The McAlvany Weekly Commentary
with David McAlvany and Kevin Orrick
“I am afraid the standard of living is coming down in most of the Western countries, because the standard of living has been propped up by debt. I think debt liquidation, and the reduction of the leverage in the system is coming. Current international currency turbulence is going to breed increasing protectionism, and that is going to lead to the reduction of living standards.”
– Ian McAvity
Kevin: David, you are back from the New Orleans conference. I know that is something that you have gone to every year, but your dad went to it for many years before that. This is a conference that has gone on for how many decades?
David: Right. Four decades, celebrating 40 years. It was fascinating. I took my son and we went around and looked at the different placards of people who had spoken, Franz Pick and Hans Sennholz, some very interesting economists from an Austrian perspective, if you will. We also, this time around, got to listen to Alan Greenspan.
Kevin: I was shocked, Alan Greenspan, the guy who created the bubble that burst in 2008, and we have reflated.
David: Both Alan, and his mentor, Ayn Rand, had spoken at this conference years ago, so there is sort of an old Alan, an interim Alan, and then the newest Alan actually looks a little bit like the old Alan. I say that because, the question was posed, and again, maybe this is the difference between things that he is allowed to say while in the private sector as opposed to the public sector, but he had an affinity for gold many years ago.
Kevin: Before the treasury in the ’70s, and before the Federal Reserve in the ’80s and ’90s.
David: Yes, and it is interesting because the question was asked, where do interest rates go from here, 3-5 years from now? And he first said, higher, and then he said, no, considerably higher. And the same question was asked, what of gold? Where do we go from here? Not talking about the current downside volatility. He is saying the next 3-5 years, higher. And then he qualified that, too, and said, considerably higher.
Kevin: And this is a man who is used to understating things, because as head of the Federal Reserve, they purposely understate everything.
David: I will tell you who doesn’t understate anything, or overstate for that matter. Ian McAvity has joined us on the weekly commentary many times, and he brings insights, both from a technical perspective, because he is an expert, probably one of the best technical analysts alive today, but also with a strong fundamental bent, understanding what is happening in the world. It is not just a world of pretty pictures. He gets it, in terms of macro trends. And so, the conversation we have with Ian that we recorded in New Orleans, this is intriguing, because from a big picture perspective, and from a technical perspective, many things worthy of note, and I think very strategic at this point, for those wondering where we go from here. Should we be concerned about the gold price? Should we be concerned about a rise in the dollar? Should we be concerned about bubble dynamics in the U.S. equity market? He sheds quite a bit of light on all of those areas as we discussed them in a very casual environment there in New Orleans.
Kevin: Again, he is a regular guest, but let’s face it, Dave, a lot of these people have become friends of the family, as well, and your dad and Ian go way back, long before you, actually, were in the business.
David: Each year, we get together with the other speakers at the New Orleans investment conference and this year we sat down with Doug Casey, Adrian Day, Ian McAvity, the Aden sisters, Bob Prechter, and Gary Alexander, and we just had a great time, sitting around at dinner and discussing what we thought about the world affairs as they are today. The U.S. fiscal picture, monetary picture, and market dynamics. What are the implications of what we see, policy-makers and investment decision-makers on Wall Street making? What are the implications for investors today? It ends up being a very balanced perspective. On the one hand you have some in the group who think hyperinflation is inevitable. On the other hand, you have, for instance, Robert Prechter, who thinks that deflation and a deflationary collapse like the 1930s is inevitable. And there comes from this a synthesis of ideas and you get the best of both worlds with Ian. He appreciates both, because the charts suggest both, and he is open to a variety of outcomes, and a variety of step-sequences. So, without further ado, Ian McAvity, and our conversation in New Orleans.
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David: I always enjoy your perspective, looking through your charts. You are able to bring the big picture, long-term charts, pivotal moments in time, the short run, and make the distinctions between your comments being very, either short-term or long-term and I think that is pretty helpful. It seems that
When people start talking about bull and bear markets, sometimes they forget to make the distinction between cyclical versus secular trends, and that is something that is always addressed by you.
There are a number of things I want to cover in our conversation. In the biggest of pictures, you would say that 2007-2009, while we had a crisis, all we have had is, really, a deferral of that crisis from then to now. Maybe you could expand on that.
Ian: Everything that they did to resolve the banking crisis, essentially, didn’t resolve anything, it just deferred the problem. Massive amounts of debt, 4 trillion dollars’ worth of debt thrown at it, then apparently 4 trillion dollars buys you a pretty good rebound. But in terms of, have they changed the banking system? Not at all. And in point of fact, when you look at the amount of mortgage debt that is still outstanding, that really, are still the liars’ loans from the early 2003-2005 period, they are still out there. It turns out the Fed owns some of them now, although they claim that they are triple-A rated somehow, I don’t quite know how.
But in essence, all of the financial excesses that fueled the great run from 1982 up to the tech bubble bursting in 1999-2000, we had the tech bubble burst at that point, then at the next top we had the financial crisis that set the seeds for questions about sovereign debt after the 2007-2009 period, but that was also when a lot of the established market money flew out to the emerging markets. And at this stage, we are now making what I regard as the third significant top of the last 15 years, that, to me, is really completing the whole process that dates from 1974-1982.
