The McAlvany Weekly Commentary
with David McAlvany and Kevin Orrick
“In today’s show, U.S. investors are piling into a historically overpriced stock market just as the rest of the world is spiking demand for gold. Also, is the gold and silver ratio suggesting an increase in allocation to silver?”
– Kevin Orrick
“You want to double the amount of gold in production? This is not like running an extra shift at the manufacturing plant and cranking out more widgets. You can’t get it out of the ground to meet supply. So what happens? It triggers a massive increase in price. We’ll talk about this more as this unfolds in 2017 and 2018, but I think that is exactly what we have in front of us.”
– David McAlvany
Kevin: I was excited yesterday, Dave. I got my Legacy book from Amazon. Obviously, I had read the book, the pre-reader copy, but I ordered my copy from Amazon and it had been on pre-order, so I would guess that a number of people who pre-ordered the book received their book yesterday.
David: And I don’t know why it still says “back-ordered” or “out-of-stock” because they have thousands of copies, and they are shipping them out as we speak.
Kevin: I think you printed thousands of copies at this point. But now, you’re just getting back from a fascinating interview with a person that a lot of people know, a lot of people listen to, Dr. James Dobson, on Family Talk Radio. I believe that will be aired in less than two weeks on February 27th and 28th.
David: That’s right. I know him because his books were a part of my childhood. At least three or four of them have been interesting in terms of the insights they have offered to raising boys, raising a daughter, having strong-willed kids. As a child psychologist, he has shed real light in terms of family dynamics.
Kevin: He has written a book about legacy. You guys are on the same page, talking about looking forward into your family, and actually, looking almost into a forward form of history.
David: That’s right. And so what we got to do in both of those shows is kind of explore the content in the book that I just finished, which is The Intentional Legacy. It was a great conversation and just sort of expanded a little bit our thinking in terms of the importance of it – why it needs to happen, and sometimes why it doesn’t happen.
Kevin: You were sharing a conversation that you had between recording the two programs about legacy as far as monetary value. We know legacy as far as the family value. You addressed that deeply in the book. But as far as money, money can sometimes can ruin a family. I think it might be worth addressing that a little bit because money can either propel a family forward or it can destroy it.
David: Or repel them from each other. I think one of the stories that I liked in the exchange with Dr. Dobson was a few shares of Coca-Cola which were gifted to Myrtle, his mother, by his grandfather. Those dividends from the Coca-Cola shares kept their family fed and alive through the Great Depression. When his mother was in her 80s she actually was still receiving dividends from those Coca-Cola shares. They had increased in value, there had been a number of share splits, and her assisted living needs were still taken care of by that original gift. It makes me think, there is a forward-thinking man who took care of future generations and needs yet unknown.
It has to be done carefully; it has to be done deliberately. I just think that there are many areas of neglected value, and this is one of the things that we were really discussing in the interview. The neglected values in our day and age are not the dollars and cents, the shares, or what have you. The neglected values are forgiveness, grace, creating an environment where conversation occurs on a consistent and regular basis, where family members can be on the same page, so that when it comes to the dollars and cents…
Kevin: You’ve already laid the relationship groundwork.
David: That’s right, and that relationship groundwork speaks to, again, neglected value and neglected values. Now, honestly, one of the things I really want to talk about today is where the greatest value is being neglected in the financial and monetary world today. We think of money, and we think of them as greenbacks, or if you are from some other part of the world it’s a different color, it’s a different shape, but all of them are paper.
Kevin: Or an electronic blip on a screen. The younger generation doesn’t even think of cash anymore.
David: And the definition of money, which is very simply a medium of exchange and a store of value, has been shifted, because we still maintain the medium of exchange, part of the classic definition, but we have dropped the store of value part. This is where, again, I think gold is a currency. Gold is a currency with no liability associated with it.
Kevin: Let’s stop there for a moment, because we’ve shifted. You’re talking about it being a medium of exchange and a store of value. Well, it can’t be someone else’s liability if it’s a store of value. Right now, Americans are using a U.S. dollar that, if somebody says, “What is it backed by,” the only thing you could say is, “Well, 20 trillion dollars’ worth of debt, plus the promise that they’re going to print more.”
David: And the guarantee that they can increase taxes if they run out of money. So, we do have this under-appreciated point that gold is a currency and it has no liability associated with it. And at this point the world, while it appears stable – again, I emphasize, appears stable – I think this is an under-appreciated aspect of real money.
Kevin: People look at gold sometimes and they will say, “I’m just treating it as another market. Is it going to rise, is it going to fall?” And they’ll trade in and out of that market. There is nothing wrong with that, but there is a portion of a portfolio, Dave, both you, your father, the associates here who have thousands of clients out there – we’ve all recommended that about a third of a portfolio be laid as a foundation, like a foundation of a house, not worrying about whether it is rising or falling, but actually just preserving.
