period or investment horizon; this assumption is reasonable in a study that takes as given that frequent trading by typical investors, particularly within their retirement accounts, will yield inferior returns, especially when transaction costs are factored in. Table1 shows the average annual rate of return on stocks, bonds, gold and rare coins over the last 32 years (1979-2010 inclusive). While any particular sample period is somewhat arbitrary, I wanted a period long enough to cover several economic cycles. As can be seen, high-quality coins and stocks had the highest returns over the past three decades, despite the strong performance of gold over the past nine years. 3
  • 4. Table 1 Evaluating the Performance of Individual Asset Classes Over Time Average Annual % Returns 1979-2010 Stocks 12.6% Treasury Bonds 8.8% Gold Bullion 6.7% Coins (all types MS65) 12.9% Coins (all types MS63-65) 10.8% 4 Source: R L Associates, Penn State University
  • 5. Volatility Next, I extend the analysis of performance to include the historical fluctuation or volatility of the annual returns, typically measured by the standard deviation of the returns. I also provide a simple count of the number of years each asset type registered positive and negative returns; this calculation provides a sense of the challenges facing those who might think that timing the ups and downs in the returns on various assets is a viable investment strategy. The data in Table 2 show that the returns on stocks, gold and coins were the most volatile, while, not surprisingly, those on Treasury bills were the least volatile. 5
  • 6. Table 2 Investment Returns, Risk and Timing A Long Term View: 32 Years, 1979 - 2010 Average Years Years Best Year % Worst Year Standard Annual % Up Down Return %Return Deviation Return Gold 6.7 19 13 100.2 -26.4 16.0 Stocks 12.6 26 6 36.8 -37.3 13.1 3 Month T-bill 5.5 32 0 14.3 0.8 2.5 Treasury Bond 8.8 27 5 34.8 -9.3 8.2 Coins (all types MS65) 12.9 19 13 198.8 -40.6 22.7 Coins (gold type- MS63-65) 10.8 21 11 198.8 -42.7 21.8 6 Source: R L Associates, Penn State University
  • 7. Market Timing In roughly five out of six years over the last 32, the returns on stocks were positive; however, the -37.3% for 2008 (Russell 3000) was the worst over the period. In contrast, annual gold and rare coin returns were positive in each of the last eight years, but were positive in only 60 % of the 32 years covered. These data are again suggestive of both the difficulties of implementing a successful market timing strategy and of the benefits of investing in a diversified portfolio over the longer run. The data in Table 3 provide additional perspective on market timing. The best years for coins and gold were indeed very good, especially for coins, with average annual returns in excess of 100% for the best three years. In contrast, the worst three years for stocks, gold and coins were significantly negative, while in the remaining 26 years returns were, on average, respectable. 7
  • 8. Table 3 Market Timing 1979 2010, Average Rate of Return Stocks Treasury Coins Coins Gold Bonds MS65 MS63-65 Bullion Best 3 Years 33.2 29.5 107.4 101.3 53.0 Worst 3 Years -13.5 -6.2 -27.9 -34.7 -23.9 Other 26 Years 14.4 8.5 6.7 5.6 4.8 Total 32 Years 12.6 8.8 12.9 10.8 6.7 8 Source: R L Associates, Penn State University
  • 9. Too Risky? Taken together, these data suggest that yearly returns vary quite a lot over time. Is this sufficient to conclude that asset classes with large standard deviations and a non-trivial number of low or negative return years are too risky to be included in a typical investors portfolio? The simple answer, of course, is no. The data presented so far show the performance of each asset in isolation from other assets and from the economic environment, particularly the rate of inflation. 9
  • 10. The Economic Environment Table 4 shows the correlation of asset returns with inflation over the disinflation period 1979-2010. The contention that gold is a better hedge against inflation than, say, rare coins, is not supported by the data. The same result holds if we calculate the correlations between gold and a measure of GDP volatility and between rare coins and such a measure. Looking ahead, with the amount of monetary and fiscal stimulus still flowing into the world economy, we know that at some point talk of deflation will give way to the reality of inflation. Given the considerable uncertainly about timing and duration, the longer term relationships embedded in Table 4 are relevant for those with longer term investment horizons. 10
  • 11. Table 4 Correlation with Inflation 1979-2010 A Long Term View Stocks .19 Treasury Bonds -.20 Gold .23 Coins .59 NOTE: +1.00 is a perfect correlation, meaning moves exactly in tandem. -1.00 is a perfect negative correlation, meaning moves exactly opposite. To hedge against inflation, highest positive correlation best. 11 Source: R L Associates, Penn State University
  • 12. Rare Coins: Can they help hedge against stock market fluctuations? The beta coefficient can tell us how the return on a particular asset is correlated with the return on stocks overall; but beta is not simply correlation, it also tells us about direction and magnitude. If, for example, when the stock market is up 5% a particular asset is always up 10%, the correlation is 1.0 but the beta is 2.0. Over the turbulent 1987-2010 period, covering the 1987 and 1989 crashes, the dot-com collapse, 9/11 and the subsequent recession, and the 2008 financial crisis, the beta for rare coins is 0.06. The lower the beta, the more effective the particular asset will be in improving a portfolios overall performance, that is, reducing volatility without sacrificing return. Given the low beta it should not be surprising that hypothetical portfolios containing stocks, Treasury bonds, Treasury bills and proportions of gold and rare coins that vary between 0 and 10% show that, in general, average returns over the challenging 1987-2010 period are improved and portfolio volatility is reduced by augmenting standard stock, bond and bill portfolios with about 5% rare coins. 12
  • 13. Summary of Findings 1.Over the last 32 years, high quality coins and stocks had the highest average annual returns. 2.At the same time, the annual returns on stocks, gold, and coins were the most volatile. 3.Taken together, these findings suggest that those holding stocks and coins were rewarded for bearing the extra risk thought to be associated with larger fluctuations in annual returns. 4.The correlation of the return on coins with inflation over the last 32 years is well above that of other assets considered, and twice that of gold; thus, the contention that gold is a better hedge against inflation than, say, rare coins, is not supported by the data. More generally, hypothetical portfolios containing stocks, Treasury bills and bonds, and a modest proportion of rare coins, generally perform somewhat better than those without coins or with a modest proportion of gold over the past two decades. 5.The results continue to suggest that including rare U.S. coins within an existing portfolio could improve investment performance. 13