In PodCasts

This week and next we answer your questions that were submitted over the last few weeks regarding investing, the market movements through 2018, and what is ahead for the markets in 2019. Thanks to our listeners and subscribers for a great 2018!



The McAlvany Weekly Commentary
with David McAlvany and Kevin Orrick

December 19, 2018

“There is not enough data related to cash, and digital provides data, system-wide corralling, and ultimately, I think, digital provides control. So I’d love to talk this over with Ms. Lagarde because perhaps her intentions are different. Again, I think it is how the political system would use such a move, in my mind, in the final analysis, which would be dystopian.”

– David McAlvany

Kevin:I look forward to this every year. I’m just amazed, Dave, when we ask our listeners for questions for the annual couple of question and answer shows. They’ve gotten better and better and better. We’re moving into the 11thyear and I’ll tell you what, some of these questions, it is humbling to just be around the people who are asking some of these things.

David:It’s really fun engaging in this way. We have the opportunity to have a conversation, the two of us, every week, that gets broadcasted to an audience that we don’t necessarily know. They get to know us in some respects, and I know when I published The Intentional Legacya year or so ago … other people know us perhaps better than we know them. But getting through the questions, it’s really wonderful to see the minds and the hearts and the interaction and the concerns and where people are at with ideas and social trends. And so for us, the part of the Q&A that makes it so rewarding is getting an insight into who our listeners are. We thank you for joining us this year again.

Kevin:The questions run the gamut. There are questions here that probably everyone needs to hear the answer to, and then are others that a little bit more probing that get into economic theory. So why don’t we jump right in?

This question, starting out, a listener just said:

Regarding your new Vaulted service, it seems like one of the ideas is that it makes it easier to move money in and out of gold on a regular basis. However, if you were to buy gold and sell it later and make a profit, I’m guessing Uncle Sam is going to want a cut. Am I mistaken? If not, does the service help you keep track of your cost basis? If you were to be buying and selling gold on a regular basis, keeping track of the cost basis could get hairy really quick.

Dave, answer that question. It’s a straightforward question, but the answer is yes, when you make money on gold, or anything, you owe taxes.

David:That’s right. The 1099s are the forms that get sent out at the end of the year for each sell transaction, and that happens at the end of the year. But at any point during the year, if you go to your user login and look at the activity, it will provide your realized gains and losses on each trade. We have chosen LIFO – last in, first out – as a methodology, but again, with the numbers that you have from the 1099, whatever methodology you and your accountant agree to, whether it is average cost or FIFO, or LIFO, you have the data to determine how to do that, and choose the methodology appropriate for you.

Kevin:Well Dave, I’ll just mention, when I use Vaulted I really am not moving in and out all the time. I’m moving in and out – it might happen once or twice a year, but it’s not that rapid.

Moving on to the next question:

Hi guys. My holdings, in terms of metals, is about 50% in gold, 50% in silver. With the gold and silver ratio at a 25-year high [I think it’s like 83 or 84-to-1 right now, Dave], what would you consider as far as trading some of your gold for silver? Any thoughts or inputs would be appreciated. Love your show.

J.D. asks the question, at 50/50 should he be moving more gold into silver?

David:It’s a great question. My response would be no. From a gain standpoint, it does have logic, and in fact, doing that may prove more profitable. But remember that gold is a metal for all seasons, and I think favoring industrial metals – we’re talking about the white metals which include silver, platinum, and palladium – over gold, that puts you at risk in the event of a systemic or global economic recession or depression. Again, the industrial nature has a demand reliance and vulnerability there in a real severe economic downturn.

So coming back to the asset preservation aspect, that goes by the wayside when you’re moving the balance to the white metals instead. So this is really a personal question. If you are comfortable compromising that aspect of security or asset preservation for the possibility of gains, and you are willing to allow the ratios to play out over time – great, that’s your prerogative. I just want to keep in focus one of the primary reasons to own metals is asset preservation, and to some degree, you’re giving on that by over-emphasizing the white metals.

So again, the ratios, I think, ultimately will be additive. And there is sound logic here. It’s a great observation, but you have to remember that endurance and patience are not easy, and if a market moves against you – Kevin, you said 83 or 84-to-1. We’ve seen that ratio as high as 100-to-1. I like the 50/50 as sort of a max allocation, and would probably be slightly under that in terms of a silver allocation if I was making room for the platinum group metals in the portfolio, still with 50% in gold.

