In PodCasts
  • FAANGS – Facebook, Amazon, Etc account for 80% of S&P’s appreciation
  • Currency war elephants will trample citizen mice
  • Russian election tampering! Gallup poll shows no one cares

The McAlvany Weekly Commentary
with David McAlvany and Kevin Orrick

July 25, 2018

Barron’smagazine runs an article on gold in 2012 saying, ‘Everybody should own it. It’s the most reliable investment that you can own.’ And it’s difficult to argue with the track record, except that when you get too many people into an asset class you ultimately run out of buyers and the price has to go the other direction. Are you comfortably contrarian? I’ll tell you from personal experience, it’s hardly ever the comfortable thing to be.”

– David McAlvany

Kevin:You know, each week we tend to talk about things that we have done that week. Dave, you never cease to amaze me. You push your family far beyond what I think I’ve pushed my family. I did my first 14-er when I was in my 20s, a 14,000-foot peak. There are over 50 14,000-foot peaks in Colorado. But you took your entire family, including your youngest – how old is he?

David:He’s four years old. We went over near Salida.

Kevin:It wasn’t a mild 14-er either.

David:No, it was 5,000 vertical feet of climbing. We actually thought we could do two in a day, Shavano and Tabeguache – they’re right next to each other. You cross a saddle, drop a little elevation, then climb the next one.

Kevin:If one weren’t enough. Let’s try to get a second one.

David:I’ll tell you, it was worth recognizing our limits. It was also worth playing according to our game plan. We were up and climbing at five o’clock. The reason you do that is because in the summer months you have the monsoons, which come in between 12:00 and 2:00 and you want to be off the mountain by 12:00.

Kevin:One of our favorite books, Dave, is Deep Survivalby Gonzales. He talks about people who have a good experience, maybe they’ll do something that is high risk and they succeed. Unless they know history and unless they have a plan, a lot of times that high – literally in this case with a 14-er – that high of success can be taken into a disaster. Now, you knew history. Anyone who climbs 14-ers in Colorado understands you have a turn-around time where you’ve made the top or not.

David:Right. And it was interesting because we are sitting at the top, and it’s so tempting. You’ve already done most of the work, you’re at 5,000 feet, you have only about another 600-800 foot gain to get to the other one. Why wouldn’t you just do the second? Now, it’s an hour out and it’s an hour back.

Kevin:You were past your turn-around time.

David:We would have been past our turn-around time. As it turned out, as we got to the base of the mountain, sure enough, the clouds were in, the thunderclaps began, the rain started, and it was a good call to just be modestly happy with one and know that we could come back for another at another time.

Kevin:Especially with your whole family. In a way, it’s a lot like investing. If you don’t know history you can be running on an endorphin high. You see the markets that are high, you want to buy higher, and higher, and higher. Why would it stop? Unless you understand history, unless you have a turn-around time…

David:I’ll tell you what. It was a downer, actually, for me to be on top of the mountain and know that we had to turn around. Yes, we made the first peak, but we weren’t going to make the second. And it was sort of the end of the momentum, if that’s what you’re getting at, because the momentum trade, the momentum trend, in investing is, “We’ve made it this far, we can go a little further,” versus recognizing limits. There is a money manager by the name of Howard Marks. He says, “The big money in the investment world, the dependable money, the safe money, is made not betting that things that have gone up a lot will continue to do so, but on betting that the things that have gone down and have become unloved will rebound.”

It’s funny, because as we we’re coming down the mountain, there are people who are just marching up and they don’t know better. They really don’t know better. They don’t know about a turn-around time. We passed a group, actually, early in the morning, from Connecticut, and one of them was actually lying at 13,500 feet in a fetal position with altitude sickness, but he is determined that he is going to make it to the top. He won’t quit. I appreciate his tenacity, but they don’t know some of the rules of the game, which is, if you don’t get off you can end up with other issues like lightning strikes and things like that.

Kevin:It reminds me of the book that Jon Krakauer wrote years ago about the two expeditions up Everest that betrayed their turn-around time and it ended costing many lives.

Dave, enough of analogies, let’s move on to currency war, because we live in a day and age where it is beneficial to have a currency that is cheaper, or lower value, than a currency of your neighbor. That makes you more competitive. The problem is, it’s just like descending that mountain. You can only descend that 5,000 feet. There is a point where you hit rock bottom. Currencies really, in a way, have no bottom except for zero, or zero buying power. Venezuela has reached that zero buying power. They won the currency war for a short time, and then of course they lost all.

David:And I think the IMF now estimates that by year-end they will be at a million percent in terms of their rate of inflation.

Kevin:A million. Where do you stop counting?

David:Exactly. At 43,000 percent you begin to think you’ve got an inflation issue, but oh, there’s still more to the year, and more to the decline in their currency.

Kevin:Let’s look at something bigger though. The Chinese are purposely lowering the value of their currency.

