In PodCasts
  • Wall Street cookie cutter investment plans don’t work
  • When gold rose from $700 to $1900 there were five $100 corrections
  • China & India buying increase whenever gold corrects down


The McAlvany Weekly Commentary
with David McAlvany and Kevin Orrick

What Is Your Next Strategy After Gold Goes Parabolic?
October 9, 2019

“That is an end-of-cycle dynamic, we have in private equity today, and again, I think now it is a part of the pie. The little pie chart of the financial advisor, you now have a designated private debt, private equity position, and you can feel like a sophisticated investor. What you don’t understand is that you are being handed the bag as the big boys are exiting the room.”

– David McAlvany

Kevin: After 32 years of working in the gold industry it is interesting, there are two types of people who buy gold. I’m thinking of the way the Chinese and the Indians buy gold. They buy gold anyway. They’re not really speculating on price. Then you have the person who is mainly just interested in making money and they really only buy when they think that gold is going up. But I would rather be like the Chinese and the Indians that really just buy gold anyway, especially when it drops.

David: I think you have hit on something very key because you are talking about one group of people that see gold as real wealth, and a store of real wealth, and the other who only see a price, and only speculate up or down on the basis of price, and they don’t see the added dimension to what gold is, like what art is, or what real estate is – a representation of real wealth.

So yes, real wealth, and a store of it, you continue to buy, and as you say, you buy gold anyway, regardless of the price. And those statistics are generally higher, the volume statistics for both the Chinese and the Indians are higher when the price is lower.

Kevin: I was just reading about how Chinese buying goes up as gold goes down. The amount of ounces or tons that they buy actually goes up. That is the kind of investing that you would want to do. We have talked about value investing and when you have corrections, like we’re getting a little bit of a pullback now on this large gold rise that we have. A person who understands the long-term trend is going to go in and buy more as it drops. But what is amazing is that 90% of the investors, especially here in America, because we are very, very spoiled to Fed interventions, control of the markets, that type of thing this last ten years. People back away any time it starts to go down.

David: Well, glancing through a chart of weekly performance for a long list of assets, the standouts, at least in the last week or two, have been all the fixed income. The fixed income space is where the volatility has been. I mentioned last week radical volatility in the treasury market, and it has been nothing short of breathtaking this year. You look at investment grade bonds. Their yields have collapsed over 35% so far this year. Two-year treasuries – those yields are down 44%, 14% last week alone. So again, the changes from one week to the next have been really intriguing.

Kevin: What is amazing, too, is that they are not really paying more for more time. In other words, normally you could go in and buy a ten-year treasury and say, “I’m going to get a fair amount more for the time that I’m going to put in.” There is hardly a difference.

David: And the gap between the two-year treasury and the ten-year treasury almost looks like a rounding error, ten basis points – 1.46 for the two-year, 1.56 for the ten-year – and as you say, if you go to one-month paper instead of ten-year paper, you have had a 1.76 yield, a 20 basis point premium for the shorter term.

Kevin: We’ve talked about how crazy negative interest rates are, but in a way, all through history, we’ve talked … negative interest rates haven’t occurred until 2015, but there is sort of a cousin of negative interest rates which is called the negative yield curve. What that means is, for a very short period of time, oftentimes, it is signaling a recession. Something is going to change. You’ll have longer-term paper, longer-term loans, actually paying less interest than the shorter-term loans. Usually that is a signal that you are about to collapse into a recession.

David: And I think one of the things that it is suggesting, what you were referencing, an inverted yield curve, is that liquidity is prized, and there is a premium to be paid for that liquidity. So as for volatility in stocks, it continues to be challenging. This is a challenging environment. The major indices are all about 3-4% from all-time highs, but have been in a long-term topping process for over two years.

Kevin: When you have corporations borrowing money and buying back their own stocks, it can be in a long-term topping process for quite a while, can’t it?

David: And ordinarily when you are in a bull trend you have significant pushes higher, and then a digestion phase, if you will. And then another significant push higher, and then a digestion phase. We have been through more than a digestion phase. It is almost like people are having a hard time believing that we can’t go higher. They haven’t been willing to throw in the towel, and yet there has been no motivating factor to drive prices higher.

The technical picture argues for a significant multi-year decline in the Dow, the S&P, the NASDAQ, and yet confirmation on the downside to this point has remained elusive. You have a bad day, you have a bad week, but then of course that gets turned around with a simple tweet or some sort of a news flash. So weakness in the global markets? That’s obvious. Everyone is aware of it. And real caution is already present in the investment community of you’re talking about Asia or Europe, but not in the United States.

Kevin: I have a couple of friends who are – I hate to say it – diagnosed manic depressive. And they can be the greatest guys to be around when things are going well.

David: (laughs)

Kevin: And then all of a sudden, halfway through maybe even a sentence, their world is collapsing.

David: The shadow casts over them.

Kevin: Yes. And in a weird say, these longer-term topping markets are a little manic-depressive where it is like, “Is he happy? Oh, he’s sad. Oh, is he happy? Oh, he’s sad.” At some point it takes on a particular flavor to the downside where it is all depressive.

David: Right. Behavior in stocks are manic-depressive. Days in a row you have despair and the market has trended down for three, four, five days, and there is concern of recession in the coming months. And then – boom – news item triggers positive algorithmic trading to the upside.

