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The McAlvany Weekly Commentary
with David McAlvany and Kevin Orrick

Gold’s Rapid Rise: Is It Guns (Iran) Or Butter (Devaluation)?
June 25, 2019

“I want possession of real things, and I want real things with cash flow. I want cash flow, and I want more real things (laughs), whether this is gold, or toll bridges, or RV parks, or infrastructure, or gold coins, or silver bars, or a bunch of cash, hopefully with a little bit of cash flow. Frankly, the things that are listed there, yes, we think it is an excellent time to swim upstream.”

– David McAlvany

Kevin:I was looking at the markets, Dave, and I was thinking, “Gosh, 30 days ago gold was below $1300 and now we’re up in the $1400s.” We’ve waited for this and we’ve had controlled markets that have just sort of put us to sleep, and then all of a sudden – kapow – something is happening where you have flight capital going in there, and I was thinking, in a way, we were made for this. You had told me a story about your daughter. You guys went mountain biking this weekend and you said she just continued to say over and over. “I was made for this. I was made – I was made– for this.

David:Yes, she’s eight years old and she’s out in the trail in front of me and I’m just hearing this conversation. Of course, she’s a verbal processor like more than a few McAlvanys are, and I don’t know if she’s talking to me, or the trees, or whoever, but, “I was madefor this.” Gold gets to $1365, and it gets to $1365 again, and it gets to $1365 again.

Kevin:I was getting sick of watching it get beat down every time it got to $1365 the last few years.

David:And you know that above that point, if you break the glass ceiling, so to say, there is room to move on the upside. So it re-establishes something of a floor, or a higher floor, and we may see some consolidation in the coming months, but that’s okay, we have decisively broken out of what is really a seven-year consolidation. If you look at what happened between $252 and $1920, those two price points, there was a massive move in gold and it has taken seven years to consolidate it. It has gradually been getting its feet from the $1050 level back in December of 2015. Again, it keeps on tempting fate here, just below $1400 – $1365, $1365, $1365. So you’re right, it is almost a surprise “Oh – it happened.” And you’re right, I think we are made for it.

Kevin:I was thinking back to the first Persian Gulf War because we were seeing gold move, but not silver move, during that period of time. One of the questions that I have had here recently is, what is causing this rapid move? Is it a fear of inflation, or is it geopolitical? I know in the past gold has moved and silver, platinum and palladium have sort of ignored geopolitical events initially, and I’m just wondering if somebody knows something that maybe we Americans don’t know.

David:And whether it is geopolitical or political trade-related, I’m not sure that even matters at this point. We’ll figure out why investors were moving more or less after the fact. But what we do have is this bifurcation between gold and silver where the safe haven purchases of treasuries and of German bunds, and of gold coins, or gold bars for that matter – that’s on display.

What is lacking is silver as a monetary metal with concern for inflation, or platinum with a concern for inflation, or what have you. There are periods of time when all real assets do very well, but at least at this phase we have safe haven buying. That is the determining factor in terms of flows, both into treasuries, bunds, and gold. So the safe haven buying is the defining factor here, probably not much more than that.

Kevin:I think about how central bankers have smoothed over any kind of fear in the past. I remember Mario Draghi back in August of 2011 – he said, “We’ll do whatever it takes.” Well, little did anyone know what that meant was they would just buy everything. I’m thinking China here recently is making liquidity very, very available. Are they trying to mask, possibly, a slowdown?

David:It’s amazing when you think back to that August 2011 period and you are looking into the precipice and the potential demise of the eurozone. By the way, that potential demise and looking into the precipice still exists, but what we did buy was a certain amount of time. Draghi is running out of time, himself. He retires later this year, and we don’t know if Weidmann or whoever replaces him will have the same resolve to do whatever it takes.

But imagine this. Go back to August 2011 and the words are spoken again. You hear them in your head. “We will do whatever it takes.” And all of a sudden those words transform Cypriot bonds, junk bonds in Greece and in Italy and Portugal and Spain, into the best performing assets of the next three to four years, and you say to yourself, “Now, how is this possible?”

Kevin:The things that were going to go bankrupt are now the best investments you can possibly buy. Why? Because Draghi is buying them with two or three generations of future money. He doesn’t have the money, let’s face it.

David:You mentioned China. The PBOC, their central bank, is making sure that there is ample liquidity flowing right now. Last week there was over 40 billion dollars injected into the banking system to bring calm to what otherwise could have been significant bank run dynamics. But the markets, themselves, in China are discriminating between the large banks and the non-bank financial institutions.