This goes back to the legacy. The foundation of a house – you can build many houses on the top of the same foundation, and I can tell you, after 30 years of working with the family, I have had parents that I have worked with that have now passed on, and they have given that gold to the next generation, and we’re teaching that next generation how to give that gold to the next generation. And so, talk about the preservation aspect, and then I’d like to go into the market aspects of the possibility of it actually rising.
David: I think one of the reasons why gold is not front and center in conversations from one generation to the next is because it is neglected. Precious metals, in general, are neglected in proportion to the confidence that people have in the system, whether that is stocks, whether that is the current definition of money, whether it is the Ph.D.’s that are leading the charge as technocrats, be that in Washington, D.C., or on Wall Street.
Kevin: Right. They manage the perception of complete control.
David: And so, to the degree that confidence exists, it is something that is not needed as sort of a rock solid basis for wealth building and accumulation. So it ends up being a neglected element in conversation from one generation to the next because, quite frankly, it falls in and out of popularity, and it falls in and out of seeming importance. Because again, we’re dealing today with the appearances of stability. We have stocks reaching like trees for the sky, and you would say, in that context – “Why?”
Kevin: I read something yesterday that just shocked me. I was telling my wife this last night. I said, confidence in the stock market right now, and in the economy, is at an all-time high amongst Republicans. And it is at almost an all-time low amongst Democrats. One side or the other is going to be right, but we’ve talked – Donald Trump is inheriting a stock market that is hitting all-time highs. The Americans right now are a little bit confused, but if you look at what is going on worldwide, if you were sitting in an emerging market right now, or in any other market other than America, you’re buying gold and you’re getting out of paper.
David: Right. So, let me be very clear. The main topic that I want to cover today is gold – why, and what to expect. I think a combination of, first of all, the emerging market pressures, and second of all, the domestic or U.S. demand for gold, together, will raise demand for gold globally, which is likely to drive the price nuts, even in the face of a strengthening U.S. dollar in the years to come. There are reasons to believe that we will see a strong U.S. dollar.
Kevin: The emerging markets are already there.
David: Right. We have the first element already in play. The second, that of U.S. demand, or domestic demand for gold, is likely to be triggered by financial market concerns, which admittedly are non-existent today if you were looking at the mainstream media’s presentation of the facts. We’ll cover that when we talk about sentiment numbers in a moment. Citi Group’s currency and gold analyst, Willem Buiter, said this last week, “Trump probably would do better to look at basic economics of exchange rates. You cannot have anticipated fiscal expansion, and anticipated monetary tightening while the rest of the world, by and large, is in a monetary loosening mode and still expect your currency to weaken.”
Kevin: Yes, because their weakening their currency quicker than you can. Even if you were trying – even if Trump tried to weaken his currency, the rest of the world at this point is just – it’s called loose policy.
David: This goes back to a topic we have spent quite a bit of time on. Again, if you’re dealing with fiscal expansion and monetary tightening at the same time – those elements – it is impossible to expect a weakening currency, because of the knock-on effects in the foreign markets, because when you start tightening monetary policy here, you are going to see an increase in flow into the United States. Tightening monetary policy here means an increase in interest rates, which makes our bond market more attractive, relatively speaking, to the rest of the world, and puts currency pressures on the emerging markets.
Kevin: One of the promises that Trump made was to basically decrease the trade deficit that we are running with other countries, which puts them at a surplus. So the U.S. current account, which has to do with those deficits and surpluses, the current account is going to shrink.
David: Right. So, if the U.S. was not already involved in the global currency war, we will, under Trump, be asserting our role as sort of the superpower in the conflict. And you’re right, shrinking the U.S. current account – I want to repeat this like a broken record until its significance is just flat obvious – shrinking the current account is the most emerging market disinflationary event imaginable. The U.S. dollar liquidity, which has fed growth in the emerging markets for the last 15 years, is what gets taken away.
Kevin: It’s like shutting off their air supply, putting a hand over their mouth and they can’t breathe.
David: You take away the liquidity and you get a significant emerging market crisis. We’ve seen those kinds of emerging market crises in Asia in the late 1990s, in Mexico in the mid 1990s. And it’s pretty consistent, you start tinkering with the current account and there are knock-on effects. A significant emerging market crisis – what does that reinforce? It reinforces currency pressures, that is, downside in your emerging market currencies. And it exaggerates demand for U.S. dollars. When you have exaggerated demand for U.S. dollars, it increases the U.S. dollar exchange rate. And this is a classic negative feedback loop – higher U.S. dollar values relative to other currencies reinforce the disinflationary trend abroad, and again, that serves to increase the U.S. dollar value in the foreign currency markets. So again, if that sounds circular, it is circular, not in reason, but in cause and effect. And there is that knock-on effect. To the degree that we continue to see this goal of shrinking or elimination of the U.S. current account, guess what you have? Major emerging market crisis.