Kevin:Dave, I’ll just add to that, too, if your dad were answering that same question, he would say 100% in gold and then I’m just done. He’s very conservative that way.


Kevin:And I’m more conservative toward maybe ¾ gold. But I think age also plays into this. If you’re a little bit older and you’re really looking mainly for security, there is virtually nothing more secure than gold.

Going on to the next question:

Would you consider a few videos on selling or exit plans?

Dave, this is where you are unique in the industry. When people are buying from us, the first thing you talk about is, “Let’s talk about your exit plan.” So this question is very appropriate. The question is:

Just for example, if you had purchased at $20 an ounce some silver, American Silver Eagles, Maples, Libertats, generic rounds, 90% silver, 5-ounce or 10-ounce bars, what have you, if spot prices rise $25, $30, $35 an ounce, what would you sell first? And if you do sell some, what would you do with the dollars? I’m guessing buy more certain coins. Would you go silver to silver?

You can talk about this, Dave.

David:I think I would reframe the question a little bit. Like we alluded to in the last question, ratios do matter. Ratios are very important. And I think premiums do, as well – premiums on a variety of products. The ratios and premiums are often more important than the price, that is, the nominal value of gold or silver. So in a mixed up world where the prices of assets are subject to monetary policy-driven inflation, I think it is very important to have another means of assessing value, and those ratios and the premiums do give you some advantage there.

So let me look at each of those real quick. With ratios you have the gold-silver ratio, and 60-to-1 up to 100-to-1 serves as the range for silver in a bear market. Acquiring in that ratio range is in anticipation of a shift to bull market range, which is more like 30-to-1 to 40-to-1, in that range, up to 60, but you’ll see a trade into the 30s and 40s. The reason these ratios matter is because you are trying to build ounces organically using the ratio to generate more essentially free ounces. So going from silver to gold, and back to silver, allows for a permanent metals allocation in your total net worth picture, which is compounding ounces, and it addresses one of the major concerns that investors often have, which is why would I own gold and silver when it doesn’t pay me any interest? And in fact, you can compound your ounces if you play the ratios.

So what do I mean by compounding ounces? You take existing ounces to generate additional new ounces net of your capital gains, net of your tax, net of your storage and transaction costs. So what are the extra ounces you have after all of those expenses? Obviously, if you’re talking about IRA assets you have some huge advantages in terms of the compounding of ounces because your biggest hit there is not storage, is not transaction costs…

Kevin:It’s Uncle Sam.

David:It’s the capital gains tax. So you have cheap storage, and you have no capital gains tax while in the retirement account structure. That’s on ratios.

The second point is on premiums. There are certain products that sell with a heightened sensitivity to supply and demand, and therefore you see swings in the premiums above the raw metals content.

Kevin:Look at junk bags to 1,000-ounce bars. How many times have you made that work for you, Dave?

David:Just in the last decade there have been three instances where that trade has worked very well. That premium is not a constant, and that is the thing to key in on here. The premium is not a constant, and properly played it allows for additional free ounces, just like with the gold-silver ratio the premiums can also play the same way.

90% junk is a great example – 715 ounces of silver in a bag, with a $1,000 face value. Sometimes it is available on the market at almost no premium where you are just paying for the silver itself. Sometimes it is available under very high demand scenarios and those premiums can be as high as 20% or 30% above the silver content. So what we are talking about here is harvesting the premium, liquidating into those high demand environments and turning around and re-investing the premium gained into new ounces of silver.

Kevin:So one of the main points, and we have talked about his many times, is price in dollars is really one of the least important measures of exit strategy.

David:Right. There is the proper construction of the metals portfolio which allows for this. We’re talking about silver primarily and the gold-silver ratio, but there are premium plays on the gold side, too. Again, proper construction of a portfolio on the front end allows for you to accumulate greater ounces as you go on with a hard asset metals portfolio. So price, as it relates to silver, and the question that was listed here by Eli, price as it relates to silver and an exit strategy, to me, it’s more than a matter of price. There are other factors than, say, a $5 or a $10 move, which are important to consider. And ultimately, a move out of the metals altogether is in light of what those tangible assets can be exchanged for. Does that make sense?


David:So how do ounces translate into acres?

Kevin:If you’re a farmer.

