In Transcripts

The McAlvany Weekly Commentary

with David McAlvany and Kevin Orrick

Kevin: David, we are talking to you via phone in Orlando, where you are meeting with clients, and you are on your way to the Bahamas next week for private consultations with clients.

I wanted to mention something. There was a Wall Street Journal article just a couple of days ago, speaking of manufacturing firms going long on the products that they think they are going to be using over the next 3-6 months.  Did you see that article, David?

David: Kevin, it was interesting, and we talked about it a little bit on Friday in our comments on our Wealth Management website.  The point was this:  They are increasing stockpiles, and to look into the details of that, I think, is pretty important, because essentially, the rise in commodity prices has turned the major manufacturing firms into speculators.  It may be prudent for the CFOs and CEOs to be organizing the purchases this way, but it is worth discussing, anyway.

Kevin: Speaking of speculators, what are they speculating on? Is it that their sales are going to be increasing, or is it that the costs of making those things that they sell will be increasing?

David: It is the latter, Kevin.  When you have resources that are increasing in price and these are your basic input costs going into manufacturing goods, what they are doing is stockpiling, both those resources, and the finished products themselves, so you are seeing inventories get quite bloated.

What someone may describe as strategic, others would describe as opportunistic, if they are speculating on the price of the commodities that they are stockpiling.  Some might even view it as a necessary precaution, to avoid having to pass on those higher costs to a very wage-constrained middle class. That is, I think, the real cost to be looked at, being unhedged from a rise in input costs, because it can very quickly squeeze your margins.

Kevin: We do not usually think about spices going up, for instance, but the McCormick spice company has pre-purchased a lot of extra spices.  Cotton has been skyrocketing.  You mentioned last week that the price of wheat was contributing to the unrest in the Middle East and in Asia, so it seems that we have price inflation right now, though it does not seem that the consumer here in America is really feeling it.  But manufacturers, at least the smart ones, are seeing something ahead of time, and they are looking down to the end of the horizon and saying, “I’d better buy it now, or I am going to have to raise my prices later.”

David: It is a bit of a balancing act, because if they do not do something to hedge those input costs, then they are looking at absorbing those higher costs and impacting profitability significantly.  It is eating into profitability.  If the price move is considered short-term in nature, or something very cyclical, then generally, they will just absorb it and try a very reasonable increase if they can get away with it, in the cost of the consumed product.  We have seen that with the Snickers Bar shrinking in size.  We have talked about the cereal boxes, my favorite of course, also shrinking in size, and changing the color scheme so that you will not perceive the change in the size of the box.

There are those games which can be played, but the real risk is to be the first to raise prices and shock the consumer, leading to a shift in purchasing habits, and a loss of market share, because those have long-term consequences.  If you end up driving away the consumer that you have spent so long fighting for in the marketplace, the odds of getting them back are pretty slim.

That is the great risk, losing competitive advantage as they move from one product to another.  Successful marketing is about bringing those consumers into the marketplace to buy your product, as opposed to someone else’s, even though there is not very much difference between the two of them.  Price can be something which is very disruptive, if that price increase is noticeable, so if nobody wants to be the first to raise the price, and there is the idea that perhaps they can just hedge it out by buying or stockpiling it.

So you see corporations doing something quite similar to what we have seen several Asian and North African countries doing – stockpiling significant quantities of commodities.  In some cases they are consumable, and in some cases they are industrial and will be consumed, but not by the belly, as they are put into products.

Kevin: Is this something that we can consider to be a cyclical price increase?  We all know that there are seasonal cycles, and sometimes supply and demand cycles, and they come and they go, oftentimes they will go away, or could this be a portent of something longer-term?

David: It is interesting, if you look at a chart of the CCI today, the Continuous Commodities Index, or the CRV, they are both moving up significantly, CCI to recent highs again.  To me, we are looking at a short-term inflection point, perhaps lower.  We have everyone who is now going “long the commodities” and it is a good time for those markets to take a step back.

We may, in fact, have had the reason for that here in the last day or two, with the central bank in China raising rates, yet again, the third time in a very short period of time, trying to cool off their economy.  We will see if that has an impact.  Certainly, at least here in the first couple of days since that decision, we are seeing a bit of an impact into the copper market and some of the industrial commodities.