Kevin: Let me throw an aside in. Sometimes people think a strengthening dollar means their dollar buys more. That’s not the case at all. We could have a strengthening dollar and high inflation here in the United States.
David: A strengthening dollar does increase your buying power in terms of imported goods. But here we have the stated objective, again, of increasing U.S. jobs, increasing U.S. manufacturing, and increasing exports, as well as the products that are manufactured and bought here domestically, which, a U.S. dollar doesn’t really help you with a number of those things.
Kevin: Let me challenge the model a little bit because there is something that is replacing people all over the world, and it is a scary phenomenon. It’s going to happen. What about robots, because anything that you can repeat over and over, including orders from a Wendy’s restaurant, can actually be turned into an automated process.
David: I felt like there was a gaping hole in our conversation a few weeks ago because this is a really critical thing. Something we’ve left out of the conversation is that the vast majority of lost jobs in the U.S. manufacturing space have not been lost to overseas workers, but have been lost to robots. We have technological innovation and productivity improvements which are a massive factor to consider, and I think supersede “off-shoring.” Because if the idea that Trump is fighting for is to bring U.S. jobs back, put that in reverse you’ve got now on-shoring, and that is to bring jobs back into the manufacturing space, Kevin, many of those jobs simply don’t exist anymore.
If you look at labor cost reductions, it is sort of two parts wages to four parts automation. So yes, there is some marginal benefit to moving plants overseas, but quite frankly, you have automation in overseas plants, as well. So what are you bringing back, exactly? This is a real estate deal, if anything else. Bring the plants back, build the plants here, but guess who is not going to be staffed? Hundreds of thousands of formerly employed U.S. manufacturers. Why? Because again, automation has been with us since, really, the year 2000.
Kevin: So even though some jobs may come back to the United States, it’s the amount that is being counted on, especially having to pay workers in U.S. dollars at U.S. wages. It’s going to be a robot.
David: That’s why we said last week that we would expect anything made in the United States and consumed in the United States to cost five to seven times the amount, as compared to manufacturing overseas, because the wages that are involved, even when you assume that automation makes up a lot of the work flow, are considerably higher.
Kevin: And you’re still seeing the U.S. dollar strengthening. I remember when we talked to Russell Napier just a few weeks ago. From an outsider’s point of view, someone sitting in Scotland looking at the world markets, he expected a strengthening dollar. Now he expected strengthening gold at the same time, and that’s what I want you to address. For the U.S. dollar, weakening is not really an immediate possibility.
David: Just before we move on to that point, it is an important one. But I think, as parents, as grandparents, it is really necessary for us to think about this changing world of automation and technology, because quite frankly, if any repetitive task can be done more cost-effectively with a machine, that trend is going to displace working people in the future, as well. So when you’re sitting down with your son or grandson and you’re trying to give them advice, it’s going to be a totally different set of advice today than it would have been 20 years ago.
You can’t read the book, What Color Is Your Parachute? and expect to land firmly on terra firma in a job that gives you security for the next 20-30 years. Again, I think it is important to think about what is changing. We have many benefits from technology, but as you’re counseling people in your family, recognize that there is going to be a lot of job obsolescence over the next 20-30 years.
Your point – back to Willem Buiter’s comment and the U.S. dollar. The U.S. dollar weakening – it’s not an immediate possibility. It’s not an immediate possibility if, on the one hand, you have fiscal spending, and on the other you have monetary tightening in play. You have to watch out for emerging market pressure. Where does that pressure show up in terms of market pricing? It shows up in emerging market bonds, it shows up in emerging market currencies first. And really, first and foremost, because if you do have much of a devaluation trend continue in the emerging markets you could actually see some benefit, some upside, in emerging market stocks.
Kevin: What about the stock market?
David: Yes, and I’ve heard the saw so many times, that on a relative basis, your emerging markets are much cheaper than the developed markets. And that is true, but there are some factors, like trade wars and currency wars (laughs) that can make cheap, cheaper still.
Kevin: Let’s go back to gold for a moment then, taking this into consideration.
David: Well, right. There is this final conclusion, which is that demand for gold has already begun to reflect overseas traffic. Again, we’re talking about something that is already occurring in terms of emerging market stress and emerging market economic decline. And as people anticipate trade wars and tensions with the United States, looking at the cabinet that he has, that is, that Trump has put in place, we have folks overseas who are getting nervous, and gold demand is likely to step up, on a continued basis, overseas. But again, back to that second point, I think it is also likely to step up in the U.S. Why? Because U.S. equities, I think, are imminently to come under pressure.