Kevin: And could it be the algorithmic trading? Are we seeing different patterns now because computers are making these decisions?

David: I think there is a lot more volume that is being managed through black box trading models and the memory in the market seems to be almost gone. So again, if the algorithmic trading goes to the upside, it is devoid of memory. It is devoid of reflection on the days that just preceded it. And it might have been bad news yesterday, but the market is trending higher today, it’s good news, it must be. And yet, we have a number of investment managers who are growing concerned about a recession in 2020. I don’t see that translating into individual investors taking tactical or practical steps to minimize their downside risk.

So again, there is kind of a divergence here between the voice amongst professionals saying, “Gosh, I just don’t know how we avoid some downside 2020, given the global economy and the sort of ruckus we have in Washington, D.C., unhealthy behavior between the U.S. and China. Something’s gotta give. The individual investors are just kind of sitting fat and happy.

Kevin: You were talking about devoid of memory. You mentioned it in the terms of algorithms. I remember when I was computer programming back in college, back in the early 1980s, Dave, when computers took up whole rooms, not like cell phones today. But when we would program, we would program something called nested loops. You can have a long-term loop that has shorter-term loops inside, that have even shorter-term loops inside.

This is what the algorithms are devoid of. They don’t really look at a hundred-year picture of the economy, or even a ten-year picture of the economy. They are these tiny little loops that actually can transact many trades in a second, but they don’t understand the bigger picture. If you don’t nest those loops into longer-term looping action – and actually, that is what this show is about, to teach people longer-term economics – it will catch them completely by surprise.

David: I’ve told this little anecdote multiple times, but there is a semi-pro bicycle racer here in town, and I was on a flight with him somewhere. Turns out he was a physics Ph.D. who sold a technology to Google. It was mainframe management, and he manages six, eight, I think at the time it was seven and he was working on expanding to a couple of more sites mainframes that trade the stock market. He has one in Sidney, he has one in New York. They’re just all over the place.

I asked him how often he is turning over his portfolio and he said, “Oh, probably a hundred times.” And I’m thinking, “Well, that’s pretty aggressive for a year.” He said, “No, a day.” So when you talk about time cycles, and when you talk about what is the value of memory, in this digital age of speculation and trading, the value of memory is zero. And I think that is what comes and bites us in the butt at some point.

Kevin: When you get into a cycle, though, long-term secular cycle change, you need guys like Doug Noland. You guys are managing with a longer-term, long loop perspective. You’re not going to be trading 100 times a second, or 100 times a day.

David: Particularly in the Tactical Short it is rebalanced daily – not the entire portfolio, but to adjust an exposure to what the risks appear to be in the marketplace, depending on how we figure out our mosaic of indicators.

Kevin: You guys are doing your call next week, aren’t you?

David: Yes, conducting 3rd quarter conference call for the wealth management non-correlated accounts and Tactical Short offerings, and the title this time is Managing Short-Side Beta in an Extraordinary Environment. To me, very few investors are aware of the dynamic nature of implicit portfolio risk. And it is dynamic because it does change. You say, “Oh, well, I have risk of X in my portfolio.”

When variables begin to change in the market, the risk implicit to a portfolio becomes dynamic and can actually be multiplied. So when we’re managing a short portfolio, we’re doing it on a disciplined basis, a disciplined fashion, and this is really what is critical to success or failure on the short side. It sets us apart from virtually anyone else in that space.

Kevin: So few people understand actually what that means, but a short portfolio would be a portfolio that would benefit when the market goes down. That sounds like a great thing, if a person says, “Oh, well, it’s high, I’m going to go ahead and buy into that.” If that is not actively managed, that can be a very terrible or perilous action.

David: That’s right.

Kevin: But Doug knows how to go into cash, come back out.

David: So we have two kinds of investors that come to us for the non-correlated and Tactical Short, either someone who is looking to hedge an existing portfolio – perhaps they have been working with a money manager they really like, maybe it’s just on a personality basis, they trust and like that person, and they’re not going to upset the apple cart changing allocations…

Kevin: They’re just buying insurance, basically.

David: And that is where the Tactical Short is a hedge or an insurance on that other portfolio. So that works well. We also have investors who want just an outright speculation on the downside in the market. They look at valuation metrics as we would and say, “This is pretty overextended,” and should have some downside and good benefit from that.

Kevin: I’m going to bring something up that people who are listening are going to say, “Wait a second. That’s my broker.” Because oftentimes these brokers will tell you, “Well, you know, every time the stock market goes down, just invest for the long run. You’re going to get a long-term 7% gain. Just invest for the long term.” That’s really just an excuse for not managing for risk. And the problem is, a lot of times you can lose 20%, 30%, 40% of your portfolio before you find out that you have a broker that doesn’t really manage for risk.

David: That’s right. I think the willingness to actively engage in risk management in a portfolio is something that very few financial advisors – they can speak to it, but they don’t actually do it. “Oh, we rebalance a portfolio to recognize this or that.” They’re playing games with a pie chart. Again, as you said, investing for the long run – this is the mantra that we hear from investors.

Kevin: Is that just an excuse?

