The McAlvany Weekly Commentary
with David McAlvany and Kevin Orrick
“We are sitting on the finest hoard of gold coins that I’ve seen in my lifetime. We have never seen this quality before. This is not a normal supply for us. This is unusual, this is unique. When these particular coins are exhausted, I have no idea where we are going for an encore.”
– Drew Crowell
Kevin: David, you and Drew are both in Europe right now. You guys have been to three countries in four days. For you, Dave, it is perfectly understandable. You would rather travel than just about do anything, but Drew, you don’t care much for travel, and you have been to Europe, I think, nine times in the last year, haven’t you?
Drew: Well, Kevin, it has actually been twelve total, but it has been nine or ten times, just for this one particular mission.
Kevin: That one particular mission, I know we have talked to you before about, and we are going to talk to you a little bit later about it, because it is very, very interesting, very exciting, given the situation right now, not only with supplies in the gold and silver market, but the current demand. I know that Europe is just really popping as far as physical demand, as well as Asia. But David, I’d like to shift to you quickly and talk about a couple of things that have been happening here over the last few weeks because they are critical to our understanding of what is going on economically, worldwide. We were in Argentina when the yields on treasuries just dropped dramatically, and what that shows is a massive inflow of money into treasuries. I think that was a response to what was about to be a panicking stock market, wasn’t it?
David: You’re right, and there are a number of things that I think we need to focus on this week in the Commentary. Number one, looking at that interaction between people moving out of stocks and into bonds, we are about a month on from that event, but I think October 15th is going to be remembered as one of the red letter days in the financial markets, not only for 2014, but moving forward, because the kind of volatility that we saw had never, ever been seen before. Some of that has to do with how trading is done today, which is on electronic platforms, and if these trading systems are overwhelmed with volume, what you will find is that the operators hit a kill switch, and all of a sudden you have no trading, no prices offered, and liquidity dries up. Imagine that – liquidity in the U.S. treasury market drying up and there being an impact in the market.
So, I think there is an adjustment phase here, where investors are saying, what does that mean? What is the significance? Was it just a one-off flash crash where somebody got something triggered, but it is never going to happen again? Well, we had a flash move in the treasury market there on October 15th, and for anyone who was paying attention it was very, very unsettling. But again, more of that to come. I don’t think it was a one-off deal.
But two other things, bringing us more to current events this week, Japanese QE and the G20 meeting which ended this week in Brisbane – two very, very important events.
Kevin: Well, it is interesting, talking about Japanese QE, we know that the Japanese have just announced a quantitative easing program that is larger than the United States had been doing, even at its peak. So, they are trying to thrust themselves out of what was announced yesterday as a new recession in Japan. It looks like Abe-nomics and quantitative easing seem to be falling short, Dave.
David: QE is not so easy. You might say Japanese QE is making everyone a little queasy. It’s not getting the job done. The thought had been that in spite of the inherent risks of monetizing assets, that is, printing money and going out and buying those assets on the open marketplace – everyone knows that is inherently inflationary. But they assume that the economic growth desired was so crucial and so necessary that it was worth taking those risks. So we have an all-in bet to stimulate economic growth. It has not yet worked. And then we have the latest GDP report this week showing a further contraction.
What that implies, Kevin, is a lot more money-printing, because it is not as if the egos anywhere in the world, let alone in Japan, are ready to acknowledge that it is a failed project from the start. They are simply going to say, “We did a little, we should have done a lot more.” So, what does that mean? It means that the Japanese yen compared to the U.S. dollar probably is going up to 140, as our guest, Ian McAvity, suggested just a few weeks ago.
And with that comes a tremendous amount of pressure on the German industrial complex, because again, you are dealing with two strong powerhouse exporting nations which rely on exported finished products, and these are all high-end goods and they do compete. The Japanese and the Germans do compete. And if the Japanese gain a trade advantage because of a much weaker yen, that puts a tremendous amount of pressure on the German industrial complex. We have those issues in play. Clearly, Japan is not out of the woods, just announcing this week that they are back in recession, and a triple dip is what they are afraid of here in Europe. It has just been one long economic bleed-out for the Japanese.