Kevin: Wouldn’t you say the United States is just amazingly distracted at this point? We never let the election actually finish. We were distracted for about two years as we moved into it, and then Trump taking over, actually, was such a surprise that the distraction has continued. So, U.S. investors – no wonder they’re not buying gold, they’re watching the news. I know when my wife calls her parents – I asked her father the other day, “What have you been reading?” He is retired and he loves to read, so he always has three or four books that he has read by the time I talk to him. He said, “Oh, I’m not really reading right now. About 80% of my time is spent watching the news.” Why? Because they’re distracted. They want to know what the next thing Trump is going to say. Whatever comes out of his mouth, it’s entertaining. Right now, the rest of the world is nervous.
David: That’s right. And that’s why the last 100-dollar improvement in the gold price has been attributable entirely to overseas buying, because U.S. persons are very intrigued by the Dow above 20,000 and not very intrigued by anything else, which just speaks to our ability to sort of contextualize and interpret information.
Kevin: How many times, Dave, since you’ve been born, has bullish sentiment been high, like it is now, right before a major crash?
David: Investor Intelligence Advisor Survey has positive or bullish sentiment at the highest level since 2007.
Kevin: Well, does that ring a bell? 2007?
David: That was the market top, and it’s not a coincidence that the Dow is at extremes at the same time you look at the Dow-gold ratio, you’re sitting at an extreme counter-trend level. What do I mean by counter-trend? Because that trend has seen a shrinkage in numbers from 44 down to 6 circa 2011, and we’re back around 16. So you would expect with softness in the gold price, and strong pricing in the Dow, to see that number have given some ground back. And in fact, the Dow-gold ratio has.
Kevin: I want to go into detail on that a little bit later, because it can be sort of confusing, but there is a counter-trend any time you have the Dow-gold ratio go from its high down to, say, 3-to-1, 2-to-1, or 1-to-1. There has always been a counter-trend at a top.
David: Although we never did get that low. We got to 6.
Kevin: We got to 6. We’re not there yet.
David: That’s right. I think, unfortunately for Donald, he is inheriting a stock market which is similar to Hoover’s. Hoover was considered a shrewd, business-minded leader. But honestly, his timing couldn’t have been worse, to be caught holding the bag in 1929. It was not Hoover that created the Great Depression, it was Hoover who was forced to deal with what was given to him. He inherited an over-leveraged system. He inherited a stock market that had been priced for perfection. And even though he had business acumen, do you know what he was able to do with the chaos that the market threw at him? Zip, zero, zilch. Nothing. There was nothing that he could do because, quite frankly, the man in the Oval Office does not determine the direction of the market or the economy.
Kevin: Right. And he inherited the reputation of just a buffoon, when actually, that wasn’t the case at all. Now, something that has occurred, Dave. 1987 was my first year here. Something that was occurring at that time, that occurred in 1999 before the crash, that occurred again in 2007, is the mutual fund management community feels tremendous pressure when things are so bullish to have cash sitting in an account. You know this yourself as a money manager, to have cash sitting in an account is almost heresy. And so what happens is, the mutual funds, instead of their cash being 7%, 8%, 9%, or 10%, it whittles down to 5%, 4%.
David: That’s right.
Kevin: And if it gets down into the 3s, it’s always a crash because they’re out of cash. There is nothing left to spend in the market.
David: Well, they’re job is on the line, if a mutual fund manager isn’t keeping up with the competition, and they’re constantly being harangued by clients who say, “I’m paying you for what? Why is cash on the sidelines? I thought your thematic was to be fully invested in this, that, or the other?” And so, what happens is, as prices rise, again, more money gets pumped into the market. Ergo, we have a cash-to-asset ratio at mutual funds at a record low. We have that today. It was Stephen Hochberg and Peter Kendall’s recent research where they pointed out that 1973, as the stock market peaked – again, roll the clock back to the early 1970s – the stock market peaked and the ratio hit a low of 4%. That’s 96% invested, 4% in cash. There is a huge disdain for cash at a market peak.
Kevin: Yes. Why own it?
David: And this time, the same coincidence occurred in the years 2000 and 2007. Stock prices reached what, in retrospect, where unsustainable highs, and where was the cash-to-asset ratio? Sitting at 4% in the year 2000, similar to where it was in 1973. And then, for the first time it reached 3.5% in 2007, and that was, again, as bullish enthusiasm was blinding investors to risk. What they were preferring to focus on was the possibility of greater and greater reward.
