The McAlvany Weekly Commentary
with David McAlvany and Kevin Orrick
Kevin: As promised, David, we have Alan Newman back today to talk about precious metals. Precious metals, as long-term safe as they may be, really do, in a way, require in the short-run, a cast-iron stomach.
David: What we have seen over the last ten years is a steady two steps forward, one step back, and that is a normal healthy behavior in any bull market. What I mean by normal is that you have people who are both bullish and bearish, and there is a struggle for who is right in the equation. It is almost like a market argument: “No, I have reasons to be bullish.” “No, I have reasons to be bearish.”
We see that volatility on a daily, weekly, monthly, or annual basis, and there are periods when the bulls are winning, and there are periods when the bears are winning, at least in the short-term, these short-term little cycles. But ultimately what we see is an unhealthy and unsustainable market dynamic in which there are only bulls, and the price is only moving up. There is no period of consolidation, there is no step-back. That can, of course, be very profitable, but it is unhealthy because, ultimately, you run out of people to come into the market, you run out of buyers.
Kevin: That’s what a bubble is. When people talk about gold being in a bubble that is laughable, because there is hardly anyone in the market right now. As you have brought up in the past, America, right now, is buying just about twice what Turkey is buying, and about 2½ times what Vietnam is buying, in the way of gold. You even mentioned in the latest video that we have online, The Fuse is Lit, that people do have to have a longer-term view, and a cast-iron stomach, and be willing to hold on. But when you are in a bull market, the consolidation phase is always the best time to buy, is it not?
David: That’s true. What we contrasted in that most recent film clip was what kind of volatility a client should be expecting. In the physical metals there is far less volatility, specifically, gold, a little bit more volatility with physical silver, more volatility with gold stocks, all of which can be appropriate. But again, know who you are as an investor as you approach the investment markets so that you know what you are going to experience and what you can actually sustain. Are you going to lose sleep at night? With physical gold, I would guess no one would. Physical silver, perhaps a little bit more, and mining shares, spectacular, indeed, but they can also add a line item to your monthly budget, for Maalox or Pepto-Bismol.
Kevin: I must mention Crosscurrents, the newsletter that Alan Newman writes, is a stock market newsletter. It deals with equities. In fact, he even told you recently, “I’m not going to talk about bonds, I’m not going to talk about things that are not my specialty. Stocks are.” And David, there really is a volatility difference. As you said, regarding physical gold, I don’t know that I know what I have paid for any of my physical gold. I don’t care. I just put it aside. I know it is worth more and more against the dollar. Silver, you have to watch a little closer. Gold stocks, on the other hand, are pieces of paper representing a company. It is something that you want to buy well and sell well.
David: It is so fascinating to me, Kevin, because I’ve done a number of interviews the last couple of months in Toronto, and in New York, and in London, and it is New York and London that look at the gold market like it is an insane investment thesis, that you don’t want to be invested in it, that it makes no sense. It’s almost as if it has not been in a bull market the last ten years, because as far as they are concerned, they didn’t buy it and they don’t care about it.
But in Toronto there is a much greater openness, I think, because their system of capital formation, their stock market, the Toronto Stock Exchange, funds a huge resource sector, and gold is a part of that. So there is an implicit understanding, a deeper understanding, within that stock market, of the role that gold has played the last ten years, a greater market awareness. We really haven’t seen that kind of attention given to gold in the U.S. space.
Alan, we come back to the issue of being in a long-term bull market. We certainly see it being intact, but let’s just begin there – your basic summary. Is the bull market still intact?
Alan Newman: Yes, it actually began on 9/11. I was sitting there watching the second tower coming down and I said, “You know what? The world is a different place.” I immediately started writing about gold and gold stocks. I am, if not the world’s biggest bull on precious metals, I am darn close. I think we are in a very, very long-term secular phase that is going to extend out years to come. It is going to surprise anybody, and as far I am concerned, there is no way this can possibly end until we see the most incredible rush into gold shares, pretty much like we saw for technology issues in 2000 – an absolute mania. That’s the way it will end, and it’s probably many years away.