David:Well, if the Chinese orchestrate a lower RMB we tend to accuse them of currency manipulation. But it was just last year our currency was declining, and if our currency declines we don’t seem to care. In fact, today we have a president that prefers a lower dollar value, and it is to do something that all leaders want, improve trade competitiveness. Everybody wants that. That makes for the currency war which is already live, and I think it’s hotter than many people suspect at this stage already.

So you have talk of trade policies and their importance, but I think we should not neglect currency differentials and exchange rates. We hinted at this last week, we spoke of this last week in terms of debt, and the vulnerabilities in the emerging markets where you can have financial panic and hot money outflows from a country where they have denominated too much debt in the foreign currency, and that can be highly destabilizing, those hot money outflows. But you have product and overall trade competitiveness, which do increase significantly with a currency depreciation, so there is actually some motive there.

Kevin:One of the ways that we try to stay away from hot war with a lot of countries is that we use – I won’t call it cold war, but I’ll call it currency war. We have manipulated in many countries, and you’ve done a lot of reading on this and talking on this, Dave, but Iran is a case where we use currency war to keep a hot war from happening. But don’t you think politics, at some point, reaches a point where currency can no longer be used? The harmony of politics between China and America is what I’m thinking about right now.

David:Even the internal politics and internal social dynamics, there is a lot of political and social harmony at stake, both inside the United States and inside China, that relates to the transitional phases for trade, productivity, imports, exports and global cooperation. So as much as Russia still gets a number of headlines – the U.S. asks Putin for another summit or whatever the headlines may be from the New York Timesor the Wall Street Journal, or what have you, I think China is probably the bigger deal.

Kevin:Let me ask you, though, if the weapons of war are currencies, and you and I have to earn a certain amount of currency – we work eight to ten hours a day for a certain amount of currency – it seems to me like I’m at the mercy of political elephants battling, and I’m just a mouse holding the dollar.

David:I think this is one of the strong reasons to consider the trajectory of gold in the coming years. You have politicians all over the world that want their economies to boom, they want to be first in line, and they want their goods and services to be chosen before anyone else in the world that offers a comparable product. Since inflation is one of those topics that is rarely connected back to political choice or political pressure coming from politicians to the coordinators of monetary policy, investors, I think, must be aware of the vulnerability that exists to currencies, to these political priorities, where politicians are attempting to drive growth and gain market share in the global economy.

Kevin:Is there a safe currency then? When you have fiat currency, is there anyone who wouldn’t be at risk?

David:I think in this environment all currencies are at risk. So for the saver and investor in the 21stcentury some part of your wealth must be insulated. It has to be insulated from the desire of politicians to drive the economy forward, which on the surface sounds great but it’s at the expense of the long-term stability of their currency. I want to comment on the gold market in a moment, but we have weak second-quarter numbers for gold demand, and that was a reality. We’ll try to look ahead to the drivers of growth that we do anticipate between now and year-end, as well.

Kevin:I stayed in a hotel that was Teddy Roosevelt’s favorite this weekend, the Hotel Colorado in Glenwood Springs. They have Teddy paraphernalia all over the walls. Taft also stayed there. But I started thinking about it, I’ve never seen a president who actually liked strong monetary policy. Once they become elected as president – at least after World War II – things seem to change when the voters are really speaking the monetary policy.

David:The preference is there. I remember taking notes as we spoke with Giulio Gallarotti several years ago when he was on the Commentary as a guest. He made this simple observation, but it unlocked a number of mysteries for me at once. It was the shift in voting which began to occur after World War II. You remember he was talking about the shift toward universal suffrage and its implications for the budget. It became a political objective.

Kevin:Yes, the economy did.

David:Yes. You politicize the budget, you connect the dots between the economy and the voter, and from that point forward voters are far more sensitive to economic benefits that they can garner via their vote.

Kevin:It’s buying a vote, basically.

David:Yes. If you recall Al Sindlinger, a famous pollster, he pointed this out decades ago. It’s the economy which is the first priority for the voting base, and the second is personal security. Again, these are things which register as priorities for voters.

Kevin:And Trump is not exempt from that. Trump, at this point, is pressuring the Fed to keep rates low.

David:That is certainly the case, and I think part of the reason that he is keeping the pressure on the Fed and increasing the pressure, from the Wall Street Journallast Friday, “Trump breaks tradition and raps Fed,” where an interview at CNBC says, “I am not happy about it,” talking about interest rate increases. The issue there is that if there is a tightening of the interest rate, a raising of rates and a tightening of monetary policy, there is likely to be a slowing in the economy. And that does matter for the politician because people vote according to their pocketbooks.

Kevin:Is that not really, truly fake news, right from the Wall Street Journaland CNBC, Bloomberg – all these guys saying that Trump is doing something that no other president has done?

David:That was interesting because CNBC and Bloomberg covered the issue and you’re right, they talked about it as if it was without precedent – never happened – saying essentially that the Oval Office never gets involved in steering or trying to influence monetary policy. I think you could say that’s partially true if you think of the Greenspan and Bernanke eras, which are part of this 20+ year credit indulgence.