Kevin: Well, where are we now?
David: Now, 2017 rolls around and we’re at 3%. Just to reiterate, what followed these low readings of cash with mutual funds, the cash-to-asset ratio, was a consistent move 48-58% lower in equity prices. I don’t hear warnings from Wall Street. I don’t hear caution from the business news outlets. What I hear is cheerleading for Dow 30,000. Amongst the many neglected, but relevant facts – what the news media loves to do with those is just kind of sweep them under the carpet.
Kevin: One of the things you look at to see if the economy is actually supporting it is just how much of it is coming in in tax receipts.
David: Tax receipts. The total federal tax receipts year-over-year have declined for the first time since 2002 and 2009.
Kevin: Those were recessions.
David: That’s right. You have individual tax receipts, also, which have slid, year-on-year. We have corporate tax receipts, which fell 12.4%, according to Meridian Macro Research. Only with non-GAAP earnings can investors remain enthusiastic with corporate financial performance, but if you’re looking at things – again, what is GAAP versus non-GAAP? Generally Accepted Accounting Principles? Non-GAAP is, how do you fudge the heck out of the numbers and tell whatever story you want so that you keep the investment parade going a little bit longer? That is what non-GAAP means.
Kevin: That’s perception management – again.
David: But on a GAAP basis, corporate America is in a 24-month systemic decline. But again, we don’t report on a GAAP basis anymore because bad news bears come out and now you have to give them air time, too, and that’s not what you want, to sell product and sell advertising.
Kevin: Well, yes, Dave. The Dow is up. Stop talking negative.
David: The Dow is up, so who cares about corporate taxes? But think about this. Think about this. If corporate America is on the mend, the one place you don’t want to be caught lying is with the IRS. Tax numbers are kind of important, and they kind of tell you something significant. There are games, and there is reality. But how does Barron’s sort of pretty up this pig? How does Barron’s talk about it? I quote from Barron’s and the article which was pushing Dow 30,000 as sort of the next destination. “Today’s stock prices are well-supported by corporate earnings and economic growth.”
Kevin: But what you are basically saying is, it is possible that we could have a 48-58% drop in the stock market, given the numbers you’ve talked about. Dave, you’re talking about a 10,000 Dow, not a 30,000 Dow.
David: For the uninitiated, a 48-58% decline – that’s a crash. That’s a crash. And that does imply a move to 10,000 on the Dow. That’s not out of the question. And you have to have buyers to drive prices higher.
Kevin: Right. And the mutual funds are out of money.
David: That’s right. So when you run out of buyers, you run out of price improvement, you run out of momentum. So you know what we’re doing right now? All we’re doing is counting the last buyers in. Does that happen this week, does that happen next month, does it happen three months from now? Oh, that I don’t know. I don’t know. But I can tell you that mutual funds are all in. They’re all in. And in a game of poker, when everyone is all in, that’s it. You’ve got to show your hand.
Kevin: The other thing that it causes is, there are no buyers as it falls. It forces more liquidations of stocks when something like that happens and there is no cash in the market. These mutual funds can’t go in and bargain hunt when the market does go down. They are eliminated as a market-saving mechanism.
David: Right. So when sentiment in stocks is strong – and I think this is the key take-away for the second point in terms of why gold, I think, is going to do very well in the next couple of years – when sentiment in stocks is strong and price action is positive, demand for gold in the U.S. is relatively low, particularly amongst the public. But the opposite is also true. You see a snap in sentiment, you see a change in confidence levels. And guess what happens? People start looking desperately for alternatives.
Kevin: Dave, you, for years, have recommended people not necessarily look at the Dow in dollar terms, because the dollar can be printed. We talk about the dollar going up and down, over time the dollar devalues. But probably the best measure of the Dow, and one of the better measures of gold, is to put the two together. It’s the Dow-gold ratio. You were talking about an interim peak on the Dow-gold ratio, and now as it drops – and this is sometimes backward thinking – but keep in mind, as the Dow-gold ratio drops from where it was 44-to-1, all the way down, say, to 3-to-1, 2-to-1, or 1-to-1, as it is dropping the price of gold is rising relative to the Dow. In other words, how much stock can an ounce of gold buy?
David: Think of it as a measure of market preference – a preference for paper versus real assets. There are times in history where there is definitely a preference for paper, and stocks will do very, very well. And you think, “Okay, well great, that would be right now, correct?” We’re at all-time highs. And there should be less of an emphasis on real assets in that kind of timeframe. But the ratio tells you a very different story. It tells you a very, very different story.