David:How do ounces translate into square feet? If you want to own rental properties, how do ounces translate into shares of publicly traded companies? The point of the question that I like the most is that a one-time liquidation is not advisable. You have dollar cost averaging into a position in metals, which makes sense, and dollar cost averaging out also makes sense. And you will see the premiums change, You will see the ratios change.

We talked about 30 or 40-to-1. In the Hunt brothers days we did see it get as low as 15-to-1. And the difference, if we are looking at the long-term projection for gold and silver, the difference between a 30-to-1 ratio and a 15-to-1 ratio is the difference between $120 silver and $250 silver, or thereabouts. So you do see a radical shift higher in the price on the basis of the gold-silver ratio.

Kevin:Isn’t that why you also don’t recommend just going all in or all out at the same time? Increment. Increment.

David:What it assumes is that you have more information than you actually do. It assumes that you know exactly what is going to happen in the future. And that’s not realistic. So incremental acquisition, incremental reduction – you can use the ratios, you can use the premiums to compound ounces within a permanent metals portfolio. And I think this is the happiest scenario for the long-term gold and silver holder – it’s when you have reduced your position of ounces by the original dollar amount that you invest.

Kevin:Everything else is free.

David:Yes, you hold the remainder, theoretically, for free, with a zero cost basis. That is another topic altogether, maybe one that we could do even an entire program on – intergenerational strategies for a zero basis portfolio.

Kevin:Dave I think I have to just add, after doing this for about 31 years, and these strategies, it is a moving target. There is not just a set algorithm that we use. You have to look at a lot of different factors.

Let me move on to Dave’s question. Dave says:

I have an observation that will turn into a question. When I was a young man I always wondered why so many people had mortgages, but there couldn’t possibly be enough bank deposits to finance the mortgages. Now I understand why. Is it easier to understand the subject of the economics if we begin with the assumption that we have a fraudulent monetary system?

David:And I appreciate that completely. What I would say is that banking and credit are essentially ingredients in a political bargain. And whoever is in political office gets to decide, not only what banks exist, but how those banks will be rewarded for the issuance of credit. They set the tone in the credit markets. There is, inextricably, this link between politics and banking. So lending to a particular constituency is the result of banks and politicians figuring out who else they want to benefit. In one administration, that might be corporate fat cats. In another, that might be the lower middle class.

Just fill in the blanks. Whoever is in office is going to help influence the direction of credit flow. And they ultimately do that because banks want to profit, politicians want to secure power and need money to do that, so they benefit from the process, too. And so, I guess when you describe the system as fraudulent, you might describe the fiat money system that we have as fraudulent just because there is nothing back it. But it’s probably more accurate to describe our credit system as politicized and self-interested.

Kevin:Dave, if I were to think back, there are a lot of presidents who have challenged the Fed and said, “I wonder about the Fed,” but really, you have to go back to Andrew Jackson to find a president that actually would discredit what you just now said. So what I am saying is, that adds credit to the fact that politics and banking play a key, hand-in-hand role. Look at Trump right now. He has talked about auditing the Fed, he has talked about cracking down on some of the banking problems, but in reality the banks have to be there for him to get done what he needs to get done. So there is a charade that continues to go on, so like the budget deficit, you have to act like you’re going to shut the government down, until you don’t.

David:Credit flows, and that has an impact on the economy. To the degree that the economy is doing better or worse, there is a direct political consequence, and that is what politicians absolutely care about, the credit flowing, and who it flows to. If they can help direct that flow, they certainly will. Banks want to make money. That’s clear. They need government support, and they also need government protection. You can see how the banks were protected during the last global financial crisis, and how the losses were apportioned to other players, not directly to the banks, themselves.

So again, you see this link between politics and banking. Politicians typically look for longevity in office, and they are constantly looking for ways to favor their constituencies. So lending and credit availability is one way of doing that. More and more people have mortgages – that’s an expression of social system design, and as a favor from politicians to people. Because essentially, the better off you feel – better lifestyle, new home, even if you couldn’t afford it, you may be living beyond your means, using someone else’s capital for your lifestyle, but it makes you feel good. And gratitude, I think, does get expressed to the crew that “made life better for you.”

Kevin:Moving on to something that really affects our retired folks right now:

What potential do you see for a large-scale pension crisis in the coming years?

