The McAlvany Weekly Commentary
with David McAlvany and Kevin Orrick
“What is actually happening? What are the driving forces in our economy today? Rather than be discouraged by price action, think what has changed that fundamentally alters the place of gold and gold-related assets in a portfolio. If you answer is that we have recovered from the Great Recession, frankly, you may be reading the wrong people, or simply be a bit of a Pollyanna.”
– David McAlvany
Kevin: Yesterday the U.S. mint came out with their figures, year-on-year, as far as the increase in bullion demand – the bullion American Eagle. Dave, they have sold 469% more American Eagles than last year at this time. So what the heck is happening to the paper price on gold?
David: Well that’s right. It is interesting you have a major increase this July compared to last July, and if you are looking at all of the months so far in 2015, it is still a pretty significant jump – 38% for the entire year. And of course, you have a standout – 202,000 ounces of gold compared to 35,000 ounces last year. It is significant. It is very significant, for this particular reason. In the paper world there is a lot more trading than there used to be. And lo and behold, a lot of that paper trading is negative. In the paper world, what I am talking about is futures contracts.
David: Where you have paper IOU that is associated with a certain number of ounces. Now, you roll the clock back. Let’s go back five or six years, and it was a 50-to-1 ratio, where you have 50 times the amount of paper IOUs for actual gold that could be delivered. So, 50 ounces traded and one ounce actually there if people wanted it. And then, about two years ago that jumped to about 100-to-1, and in the most recent reports we are seeing about 124-to-1.
Kevin: So, for one ounce, for every real physical ounce that a person would own, there is 124 ounces traded on paper that really don’t exist.
David: And what it suggests is that reality is not what you think it is. Price in the metals market has never been less relevant. And what I mean by that is simply, there are dynamics relating to the physical market which are less obvious to most market participants. For us it is pretty obvious because we see the discrepancies and the disparities between what is being moved on a physical basis, that is, metals actually being bought and taken delivery of versus the metals which are just, again, paper IOUs being swapped like so many IOU receipts. This is essentially what we highlighted a few weeks ago relating to the selloff late on a Sunday night – 2.7 billion dollars’ worth of gold. It wasn’t physical gold sold, and in point of fact, the last couple of months, gold delivered off of the Shanghai gold exchange, that is, people taking delivery of kilo bars, has been upwards of 200 tons.
So, you contrast a 57-ton dumping of gold in a two-minute period, but it is actually not physical, it is paper, contrast that with several hundred tons which is actually being delivered off the exchange, people want delivery of it, and you end up with a very different picture. The picture is this: The price is declining because the volumes in the paper world, the volumes are bigger. But the supply of physical is actually getting thinner and thinner and thinner. We spoke with one of the NYMEX COMEX depositories last week, and they made it clear that the Silver Eagle shortage would go away quickly. That is just a matter of getting caught up on production. But that silver rounds, junk silver, these other things were certainly more of an indicator of increase in demand and not too much supply.
Kevin: How about kilo bars?
David: That’s right.
Kevin: Even kilo bars there has been a delay. The average guy on the street doesn’t buy a kilo bar, but someone who has some degree of wealth, but also wants redeemability, they want kilo bars, and right now there has been a scarcity of those.
David: As of last week it is upwards of one to two weeks delayed delivery. Again, what that suggests is adequate demand and not a whole lot of supply. So, what we see, as we talked about last week, I just want to reiterate the COT report, Commitment of Traders report, silver and gold, to sum it up, are set up for a rally. You have the commercials versus the managed money crowd and speculators, and I realized after listening to last week’s Commentary that the word hedge was being bandied back and forth with two separate meanings. So I just want to reiterate what the COT reports mean, what the importance is, and maybe get rid of the equivocation of that particular term.
Kevin: Well, could you just initially define again who the commercials are – the mines, the companies that actually deal in gold, that would be the commercials. These are people who are actually mining gold or actually own some.
David: So, if it is easier to think of them as the producer, it is like Chiquita being the producer of bananas. They have the fields, they have the product, they deliver gold to the market, it just happens to go from green to gold in a certain period of time. They are the producers, they are the commercial banana interest – Chiquita banana. Then you have the speculators. Well, I guess that speaks for themselves. These are the little guys who are saying, “Gold’s up, gold’s down, silver’s up, silver’s down. I want a 5-to-1 leveraged position on that move and I think this is the direction it’s going to go. Very short-term in terms of their mindset and very low capitalization in terms of, very small PNLs, if you will – these are interests that can’t really put on huge bets.
Then you have your managed money crowd. The managed money crowd is going to be more of your Wall Street trade desk, maybe even a speculative trade desk where they have the ability to throw around a couple hundred million dollars, even a few billion dollars, into a particular trade. And again, that is where we see both speculators and managed money following the same trend. The belief is simple. Gold has gone down, and it will continue to go down, ad infinitum. That is the direction of the trend, we’re playing momentum, and we believe the price will go down and we can profit from that downside momentum.
Kevin: Yeah, but producers are buying gold contracts going long.