Kevin:Well, did they have to get involved, because Greenspan and Bernanke were just loose guys anyway, period?

David:That’s right. So you had this period of time which was without historic precedent which marked the final transition away from capitalism to what we now know as creditism. You have Clinton, you have Bush, and you have Obama, all who had the monetary winds at their backs – full support from Bernanke and Greenspan, but it really is not the case that presidents don’t mess with the Fed. Yes, we now have central bank activism, which has become the norm, but there was a time when central banks would, as they say, lean against the wind, or would move opposite the direction of the market trend to keep things in balance. Harry Truman was constantly fighting the Fed – constantly. Lyndon Johnson invited William McChesney Martin to his ranch in Texas, and as the story goes, slammed him up against a wall, threatening him – physically threatening him – if he didn’t adopt a more accommodative monetary policy. Nixon put a tremendous amount of pressure on Arthur Burns, and Arthur Burns was clearly not the greatest central banker that we ever had.

Kevin:Didn’t Carter fire him?

David:He did, because Carter was pressuring him, as well, and he did not ease, so here, actually, Burns has a little bit of backbone and Carter fires Burns for not easing monetary policy prior to the 1978 mid-term elections.

Kevin:We had a guest – Dave, you might remember this – on our Commentary who had worked for Reagan in the early years when Volcker was raising rates. He said Reagan and their administration hated Volcker. It was horrible timing, in their thought process, to raise rates. That is not news that we hear from the history books, but actually, they hated him because they were going to destroy his possibility for a second term.

David:That’s right. Well, easy money makes for a speculative environment, and the speculative environment in stocks increases the value, typically, in the stock market. And that becomes easy advertisement for economic progress and growth. That’s the prize for the politician, to be able to say, “Look what I delivered on a silver platter. Look at all this well-being and wealth and everything.” So that’s what they’re after.

Kevin:So in a way Clinton was correct in the early 1990s. It’s always “the economy, stupid.” It wasn’t just for Bush. It’s always “the economy, stupid.”

David:I think you’d have to go back to the 1910s, maybe up through the 1930s or 1940s where there was some confusion because people weren’t really connected to economic and monetary policy in the same way that they are today. This goes back to Giulio Gallarotti’s comment that the budget was only politicized after World War II as a result of universal suffrage.

Kevin:It’s like the weather. We don’t think of politics controlling the weather but if we found out that it could, that would become part of the vote, wouldn’t it?

David:That’s right. So at the end of the day it’s the economy, or it’s the people’s perception of the economy, that drives political outcomes. This is post-war, in particular. But you have market interventions and manipulations we are, today, part and parcel to democracy. It’s the way it functions, because you have politicians who are more than willing to put pressure on various organizations or create certain allowances to create opportunities for manipulation in the markets.

I don’t think that would have been the case if you go back 200, 300, 400 years ago. I think democracy was a little bit different. Of course, it wasn’t exactly the democracy that we know today. It was five people voting out of five million (laughs), a very select number of people in the old versions of democracy.

Kevin:So we have an expectation of direct participation even though there is a public admission of separation.

David:That’s right. And because we can connect the dots to the rewards we’re getting from the markets, there is more of an inclination for politicians to get involved in the process. But you saw in the 1980s and 1990s that there was a growing disparity between the working man who largely spent what he made, living paycheck to paycheck, and didn’t really see an increase in wages. We’ve had wage stagnation, income stagnation, since the 1970s up until the present. So even though you’ve had the rising price in consumer goods, there has been that growing pressure for the working man. If you had someone who was able to save any money and invest any money, then to some degree that pressure was alleviated by the inflation of asset prices. So real estate, and stocks and bonds, the upper class and the upper middle class benefitted from the boom in asset prices, and they haven’t had to pay as much attention to the rising cost of things. On balance, they are more wealthy and have had a better lifestyle than before. But this is the heart of the Trump phenomenon which is really a populist phenomenon. We’ve talked about this ad nauseam, and it’s not just in the U.S. We see the same thing which just happened in the Mexican election. This was a populist expression, only that’s a populist expression from the left versus a populist expression from the right. You go around the world and there is a common thematic, politically, but I think the source is not what people are assuming it is. It is being said that it is racism, it’s being said that it’s xenophobia, it’s being said that it’s immigration.

Kevin:It’s monetary policy. It’s the Federal Reserve. It’s loose money.

David:I totally agree. Federal Reserve monetary policy, I think, is what we’ve exported to the world, creditism exported to the world, and now we have central bankers all over the world doing the same things, creating the same income and wealth gaps, leaving the “hoi-polloi” behind. And those hoi-polloi are now standing up and saying, “What about us? The system is rigged. The system is not working for us.” And again, it has expressions of left and expressions of right, but it’s still the common man, whether it is left or right expressions saying, “Something is not working for us, while it is working very well for you.”

Kevin:So would you say the deep state, or the establishment, the elite, really created their own problem? They created the populist move. They created Trump.

