The McAlvany Weekly Commentary
with David McAlvany and Kevin Orrick
“It is a surprise. We are going to see things that were unexpected, and those are the kinds of things where we say we are watching the red lights flashing. These are the sorts of things we are watching, because if you get too many of these sorts of thing, you are definitely going to have it hit the market, investors are going to begin to panic, and then we could see the end of the bull market come about.”
–Mary Anne Aden
Kevin: David, friends of yours, friends of the family for many years, are the Aden sisters, and of course, for decades they have written an excellent technical analysis of the market. One of the questions that a lot of our clients ask is: “The stock market shouldn’t be rising, but it is. Gold shouldn’t be rising, but it isn’t. So, is it better, if you can’t beat ’em, to just join ’em?”
David: I think that is a good question. It’s not the question that I was asking the first time that I met them. I was probably 10 or 12 years old, we were at their office in San Jose, Costa Rica, and I just thought they were lovely ladies who had very bright ideas, making keen insights and observations, most of which I did not understand at that age. So, the question that you raise, yes, I think, is a relevant one. The question of how far the markets can be pushed through manipulation and money-printing is also very critical, because it is a game of confidence, and it is a game. If we have learned anything from history, it is that games based on confidence work until they don’t. It is very difficult, if not impossible, to predict that moment of catastrophe when everything changes.
Kevin: And there are different time scales. For those who are retired right now and living off of their principal, because there is no interest, timing is critical to them, and it can create almost sweat of blood as far as watching the markets do what you don’t expect because of manipulation. But for the person who has the longer-term time scale, who doesn’t have to spend their principal, who can wait, it still seems that probably the best policy is to do the right thing and wait.
David: Well, that would certainly be my opinion, and I think as we touch base with others, there are echoes of that. If you will recall our interaction with Andrew Smithers just 6-8 months ago, he would prefer to be 100% in cash. He doesn’t care that there are gains to be missed out upon in the stock market, and it is almost as if he looks at that pile of sand, and it continues to grow in size, and it is growing in size, and it is the biggest pile of sand he has ever seen, but his concern is, really, that we are getting to a point where it only takes one grain for the entire pile to collapse. And he is not sure which grain it is, I don’t think he even cares which grain it is, he just looks at the total base and realizes that it is insufficient to hold everything above it, and on that basis, would rather not speculate with money that took decades to create in order to just earn a few percent more.
So, there is an interesting component, as I read the Adens, and we read very broadly each day, each week, each month, for our business and for the Commentary, things that I glean. I will probably part company on the long equity position, generally speaking. You can afford to be long equities if you have a sufficient amount of cash and precious metals on the sidelines. That is the beauty of what we call our perspective triangle. You can be one-third wrong and be allocated as much as one-third to equities, as long as you are two-thirds right; that is, having some diversification into cash and precious metals that serve as an offset to volatility and other forms of loss that can be incurred on the equity side.
So, very interesting insights from the Adens today. We hope to explore those in the area of bonds, the dollar…
Kevin: Equities, gold. I know they are still very strongly bullish on gold in the long run, but there seems to be a strange duality, Dave, and I think you can address this today with the Adens, in that you do have people who acknowledge that manipulation is working, and there are people who are willing to play that game with a portion of their assets, even though they know it won’t last. And then there is the other side of the market, which is, “Yes, we do know reality, and we’re just not going to touch it.” I would love it if you would bring that up with them.
David: Certainly, and it’s really the contrast between long-term thinking and short-term thinking, long-term investing and short-term investing. I remember a conversation I had on a plane, as I am often on a plane, this was a gentleman, an executive, who had sold his technology to Google, for data mining. He was originally a University of Texas physicist, now a bicyclist extraordinaire, competing internationally. He has supercomputers in half a dozen different locations around the world, and he trades the market. I asked him what his perspective was, long-term or short-term, and he cussed at me. He said, “I’m not a something-something investor.” And he went on to say, “My portfolio turns over completely at least 100 times in a day.”
I guess what I am saying is, you can define perspective on the basis of being very short-term, as in nanosecond trading, or very long-term, thinking in terms of the next 50-100 years, or somewhere in between. I think that is very critical as you are coming to terms with who you are as an investor and the decisions that you are making, what kinds of time frames you have in mind, and if you make decisions, as most investors do, with a stated long-term objective, and then come under pressure, over a six-month period, a twelve-month period, three-year period, what have you, and then begin to think like a short-term investor, what you have basically undone, mis-engineered, deconstructed, is the original rationale for what you own and why you own it.
Kevin: You forgot who you were. Shakespeare said in Hamlet, “To thine own self be true.” That sounds selfish, but actually, it is a great concept. You need to know who you are, and stick with it.