David:The crisis is here. I think underfunding is a real-time issue, and it ebbs and flows in terms of the value of stocks and bonds. So it is a bigger crisis or a smaller crisis in light of where financial asset are. But any volatility with current assets – lower stocks, lower bonds, or both – and you now have a real PR problem. It’s already set, you already have underfunding in almost every pension out there today, but the underfunding becomes more exaggerated with a decline in the value of the assets. So ultimately, if it’s a PR issue, it then becomes a political issue. I assume a pension crisis will be full-blown in the context of the market illiquidity and decline in equities which we anticipate heading into 2019.

Kevin:But it’s not just equities that these pensions hold. Aren’t bonds the bedrock of a pension plan, generally?

David:Generally, that’s true. But I think bonds are likely to see higher rates, which equals lower value. So to the degree that pensions have exposure to bonds, they have some capital losses to take there. And the reality is, they have been allocating more and more to favor equities over bonds to get to their expected rates of return of 7%, 8%, 9%. So I would guess that as they have shifted toward equities, they have a real beating to take there. And ultimately, as they shift back toward bonds they may take another beating all over again, losing on bonds, again, as yields shift higher and prices lower, because I think that is probably a new secular trajectory for interest rates and bonds.

Kevin:Do they have to use the shell game? Since they’re under-funded it becomes almost like fractional reserve banking. You just hope that everybody doesn’t come for their money at the same time.

David:And this is the beauty of holding long-term assets. To the degree that they have a reprieve on mark-to-market, in the bond world they may not be penalized as much in terms of under-funding because they can say, “Look, we bought a $1,000 bond. Currently it is priced at $600, but we’re not intending to sell it, we’re holding it to maturity anyway, so don’t force us to mark it to market, and therefore we won’t appear as underfunded, and you won’t impinge upon current cash flow for the corporation or the entity that is supporting the pension.” Pensions will have to ignore any and all mark-to-market rules, which, if allowed to be in effect, would reveal greater degrees of underfundedness.

Kevin:But politics will probably play into that, as well. Let’s face it, if you have a pension crisis, they are going to be screaming at the president, whoever he is.

David:Yes, so to the degree that the pension crisis takes on a political tone, companies may get bailed out by the U.S. government. And there is variety of ways that might occur. You might see the government come in like a knight on the white horse, offering retirees something like an annuity from the government. So, again, imagine a world where the Treasury Department, for instance, absorbs the remaining assets of a pension fund that is underfunded. They take on the assets in exchange for a long-term liability to them to pay out this annuity, and it is tied to U.S. government bonds. They are able to convert those assets, to some degree, into a captive audience for bonds. Again, these are all theoretical possibilities.

But a final note – the greatest risk to a pensioner has always been what a government does to the money, that is, the value of the currency that you are denominated in. Even with a guaranteed payment on a pension, like an annuity structure, how does the Treasury manage that liability via the Fed? And there I think you see the classic inflation tax on display. The reason they know they can take on that long-term liability is because they know they can inflate it away.

Kevin:They manage it just like they’ve managed the deficit. Keynes says that this is a tax – inflation, that is, that only one in a million understand.

The same person asks the question:

Do you feel some pensions are safe, or will it likely be systemic, and all pension managers will request a bailout? I often think of the city of Stockton when it went bankrupt, and many of the workers lost their pensions.

David:I often think of City Bank, not just the city of Stockton. When we went through the global financial crisis, how connected was City Bank? Who takes care of government payroll? How integrated are they into the spheres of both public and private life? Pension risk is directly related to how politically important, or unimportant, the pensioners are seen as being. So I think size matters, I think location matters, I think future political strategy matters. So that question would be, “Do you matter?” That’s the question on the table as far as a politician is concerned. Is there a political benefit to the cost incurred from a bailout for a particular pension? And if there is not a benefit (laughs), then your pension would be in a high-risk category.

Kevin:Staying with pensions, this is the final portion of this question:

Could the Fed raising interest rates to double-digit levels be a form of bailout if there was a crisis, ignoring the inflation factors that would also hurt the pension’s drawers at the same time?

David:Keep in mind how much debt is in the system today – corporate, private, governmental. With so much leverage in the system, what would be good for the pensions would crush the corporate sector, and would make rolling over national debt obligations impossible. So raising interest rates to double-digit levels à la Paul Volcker is not possible. That’s not to say it can’t happen, driven by market mandate, but it’s not possible from the standpoint of policy mandate, because you would be forcing bankruptcies.

Kevin:This next question is directed toward Doug Noland’s Tactical Short that you and Doug work with, Dave. It says:

In the last conference call for the Tactical Short, it was mentioned there could be a traditional mutual fund coming like the Tactical Short. Do you have any further information or a timeline on that?