David:In many senses they did.

Kevin:Whether they like it or not.

David:Right. Does art imitate culture, or vice-versa? I think in this case we have some sort of orange-colored art which does imitate or reflect culture (laughs) in the form of the Oval Office. But you look at what is happening to the Democratic party here in the United States, and it is losing its edge. Consider the reality of the typical blue collar, died-in-the-wool Democratic factory worker. Not in total, but there has been a creep from left to right on the political spectrum, shifting toward the GOP, at least in the last election. And I don’t know that they were voting for a Republican party line as much as they were someone who represented a non-politician, who represented, at least in the words spoken, that appeal to populism.

Kevin:And the words weren’t that eloquent. That’s the thing. You can appeal, actually, to a person when you speak in their own language, and Trump does speak in that language.

David:That’s right. I don’t think the working man is wooed with fancy words. What they want to know is that they’re going to have a working wage, a better life. And to the degree that Trump can maintain the narrative of economic success, of onshoring of jobs, of protection of the American dreams – I don’t know if he can do it. Maybe he can, maybe he can’t. I don’t know if he intends to deliver it. But I can tell you what. The simple rhetoric that he is communicating around the mainstream media direct to his audience through his Twitter feeds is reshaping and remaking the body politic.

Kevin:Bill King brought that up. Bill King said he is a master at finding where the hot buttons are and pushing those buttons. Whether they are Democrat or Republican, he doesn’t care.

David:Right. And I think that in November we could see further deterioration in the economic party base if Trump is able to continue to frame the issues in a way that working class Americans can agree with.

Kevin:Isn’t it amazing the Democrats keep focusing on, “Oh, the Russians are the ones who put him in?” Really? Really? The Russians put Trump in because they wanted what we’re seeing right now. Is that what they were looking for?

David:Because they wanted a strong dollar, because they wanted us to go after Iran, one of their trade partners (laughs).

Kevin:How many people, Dave, are really paying attention to what the Democrats keep trumping up – I guess, pun intended – on this Russia thing? I could care less when I listen to it. How about you?

David:Gallup did a poll to see how big a deal the Russian thing was as a threat to Americans, with mid-terms coming up, the possibility of greater interference of Russians in the elections and things like that. Again, it’s mainstream media, it’s the Democrats who continue pushing this meme. Honestly, I think they’re ruining their shot at capturing voters’ attention, because at least according to this Gallup poll, it doesn’t even register. It’s not even a low single-digit concern.

I don’t care what you think about Trump, if you’re not sensitive to what other people are thinking, if you’re not aware of what is in the constituents’ minds, then you don’t know what game you’re playing. You don’t know your audience and how the message needs to be crafted. That is, I think, where Trump is maintaining an advantage. He is simply picking the right hot button issues. While the economy is helping him, I think he will maintain pretty high approval ratings.

Kevin:So as we’ve stated over the last few weeks, Trump’s only real concern, probably, going into the mid-terms, is monetary tightening.

David:This has to be the Republicans’ greatest risk, whether they recognize it or not. While they have something of the wind at their backs with the economy improving, appreciate the role that monetary policy has played up to this point, and the way in which it can batter down the financial markets, in particular. So coming into the midterms, if we have further monetary tightening, that is, raising rates, it may affect the stock market negatively, and that would throw a lot of relief to the Democrats.

It was very astute for Trump to start connecting the dots here in recent weeks to the economic and financial market impacts, the consequences which result from Fed tightening. As he is squawking, maybe he is crossing a line, but whatever he is doing he is certainly expressing that he doesn’t want rates to go any higher between now and the end of the year. I think what he has done – and again I suggest that this is very astute on his part – because if the markets do unravel before the election he has basically created a scapegoat of the Fed. And he can try to shift blame from himself and his own policies and his agenda priorities and say, “Well, look, everything was fine. I told them not to, and they went ahead with it anyway, and this is what they served up to you.”

Kevin:Do you think he is catching them off guard, those who still oppose Trump, just because he doesn’t speak Ivy League?

David:Yes. As a person he is unpalatable, by personality, I don’t think he, in terms of decorum, I can think of about ten categories where on a scale of 1-10 he registers somewhere around a 2 or less (laughs). But…

Kevin:But. Everyone says, “I don’t like his personality, but…”

David:But, he’s not an idiot. He’s not an idiot. Again, you’re impression may be that he’s an idiot, but I’ve met a number of New York cosmopolitan types that went to the right schools, they worked for the right bank, or the right law firm, and they speak with the right diction, they vacation in the right places – usually the south of France – and Trump doesn’t fit their grid as a cosmopolitan leader.

I’m speaking from the standpoint of stereotypes here, but he’s like the Texas hick being elected to the office of president. There is this dismissive attitude that is common among the cosmopolitan elites and I think it actually factors into Trump being underestimated. They are assuming that he is just an idiot and at some point the world is going to figure it out.