David: Self-awareness is something that is critical, not only for healthy living, family dynamics, but also in the context of investing. Maybe that is an aside, but the long-term versus short-term thinking, there is always going to be, when you are looking at charts, both that birds-eye view, looking at a long-term chart, and focused in on the last six months’ view, and you are really having two conversations which sound very similar at the same time. So as not to confuse that, we will be discussing cyclical, secular, short-term versus long-term markets, and the insights, hopefully, are helpful from the Aden sisters today.
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David: So many things are in flux, just here in the next few days to weeks we have the end of Quantitative Easing 3, something that has been a great boon to the investment markets of late, and quite interestingly, we have a gap. We have a gap between global GDP estimates and global stock markets, and that gap has widened considerably over the last 18 months. We have economists at groups like the IMF and the World Bank, perhaps they are getting overly cautious, but meanwhile the equity markets have continued to exhibit euphoria, you could say. Maybe you could just talk about this difference between declining expectations in terms of the global economy, and yet, really strong market activity as it shows up in the charts, and as we see, in the pricing of the equities markets, in particular.
Pamela: I think we both want to make a comment on this, but, for one, we think the bond market has been telling us all along what is going on, and we don’t think it is that much of a coincidence, but exactly when they announced tapering at the start of the year, that is exactly when the bull market in bonds started, and it looks like it has a way to go still on the upside, at least for, say, the next six months to a year, and maybe longer. Really, we think this is going to be an important moment.
Hearing that they may postpone the end of the QE program has caused the markets to move a lot already, lately, so we think this is going to be a big influence on the market, especially looking over the rest of this year, and possibly going out into the next year, exactly, where the trends are going to fall, depending on their program, and depending on the world program, too, because everyone else is starting up a QE-equivalent type of program, and the world is sluggish, so we think that the bond market is kind of telling us which way everything is headed and it is starting to outperform, on a big-picture basis, the gold market and the stock market. Not to say anything else is going to be bad, it is just saying there is a change.
Mary Anne: I just wanted to add that you are right, the slow global growth has been very much contrary to the stronger global stock market, but just recently, in the last couple of months or so, the global stock markets have really turned weakish, and they are more reflecting these deflationary pressures that are intensifying, therefore the bonds going up. But our feeling is that we really think QE4 is probably right around the corner, especially if these stock markets stay weak, or keep fluctuating wildly like they have here in the last week or so. It is just too risky, I think, for all of the world’s central bankers, those that are in charge. I don’t think they are going to just stand by and idly watch the stock market keep heading down.
David: Something is apparently different this time, in the sense that we have had a bull market in equities for a number of years now, off of the lows since 2009, impressive growth figures in the U.S. equity market, to a lesser degree in the global equity markets, but we are now coming to the end of this QE3 period, and stocks have declined at the end of each period of bond-buying over the last five years. Isn’t it fair to say that the nature of this rise is quite different than the past bull markets, say, of the 1920s, of the post-war period, of the 1980s and 1990s, that there is something different, by character?
Pamela: Yes, clearly, we have thought that this has been a subsidized bull market, and if we didn’t have the QE program at all, who is to know where the stock market would be today and since 2009? So yes, it is a different bull market, we feel it is definitely more of a manipulated bull market, but nevertheless it is a bull market, and that is where we have taken the idea that it is better just to go with the trends that are in force, rather than try to not be in them just because they shouldn’t be in a bull market. But yes, clearly this is different this time.
Mary Anne: I just wanted to add, too, that as you mentioned, since 2009 it has been pretty much QE-driven and every time they taper QE, or take it away, the stock market has come down, and that is just another reason why we think it would be very surprising to see the Fed stand by and take away QE3 and not do anything more. It is kind of hard to imagine, so we think if for no other reason than a very weakish economy, low inflation, and a falling stock market, those would be reasons enough for a QE4 to come along very soon.
David: Changing tacks just slightly, we have bonds which you have described as being in a bull market, and perhaps another six to 12 months of that, that is, with rates in decline and higher prices of bonds, and if that outperformance continues, what does it mean to you when bonds have above-equity-market returns?
Mary Anne: The fact that bonds are so strong – the bond market is a very interesting market, a lot of people think it is boring, but it is far from boring – is really a very good leading indicator, and bond investors, per se, are known to be more sophisticated and more forward-looking than, say, stock investors or precious metals investors, so what the bond market says is very important to everybody, and to the economies of the world. So, basically, what bonds are saying, very loud and clear, is that deflation rules right now, and it is in the driver’s seat, and until bond prices turn down, and interest rates start to rise again, that will probably continue to be the case, as you mentioned, for at least the next year or so.