David: Well, that’s right, and it’s the producer that generally wants to protect and survive to live another day. These are firms that collectively represent hundreds of billions of dollars of assets of in-ground resources, but also of lands, plants, infrastructure, what have you. And you don’t want to push the commercial interests, the producers, too far, or you will push them out of business. So at a certain point there is a line in the sand where the commercials tend to make a point and make the market move a certain direction. I think the commercials are actually far more powerful interests collectively than what you have in either the managed money crowd or the speculators combined.
Kevin: So what is the take-away for the person who owns gold right now?
David: Silver and gold are going higher. There is a rally imminent. Why do we think that? You look at the COT report, the Commitment of Traders report, and it shows that the commercials are not concerned about the price of gold moving lower. They would have covered that risk. They would have covered that risk substantially. But they only cover that risk when prices are incredibly high and they anticipate a move lower. In this case they are anticipating a move higher, and I would bet with the commercials any day.
Kevin: We seem to be living in a world of perception management, not reality, and the Federal Reserve is the king right now, or with Yellen there the Queen of perception management. But, transparency is not their strong point because the Wall Street Journal, unfortunately for Pedro – the Wall Street Journal is not voting for Pedro at this point. The Wall Street Journal told him to pack his bags. It sounds like he asked one question too many of Janet Yellen.
David: That’s right. Pedro Da Costa is creating these awkward moments for the Wall Street Journal, and certainly even more awkward for the Janet Yellen. What he was getting at was the Senate subpoena. There was information leaked to the general public before the reports were actually supposed to be. So, there was essentially insider information that was traded upon, and the question is, who leaked the information prior to the official release? And Yellen has been subpoenaed and she is refusing to respond to it. Refusing to respond to it is interesting because last time I checked, subpoenas are something sort of non-optional. So the questions came from Pedro Da Costa, the Wall Street Journal writer, “Tell us about the nature of Fed transparency. Tell us about the nature of accountability.” Lo and behold, Pedro Da Costa finds that the Editor in Chief of the Wall Street Journal doesn’t like getting calls from the Fed, and rather than sort of putting a leash on the reporter, they have politely dropped him.
Kevin: Dave, this sounds more like Russia than it does the United States.
David: Well, in one sense I think Pravda would be proud. I guess we can probably gauge where we are at as a society by these kinds of exchanges. At least Pedro wasn’t found floating face down in the Hudson. So, on that basis, things really aren’t that bad, and I guess we do still have a free press.
Kevin: And I think it is important before we move on to talk about how powerful any information coming out of the Fed before the fact could be. The markets move on any word that is spoken and so if you had insider information, Dave, early, you could be an instant billionaire by the bets that you could place. And so, this is a very serious allegation.
David: It brings the issue of Fed independence into question. It certainly brings it into the light. How independent are they? Who do they work for? What advantages are given? Are they truly as transparent as they proclaim to be? And so, this issue of transparency of accountability does sort of move to the center limelight again.
Kevin: And speaking of moving markets with single phrases, I think of Bullard, who seems to say, “Yes, no, yes, no,” to interest rate rises, and the markets really pay attention now. Bullard has said that we are seeing enough of a recovery that we should be able to see an interest rate rise of a quarter of a percent this fall, but Caterpillar sales, which is one of the large indicators of economic direction here in America, they would say probably it is a little early for an interest rate rise, wouldn’t you say?
David: Yes, and it is sales all over the place. Looking at their global sales, you can look at it in different time slices. Mark Faber looks at their sales for the 19-month period in the “Great Recession” when everyone was suffering, including Caterpillar, and then they had a recovery in sales during the period of 2010-2013, and now they are stretching into 31 months up to the present where they have had a constant and steady decline in global sales, and this is supposed to be the Great Recovery. Latin American retail sales for the yellow iron metal producer dropped 50% year-on-year as of this last quarter.
And Faber notes that, moving beyond Caterpillar, the general retail sales environment in Brazil never went negative during the Great Recession of 2008-2009, but it has done so, and is now at levels back in the 2003 era, which is sort of in keeping with a 62% devaluation of the Brazilian real which we have seen from 2013 to the present. So, why is that important? It is because Brazil is a major commodity producer and a major commodity supplier to China. It is a world deeply interconnected. As goes China, so goes many others in the developing world and the real is certainly showing its weakness, the economy is showing its weakness, and lo and behold a U.S. multinational, Caterpillar, is showing that same weakness.
Kevin: Well, and it’s not just Caterpillar. Of course, as goes Walmart, as goes Dupont, as goes IBM, so goes the economic future of the United States.
David: Yes, Alan Newman pointed that out, sort of in a similar vein, a deterioration in the giants, multinational giants – Dupont, Walmart, IBM, Caterpillar, just to name a few. What he is suggesting is that the steep declines that we have seen in the share prices for these stocks suggests more than just an economic speed bump ahead. Slowing global economy? Oh yeah. Severe currency devaluations? Oh yeah. And a concern of contagion or transference? No, no, no, no. None, whatsoever. And that is kind of the comparison and contrast. We have great confidence that somehow we have – I don’t know what the prophylaxis is, but in an interconnected global world we benefit when everyone does well, but somehow we don’t stand in jeopardy when others begin to suffer.