David: When you say long-term, or if we call it a super bull, does that have a time frame or price destination in mind? Obviously, you don’t have to mention both, but we generally think in terms of the next 2-5 years. Is that in keeping with your view of a super bull in gold, or are we too conservative in that?
Alan: No, I think the horizon is further out than that. I don’t think the fundamentals change against gold until we can find ways out of our fiscal mess, and it is not only the general population that has too much debt, it is the Federal government. I think we are in a period where we are bound to see a huge surge in inflation somewhere down the road, and it may be a phase in which it just continues to build and build and build, going to 4%, to 6%, to 8%, and finally goes to 10%. Who knows? Possibly higher. Everything costs more. You have to have something that will trade well against currencies, against anything that you can buy, and that will be gold. It has always been money, for thousands of years. That will be the storehouse of value, as it always has been.
David: The last period of consolidation lasted nearly 19 months. What do you view as, from a technical standpoint, the function of a consolidation? Why do they occur in the context of a bull market? Do you welcome them? Do you dread them? How do you view the step-back, in a larger context?
Alan: I think they were all opportunities, particularly the consolidation that has been taking place in gold. The more that irks people, or makes them feel uncomfortable about something, the more people are going to be on the sidelines to be buyers later on. I think this consolidation mode in gold that has been going on for a long time is just a wonderful consolidation mode. We had a huge move last year. We got up to over $1900 an ounce, and, going back to $1588, this is nothing, this is fine.
On a downside basis where could gold go? It wouldn’t totally surprise me if we saw a move to just $1500 an ounce. It really wouldn’t bother me. I don’t think we will, but it wouldn’t bother me. I think we are well on our way to higher prices. I think the gold companies have started to pay dividends for a very good reason. They know what is going on out there. They can see the future better than any of us, and they are all looking at prices, if not this year, then next year, of $2000 an ounce. Further down the road, I don’t even want to say what might be possible, but it could be much higher than that.
David: We often think in terms of nominal values and that is where you are picking a price – $1585, $1900, $5000 – whatever the nominal value is, to me it is less relevant than your purchasing power, and what that ounce of gold buys you in real terms, whether that is Dow shares, or acres, or single-family homes. We’ve seen the Dow gold shrink from 43-to-1, the Dow-gold ratio, now hovering around 8-to-1. What do you think is more likely? That we will see the shares, the Dow component, diminish, or gold increase, or do we get the best of both worlds? What do you think?
Alan: When I became a gold bull I put together a Dow-gold ratio target of 5-to-1. I later adjusted that to 6-to-1 because it looked like terrorism was on a significant decline and we didn’t have to worry about that part of the equation. But just a few months ago I lowered that ratio back to 5-to-1, noting that, fiscally and economically, we still have problems ahead of us that are near insoluble because Congress doesn’t want to act, the S&P doesn’t want to act, the banks don’t want to help. So I think we are going from 8-to-1 to 5-to-1.
Any incarnation of that ratio that you might want to look at, between 8-to-1 and 5-to-1, favors gold and certainly gold stocks, over the Dow. Just for the sake of argument, if you were going to think the Dow would double over the next ten years to 25,000, gold is probably going to triple, so where do you want to be?
David: We have seen the ratio get as low as 1-to-1, going back to the 1980s, and of course, we were at probably a 3-to-1 ratio on the basis of economic and financial issues. It wasn’t until the Russians invaded Afghanistan and there was a major push, a fear factor which we hadn’t seen in metals, on the basis of geopolitics and a shift in oil to the russkies. That was a real concern, and it quickly went from 3-to-1 to 1-to-1. Political overlays, obviously, those are X factors, things that cannot be accounted for. You are more comfortable with a 5-to-1 than, say, a 3-to-1, I guess?