It would be normal to see the commodity index drop back, but I think what the CEOs and CFOs of the Fortune 500 companies are considering, is not a cyclical move higher, but maybe even a structural move higher, in commodities.  It would be very similar to what we saw in the 1960s when, finally, copper stepped out and broke out to new levels, and as we moved into the 1970s, it got into nosebleed territory, but it was a new plateau.  Up until the 1960s and 1970s, it had been range-bound, that particular commodity, and it finally broke out into a new kind of stratosphere, and we really have not gone back since then.

Is that what we are in the process of doing?  That is probable.  How probable, we will see, but I think the odds are pretty strong.  There are some issues to be dealt with, though, and some details to consider.

Kevin: That takes me, then, to the retail sector.  We have inventories seeming to be expanding right now.  That also would be interpreted by the mainline media as people looking ahead and saying, “Hey, business is back, we are in a recovery, let’s go ahead and expand our inventory.”  Is that what we should read from expanded inventories, or is there something else behind the curtain?

David: To me, it seems they are taking on a significant amount of risk, because we are still in an environment, and we will talk about this in a few minutes, where the two elements of unemployment and housing are really significant, still.  It is worth considering, if you are manufacturing new goods to be sold, what is the likelihood of turning that inventory over quickly?  If you are not going to turn it over quickly, then you have issues of that inventory either being rendered obsolete, or you have to sell it at a steep discount.

Instead of stockpiling the commodities, manufacturing the product, accruing your costs on that kind of product now, with the idea that you are going to save yourself billions, or add to profitability in the billions of dollars – guess what?  In fact, you end up taking it on the chin, so what looked like a smart equation ended up not being so smart, simply because there was not enough inventory turnover.

Kevin: What we are seeing then, both in the manufacturing side of things, and the inventory side of things, may be a little premature, because we are not necessarily seeing a pickup in consumer spending, are we?

David: Not adequately, and I think when you look at unemployment and housing, you can clearly see why.  To recap, we do have a pickup in manufacturing, which, in our opinion, does not relate directly to the return of the consumer to the marketplace, or a robust economic environment, but we feel that the next wave of product that will be available will be at a steep discount.  If you are talking about retail products in the second half of 2011, or the first half of 2012, you are talking about a steep discount, as retailers try to move products that they were filling the pipeline with, maybe a little too early.

Kevin: Maybe what we are seeing is a prediction from you that this next Christmas shopping season, there are going to be steep, steep discounts on items, a little like we have seen in the last year or two, with the so-called financial crisis, where prices are cut so dramatically that it looks like there is an increase in sales, but really, the profitability of the companies has just gone right out the window.

David: I think for 2011 and 2012, giving gift cards could be pretty smart, because not only will you get the after-Christmas discount with those gift cards, but you may even get a pre-Christmas surprise in terms of discounting.

Kevin: That leads me to the question of employment, because the unemployment numbers they have been publishing have been much better numbers – in fact, suspiciously better unemployment numbers.  A person cannot really go Christmas shopping unless he is employed.  We have talked about this before.  You can only get so many government bailouts.  How about the unemployment numbers?  Are we seeing an increase right now in the job market of employed members to that market?

David: I think this is where something definitely needs to be clarified, because while we look at U3 and U6, the standard unemployment numbers, those numbers seem to be improving, from 9.6 to 9.4.  Now U3 is 9%.  That would imply that people are going back to work, when, in fact, that is not the case.  As we pointed out on this last correction from 9.6 to 9.4, the change had to do with people coming off the unemployment rolls.  In other words, they had just been on so long that they fell off, and were no longer counted.  That did not mean that they actually had jobs.

You can see that reflected, if you look at recent Gallop polls, there is quite a different story being told in the unemployment numbers, and we can talk about that in a minute, but the biggest issue with this last correction, down from 9.4 to 9%, which seemingly, is a spectacular move in the right direction, is that there is really one significant factor which contributed to that, and that was seasonal adjustments.

When statisticians put these numbers together, there are extraordinary things that they want to take into account.  For instance, in the fall you have a seasonal adjustment, which is applied, because you have an excessive amount of purchases made in light of kids going back to school.  In wintertime, of course, you have Christmas, which is out of the normal buying pattern for people to be buying as much as they do, coming into the Christmas holidays.  These kinds of things tend to distort economic activity, so what the statisticians have done it to create these adjustments to accommodate that.