And I could give a bit of a parallel, in the sense that after World War II, the actual bottom was in 1942, but the breakout was in 1949, and that great run was largely fueled by high savings. It wasn’t fueled by debt the way the more current run was, but that reached its first peak in 1966, and then we went on to have a series of three successive higher peaks, 1968, 1970, 1972, in that period, and in essence, that led to the bottom in 1982. So, it’s really the 1965 to 1982 cycle, roughly 17 years, that is being replicated from 2000 out to 2016, 2017. A lot of people would say that the 2007-2009 market crash was the worst of the crashes we will see in the period, not unlike 1973-1974. It was a bigger crash than the 1980-1982 crash. But I am not convinced of it, only because never in history have we had so much bad debt created.
David: So, let’s look at that, because in that period of time, what really made the decline into the early ’80s even more painful was the inflationary impact. So, you may not have had, in nominal terms, as bad a drop as in 1973-1974, but inflation ate your lunch as you moved into the late 1970s, in a significant way. Now, the discussion today is that there are more concerns with an unraveling of debt and the deflationary implications of that. Is it fair to paint with broad brush strokes and say deflation, therefore, and all of a sudden color the world with deflation? Or do you have something that is perhaps a little bit more nuanced?
Ian: No, I am very concerned about the deflation risk, and I keep pointing to the breakdowns of what I call the various canaries in the coal mine for the last few years. The Canadian dollar broke, then the Aussie dollar broke. More recently, the oil prices broke, silver broke, copper hasn’t quite accelerated down, and similarly, the gold price, I still think may have one more kick on the downside. It is holding quite impressively in the $1180-1200 area, but when you have everybody looking at a prospective triple bottom, quite often you have to break the obvious level to get that final emotional flush. If they take it down to $1050, I think we then go back to $2000 faster than anyone can imagine.
Sometimes you have to snap the elastic band the other way to get it going, and I think that, in fact, could occur against a deflationary collapse, because, really, from the 2009 low, within this secular period, this cycle has been entirely fueled by the Federal Reserve and the other central banks just throwing money at every problem. They basically have bankrupted the next generation to buy this generation’s retirement bonuses. And I am very concerned that there are parallels, not just in terms of the financial markets, but in terms of the international currency system, I think, comparable to the 1968-1971 period, in which the whole international monetary system, from a currency point of view, has to be altered, and is going to be altered.
I think one of the great mistakes in foreign policy moves that the U.S. has made this past year was trying to force Europe to put sanctions on Russia vis-à-vis Ukraine. And what that has done is, it has now forced Russia to work more closely with China on this Shanghai cooperation organization to set up an alternative payments mechanism…
David: …to SWIFT…
…and the minute that they announce that they are going to force Russia out of this SWIFT transfer system and force them to create another international system to compete with it, and now you have a new leader elected in India who has shot down the World Trade Organization’s plans, which is the old G20 establishment elite, and he is probably going to end up doing something in combination with the Chinese and the Russians, and at that point, you have this emerging world that has a lot of newfound wealth that has been accomplished over the last 20 years. Literally, they are going to be in a position to set up their own IMF, their own G20, of their crowd.
David: Let’s talk on that point a bit, because on the one hand, they have healthier balance sheets, but on the other hand, if you are looking at a cash flow statement, it is dependent on our continuing to run a healthy trade deficit, and surplus dollars that are floating around out there come from deficit spending, and what if… If you look at our trade deficit numbers, and maybe it is just the energy sector, but there are other inputs, as well, that are eroding the surplus dollars that are floating around out there. Can you make the next step forward with the emerging markets, just on the basis of balance sheet strength, or do you still need that annual income?
Ian: You need cash flow, but to a much larger extent. You are starting to increasingly see China cutting bilateral trade deals. They did it early on with South Korea and with Brazil and a number of others, where they have agreed to settle their trade balances with each other in their own currencies, so that means Brazil can build up a holding of Chinese RMB. They will still trade the international commodities based on the dollar-quoted price because that is the predominant market price, but at the end of the year, if you are balancing the books once a year, however many billions of dollars are owed one way or the other, it will not be settled in dollars. It will stop the accumulation of dollars.
David: It is an interesting transformation in terms of the architecture of the world monetary system. What is, from an experiential standpoint, still habit, for most countries in the world, the dollar, for the man in the street, is as good as gold.
Ian: The perception that the dollar is as good as gold amuses me in the sense that…
David: I’m just back from Argentina, so maybe that’s a poor example…
Ian: The dollar is by far the dominant float, so it is by far the most liquid market. The dominant banks, the money centered banks, there is no question that the dollar, as a transactions currency, is terrific. The problem is, think of the old days when we all had a checking account and a savings account. It is a useful checking account currency. You wouldn’t put it in your savings account, because you aren’t going to make any money on it, and you are going to lose value over time.
The mistake that has been made by the Western elites, and most particularly, for the last couple of years by the U.S., is starting to use currency as a weapon. So anybody they don’t like, they will freeze their foreign assets. Think in terms of the Iranians, the Libyans, all the different countries where they have funded one dictator and then thrown him under the bus. And in the final stages of throwing him under the bus they seized all of his assets that are held in dollars. Well, if you are in a position anywhere in the world where there is any chance that the U.S. might decide to stab you in the back, you are not going to wait until the knife goes between your ribs before you withdraw your money from the dollar system.