David: They’re parroting their investment advisor, and yes, it ends up being an excuse for not being actively engaged. It’s a truism, but again, when you are in the context of a down market, I think that is when investing for the long run and not timing the markets becomes the excuse for having ignored risk. I think the vast majority of investment dollars are today, really, passive allocations. They are determined, they’re guided, not by a professional steady hand, but by some ridiculous pie chart which is supposed to magically prevent market declines by owning a little bit of everything in the market.

I do hold that there is value in diversification, but I have witnessed over and over again the Wall Street norm of ignoring risk until after the emergent issues which could have been predicted, could have been seen, could have been acknowledged, become acute downside events and then you are put in the posture of playing for patience. “Gotta invest for the long-run, couldn’t have timed the market, just be steady, don’t make any rash decisions.” Again, it just seems like an excuse for being too passive and playing golf by whatever time in the afternoon, because actually, the portfolio is not being managed.

Kevin: Do you remember when accountants were replaced by TurboTax and programs like that, where people can sit down now and do their own taxes? It’s about the same thing, you plug things in different areas, press the button, it goes straight to the IRS. Investing isn’t like that. You can’t have TurboBroker where it just plugs in all the figures and it’s the same for everybody. Hit Send and you get your 7% return.

David: (laughs) Well, there is a trend toward robo-advising in which case you do have, not a person, but now just a little black box that tells you, “Oh, given your age, given your approximate life expectancy as a white male in his 50s, this is how you should be investing and we’ll do it for you at a very low cost.” Again, you are homogenized beyond…

Kevin: Black box, or is it black pie chart?

David: Well, this is where I think you can cling to a pie chart, you can hold tight to that performance figure which implies 7% return in equities over the long run.

Kevin: In quotes – “over the long run.”

David: Sure. But please, please don’t assume that your financial advisor is willing to hedge beats or be proactive in advance, because here is what they are facing from a sociological perspective – too much professional risk in stepping away from the Wall Street crowd. It is actually much easier to be wrong with everyone else than to be right in the end but face that socially awkward moment of “I’m doing something different from the Wall Street crowd.” All the trading strategies I see that cross my desk as I review incoming portfolios are fairly similar. Allocations are pretty uniform. I can be looking at a Merrill Lynch portfolio, a Goldman-Sachs portfolio, a portfolio from a bank trust department – they all share about 80-90% overlap in their allocations. It’s the same pie charts, it’s the same tired operating assumptions about market efficiency, market timing. It is fascinating to me that investors don’t look at those pie charts and say to their financial advisors, “Don’t you realize I was just next door last week and I’ve only seen that a million times?”

Kevin: We’re the little guy, and you have broker experience with a large brokerage firm. You understand the small portfolio that is allocated a certain way is actually a place that the large portfolios feed their shares. You mentioned Goldman-Sachs. Remember three years ago, the 1st quarter of that year Goldman-Sachs went 90 days – their large portfolios, their big pension funds, hedge funds, things like that – went 90 days without a single loss. But when they took that same quarter and they looked at the smaller clients for Goldman-Sachs, they were 8th out of 10 brokerage firms. So these guys were selling them the shares that they needed to offload. So being the little guy is hard.

David: I remember 2000-2001, that timeframe, I had not come back to the family business, I was working for Morgan Stanley out on the West Coast. And our sales manager – we had Wednesday callouts. We would be making cold calls, or whatever. We had the product of the week to sell. And I was never a very good boy. I didn’t really march to the beat of Fred’s drum. As nice of a guy as he was, I didn’t agree with some of the things that they were doing.

At the time, 2000-2001, they rolled out a technology mutual fund. Technology had already taken a major step down, and they issued it at $10 a share and it wasn’t 90 days before that thing was trading at $2 a share. At $10 a share what the mutual fund offered was mass liquidity. And again, to your point, mass liquidity to a few of the large clients – it’s the bag-holder theory. Who got caught holding the bag? The little guy as he rode an 80% loss. It was just the question of, “We need to provide liquidity and it’s time to launch a mutual fund, and the guy in the street is willing to pay anything to get in on tech. And by the way, look, it’s cheaper than it was just a few months ago.”

Kevin: Absolutely. Anytime you are a seller, you have to have a buyer, and a lot of times these brokerage firms make sure that they have both going on at the same time.

David: 2000-2001-2002, my life was fairly boring. I was interested in gold stocks, which had been in a bear market for 25 years, and tax-free municipal bonds, which were yielding at the time 6-6.5% tax-free, which was just a beautiful thing to be buying, particular in advance of this crushing move lower in interest rates.

Kevin: Yes, that’s also when the tech stock bubble blew up and you weren’t in it, for the most part, at that time.

David: No.

Kevin: I saw Trump tweet something a couple of days ago. It made me laugh, I have to admit. I don’t know who writes his tweets. My wife thinks he writes them all himself. Maybe he does. But he tweeted, “3.5% unemployment? Yeah, it’s about time to impeach your president, isn’t it?” What he was saying is, it was a 50-year low in unemployment. I also saw a chart, and this is not to take anything away from 3.5% unemployment, but I saw a chart that went back for 100 years, and the unemployment number reaches its lowest point right before a recession, which is a strange anomaly. Did you see that chart?

David: (laughs) Of course, because trend reversals start at extremes. You start moving into a bear market after markets have peaked. You start moving into a bull market after markets have reached their ultimate low. The same thing is true, here, of unemployment. When you get to an absolute low, where do you go from there? Lower? We’re not talking about engineered interest rates here, we’re talking about the total population and the job opportunities, and when it hasn’t been this good in 50 years, it’s probably about time for a trend reversal.