Here is the real issue:  We had John Williams on the program a number of months ago.  He has done some of the work looking at both the benchmark revisions and the seasonal adjustments.  The point that he makes is that these seasonal adjustments are particularly healthy, and helpful, in the context of a growing economy, but when you are in a recession, they are using the same seasonal adjustments that they would in normal times, and it tends to distort the numbers greatly.

In fact, the U3 unemployment number would have risen to 9.8% from 9.1% in December, if it were not for the seasonal adjustment.  So we actually have the opposite thing happening.  The unemployment situation is getting worse, not better, and yet the number is saying that it is actually getting better, which is going to be heralded, and has been advertised broadly by Wall Street, as further significant evidence that we are, in fact, in recovery.

Kevin: That reminds me of getting in the car, in the past, not necessarily knowing the direction that I was driving, and for a period of time (this has probably happened to many people), driving the wrong direction thinking that I am perhaps driving east, when in reality I am driving west.  It is pretty embarrassing when you do it, but it is not devastating.  What we are saying right now is, we are really heading south on the employment numbers, yet the people who are listening to the statistics right now are thinking that we are headed north.

David: That is exactly right, and I think this is one of the things that really skews an investor’s judgment, is that they are assuming they are working with legitimate numbers.  The more I study China, and the issues of investment opportunity there, the more I realize how important solid information is, and there is virtually none, particularly on that front.  Having good, fundamental analysis on Chinese companies is impossible.  We just got China’s GDP numbers and they were, in fact, better than 2009.

Kevin: Weren’t they over 10% this time?

David: Yes, 10.3, up from 9.2.  Things seem to be humming along nicely in China, but there has to some suspicion laid on the veracity of the numbers, themselves.  The error measurements that I think can be applied to the Chinese GDP numbers could be anywhere from 2-4%, which, again, if you are moving out over the next 2, 3, 4, or 5 years, or even looking back over the last 2, 3, 4, or 5 years, if you were off by 20, 30, even 40% on your total numbers, then no, the economy has not grown quite as interestingly as some think.

I think one of the things that came out of the recent numbers from China had to do, not just with the main GDP number, but particularly, retail sales.  The highs were into something we will talk about in a bit, which is banking issues here in the United States, but retail sales in China fell, in the early 1990s, and have never recovered.  They fell from 45% of GDP to 36% of GDP, and everyone is hoping, and assuming, that we will see the consumer in China be the next great driver of bull markets, both here in the United States, and around the world.  They are supposed to be the driver of recovery.  They are supposed to be the growth engine of tomorrow, as the lead in the emerging markets, and we are just not seeing it, and the most recent GDP figures from China would say so.

The areas that saw significant growth in terms of retail consumption were, interestingly enough, gold, silver, and jewelry, which rose by 46%, and of course, right in line with the real estate bubble in China, furniture is up 37%, appliances and audio/video equipment also up 27.7%.

A major boom being real estate, which to our minds, is clearly in a bubble mode, not unlike 2005 and 2006 in the U.S., but with inflation comes an increased demand for investment dollars flowing into gold and silver.  We saw that in India, where the investment component in India, the growth there, was shockingly high for 2010, and it is not a surprise that in China, as well, the investment demand for gold is off the chart.  Those in the World Gold Council actually think that China’s consumption of gold could exceed India’s this year or next year.  We are talking about massive quantities, between 600 and 800 tons of gold per year, in terms of consumption per country.

Kevin: We have talked about this in the last few weeks – China has now become the largest producer of gold in the world, surpassing even South Africa, yet they are consuming twice what they are producing, or more, so we are not really even seeing this increased production.  It is never even really coming to market, is it?

David: No, in fact, over 300 tons is produced and consumed.  In addition to that, 209 tons was imported this last year, on top of what they produced.  So the numbers are moving significantly, and the investment environment is such that people are sensitive to inflation.  They are sensitive to gold as a real asset class, whereas in the West, as a result of generations now, certainly decades, of indoctrination and re-education, investors look at paper, and paper only, as a legitimate asset class, whether that is stocks, bonds, insurance products, or what have you, whereas in other parts of the world, with a little bit more connection to history, and frankly, less developed financial markets, they still have a deep appreciation for the metals, themselves.