David: Just a question added to that, Mary Anne and Pamela. It seems that, not only is the bull market in equities subsidized, but we are in this low rate environment, also, in part, because of the manipulative purchases of assets by central banks. So, the bond market may very well be sending a deflation signal. But on the other hand, we have record amounts of market intervention and price-setting by the Bank of Japan, the European Central Bank, and the Fed. It is virtually a free-for-all – who can buy what the fastest – by the world central banks. How do you factor that in to bond market behavior when you have this tremendous amount of artificial buying?
Mary Anne: Again, this is one other factor that contributes to the bull market in bonds, because yes, they are buying a tremendous amount of bonds, and again, whether that would be the case that the bond market is as strong as it is without it is probably very unlikely, but the fact remains, I wouldn’t say it is the only thing driving the bull market, but it is certainly a contributing factor.
David: It is just curious that the basis for market activity and pricing, at present, has less to do with economic factors, less to do with company fundamentals, and more to do with central bank liquidity, than anything else. Does that, in any way, concern you, or have you taken cautious measures within an allocation?
Pamela: Clearly it concerns us. The base has changed. It is a central bank intervention-led market, and will be, it looks like, for some time to come. That doesn’t mean there aren’t trends there for investors to take advantage of, it means you have to invest and always be cautious. Being cautious and walking a wall of worry is not a new idea, either. But yes, we do have different rules right now, and that is what concerns us, and that is why, ultimately, gold will always be in the background as an excellent investment, and to buy during weakness. We think it is very impressive to see that gold didn’t want to break its December low just recently. It had all the reasons to break it.
It’s not to say it’s over; it could be broken. And if it does clearly break those December lows, then the bear market will get a little bit deeper before we see the end of the line, like looking over the valley. But we think, like with the gold market, it might stay quiet for several more months, or more than several months. Say, within a year from now we will start seeing it react to all that has been going on.
So, gold we still like it, we think it has been the best one in the bull market, for looking at the precious metals in general, aside from palladium, of course. But, looking at silver, and silver being more the reflection of the reality of the global growth, so therefore staying more sluggish, but it will, in time, move with gold when the time comes. We don’t really think that time is now, but it is good to see they are not falling more for the moment. That shows strength right there.
David: Looking through your most recent report, and the portfolio recommendations that you make, there are outsized, triple-digit gains in a number of your recommendations. They are metals-related. For anything triple-digit, you have to be in the metals. For anything less than that, there are a variety of options in terms of gains over the last several years, even the last several months. I just thought it was interesting that between equities, bonds, and precious metals, there is a standout in terms of performance in the precious metals sectors from your point of recommendation. I am wondering if you might shed some light on that by discussing the difference between a cyclical bull or bear market and a secular bull or bear market.
Pamela: It’s funny, we were just talking about this. It depends on what trend you are looking at. If you want to call it a trend, or a tendency, if you look at just since 2009, yes, that would be the cyclical, yes, gold is down, versus the stock market, say. The stock market since 2009 has been rip-roaring, and even with the corrections lately, it hasn’t changed that, whereas gold has. But if you look at gold going back to the beginning of the bull market, at 2001, 2002, that trend is clearly still under way, and that is the difference between what you are looking at. Are you a longer-term investor, are you a two-three year investor, are you a yearly investor? It really depends on what you are, and how much you are willing to hold and ride through things. That is why you will see a higher percentage in our breakdown because you will see those positions were bought a long time ago versus the other ones. That is basically what it is. It depends on how much you are willing to ride through any market.
David: You have the Dow, you have the S&P, and they hit new highs in mid-September, going back to the stock market for just a moment, and there has, at the same time, been divergence between the small caps, Russell 2000, even between the utilities and the S&P 400, all diverging, moving down in trend, for the last three to six months. With this change in dynamics, if you will, the internals of the market, less new highs, things of this nature, what can we learn from the Dow and the S&P moving higher, with a variety of other markets signaling a decline? Are we moving into a change in dynamic with the Dow and the S&P now potentially moving lower, following the S&P 400 utilities, the small caps, or is that something of a head fake? Are we in a longer-term secular bull market in equities, or is this just a short-term cyclical trend?
Mary Anne: It is interesting, because it is true, the small caps started down months ago. That was the first time you saw that divergence. And then it comes down to, are they leading, or is the Dow leading? For example, are the Dow transportations, the markets that were S&P 500, they were all hitting highs. And so, we were watching that for a while, but here in the last recent couple of weeks the stronger markets followed the weaker ones down. Now we are seeing them all start moving up again, and they are still technically bullish. They never did break down enough to where it was worrisome, looking at a longer-term trend. For now, we are still saying that they are looking okay. There are obviously cautious signals and red lights flashing, to keep an eye on them, but so far so good.