Interesting, this week oil and copper reached new lows for the year, and again, we know what Dr. Copper represents, we know that oil represents sort of what all industry and individuals need. Clearly, it is not just a demand story, it is also a supply story, but those two things converging. Slack in demand, and oversupply, have made for an interesting oil equation. The same is true with copper. What does this mean, specifically, for stocks? Well, it means that there is probably more risk here in the month of August, with volumes the lowest of the year. And I think that is what everyone is missing, perhaps.
Kevin: Well, talk about missing. Alan Newman has brought this out, and you have been continually bringing out the fact that margin debt in 1929, 1987, 1999, 2007, every year right before we have a crash, margin debt rises over 2% of the GDP.
David: I talked to somebody every day, shared the number that we are now over 3% of GDP, which is largest in an 85-year history or longer, and it was like, well 3% is not that big of a number. Well, it’s 3% of 18 trillion dollars, and that is a big number. So, not only that, but this is what you describe as the hot money. Margin debt is money that has borrowed to buy stocks that you couldn’t afford otherwise, and the reason I describe it as the hottest of hot money, is that when that trade has to be unwound, it is unwound very, very quickly.
Kevin: Well, if you are talking about a quick unwind, it gets unwound very quickly when the market starts to fall because it is leveraged, so for every 1% or 2% or 5% that it falls, it is much greater for a person who is riding margin.
David: Yes, and the point is, it is forced liquidation. You are talking about house calls and forced liquidation. Newman also reflects on Shiller PE which is the ten-year rolling average of the Price Earnings Ratio and Tobin’s Q which is the replacement cost of a company’s land, plant, and infrastructure. And he says, “Listen, we are near the valuation levels that we had in 2000 and 2007. We have yet to exceed the market valuations of 2000 and 2007, but will likely do that before the rotund operatic takes the stage, so to say. Margin debt, as we gave you the percentage of GDP is 32% higher today than it was in 2007. It is 83% higher than it was in the year 2000 prior to the NASDAQ implosion, just as an indication of how much speculative excess is in the marketplace today.
Kevin: And look at the bullishness, though. You talk about general sentiment right now toward the stock market, it seems that everybody – everybody – loves the stock market, and they want more.
David: Do you remember the scene in the matrix where the guy says, “I’m not interested in reality anymore. I want a steak dinner, and I want a fine glass of wine, and I don’t care if it’s not real.”
Kevin: He went back and took the pill that took him back into perception, not reality.
David: “I will take the pill that redefines reality.”
Kevin: I do remember that.
David: “I just want it to be just so. Life is too hard to be dealing with the truth. The perception that you can create for me, I’m happy to adopt that now.” Newman’s thoughts on investment advisory sentiment numbers are intriguing to me because they are, today, according to him, three standard deviations above the norm. In other words, bullish sentiment amongst investment advisors is off the charts. Three standard deviations – so if six standard deviations is the equivalent of once in a million years, you are talking about something that is only supposed to happen once in several thousand years. Three standard deviations above the norm is an incredibly high bullish sentiment number.
Kevin: And as high as it is, you still watch financial TV and they are still talking about how many people are pessimistic about this market.
David: Right. Well, just last Friday, CNBC, one of the big discussions they had during the day was that there is a real bubble. And the bubble is in pessimism. The number of pessimistic people out there, boy, when this bubble bursts guess where the market is going?
David: Pessimism – you can’t make this stuff up. The major indexes are within spitting distance of an all-time high, and CNBC thinks that we have an epidemic of pessimism.
Kevin: Well, it might be here. We have a little pessimism in this studio.
David: (laughs) Well, when you think about CNBC and that positioning, I guess it explains why their ratings are at multi-decade lows. Part of it may be a failure to be relevant. To me, it is a failure to be funny. Maybe that is where they see their comeback. Maybe they are trying to put on a comedy routine.
Kevin: Dave, I want to go back to gold for just a second. If you are looking at gold in dollar terms, it is not funny, it has not been comedic.
Kevin: But if you were Japanese right now – why don’t you talk a little bit about that, because talk about living in a bubble, going back into the matrix, the rest of the world is not necessarily in the matrix right now.
David: You are right. Gold is down 46% from its highest levels in 2011. That is in U.S. dollar terms. The Japanese are not so downtrodden. Gold is near all-time highs in yen terms. It suffered a bit of a correction, but nothing as severe as the U.S. dollar in euro terms, and it is in a dozen different currencies around the world, shining brightly. I think people should keep this in mind. Although we have the largest capital markets, we certainly don’t have the largest population, and therefore we don’t make up the largest audience in the world. We are 300 million people. Very few of those 300 million take an active interest in gold. Meanwhile, well over seven billion people the world over, with close to half of that being in China and India, and certainly, if you use Asia as a collective, then over half the world actually takes an active monetary interest, social interest, religious interest. It is multi-faceted and fairly intense.