Silver, right in line with gold, has seen a massive increase in imports and in consumption in China – both metals, the story of growth in China.  If it were me, I would not be looking at the Shanghai Stock Exchange, as much as I would the consumer demand for the metals in light of monetary policy, starting here in the United States, and being very impactful throughout the world.

Kevin: David, it seems to me like we have a theme running through this, both with what we were talking about when we first started the show, with manufacturers buying goods now in an effort to try to defray inflation in what it is going to cost to manufacture their goods down the road.  We have the Chinese, and we are being told there is huge growth in GDP, but a lot of that growth in GDP is inflation hedging – people buying gold and silver.

There is a thought, in the Chinese markets right now, that whatever loans that these banks are giving out, and there is a tremendous amount of borrowing in China right now, whether they are nonperforming or not, it can just be evened out over time, a little bit like it was a decade ago.

David, the people who were here in the 1990s and saw the Chinese banks come back out of the 1990s relatively unscathed – is that something that we could see again, or is the consumer someone who loses this time?

David: I think, just in review, if you go back ten years, 20-40% of loans in the Chinese banking system were nonperforming loans.  That is a massive, massive amount of nonperforming loans, but ultimately, the two things that helped them out of that dilemma of a vast number of nonperforming loans, was aggressive recapitalization by the banks, in addition to gross domestic product, which grew at an average of 10% per year.

Kevin: And that was funded by our consumption on this side of the Pacific, wasn’t it?

David: That is correct.  The U.S. consumer, in essence, was partially responsible for helping bailout the Chinese banking system.  There are several things, though, that I think are worthy of note, because it really is the Chinese household which has been behind the curve for 10-15 years now, and it is worth mentioning because I think the U.S. household, and the European household, is in a very similar position today, because we have some similar themes going on – incredible fragility in the banking system, both in the ECB, and in the U.S.

That partially explains why the European Central Bank and the Fed are keeping rates so incredibly low.  They are keeping rates incredibly low so that they can rebuild the balance sheets at the significant banking institutions.  Again, that has echoes of China circa 1993, 1994, 1995.  If you were looking at the crisis in banking in the 1990s in China, you realized that a tremendous amount of wealth was transferred from the household sector to those banks in order to repair the banking system.  They did that primarily through the difference in interest rates, keeping rates incredibly low, and basically robbed the household, or depositor, of interest income, and that spread, the interest, instead went to the bank directly.  How similar is that to what we have today?

Kevin: I think about the older people we talk to who thought they were going to be able to retire on CD or interest income, and at this point they are having to go and get jobs, perhaps in their 70s, perhaps in their 80s, because interest rates have been kept unnaturally low for so long.  You are saying that this is really just a bailout straight to the banks.

David: Yes, there is a finance professor at Peking University, I have mentioned him before in past shows, Michael Pettis.  He is a fascinating character.  He writes a regular piece for private institutions, and we are fortunate enough to take a look at that.  Some of this thinking was distilled by him.  There basically were three or four different solutions that the banks had in China, and our banks have, too.  One was what we saw in the 1930s where you just simply default on paper, that 20-40% of nonperforming loans, or the loans which we are currently keeping off balance sheet, which the FASB has allowed us a free pass on, and is just completely ignoring in terms of current market value.  Thus, the credibility of the banks remain intact, and the balance sheets appear to be healthy, we are just not looking at any of the bad loans.

What we saw in the 1930s is not likely to happen, where you simply default, and the depositors absorb the full loss.  That is not likely to happen.  An alternative is a government bailout, followed by an increase in taxation.  We have certainly had our fair share of that in the United States, and that does tend to spread the cost evenly.  This is what we have referred to in the past as debt being democratized, and then in the context of collapse, the consequences and risk being socialized, where all households bear an equal weight of the loss through an increase in taxation.

But where banks begin to come ahead on this is where you manage interest income and instead of that interest, short-term rates, going to the depositor, they go to the bank instead.

Kevin: That question has come up many times, when a person says, “How come I am only getting 1%, or maybe 2% on my CD?  But when I go to take a loan out, even a mortgage loan, which is being kept unnaturally low, it is 4, 5, 6%?”  That seems to be quite a difference in the profit from the saver, the person who is putting money into a CD, and what the bank is making on interest.

