The McAlvany Weekly Commentary
with David McAlvany and Kevin Orrick
Kevin: David McAlvany is in Singapore today. We have him on the cell phone. David, tell everyone who is listening why you are in Singapore right now and why they should be interested.
David: For me it is a point of curiosity. We have to know, and we have to figure out, as best we can, what is taking place in this part of the world – Asia, in general, but China, in particular. And what is changing? What does it mean if there is a successful transition to a different form of growth in China, and how does that impact the major trade partners in this region, and throughout the world?
One of the projects that we have been on now for several months is the second installment of our DVD. This is the one that looks specifically at China and Asia, we call it Asian Ascendance, and it is still probably six weeks out from being finished. This is a part of our research, boots on the ground, to look the economists straight in the eye, to look at leaders of thought straight in the eye and have some frank discussions. What is working? What is not working? What are the greatest challenges ahead?
It is interesting, because Singapore, in particular, is a little bit like Switzerland in Europe. It is an enclave, it is out of the way, it is neutral. It is no one’s friend, no one’s enemy. They kind of mind their own business, and mind their business well. It is a place that has become a regional banking center, and competes vigorously with Hong Kong, which is sort of an extension of mainland China, a business depot, if you will, but it competes with Hong Kong as one of the primary financial centers in Asia.
Singapore is, in that regard, running neck and neck with Hong Kong. There are probably a few more money managers in Hong Kong, and a lot more smog, so you do find some very interesting companies and stories here in this place.
Kevin: Talking about Asia, this is something that we have been watching from a gold perspective for the last decade. It is really not American buying that is causing gold to go up. It is maybe not that much European buying. But it is the Asian buying. Since 2008 Asia has been acquiring hard assets, as well as energy assets, just voraciously, have they not?
David: They absolutely have, and even when they take a break they get right back to it fairly quickly. I’ll give an example. We went to Little India, which is a small enclave here in Singapore, for dinner the other night, and after having a delicious Indian meal, we then walked around the streets. We are right at the end of the Ramadan fast, and there are only two kinds of retail outlets that are open, restaurants and gold shops, and there are many gold shops up and down these Indian streets. Everything else is closed.
On the outside of the storefront they are showing their revised hours given it is still the celebration of Ramadan. It is this notion that, “When we finish the fast, there are two things that we want to do. We’d like to eat, and by the way, we’re celebrating.” They would like to celebrate in the way that they do traditionally.
This is one of the reasons why there is some seasonality to the gold price. At least 20 out of the last 21 years we have seen the price of gold recover nicely toward the end of summer, and at the beginning of fall, for two primary reasons: The end of Ramadan, and the beginning of the Indian wedding season, both traditional periods when these two people groups are very interesting in owning, and they do own, and add to what they own – significantly – gold.
Kevin: David, I saw a statistic just the other day that was amazing to me, that China, in the last three months, has purchased more gold than all of England’s holdings. England was the empire for a thousand years, and when you go to London, you realize that a lot of that empire was built on gold. At some points it was Spanish gold, at other points it was gold from around the world, the five continents that they occupied.
But what is interesting at this point is that China is buying enough gold right now to overwhelm all the reserves in England, and that just occurred over the last quarter. It is hard to put in perspective, from this side of the Atlantic, just how much there is interest in things that are going to be real, things that are going to be tangible, and actually, going to the energy side of things, things that will run industry and produce from this point forward.
David: There are a number of things to say there, because obviously, China’s oil ambitions are fairly intense, with Cnooc buying a Canadian company, it is one of the largest acquisitions they have made since their failed bid for Unocal. This is a 17.9 to 18.2 billion-dollar deal that is being made, again, to rival Unocal. Unfortunately, they couldn’t get that done. But the Canadian government has allowed many of these kinds of acquisitions to go through.
In fact, since 2008 China has acquired hard assets aggressively, 40 billion dollars in Canada, 23 billions dollars’ worth of acquisitions in Australia, and nearly 19 billion dollars in Brazil. Again, this most recent announcement of China’s, that is Cnooc’s purchase of Nexen, the Canadian company, is a major move forward for them. It is a little bit different than their past acquisitions because it is a major move into oil sands, and as far as the Chinese are concerned, higher oil prices are the wave of the future.