And so, in a sense, the U.S. tendency to use their dollar as a financial weapon is forcing people to use alternatives, and the most extraordinary thing now is the loss of individual liberty with this FATCA stuff, where the U.S. government is now basically blackmailing other countries into what I call the extraterritorial application of U.S. law. If an American citizen opens a bank account in Switzerland, where does America get the right to instruct a Swiss bank to report on that client’s activities back to Washington? Since when did foreign banks become tax collection agencies for the IRS? These FATCA filings that have taken effect now are driving a lot of capital away from U.S. markets, and at the moment, I don’t think people realize how much liquidity has been driven away from U.S. markets, but a huge amount of money. I personally don’t have an account in the U.S. any more.
David: It is interesting, this issue of phantom liquidity. We assume that we have liquidity, whether that is dollar liquidity, liquidity in the equity markets, liquidity in the bond markets, the emerging markets, even, where we have seen an influx of funds into the emerging markets like the ’90s, only it has been in the form of debt instead of equity this time around, and how exactly… Is there liquidity in the emerging market bond world? Or frankly, any of what we just mentioned?
Ian: All of the liquidity in the emerging markets is largely coming from money managers based in New York, Connecticut, London, and Zurich, and to a degree, Hong Kong, and they are all there basically by pushing a computer button. It is all electronic money. In a stock market crash, if you take the New York market down 30-40% in a 12-month window, the emerging markets, all of the foreign inflows that have gone in are all going to come out and they are going to have horrendous declines, because most of those emerging markets, the locals probably represent a very small proportion of the actual equity that is outstanding that is traded.
David: Right. One of the things that we started talking about with the U.S. equities market in this 2007-2009 period, you make mention of the fact that breadth peaked in 1998, so we can look in inflation-adjusted terms and see that the equity markets actually topped in 2000, and that it is something of a fiction to assume that we are at new highs in 2014. In nominal terms, yes, but in real terms, no. And maybe you can explain what is breadth, why is it important, and how does that factor in to an observation that 1998 was actually the real peak in terms of breadth?
Ian: Breadth would be, I would say, more of a cyclical phenomenon, not necessarily a secular phenomenon. But essentially, the breadth of the market, if you look, for example, the gold stock index, we have a gold stock index of 20 stocks, but almost all of the indices are based on market cap, so because of the conglomeration of everything into Barrick and Newmont you typically have two gold stocks that represent about 50% of the market cap of the industry. So, the net result is, when you see fluctuations in the XAU or the HUI gold index, the primary driver in that are Barrick and Newmont. You could have ten of the others up, but the two heavyweights drag the index down. What you are looking for, when the value line geometric index is one in which every stock carries an equal weight, and what you are looking for is, if there are 2000 stocks traded, 1200 are down and 800 are up, that is a negative day, even if the Dow happened to be up that day, or the S&P happened to be up that day. And when you start accumulating the daily net advances minus declines, that is, on balance, a way of measuring the breadth of participation.
David: Well, in that case, we have had negative breadth in NASDAQ and Russell 2000. A number of indexes, NASDAQ, for instance, I think it was either 47 or up to 53% of declining.
Ian: The problem with the lesser, or the lower level markets like that, is that you have a huge failure rate in NASDAQ. You want to try to restrict to the breadth sample to try to exclude some of the biases that would be structured into it. The Vancouver stock exchange would have a vertical breadth line going from the upper left to the lower right because the majority of those venture entities are destined to die because the whole point of them is that you float ten of them and one of them may work. And when it does work, it normally more than offsets the other nine. But, when you are looking at the broader market, then within the context of the New York Stock Exchange, as an example, probably the best price-weighted measure of breadth would be the Russell 2000 index and the way the Russell 2000 is constructed is the Russell Group, I’m not sure who owns them now, they have changed hands a couple of times. But they take the 3000 largest market caps, once a year they rebalance, the 1000 largest market caps is one index, the next 2000 are the so-called smaller caps. The smaller caps these days are bigger than the large caps used to be ten years ago. But, for many years I worked using the Russell 2000 as a measure relative to the large cap stocks. And even within the S&P 500 stocks there is another index called the S&P 100, which is larger cap. So I tend to watch different measures of it, and what you start seeing, increasingly, is narrowing leadership. The phrase that has often been used is, when the generals don’t have any troops behind them, you have a problem. And I’ve used that first back in Wall Street Week in about 1980 or 1981. “The generals are on the battlefield, and there are no troops in sight.”
David: Listen, you have a real knack for little turns of phrase. I find myself quoting you and giving you credit for that. There is a bit of Chesterton in you. You have a way with words. When it comes to the dollar, going back to this notion of deflation being the primary concern, the understood relationship is, deflation emerges, people flock to dollars, you have something of a synthetic short in the dollar market, people clamor for cash, the dollar goes up in a deflation that would entail gold going down, along with other assets. At least that is how Wall Street sees it. Shed some light on that.
Ian: And actually, the history of it, in a really severe protracted deflation, gold, in nominal prices, would go down. It would go down substantially less than everything else. If you look at the modern history of gold, going well back, would be the book by Roy Jastram, The Golden Constant. When you look at what actually transpired during the 18th and 19th centuries, the bulk of that period of time was phases of deflation in which the gold price quite often declined, but invariably, through the declines in price, gold fell less, so when we talk about gold better preserving purchasing power, it better preserves purchasing power whether it is inflation or deflation.