David:Working on it, negotiating things, nothing on the immediate horizon. I think the current structure is adequate, but we’re still exploring the mutual fund option. I would say that is long-term. And again, I can only hold my breath for about three to three-and-a-half minutes. I wouldn’t hold your breath much longer than that.

Kevin:But you do have an option, I believe, for IRAs. That’s to a smaller minimum. It’s not a mutual fund, but it does allow a person with a larger IRA that has money, say, in equities that have to be hedged. You do have an option there.

David:That’s right. It’s called the Tactical Noncorrelated, as opposed to the Tactical Short, and there are just a few limitations that we have to be cognizant of because you can’t have a margin function within a retirement account. So we can accomplish almost the same thing and our results have been very comparable between the Noncorrelated and the Tactical Short.

Kevin:This is on a similar mutual fund note:

Is it possible to create a traditional mutual fund that works the strategy of changing percentages in metals held – the ratios of gold, silver and others – as you often discuss?

David:It has been done. I guess what I’m thinking of is one that had a mix of the metals. It was not a dynamic fund, trading between them, but it did have a mix between them, a combination of gold and silver. Because the fund structure was a closed-end fund structure, that fund would periodically trade with premiums or discounts. So nothing exists today that dynamically trades the ratio. We have a huge number of clients that trade the ratios at our direction, and I think their hesitation in the form of a mutual fund would be moving from direct ownership in the physical metals to indirect ownership of metals via a basket that holds the metals.

So now you’re just an owner in the basket – shares in a basket, with the underlying asset being the metals themselves. A lot of our clients generally eschew counter-parties wherever and whenever possible, so I’m sure there is market for it but I know our clients are much more sensitive to just owning the physical metals and looking for us to advise them on the ratio trades.

Kevin:Just to repeat, on the compound ounces trades, I think a good advisor who has done it for decades is better than a simple mutual fund algorithm that does it for everybody. In a way, that cancels out some of the effectiveness of it because these things have to be customized.

This next question moves to surveillance. It is from Vietnam. I was fascinated when I read it. It says:

Your interview with Dr. Gandy [that was the author of The Panoptic Sort]brings some things to mind for me, living in Vietnam. Vietnam is not China, but there are some elements of similarity that I see in your discussion concerning China. One of those is the cultural desire for control. By the way, that’s not just China. It is cultural. Those private businesses in Vietnam use cameras and microphones and place them in many places – as many places, actually, as they can. As an example, the gym I go to has nine cameras placed strategically throughout the fairly small facility [boy, I’d have to suck my gut in, Dave, if that was the case]. If you had the wherewithal, you could actually hack the system and watch my whole workout. It’s the same with my apartment building. Not only does the garage have four cameras with microphones, each landing has another camera positioned on the tenants’ doors. Why is that? To put it simply, the Vietnamese, as well as the Chinese, have very similar cultures in certain regards, and Vietnam was essentially an extension of China for over 1,000 years before the French showed up. They have a great deal of insecurity and distrust concerning their stuff and what they have. When I lived in Columbia, I saw a similar amount of cameras everywhere. In Columbia, it was driven by just as much distrust as the poor people stealing their stuff. I’m not much of an investor, but I see, unfortunately, that there is an incredible investment opportunity in companies involved in security cameras throughout the third world.

Dave, when I read this question I went and looked online to see the returns on security camera companies, and actually, 2017, not 2018, was a very good year for security cameras. When we talked about this last night, we actually launched more into an ethics discussion than we did a making money discussion. So I’d like you to address a couple of things – one is The Panoptic Sort, this encroachment on liberty, the surveillance. If you have cameras up to defend yourself, there is a difference between defending yourself and your home and your business, and surveilling people for control, is there not?

David:Yes, and I think this is where, to some degree, political philosophy would represent something of a restraint for me in certain investment opportunities. Just because it’s an opportunity doesn’t mean that I’m necessarily going to feel compelled to take advantage of it because I may feel uncomfortable to one degree or another. Describing Vietnam and insecurity and distrust – that I understand. That is sort of in defense of liberty, and in defense of personal protection – that makes sense to me as a motive to have security cameras.

But if you move to a more developed use or abuse of them, whether it is in China, or very acutely, a million, two million cameras – I don’t know how many millions of cameras they have now in the U.K. – you’re talking about data collection, you’re talking about people control, you’re talking about a dynamic which, to me, is surveillance versus defense. And it’s really tough for me to see that as – some people might object on moral grounds to investing in a tobacco company. Whether that is you or not, it doesn’t matter.