The reason I say that is because the supply source you are talking about, oil sand is a very bad bet. It is a very bad bet on any other pricing assumption. If you think oil is going to be sub $60, it’s a losing proposition. If you think oil is going to be over $100, then your purchase of oil sands assets is quite profitable, and that is what they are doing at present.
I just want to say one other thing about Singapore before we move on, and it is simply this. As I look at the cityscape, what I see is countless skyscrapers that are being built for residential purposes. We are talking about 20, 30, 40, 50-story buildings that are being put to use, primarily as a second residence. What is interesting is the flow of people into this place for second residences. By the way, the areas of town where these are going up, you can’t buy a small little shoebox apartment for less than $500,000 to 1 million dollars, American equivalent.
Kevin: So David, what you are saying is, you don’t go to Singapore, necessarily, for the bargains.
David: No. There are no bargains here, but what is compelling is the flow of people who are coming in to buy a second residence. When you want assets someplace else, and when you have a lot of assets that you don’t want to necessarily tell anyone about, and I’m specifically talking about the wealthy Chinese, it makes a lot of sense to pay cash for real estate in a place like Singapore. It’s a hop, skip, and a jump away. It’s a place that you are comfortable with, culturally, and it’s a place where you can have a banking relationship, and maybe even hang a few nice pieces of art in that apartment that is worth $500,000 to a million dollars.
What you see in Singapore is a lot of luxury cars, and a lot of luxury residences, and a lot of luxury that is non-Singaporian. It is, frankly, mostly Chinese. Granted, there is a cross-section that truly is a melting pot. Their cuisine is reflective of this being a melting pot. There are influences from Malaysia, influences from India, influences from Indonesia, South Korea, and the whole Asian region, but the primary money flow into this place, at present, is Chinese wealth.
This goes back to what we discussed with several of our interviews in weeks past relating to China, and that is that there is a need, certainly a desire, maybe as much as a need, for money to be outside of the Chinese system. There are officials who are in China who are no longer comfortable with having all of their eggs in one geographic basket. They know that their government may or may not successfully make this transition, and that leaves their new-found wealth in jeopardy.
Kevin: David, is it overstating the case, that Singapore may be an Asian Switzerland? For hundreds of years, Switzerland has been used as a safe haven, even from warring enemies. They can keep their assets in Switzerland and know that they are safe. Are you saying Singapore serves, to some degree, that same purpose for Asian investment, or even American investment?
David: Even more so than Costa Rica in Central America. Oftentimes people will talk about Costa Rica as the Switzerland of Latin America, or Central America. While it is, to some degree, because of its political stability and its strong rule of law, those things are very interesting about Costa Rica, but there is more sophistication, more money, and really, a true competition to be one of the financial centers of the world here in Singapore.
In the past we talked about New York, London, Japan, or Tokyo being really significant money centers, and again, going back to my earlier comment, we have Hong Kong and Singapore competing for that Asian space of pre-eminence.
Kevin: CNBC is going to be interviewing you today, and you are only going to have about five minutes to talk about a lot of issues. I know one of the things that they are going to ask you about is the recent rise in grain prices. Let’s put this in perspective for a moment. If we just go back a little over a year, Egypt was being affected dramatically by inflation and grain prices, enough so that we saw a change in leadership, and then not too long after that, Libya. So we have seen an Arab spring type of issue, and of course, we have Syria right now. We know that a rise in grain prices has more of an effect on politics sometimes than it does even the financial markets. What are you going to say today on the CNBC interview on grain prices?
David: Kevin, truly, there is a small number of people who are interested in trading the grain markets, or the “ags,” if you will. It’s a pretty small community. To me, ags or soft commodities are a reasonable bet until it rains, which in this case, may be this afternoon. The issue with ag speculation, in my opinion, is that the supply side has many more unknowable elements, and these are what remain the most important component pricing.