Kevin: Yes, but people don’t think about recession when we’re thinking this good.

David: Right. We had the revisions on Friday of the non-farm payrolls, so a little bit of a disappointment on Friday with the current numbers, but they revised going back three months, and everybody was happy with those revisions, all positive revisions going back two to three months, so we’re at a 50-year record low – 3.5% unemployment – and recession seems, to most people, very unlikely. And the interest in hedging downside risk appears to exist with the hedge funds, and only a few contrarian investors. Everyone else is uninterested, as long as they can enjoy what looks like a permanently high plateau. If you recall, those were Irving Fisher’s famous words on, I think, October 6, 1929.

Kevin: Right before the depressionary crash.

David: The world’s most famous economist of the time said, “We have reached what looks like a permanently high plateau.” And honestly, that’s how the investor today is acting – “Look, until things change, I think we’ve got the greatest thing going of all time.” We’ve reached what looks like a permanently high plateau.

Kevin: You know what proves that? We’ve had gold come up several hundred dollars this year, and yet you would think traffic into gold here in America would be higher. But the premiums, even on coins that have quite a bit of rarity, just are not there because the American buyer just does not buy the need to hedge against risk.

David: Let me give you a couple of examples, because I think you’re right, when we look at traffic into the gold market, it is much improved, but it is nowhere near what I anticipated with a solid $1500 an ounce price. So I think there is still faith in the equities – that remains. There is faith in the system which is unshaken. And frankly, it is unshakeable prior to the first major shock. But on this issue of premiums, you look at something generic like junk silver. You can buy it pretty near the spot price of silver. And this is something that hasn’t been made. What I’m calling junk is your pre-1965 dimes, quarters and 50-cent pieces because they haven’t made it since 1964.

Kevin: There will never be any more.

David: And so, it trades with a supply and demand premium, and you know that there is a lot of buying in junk silver when the premium starts to march higher. The fact that it is nonexistent today suggests there is really not a lot of traffic into silver. It is the same with U.S. 20-dollar gold pieces. Premiums are very low, some of the lowest we have seen in 20 years. Attractive on the buy side, but what it is indicating is, and this is my point, the U.S. market has yet to really come alive, and is not really aware of why they should, or what is a warranted argument for owning gold in this era? Because again, stocks are doing well, bonds are at all-time highs, with interest rates at all-time lows, and so what is there to worry about?

Kevin: Do you remember the last time premiums were low? It was the year 2000. It was a time when stocks had just been exploding. There was absolutely no reason for worry. You were, of course, a broker at Morgan Stanley at the time. But premiums were very, very low at that time. Now, from that point until 2008-2009, remember where premiums got in 2008 and 2009? Drew, our numismatist says that all we really need is ten minutes of real fear and everything changes.

David: Right. You back to 2009, you had premiums, and from 2009 to the present there have been three trades through the junk silver market where you could increase or compound your ounces anywhere from 12% to 30%. That is just an intelligent way to structure a precious metals portfolio. But again, it is taking advantage of premiums. And we’re not talking about high-falutin’ stuff. You look at a dirty old dime from 1962, and it’s not a collectible, there is nothing particularly interesting or attractive about it, except that over time if you play that right you end up with free ounces of silver, free dimes, in essence.

Kevin: Speaking of free, we also talk to people about the silver to gold ratio, and right now silver is about half what it should be relative to gold.

David: To me, this is a concern. It has been a concern. We’ve talked about it on the program before. And we did that with the gold-silver ratio about 95-to-1. It has improved to 85-to-1, but if you will recall our conversations with technician Ian McAvity, when Ian would come on the program he would say that when gold and silver are in a full-blown bull market, that ratio will bounce between 40 and 60. And when it is in a bear market, it will trade between 60 and 100. Well, I’m sorry, it’s an improvement from 95 to 85, but we still have yet to get into the 60s. So silver is lagging, and you have the gold shares, compared to gold, if you put that in a ratio, they are lagging, as well. They have performed as well as gold, but no better.

Kevin: So what is that telling you?

David: That tells me that either this is a giant head fake and gold is going nowhere quickly, which I have a hard time believing given the macro-economic backdrop, the amount that we are running in terms of fiscal deficits here in the United States, and likely to run if we end up in a recession in 2020 or 2021. And of course with the crazy monetary policies both here and abroad, I don’t think we are getting a head fake from the gold market.

But what that would imply is that there is a big wave of investment dollars ahead of us coming into the space, not behind us. So yes, we have something of a correction in price (laughs). An ordinary correction will take 8-10% off of peak price, but this is pretty stubborn. What seems to be occurring is sort of a stubborn sideways move. We’re 50-60 bucks off of the peak, but it has been clinging to 1500 in a fascinating way. We will see what October holds. If we get a normal correction, again, off of $1560 maybe we dip to $1400. And here we are, gold hitting one of its worst months of the year.

Kevin: Which is interesting because historically, September and October have been the worst months for the stock market, as well. There seems to be, in a year cycle – we were talking about loops. You have the long loop, the intermediate loop, the short loop. If we were to look at the loop on a year, and you were to say, “Okay, I’m only investing for a year in a particular investment,” there are certain months that you would invest in stocks, certain months that you would invest in gold, and certain months that you would stay away or sell.