You have the overnight repo rate, which drops to as low as 1% for the big banks, and that is as a result of the central bank intervention. But your non-bank financials remain at a much higher 8% for overnight borrowing. So what your seeing is that liquidity is not flowing equally, and as Doug Noland pointed out in one of our recent portfolio manager meetings, that is precisely a late-in-the-cycle dynamic.

Kevin:And the Chinese must be expecting a too-big-to-fail kind of move where you only have to pay them 8% – 8% is a high rate in this environment.

David:Right. So the differences between the repo market and the pledge repo market, and the pledge repo market is sending a strong signal. And this is, again, in contrast to the repo market. Not everyone is getting the easy money from the PBOC. The PBOC is creating it, and as we’ve said many times before, you have central banks that create liquidity, but the markets direct the flow. So you create the liquidity, markets direct the flow, and this is now the unseen hand of the market works, whether it is self-interest, self-preservation, that unseen hand determines who gets what.

Kevin:Isn’t it strange? We have a country that is still communist that is looking more like a free market country where we are actually seeing dynamics, an 8% interest rate shows free market dynamics. Yet here in our economy, which is supposed to be free, we’re almost more command and control.

David:And of course Xi Jinping has tightened controls. We know that he has given himself kind of a lifetime rule. Since Mao there is no one in China who has had more concentrated power than him.

Kevin:He controls the vertical, he controls the horizontal, he controls – he actually controls the central bank.

David:(laughs) Yes, so there is irony, you’re right, that you have some – not all, but some – free market dynamics on display in China. And then you cross whichever direction you want to go across the pond. You have Western Europe and the U.S. still increasing the dynamics of command and control. You have the top-down central planning style, those operations through targeted inflation rates and what the European Central Bank has called OMT (laughs) – outright monetary transactions – the purchasing of a variety of assets using the size and force of the central bank balance sheet. I guess the question today is, what is capitalism, and where is capitalism truly on display? And I guess I’m not thinking of the crony capitalism or what not, but really, as we described it, and have in earlier shows, the free markets on display.

Kevin:We’ve talked about the distortion of what we call market discovery. That’s just a fancy way of saying, nothing is priced correctly. You have to point a finger at the central banking community over especially the last seven years for completely destroying real pricing.

David:Add math to a study of economics, and instead of just appreciating historically what has been done and good, better and best business ideas, you conflate who you are and what you do as an economist and consider yourself to be an engineer of sorts. This is how economics and Ph.D.s in economics have gone to the heart of central planning. The thesis is that you can engineer economic outcomes, and again, central bankers are right in the heat of this in the community – the Fed, the ECB, the BOJ, the PBOC – they all have a finger in the pie. They have overstepped their traditional roles. And if you go back, this goes straight to the global financial crisis, and what they were doing is implementing, at the time, what was considered extraordinary measures.

Kevin:They even used those two words, extraordinary measures. That was quotation by the central bankers saying, “Listen, we’re not going to do this all the time. This is because we are in an emergency.”

David:But those emergency measures, those extraordinary measures, have never normalized. They are considered permanent tools in their toolbox, so this is a classic power ratchet. You have crisis dynamics called for a more muscular approach and a more invasive policy stance. As the crisis recedes, the invasive policies remain, so you have both governmental power and central bank influence that share that in common.

The market dynamics at present, I think, are very fascinating. What they share in common is this idea that you ratchet this massive power forward and then as the emergency recedes, as the crisis recedes, the power structures stay. This is the growth of governments, the growth of central banking in the marketplace. It is an unhealthy thing, it is unnatural, but this is how power ratchets into places that it doesn’t belong.

Kevin:And they have trained investors to love bad news. It’s amazing. They love to hear that maybe there is a slowdown, maybe in employment or in growth or what have you, because they know they are going to be fed candy from the Fed, or candy from the European Central Bank, or what have you. They don’t even want to hear good news about the economy because it doesn’t give them enough of a spike.

David:Yes, it is a sick mindset. It is a disturbed mindset. Whatever justifies the presence of ongoing and increased liquidity is somehow good. So we have transformed the negative, the bad, into the good because that is the justification, that is what allows the central bankers to keep their presence in the marketplace, no longer extraordinary measures, but common and expected.

Kevin:It’s Pavlovian.

David:It is. If you’re thinking of the market dynamics today, I think they’re challenging. I think they’re fascinating. I think they’re deadly in the sense that you have a lot of global investors who are unaware that this is not normal, and it is not sustainable, and it is entirely dependent on the largesse of the central bank community.