Well, what if he’s not an idiot, and what if he is moving a certain number of agenda items, and they’re assuming that they’re speaking to a very broad audience that agrees with them that he’s an idiot, and in fact, they’ve lost their audience long ago? I’m very fascinated to see what happens in the midterm elections from a sociological standpoint. I have no dog in the fight. I don’t vote Republican, and I don’t vote Democrat, so truly, I don’t have a dog in this fight.

Kevin:How many clients have you had through the years, and friends that you have had through the years who own ranches in Texas that come across sort of “Aw shucks, I don’t really know much,” and you realize – wait a second…

David:Smart as a whip.

Kevin:Yeah, they’re dumb like a fox.

David:Oh yeah. Well, it’s the anger, and it’s the shock, among Democrats which is acute. I sat this weekend at Mount Princeton just below where we hiked and climbed a mountain. There is a great hot springs there.

Kevin:Yeah, you sit right in the river, don’t you? Right on the side of the river is the hot springs while the cold river runs by.

David:And above the gurgle of the stream there are these conversations, and I was listening to one about the similarities between Hitler’s inaugural speech and Trump’s inaugural speech, and this historical analogy to Hitler which was pervasive, I think, in 2016, and it’s still lingering. What was fascinating to me it this, because the accusation which is often leveled is that it’s fear which Trump is leveraging for his success, and he is taking advantage of fear of immigration, fear of this, and fear of that.

But as I was listening to this critique of Trump, and again, I don’t know that it’s a true historical analogy to Hitler, but there is a foundational response which is including fear. And it’s like, “Well, we think that he is a fear monger.” But the only critique they have it also based on fear. It just reminds me that hyperbole is the curse of partisan politics.

And it is the one reason why politics – and this might be a stretch – is a little like eschatology to me. And I’m not really talking about the categories as much as I am the people. Sometimes people speak so emphatically about topics that are far more complex than they represent, and are presented in such a way that they assume they have more certainty on a particular topic than is reasonable, or really, truly representative of the underlying reality.

Kevin:Yes, both politics and eschatology affect our lives but it’s those people who play fast and loose with the facts that give both subjects a black eye. It’s like what you’re saying, at this point people are moving to reactionary, emotional types of responses. The facts, really, are not being looked at.

David:I don’t think people care to have honest debate. It’s a lot easier to argument and ad hominem. And I saw it during the Clinton administration. Conservatives did the same thing with the Clintons. It was attack against the man. There was really no discussion about policies, it was almost depicting the man as the antichrist, and therefore – what I never appreciated about politics is the lack of true engagement.

Kevin:And don’t you think it can go the other direction, as well? Some of the family members I was with this weekend – I know some of you listen, and I love you very much, but I heard from some family members who really love Trump, them saying things that I know he can’t possibly do. They’re happy with the economy, they’re happy with a lot of the decisions that he is making. And so at this point there is just an assumption that he will solve the debt problem. Where did that assumption come from?

It reminds me, often, we have a tendency to have these almost personality cults with our leaders. You see it in churches. You can see it sometimes in companies. You see it with presidents oftentimes. I think we had a little bit of that cult type of personality with Obama. There were a lot of people who loved Obama and thought that he could do almost anything because he was the first black president, and because he represented something that had never been seen in America in the minds of the people. That’s where we have to be careful, and add objectivity to our discussion.

David:That’s right. Ray Dalio may write a big, thick book about investing and creating a culture with his investment company. Obama may lead in a certain way. Warren Buffet may invest in a certain way. None of these guys are perfect, and all of them are subject to legitimate criticism and discussion about things that they believe, and think, and what not. Just as a thought experiment, what is the market impact, what is the political impact, of announcing another tax cut?

Kevin:Do you think that might happen?

David:I think this is why you have to care about politics, even if your primary interest, whether it is in this podcast or any other, is primarily in investing because there are impacts in the marketplace from things that happen at a policy level. If the markets are in retreat at some point between now and the election, does Trump dust off a little bit more deficit spending? Do the fiscal policy maneuvers become a primary tool to smooth things over through the midterms?

We suggested a few weeks ago that there may be some underlying political bias at the Fed. And as we’ve seen revealed here in the last few months, there is clear political bias at the Department of Justice and FBI, but even without diving into those murky waters, the Fed now also has the opportunity under Powell to make its case for political independence because here is a president that, as the Wall Street Journal and the New York Times and everyone else is saying – Trump is breaking with precedent, he is speaking to monetary policy directly, and he is putting pressure on the Fed.

Well, what position does that put Powell in? Does he acquiesce and not raise rates? Or does he make his case for political independence and hike rates several more times between now and the end of the year? Powell may not wish to be remembered as a weak Fed chief. I don’t think that’s likely. So what is he going to do? Powell is going to do his job as he sees fit. I think what I like about Powell is there is a bit of the Volcker realist in him, and I think he has enough backbone to not really care.

Kevin:Volcker definitely disengaged with politics and that is why the Reagan administration didn’t like him.

Going back to my discussions when I was in the hot springs in Glenwood, I didn’t know you were going to the hot springs in Princeton.