Alan: Well, you know what? Let’s take it one step at a time. I think 5-to-1 is quite reasonable. 1-to-1 is going to require things to happen that I don’t think any of us want to consider – a world that is, wow, a fraction of what we want it to be, so I don’t want to consider that scenario. I don’t think it is wise to consider that scenario yet. I still think it a low percentage probability, whereas, the 5-to-1, I think, is a high percentage probability.
David: Coming back around to what we were talking about a minute ago, with the shares, there are concerns over de-leveraging in the financial markets. Those abound. Can you see an environment where gold holds its own while mining companies trade lower in sync with the general equities market?
Alan: Yes, it could happen. If we are talking about a Dow that is going to 8,000 for years to come, investors just don’t want any part of any equity, whatsoever, but I don’t think that is going to be the case. If gold is on its way to $2000 or $3000 an ounce, at some point I think you are going to see that sponsorship, where people say, “You know what? It’s not only that gold is going up and these companies are making more money, but heck, they are paying dividends, and they are paying big dividends.”
Take a look at a stock like Newmont Mining, in which their chairman has decided, “All right, folks, we have a dividend policy in place, and it is going to be generous. And if gold gets to, let’s say $2400 an ounce, we’re going to be paying 9-ish based on the price of Newmont right now.” We’re talking a humongous yield. I don’t even want to have my money in a bank. I don’t want to be investing in Exxon Mobile for a dividend, I want to be investing in Newmont. I want that big dividend somewhere down the road.
David: It was a stroke of genius that I think managers are repeating from the 1970s. If you recall, during that time frame, with many South African shares, the annual dividends were more generous than the original cost basis. (laughter) It was an interesting era. One of the things we have to come to terms with, as you mentioned, we have the general population with too much debt, and we have the Federal government with too much debt, and again, those concerns about de-leveraging have more to do with default. I guess what you are implying is that default may be less of a risk, and inflation more of a risk, given the tool set that the Fed and the world’s various central bankers are working with. Maybe this last week was an indication of that with the ECB, the Bank of England – everybody – are kind of letting loose, including the Chinese.
Alan: I don’t see any way out of the mess over the long term, without a substantial phase of inflation, for probably years ahead, because when you have inflation you are paying off debts with cheaper currency – cheaper dollars, cheaper euros, cheaper whatever it is. Whatever the currency, you are paying off less. It makes the problem a lot easier to solve.
David: Taking the inflationary route?
Alan: Correct. I think this has to happen, particularly with government.
David: Isn’t it interesting that the BLS is back to the NBER? The whole economic community is back to debating the academic point between chained versus unchained inflation statistics, and the big argument is that the current rate of inflation is grossly overstating reality, that in fact, the real rate of inflation is lower than the current stated rate. Do you smell a rat?
Alan: Of course I do, and God bless John Williams for establishing shadowstats.com. I visit there every once in a while and I take a look at the charts. He was formerly with the government, he is an economist, and frankly, I trust his charts more than the government. I think he is telling the truth.
David: The beauty is, we actually have a stock of debt which can be paid back. If you are saying that inflation is 1-2%, or 2-3%, and you are running a real world rate of 4, 5, 6%, creditors might not be too happy about that, but over a long enough period of time, you are, effectively, taking care of your debt problem, aren’t you?
Alan: Yes, you are. But we have to get cracking about this very soon. I remember a few years ago looking at the national debt which was 9 trillion dollars and it is soon to be 16 trillion. Congress is going to have to raise the debt limit again very soon. What is going on here? Can anybody play this game? They keep saying, “We’re here to observe.”
David: Backtrack just for a moment. In your own portfolio, and this goes back to gold versus gold shares and things like that, would you tend to emphasize physical gold exposure, or the companies that mine the metal? What risks and benefits come with either approach?
Alan: We are probably at a stage where there is so much apprehension about the future that you want to have small physical holdings, and by that I am talking about coins, something that can be readily exchanged in case there is some type of huge national emergency down the road. It’s a scenario that no one wants to consider, but heaven forefend if you are not protected to some degree.