So exhibit A – you have the naïve investor. And what are they doing today? They are relishing the new highs in the stock market. Good for them. But they’re doing that without asking the question, “Where do we go from here?” For investors in the current context, again, you sink into the present moment – and this is kind of the mug’s game because you’re losing what is most important in the investment process, which is anticipation. A long gaze into tomorrow, whether it is next month or next year, you neglect that for the present pleasure that you are experiencing. It is what happens next that has to be processed, not what just happened. Again, investing by looking in the rear-view mirror is just a bad idea.

Kevin:Let’s face it, we’re all looking practically at how we’re getting ahead. I even look at Trump. Trump was very, very critical during the Obama administration of a loose Federal Reserve policy. At this point Trump knows that he has to have it himself.

David:I think this is at the heart of why we have a continual critique of central banking on our program because there really isn’t a ton of independence, “political independence,” between the Fed and government, and frankly, we’ve moved away from rules-based administration of monetary policy to ad hoc, and I think that is dangerous, too. But you’re right, Trump in this market environment, would like to make it even better. He believes that the stock market could be 2000, 3000, 4000, 5000, 10,000 points higher, and what does he need to “trump” the current market environment (laughs). He needs lower rates, he needs a more accommodative Fed.

And that is what the commander in chief is currently whining about. Just in this last week he said, “Powell is like a little boy. He’s spoiled. He’s not doing what he is asked to do.” Well, we need more asset purchases, we need another round of QE, if we’re going to keep this current buzz from fading. And that is why the president is asking for what he is asking for. We need external stimuli, the kind typically reserved for crisis dynamics. But today, it is being framed differently – an ounce of prevention – and the oval office has, frankly, too much at stake to wait for the pound of cure. They can’t let the markets roll over at all. They can’t let the business cycle flow and then ebb. There is no ebb. No, absolutely not.

Kevin:He was a critic of keeping Fed rates low in another administration. Now, I’m not trying to be political here. All I know is that when you’re president, you want to have easy money.

David:Yes. And you could say, “Well, this is a living contradiction,” or whatever else. No. No, he’s no dummy. He knows what it takes to keep this empire of debt in motion without cracking apart on his watch. And he wanted the presidency before he was in office, and he reasonably critiqued that this system was held together for the benefit of Obama with accommodative interest rates. But now it’s his system and he still wants it held together, and he knows what it takes – accommodation from the Fed, money-printing, lower rates, asset purchases. He wants to gift – if you want to think of the common man investor – the lumpeninvestoriat – he wants to gift them with fresh all-time highs in the stock market as evidence that he, Mr. Trump, has delivered something excellent, like a Trump Tower upgrade for all.

Kevin:You know how he could have done it, and I don’t see it happening, but if he would have come into office like Reagan did in 1980, when we had interest rates that were close to 20%, maybe even higher, Reagan rode this roller coaster down ride of interest rates from over 20% to – what did they fall to? During his administration, interest rates just plummeted from the Carter years, and of course, that’s perfect if you’re a president because people can borrow for less and less and less expense on the interest side of things. And it created a huge boom.

David:Exactly. At least halfway through his first term Reagan started to see that gift in an obvious fashion, and you’re right, the Fed was dropping rates from the 20% level down to 8%, and then 6%. This was after Volcker dosed that strong medicine to tame the runaway inflation of the 70s. For Reagan, this is what made a trillion-dollar increase in debt affordable. As his administration doubled the national debt from 1-2 trillion it was no big deal because the interest component was shrinking so rapidly, he probably could have done even more than that. What he was focused on was outspending the Russians in an attempt to take the lead and gain an advantage in the Cold War. And guess what? He did it. So Reagan was successful in beating the Russians by being a fiscal profligate.

Kevin:Could you imagine? Let’s just assume interest rates are 20% right now, and we’re talking about what the future looks like. Well, gosh, you can lower rates dramatically. But Trump is actually starting with interest rates closer to about 2%.

David:That’s right. So you don’t have the same generosity, it’s not as juicy for the kind of easing cycle that you could have if interest rates began to decline again. We could take the ten-year treasury from the 2s, percent that is, and then follow the Germans and other European counterparts into negative territory with rates below zero. Right now we are at about 11.6 trillion and counting.

Kevin:Isn’t that amazing?

David:That’s debt that yields less than zero. It’s a dollar value of debt with a negative yield.

Kevin:Before 2015 never in history had there been negative rates. You said 11.6 trillion.

David:Right. But if we took our rates negative, even then we have to wonder if the results are positive. Yes, it perpetuates a business cycle, to a degree, but it also completely mutes the signaling typically present in the bond market.