David:We needed it. I can tell you, I’m still having a hard time walking. And I’m looking at my little four-year-old, saying, “How did he do it?” He walked all the way up unassisted. I carried him halfway down, but he made it all the way to the top on his own.

Kevin:That’s incredible. He’s a McAlvany. What can I say?

David:I couldn’t believe it. And my daughter, age seven, this was her first 14-er, as well. They were troopers. I’m sitting in the hot springs just thinking, “I think someday I’ll recover from this.” (laughs)

Kevin:As we were talking in the pool, family members and I, one of the things they pointed out was how strong the economy is. Now, that perception, I could tell, came from the stock market rising, and I really didn’t want to go there this weekend. I didn’t want to be Kevin, the gold broker downer – that guy – but I wanted to just let them know, “Hey, it really is four or five stocks that make up the majority of the stock market rise, otherwise this would be unimpressive.”

And as far as the debt, the increase in debt spending under Trump is going to be a very dangerous thing to reckon with because we are now reaching the point of no return. If interest rates do come up, like you said, if even a small Volcker card is played by Powell, the interest expense on this increased debt is unbearable.

David:Right. In past programs we have highlighted the fact that you can have an infinite amount of debt as long as you’re not paying any interest on it. But the day that the interest rate starts moving up, the bond market holds that reality in check and creates some accountability within the financial markets. It’s like checkmate in the game of chess. Game over when you begin to have rates rise if you’re talking about a huge stock of debt, or an ever-increasing stock of debt.

Kevin:So I’m hearing an echo in the background, your dad saying, “The majority is always wrong. The majority is always wrong.”

David:I think every presentation he ever gave, and still gives, begins with one of his principles. He has five, six, or seven of them which he introduces his lectures with, and one of them is the majority is always wrong, which is to say, the contrarian view is more often than not, a better position to take. That doesn’t mean that it is the easiest position to take from a sociological standpoint or a psychological standpoint, it’s just that as time and the tide of events roll through, it will have been the better position to take.

Kevin:So is a contrarian buying FANG stocks right now – Facebook, Amazon, Netflix, the works?

David:These are thefive most popular holdings if you count who owns them and in what quantities. This is amongst individual investors, this is amongst hedge funds, and this is amongst passively managed ETFs. In 2008 only five ETFs held these five companies in their top 15 holdings. Now you have 605 ETFs, Exchange Traded Funds, which hold them as a top 15 holding.

Kevin:Monkey see, monkey do.

David:This was a topic that we talked about here last week – these five stocks account for 75-80% of this year’s move higher in the S&P. The appreciation in that index is tied to just a handful of stocks.

Kevin:What happens when you concentrate that in such a small space?

David:The concentration of interest is telling, because the concentration of interest in any asset class is the kiss of death. Here is why – you eventually run out of new money to drive prices higher and that ends up forcing the old money to convert to liquidating instead of buying. When you run out of buyers, that’s the end of a market move. You had negative sentiment for gold, which is the flip side to positive sentiment for stocks – that’s today.

But there is an interesting mirror here where on the one hand you have positive sentiment for stocks, and this really is concentrated in just a few names. Meanwhile, you have wholesale negativity when it comes to the gold market. It doesn’t matter what it is, anything related to gold and silver is almost persona non grata within the investment community.

I spent some time with an asset manager two weeks ago who manages about a billion-and-a-half in assets, and he said, “Do you think I should have 50 basis points, a hundred basis points, allocated to gold?” For him, that would be a first move. He hasn’t really considered owning any gold, and that would be a big move for him – 50 basis points.

Kevin:Which is half of a percent, or one percent.

David:A half percent allocation, yes. Again, it’s that the whole Wall Street world has come to view it as irrelevant. What is relevant, going back to Howard Marks’ thought that I mentioned earlier, is that you bet on things that have gone up a lot, and you assume that it is going to continue that way. Mark’s point was the opposite. No, the big money is not made in the investment world. The dependable money and the safe money is not made following those trends.

Kevin, one of the hardest lessons I ever learned as a young investor was using a third-party asset manager in the year 1999 and the year 2000. This was before I joined Morgan Stanley. Actually, this was one of the catalysts for me joining Morgan Stanley. Inside Capital was a momentum trader, and they did so well in 1999, so well in 1998, so well in 1997, that as a young investor I thought to myself, “Why would I use someone who has only made 20% this year when Inside Capital is up 60?

Kevin:You have those positive chemicals flowing in the blood.

David:I did not respect the turn-around time and I got my butt handed to me in late 2000 with that portfolio being down almost 70%. And I thought to myself at that point, “There’s a lot of things that I don’t know that I want to know, that I need to know, that I’m going to know.” That’s when I went to work for Morgan Stanley because it was my expression of, “I will know, and I will master this trade.”