David: The practice of the last several years, not every company is subject to this critique, but certainly, with IBM’s earnings out here recently, they were not able to prop up their quarterly results as they have for nearly two years by a massive expansion in corporate debt, and the simultaneous funding of share buy-backs. I am wondering if this sort of pervasive practice is concerning to you, because certainly, if you are looking at the performance of IBM shares, up until this week’s disappointment, it didn’t show up in the charts.
Mary Anne: No, it didn’t, and it is a surprise. These things are going to happen. You are going to see things flying at you from left field that were unexpected, and those were the kind of things where we say we are watching the red light flashing caution signals. These are the sorts of things we are watching, because if you get too many of these sorts of things, you are going to definitely have it hit the market, and investors are going to begin to panic, and then we could see the end of the bull market come about. But if that happens, we still believe that it is going to be very much a Fed reaction, and it will probably happen quite quickly, to get it back on track. And if that doesn’t happen, we would be very surprised, but as you mention, anything is possible in these manipulated markets, you just don’t know what is going to happen.
Pamela: I’d like to add to that, NASDAQ has one of the best rises of the last several years, being a tech-related index, so some bad news, can’t get it back into what you may want to call normality within the indices, so that could be part of it. Another thing, too, on a technical basis, we could be seeing more of a downward correction than we have seen for the last three years. Even if we get a 10% correction on an index basis, that will be shocking for many people, and we haven’t even had that yet. It’s getting closer. We could see a little more downside, yes, on the stock market, but that doesn’t necessarily change the major trend yet.
David: And as you say, QE4, or QE-to-eternity, still may be in line. It is interesting, it is becoming apparent that the total stock of debt, whether that is private, corporate, or governmental, the whole caboodle of debt (I don’t think that’s a technical term) is becoming unsustainably high. We have quantitative easing, which has failed, and equity investors are kind of the last to get the memo because, again, we assume that asset pricing, moving higher, is intended to create a wealth effect, intended to thus boost the economy, and it hasn’t exactly happened that way. So, in spite of the trillions of dollars in credit created over the last five years, there is still a real threat of deflation, which you have already highlighted. In your opinion, will the Fed and other central banks be forced to redouble their efforts, go back to QE4, or at some point are the markets going to figure out that these liquidity stopgap measures are not actually delivering what they are supposed to deliver? Yes, they may boost asset prices, but it is not trickling down into the real economy.
Pamela: Exactly. That is exactly the point. When could that possibly happen? If there is another QE4, or to eternity, as you say, during that period, and it could be as soon as next year, looking ahead, there is going to be a point where things can’t continue staying the way they are. But for the moment, we think it can, it does look that way, because it seems like things always take longer than you would imagine.
Mary Anne: I want to add, look at Japan. Japan has been doing this for ages, and it is still plugging along, and so the U.S., and now the European zone, are following in Japan’s footsteps. You could say, how long can this continue until people finally get the memo, so to speak, as you mentioned? It could keep going for a long time.
Pamela: Yes. And also, we are in, as you mentioned, a low interest rate environment, and it looks like interest rates have already started trending down. It looks to us like they will continue down to probably test those 2008 lows over the next, say, six months to a year, even. And that also is a good thing for the stock market. Low interest rates are good for the stock market. And it’s good for gold, too. In the meantime it is also, of course, good for bonds. So, it could go on for a while longer, but yes, you are very right in saying that at some point, things are going to click and change; we just don’t know when. That is the big question.
Mary Anne: And just to add to that, when is the big question on everyone’s mind. There will be signs along the way. We think we will be able to identify warning signs that the end is near, so to speak.
David: There is upside potential in many markets. It seems like the one place where there is only downside potential is for the saver, and the household, who have diligently set aside capital. Rather than spending it all as they earned it, they have set it aside to help cushion a retirement income draw and there is this notion of the magic 5%. If you save a million dollars, or 100,000 dollars, or somewhere in between, earning 5% on your money was the implicit, unstated, expectation of the saver. And not only do we have far less than 5% on offer, whether it is in bank CD or in U.S. treasury bills, or in U.S. municipal bonds, but we also have just general incomes in decline. Coming off of 1999-2000, the real median income was roughly $57,000. Today, it is about $52,000. We have been in decline in terms of income.