David: I have tried to make the case, and apparently I haven’t been effective in doing so, that deflation is the best scenario for a gold-holder, in the sense that you can see an expansion of your financial footprint many times and not be paying Uncle Sam a large portion of your gains. In an inflationary world where, let’s say gold is $5,000 or $10,000, number one, you know the rapacious nature of government, increase in taxes is coming, so your capital gains tax rate, you can count on it, just as night follows day, the tax man cometh.
Ian: Oh, yes, you can rest assured on that one.
David: So just as soon as you think you’ve got good news on that front, you are paying even more. It seems to me that people have forgotten that it is only the over-leveraged that are damaged by deflation. The problem with deflation is really the problem for the tax man in the sense that you have an increase in the value of your money, the increase in your ability to purchase goods and services and that equivalent of a pay increase is a nontaxable pay increase, which again, is a problem for government, but not necessarily a problem for the consumer.
Ian: It is less of a problem for the consumer. The bigger problem was that the government has the ability to change the rules to deal with whichever wind is blowing in their face at that time, and if there is one thing that every voter in America should understand, it is, when the rules change, it is never in the voters’ favor. You have a bureaucracy that demands to be supported, and they will be supported for as long as they have the ability to change the rules. In terms of long-term preservation of purchasing power, I would agree that over the long-term, yes, gold is a preferred way while you have the tax system that you have at this point, because there is no question that any inflation is a form of taxation, and they will pile onto it.
For many years, Americans worried about the government calling in the gold, and for as many years as I can think back, I’ve always said don’t worry about them calling in the gold. Now that the IRS has perfected the art of strangling the taxpayer, all they would have to do is essentially declare an excess profits tax. If gold was remonetized at $3000, they may say that you aren’t allowed to benefit on anything over $3000, and we’ll take 100% of the difference. Jimmy Carter actually proposed that during the oil price spike at one point. They were discussing an excess profits tax on oil, but the oil price came down before they could even institute the tax. The problem is, the corruption of the political process brings in all of these people that haven’t got a clue what they are doing, other than dealing with next week’s polls, and which way the wind is blowing.
David: It was interesting, a few weeks ago, being in Argentina, the gal who drove me to the airport, we drove past one area of town and she pointed over here and said, “This is old money over here, and this is new money over here.” I said, “In your opinion, the old money, where did that come from?” She said, “Agriculture, land, commodities.” I asked her, “What about the new money?” She said, “Politics.”
Ian: Oh yes.
David: She has no idea that that really is the nature of – maybe it is more exaggerated in Argentina than it is in North America, but as far as the U.S. is concerned, it really is a question of reshuffling the deck using politics as a way of ultimately pimping a rolodex in the private sector to create a vast fortune. It is corrupt at every level.
Ian: We had that in Canada, back in the early 1970s when they first introduced the capital gains tax, in Trudeau’s era. When Trudeau, at one point, was challenged… the old money was going to challenge him, and the class warfare that was going to evolve, Trudeau said that people have to realize the power of the new political elite, and there was a bit of an outcry in some circles. He never used the phrase political elite, again, that I can find a record of. That is when I started focusing on these elites that have progressed up through the revolving doors of politics and the lobbying process, and in a sense, they are the most dangerous class we have on the planet. How often do you hear somebody talking about somebody violating international law? Who passed that law? Who voted for it?
David: Exactly. Well, and back to the dollar. We have had a remarkable amount of short-term strength in the context of a long-term decline, and I think people prefer to look at the short-term charts than the long-term charts if they happen to be dollar bulls. But maybe you can talk about the retracement we have seen, or have yet to see.
Ian: I think the dollar is probably even going higher still, because in a sense, you have a new wave of currency devaluation going on. I think the yen/dollar rate was up around 108 recently, it is probably headed to 120, 125, maybe 140. And what they are doing now, it looks to me like they are bolting out of the club where they weren’t supposed to be doing this, but in a sense, they are moving toward a devaluation and blaming it on other factors, and you have the same situation unfolding in Europe, where Draghi keeps making all these glorious promises about all the paper that he is going to buy, but the Germans won’t let him buy it. And then that resolved as the market is starting to see through a lot of his rhetoric, and that it has no substance. Literally, Europe needs to significantly devalue the euro. They can’t create inflation through monetary policy, they have to devalue the currency to try to combat the deflationary forces they are fighting. But if you devalue the euro, what you are doing is driving the dollar up.
David: And creating a deflationary chandelier.
Ian: And the last thing that the U.S. needs right now is some additional external deflationary pressures. So in a sense, you have this currency triangle now imploding. Each of the corners of the triangle is sitting there resisting the inevitable that is headed their way.
David: We have what we call our perspective triangle. It is the idiot’s guide to investing. You need gold, you need an equity exposure, and you need cash. We basically say, if you don’t want to play the genius, have equal parts.
Ian: I have made the point many times, go back to the Harry Brown permanent portfolio concept. You want treasury bills for day-to-day liquidity, you want some long-term bonds in the event of deflation, but from a credible lender, and you want 25% in gold to preserve purchasing power in the event that inflation does run away, or hyperinflation takes off, and you want 25% of the stock market just in case they can hold it together for a while longer. And in any investment decision, turn your head around. Don’t think in terms of how much you are going to make. Appraise every investment in terms of the risk. What is going to hurt you?