So yes, more yen-printing is on its way. If you look at gold in yen terms, it has an outstanding performance. We are very aware, in the United States, of weakness in U.S. dollar terms, but if you are a Japanese saver, guess what you see in the gold price? You are going from strength to strength, and you want to own the stuff. You certainly don’t want to own Japanese yen. So, there is that.
And then we mentioned the G20 meeting this week.
Kevin: I wanted to bring that up, David, because I have had clients calling me, and their hair is standing on the back of their necks, because what they have read is what they think is bail-in. One of the decisions from the G20, and of course, Russell Napier, a friend of yours and a regular guest, wrote about this, that bank deposits have changed their very definition. It used to be you would put money in the bank, and that bank was safe-keeping that money for you, and paying interest on it. But at the G20 it has been announced that, possibly, those bank deposits could be used to bail in banks. Now, they didn’t use the words “bail in” but isn’t that what it is, Dave?
David: This is basically a provisional agreement by the top 20 countries in the world to say that a depositor in a bank, in the case that bank goes under, is no longer in a first position to receive their own money back. In fact, there are other creditors who are more important. If that sounds disturbing, yes, it should be incredibly disturbing. It makes far more sense to be sitting in your own currency, than have your currency sitting in the local bank. Now, obviously, the G20 doesn’t have an enforcement power to make sure that each country legislates and gets this done on an equally equivalent basis, so the next year or two it is very important to watch what happens with various bank regulations. And again, this isn’t just the United States, or Europe, or Australia, or Japan. We are talking about a global move to downgrade the solid nature of a bank deposit.
I can’t think of anything more disturbing. If I were a banker, and was subjected to something like this, where essentially, I couldn’t look one of my depositors in the face and say with any confidence that what you see is what you get – no, quite frankly, you might be second, third, fourth, fifth, and as it has been outlined, you could be eighth or tenth in line. It does go back to what you were saying, Kevin, it implies that you have, basically, a bail-in proposition. If the bank begins to founder, your assets are on the hook, and can be a part of the solution. And I think that has a radical consequence as we move toward 2016, 2017, and 2018, stresses and strains in the financial market.
What bureaucrats don’t appreciate is that when you set things in motion like this, you are setting the groundwork for not only a small bank run, but a system-wide financial failure, in which case, every Tom, Dick, and Harry who has their heads screwed on straight and says, ‘I don’t want to participate in the bail-in,” does something else with their money. What happens to the banking system when you run out of depositors? How does the bank make loans if it doesn’t have a stable stock of depositor assets? Again, borrowing short and lending long, that’s the nature of banking. But that changes dramatically when you lose a depositor base.
Again, this will have to be implemented on a country by country basis. We don’t know what that will look like in the United States, exactly, but this is now something that you have to pay very clear attention to. If you were worried about counter-party risk à la Lehman and AIG, and those kinds of risks, now you can dial it back considerably. It’s not just being concerned about a derivatives market implosion, it is something as basic as bread and butter deposits at your local bank, and as we see this implemented in the United States, I am very curious to see if the general public has any response.
Frankly, I think they won’t even care because they won’t even know. But I think those in the know will be very cautious about what they do with their money, and it probably means there are a few more greenbacks going into the mattress, into ounces, basically being pulled from the financial system. Because, you may not have been a part of the problem, but if your assets are considered a part of the solution, and you are not volunteering for that, well, again, this is where it gets a little bit awkward.
Kevin: The crazy thing is, Dave, we were raised to, when we get paid, put our money in the bank, earn interest on that money, and that money is not only safe in the bank, but it is insured by another insurance entity, like the FDIC. But at this point, there is no interest, really, to be paid, so a lot of people are questioning why they put money in the bank in the first place, but now, with that money being reclassified as something other than just safe-keeping, that could be very dangerous.