The other thing it does, and I think this is important to keep in mind, moving rates lower is a way of stealing from the savers of a society.

Kevin:It’s the retired, especially, that really suffer.

David:Yes. So it’s just a different form of wealth redistribution and it takes from the savers and gives to those who are so far in debt that they need some sort of crutch or help with their massive quantities of debt.

Kevin:Well, they have to speculate in the market to actually pay their bills, which can’t last. But you were talking about signaling. Signaling is another name for this price discovery that we talked about.

David:Yes, signaling – interest rates, the role that they play – is what creates restraint in lending, and this is completely muted in the bond market today. But it creates restraint for corporations and yes, it is restraint for government fiscal commitments. If you wanted to look at the road – I’m not trying to be overly dramatic here, but the road to monetary hell is marked with signs that say very clearly where you are, and it tells you very clearly your direction of travel. That’s what interest rates do. They tell you when there is stress in the system.

Kevin:But if central banks are coming in and buying all the bonds and lowering the interest rates, at that point it totally destroys that signal you’re talking about.

David:You’re controlling the price of bonds, you’re lowering the interest rate, you’re eliminating that signal, and it’s like the signpost being eliminated. You don’t know where you are on road to hell.

Kevin:Bridge out… bridge out.

David:Your direction is still your direction, and the monetary disaster that awaits you is still the same, but the harbinger is gone. You lose the signage which in earlier business cycle episodes would caution you, might even compel you to turn away, go back, before your currency is destroyed, before your business is destroyed.

Kevin:Remember when you had Steven Hankey on, just a few weeks ago. He talked about those commitments that governments have that are ongoing commitments. That is why they have to print money. That is why they ultimately destroy their currency if they can’t meet those commitments.

David:And I think one of his points would be that it is when you lose your normal sources of funding, when that dries up, and you maintain those fiscal obligations, and then all of a sudden you have the monetary and the fiscal meeting in the middle where money and credit creation out of nothing is directed toward government spending. And again, you can’t finance it the ways you used to, and then the inflation rates go crazy. Yes, that’s what modern monetary theory is in a nutshell. You need the signals to know where you are on that path toward destruction, and within the financial system you can pretend like all is well, but without the signals you have no idea how close you are to the edge.

Kevin:What you are basically saying, Dave, is money is free and at negative interest rates money is freer.

David:Well, yes. Dick Sylla is going to join us later this year to discuss interest rates and an important observation that he has made is that the way the current central banks have constructed this is that they are doing things that haven’t been done in the four to five thousand years of interest rate history, which he described, going back to 2014-2015, didn’t exist – just didn’t exist. So what do you do?

Dick wrote the book on interest rates. Literally, he wrote A History of Interest Rates. It’s a tome that any financial library should have. But when the signals are muted, speculators know no limits, and the main street investor then moves into this perfect place of oblivion, moving forward with a sense of confidence, and what we would argue is overconfidence because they don’t appreciate the kinds of risks that are endemic in that environment. But you don’t have the risk signals around you.

Kevin:Do you remember the old days when we would say, “I wonder where the bond vigilantes have gone, or where they are? Because if they ever came out of the woodwork, which sometimes they did, they spanked everything that was mispriced.

David:Exactly. The bond vigilantes were the discipline factor, if you will, and classically, it was the bond investor that we called the vigilante. It is like this – when the adults stopped behaving with discretion and honor, and when the adults started to become just straight stock promoters and financial pimps, then the bond market would discipline them with higher rates. And that is when they would be called vigilantes because they would be working sort of on their own to create this sense of discipline. And those higher rates would rein in excess liquidity and credit in the system before you had a real nasty bubble dynamic take hold and become self-reinforcing and become something that just couldn’t be controlled. And this is really what is unique in this period of time, if you contrast the way that the bond market used to create a discipline within the financial system, and now you have central banks of the world cornering the bond market, it remains to be seen whether the bond vigilantes can match the determination of the central bankers to push rates to zero and to keep them there.

Kevin:I’m reading a pretty good book right now by Nassim Taleb. He has written several books – Black Swanand Fooled by Randomness. This one is called Antifragile. He talks about how systems can become fragile when they are given gifts. Think about these low interest rates, Dave. Businesses out there that have to borrow, or governments having to borrow, what have you, if they don’t have to run efficiently, and can be given loans virtually for free, it creates a fragility that later has to be fed with more free money.

David:That’s exactly what Jim Grant said in a recent missive. He said this of the low rates: “In other words, low interest rates, which foster leverage and speculation, require still lower rates to protect the fragile corporate structures that those very rates made fragile.” There is a sense of policy determinism here. You get into this vortex, you can’t get out. We can’t get out of the cycle of lower and lower rates as we have piled on more and more debt.

