Pinnacle has various defenses built into to how we manage our portfolios. We live by the two unbreakable rules of keeping diversified and avoiding overvalued assets. In addition, we also look to keep various hedges in our portfolio to defend against adverse conditions that have the potential to rattle financial markets. Over the last few quarters we’ve owned treasury bonds to hedge against deflation taking hold, gold to defend against money printing and currency debasement, and the dollar to hedge against continuing risks seeping out of Europe. Today we’ll be buying a few points in oil to defend against the possibility that geo-politics creates a price spike in oil.
In addition to the geo-political hedge, oil has some positive technical aspects (see Sean Dillon’s post from yesterday), and it adds to our real asset positions at a time when central bank prime pumping could ignite another round of commodity inflation. Like most of the hedges we have employed, this one is not without risk. Oil is highly volatile and there is arguably a geo-political premium baked into the price now. If tensions with Iran cool off, that could produce a quick flight out of oil. Oil is also economically sensitive, and if the economic data takes a turn for the worse, it would be vulnerable to a sharp correction. Lastly the correlations are tough to deal with, as we will label this an equity alternative due to the inherent volatility of the asset, but we may or may not get equity-like returns depending on how correlated oil remains with equity.
Despite the risks inherent in oil, we think the hedging benefits combined with high liquidity and supportive technicals outweigh the risks. Therefore we will initiate a couple of points of oil insurance into our portfolios at this time.