I prefer something like gold, frankly, in terms of an interest in commodities, and certainly we view it as currency, as well, I prefer a supply-constrained commodity where the primary variable in pricing is demand, and that, I think, we can quantify, to a greater degree. So in my opinion you have something that is less of a speculation, and something you can come to a sound understanding of.
The interesting thing with ags is, as we are all aware, there is a major drought happening in America, and as a consequence, we have high ag prices. That probably means that there is going to be major culling of livestock herds, and as there is culling of livestock herds, there will be a smaller group of pigs, and cows, and what not, to be slaughtered next year. So hogs and cattle could be an interesting bet.
We’re not particularly interested in investing there, but a major move in hogs, and again, this is how interconnected these worlds are, drought in America can mean price inflation in China because pork is a main staple within China. These are things that you have to keep in mind and just remember how small the world actually is, because, as you mentioned, politics is actually one of the most important things in that inflation scenario. To the degree that you have price inflation in China, you have folks who are not quite in the middle class, who would like to be, and who now can’t afford what they thought they would be able to. Yes, that spells discontent, dissatisfaction, even putting the boots on and marching in the street. So it’s a real problem. Price inflation has always been a Chinese issue.
Kevin: David, it is interesting, when we talk about inflation, sometimes we think in broad terms, that everything is just rising in price. But we have a strange scenario right now where we have price inflation in the thing that poor people cannot buy, but have to have, and that is food. But are we going to have price inflation in, perhaps, the industrial commodities? We are experiencing a slowdown right now. Granted, we have inflation in food prices, and that could be attributed to, as you said, the weather, or it could be attributed to a number of things. But how about industrial metals? How about the hard commodities?
David: This is where I think you see the key distinction between needs and wants. We have industrial metals that are weaker. We have copper slipping to one-month lows. We have nickel, which is at three-year lows, and these are the kinds of things that go into new development, that go into the things that you may want. If you want a stainless steel refrigerator instead of the old black-covered Maytag, this is the kind of thing that you pay up for, but you don’t need it, you want it, and those needs, again, go back to what you were describing. It’s the bowl of rice, it’s the tortillas, it’s the things that are the basic staples around the world and that is where you see price inflation as very dangerous politically.
Kevin: David, what you are talking about with these industrial metals, let’s say platinum and copper and some of these types of things, they can have a very different life than a monetary metal like gold. Gold has been relatively boring, from a price perspective, over the last few months, but could you address the difference in the prospects of the gold market, and the prospects of, for instance, the copper market, and how they differ?
David: I want to give credit where credit is due, as it is not very often that you see a positive article on gold in the Financial Times, but we do have one today, and maybe this is just in the Asian version, I don’t know, someone will have to check this, but John Plender writes that even those on the Panglossian side of the argument should recognize that there is a case for taking out insurance, via gold, against the alternative scenario.
Just to put that in context, earlier in the same article, John is talking about the unlikely event of policies being put in place to address both fiscal deficits and the debt problems that we have in the developed world. And this is the reality: We may come up with the best plans, but it is still going to take political will to put them in place, and so the argument for owning gold, at least in John’s words, are that you may need an insurance against this kind of failure to proceed in a positive manner.
Kevin, it is just the way we have looked at gold. We have always seen gold as an insurance. This is, I think, one of the things that is interesting, because I think precious metals are a great bet, given that buying systematic insurance is not only in vogue today in Europe, and specifically, what I am talking about is, if you consider the Spanish credit default spread. They are about 600 basis points, today, and they were 100 basis points a few years ago. Again, Spanish credit default swaps – any credit default swaps – this is just a means of protecting against default on paper that you may own. If you own Spanish bonds, you can turn around and buy CDS, or credit default spreads, credit default swaps, and cover that credit risk by paying a small insurance, if you will, for that.
The insurance costs have gone up many fold there in Spain, but it is really likely to be even more popular, globally, as Western politicians largely ignore the imbalances that exist today in the global economy, so we are really not talking about just Spanish concerns, or the need to insure against Spanish default, but we are talking about a need to insure against default on a larger, more systemic basis. And this is really where monetary policies only serve to intensify the flow of investors into metals, seeking to protect assets in a low-to-negative real rate environment.