And if you want to know where we are on the continuum, as an investor, where we are circa 2017, it’s very important that you pay attention to the ratio. The ratio implies that Mr. Trump is coming in at a counter-trend extreme with a number – again, the Dow-gold ratio, dividing the Dow by the current spot price of gold – it’s about 16.5. Now, where is the spectrum? The full spectrum is 1 on the low side and 44 on the high side – 6 was the number we reached in 2011 – 1 or 2 is what we anticipate over the next three to five years.
Kevin: That’s where the big move actually happens.
David: Absolutely. Trump comes in at a phase where the ratio is actually kind of on the other end of the continuum, say, in contrast to where the Reagan era of policy and politics…
Kevin: Reagan came in a 1-to-1. He couldn’t lose. At that point, the stock market has to go up relative to gold.
David: That’s right. Reagan emerged as president with the Dow-gold – let’s say it was 2-to-1, followed by that extreme which was set at 1-to-1. And as we’ve said before, Reagan emerged a little bit like Erdogan in Turkey. When Erdogan came in to power, the lira was at a low, stocks were at a low, the economy was on its back, and Reagan shared that kind of common thematic. He came in at a pivot-point for everything. He came in at a pivot point for stocks – bear market lows, and ready to turn higher. The bond market was absolutely in a crushing era of high interest rates. And the value of bonds had been squeezed to virtually nothing. The dollar, and in this case gold and its ratio companion to the Dow – all these things were in flux. He came in at a pivot-point. But Trump comes in at the opposite extreme, the other end of the spectrum. Look at bonds, look at stocks. Certainly the ratio between gold and stocks is not at 44, where it was in the year 2000, having retained most of the progress since that time. Think about that. The Dow is at all-time highs, and we should see gold, a completely worthless asset, on its butt. And where is it instead? No, it’s not at 44-to-1. The ratio is not at its all-time highs, along with the stock price. It’s at 16-to-1. This is very key. This is absolutely critical. Study the relationship and it will tell a more important story than the nominal value of the Dow. In essence, the Dow, even though it is at all-time highs, in real money terms, that is, gold ounces, it remains 62.5% below its year 2000 levels. Let that sink in.
Kevin: Yes, Dave, the positive sentiment, if you were to weigh things out right now, is still in the stock market.
David: And what is that based on? That is based on some sort of a fantasy, some sort of a chimera. Trump made the political freshman’s mistake of claiming responsibility for this last step move, and getting enthusiastic about getting past the 20,000 mark, because remember, before he was elected he was describing the stock market as a bubble. And now that he is president – we kind of talked about this before the election – he’s got to own it, and he is going to go from being critical of the Fed to being dependent on the Fed, because guess what happens if the bubble bursts on his watch?
Kevin: The likelihood is, he’ll be holding the bag, and the mainstream media is going to be waiting for him to fumble.
David: Well, isn’t that right? I’m sure the mainstream media will treat him kindly, don’t you think? I’m sure that fears of further decline won’t be like flames fanned by an ingrained media bias. That’s where, if you want to see rabid dogs feeding on flesh – Trump unfortunately set himself up for that. If prices are not maintained at high levels in the Dow he is going to be criticized for the stock market collapse because he already took credit for the stock market “Trump effect.”
Kevin: Another ratio that we watch very closely is the silver-gold ratio. It’s not just when to buy silver, or when to buy gold, but a lot of times it actually tells us where we are in either a bear market or a bull market in gold and silver in general.
David: I’m running out of ounces at home. I generally keep 20-30 ounces there, and the kids love to spend their allowance filling their own treasure boxes with ounces of silver. And there was a raid this last weekend (laughs). I had two boys and a girl saying, “Well, what’s the price?” And of course I have some sort of a matching program where they actually are buying at a discount. It’s the best deal in town. The day they buy silver they automatically have a 100% gain. It’s kind of cheating in terms of teaching your kids about the value of money and investing, but they’ve figured it out.
Kevin: They’ll always remember the matching program from Dad.
David: That’s right. An allowance is actually a 2-for-1 special if you put it into gold as opposed to buying bubble gum or Legos. But watching the silver market – and I sometimes tell them about this, which may be why there was a run on silver – silver broke the pattern of lower lows and lower highs, if you’re looking at a silver chart. In other words, it’s starting to move up out of its recent four to five-year downtrend. So that’s a positive sign. You also have the gold-silver ratio, which has long been stuck above 70, and it is on the verge of coming back to life, implying that you have out-performance in the white metal.
So translate this. If growth is your game, then silver is a more attractive play than gold. Seeing the ratio move back into the precious metals bull market range of between 40 and 60 on the ratio, what does that tell us as practitioners? What that tells us is that we have a confirmation of a multi-year move higher in the metals. Current level 68½, and as you’re watching the ratio get closer to 60, I say consider a reorganization of a metal’s portfolio from under-allocation of silver to at least equal allocation to that of gold.