Kevin: Our guest, George Gilder, said that one of the worst things you can do to money is you can make it variable, because it really is supposed to be the measuring stick, and when the measuring stick is variable you really can’t measure anything else. And so, as we sit here in America and we look at gold versus the dollar, we say, “Gosh, it’s down.” If you are in Japan, you are looking at gold versus the yen and you say, “Wow, it’s way up.” But that is not really reality in either case.
David: Gold is gold, is gold, and these currencies are moving up and down around the north star. They are moving up and down around a true reference. And it does speak to the volatility and the higher or lower valuation of those fiat currencies. But it is interesting to see what happens to investor psychology when something that is fiat in nature is temporarily valued either at a higher level or a lower level when its intrinsic value is zero.
Kevin: Well, then let’s value it against something of real value – the U.S. corporate sector.
David: And that is just to say that the land, plants, and infrastructure represented by the Dow Jones Industrial Average, the companies that are making stuff, make stuff with stuff, so how much is their stuff worth?
Kevin: So, let’s look at the Dow-gold ratio because it has been a great indicator in the past of when stocks are too high, when gold is too high, and when to make the switch between the two. So, Dow-gold ratio 101 – tell us where we are.
David: It stands at 16-to-1 right now.
Kevin: That means that 16 ounces of gold would buy one share of the Dow in the mid 17,000 to 18,000 point range.
David: That’s right. And it’s not the 6-to-1 ratio, which is what it was at its low ebb, and it’s also not the 43-to-1 ratio which we saw in the year 2000 where the Dow was very well priced and gold was very inexpensive and thus, this value exchange would have gotten you – one share of the Dow would have given you 43 ounces of gold. Today, even though the price of the Dow is higher, it only gets you 16 ounces, at its extreme, 6.
Kevin: Dave, I remember the high. When it was 43-to-1, when the stock market would buy 43 ounces of gold and now the stock market would only buy 16 ounces of gold. But where should we be looking? Right now the stock market has been rising relative to gold. Where would you start being concerned that the stock market is in a new bull market and maybe we should start moving out of our gold?
David: Looking back at history, there are two other peaks, both in terms of the stock market, and that signaled a low, actually, in the price of gold. In 1929, the stock market, of course, peaked, and you could have exchanged it for about 20 ounces. And then in 1968 you could have exchanged it for just shy of 30 ounces. So, progressively, it has gone from 20 to 30 to 43, in terms of this value exchange, and on the measure, I would say 21-to-1 would be sort of an outside figure where you would want to argue that there is a deep structural, and thus negative, change in the gold market. We are 16-to-1, if we saw that ratio exceed 21-to-1 you could say structurally the bull market is over. And I don’t see that happening.
Kevin: So, we’re talking 16-to-1, Dave, but actually, what we’ve seen, you’ve talked about when the stock market was at its high at 20-to-1, 30-to-1, 34-to-1, but let’s talk about the lows, when gold is at its high relative to stocks. We have seen it get to 1-to-1 several times.
David: Sure. And this is one of the reasons why it would have been foolish to sell gold in 2008, 2009, 2010, 2011, 2012. At the extreme, the market got to a 6-to-1 ratio. Now, keep in mind, from a historical standpoint, the journey from 6-to-1 to 1-to-1 is still a five to six-fold increase in terms of your purchasing power in gold terms. So, we have retraced back from six to 16.
Kevin: Well, can I make a comment, too, that each time gold went to a new high it did retrace against the stock market to about 16-to-1. This is not unusual to see it come back, where gold went down to about 6-to-1 and then now it is t 16-to-1 relative to the stock market, and then it reversed and went on down to 3-to-1, 2-to-1, 1-to-1. It is not unusual.
David: It doesn’t feel, in dollar terms, like gold has managed to hold its own, but gold has managed to hold its ground relative to stocks. And again, that is small consolation for the gold holder the last five years. Stocks are up, gold is down, in the short run. Big picture perspective is this – 198% gain since 9/11, measured against a 37% gain for equities in the same period. The Dow is up 37, gold is up 198.
Why do I bring up the ratio again? There is a large consolation in these trends as they play out, with extremes reached in the sentiment swings from irrational greed, where investors love stocks and buy them with reckless abandon, to the other extreme which is irrational fear, where stocks are not loved and gold is as precious as the Linus blanket, if you remember, from Peanuts. We see a ratio of less than 5-to-1 in the future, in all likelihood, even a 3-to-1, 2-to-1, 1-to-1 ratio, which is consistently where that irrational fear has taken the demand for gold.
Kevin: And like I was saying, this is not unusual. Let’s just go back. Your family goes back to the early 1970s in the gold business. Dave, you were young at the time, but your dad experienced this while the company was open where we saw gold retrace back before going up record numbers.
David: Right. So, the Dow-gold ratio from 6-to-1 to 16-to-1 is not dissimilar from the countertrend move that we saw in gold during the 1974 to 1976 period. Gold dropped 50%, the Dow was recovering, and of course, inflation was zero concern in that timeframe, 1974 to 1976. Of course, that was just prior to the additional eight-fold increase in gold. Then, as now, my dad would say, and I support this. Think more, feel less.