Kevin, as you will recall, we talked about being in a negative real rate environment, or even just a low real rate environment, and that is one reason why investors flock to metals, but as people are concerned about what their money purchases, or are concerned about the credit quality of the country that they live in, and they can no longer consider the sovereign paper of that country, the best place to store their assets, then gold becomes, again, that natural insurance, that natural lifeboat.
Kevin, that’s what we have seen over the last ten years, a gradual shift in the audience from just a few mavericks thinking that it made sense to have insurance, to now some really, really concerned people who are frankly middle-of-the-road in terms of their political or economic concerns, but somewhere deep in their guts, they are still feeling like something is not going to be fixed, or if it is fixed, it is not going to be fixed easily or without pain, and those are folks that ten years ago would not have been interested in owning gold, but today, do own it as an insurance policy.
Kevin: David, on our website where this show is found, listeners can click and see a beautiful chart showing this last ten years that you are talking about. There is a repeating pattern that started right in the middle of 2001 that this chart shows. Gold went up about 66%. It had started below $300 an ounce, went up 66% and then, after hitting a new high, leveled out 15 months, which was like a step, and then it went up 73% to a new high.
Then it came down and leveled out for about 15 months, like taking a breath in the market, and then it went up 56%, hit a new high, came down, leveled off, took a breath. And then this last move from 2009 until about 2011, we went on past $1900 briefly, and now it has come down, it is taking a breath in the mid $1500-1600 range.
But all of those breaths, those steps, and this can be seen in the chart, last between 15 and 16 months, and then gold goes on and makes a new high. This is in an environment that has had no hyperinflation in it. This is not a bubble environment. This is just what you are talking about. A low real rate of a return environment and a low faith environment in the paper markets, and we are seeing that in the steady rise of gold.
David, would you address the moving average, and just how that is so important to look at, versus the daily prices?
David: The conversations that I have had in recent weeks, whether in Las Vegas, or in Zurich, Switzerland, or Geneva where I was just a few weeks ago, or even here in Singapore, it is as if people are expecting there to be a catalyst to take gold to a higher level. I am wondering, as I look back over the last ten years, what the catalyst was in 2002, what the catalyst was in 2003-2004, what the catalyst was as we took off again in 2006, what the catalyst was at the end of 2007 into 2008, what the catalyst was … I could bore you with this.
But the reality is, there has been no catalyst. What we have had is a gradual migration of investors who are putting the pieces together and realizing that we have political issues which have to be addressed, economic and fiscal issues which have to be addressed, and I don’t know that we have the right people in place to get that done.
Frankly, that is not a question of changing from one party to the other, from the red shirts to blue shirts, as it were, here in the United States. We have had a series of elections around the world, and the proof is still needing to be put on the table. We don’t know yet if we have the resolve, in any of these countries, the leadership, to say, “I’m going to do the right thing.”
Ironically, there is leadership that, today, in Italy, has a good shot at putting in stabilizing reforms. Mario Monti is not the country bumpkin that some would like to think that he is. In fact, one of his favorite authors is … do you have any guesses?
Kevin: Well, I hope it’s not John Maynard Keynes, like most of those guys.
David: That’s a reasonable guess, that’s an educated guess. But, Friedrich Hayek is one of his favorite authors, and this is telling to me, Kevin, because there is a different set of ideas that is going to be present amongst the decision-makers that will actually turn this around. Ultimately, that is very positive. But we are talking about one person in leadership today, in one country in Europe. Meanwhile, the French bring in Francois Hollande.
Kevin: Yes, that’s just pure socialism.
David: Beyond pure socialism, it’s national suicide. I don’t think you understand what the importance of that election was. What may actually tip the scale in terms of European stability has nothing to do with Spain or Italy, because yes, they have their problems, but they may, theoretically, be solvable. Greeks? Sorry, they are not solvable. They are going the way of the dodo bird, to some degree.
But this is the issue. France and Germany were the lynchpin of the whole euro project. And now we have someone who is willing to play chicken with the whole project, for France’s benefit, and a very socialist agenda, and that’s quite dangerous to global financial stability, but he would probably be heralded as a hero, at least in the streets of Paris.