Kevin: I think that is important to note. You don’t sell all your gold, necessarily, but you swap some of your gold into silver at this point so that you can go back into far more gold when you get down into that 40-to-1 ratio or 30-to-1 ratio.
David: This range is really important. It was Ian McAvity who was always fond of the chart contrasting the trading dynamics of these two precious metals. In a bear market, whether it is a secular – that’s a long-term – or cyclical, shorter-term bear market in precious metals – he would say it doesn’t matter. Silver, in a bear market, grossly under performs.
Kevin: As we have seen. Even in this cyclical bear market we saw silver drop from 49 down to 14.
David: 13 and change. So, a blistering pace to the downside, gold gave up the ghost, but not quite the way silver did. In a bull, or growth phase, on the other hand, silver outperforms. So, for McAvity, what defines the transition is whether or not you’re above 60, or below 60.
Kevin: Well, and we’ve got a little bit of a preview, Dave. We don’t have to wait for the metals to do what you’re talking about because the mining shares oftentimes lead the pack.
David: That’s right, and you’ve had silver mining companies which have outperformed. That is, for the last 12-16 months they have been much more beneficial to own than your gold stocks. Being aware of that ratio, it will tell you the power, or lack thereof, of the bull market that is ahead of us. So, again, a drop below 60 – that is, ounces of silver to one ounce of gold – that is a massive confirmation of the trend.
Kevin: Well, and this is a wonderful time to be looking at these things because the Americans – the United States – they’re looking the other direction. Who is really buying the metals right now?
David: Who’s buying, who’s selling? As stocks have motored higher in the post election period here in the U.S., you’ve had the gold ETF, that is, GLD, the most popular one – it has seen 43 tons of liquidations.
Kevin: That’s out of the United States, though.
David: Yes, that’s U.S. investors not interested, in the month of January. So they’re moving out. You’ve had large speculators which have been jumping ship – and this goes to the futures market – they’ve been jumping ship since mid summer. They’ve continued to liquidate through January, the equivalent of 625 tons. Again, this is in the futures market so you’re talking about hundreds of thousands of contracts, not actual physical metal moving. But again, the large speculator and the investor in a gold ETF here in the United States, they’re moving to the exits. So who is it now? It’s the Japanese, it’s the Chinese, it’s the Russians, it’s the Turks, it’s the Germans that are buying. December gold imports into China were larger than in any month over the last three years. You’ve had Swiss gold exports to China, again, going back to December, which were up 400% in December. This was just before the Chinese New Year.
Kevin: It’s amazing the contrast, Dave. Folks in the United States are selling, everybody else in the world is increasing buying.
David: Notice the tone and tenor that Trump has set in terms of global trade. Are the Chinese set on edge, or put at ease, by his commentary. Is a Chinese investor thinking that there is going to be greater global trade and cooperation, or a strain in the relationship, which means that not only is there a problem in terms of product flow and capital flow, but ultimately, maybe even in terms of a flow of tanks and bombs and guns. The way things get resolved, in the final analysis, when you have a financial problem, is somebody starts a war and that distracts the people. And that makes sure that the people who are entrenched in political office don’t lose their jobs.
But back to gold in China, because in January you had Chinese investors who kept on buying the physicals. The export numbers from Switzerland were a big part of that. The import numbers were huge, as well, from a variety of sources other than Switzerland. But then you also have the increase in buying via the Chinese gold ETF. So these might be shorter-term buyers, but nevertheless, here in the early part of 2017 you’ve got long-term investors and short-term investors in China accessing the market. The America-first rhetoric – and again, the potential for a trade war where currency values may be the first casualty – that has a global audience for gold swelling.
Kevin: And it’s not just Asia. We’re seeing European buying right now in the ETFs as well.
David: Yes, the gold ETFs that have seen the largest dollar inflows have actually been in Western Europe, and you had one German ETF which had about 544 million investor dollars come in in one week here in the last 30 days. So you have politics, you have geopolitics. These are, as it turns out, relevant factors that drive the gold investor to shift allocations from cash to gold. And look, we’ve got the gentleman from the University of California Irvine, Peter Navarro, who is now heading up Trump’s National Trade Council, and he is doing a masterful job, stirring concerns both of the Chinese and of the Germans.
I forgot – Japan, we noted this last year – Japan has also been a considerable buyer in the gold market, with an up-tick in gold buying there as money printing… Look at their monetary policy. It’s full-blown reckless. It’s full-blown reckless and desperate. And the average Japanese saver – it has not been lost on them that when a government is buying stocks and bonds and they are the buyer of first and last resort, something is not sustainable, something is healthy, and something will not end well. So, any surprise there that the Japanese are gobbling up gold?