What is actually happening? What are the driving forces in our economy today? Rather than be discouraged by price action and then wearing it on your sleeve, think what has changed that fundamentally alters the place of gold and gold-related assets in the portfolio? If your answer is that we have recovered from the Great Recession, frankly, you may be reading the wrong people, or simply be a bit of a Pollyanna. The minor improvements we have made have been at the collective cost of more than 19 trillion dollars in additional debt, and that is just central bank balance sheet debt. That has nothing to do with corporate sector debt or the totality of debt as it has increased since 2012.
Kevin: Adding 19 trillion dollars should have sent us to the moon, as far as economic productivity.
David: I guess maybe the other answer is, the markets are more manipulated today. They are controlled more than ever before, and therefore, the course that they are on right now – stocks higher, gold lower – that course will hold. And I guess my response would be, I do acknowledge the length of time involved has stretched beyond what I anticipated already, four years versus perhaps two, two-and-a-half, a normal correction. But I know that this is an issue of degree. The type of manipulation has been tried before, and failed. And it is being done today on a larger scale, indeed, to a greater degree. But the notion that economic prosperity is driven by credit creation, I think that remains challenged. Remains challenged is a polite way of saying it’s bunk, it’s otherwise unreasonable, it’s a glorified BS.
The creation of money and credit to prop up an already over-extended system, this is what serves as the theoretical basis for von Mises’ critique of artificial booms, which he emphatically argues lead to real busts. And it is also the basis for Hyman Minsky’s financial instability hypothesis. These are economic giants who would diagnoses the current malady, yes, as a debt problem for which more debt is no real solution. And these gentleman – Minsky, von Mises – they would suggest that the worst is yet to come, not the best. What is this like? This is like holding winter at bay and having the economists go out with Scotch tape and literally tape leaves to the trees and pretend that nothing in the season has changed. Does that make sense?
Kevin: It does.
David: And it seems silly, it seems artificial, but if you can convince people that the leaves haven’t fallen off, therefore winter is not coming…
Kevin: But winter always does come, Dave. It follows fall, year after year.
David: It seems to me it is a similar argument to what was put out there in 1927, 1928, 1929. You can’t argue with success. You can’t argue with success. The stock market is up 27%, then the stock market is up 40%. Then the stock market is raging higher until you get to October of 1929. And in the 1930s the question was then asked, “Why didn’t anyone see it coming? Why didn’t anyone tell us the crash was imminent?” And the answer was, plenty of people saw it, plenty of people did get out of harm’s way, and some were simple-minded and they suffered for it. Some were thinking people, but the vast majority were confused by the signals that they got from their own emotional feedback loop. They looked and they said, “You can’t argue with success. Look, you don’t understand. We’re in a new era.” And of course, this is the feel of the 1920s. It is also the feel of the current era. We are borrowing money to buy a sure bet, to a greater degree than we were in the 1920s, which in itself is telling.
Kevin: Again, I bring up this American bubble, because here in America we can be so near-sighted that we don’t see anything outside of our shores. If you were in Brazil right now, if you were in Turkey, as you brought out a couple of weeks ago, some of these currencies are in freefall. It is a devastating feeling outside of this country, yet here in this country you have this insanity, believing that we are actually in a recovery, and who knows? Maybe we are going to have an interest rate increase. And who knows? Maybe the stock market is going to go to 25,000. It’s just not real.
David: You’re right about the near-sightedness because U.S. dollar/gold is down. The rest of the world is a champion of higher prices, and they are getting what they want. They may not want it, but that is what they are getting anyway – higher prices for gold in their domestic currency terms. It was suggested by Marc Faber in his recent missive that the Chinese yuan, or renminbi, whatever you want to call it, and the Indian rupee are next. They are the two currencies which have actually held up pretty well. The Chinese yuan is only down 22% in the last three to five years, and the Indian rupee has actually done okay in the last year or so. And this is very important, because if you just think about those two countries, China and India, three out of every eight people in the world come from those two countries. And Faber’s suggestion, and I agree – I don’t know how the Chinese avoid a massive devaluation. The Indians – a little bit different story, but you are talking about half the world population, or just shy of it, in these two countries.
Kevin: And these are gold-owning countries. You have brought that out before.
David: Devaluation drives the desire for protection of savings, and it drives the demand for gold on the basis of fear in the marketplace. It happens with routine knee-jerk response. If inflation rates are running high – it happened a few years ago in Vietnam. Import numbers for gold were off the charts. Why? Because people weren’t going to sit around in the local currency and get slaughtered. They wanted to step outside the local currency until it had stabilized and then they could jump off their life raft back into the local currency as and when they need it. So, you have this long tradition of gold ownership and it ties to, well, you know what? It is the perpetual instability of a fiat currency system. And moving forward, I think that this historical anchor, the nature of a fiat system, inherent instability – it is going to hold, and so will, thus, the demand for gold from these various countries.