David: Yes, statistically July to September is a really good period for gold. October ends up being soft. November to January is strong. January to April is weak. A little bit of a pop thereafter and then calms down again as you go into the summer months, again, picking up in July. So there is seasonality, and that puts gold hitting one of its worst months here in October, which is good. We have made significant progress from that $1360-1400 range, the breakout level, and then we moved quickly to September 4th and the interim high of $1560. We’re now consolidating those gains, we’re seeing a bit more downside. That, to me, is healthy, although as I say, it can be just as healthy for those gains to be digested as the price of gold and silver move sideways, which in essence, here we are at $1500 and change and it’s kind of a sideways move.

Kevin: Well, and I was mentioning stocks. We can look at gold and say gold hasn’t really taken off yet, but actually, it is neck-and-neck with the stock market.

David: Year-to-date it is. June to September gold and silver did very well, but in the year-to-date gains neck and neck with the double-digit gains in the S&P and the Dow. The S&P has been slightly stronger than the Dow, gold has been slightly stronger than silver as we speak. So why is a correction needed? Just a few weeks ago the daily sentiment index for gold reached 97% bullish.

Kevin: So everybody is in that trade, at least on the paper trade.

David: That’s right. And then you get the COT reports a few weeks back, and we peaked at a record of 290,000 long contracts in the managed money category. There are different categories, and the managed money category tends to get it wrong at every extreme. They are over-invested at a market turn, and they are under-invested at a market turn. But both of these indicators, the daily sentiment index, and where the managed money ends up, going into the gold market, and to what degree they are, these indicators implied a correction in price was coming. There are just too many interested parties in too short a timeframe. So correction in any asset class takes off the edge of over-exuberance and brings performance of that asset back into sort of a longer-term trend.

Kevin: I think this is time for a definition in terms. Sometimes we throw things around quickly, but speaking of loops, the long loop is the structural side of the market. You’re either in a structural bull market or a structural bear, and sometimes that can last decades. And then you have the cyclical, which is the intermediate, or even the short loop. The cyclical, you will have ups and downs. So when we are talking about seasonality for a year, in the long run, the seasonality has zero impact on the long run structural. It’s going to do what it’s going to do.

But let’s say that you were buying for jewelry or something like that. You’re going to look at that seasonality. So structural is the big one – think of a large structure. Cyclical is the short run – think of a guy riding a bicycle, if you need to.

David: Or if you were patient and you were slowly adding to positions you might be sensitive to, in terms of dollar cost averaging, the seasonality of gold so that you can, on a methodical basis, on a routine basis, be adding to a position, but doing it advantageously when there is weakness in the market.

Kevin: Like the Chinese and the Indians.

David: Exactly.

Kevin: Exactly right.

David: So you need to know what the long-term trend is, of course. In the case of precious metals, they have been quietly moving higher since early 2016. The long-term trend is up. The metals have, in my opinion, a lot further to go on the upside. But again, you have these short periodic declines, which are typical. They’re not discouraging events as long as the long-term trend is in place.

Kevin: I think it is good to go back and say, remember that period of time when gold rose all the way to $1900. Well, it started that move at about $700. We sure enough had some of these downturns, these breaths that they are taking, exhales and inhales.

David: It looked like the market was going to be kept at the old highs of $850, intra-day high of $875, so when we got to $700 it was sort of getting close to the ceiling. And so the rise from $700 to $1900, 2008-2011, was punctuated by five corrections, each of which was over $100 and each of those corrections, decline in price, lasted at least a month.

Kevin: That takes the enthusiasm a little bit out of the market at that point.

David: Particularly if you have just purchased something and it is down $100 within 30 days, you think, “What have I done? Is this crazy?” But the exuberance in the market is moderated each time by one of these down strokes in price, and it sets the stage for the next move higher. In this timeframe, fast-forward to today, not the 2008-2011 timeframe. But I think the next step higher is the November to January timeframe if I were to guess.

This is a correction currently in effect. It can easily get us back to $1400. Maybe it doesn’t, maybe it just moves sideways. But it is not out of the realm of normal for it to get back to its level where it broke out. So $1400 – great. Now we’ve got the 200-day moving average at around $1360, in the $1360s and rising currently. But you look at the trade tensions, you look at high political anxieties. All of these things argue for gold going higher. This may be a very, very shallow correction when all is said and done.

Kevin: So it can be a good thing. If you’re buying, and you say, “Okay, well, gold is usually weak in October. Why don’t we go ahead and take another position?”

David: So why did I say October is a good month? That’s exactly why. I’m going to put my other cap on. As a wealth management team, we discussed a couple of weeks ago with Doug and Lila on the program that we prefer to buy a confirmed trend. So for Doug, if his allocation on the short side is going to increase, it is because he has greater confirmation of the trend in play.

Kevin: He has discipline. It’s not just his gut feeling.

David: No gut feeling, no hero calls, and market top calls. That is financial suicide. But on a very disciplined basis, buying a confirmed trend. In the case of Lila and what we do with a MAAPS portfolio, it is not the short side, again, it is confirming an uptrend. If there is temporary weakness, great, we’re already methodically, dispassionately taking allocations and it takes patience to do that. It takes daily engagement with the markets to do that.