And frankly, the rate function, it’s that factor, if you will, it’s the only factor that can be controlled to make the math work. Without low rates we already know we have too much debt. But with lower rates we can, and have continued to, pile on more debt. And what that allows us to do is keep the wealth illusion going a little bit longer. Everyone feels good, everything looks good, everything is fine. But you have this one factor that has to be controlled. In this case, Trump wants to control interest rates, at least through the next election cycle.

Kevin:But for the person who is listening and saying, “You guys make perfect sense on all of this, but this has lasted longer than any of us really thought. Could low rates be a permanent factor in our economy?

David:I think this is one of the things. From an investment thesis standpoint we had assumed that we would see rates return to a normal type of a cyclical behavior, and maybe they ultimately will, but the battle is on. The battle royale is there with the central banks going up against the bond vigilantes. And the one thing I would say is that the central banks have the printing presses in support of their cause. But if they print one dollar, one euro, one yen, one RMB too many, then they flip an emotional switch in the marketplace and they instantly lose.

Kevin:The currency is no longer trusted.

David:That’s exactly right. So they have the power to buy everything under the sun. And yet, they have the power to destroy the value of everything under the sun because of the power they possess. So it’s a weird irony. You would say, “No, don’t bet against the central banks.” Yes, but if they abuse their power and print one currency unit too many, they’ve played with psychology and they cannot recover from that. You cannot control the mind of the crowd in that way.

Kevin:Look at the arrogance in how they have been proceeding.

David:I think somebody like John C. Williams who is the New York Fed President. There is another John Williams who does some good work on monetary policy.

Kevin:But this guy is at the New York Fed.

David:He is the New York Fed President, also a bright guy. He was speaking to the Council on Foreign Relations recently. Just think about the audience. The Council on Foreign Relations is listening to the New York Fed President say, and I quote, “Low interest rates are real, and they are here to stay.”

Kevin:Well, there’s the permanence.

David:There you have it. If this backdrop creates a greater likelihood of monetary accidents – that’s what Grant would suggest it does – then it really should come as no surprise that in other parts of the world you start hearing about an opt-out. The Malaysian Prime Minister, Mahathir Mohamad, urging his fellow heads of state in Asia to develop a common trading currency based on gold.

Kevin:He can’t be the only one. China has been buying thousands and thousands of tons of gold.

David:When you listen to the plea of Mahathir Mohamad, the Prime Minister of Malaysia, when he says what he says to this group of people – it was the Nikkei Group – meeting in Japan not long ago, he sounded like de Gaulle. So 50 years later he sounds like de Gaulle, only not from France, but from Asia. And even though the bond market vigilantes seem to have exited the stage, gold has not. I think that is one of the things we’re seeing in the price action of gold. Gold is expressing a view, as it rides a wave of safe haven purchasing. The central planners are playing with fire. That is what gold is signaling. They are playing near the limits of what is tolerable, says the gold vigilantes.

Kevin:Boy, what an amazing point you make – gold vigilantes. We talk about bond vigilantes, which is really the interest rate cycle. It is interest rates going up when there is danger, but actually older than the bond vigilantes, which go back thousands of years. Older than that is the gold vigilante, and really, it’s not the person or the people who can control that. Gold somehow has a mind of its own, and it stomps on anyone who has hubris.

David:It tends to bring a discipline that is unrelished and as quickly as possible disregarded by central bankers, because it is the opposite of ad hoc. It is a rule unto itself.

Kevin:But remember what Volcker said in his memoirs. He said the one thing he regretted in the late 1970s was that he didn’t try to control the price of gold.

David:Yes. So the action in gold in recent weeks is notable, and it is not because of the rapid ascent taking it from the $1200s to the $1400s. That is a very short period of time, and it’s a decent move, but I think notable is what is moving with it and what is not moving with it, because it is telling you who is buying and why. There is ample signage here, again, talking about signaling here, for an investor. In the absence of a free market in rates and with a cornering of bond prices by central planners, you have to read between some of the lines. So by the way, if gold is acting as the vigilante in this era, guess what you can expect? Exactly what you suggested. You can expect some breathtaking counter-trend moves as the powers that be try to stuff it back into a box.

Kevin:Oh you know they’ll knock it down – Maxwell’s silver hammer. Except for in this case, Maxwell’s gold hammer.