David: Yes, not only does the banking industry benefit, but our whole debt structure benefits from rates being kept artificially low.  It is an interesting concept if we can explore it a bit, the idea of there being something of a resolution to our debt, and an absolution of our debt, by these rates being kept so extraordinarily low.

Again, I credit Michael Pettis with putting these numbers together.  If your rates are too low by 4%, or 400 basis points, over a one-decade period, you are looking at the equivalent of a 25% debt forgiveness.  If your rates are too low by 8%, which is of course an extraordinary amount, but assuming that the risk implied in a certain market is something like 9%, and the current going rate is 1%, that 8% differential where the debt is being price 8% too cheaply, in a matter of a decade, you are looking at a 50% forgiveness of the total stock of debt.

You have to wonder, is that what Bernanke has in mind, a rebuild of the bank balance sheet?  Certainly, he is not only head of our money system, but also of our banking system, so you would expect him to defend, tooth and tong, the system which he serves, and certainly rebuild it first, even if it is at the expense of the consuming middle class, even if is at the expense of Joe and Suzy Lunchbox, and the interest income, or the retiring class, which depend even more heavily on their interest earnings.

Kevin: So what you are saying is, this debt forgiveness is actually paid for by the common man, and even still, the common man who has done things correctly, who has saved money, who has put money in the bank, who is trying to earn interest.  These are not people who are necessarily going further and further into debt, these are people who actually have saved a little bit of money and are trying to find some way of either preserving it or making it produce growth or income.  That common man is basically shifting any interest income that he would normally get over into bailing this system out.  It is not true debt forgiveness for the person, it is debt forgiveness for the bank, isn’t it?

David: Exactly.  We are talking about a direct transfer of wealth from household depositors to banks and borrowers.  As that wealth is transferred, the unintended consequence is into household consumption.  I think that is where you can look at the Chinese and say they went from 45% of GDP being tied to consumption, to 36%.  Why?  Again, they have rebuilt their banking system and put themselves on a different trajectory, but at the cost of households, and to realign their economy now is going to be difficult.

We are at the front end of that, where we are seeing the direct transfer of wealth from depositors to banks, and the question is, can there be anything but a contraction in consumption as a percentage of our own GDP?  This implies a very significant step-sequence.  There is no way for the U.S. Treasury to issue less debt in the next couple of years.  They will be issuing more and more debt.  As we look at 14 trillion and consider throwing in Fannie Mae, Freddie Mac, student loans, and other off-balance sheet funding, this brings our total national debt, instead of the 14.3 trillion, which it is capped at, to actually 20.7 already – 20.7 is our official public debt.

You can even get that from the Treasury’s website, where they do, in fact, count Fannie Mae, Freddie Mac, the student loans, and off-balance sheet funding, as a part of the total stock of debt.  We are playing games with ourselves if we assume that we are only in debt to about 100% of GDP.  We have far surpassed that already, and we will need to continue to issue IOUs to make up our difference in spending versus income.

Again, if it is the household that is contracting in their consumption, you know that government has to step in and spend that much more to make up the difference, so that our GDP numbers do not, in fact, go into the red.

Kevin: You are talking about the issuance of treasuries.  It would be far healthier if we were issuing treasuries and actually selling them to people who were buying them, other than ourselves.  The Federal Reserve, which is our own people, our own government, basically, even though it is not a government entity, is the largest holder of treasuries right now in the world.

David: That is the scary point.  You would like to think that it is a real market, but it is not a real market.  Other central banks, which typically have bought treasuries for political reasons, not as an investment, but because it opens up trade agreements and things of this nature, are a large component of holders of the treasuries that we have issued, but the single largest holder of treasuries is the Federal Reserve.  It is scary when you realize how much of a non-market the treasury market actually is.

But it underscores one other point, which is this:  We saw massive buying in recent weeks in euro bonds.  We had the issue of European Financial Stability Facility bonds.  This was about a 61 billion-dollar offer, which was bought up largely by Asian banks and central banks.  There were 500 bidders, and this was the first bond of this type – 61 billion dollars worth of bonds snapped up with quite an appetite.