I do favor the gold stocks, actually. Holding onto bullion is crazy. I don’t know that I am ever going to see it, I don’t know that I am ever going to hold it in my hands, I don’t know that it is ever going to be necessary. I would rather invest in gold shares and look for a modestly depressing scenario ten years down the road in which I can make a lot of money in gold. That’s the place to be, because as I said, there is going to higher inflation, and gold will shine under those circumstances. I would stick with gold stocks. I tend to be conservative, so I like stocks like Newmont the best, but I think there is always room to be a little bit speculative and climb onboard with the juniors.
David: In May you sent out a special report on this. The XAU gold ratio had slipped to about 11. We’ve only seen that ratio maybe twice or three times in 30 years. They are a compelling value, but the flip side of that is that they’ve been a losing prospect to get to that sort of compelling value level. We have the political risks with the South African miners. The ANC is talking about either taking over the mines directly, nationalizing, or just slapping a tax of (laughter) 50% or more. It starts to sound like the French with their 75% tax.
We also have regulatory risk. Lucky Friday, this last year, for Hecla – shut down. The government basically said, this is what you need to clean up and you can’t operate until it happens. There is a whole host of things. Are those the kinds of things that are weighing on those shares, or is it really that the American public has no imagination for a gold bull market, and have been thoroughly educated against owning gold, in any form, because frankly, Wall Street would prefer that you are buying regular issues, things that are more of their staple, and that they are hawking on a daily basis?
Alan: Yes, the regulators don’t want you buying gold, certainly not. I think the issues that you mentioned before do have some impact, but to a greater extent, it is that people are just generally ignorant about gold and gold shares. I think that point is going to come. We just have to see higher inflation, we have to see a little more turmoil worldwide before they get involved.
A gold super bull market is what I have called it for years, and in fact, when I made the decision that gold was in a bull market on 9/11, I said, “Super bull market.” I used those words. There is no way that this is going to end, so you have a mania at least as emphatic as the tech mania in 1999 and 2000 – at least as emphatic.
David: It was interesting that we saw a foreshadowing of that in late summer, early fall, of 2008, when investors were looking at physical metals and just wanted to own it, didn’t like what they saw developing in the equities market and for the first time in that stretch, you mentioned 2001 up to that point, price was not relevant, but the product, and getting immediate delivery, was.
And we saw very generic things: kilo bars – you were allocated one per day off of the exchanges. The demand for physical metals was off the charts. The premiums were on the rise. Krugerrands were pulling 10-15% premiums over the spot price on the wholesale market. Eagles – 30-35% over. All of a sudden, when people wanted to own the physicals, there was a strange reality, something that most investors were not aware of, that in fact, there was not an infinite amount of product available. They couldn’t snap their fingers and say, “Okay, now, I want my 10 million dollars in gold delivered tomorrow.” There was a bit of a process, and a premium, because they waited.
Do you feel like the summer months, when you look at today, you can buy anything you want, there is no premium, no premium in the gold shares, do you see contra-indicators? Yes, we are in a bull market, and yes, now is a decent time to be looking at anything that is gold or silver-related.
Alan: Oh yes, it is certainly an opportunity. Any time you are in a consolidation mode, and sentiment is turned so sharply south of where it was at the highs, you know that it is a buyer’s market, it’s not a seller’s market. Yes, there are certainly opportunities here.
David: Maybe one last thing. This is a super bull market in the metals. If you could contrast the metals long-term bull market with perhaps an overall commodities bull market, is the common theme global central banker intervention, or is there a difference, actually, when you start getting into the specific supply and demand dynamics, separating out gold and silver from the soft commodities, the industrials and other things like that?
Alan: Well, we’re not even sure that central bankers can do anything about the problems. That is one of the reasons why I am so bullish on gold. The longer problems remain unsolved, the longer there are some questions about the future, the brighter the prospect is for gold. It is just a question of finding ways to hedge against problems in the future. It is finding ways to protect yourself, and that would be precious metals.