David:(laughs) Well, if the trend is now a long-term trend, and arguably, clearing $1365 is a hurdle that from a technical standpoint almost feels like Caesar crossing the Rubicon. I think what you can see is down moves which can take your breath away, and I think that will keep a lot of faint of heart investors on the sidelines and keep them second-guessing the move. That’s great. No problem. As you see the price grind higher over the next several years, what should emerge is a price structure well above what we saw in 2011 and 2012.

Kevin:So you’re thinking it could go about $1900.

David:Yes, but those down-strokes in price – that is where, in my opinion, you’re going to find the opportunities to purchase and allocate to the metals more advantageously, if you haven’t done so to this point in a meaningful way.

Kevin:I was asking myself the question last night because honestly, Dave, I get emotionally angry at the control that the central bankers have exercised, especially since 2011. And I thought, “How can I beat these guys?” They’re on their thrones and so I can’t dethrone them, but how do I beat them?

Well, here’s how I beat them. I understand that gold is a limited quantity asset. They like to control unlimited quantity assets. They like to create money out of thin air, control those types of things. But if I buy physical gold, every time they knock it down, and you know they’re going to do it, just like you said – if I buy some every time they knock it down there is that much less on the market. Now, I’m not going to make that much of an impact, but people worldwide, especially the Russians, the Turks, the Chinese, and it looks like the Malaysians at this point – they’re buying, and they will ultimately beat the system.

David:Of course you know that my dad raised me with two versions of the Golden Rule – Do unto others… But the second Golden Rule was, “He who owns the gold makes the rules.” I think what is often missed by investors is, in this period 2011 to the present, a lot of physical gold has moved toward non-Western countries. It’s no longer sitting in Zurich, it’s no longer sitting in London, it’s no longer sitting in New York. It’s not a U.S. asset, predominantly. What we saw when we had massive liquidations out of the exchange-traded products, over 800 tons of metal moving from London and New York to Zurich to be melted down and then transferred to, lo and behold, Hong Kong and Shanghai, is a move that we will never see undone. He who owns the gold makes the rules.

Kevin:So who makes the rules, at the end of the day? Is it the Western European central bankers and the American central bankers? Or is it the Asians, who now probably control and sit on a big pile of gold larger than we have?

David:This is one of the greatest stories in economic and financial and monetary history and it is being told in our time, the great battle for monetary hegemony. You would have to go back to when the British were handing over the keys to the kingdom and the U.S. was taking them forcibly. We took the keys to the kingdom from the British. Now, we have that same kind of wrestling match – who is giving or taking – and as we have said many times in the program before, what you see in the trade spat between Xi Jinping and Trump covers over a much larger issue, which is who will lead the world over the next 20, 40, 60, even 100 years? And I think this issue of monetary hegemony is a very big deal. He who owns the gold makes the rules.

Let’s get back to gold for just a minute because what is moving in lockstep with gold is absolutely critical. We talked about the buying of bonds. We also talked about central planning and how central bankers are purchasing massive amounts of bonds, pumping up the price, and suppressing the yield. There is also a huge set of investors who expect more pronouncements from the government, from central banks, for asset purchase programs. They expect even lower, even more negative rates in the future, and they are buying bonds as a play, as a speculation on that trend. So it’s almost like a speculative front-running of central bank pronouncements in the context of what they expect to happen shortly.

Kevin:If somebody looking down the road at this point on the horizon, somebody that we can’t name – I think sometimes we try to analyze things, like why did gold do what it did, or what are bonds doing what they are doing? Safe haven assets seem to be the thing right now.

David:That’s what I’m getting at. You have multiple audiences doing different things for different reasons and you have to carve out some of this volume, moving into safe havens, moving into gold, moving into treasuries. It is going there because it wants to be in plain vanilla, straight liquid, safe assets. And someone, I think, is looking to the horizon, and doesn’t like what they see. And up to this point it hasn’t been the U.S. investor who is looking to the horizon at all.

Kevin:They’re still not.

David:No. But it’s easy for me, if I were in Europe, to say, “Look, I can get out of German bonds and be sitting in U.S. treasuries and get multiples on multiples of yield just by going to the U.S. treasury market. But I can also go to gold and it has its own safe haven properties.

Kevin:Yes, but let’s go back to the Americans. Where are they?

David:They’re not in the market. Gold purchases, to date, have been predominantly in Europe and Asia. That is where it has been robust. But not here. We run a large precious metals brokerage and I can say that our dollar volumes, along with those of our competitors, is still off 30-40% from 2016 levels. Now, if you’re going back to 2016, that was one of the first times we hit the recovery level of $1365, and then moved sideways to down again. But if you want any further comparison, we’re down 70-80% in terms of dollar volumes from the 2011/2012 levels. There are really not that many people coming into the market today.