This is more than a pretty little pie chart. It is an endeavor that takes active management every day of the week. All I’m saying is, consider something similar for yourself. When you are buying, buy incrementally. When you’re selling, sell incrementally, and do so on the basis of established trends – uptrends or downtrends. Months ago, prior to the move in metals, we said that gold rising above the $1360-1400 area opened the door to the old highs.

Kevin: Which was over $1900.

David: Yes, and sure enough, we broke $1400 and it ripped another $160-200 off the $1360 number. A $400-dollar move in gold from here to the old highs sounds rather grand until you do the math and measure it in percentage terms. That’s 26% higher.

Kevin: It doesn’t sound that far away.

David: It’s just no big deal. Actually, getting to the old highs, $1920, that’s a very modest price target, 26% above the current levels. A very modest move over a 12-24 month period. Gold covered six times that amount of ground in 36 months right after the global financial crisis.

Kevin: Right. When there was a change in sentiment.

David: With the global financial crisis taking the world by surprise in 2008 and 2009. Look, we’re back to what you described. We get a change in sentiment. This go-round we have the fiscal and monetary issues looking like a slow-motion accident. Everybody can see it, but nobody is surprised by it, and no one is really drawing any conclusions from it, so sentiment has remained fairly strong. Sentiment shifts and it would not surprise me to see the demand for gold in the investment community go parabolic over the next few years.

Kevin: Think about what causes that. What causes that is actually people being caught off guard, and talk about off guard, that characterizes the current situation. No one is on their guard.

David: Well, it is going to come like this. Somebody says, “You mean they’ve done thus and such?” We are in the process of redefining cash. So we are in the process of redefining what interest rates look like when they can actually be observed (laughs). So we are in the process of redefining how people relate to their money. There is going to be an aha moment when people are like, “You mean that I’m not getting paid – you mean that I’m getting dinged for having deposits in the bank? How does this make any sense at all?”

There is an aha moment coming, and I think it is when this is observed, all of a sudden the redefinition of the role of credit, the propping up of quasi-capitalism – all of this becomes the reality. It has been there in front of people all along, but they don’t have eyes to see it. As and when they do, it is a very significant issue. Again, when we’re talking about things that exist in front of us today, the difference is down to perception.

Kevin: You mentioned quasi-capitalism. The question is, does capitalism exist anymore? We are in controlled markets. I keep bringing Howard Onstatt up, but he said, “The cycle prevails.” Call that capitalism, call it the cycle, but somehow, some way, gravity is still the winner. No matter what you do, gravity stills pulls things back down to earth.

David: I don’t remember if it was 2014 or 2015, but it was an early interview with Russell Napier where he said, “If you want to understand the dynamics of the markets moving forward, you need to recall the way things operated in Eastern Europe.”

Kevin: Oh, that put a chill down my spine when he said that. It was sad.

David: Because what he was describing was not the end of capitalism, but a compromised version of capitalism, a corrupted version of capitalism where you see so many command and control dynamics that you’re not sure what you have. Is it capitalism, or is it command and control, or is it some blend of the two. And that is where he thought it would be wise for us to take note, take heed, and then maybe allocate according to what we saw unfold in Eastern Europe over the last 34 years.

Kevin: Well, those who control, though, have a very, very hard time controlling something like gold. They may be able to in the short run. We’re seeing in the news now guys being prosecuted.

David: You’re talking about J.P. Morgan?

Kevin: Yes, manipulating gold. A slap on the hand, whatever it is. Maybe it is more than that. But the thing is, that is the paper market. The Chinese and the Indians, we keep coming back to them. You keep talking about being disciplined and patient, they just go in and buy gold. If it goes down they buy gold. They’ve been buying thousands of tons a year of, really, all the gold that is being mined, plus quite a bit off the secondary market. So your assumption is that, speaking of the long loop, we are in a structural bull market in gold.

David: Yes, I assume we are in a long term structural bull market in precious metals, and I think that began with gold around $252 an ounce. I also assume that the 2011-2015 period was a cyclical bear market in gold and silver, and that was in the context of that longer-term structural bull.

Kevin: And now we’re back in the structural bull rise.

David: I assume that we have re-engaged the structural bull and are several years into a well-established trend that, as it plays itself out, will attract a lot of investor interest in gold. To all these things you might ask, haven’t we already seen a pretty health move? $1050 to $1560 – isn’t that a pretty big move? On the one hand, yes, but on the other hand, no. It has moved at what, at current levels, is a healthy 13% annualized rate since its lows December 2015. Not all at once, and it has had numerous mid-course corrections. A great run there in 2016 with a nasty correction into 2017. So the mid-term corrections in that timeframe have kept the temperature, the sentiment, in the precious metals market from getting crazy.

Kevin: Speaking of crazy, one of the conversations that you have that virtually no one who sells gold and silver has, is something called an exit strategy, because there will come a point when things start happening very, very quickly. If we are on the third cycle of this bull market in gold there will be a parabolic blow-off stage. You and your dad have been talking about this and saying, “What do we do with billions of dollars’ worth of gold investments when that parabolic stage hits?”

David: Right. And this is maybe an old conversation for those of you who have listened to the Commentary for 10-11 years now, but rate of change is a significant indicator of, again, if you’re taking the temperature of a market, and the temperature of an asset class, and how people feel about it. The rate of change is measuring the increase in price for a particular asset class from January 1 through the end of the year. Your typical rate of change in a parabolic move, an unsustainable sort of hockey stick type move higher, for any asset, is between 100% and 150% in a calendar year.