Kevin: We’ve seen the Turks, we’ve seen the Russians, we’ve seen the Indians – they’re buying with both hands at this point.
David: Erdogan has basically said there is a conspiracy by Western powers against Muslim nations, and specifically Turkey. And he points out that the lira, the Turkish currency, which has been in collapse, needs the support of domestic buyers. So if you’re sitting there on euros or dollars or any other currency, under your couch cushions, or under your mattresses, you get it out and, he said, “Do one of two things. Buy gold or buy Turkish lira.” Lo and behold, Turkish gold imports jumped 688% in December.
Kevin: Well, it’s not just that. Look at, even Putin’s country – 200 tons was added to the reserves.
David: Right, but think about this. Turkey is the fourth largest importer of gold in the world and December a year ago – 2015 – they brought in 4.7 tons. Nothing to sneeze at, that’s still real gold, on real pallets, taking up real space. 4.7 tons was imported December of 2015. That jumps, December of 2016, to 36.7 tons, a pretty significant increase.
Kevin: Well, Turkey is a Muslim nation, and a lot of people have looked at the news here recently and said, “Wait. Under Sharia law you can now buy gold.” We’ve discussed this in a couple of Commentaries, but it is important to go back and say, “This represents over a billion people in the audience that can now buy and sell gold in a portfolio, legally, under Shari’a law.
David: Right. So what we’re talking about is the Shari’a policy which impacts around 2 trillion dollars involved in the Islamic finance market, and there are strict laws that apply to be Shari’a compliant, to be consistent with the Koran. And you’re right, this impacts 1.6 billion people, over 100 million investors. As Mark Mobius of Templeton Asset Management, who said, in Dubai, at a gold conference here in recent weeks, “This Shari’a gold standard is a godsend for those Islamic households that would like to invest in gold funds.”
This is a big deal. Mobius is emphasizing the importance of the fact that the new Shari’a gold standard is all about the ownership of the underlying asset. He is talking about allocated, physical gold coins and bars. And it is very interesting, because this was a presentation that he gave over in the Middle East. He said, “Look, it’s pretty well established there is not enough transparency to hold your gold at the Fed or with other central banks. And the Shari’a gold standard is necessary in order to bring transparency required by this particular community because they don’t really want to be gamed.” And you know what? I think that’s pretty savvy.
Kevin: This is an amazing economic phenomenon.
David: It’s the single most important thing that has happened to the gold market in the last 24 months, and yet it’s not getting very much press. Why? Well, it’s latent demand, it’s future demand. And that’s what you were getting ready to say.
Kevin: Yes, any time you add only demand, because this is a market that has been shut out up to this point, in something that has limited supply, you’d better come up with new supply or you’re going to have higher prices.
David: Right. This is where, again, if you’re looking at 2017 and 2018, as a very interesting time, and a very beneficial time to be invested in anything gold or silver-related. This is it. Add to this the supply dynamics you have in the mining space, we are hitting a wall, as we speak. We have 10-15 million ounces a year coming to market in new discoveries. None of those are large discoveries, but if you cut and paste all the little properties that are bringing new product to market, it brings the total to about 10-15 million ounces a year – that’s new discoveries. What do we need to keep up with demand? Oh, only about 90 million ounces a year. So from an exploration standpoint we are way behind the curve. And by the way, the minute you find a discovery, you’re still counting five to seven years before you can put it into production. This is where I think it is absolutely fascinating. No one is really paying attention to the gold market. Nobody is really paying attention to something that for the last five years…
Kevin: In the United States.
David: Well, you’re right, because in Japanese terms, in euro terms, in other foreign currency terms, gold is not on its back, it has actually performed pretty decently. 2016 was a good year for gold.
Kevin: Even in the U.S. (laughs)
David: Even in the U.S. But I just think, in advance of the maddening crowd storming for the ounces of gold that are available on the market, I would encourage you to consider your allocations. I would encourage you to aggressively double them, if possible. And maybe I’m getting a little enthusiastic, but the supply and demand imbalances are already here. The demand side is from a host of investors around the world, and as we discussed earlier in the program, it’s set to swell, for a variety of reasons.
But when the demand side is lining up in your favor, and the supply side – you can’t do anything about it. That’s what supply inelasticity is all about. You want to double the amount of gold in production? This is not like running and extra shift at the manufacturing plant and cranking out more widgets. You can’t go dig it out. You can’t get it out of the ground to meet supply.
So what happens? It triggers a massive increase in price. We’ll talk about this more as this unfolds in 2017 and 2018, but I think that’s exactly what we have in front of us.