Kevin: So do you think that a lot of the manipulation that we are seeing in markets worldwide is because there is a knowledge that this thing is teetering on the edge of collapse? Look at the Chinese manipulation. They’re not spending millions a day, they’re spending billions a day, to manipulate their markets.
David: You have to kind of let these numbers sink in, because it was less than a 2.7 billion dollar paper transaction that dropped the price of gold $40-50 a few weeks back, but the Chinese, if you want a working definition of manipulation, the Chinese are intervening directly in their stock market, to the tune of 29 billion dollars a day. That is, a government agency is buying up equities as the buyer of last resort. It still hasn’t prevented renewed weakness in the Shanghai market, and the Shenzhen markets. And that is manipulation, or at least it is an attempt at it. What do you think the cost to the renminbi is? What do you think the cost to the currency is to maintain those interventions, where those interventions are commonplace?
And you should note, this is not just in China. Think about the yen. One of the reasons why gold looks so good in yen terms is because of their extraordinary interventions. They are buying Japanese government bonds, they are buying Japanese corporate. They are buying Japanese equities, the bank of Japan is. The same thing is happening in the eurozone where the ECB is buying government paper and certain commercial paper, that is, corporate bonds. The U.S. dollar – of course, we were the first ones to lead and demonstrate and show them how it was done. Buy all the agency paper and treasuries that you want.
This is where it becomes very confusing, Kevin. When you look at our currency system today, we have a floating system – a floating system of currencies where one which is up or down on a given day, is measured against another, which is up or down in a given day, and that floating system softens the direct impact of economic and monetary intervention. It makes it more difficult to actually gauge the impact.
Kevin: And it is not just the currencies that are floating. Most people look at stock markets and bond markets to see the health of the economy but the two really don’t correlate sometimes, if they are manipulating, like you said, 29 billion dollars a day to manipulate the stock market. Well, why are they manipulating the stock market? Is it to keep stocks up? No. It is to let people know that “the economy is just fine and dandy, thank you very much. Don’t you worry about it.” The economy, which is everything, is what is really suffering right now, and the financial markets are hitting new highs.
David: “We are in control. You can trust us. Nothing bad will happen.”
Kevin: “Do not touch your television set. For the next 60 minutes we control the vertical. We control the horizontal.” Remember that from Outer Limits?
David: Yes, this is the interesting thing. It really is a perception management game, and are you willing to spend billions of dollars to do it? Well sure. There are trillions of dollars at stake, so why not spend in the tens of billions of dollars to do it? We’re as interested in the financial markets as we are the real economy, and sometimes the contrast between them. And as we suggested a few weeks ago, we have rail freight in China which has declined to such a degree, the difference between the real economy and the manic markets is obvious. But in China you also have, today, the automakers, whether it is Ford or BMW, the automakers are expecting declining sales in China for 2015. This would be a first since 1998 if the low-end projections stay the reality.
What is this signal? Is it a signal? Where auto sales have been on the increase, on the increase, on the increase, imports of autos into China on the increase, on the increase, on the increase. What are we talking about? Seventeen years? Is it significant when you begin to see a trend change? It would be very consistent with what we have seen in terms of declining export figures from China as reported this week by the bank credit analysts. And of course their exports are not the only thing in decline. You look at container transport figures and it is just flat scary. We know what happens when world trade begins to diminish.
Kevin: And one of the ways that you can measure that is watching what it costs to transport a container – what are they – 20 foot containers – from one place another? And if the cost to transport freight is rising, usually that means that is economic prosperity.
David: From Asia to Europe and the Mediterranean, you have those transport figures, container costs down between 22% and 24% – they have dropped precipitously, reinforcing this massive decline in world trade volumes. And I didn’t finish my thought a minute ago, but we know the implications of a decline in world trade. It is an increase in global political tensions. When people are making less money, politicians begin to point fingers, and sometimes they can do that domestically, sometimes they have to do it internationally. But your greatest periods of global conflict, frankly world war, have followed those periods of decline in world trade.
Kevin: So, it goes from the financial to the economic to the political, and then you have the geopolitical or the strategic, and unfortunately, that is where bloodshed starts.
David: One more thing on auto sales, not relating to China, but about U.S. auto sales. It turns out that the U.S. auto sales have beat estimates – great numbers. If you look at how, it is kind of interesting. Government sales were up 38%, deliveries to state and local governments were up 59%.
Kevin: So, thanks to the taxpayer, auto sales are up.
David: Yes. Only in Amerika (with a K).
Kevin: Our guest, Richard Duncan, in the past has talked about how you can either grow by producing something, or you can grow by using debt. Now, sometimes you can use debt and get more growth out of the debt. Let’s say you borrow a dollar and you get a buck-and-a-half worth of grow, let’s say. Or it can go the other way, and you can borrow a whole lot of money and get virtually no growth.
David: It is the law of diminishing returns in real time. As recently as the 1970s, a dollar in GDP – you could buy it with a $1.40 in debt.
Kevin: So, you borrow a $1.40, you get a dollar in GDP growth.