Kevin: Like you said, unsustainable in the long run.

David: Yes, so at that point, when you have a rate of change that is exceeding 100-150%, you should be very diligent in trimming back your total position size.

Kevin: Even in gold.

David: And I think we get to the old highs, 1920, gradually, over the next year or so, and then I think we double in a shorter period of time thereafter. This is going back to the 1980s, doubling the inflation-adjusted number is precisely what we did in the early 1980s. 400 was roughly the inflation-adjusted number for gold. It got to an economically sustainable point. I remember one of my dad’s good friends and mentors at the time said, “You’ve got to get out. We’ve gotten to the inflation-adjusted number.”

Kevin: But it went to double that.

David: It doubled that. It doesn’t have to repeat that cycle exactly, but if we did that today, doubling the inflation-adjusted number would bring us into the $5000-6000 dollar range per ounce for gold. If you took the older 1980s modeling of the CPI, John Williams of Shadow Stats, this is what he prefers. I don’t know if I can go quite there, but it implies a gold price closer to $12,000. And that’s not a doubling of the inflation-adjusted number, that’s just the inflation-adjusted number. If you doubled it you’re talking 24. At some point you start sounding like a lunatic.

Kevin: Yes, but what if you just use the government’s numbers the way they mess with them today?

David: That’s what I’m saying. The new and improved hedonically adjusted (laughs) CPI, what we deal with in today’s terms, you get to roughly $2600 an ounce. I may not agree with the calculation of the CPI in its modern restatement.

Kevin: We could call it hypocritically adjusted, not hedonically – oh, I’m sorry – hedonically, yes.

David: I think it’s a reasonable starting point from which to launch on the gold price and the market moves in front of us. That inflation-adjusted price is sustainable, long-term. Two times the inflation-adjusted price is not. So a little thought experiment here is helpful. If you can imagine a future context of $2600 gold, I think that is the new floor, and I think you were talking about coming off of a much higher level where that becomes the new floor.

Kevin: And Dave, with the racing that you are doing in triathlon, you actually race like you train, and you need to train like you race. One of the things that I like to do with clients is rehearse, looking forward, and say, “Okay, let’s pretend just for a moment that I’m making a call to you after a parabolic rise. What is our next conversation? I think it would be wise to cover that now because we have prepared for this.

David: In many respects this comes back to our “back of the napkin” so I can poke fun at the magic pie chart. Well, the magic pie chart is not so magic, and I’m not saying that our triangle is any more magical than a pie chart.

Kevin: It seems to work though. I’ve done it 32 years. It works.

David: Well, what it is at least helpful with is organizing the assignment that you are giving to certain assets. When we draw our perspective triangle, we call the right hand side of that triangle liquidity. This is an assignment. Part of your assets needs to be designated toward liquidity. This is cash, cash equivalents, T-bills, money market funds, short-term laddered CD portfolio, what have you. But very liquid, very useable for anything – household management, business management, opportunistic purchases of assets, no name it.

Kevin: Stuff you tap into if the roof leaks.

David: Liquidity is the task you are assigning to the right hand side of the triangle. The left hand side of the triangle we call growth and income. This is stocks, bonds, annuities, other things that are not so liquid, but have a purpose, and the purposes are either growth or income. The bottom of the triangle is what we would call insurance. Again, this is a task, not an asset class. I’m not talking about whole life, or – that’s not it at all. Insurance is what it does. The products, themselves, gold and silver, are what you are employing to get it done.

Kevin: It insures the other two sides of the triangle.

David: Exactly, reducing your currency exposure risk, reducing your stock market volatility risk. Gold and silver become a little bit Linus’ security blanket. In a certain context people want more security, and they cling to it. So that is what they do with gold and silver, why the premiums go higher, prices go higher when stocks sell off or you have major currency issues.

Kevin: And you always have some insurance, but let’s say that one-third of the portfolio on the base of the triangle doubles. Now it’s two-thirds of the total. This is what we would need to rehearse.

David: That’s the thought experiment. You should expect, in this hypothetical scenario of gold doubling its inflation-adjusted price, going to $5000-6000. You should expect it to get cut in half, from the two times inflation-adjusted figure back to the $2000-2500 level. Now, the question is, will you make a lateral move, with a portion of your gold holdings into some other portfolio structure? For us, it’s the managed portfolio of hard assets like what we have on the MWM site, where we are managing, what we are doing is highly visible, and we’re not interested in everything under the sun, just real assets.

Kevin: It’s still real stuff. When you say hard assets you should just define a couple of those categories so that we can understand.

David: Infrastructure, global real estate, natural resources.

Kevin: Even toll roads, cell towers, things like that.

David: Sure. Yes, basic stuff that has real intrinsic value, but also fits a world in which crazy credit expansion has to be accounted for, and the risks inherent to the financial system because of that.

Kevin: So are you being self-serving, Dave, because we sell gold and silver, and we actually have a net right now that will catch the profits out of gold and silver coming up in the future?

