Very timely post Radagast! I have been looking into all this for a little while now and conversing with Tyler about how to best use his charts as well. So, many thanks for laying this all out there to consider.
And a very public thank you to Tyler who keeps pushing the envelope on visualization... on his own time. your work is very helpful and is a great teacher.
Much as it would be nice to know what price the market would have assigned to gold throughout this period, I can't see that the actual prices assigned by the Nixon administration are a good indicator of this, nor the first few months after the market was allowed to determine the price.
Now that you have figured out what price the market assigned to gold (within a few months of the market being allowed to do so), would it be too artificial of a proxy to use that price for 'all time leading up to 1973'? Just an idea. That would smooth things out quite a bit, but would nonetheless be pretty 'artificial' / unreliable.
1. The asset class correlations change over time so you and I can't spend too much time tweaking the percentages. (I'm going to blog about this next week, but Bernstein notes in "Rational Expectations" that after you add riskless assets to your portfolio, throwing in additional uncorrelated asset classes gets pretty inefficient in terms of predictably dampening volatility...)
Correlations do change and that's why it pays to have more than two assets. But you're correct that there's also a practical limit to diversification. IMHO, it's not about buying as many different index funds as possible but about wisely spreading your money among a few different major categories.
Excerpts: The Volatility of Correlation: Important Implications for the Asset Allocation Decision by William J. Coaker II,* The average variance in correlation measured 0.98 over one year and 0.25 over ten years. In short, the relationship among many of the asset classes appears to be inherently unstable.
* Correlations exhibit uniqueness, meaning periods are distinct from previous time periods. For example, international stocks' correlation to the S&P 500 was 0.48 from 1970 to 1997, but 0.83 from 1998 to 2002.
* Rather than rely on historical correlations, a more comprehensive and dynamic approach is needed in making asset allocation decisions.
WTF kind of cliff hanger is that?
...Heres his next paper:Emphasizing Low-Correlated Assets: The Volatility of Correlation by William J. Coaker II
The fact that correlations change is well known. But the severity of change, and which relationships are subject to change, needs to be better understood because it has important implications for containing risk.
This study evaluates the volatility of correlation among 18 asset classes to each other to determine the consistency or inconsistency of relationships.
In the asset allocation process, some assets often are used together even though diversification benefits have been very low. (high correlation = low diversification benefits) For example, the correlations of the S&P 500 to large growth, mid-blend to mid-growth, small blend to small growth, and large value to mid-value, have been very strong.
Several assets often are neglected in the asset allocation decision, even
though their diversification benefits have been very high. Natural resources, global bonds, and long-short, for example, stand out as having consistently low correlations to all the other assets in this study.
Growth and blend styles are highly correlated, and using them together does little to reduce risk.
Real estate, high-yield bonds, U.S. bonds, and long-short are more closely linked to value investing than growth. Emerging markets are somewhat more connected to growth than value.
The asset allocation decision should emphasize low-correlated assets that satisfy return objectives. Two sample portfolios for different style investors show how risk and return are improved by combining lower-correlated assets
https://forum.mrmoneymustache.com/investor-alley/what-am-i-to-make-of-this/msg1331388/#msg1331388