I want to shift gears here, though, because we have seen here, recently, large fines being paid by banks for manipulating the gold price, and we are starting to see these manipulations in the market at least being called out. One of the areas that has been accused of possibly falsely pricing the market has been in London for over 100 years. It is the London fix, and I know that while you guys have been there in Europe, there has been a change, I think this week, with the London fix. Would you talk about how gold now is fixed in London?
David: Yes, the London fix, if you take that as a euphemism, in itself, sounds a bit dodgy, but it has basically been changed from an old boy’s club where the price is set twice daily, where literally, guys gather round a table and determine what the price will be twice daily. Obviously, undoubtedly, the bullion banks have been self-dealing in this way for generations. Now they are moving to an automated algorithm, and the London Bullion Metals Association is introducing this as a much more transparent high-tech process. I don’t know if that is actually going to be the case. Transparent and high-tech – that’s not axiomatic. You can have high-tech, and, as you know from the black pool trading on the New York Stock Exchange and the high-frequency trading, tech improvement can bring with it new and sundry risks, so we will have to see exactly how that plays out.
But this is what we are hearing on the street as it relates to gold supplies. In essence, gold supplies are drying up. Let’s look at this in detail. Number one, you have had lower prices. The last 2-3 years have delivered lower prices of gold, and what we have now is competitive currency devaluations afoot, and no one really wants to sell their physical metal en masse. So, there are no large blocks of gold coming to market by your average physical gold investor. And we’ve talked a lot about interest rates. One of the sort of unique things is the gold lease rate. Let’s say you have three tons of gold sitting in a gold vault somewhere. Someone may come along and say, “Hey, I’d like to borrow that gold from you. I’ll give it back in the future, and in the meantime I’ll pay you X percent to borrow your gold.” That is the gold lease rate.
Well, that rate is scraping the bottom of the barrel. Banks have gotten rid of a lot of their gold because it is no longer profitable for them to loan it out or lease it out. Does that make sense? We are talking about the miners, the refiners, the jewelry fabricators, who always have this expectation of gold inflow, and in a short, interim period, will borrow gold. They need a fairly deep pool of borrowable gold in order to do that. But quite frankly, with rates being so low, and I think this is absolutely fascinating, and absolutely ironic, central bank policy has driven rates incredibly low, and have basically made this part of the banking business unprofitable.
We can explore this a little bit further, but there are some interesting coincidences as to why we are here right now. You know as well as I do that central banks don’t want higher gold prices. It shows what they have been doing in the marketplace. As they print and create inflation they can cover their tracks, in part, by keeping a lower gold price. And yet, what they have set in motion, with the zero interest rate policy, not only in the United States, but in other parts of the world, a zero interest rate policy means virtually zero gold lease rate, which means no financial motive to hold the gold. And what has happened is that gold is moving into private hands, so the balance of power in the gold market already moved away from central banks earlier in the decade, 2008-2009, when the preponderance of ownership is now in private versus central bank hands. Now all of a sudden you have bullion banks that are losing control, as well, as more and more control slips in the direction of a private owner.
Kevin: It seems like an unusual opportunity, because supplies are drying up, yet you are seeing these changes in the laws that came from the financial crisis of 2008. It is almost forcing some of these banks to sell a little bit of that gold that they would be leasing. Doesn’t that have to do with some of the new capital requirement rules that came about back then?
David: That is exactly right. It is spot-on. Following the 2008-2009 financial and banking crisis, we have seen all over the world an expectation of higher capital requirements. If you are looking at gold as an asset on the balance sheet of a bank, and it is not a profitable asset in the sense that they can’t generate an income from it, in an environment of higher capital requirements, there is much more of a desire or motive on the part of a bank board to simply scuttle that asset and get rid of it. And so, this is what we are finding, again, in an environment with higher capital requirements, this all started five years ago, but this asset now needs to go. Gold needs to go.