Kevin:You tell the story, Dave, that about that time you also were reading Barton Biggs who was a Morgan Stanley broker, but he mistrusted the market because he also understood history. He wrote a wonderful book at the time – Wealth, War, and Wisdom. You were reading his in-house reports and they didn’t represent what the rest of the guys were talking about. During the tech stock bubble he was actually writing reports saying, “You know what? I think it’s about time to buy gold and maybe sell some of these stocks.” You took his advice and sure enough, that paid off.

David:That was a long time ago and it was kind of an insider note to the staff at Morgan Stanley. He mentions this crazy derivatives trader, Peter Palmedo, who left the firm in the 1980s after shorting the market with everything that he could muster, every dollar he had and every dollar he could collect from friends and family.

Kevin:Didn’t he short just at the right time before the 1987 drop?

David:He shorted it in 1987 and retired to Sun Valley. The point that Biggs was making was, “It’s probably time to get in touch with Peter, if you’re crazy, if you’re stupid.” And it was funny how he couched it because he didn’t want to take responsibility for the recommendation, but he was saying, “He’s pedigreed, he’s one of us. We thought he was nuts at the time and he was right. We still think he’s nuts and he may be right.” He started Sun Valley Gold which is sort of a fund of funds for institutions to invest in mining companies. Peter Palmedo is an interesting story for me because he helped bridge the gap from working at Morgan Stanley to coming back and working with our precious metals company here in Colorado.

Kevin:And probably the only reason Barton Biggs could actually send an inter-house memo like that was because he was nearing retirement and he was highly respected, otherwise Morgan Stanley probably wouldn’t have been talking about gold. But let’s go back to the gold market because you mentioned it a little bit earlier. Let’s talk about just the market right now. People are writing in saying, “When do you think the price is ever going to go up?”

David:Right. And there is a part of me that cares about that and a part of me that doesn’t care at all. I’m a long-term holder and investor in gold. The issues which inspired a very significant allocation to metals for me in 2001 and 2002 and 2003 remain the same today. In fact, they have increased in terms of severity and scale.

Kevin:And you treat it differently. You actually have a goal of how many ounces you want to own in your lifetime and pass on to your family.

David:Right. So long-term I’m very bullish on gold and silver, and I add routinely to that lifetime ounce objective. And so, in part, I’m doing that because I assume that there is a retirement income enhanced by Social Security which is going to be meaningless to me when that day arrives because that system, the social safety net, is broken, and at this point I think it is beyond repair.

But my penchant for saving for retirement, and frankly for other future legacy objectives gets channeled into what I view as a reliable currency, a currency which is positively impacted, not negatively impacted, by the arbitrary choice of targeting devaluation. That’s the way I see it. When the Fed says we’re targeting an inflation of 2% I say, “You’re devaluing by 2% a year and we’re supposed to be happy about that?” That’s their inflation target.

But what bothers me is when gold breaks below technical support. It bothers me like it probably bothers a lot of people. Price action has gone down. What do you think? It broke below $1240 and I first experienced frustration by a trend that has been down since 2012 and I wonder how low it can go. $1200? $1150? These are just meandering thoughts, of course, and emotions, because it is never fun to lose money, but it is fun to make money.

Kevin:And there is the benefit of having a family and a company that has been in the business – this is the fifth decade of business – and so when you look at that and say, “How many times has this happened, and where did gold start when the company started?” Gold was $35 an ounce when this company started. When I first started here gold was about $300 an ounce. Now gold is $1200 an ounce. Is anything actually really happening here long term?

David:It’s preserving purchasing power through time, which is my desire, and at some point, at punctuated points in time when other assets are cheap you spend your cash. You spend the currency that you’ve hoarded on things that represent a compelling value. So short term, there is that question – how low can it go? But long term, there is the same question but on the opposite side of the equation – how high can it go?

When you have hundreds of trillions of paper promises which have been made globally, with zero intention of payback, when you have tens of trillions or more in money that has been leveraged off the asset base created by the central bank machine, and then you add to that derivative investments and the products related to derivatives which dwarf the underlying assets which support them, and then you weave in the component of politicians predictably playing for their incumbent position, and they will do that at any price, and they’re playing that through the currency markets and devaluation, that’s one tool, but it’s a predictable tool, you come back to how high can it go? How high can it go? I think it’s far higher than market participants can imagine today. I don’t know that my dad, when he started our company, had the imagination for seeing gold at $2000 an ounce off of $35 an ounce.

Kevin:Or even $1200. What if we were doing a Commentary back in the early 1970s when your dad started this, and we said someday gold will be $1200 an ounce? That didn’t even seem realistic then.

David:Unfathomable. But what makes the gold market particularly powerful, more powerful than the traditional stock and bond markets as they grow, is that a bull market in precious metals is driven by both greed and fear. And once you’ve seen it – once you’ve seen that dynamic of both coming into play, you’ll never forget it. But there is the current price action which is hardly encouraging if you’re timeframe for selling is today. (laughs) That’s just a reality.