David: Great point.
Ian: The beauty of the Harry Brown model is that he is talking about four corners. At any point in time, at least one of them is going to hurt you. What you are trying to do is make sure that the others don’t combine to hurt you. Right now we have a risky situation where I would say that the bond market is probably the biggest bubble in search of a pin at the moment, and if it breaks it probably takes the stock market with it, and that could be tilting two of the four corners.
David: How do we come to terms with the bond market being the biggest bubble on the planet, but we have central bank intervention at a scale never witnessed in human history? It is almost like the widow maker trade that we used to call the JGB trade back in the day, short Japanese government bonds, but on steroids. To go short the bond market might be suicide, to be long the bond market for fundamental reasons, it gets almost unconscionable, and yet we are on the cusp of a massive deflation, which would argue for being long bonds.
Ian: I added the one caveat of a credible lender. The Japanese Central Bank has not been a credible lender and the biggest problem I have now is, I’m not sure there are any credible lenders left.
David: And that is certainly a question of market perception because you and I would agree that there are more people in terms of the beauty contest, who are still voting for dollar confidence, government bond confidence, U.S. government bond confidence, and U.S. equity market confidence. So, maybe we have a different idea what beauty is.
Ian: Well, exactly. It is only in the eyes of the beholder, and for the blind man, he has the greatest imagination. It is a very interesting challenge that we are up against at this point, but to me, when we think in terms of the dollar as the haven, the bigger aspect is the geopolitical divide that is being forced, where we are going to end up with sufficient wealth now in the non-G20 leadership. Again, coming back to China, Russia, India, Brazil, and even South Korea, America thinks they own South Korea. They don’t. South Korea is very independent. Both South Korea and China have absolutely zero sympathy for Japan. Japan is very independent of the club. We think in terms of the G3, the G7, the G20, and every one of them would stick a knife in the other’s ribs the first time the wind blew in their face.
So, you are forcing the new wealth in the emerging world to set up their own systems. And their system is probably not going to be all that friendly to establishment investors if they happen to have U.K. address or a U.S. address, because the U.S. is going to try to punish anyone with U.S. dollar assets abroad. So what do the Russians, Chinese, and Indians need American investors for? They are offloading the dollars they have accumulated, and they have something like 8 or 9 trillion dollars in foreign reserves that are either euro-denominated or dollar-denominated. Every time China has tried to convert a lot of those dollars into a take-over of tangible assets, they started running into political opposition, whether it is in the Canadian tar sands, or continental oil a few years ago, and various strategic enterprises in the U.S.
So, the net result is, they are funding a lot of the growth in Brazil, they are funding the development of the oil sands in Venezuela, they probably own Nigeria by now, or Tanzania, and will soon, I think, own Nigeria. And you are creating this world outside of the old boys club, but I don’t think the old boys club grasps the degree to which they are shooting themselves in the foot by alienating that portion of the world where the growth is.
David: There is an old phrase, pride comes before the fall.
Ian: Oh, absolutely.
David: And this is hubris on the scale…
Ian: Oh, it’s like arrogance to the third power. And to me, one of the great slaps in the face to the third world was a couple of years ago when they appointed Christine Lagarde to head the IMF, everybody in the international financial community agreed that the logical candidate for it was the woman that ran the central bank of Nigeria at that time. Of all of the third world central bankers, she commanded great respect. I don’t recall her name at this point. But she was the most obvious candidate, and if they really were going to try to legitimately broaden the G20, that was the window in time to do it. But instead, they take a French-trained political hack, which is all Christine Lagarde is, and put her in charge of it, and that sent the message to the third world, “You are on your own.”
David: There were shenanigans back when the IMF and World Bank were cobbled together, shenanigans that were played that allowed for someone on the continent to be…
Ian: Oh, exactly, and the U.S. would run the World Bank and Europe would control the IMF.
Ian: And that’s a 1940s to 1960s mentality.
David: But here we are circling back around to this idea that 1968 to 1971 was a departure from the old monetary system, and there are things that are afoot that are a departure from the old system. People in the old guard aren’t aware just how much is changing. They are still making assumptions on the basis of the old political maneuverings.
Ian: Yes. And the U.S. state department and British state department still think that they are trying to cobble together the commonwealth and continue to run the colonies. When you look at what is going on in the Middle East right now, suddenly they have an alliance with the Saudis to fight this ISIS group where the only reason the Saudis are in there is they want to overthrow Syria, but Obama didn’t want to overthrow Syria. So, you have the Saudis funding the ISIS group on the one hand, and dropping bombs on them on the other, and the ISIS group are fighting the Western interests with weapons that the Americans gave to the Iraqis who turned it over the ISIS group, or left it behind for the ISIS group. If somebody wrote a script like that and sent it to Hollywood it would be rejected for lacking credibility.
David: Well, we’ve talked about the deflation risks, we have talked about the Canadian dollar and the Australian dollar, along with copper and silver. Gold – you still have a little bit of a gold bug in you, I think.
Ian: Absolutely. To me, gold still is the core asset.