Kevin: David, that’s just talking about Europe, and yes, Europe’s a mess. We are all sick of hearing about Europe, I have to say, but I have clients who are calling in and saying, “Yes, but what if we have a political change? What if we have a change in Washington?” I have to say, if our listeners would just look at this chart, it is amazing. Two-thirds of this chart, from 2001 through 2012, is a steady rise of gold, not even a blip when we switched from Bush to Obama, and so my thought would be, we are probably not going to have a blip if we switch from Obama to Romney.
What is your thought on the effect of new change in leadership, if we get it in Washington, on the currently rising gold bull market?
David: The democratic system that we have in place today is one that is, frankly, compromised. It doesn’t allow for a politician to do what they should do. They are always at the beck and call of the 51%. We’ve talked about the 1%. We’ve talked about the 99%. This is the way the haves and have-nots are being cast to the popular mind today. But the real problem is not the 1% or the 99%, it’s the 51%.
The 51% is what makes real political change, and doing anything right, unreasonable, because most of the people who are going into political office have the resources to get into office. And frankly, if they are going to spend the money to be there, they are going to stay as long as they possibly can, and reap as much reward from it as they possibly can. That has become the nature of politics in America.
We are talking about a different environment altogether, in which you are attracting, not people who are in it for themselves – frankly, I can’t imagine who would want to run for president. Honestly, I can’t. Looking at Romney, I would say this is probably sort of a Bain Capital, vulture capital, kind of approach to what he can do to reorganize this country. Do we need reorganization? Yes. But frankly, I don’t want it to be to the benefit of the Romney family. That I find appalling.
What I do find equally appalling, is that we have the same kind of aspiration, less spoken, less obvious, but if you look at the balance sheet of Señor Obama, you will see that his balance sheet has grown considerably since he came into the Senate, and then now, the White House. How is that possible? How does someone who makes a low six-digit salary as a paid official, rise in the ranks of the American wealthy?
This is what we talked about a few weeks ago in terms of Chinese crime and politics. This is what we talked about also looking at our deficit in the United States. We have, roughly, 8-10% of our economy going to political graft. This is spending which we cannot afford, politicians have put us on the hook for it, and this is the way they have bought their votes, plain and simple, and they cannot cut the budget.
When we look at fiscal issues, when we look at debt issues, and it seems plain to you, or to me, or to any of our listeners, that it is real simple, you just have to stop spending as much and maybe save a little bit more, the problem is, they are a part of a system which is, today, corrupted. The kind of democracy that we have today has too much political graft wrapped up in it, and to change it will take nothing short of a revolution.
Kevin: David, what we are saying then is, whether it is China, whether it is Europe, whether it is America, right now the best bet is to get out of the system that is represented by unpayable debt and get into something physical that actually maintains value until they play this thing out, whether we have a political change, a partisan change in Washington, or not, the debt system is not going to be solved with the current solutions that either party is offering. That is what I think I hear you saying.
David: The alternative is that you can just go through the meat grinder, and again, you don’t see catalysts driving the gold market, you see a gradual migration of people who are waking up to the fact that debt is a killer to our economy, and we have too much of it, and there is no way that our economy can recover under the full weight of the debt and obligations that we have. So the question for the average investor is, “Do I want to go through the meat grinder or not?”
That is why people look at gold differently today than they did two years ago, three years ago, or ten years ago, because we were not in the process of being grist for the mill ten years ago, and we are today, and we have become so even more with every passing day since the year 2000. This is really the crux of it. The audience is growing. It is a global audience.
We have talked about that in the past, the fact that Asia and the Indian subcontinent represent the lion’s share of gold ownership, which means that Americans will come late to this market. It means that Western Europeans will come late to this market. And the benefits received by being early, for the mavericks who bought in 2002, 2003, 2004, 2005, 2006, 2007, 2008, and 2009, will continue to benefit, and the ones who come in late will benefit only marginally.