When we talk about the treasuries that we have in the United States, when we talk about the dollar and how fragile it is, you realize just how important the euro is to our foreign creditors.  The fact that Asians were buying up these bonds, left, right, and center, should send a very clear message to investors that they have no intention of letting the euro fail.  They do not want it to fail because they do not want to remain with the dollar-centric monetary system that we have had since the 1940s and Breton Woods.  There are radical things occurring, both in the debt markets and the currency markets, but it is telltale when the Fed becomes the largest holder of treasuries.  In my mind, that is a significant tipping point.

Kevin: I was just thinking: what an irony.  We just talked earlier about how China is not only producing the most gold, but they are buying the most gold.  And yet, at the same time, we are producing the most debt, and we are buying it back from ourselves, because we cannot sell it to other people.  It makes you wonder how sustainable it is when somebody is producing paper out of thin air and then buying it from themselves, and on the opposite side of the ocean they are producing gold and buying it from themselves.

David: I think it is worthy of note that just here in recent weeks, the Industrial and Commercial Bank of China, the ICBC, penned a deal with the World Gold Council to create what was called the ICBC Gold Accumulation Plan – ICBC GAP, as it has been called.  This allows investors to buy as little as 1 gram of gold per day, into the equivalent of a savings account, and they can either take delivery of that in gold, or they can just accumulate it in the plan, as a savings program.

When you have the government encouraging investors to buy gold and silver in that economy, as they deal with being tied to the U.S. economy, our consumption, our export of inflation globally, and the implications into the foreign currency markets of our inflation being exported globally, this is an investor base that says, “Well, we have to do what we have to do.  Even if it is 1 gram at a time, we are going to save our personal balance sheet.”

I think it is fascinating that we are on the cusp of changes in China – we are not there yet, but we are on the cusp of significant changes in China, where the consumer has more money to spend, where instead of the household taking it on the chin within China, instead of the household paying the price for manufacturing growth in China, we do have shifts taking place, shifts we talked about in recent weeks.

In early January we talked about one of the largest provinces in China raising their minimum wage between 18 and 26%.  These are massive, monumental shifts, because what it means is that for the U.S. consumer to now buy those same Chinese goods, exported from China, imported into the United States, we have one more version of inflation on our side of the pond.  Not just monetary inflation stoked by the Fed, but now price inflation stoked by rising wages and rising costs to the goods that are being exported from China.

The U.S. consumer ends up getting squeezed on several fronts.  Not only on the backs of the U.S. consumer is the banking industry being rebuilt, but we are also going to face higher prices with consumer goods, as well.  The one area we were sort of on balance – seeing deflation, if you will, because even though we might see monetary inflation on the one hand, it was offset by cheaper goods being imported and made available to us at distribution centers like Walmart – no longer.  Those prices move up, too, in lock-step.

I wonder when the U.S. consumer is going to wise up, as the Chinese consumer and the Indian consumer already have, to the necessity of owning gold – the necessity, not the option.  It is not another asset class that maybe is in favor, maybe it is out of favor, maybe you want to own it, maybe you do not, maybe you believe in the long-term story of gold, maybe there is no veracity to it, whatsoever.

But we are moving to the point where it is simply necessary, as an insurance policy.  That is the way we have always looked at gold, as an insurance policy, but one that is absolutely critical to any portfolio in any quantity.  I look forward to the day when the World Gold Council can accomplish the same thing that they did with the industrial bank in China, and do that with an HSBC or a J.P. Morgan, here in the United States.

I just noted that J.P. Morgan, here in the last week, is willing to take your gold.  Interestingly enough, J.P. Morgan is willing to take your gold and silver as collateral on loans, so they can appreciate the value of gold, but they would like it as collateral to loan you money.

Kevin: That is the kind of collateral that I would take.  I have no problem loaning almost anybody money right now if they want to put up the same amount of collateral in gold, how about you?

David: (laughter) That is right, that is right.  It is a different arrangement when the ICBC is encouraging ownership of gold, and not putting your gold in hock, so we are making progress here in the United States, but not much.  I think it is going to take something radical, either in the interest rate market, or in the currency market, to have U.S. consumers wake up to the fact that gold is, in fact, a necessity.