Kevin:But how about the ETFs? I know that is an alternative way people have been buying gold.

David:In Europe, it’s robust, but the last time gold was at these price levels – $1365 and higher – GLD had an extra 200 tons of metal in it. Again, this goes back to the 2016 timeframe. U.S. investors have yet to show up, and I think it is for obvious reasons, because I think on their minds is why should be worry about tomorrow when today the stock indices are at new highs and we have a president who is poster boy for some form of capitalism and he is going to push his weight around and ultimately may get Powell to capitulate.

Let’s go back again to Exhibit A. You are talking about the investor relishing the present. That’s fine. Enjoy it while you can. But remember that the European gold market is telling you something; the Asian gold market is telling you something. Those ETFs are seeing huge inflows by contrast to the U.S. exchange-traded products. The U.S. investor demand for physical gold has been low. Very low. Year-to-date, you check in with the U.S. mint – they’ve sold 75,000 1-oz gold coins. That’s only 22% of the total gold volume sold by this time in 2016. Remember 2016 was when gold was just starting to show its first signs of life after it declined from $1900 to $1050.

Kevin:But let’s look at who is buying. We talked about Asia. We talked about China. And Russia has been selling treasuries and buying gold big-time the last couple of years. But Dave, the central bankers – these are the guys who are controlling the game – why are they buying? It’s 74% more gold they bought in 2018 than in 2017. So they’re buying a lot of gold.

David:Right. You break down the consumer into several different areas and you have the speculators who are more interested in the futures markets because you have leverage with a futures contract, you have an investor who loves the liquidity, the buy and the sell and the trade, and the capturing of a short-term gain or long-term gain, what have you, using ETFs. And then you have the central banker who is buying to have and to hold until death do they part. And the foreign central bankers are buying gold today as if Charles de Gaulle was speaking to them in their dreams.

We told you this last year, that there was massive accumulation of physical metals by the central bank community as we ended the year in the 4thquarter. That trend is still in play. You have Q1 purchases which are up 68% year-over-year. This is so interesting from a seasonal perspective because June is typically one of the weakest demand months for gold, and you typically have lows which are put in for the metal between June and July. This is not a typical June.

Kevin:Look at the European central banking community. We have seen this before. A lot of times June, July, August, they really don’t want to have any kind of perturbations in the market because they want to take their six-week holiday. At this point, we have gold instead very, very active. You were talking about certain bond purchases very, very active. This looks like it could be a long, hot summer.

David:(laughs) Yeah, for somebody. Strength in the gold market, classically, is between August and February, getting kicked off there in August. But something has accelerated the purchases, and again, give us weeks or months, we will discover why in the weeks and months ahead, but you may wish to consider that in the absence of bond vigilantes, the gold vigilantes are alive and well.

Kevin:Let me ask. Is it the trade wars, is it this new cold war that Napier talked about, is it a possible hot war with Iran or somebody that we haven’t even looked at yet?

David:Yes, perhaps it is trade. Perhaps it is a war that Washington is teeing up and Trump’s behest in the event the Fed doesn’t do its bidding. You have to have something to save the election and ensure that you are in office for another round. So yes, Iran is perfectly positioned, and if he needs to, he can swing hard at them. Perhaps it is fragility already on display in the global economy. Let us not forget, we don’t have a lot of weakness showing up here in the U.S., but we have a lot of weakness showing up everywhere else on the planet. So how long can that be ignored? And ultimately, are the consequences more grave for pretending that we in the U.S. are on a different track?

Kevin:I was talking to a client the other day, and a lot of his business goes right across the tracks as far as freight shipments go. He said, “Kevin, you wouldn’t believe the drop-off in the number of trains that are actually carrying freight right now.” That’s how he measures his business. He said, “You know, I’m preparing for a recession because there aren’t as many people shipping freight this year as there was last year.

David:That’s right, Kevin, and it points to things like the Baltic Dry Index or the Cass Freight Shipments Index. These are leading indicators for economic activity. You watch the volume, you watch the velocity of real things being moved, and it tells you what you need to know about consumption, and the anticipation of consumption, because purchasing managers have to stay ahead of the curve and put things in motion in terms of the manufacturing process and the shipment process to have things on the shelf when the consumer says, “Hey, I’m ready. I want to spend my cash.”

Kevin:Do the statistics show what my client was telling me, that things are slowing down in number?