And it is shifting tonnage from what previously had been unallocated accounts. They might call them claim accounts, or what have you, but the gold is unallocated, it is now moving to allocated accounts and that is having the unintended consequence of squeezing the entire gold industry. I’m not speaking about us in the gold industry, I am talking about the miners, the refiners, and the jewelry makers, because, as we mentioned earlier, they need a predictable and deep pool of gold to borrow from, and they are being squeezed. They are being squeezed because now the gold is not in the bank’s account, which they can go borrow, it is in a private personal account, and it is no longer available.
This is absolutely a fascinating setup for us, and I think it will set the stage for an explosive move higher in the price of gold. Why do I say that? Because if you look at this huge pool of gold, there are tons and tons of gold available on COMEX today, but as the borrowers of gold, that is, the miners, refiners and jewelry makers, have to now go to COMEX to borrow gold there, as opposed to the banking industry, that shrinks the available pool of gold that can go into an exchange-traded product like GLD or SLV. I think as soon as we see a $100-150 move higher in the price of gold, you are going to see investors clamoring to own the metals. They will click the mouse button to buy GLD and SLV and there is going to be a mad dash for the available ounces on COMEX. This sets us up for absolutely explosive pricing.
Now, you asked what we are doing here in Germany. Germany, Brussels, France – we are here to basically clean up. Why do I say that? And Drew, you can chime in any time, but we were presented with a couple hundred-million dollar deal this last year, as an Eastern European bank dumped their gold holdings for all of these reasons. Low lease rates made it uninteresting for them to keep the gold asset on their balance sheet, and they are dumping product to us which hasn’t seen the light of day in 90-100 years. And so, if there is indiscriminate selling, and we can step in, and with small premium, buy old, quality product at rock bottom prices, below $1200 an ounce, this is brilliant. We think it is brilliant. As a company, we have backed up the truck, and have tried to offer this to clients in a way that is compelling. Why are we here? This is the biggest deal our company has ever been involved in – ever been involved in. And we are very excited about it because it is the right quality product, it is the right size, fractional European, and it is the right price. Drew, maybe you want to chime in?
Drew: Absolutely, David. And Kevin, I am sorry you aren’t here to see some of the things that David and I are seeing, but it is sort of a choir over here. We are hearing the same thing from three of the largest dealers in Europe, from three different countries, all singing the same chorus, saying there just simply isn’t any new real source of this kind of gold available. It was some 13 years ago that our company was involved in a large liquidation, at that time being primarily generated from the Bank of England when they were selling coins. But we are looking at almost a unique situation here 13 years later, because one thing that David didn’t mention that I think is very relevant, the German broker on this particular deal told us today that had this deal happened only six to nine months later, we may very well not have gotten it, just due to new compliance issues.
David: And the compliance issue, this is where the whole banking industry is becoming a bit of a quagmire, and we did talk with Joseph Tainter a few months ago about the collapse of complex societies. You can even look, not at a society, but at a system. When you begin to bring in new elements of complexity, you do stress and strain the system as it is. One of the largest banks here in Germany has gone from a compliance department of five to ten, to over 550 compliance officers. And you are right, the deal that we were introduced to, and participate in, to this day, we would not have had available to us, because again, even in the last 12 months, compliance is chewing up and spitting out anything that looks like good business.
It is a fascinating thing. I don’t know where the banking industry goes, or if it survives in its current form, but it does seem like we are moving toward greater and greater complexity, which is not sustainable, and ultimately has to be dialed back. To me, the question is, where do you want to have your assets? Do you want to have them sitting in a bank waiting for the next bail-in à la the G20 from Brisbane? More on that to come, as it is announced on a country by country basis. Or do you want something that is a financial asset, but stands outside of the financial system?