David: That’s disturbing in and of itself, moving backward. It started in the 1970s that it cost you more in terms of a future liability, a debt, to generate that one dollar in GDP growth.
Kevin: So, where are we now?
David: Now it is totaling about $4 for every $1 in GDP growth – $4 in debt for every $1 in GDP growth.
Kevin: So, what they are saying is, I will gladly pay you $4 on Tuesday for $1 today?
David: That’s right. Does that seem like a good deal?
Kevin: That doesn’t seem like a good deal.
David: To assume that the GDP growth we are seeing is in any way healthy is to ignore the role of debt in our economy, and to ignore the long-term burden that creates for future generations. Bear in mind that that is really tomorrow’s consumption pulled into the present. That is what debt is. When you put something on a credit card. When you take out a home mortgage or a home equity line of credit you are consuming today what would have been consumed tomorrow. Does that make sense?
David: And I guess we’re implying that we’re witnessing a massive intergenerational heist. Why? Because we’re consuming all of tomorrow’s prosperity in the present moment, and that is leaving crumbs for our kids. That is leaving a burden of debt for our children and grandchildren. And so, again, when I hear recovery I think recovery of this sort is very short-sighted, indeed.
Kevin: About a month ago you brought up Puerto Rico. A lot of people think Puerto Rico doesn’t really affect us, but if I am hearing this right, on August 1st, Puerto Rico didn’t make a payment. Are we getting close to a default?
David: Yes, well, that’s right. This week we already had our first default. The news media seems to prefer a gloss of silence for the default which occurred in Puerto Rico. But think of it. We have our own miniature Greece as a part of the U.S.A., and I had to search through Bloomberg articles for details on the default, because nothing was run as a top headline – nothing.
Kevin: Nothing here, just move on.
David: That, in and of itself, is interesting. A news blackout consistent with a PR campaign of “All is well here in this country.” You are talking about a missed 58 million dollar payment this week, skipped on Monday after warning last week that they wouldn’t make the payment. They said, “We don’t have the money, there is no way to do it, we are going to have to restructure our debt.” No one seemed to listen. So, what do we have over the next 12 months? We have 5 billion dollars in bonds that comes due, out of a total of 72 billion dollars of debt outstanding. Does anyone care? Well, to me, honestly, the silence suggests that someone really does care.
Kevin: Sometimes, Dave, when we banter about different figures, it’s hard, because obviously, this is an audio program. We’re not showing charts. So, let’s put things in terms where people can stop and say, “How big is this, really?” The securities markets. Let’s use that as an example. How big are the securities markets, let’s say, relative to GDP?
David: You have the stock market and the bond market. We are going to include corporate bonds, we are going to include agency paper, we are going to include treasury bills, treasury bonds, treasury notes – all of that stuff, if you add it into one big pile, it’s a big pile, 73.10 trillion dollars. So, just over 73 trillion dollars is the total value of the securities markets – equity and debt.
Kevin: That is like four times the GDP.
David: It is today. We are 414% of GDP. If you roll the clock back, the last time we had a peak in the stock market, and the economic engine seemed to be buzzing along pretty well – we were at 371% of GDP. Again, that is 2007. And 1999 – you know, partying like it’s 1999, tech stock boom, everyone’s happy, people are leaving their day jobs to day trade – we were at 356% of GDP.
Kevin: So, we’re higher now – the financial markets are larger now, relative to GDP, than before either of the last two major crashes.
David: That’s right. So, the securities market, both equity and debt, has grown pretty considerably, past levels that, in retrospect, ended up being unsustainable. The same thing is true of household net worth. Now, granted, this doesn’t apply for all households, because not all households have assets that have increased the last few years, or have assets at all. At the end of the first quarter this year, household net worth compared to our total economy, that is, GDP, we were at 481%. And that compares with 476% in the year 2007, and 447% in 1999. In other words, household net worth has continued to grow.
And the interesting thing is, Kevin, there are polls – 55% of Americans polled here recently said that they expected the economy was getting worse, not better, and was on the wrong trajectory. Why would they say that? Why would the vast majority of Americans say that things are not improving for them? Why would Walmart sales, quarter after quarter, after quarter, after quarter, after quarter, after quarter, be in decline? Again, it is an indication of middle America, and the fact that they are running out of money before they run out of month. What we are really talking about is the fabricated reality the central banks have put in motion. Yes, the total value of the securities market has far exceeded anything that we seen in the past. Yes, household net worth has far exceeded anything that we have seen in the past.
Kevin: You were talking about Middle America. I’m going to shift gears here just a little. Middle America was very dubious about what they were being told about their insurance. And Obama had a legacy to leave. And so Obama, one way or another was going to give us Obamacare. Now, I’m feeling those same feelings right now with some of these EPA standards that he is pushing. Are we going to have electricity from any coal-driven plant in America here after this stuff gets passed?
David: That’s interesting, yes, and this week the EPA emission plan that promises to revolutionize the environment without adding energy costs for households, and you are right, it sounds like the health care revolution. So, we’ve got a revolution in energy. Well, that is going to come at no cost to households, just as health care, as a revolution, has had no cost to households. Let me remind you that this year our company has an increase of 5% and you, as an employee of the company, also have a 5% increase.