David: For someone who says it may be a core asset, but it is beginning to bother my core, because this kind of pain – maybe you are philosophical enough about it because you’ve been here, done this before.
Ian: It’s a question of, if you are worried about the price of gold, I’m not sure you fully understand it.
David: Great point.
Ian: Years ago I had a lot of consulting clients in Central America when the various riots and revolutions were going on down there. I remember a couple of coffee growers that I used to talk to from time to time. They measured their wealth in terms of tons of gold. They didn’t care what the price was.
David: Right. They were just thinking about ounces.
Ian: They would trade their buns off in the coffee market, and every time they made good scores, they would just add to their gold holdings, buy another dozen kilo bars, that type of thing. They would trade on COMEX, and the irony of it was that they were extraordinarily successful coffee traders and they regularly lost their butt on COMEX trading gold and silver. I could never quite understand it, because the only time they ever called me was when they got a margin call. When it was going up they were brilliant. They would call me as to whether or not to make a margin call. And they complained about the losses, but at the end of the day when you are saying, “Let’s look at some of the overall picture,” they would end up saying, “Well, don’t worry about the gold.”
David: That was the least of their concerns.
Ian: There was one of them, in one of those countries, that whenever he was in the country, on his estate, his estancia, he had a runway. Three planes. One of them always had the engines running.
David: That’s political pressure.
Ian: At some point in time, he was going to have to leave, so mostly there was a helicopter, but there was also a small plane. But there was always an engine running 24/7. He had his own little private army that would make sure that he was on the plane. Whatever happened at the gate he was on the plane by the time the gate gave way.
David: Well, if you like gold, I would think when you are looking at the gold-silver ratio, you have to love silver. Silver is the easiest metal to hate, so love/hate, maybe it is two sides of the same silver coin.
Ian: Well, silver is the more volatile trade. On the other side of the coin, as well, though, and I’ve used the argument for many years at central fund, the reason for owning gold and silver is the central banks have less vested interest in silver. If they were ever to go after and try to punish the gold-holders with excess profits tax, or recall the gold, silver may slip under the screen. And yet it has a history as a monetary metal, and it is a more volatile market. To me, silver is more of a trading instrument, but it is also an accumulation asset.
David: What do you think about this? My dad, for 40 years, has suggested in a precious metals portfolio, two-thirds gold, one-third silver. How would you adjust that?
Ian: That’s not an unusual type of formula. That’s how the Central Fund is structured. It’s a physical ratio that we have held, 45 ounces of silver for each one ounce of gold. When the silver-gold ratio is at 70-to-1 or higher, silver is cheap relative to gold, so I would be a little more in silver depending how much sleep I want to lose at night. But when silver takes a run and gets down to something like 30-to-1, I would rather trade some of that silver back into gold. You can do a long-term ratio and depending on what period of history you want to use, anywhere from a one-third ratio to a 50%, you could pick a number, but recognize that silver is much more volatile. Watch the silver-gold ratio. When silver is cheaper, add more silver.
David: That’s what I do for our kids. Roth IRAs, all silver today. Maybe that is excessive, but given the ratio, and trading between gold and silver, in the U.S. you can’t have a securities account until you are 18, so they have Roths that are in physical metals, because they can have physical metals, and trading the ratio, so they are all silver today, they’ll be all gold at some point in the future, I don’t care one way or the other. In terms of wealth preservation, though, you go back to having a gold bias if you are the South American coffee grower who says, “I may be able to count my wealth in tons of silver, but I can’t put them on my plane.”
Ian: This is the other problem with silver relative to gold, it hasn’t got the portability. When you get into the billionaire class, that is why there is still a market for large-carat diamonds. Once you get into the mega diamond carats, they also don’t show on x-ray machines.
David: You may know the company [unclear], we’ve done some business with them in Europe. They are a major logistics company and storage company for diamond wholesalers all over the world. They probably do 50% of all diamond volume, and they moved their headquarters to China, from Antwerp to China, because guess who is buying large diamonds these days? And guess who is probably taking those large diamonds out and buying properties in Vancouver and Los Angeles, and what have you?
Ian: Exactly. When the Russian tanks rolled to the border of Czechoslovakia, back in the early 1980s, I know a number of Europeans that, within 72 hours of that, had gold, silver, diamonds and dollars, in deposit in most of the airports in North and South America. Wherever the planes would land first, they wanted to have something there.
David: Right. I think that is a smart idea. Most Americans don’t think about non-home countries, but I love your idea of burying a bone in every back yard.
Ian: You don’t know what yard you’re going to end up in.
David: But what a fascinating time to be alive. There are areas that you could certainly be frustrated with when you look at change to freedoms and constitutionality of the laws, or lack of respect for the Constitution, maybe that is just a decidedly U.S. issue, but there are areas that I think we can be hopeful that are on the horizon. Resistance is probably the wrong word, but secession, the movements of secession around the world, which are basically saying, the idea that government can grow bigger and bigger and expect us to not notice that leviathan ultimately is going to eat us in the process of survival, we are not in tune with that. That, I think, is a positive.