David: I think it is obviously self-serving, and I think I’m safe concluding that, but I’m telling you what my dad and I discussed in 2004 and 2005. Our conversation then, before we even started the Wealth Management Group was, when we as a family are reducing our metals exposure – note, I did not say eliminating, I said reducing – when we are reducing our metals portfolio, will we be communicating that to our clients? Will we be advising them to do something else with their resources, as we well be? What are we going to be telling them? And the answer was, yes, we are going to be giving them that advice. Having placed 3-4 billion dollars into the metals market, our company strongly advises that you consider what is next.

Kevin: We want to keep you as a client. That’s really what you are saying.

David: Well, sure, but we’re obviously not at a peak inflection point today. Gold and silver are not at a point where you need to do this today. This is why we call it a thought experiment. This is why you call it a rehearsal. We’re still $1000 below the inflation-adjusted gold price, and I think we can double from there. Perhaps our timeframes are off, and we may have underestimated the stampede into gold, so this could last 10-15 years, and not three years. It could be five times the current price instead of two or three. We have been through a very difficult interlude in between the second growth phase, which ended in 2011, and what I think is the third and final parabolic phase of growth for gold.

Kevin: I think it is important that you repeat what you said. We don’t know the timing. There are sometimes when people will hear things like this, and they will say, “Oh, that means I can retire in three years.”

David: No, no no. What we can say, I can say with greatest clarity, is I’m not sure how this plays out precisely. Regardless of the timing or ultimate price, which is admittedly impossible to nail down, the question remains on the table – what is next? What is next for the gold investor? This is a critical one. We’ve built the “what is next?”

Kevin: It’s what we call the exit strategy out of gold, but into something that will ultimately derive income.

David: And my sense of urgency is from that of a business manager. Its time is quickly coming. Well, not as quickly as I thought. We launched the Wealth Management Group in 2008. It is now 11 years on, and obviously, the infrastructure is in place, we have a very dynamic team – the best team imaginable in my view – but we have built the “what is next?”

The next two to three years, this is what I think you should consider as a listener. You should rehearse what the decisions look like that reduce outsized positions. You should rehearse what it looks like to cut back on losing positions, and actively apply a process to the management of your assets. That’s what we do, and you can do it yourself if you want. That’s fine. If all you are managing is so many little pieces in the pie, be aware that the entire pie may be shrinking.

Again, I reflect on this idea that you own a little bit of large cap stocks, own a little bit of mid cap, own a little bit of value, own a little bit of growth, own a little bit of junk bonds, own a little bit of this. Oh, you know what we should own now because Wall Street is just opening the opportunity for the man-in-the-street to own private equity, you can now, for $5,000, $10,000, $15,000, have your piece of the private equity pie. This is mind-boggling.

Kevin, if you want to know why I think we are at the end of a cycle in stocks, notice that we have rotated from the public sector, which you can buy as a ticker symbol, and premiums have gotten pretty substantial. Then for the last three to four years, capital has squeezed into the private equity space because you could still get a better rate of return, but what you were giving up to get that better rate of return was liquidity.

And now, going back to that bag-holder idea we talked about earlier, I’m going to a meeting this afternoon where we will be discussing a foundation allocation to private equity, and I’m going to be arguing strongly against it, because I think what is happening now is that the private equity guys want liquidity and they are willing to package up and take their profits and pass on the bag to the unsuspecting average investor.

Kevin: And they are being corralled into an illiquid asset. Again, we were talking about before, if you are selling something, what do you need? You need a buyer.

David: Right, so, to me, packaging private equity for the “everyman” is an end-of-cycle dynamic, similar to what you would see in the real estate market, where all of a sudden townhomes and condos – nobody can afford a single-family home, so you squeeze into what you can. For half a million dollars you get no square feet and no yard. But that’s what you can afford. That is an end-of-cycle dynamic. We have it in private equity today. Again, I think, now it’s just a part of the pie. The little pie chart of the financial advisor, you now have a designated private debt, private equity position, and you can feel like a sophisticated investor. What you don’t understand is that you are being handed the bag as the big boys are exiting the room.

Kevin: So just to mention, Dave, even if a person is not investing here with this firm, every week I give the 800 number and we are more than happy to go over the triangle, look at current holdings, even if you have another broker, and we are more than happy to help rehearse the exit strategy as we go forward.

David: And frankly, even though the Wealth Management Group is designed to be the one that is next, we don’t have to be the one that is next. Do it on your own, work with somebody that you like, but do keep in mind what is next, because there is going to come an inflection point where gold has done what it is supposed to do, as an insurance component within that cute little perspective triangle. And if it has done its job, you have capital, liquid capital, to employ, to put to work. And of course we want to help you, but somebody else can, too, or you can do it yourself.

Kevin: There are opportunities in the future. This is not just a doom and gloom scenario.

David: No, no, there are going to be innovative technologies, there are going to be game-changing bio-hacks, if you want to call it that. There will be well-run companies with an ability to continue to pay out dividends. But prior to a significant re-allocation from metals to those places of opportunities, what do we encourage you to do as a management team? We urge caution. We urge careful risk mitigation today.

And as we approach a pretty significant inflection point in the markets, go back to the incremental moves, go back to the disciplines. Go back to an active engagement with your investments. If you are assuming that your financial advisor is actively engaged, appreciate that the only thing that he sees at the beginning of the year, or mid-year, is a simple pie chart, and that ain’t gonna cut it in this market environment.

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