Kevin: In health care.
David: So, we split it. We split the difference. So, collectively, we have a 10% increase in the cost of health care.
Kevin: But we were told it would not go up due to Obamacare.
David: So, what is interesting, as we move down the road, past this administration, and we are left to pick up the pieces, the EPA has been given teeth, and they are going to use those teeth. They are going to sink them into someone. Certainly, into coal, maybe into other areas of energy production. But anyone who has looked at the numbers, listen, I’m the first guy to love the idea of alternative energy. I think it sounds great, it is very romantic, it’s beautiful. You look at the sun and say it’s perpetual energy, why can’t we just harness it?
The problem is the cost to do so, so far, has been entirely uneconomic, which means that for anyone who is putting solar panels on their house, you and I have helped subsidize putting them on their house and they might feel like they have gotten a good deal and they will be able to pay it off in seven years, but the only reason that is the case is that it is literally picking Peter’s pocket to pay Paul. That doesn’t work now. Maybe that’s fixed in the future, but it certainly is uneconomical today. And so, the idea that it is not going to cost households, to me, really does move back to that idea of central planning. It is not going to cost you because we’re not going to tell you where we put the cost as we infuse it into other areas of your life. They have to pay for it, and these things come at a very high cost.
Kevin: Last October we went to Argentina and we saw the devastation, economically, of a government living a lie, where the government is basically saying, “Oh, no, the Argentinian peso trades for this many dollars. Period.” Yet, on the streets, the Argentinian peso was worth half of what the government told them.
David: We have run out of time, but this week we have the Argentine election which will either make or break the country. They have already been through a series of crises in the last 10-15 years and this will either be launching them in a new crisis, or frankly, potential for new recovery. We forgot to mention, too, that the Saudis have recently signed massive contracts with the Russians and the Chinese as we have cozied up to Iran. There are about ten things I’d like to talk about today and we have simply run out of time.
Kevin: Okay, but if we talked about them we’d still have to come up with a solution, not necessarily a national solution, but I’m sitting here, as a person, saying, what do I do, Dave? I have a system right now that is extracting wealth from every angle. We have a stock market that is holding near all-time highs, and you and I know it should not be there. What is the answer for the man on the street right now? What does he do to protect himself? Just like the Argentinians. They were protecting themselves in the only way they could, even though the government was telling them lies.
David: So, let me just give your sort of a preview of coming attractions. I think you will agree with me on this – we live in a democracy, correct?
Kevin: Yes. It’s supposed to be a republic.
David: But the beauty in universal suffrage terms is that everyone has a vote. It is very difficult for people not to vote their self-interest. The problem is, when you are at this stage of a democracy’s life cycle you have a minority of people who are the holders and generators of wealth and the majority of people who have no wealth or ability to create it. At this stage, if you are not lowering your profile as either a creator or holder of wealth, you are a part of the solution. Your resources, the extraction and mining of your resources, are a part of solving bad economic policies. I’m not saying it is a real solution, I’m just saying that that’s how it will be billed. And that’s how it will be voted on. Your neighbor is more happy to spend your money than his own.
And that’s the world we live in. That is the nature of a democracy at this late stage. So yes, it is very relevant, if you want to look at what has happened in Argentina, if you want to see what is happening in real time in Brazil. You recall the comments that we had from Russell Napier over two years ago where he said, “If you want to understand and prepare for what lies ahead, you need to start studying the economic decisions that were being made in Eastern Europe, in a command and control environment, in a controlled environment where prices are set by the equivalent of a politburo, not by the market dynamic.”
Kevin: Forty-two years ago your dad saw that when we went off the gold standard on the U.S. dollar, he had to change what he did for a living. He was a stock broker, a bond broker, but he knew that the time clock was ticking for the end of this paper promise called the dollar that really had nothing backing it. Now, up to this point, this company has continued to recommend that a person have some gold, some cash, and sometimes some equities. Right now, wouldn’t you say that that would be a great strategy to pursue, to make sure that you are covered with something other than broken promises?
David: I couldn’t have said it better. Make sure you are covered with something better than a broken promise. Promises that have been made and already broken should be held with suspicion. Gold is a promise that has never been broken. It is an asset that has never gone to zero. It is something that has not only stood the test of time, but when things are tested within the system, it has been, and I think, will continue to be, what people lean on, not only as a form of real wealth, but ultimately, as a form of money, which, as and when value presents itself, can be deployed in a positive manner.
I think it is very easy to listen to our commentary, perhaps others like it, and think that this is bad news. Bad news is good news, good is bad news. It depends on your perspective. And this is where I do think, having a long enough timeframe in mind – not five years, not 15 years, not 50 or 70 years, but even 100-year timeframe, begins to bring things into perspective. The decisions that you make today are very important. They are absolutely important. You need to know where you are in the historical continuum. But Kevin, I don’t think I could have said it any better.