David: It sounds to me like you are fairly certain QE-III, QE-IV, QE-V, (laughter) sounds like a broken record, QE-VI. Do you think that is really the only way forward as we get beyond the fiscal cliff and the intransigence on both sides of the aisle to make any real reforms at the fiscal level? Does this ultimately get thrown back at Bernanke to solve?
Alan: Quite frankly, I don’t know that we can keep on going to QE-VI, QE-VII, and QE-VIII. There comes a point at which they have to admit that their approach is not working. If we do have a QE-III and the Dow and the S&P and the major averages are still mired down two years from now, at some point they have to admit, “This is not working. We have to find something else to do.” Again, there is a huge question mark in front of this and it is another reason to be involved in gold, in gold shares, and precious metals, and commodities, in general. You want things that you can touch and feel.
David: This is perhaps far afield from the charts and is not meant to be divisive in any way, but statistically, 7.4% has been the cutoff for unemployment numbers, in which the incumbent doesn’t get in if the number is higher than that. What that means is that the current number, 8.2%, reiterated here recently, doesn’t spell a successful run for Obama. We are talking about a fairly negative picture for equities, a very positive picture for precious metals, over the next several years. Would, hypothetically, a Romney election help or hurt the situation, in your opinion? Again, I don’t know if you can chart that or put a statistic to it, but do you think sentiment could change?
Alan: Yes, I do. I don’t think anything happened in the last four years that would give me any confidence that a re-election of Obama would help us over the next four years. Romney, at the very least, is a change of face, and a businessman, so perhaps that will help. I don’t guarantee that it will. I think we are in an economic funk, because of what has happened with derivatives markets, with banks, and brokers, giving us the situation with this housing boom that should not have been, and subsequent fallout, and subsequent collapse. It may be that Obama couldn’t do anything about it. I’m not sure.
I hear people talk about the great surplus that Clinton had. The surplus that we had had nothing to do with Clinton. It had everything to do with the fact that we were in this super bull market for stocks, and we had so many taking an extraordinary amount of capital gains. That’s what our surplus was due to, nothing else. But yes, overall, I would hope that Romney would be a better choice for the next four years.
David: There was a similar period of time leaving the Carter era, and coming into the Reagan administration, a bounce in equities, a good 3-4 months of positive traction, and then the markets basically went somewhere close to hell, or maybe just purgatory. It was an 18-24 month slog where it didn’t matter if there were new ideas, there were a lot of fiscal issues which were already baked into the cake, and they still had to be addressed. Maybe it’s in that environment, post election 2013-2014, where, again, fiscal intransigence, very little progress made in terms of our debt levels, inflation kicking up, that we see a re-emergence of the bull market in metals. Or do you think we could actually see prices move considerably, even this year, specifically, gold and silver?
Alan: Yes, I think the odds will favor waiting until somewhat after the election until we see what is happening. I would not be surprised if this consolidation mode goes on for a while. The longer it goes on, the more bullish I am going to be anyway. I think we are still in that phase where it is discouraging people by gold going nowhere. It goes up $20, it goes down $20. There almost seems to be no point getting involved. Newmont goes up a few points, it goes down a few points. But again, with Newmont, per se, I’m getting back to dividends, and that’s where I want to be. I don’t see any immediate changes happening if Romney gets in. I will say that I have been a registered Democrat my entire life, but I can’t remember the last Democrat I voted for.
David: You raised something earlier which I think is very compelling in terms of this consolidation going on, and it taking some time, still, to finish it. It is loading sidelines with people who will be buyers later on. Anyone who is uncomfortable, that is your volume statistics in the future. Increasing prices and increasing volume, (laughter) it’s everyone coming off the sidelines.
Alan: Yes, it is loading the queue with sponsors, with buyers.
David: We would love to carry on the conversation, and perhaps you will join us again in the next couple of months or years. Your insights in CrossCurrents are fantastic, and I can’t recommend your newsletter highly enough. What is the best way for someone to look at the newsletter and try it on for size?