But I think this is, again, where you talked about the 65-week moving average. What you see here is a very stable story, and it is one of investor migration, for a very good reason. Again, it comes back to something very simple. We will see a political nightmare. So with this steady progress, there have been corrective phases every year or two, and they have lasted, on average, 15-16 months. The last one lasted 19 months. We have seen these corrections before. We have seen these consolidations before, in the larger context. And immediately following those corrective phases, what happened? Where did the price go?
Kevin: David, that is the interesting thing. The price, once it finished the consolidation, went on up to a new high. We have gone about eleven months into this consolidation. It has been about eleven months, roughly, since we saw gold above $1900. My question to you would be this: This consolidation – is this buying high, or is it like the last three consolidations, in that anyone who buys in this region actually buys gold at the lowest price that we will probably see in this bull market?
David: I think you have to answer affirmatively to both of those. Buying at $1500 is a lot higher than $250, $350, $450, $550, $650, but it is also the lowest point you could be at in a period of consolidation. If instead of choosing the lowest point in every period of consolidation, you picked the new high that had recently been set, you would be talking about $375, $435, $720. You would be talking about just over $1000. You would be talking about $1250, $1920. These are all of the highs, and as you look back retrospectively, what you will find is that there is only one that you don’t like – $1920 – and I would just say, give it a little bit of time before it, too, is left behind, and is a number that anyone would be happy owning gold at, relative to the current price.
Are we bullish on gold? I think, unabashedly, we are bullish on gold, but that is partially because we are somewhat pessimistic about the political strength that we see in the United States, and globally – people who don’t get the issues, and people who are constrained by the environment they are in, a political system which will chew them up and spit them out, if they were to even attempt to do the right thing.
Unfortunately, Kevin, this is why the book that we read so many months ago, The Fourth Turning, becomes so important, because it is at this stage in history, after basically 100 years of consistent and steady growth, that we have to see a major disruption. Neil Howe and William Strauss said that every 100-120 years we go through a cycle, and this full cycle…
Kevin: David, this full cycle is very similar to a lifetime. First you are born, you have the growth phase, then you have the teens and 20s, and then you start to mature and have middle age, growing into old age. Then finally, you have old age, and the cycle recycles itself. What these guys were talking about, if you were to just take the last cycle into account, the 1950s were that early teen stage, that exciting growth stage, and then we start to have the wake-up call in our 20s and 30s, and then in our 40s, 50s and 60s, there is disillusionment, and then finally, the end is usually, cyclically, a crisis of some sort of death, metaphorically, with a lifetime, but in this case, it is economically and politically. According to this book, we have seen that cycle at least for the last 500 years. So what you are talking about is some sort of death of this debt cycle.
David: I can’t recommend the book highly enough, to put in perspective 600 years of British and American history and see that there is a pattern to periods of renewal and regeneration, spiritually and socially, and that these things happen consistently after major crises, and these crises bring about an incredible resolve amongst a new generation that has gone through the crisis and appreciates just what pain looks like and feels like and the kind of commitment they are going to need so that this kind of thing never happens again.
Remember that the greatest generation was not the greatest generation prior to the war. They were considered the greatest generation after coming through the war, and they set the standard for growth and development and what we know as the American dream today, but that is something that I think we have become very complacent with, which is hallmark of the fourth turning, and leads into the fourth turning – complacency – and ultimately there is an accident that happens, and those kinds of accidents, again, can lead you to international conflict, which is what Strauss and Howe talk about, or even civil war, like we have seen in the United States, or frankly, in other parts of the world, too.
But consistently, there is conflict because there is a battle for ideas in play in that fourth turning, and ultimately, the first turning, or that first season of renewal, is one that is actually pretty exciting. I think, Kevin, that is something that, even if things should get worse from here, we have a lot to look forward to that is quite positive.
Kevin: And for those people who do go through those fourth turnings, the ones who come out somewhat intact are the ones who saw it coming and made appropriate preparation.
David: Kevin, when we look at the global macro-thematics of our day, whether it is concerns over the devolution in Europe, or the ascendancy in Asia, or the stagnation in America as a result of too much debt, and not enough income to pay it, consistently, what we have in the mix is change, and people need to be very open-minded to what that means for them. Our encouragement is that you just organize your resources so that whatever change looks like in our times, you have all your options open. Keep all your options open.