Kevin: It might be worthwhile right now for our listeners to reintroduce Drew Crowell. We have been talking to you, Drew, and the background that you have brought to the McAlvany company is long – 33 years as a numismatist for both Don McAlvany and now David McAlvany here at McAlvany, and you have seen a lot of changes in the industry. There were periods of time when you could buy thousands and thousands of coins. You mentioned the Bank of England. Those days, it seemed like we had never-ending supply. But it did end, and we became very tight on supply of these older, nice, uncirculated 100-year-old coins, and now you have gotten an opportunity to get them again, but that is really not the nature of what is going on in Europe right now, is it? Aren’t the supply lines going from thousands of coins at a time, to most dealers having to experience purchases of no more than a few hundred?
Drew: And even at that, Kevin, we are talking about fractional gold coins, we are not even talking about 1-ounce coins. We are talking about very small deals trading hands now. It was only a year-and-a-half ago at ICA, that David and I and a couple of others sat down in strategy meetings, just looking each other in the eye and saying, “Where are we going to get product for our clients? It’s drying up. We aren’t able to meet the demand. Where are we going to find what we need?”
And we count it a great blessing that this one particular deal came our way. One of the largest dealers in Europe put us onto this, and has been brokering this deal that we are extremely excited about getting, because it meets all the criteria that we want. They are extraordinarily high-grade coin. They are, as David already mentioned, anywhere from 80-100 years old. The quality, the age, the strike, the color, all of it is as if they were just minted yesterday. These are the kinds of things that we try to find. It isn’t just finding a bar of gold, or a bullion item to have our investors take a look at it, it is really trying to put them in something that is time-tested and probably will be the best way to increase their leverage in the profitability in the times ahead.
David: Drew, you, as you mentioned earlier, have been over here 12 times this year. We have gone, as a company, to great lengths, and you have been a part of that process, to bring the highest-quality product, what we consider to be great value, to our clients. And listen, between you and me, we don’t need to travel halfway around the world to find any old gold coin for our clients, but as you and I have talked about, this is probably the last great hoard we will ever have as a company. You can go back 13 years to the central bank dis-hoarding, we had the opportunity to buy, in large quantities, tens of thousands of coins, and it then became a trickle. And for our clients who were acquiring product in the $200 and $300 dollar gold price range, it has been an absolutely fantastic move higher, because they track gold, dollar for dollar, on the upside.
Again, we have gone from a flood then, to a trickle for about ten years, where we could buy hundreds, and occasionally a thousand coins, here or there. This year is so different. We are back to this one singular deal where we have been able to buy tens of thousands of coins. As you said, this is a tremendous blessing because, literally, it was September/October of last year when you and I had that conversation, looked each other in the eye and said, “Where are we going to find product?” We know exactly where this is going. The gold price will pick up again. And there is very little that is on offer that represents clean, clear, pristine value in the gold market. And here we are. Literally, we had that conversation September/October, and you got the call two to three days before our Christmas party last year, and you were told, “Get on a plane.” And you said, “Yes, I’ll be there in a couple of weeks.” He said, “No, you get here tomorrow. If you are interested, get here tomorrow.” And again, the last great gold hoard, we were surprised at how large it was, but clearly, it redounds to the benefit of our clients.
Drew: I find it interesting, as I know the two of you do, given the situation that we have just had where gold has been correcting, and as a matter of fact, really, we have reached a 41% correction in gold, that rather than aggressively adding to a position, people get put off by, or scared by, the fact that gold is dropping. I find that fascinating, because it is the only financial instrument that has ever truly survived the test of time, some 6,000 years that we know of, and yet people are running to a fiat paper currency that has never survived the test of time. It just seems to ironic to me that, given the opportunity to buy far more gold for the same number of dollars, and the fact that we are sitting on the finest hoard of gold coins that I have seen in my lifetime, those two things are just incongruous to me.
David: That was reiterated by the folks that we met with today, again, the finest that they have ever seen, too. This is two companies, our 40-odd-year history, their 40-odd-year history in the industry, and neither have seen anything like this before, probably won’t again. It is interesting, we mentioned the Brisbane meeting, the G20 meeting, and the reality that the financial system is creating a better mousetrap. We happen to be the mice, and I find that very disconcerting.