Alan: You can get some samples, if you go to www.cross-currents.net. There are links there where you can click for three free issues. It is a trial, it doesn’t cost a penny. As you say, I don’t charge enough, because it really is a labor of love. The best thing for me is the kudos page on my website. That’s what keeps me going. I get letters all the time.
David: I couldn’t agree more. I would encourage you to raise your price, because it’s worth it, and it is of high value, and I think anyone who is not going directly to www.cross-currents.net for the free three months, and then ultimately subscribing on beyond that, would be insane. You need as many tools at your fingertips in these markets, as possible. Making perspicacious decisions in this kind of an environment is an imperative. You can’t do that without taking on and seeing things from multiple perspectives, and having a technical overlay to fundamental analysis is a great complement.
Alan, we appreciate you joining us, and appreciate your contribution to not only this conversation, but what you do for the investment community. Thanks so much.
Alan: Thank you.
Kevin: David, that really puts things in perspective. It is interesting, listening to Alan talk about the length of the bull market, how long he thinks this is going to last, we have been looking at maybe 2-3 years, we don’t know timing, but this is a man who is looking from an equities point of view, as well, and saying, this could be many, many years of bull market before it is over. It is certainly more consistent with Don’s view that this could be a 5, to 7, to 10-year event from this point, making it a 20-25 year bull market in total. Yes, that defines it as a super bull market.
Kevin: Let me ask you a question though, because we talked about QE-I, II, III, IV, V, VI, VII, VIII, however, long QE goes, because we know it is one of the main tools in the Federal Reserve’s toolbox, but do we need QE at all for gold to actually continue up in this bull market?
David: Certainly, it put a new bit of wind in the sails – QE-I did, and QE-II did – but in terms of it being an effective policy measure, it was not very effective at all.
Kevin: So you are saying, the dollar could still continue to devalue, whether we ever see QE again?
David: I think we could continue to see gold on the rise. There is nothing in the gold price that is dependent on QE. I think that would just be more wind in the sails yet again, although not effective in terms of reviving the economy, and I think what we are really looking at is the beginning of the end. If the Fed ultimately pulls the trigger on QE-III it’s the beginning of the end, and an indication of just how desperate things are that they are now using policy measures that they know to be ineffective.
Kevin: It reminds me of the Weimar Republic back in the early 1920s. When they finally pulled out all the stops and just started printing, it turned into what Alan was talking about, this high, or super-inflation, maybe even a hyper-inflationary end game and that is unfortunate for everyone, because you can’t afford to live when that is happening.
David: Yes, monetization of specific asset classes, and if need be, stepping into the equity markets to monetize there, and just expanding the Fed balance sheet, I think we could see an explosion of the Fed’s balance sheet, that ultimately is negative for the U.S. bond market as we look at unsustainable balance sheet levels, not only the Fed, but also for the treasury.
I think one of the interesting comments from Alan today was the number of people who are in queue, the future buyers of gold, and if you will, look at the U.S. Treasury market, the long-term bull market which began in 1982 – price levels that we haven’t seen in history, and interest rate levels which are at historic lows. These are people who are concerned about the return of their capital, not the return on their capital.
Obviously, with inflation factored in, we are talking about zero return, zero interest, in fact negative returns, and in fact, in Newman’s parlance, you basically have a large queue of future gold buyers sitting in the Treasury market today. We have seen inflows into Treasuries on the basis of fear, but it is liquidity concerns which are number one in their minds. With solvency concerns being addressed simultaneously, as Treasuries appear relatively more attractive, what kind of behavior might we expect in the bond market if Treasuries were weighed in absolute terms, not on a relative basis, but on their own merits, not just relative to other sovereign paper?
Again, the notion of how long is the queue of gold buyers, both the naysayers today, but also the Treasury buyers today, who are assuming that they are making the best and safest bet. They are assuming that Treasury market paper is the most secure credit. What happens when that is turned? And we do see, potentially, yes, 5, 7, 10 years of growth in the gold market, as we see the line grow longer for people who want to own precious metals, not only today, but also in the future.