Ian: If, in fact, they are allowed to succeed. I’ve got my doubts about the legitimacy of the Scottish vote, the way they engendered the panic at the last minute. And then the margin that they actually claimed. I have a feeling the somebody had their thumb on the scale on that one. And it’s going to be the same with Catalonia and Spain because the establishment is terrified of these secession movements breaking up their central bureaucracies, and yet, when you look around at the new Europe, it is the bureaucracies in Brussels that should be, literally, if you have an exterminator, call them. They are trying to pass all of these rules from this little core in Brussels that are trying to regulate everybody’s life, that is engendering the separatist movements. And the separatist movements are nothing more than just saying, get out of our face. The one most successful model that is out there is Switzerland, and the most powerful politician in the country is the local mayor because he is on the street, and a lot of the people on the street haven’t got a clue who their member of the national parliament is.
David: Could care less, probably.
Ian: That’s the order of the power. And the problem now, even in Switzerland, is they have increased the bureaucracy in Switzerland in recent years, to the extent that bureaucracy is now countermanding the power of the local voter, so that you have a political elite, and when Dr. Leutwieler, the last credible central banker in Switzerland, died, one of my old friends over there said, one of his dying comments was that he had appointed the wrong successor, because it was his successor that ended up deciding that they were so clever that Switzerland really should sell some of its gold because they could do much more productive things with the proceeds.
David: Sounds like Britain.
Ian: Exactly. I think Gordon Brown was bailing one of his friends out. If you want to arrange to make sure that you get the lowest possible price on a wholesale disposition, announce to the world what you are going to sell next Thursday at three o’clock.
David: Right. Well, as we wrap up, maybe in two minutes or less, you can take a wild stab at a five to ten-year view of the world. For better or for worse, what does your gut tell you?
Ian: I am afraid the standard of living is coming down in most of the Western countries because the standard of living has been propped up by debt and I think debt liquidation and the reduction of the leverage in the system is coming. The current international currency turbulence is going to breed increasing protectionism, which is going to constrain trade, and that is going to lead to the reduction of living standards. The prudent people are not going to have their living standard that reduced. If they are living within their means they don’t have a lot of debt exposure. When we are young, we all tend to think we can afford to take on debt because we are so much smarter, we can always earn a higher return on the interest cost. That leverage mentality and the aggressive get rich quick mentality, I think, is going to take an awful shock, and I think we are going into a period where people want to be really cautious and prudent. To me, it is a very dangerous time.
David: Is it your advice that perhaps being completely debt free is ideal, or is there some number that you would say, on a balance sheet you could have 10%, you could have 20%?
Ian: I have no problem with debt, providing you have some understanding of the security of the income that is required to service the debt. I run credit card balances all of the time. Partly, there is a tax edge to it that works for me, there is a convenience to it. But at the same time, you don’t ever want to get yourself stretched. I know some people that run out of money before they run out of month, every single month. That’s what you don’t want to do. That’s the wrong way around. On the other side of the coin, just understand the risk.
Much the same as I made the comment before, when you are looking at an investment, don’t think about how much you can make, think about the downside first. And in virtually all of your life decisions right now, I think we are into a window of risk where the people who are running it are almost seemingly out of control. And the biggest thing to me is the loss of liberty. In my workshop sessions I have been talking about, I recently had a medical test scheduled that I didn’t understand. It may or may not be related to whether or not I may or may not have a diabetic risk. So I did a Google search. Within 24 hours, and every day since, I now get offered 30 miracle cures for diabetes the next day in my email. I get swarmed by it. At what point are people going to say, “Wait a minute. Every thought that I have, if I do a Google search, it is now a matter of public record, and they are selling my name to everybody.”
I see kids walking along the street, they are talking or texting and crossing the street. I wish I could send them a text saying, “Look at the traffic, please.” At what point is this invasiveness going to get some blowback? J.P. Morgan had 80 million accounts hacked. I happened to buy a whole bunch of flooring material at Home Depot about three weeks before the release of the fact that Home Depot had 12 million accounts hacked. Big Brother – this is so far beyond everything that George Orwell ever thought about. I refuse to carry an iPhone. I just don’t think I should be carrying a GPS unit in the back of my head for George Orwell’s buddies to know where I am at every minute of the day. And to me, there is going to be some blowback to all of this. If a terrorist was set upon really messing up the West, they wouldn’t need to shoot planes down. Figure out a way to short circuit the Internet. If you froze every ATM machine in America for 48 hours, this country is crippled.
David: Who has more than 20 bucks in their pocket?
Ian: Stop and think of it. I always make a point of having access to purchasing power. Much the same way, now that they have constraints on large units of gold, I have told a lot of people I know that have 100 and 400-ounce bars of gold, pay the premium and break down those 400-ounce bars into kilo bars, and even into 10-gram wafers, and even the 1-ounce gold coins, because in a real crisis, who is going to make change for your 100-ounce bar when you are trying to buy a loaf of bread?
David: We dealt with a family in Switzerland doing that years ago, coming out of 400-ounce good delivery bars, and into small fractional European coins. They paid a small premium to have the fractional European coins, but even in that moment, there was an issue of liquidating the 400-ounce good delivery bars, because you know what? Nobody really wants to inventory that stuff.
Ian: Exactly. It’s a good delivery bar for wholesalers, and that is the only extent for it, but now that you have this – I’m drawing a blank on the name of it, but it is to make sure it’s not blood money from Africa. But what the banks have done now is if you take a bar out of the system, you now have to certify that every single gram of that 400-ounce bar doesn’t contain one – even if it is a 4 nine’s bar – that .00001 portion didn’t come from Zambia, or Zaire, or whatever country it is they are worried about. And, in a sense, it is just another intervention into a free market. So my reaction is, you don’t want the large bars. You are far better off with a mason jar full of one-ounce coins and wafers.