This goes back to our first question, this gap between global GDP estimates and the real world economy, which is driven by real incomes and the stock market’s asset prices, which are reflecting central bank activity. There ultimately is this rubber hitting the road and the reality factor of individuals coming to terms with not having enough money to make ends meet. In the past, if you recall the 1919 to 1924 period, Rudolph Havenstein said, “Well, if there isn’t enough money, we’ll just print it.” And I’m not suggesting that the Fed, either under Ben Bernanke or Janet Yellen, is somehow experiencing a Havenstein moment, but they are creating a tremendous amount of credit out of nothing, and I wonder if there isn’t some speculation on your part about the transition between a decidedly deflationary trend, and something that could represent that Havenstein moment – a hyperinflation?
Pamela: Yes, that could be exactly where it all turns. Just this past week, Janet Yellen said inequality in the U.S. today has never been so large since the 19th century between the very rich and the very poor, and the middle class is disappearing. This is a very big concern for everyone, and this is exactly what probably is going to be the turning point. And that when we were asking about? Definitely this will have a big influence on that.
Mary Anne: Back to what you said about the savers. That is one of the saddest things in this whole history is that people who have worked their whole lives and saved, as they were told to do, and thought was the right thing to do, the prudent thing to do, are collecting zero interest, and so it is very sad. What you have here as a result, is that people are retiring that either can’t make ends meet, and the ones who did have some money saved up have to pretty much just plan on using that money to keep them going until they die, without the benefit of the magic 5%, as you said. Or they are taking a lot of risks, going into the market to try to increase their nest egg, so it is a real sad situation.
David: As we wrap up, I think we need to shed some light on the dollar. The dollar has broken out about the 85 level. It has yet to break out above the 89 level, and certainly it is constructive, in terms of the dollar trend, in the short run we have lost a tremendous amount of ground over the last 10-15 years, and you did mention something about gold earlier, that it has held up quite well all things considered.
I think of the major moves higher in the dollar. Go back to the 1990s when it went to very high levels, off of, say, 1993, 1994, 1995, it had a good 6-8 year massive uptrend. And that period of growth in the dollar certainly was not positive for gold. In this period of increase in the dollar it hasn’t been altogether negative, however. I wonder if you could shed some light on that relationship; you have market experience, of course, going back decades. We also have that timeframe of the late 1970s where the dollar stabilized and began to move up, and gold was moving up, as well, where there was not necessarily a relationship where the dollar was moving down and thus gold up, or vice versa. So, let’s talk about dollar strength, let’s talk about where we are, where we might go, and on what basis.
Pamela: It is so interesting, gold and the dollar, the relationship. This is one of our favorite things to keep an eye on all the time. It is interesting, because yes, it is true, they will sometimes move together. Most of the time they don’t, but yes they can, and they can for months on end, at times. But what is most noticeable is that since we have had a noticeable dollar rise – it has been holding above its 2011 lows – this is starting to look a little bit like when we saw the lows in 1980 and the lows in 1995, which were really the two major lows of the last 40 years, when you look at the dollar big picture. And if you look, in each case in those days, the dollar had a rise of about five years, and that was a downward correction in the gold price. So now since 2011 we have had the dollar rising, for three years now.
If you see the next year or two, just throwing out another number, we could see the dollar strengthen, gold remains lifeless, maybe, lackluster. That could happen if that is going to have a repeat sort of performance, because that is the only time in the last four years that the dollar has been strong, those two time periods, and now it is stabilizing; it is really not strong. But yes, if it goes above 89 on the dollar index, then clearly, we could see the 90, 91 level reached. And probably, much more than that is unlikely, but that is kind of the upside we are looking at.
And if gold holds, like it has been, above the lows of last year, which is the recent lows that we have had now, then yes, gold is showing a lot of underlying strength. But that alone is telling us that gold is trying to become the final currency of the world, and it could eventually become that, because no country wants a strong currency, and the dollar’s recent strength since June has already shown that the government doesn’t like that at all. It doesn’t help them, it hurts them; they don’t want it. They don’t want a falling dollar, but they don’t want a strong dollar. Nor does anyone else; they don’t want their currency too strong. So, this is what the ultimate will be, sometime in the future we are going to see that. So, the fact that gold is not falling so much is telling us a lot.
David: Again, you’re right, it seems like a strong dollar is at odds with current monetary policy. Trying to stimulate growth in the economy, you are creating a new form of headwinds in terms of our export and manufactured goods sectors.
Listen, thank you ladies for joining us, again, giving us an overview, a birds-eye view, of the markets – past, present and future. Always enjoy visiting with you, and our listeners always give us great feedback on the insights that you bring to our conversations. I very much look forward to seeing you soon.
Mary Anne: Thank you.
Pamela: Yes, thank you very much.