Kevin:To be fair to the family members I was with, a lot of these people own gold and understand the other side. I think we all have two personalities. In a way we have – I’ll call it healthy schizophrenia, it’s not the kind that is out of control. But there is a part of us that really wonders if we’re right every day. And we do go through this, “Am I right or am I wrong? Am I missing something?” And then the other side of us actually looks back at history and says, “Well, it must be right, and we have to do the right thing.” Again, I don’t want to take a shot, I was just listening to the general consensus and there is such a euphoria right now about Trump’s success that it’s easy for that one personality to start questioning the long term.

Now, let’s go ahead and look at the gold report, though, because it’s not just people that are in our sphere that we’re talking about. The World Gold Council report said that demand for gold has been falling.

David:Yes, and that is, of course, the second quarter of the year. Their report looked at the most recent quarter and disappointing demand in the second quarter was on the heels of a rather impressive demand dynamic in the first quarter. So there is good news with the bad. The good news is that the consumer, who is the buyer of jewelry, the largest component of gold consumption, tends to enter the market en masse when the price is low. So the largest consumption demand increases when the price gets cheap, and they like to buy a bargain. We’re now in the consumer sweet spot between now and October, if you’re looking at the seasonality of gold, seasonally speaking. From that standpoint you have the Chinese and Indian buying patterns which influence the two primary upswings through the year.

Kevin:That’s an annual thing that we see.

David:That’s right. The wedding season in India drives consumer purchases on a predictable seasonal basis and the Chinese New Year does, as well, there in the first quarter. So put in terms of quarter, the first and third are typically the strongest for gold, driven not by the investor, but by the consumer demand. The second and fourth quarters are typically the weakest, and we’ve just finished the second quarter.

These consumers are the base of buyers that drive the price, year-in and year-out. They are the ones that create seasonality. The investor demand component tends to exaggerate whatever trend is in play, negative or positive. It is what we have always called the swing vote in the markets. They are the ones who are making prices either higher or lower at the margins.

Kevin:The World Gold Council does believe that consumer purchasing will rise in quarter three, do they not?

David:Oh, they’re very bullish on Q3 for the gold market and they point out that the futures market is positioning for a significant move higher, where you have speculators who are more short in the gold market than they have been since, say, the first quarter of 2016, the last quarter of 2015, when gold was making its turn at $1050.

So what are they looking at? They’re looking at the positioning of the commercials and speculators suggestive of a shift in price to higher levels. They’re looking at global inflation targets being met and surpassed, and their argument is that any number above 3% inflation and you start to see a migration within the investment community toward gold doesn’t really impact the consumer demand but it does bring the investor in. And it is worth noting that you get hedge funds and large speculators which are positioned short gold today.

Kevin:Aren’t they usually on the wrong side of the trade in the long run?

David:When they aggregate and you can see the numbers at an extreme, yes. So they are as short as they were December of 2015.

Kevin:Which was the bottom – $1050.

David:That’s right. So trend and momentum – that’s what it is – it’s trend and momentum following, which you see expressed in those large speculators. They typically concentrate their bets right as momentum shifts, and that concentration of short bets is on display already. There is another category of demand which is your central bankers.

Kevin:Let’s look at that, because you have governments – Russia just sold a bunch of treasury bills and bought a bunch of gold. And I know the central banks are pretty much continuing buying their gold at about the same pace that they have been.

David:Right. So amongst some of the largest players in the universe, the central bank community, you’re seeing an interesting shift from U.S. treasuries, and positioning in U.S. treasuries, reducing that and increasing ounces within gold. Russia comes to mind, Turkey comes to mind, Germany comes to mind. These are all countries that are reducing their treasury exposure and increasing their gold exposure. We know that the Chinese have reduced their treasury exposure, as well. They don’t disclose their gold acquisitions except on a delayed basis, typically two to three years delayed, so it’s sort of the great leap forward when they ultimately do disclose.

Kevin:So if we were to repeat, things that have gone up versus things that have gone down – Howard Marks was saying the real money is made when you buy the things that have gone down, not the things that have gone up.

David:And assume that they are going to continue going up.

Kevin:Exactly. So what would you categorize as things that have already gone up?

David:I would put stocks in the category of things that have gone up, a lot, already. Gold is in the unloved category. As recently as 2012 – just roll the clock back a few years and see how this is really all about human psychology and people unable to help themselves do the right things at the right time. Barron’smagazine runs an article on gold in 2012 saying, “Everybody should own it. It’s the most reliable investment that you can own.”

Kevin:That’s when gold was hitting $1900 an ounce.

David:That’s right. And you have a 12% per year track record over the last decade. And it’s difficult to argue with the track record, except that when you get too many people involved in any one asset class, when you get a clustering of people into that asset class, you ultimately run out of buyers and the price has to go the other direction.

So as recently as 2012 you could have said the opposite, that gold was in the category of things that had gone up a lot, and stocks were in an unloved category. Are you comfortably contrarian? Well, I’ll tell you from personal experience, it’s hardly ever the comfortable thing to be.

Recommended Posts

Start typing and press Enter to search

mcalvany weekly commentary