Kevin: There is a fascinating chasm, just talking to people here in America, versus talking to people overseas, in the understanding of gold and what role it plays in preserving assets.  Here in America, there seems to be just almost a dearth of buying of gold.  The price of gold, when we see it fluctuate on a daily basis, we all know, has virtually nothing to do with American buyers or sellers.  They seem to be asleep.

It is the Asians, the Middle Easterners, the Europeans, who seem to understand at a much quicker pace, probably because they have seen currencies fail before and do not have the luxury of a reserve currency, but they seem to understand, and be moving this market.

This market correction that we are in right now, I would like to hear you comment on it, because it has been shallow, at best.  We really have not had a true, good old-fashioned market correction in the gold market in a long time.

David: It is fascinating, because the average correction over the last ten years, off of new highs, has been a minimum of 15%.  The largest was in the fall of 2008, a 30% correction before gold recovered and finished the year positive for the year by about 5-6%.  Even in the worst-case scenario, the drop was overdone to the tune of 30%.

If you look at this as a correction, you almost have to say,
“What correction?”  It is down 6½ to 7% off of its peak.  I would relish the opportunity to buy at much lower prices, and the market has been stubborn.  Often, we look at the platinum group metals and silver as the leading indicator for how deep the correction would be, and, look at palladium, look at silver.  Are they taking a nosedive?  Is silver off $1.25, $2.00 per day, five days in a row?  Whereas we have covered 25-30% in a very short period of time.  That is classic silver moves on the downside.  Haven’t seen it.

What about platinum and palladium?  Palladium is still north of $800, off of a low of $160, and it is not giving up any ground.  It has been very, very, very stubborn.  These, again, are generally very volatile metals, metals that give up a lot on the downside very easily.  The question we would have is, are the market dynamics changing?  Are we getting closer to moving from what we have described as a linear movement – two steps forward, one step back – to a parabolic move in the metals?

I think we could see prices move much higher, and for anyone considering the gold market, I think your risk is not being in the market, I do not think your risk is on the downside.  But the charts that you need to be looking at are the charts of tomorrow, not yesterday, where we look at price action moving higher, and not lower.

Kevin: So what you are saying is maybe to back away from trying to micro-time this market.  This may not be the timeframe to be out of this market just to save a few extra percent.

David: What a shallow correction in gold, the correction that we have had being incredibly shallow, means, is that the market is just remarkably strong – absolutely strong.  Certainly, we have gotten some support in recent weeks from the events happening in the Middle East, but if you will note, oil has sold off significantly as the headlines have waned, and they are less sensational, and gold has not given back any at all.  Neither has silver, neither has platinum or palladium.  The stress metals are not under stress, themselves, even as some of the pressure and tension is being relieved in the international political market.

I think the bottom line is simply this:  We have inflation globally.  We have inflation in the United States, and have for years, but it has been covered up by cheap goods that have been imported from China and the third and developing worlds, and that is largely going away, as the input costs are on the rise, and as the minimum wage costs are also on the rise.

In China, we have gold, jewelry, premium tea, stamps, calligraphy, art, jade – everything is surging, as you would expect to see it surge, in a classic inflationary environment.  We have not seen the classic inflationary environment here in the United States, largely because people impute so much value to official government statistics.  We talked a little bit about unemployment.  We talked about those numbers being adjusted.

In the past, we have talked about the CPI weightings in the United States.  It is absurd.  We look at health care and as a part of our inflation number in the United States, it is 6½% of the health care number.  Meanwhile, it is 17.6% of GDP.  Health insurance, which is something that we all look at and generally absorb 20-30% increase in costs every year, makes up less than ½% of the CPI index.  It is patently absurd.

This is the issue:  Inflation is sneaking up on Americans.  It is not sneaking up on the rest of the world.  So you have people buying gold and silver, as a defensive posture against the consequences of inflation, everywhere else in the world, why is it not happening here in the United States?  Because we actually believe that it is not happening to us!  And it is.  It is.  We just happen to have so much undying faith in the Bureau of Labor Statistics, the Ministry of Truth, if you will.  It is frankly mind-numbing to me, Kevin.

Kevin: David, I hope that it does not sneak up on you and me, and our client base, so let’s just make sure that as we see the inflation coming, we take care of business before it happens, like the rest of the world.

Thanks for joining us today, David, from Orlando, heading to the Bahamas.

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