Kevin: Drew, in years past, when you have been buying both the guilders and the British sovereigns, you have found that, even if they were uncirculated, a lot of times they were just mixed dates, a lot of different mixed dates. And of course that happens, when a bank has reserves, those coins are going to get mixed up. But there is something unique about this. You are finding dates all together. What does that indicate? That maybe they were minted together and then immediately put aside as a reserve?
Drew: Absolutely, Kevin. This is unlike anything I have seen. There are original mint bags of Dutch 10-guilders. It is remarkable. 1917, 1926, 1927, 1932, 1933, and I may have missed 1925, but those six dates are all represented in this particular hoard, and for the first and only time that we have ever been able to do this, we have been able to offer them in solid date rolls, which, again, is just a unique opportunity to buy coins just as they were minted, with amazing color, the condition is amazing, the strike couldn’t be crisper. These are, as the gentleman said today when we were meeting with a group in Germany, he just flat out said, and I reiterate the same thought, that we have just never seen this quality before on an 80-100 year old coin.
You know, David, simply put, when we have product that you and I kind of compete for in the office, I think that really speaks as strongly as anything else I can say to our listeners. These are coins that you and I personally own, we have personally bought. We never make a suggestion to anybody to buy something that we wouldn’t personally own, but when you and I start competing for them, they should know that this is really something very special.
David: And I even like the fact that gold is, as you mentioned, in a corrective stage which I think, frankly, is over. We have broken below $1180, and guess what? We recovered back above it very quickly. And that is a very positive indicator. Getting above $1180 – that is positive. Getting above $1200 – that will be positive. Getting above $1240 – that will be positive. $1340 – these are all signs of progress as we move into the next stage of growth for gold. You are looking at the long-term charts on gold, that is, the monthly chart. As and when that turns up, you are talking about 18-24 months of an up cycle, and I think we go well above the $1500 mark in that cycle, as high as $2100, maybe even $3000 an ounce, but at least to $2100 on that 18-24 month cycle. So, quality of product, plenty of it, ideal pricing. I think, if you could say, right time, right place, right product, it does kind of line up that way.
Drew: David, again, just to reiterate, one more time, this is not a normal supply for us. This is unusual, this is nearly unique. When these particular coins are exhausted, I have no idea where we are going for an encore. So again, it is a unique opportunity, gold is on sale, these coins couldn’t be nicer or more dynamic, so it is a convergence of all things. It is sort of the perfect storm when it comes to being able to buy this kind of product at this kind of price.
David: This is just a high-level overview of what we have been working on for 12 months, and the lengths to which we will go to deliver value to our clients. If somebody is interested, you can obviously find more information on our website, or call our office and get further details. Dutch guilders, British sovereigns, the European fractionals have been a game-changer for our clients for over ten years, and the fact that we have this one last great hoard, we are excited about it. As you said, Drew, I don’t know what we are going to do for encore, but we’ll just take that as it comes.
The world is a changing place. It is a very rapidly changing place. And I think very keen decisions need to be made over the next 6-12-18 months, that account for resources, and plan for generations to come, because again, I don’t believe that the financial system is being engineered today to take care of us, I think it has been designed to extract value from us, and to ignore that is to do so at your peril. To be aware of an out, if you will, from the system, has probably never been more important, and owning gold represents that out. It gives you freedom, flexibility, and autonomy.
And it is very interesting to me, as we mentioned, Kevin, a few weeks ago, this sort of reconversion experience with Alan Greenspan. It was years ago that he would say, “Gold and financial freedom are inseparable.” If you remember, that was his theme when he was sort of an Ayn Rand acolyte. Well, listen, he is coming back around to that: Gold and financial freedom are inseparable. And I ask these questions as we close. Do you value your financial freedom? Do you value your financial integrity? It is time to put a plan together for that right now.