I say I have a political, philosophical issue if it’s a company that is profiting on developing a surveillance state. That is really uncomfortable for me. It’s like partnering, for personal gain, with Big Brother, and, again, there is just something that, instinctively, I say, “I don’t know if I could do that.” I totally understand the insecurity, the distrust, and wanting defense and personal protection. That makes sense to me.

Kevin:Next question:

Hi from down under. Thanks for a great Commentary. You have inspired me to financially educate myself. Learning about the printing of money and fractional lending – what a shock to the system! My question is, how should I invest or diversify the $700,000 Australian dollar proceeds that I had from a sale in Sydney on an investment property? Keep in mind, I have one or two more properties owned outright, I have 13 kilos of gold bullion in a deposit box outside of the banks, and a few other bits and pieces. I have a limited knowledge on investing above what I have learned recently. Thanks again, and the best with all your endeavors. Kind regards, Pete.

So Dave, gold, he’s got some proceeds, $700,000 in Australian dollars, a couple of properties. What would you suggest?

David:A part of this is an issue of real estate and real estate exposure in Australia at this point. It looks as if the property market in Australia is going to come under more pressure, and if the remaining two properties are of high value, as well, perhaps one thing to consider is selling one of the two remaining properties and reducing the real estate exposure. Equity can disappear pretty quickly. Reduce your total real estate exposure – that would kind of be my take-away.

Personal investment properties – what is a healthy target? 25% of net worth. That would be an optimal goal. And you will find that in the U.S. that is usually more like 75% because people focus a lot on having a bigger and bigger house, and as they have a bigger and bigger house and then end up paying it off, it does represent a larger piece of their total net worth. But I view 25% as the real goal in terms of property, investment and personal use.

The kilo bars make sense. I think cash makes sense. I would diversify your cash between U.S. dollars, Australian dollars, perhaps additional kilo bars. I think the Vaulted program is designed to provide same as cash liquidity. Maybe even short-term government bonds – Australian government bonds, U.S. government bonds, New Zealand government bonds.

Kevin:You would say cash and gold for right now, and then move back into real estate?

David:The emphasis on cash and gold and a moderated position in real estate is not because of a dislike for real estate, or a dislike for stocks and bonds, but you’re talking about really over-valued assets given what central bankers around the world have been trying to do pumping up those asset prices. So I think the really impactful piece here is that if you have a significant slowdown in China – and this is apropos to the Australian property market – the slowdown in China would have a huge impact on Australia.

So to me, prioritizing liquidity is so that you are in a position to own all of the aforementioned assets, whether it is on the Aussie stock exchange, or more of all of those assets, but I think what you are really looking at is Chinese financial market fragility, which would have a massive impact on the over-inflated assets there in Australia. So position yourself accordingly, higher liquidity, vary the forms of liquidity, balance it between paper liquidity, dollars, Australian dollars, New Zealand dollars, and your kilo bar theme, and maybe look at Vaulted.comas a cash alternative. That is really what it was designed for.

Kevin:So Dave, it goes back to your exit strategy mentality and compounding as strategy. There is compounding ounces if you’re staying in the metals, compounding acres if you’re going into land, compounding cash. There are times when you’re actually compounding cash.

Moving on to the next question. Back to a surveillance question, Dave. The listener asks:

Edward Snowden reveals that all American telephone calls are collected and stored, along with text messages and email messages. What do Americans do? Well, they continue to use telephones and emails when they should be using alternative methods of communication that are now available. Why do businesses in America continue to use the telephone and email to communicate, including McAlvany? Please answer with a conversation on this topic.

David:I think it’s worthy of conversation. Really, we’re talking about ease of communication, we’re talking about business structure – business structures which are built around those technologies. And we know that if it travels over the Internet it’s not private. There are work-arounds for that – the dark web, or dark net – and there will come a point when weighing the costs of transitioning to new business structure and new venues of communication, weigh those against the benefits and I think an exit might occur.

This goes back to the old book, and I highly recommend it, Exit, Voice and Loyalty, in which the author looks at either you have the opportunity to voice opposition to policies and things that you don’t like, you’re locked into a loyalty structure where you’re just not going to change, or you simply get out. And you’re asking the question – why have we not exited? I don’t think the position that we are taking now will always be the case, the position that we’re taking. Perhaps being able to analyze some of these topics has taken away some of the urgency to shift exposure, but again, I don’t think that will always be the case. An exit is always a possibility.