David:Yes, the Cass Freight Shipment Index is down for the fifth month in a row. The last decline was 3%, not a huge percentage decline, but it is a consistent drop to lower and lower levels over the last five months. And that is international shipping rates. You have trucking rates, the day rates paid to haul stuff on our interstates. That gets ugly. It’s in collapse here in the U.S., down 62.6% in May, year-over-year. These are earlier signals that, frankly, run contrary to the latest retail sales figures.

You had April and May pretty positive, April revised higher, May not bad. But again, because there is less stuff moving, and ultimately you have to assume that is in anticipation of less demand for stuff, you clue in, at least I do, to folks like the FedEx CFO, Alan Graf, who says, “Look, global trade slowed in recent months, it’s a leading indicator, it points to ongoing deceleration in global trade near-term.”

Kevin:This is FedEx? He was the CFO of FedEx?

David:Yes. Steve Tam, a research analyst, points out that because trucking participates in all phases of manufacturing, it increases as manufacturing starts to ramp up, giving us a leading indication on economic growth. Well, if it is ramping down it also gives you an indication of economic decline. I’m not ignoring the service sector here. Obviously, services are far more important than manufacturing today, but we’re looking for clues, we’re looking for signals. You have to go find the signals in a world where what would have been your most reliable signal is muted because of artificial traffic, and we’re talking about interest rates again.

Kevin:So let’s just go back and look at this last decade and say, “All right, we needed to stimulate economy.” Whether a person agrees with what the central banks did or not, we stayed out of the depression that we would have gone into after the 2008 global financial crisis. So let’s say they did the right thing – lowered the interest rates, printed money, stimulated the economy – it’s like putting a body on life support in an emergency room. So you do that.

But then they kept it on the emergency life support, and they continued. We talked about fragility in the system. Well, then we stimulated what looked like an economic recovery. Now granted, it was costing us three or four times the money it normally would have, and that money was all debt. But now we have an actual slowdown occurring. How long can you stimulate things with artificially low interest rates and printed money without paying the piper?

David:This goes back to the idea of microevolution, and how we do see adaptations constantly in light of new inputs. So the weather changes. I just realized a certain sort of microevolution as I got ready for the race at Alcatraz. I started swimming in 45-degree water with a wetsuit, and 58-degree water wasn’t so cold at all.

Kevin:(laughs) Adaptability, Dave.

David:You can get used to just about anything. What we have gotten used to is a free ride from the central bank community, and we now have adapted. But as you say, this “gift” has added to greater fragility within the financial system. It has not made us more robust, it has not made us stronger, it has not made us more resilient. In fact, it has done exactly the opposite. So economic pressures, at this point, of any sort will point directly to the frailties, the weakness, the inherent fissures in the structure of finance.

Kevin:The fragility.

David:Exactly. And it is going to make sustainability of what we have today – leveraged entities, leveraged governments, corporations, households – it is going to make the sustainability of those entities questionable.

Kevin:So give me a time. I know this is completely unfair, but give me a time.

David:I don’t know if it’s 2019 which is a year of reckoning, or 2020. I guess what is lingering out there is, what are the kinds of policy responses which we will see as a reaction to a decline in the stock market, a bond market, what have you? Can Draghi or Zilk do whatever it takes, just like they did in August 2011, without there being a significant monetary mash-up? Can they avoid moving into a competitive devaluation? It is just a really interesting environment to be in because I think, as my colleague, Doug Noland, has said, we have migrated the risk from the private sector to the public sector. It is now at the heart of money and credit.

Kevin:It was at the periphery. He talked about it starting at the periphery, and now it’s moving to the very core. And when you run out of core, if it’s paper, you’d better have gold. You’d better have something real.

David:Yes. So when the problems are at the core, what do they do for an encore? I know exactly what I want to secure in this environment. I want possession of real things, I want real things with cash flow. I want cash flow, I want more real things, whether this is gold, or toll bridges, or RV parks, or infrastructure, or gold coins, or silver bars, or a bunch of cash, hopefully with a little bit of cash flow. Frankly, of all the things that are listed there as defensive plays really indicate that yes, we think it is an excellent time to swim upstream.

Kevin:Well, and you’re talking about upstream, but actually, it is becoming downstream. We’re swimming upstream for the paper guys who think they control everything. But actually, you look at the Asian markets, you look at the central bankers worldwide, the buying of gold – we’re actually getting in sync with them if we’re buying real things.

David:Or if we have been buying real things and the rest of the world is just getting on board, it certainly explains price action. Bloomberg’s article this last week, very telling – “Melt-up in Safe Havens,” was the title. Absolutely fascinating, as you are beginning to see a growing audience of people with similar concerns because I think they look at the problems on the horizon as challenging, if not unsolvable.

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