David: Well, it is a fascinating world we live in. Your contribution continues to be outstanding. I wish your newsletter was still published because the world should be reading it, Deliberations on World Events.
Ian: I’m on a hiatus right now. The formal newsletter I terminated last February after 42 years and 892 printer’s deadlines. I am in the process of trying to pack up all of my stuff and move to a small town because, socially, I think it is time to get out of the larger cities. And I’m moving to a smaller town, so I haven’t been writing much lately. My intent is to write something once a month, when I’ve got something to say. For 42 years, my entire life was run by having to be at the printer’s on the third Wednesday morning, or the second Wednesday morning, turning that over. And it is taking me a lot longer to get re-established.
Where I’m having a little fun is, I am also in the process of trying to pull together an archive of everything I have written since the 1960s. I started writing about charts and stuff back in 1967-1968, and including in the archive, and ultimately I intend to have it all on a website, paying for my little world, but I’ve even found VCR tapes of the four appearances I had on Wall Street Week with Louis Rukeyser back in 1980-1984, and I’ve got an audio tape of a television show in Canada called The Journal, which was the biggest CBC news program in its day.
On Friday, October 16, 1987, in an interview by Barbara Frum, Barbara made the comment to me, saying, “You know, Ian, every time we, the media, start wanting to talk to you about something happening in the stock market, you normally say, ‘Well, that’s the end of it.’” And on October 16, 1987, I said, “Barbara, that’s often the case, but not this time.” And of course, Monday/Tuesday was the crash, and she ended up having me on every night the following week. I have only got the audio tape of the 16th, I haven’t been able to find the stuff I did on the other days of that week. But I’ve dug up all kinds of little treasures that were buried away. When you have piles on top of piles that are on top of piles, going back 30 years, you find all sorts of wonderful things.
David: Including war medals and things of that nature.
Ian: Well, my father’s World War II medals that I thought were stolen several years ago, fortunately, surfaced under some old moth-eaten sweaters that somehow landed on top of them.
David: Well, we look forward to you adding to the conversation in the future, and I appreciate your time.
Ian: My pleasure.
* * *
Kevin: David, last week we entered new lows on gold, and obviously, for the person who is needing gold to go up in the short run, it caused a lot of fear and trepidation. For the person who buys gold and understands it is better than paper, they didn’t even pay attention.
David: Well, it is Ian McAvity’s reflection, really, that what you have with low prices are great entry points. In other words, if you want to make money in any asset, the best place to buy it is at low prices. And the best place to sell any asset is at high prices. So, you can begin to look at the whole landscape of investments and say, we know the equity markets are up, and they are up on a fairly artificial basis, taking gains there and rolling them into assets that represent value. We talked about silver. We talked about the fact that silver, relative to gold, and on its move to perhaps $15 an ounce, looks to be a compelling value. Now, it is very difficult for someone who owns it at $20 or $25, or $30 an ounce, to look at that and say, “I want more.”
Kevin: David, it is interesting, the people who are actually buying the physical metal in this period, I was reading the numbers from the U.S. mint – 60,000 American Eagle gold coins were minted before the end of October, just in this one month, but over 4.1 million silver American Eagles. That is just the mint numbers. These guys are having a hard time keeping up.
David: With demand.
Kevin: So as the price falls, somebody is buying.
David: That’s right, and so there is somebody buying, somebody who sees the handwriting on the wall, and somebody who, frankly, sees that the current projects are unsustainable, artificial, and manipulated. And we are not talking about gold and silver being manipulated or suppressed. We are talking, really, about the mass manipulation of social sentiment. You turn on the news media and what do you have? A regular barrage of, “The markets only go one direction, and that is up, up, and away from here.” Never really much commentary about the dependence on the Fed, Bank of Japan, European Central Bank, Bank of England, People’s Bank of China inputs into the market. And the fact is, we have assets that are floating on a sea of central bank liquidity. It is one thing to own an asset and to see it return value to shareholders because it is creating something that adds value and people enjoy, whether it is a new product or a new service, or what have you. But for prices to go up simply on the basis of funny money and monopoly money being printed by the world’s central bankers, ad infinitum, it is a very interesting world. It is something that, like any good con game, continues until it doesn’t. It marches forward until it stops abruptly.
Kevin: One of the people who really understand that con game, and if that con game continues, what the ramifications are, is our guest next week. We will be bringing Richard Duncan on, and his analysis of central bank input is probably second to none.
David: It is the older liquidity theory of asset pricing where, essentially, you will see an increase in the value of assets, depending on central bank liquidity creation, but it has to be an excessive amount of liquidity creation, and therein is the question. How much is too much leads you to inflation or hyper-inflation. How much is too little leads you to asset price devaluation. And somewhere in between is what central banks are trying to do – throttle trillions of dollars into the global economy to create asset price inflation, and thus, happier people. And happy people are, frankly, spending people.
Kevin: It’s the sad corner in this state of affairs that we have put ourselves into by taking ourselves off of the gold standard, originally. Nothing balances anymore.
David: It’s a dependency on debt.