Kevin:One of the things you have tried to incorporate into this show, Dave, is an awareness of the dangers. It is not just Ed Snowden that has been bringing this out, but we have had a number of guests that have helped to show where the vulnerability is. And quite honestly, most of my email, it doesn’t matter that it is collected. But the emails that it does matter, I’m not going to use email, or I’ll use some other form of communication. So you have to use a certain amount of judgment. You can’t completely exit the system and still be able to participate in the system.

David:But it’s important to know where necessary encryption is an option, and it is an option that we will use. So there are some things that we do already implement.

Kevin:This next question brings up a term that maybe not all of our listeners are aware of – the term debt jubilee. I think that references back to the Bible and the book of Leviticus when every 50 years debt was either forgiven or given back to the original owner. It was a way of cleansing the system. Here is the question:

Dear all: Please could you provide the possible scenarios on how a debt jubilee would play out and what the impact would be on precious metals prices? Is that even a possibility where debt is just relieved?

David:It seems to me a jubilee, a forgiveness of debt, would have to be focused in such a way that only one particular creditor takes a hit, and there is only one particular creditor that I think could take the hit, and that is the government. So if the government was able to cordon off the asset in question, prevent insolvencies from, in a daisy-chain effect into the private sector or the private markets, then it could be considered.

The only debt of that kind that comes to mind in the U.S. is student loans. Out of the 44 million Americans that owe debt on the student loans, 42.3 million of those owe it to the government. So again, you’re talking about this cordoned off space. 1.3 out of the 1.5 trillion – it’s a government asset. So they could write it down, they could write it off, and you have far fewer credit market consequences than other areas within the credit markets. If you start announcing a jubilee or cancellation of debts to every creditor, that debt is an asset, and you’re wiping out the asset, wiping out the solvency. There are ramifications into the financial markets. And of course we have lots and lots of those “assets” floating out there today.

So the first criteria is, I think, government-held, not private credit. That is the first criteria. The second criteria is that it must have a political benefit. There is going to be a cost. And so maybe they say, “Well, we can take it.” What, or who, does the benefit accrue to? So we go back to that list – 42.3 million people who owe debt to the government, 44 million total, that have student loans. That is 44 million voters who would agree that it is a good idea.

Kevin:Right. It goes back to politics, like you were talking about with banking.

David:Exactly. So maybe that’s enough in terms of people who would show up, or shift their votes because of the favor done, to swing an election. So for perspective, the student loan balance, the 1.5 trillion total, is about 500 billion more than all outstanding credit card debts. And as it affects the metals market, again, I think there is limited impact into the metals market because there is only a limited space where you could cancel the debt without there being massive ramifications into a broader financial universe.

Kevin:Aren’t they already cancelling the debt by printing money? It still goes back, in a way, to that inflation thing that we talked about before. You can come out and just announce a cancelled debt or you can just inflate it away.

Next question:

David, you’ve sent me down a historical, philosophical, economic yellow brick road rabbit hole with your book recommendations, and I thank you for it. Now, here is your must-read. I’m a loyal listener, so here’s my question. Since the dollar and the SWIFT system is what we have right now, they will most likely lose hegemony in our lifetime. You and I both agree that it will hit the fan, but when it does, the dollar might still strengthen against all other currencies. Don’t you think it would be a better entry point for precious metals after the next down leg of 150-ish?

David:Interesting question. Thanks for the acknowledgement on the rabbit holes. There are many rabbit holes to go down when you’re living your life vicariously through bibliographies (laughs). The gold market can rise and fall, reflecting currency strength or weakness. This is the first point that the questioner makes. That’s true. The gold market can rise and fall, reflecting currency strength or weakness. There is demand for the precious metal as a safe haven, or investment demand, which also can drive the price, and that is regardless of the currency moves. In fact, it can outstrip any currency moves.

So a strengthening dollar does not necessarily mean gold will go down, and a declining dollar does not necessarily mean that gold will go up. And we can give you some historical examples of that. When the dollar went through its initial decline in the early 1970s it finally stabilized, moved sideways, and actually started to inch up even as gold was moving from $300, to $400, to $600, to $800 dollars. It was not in a period of a declining dollar. So just be wary of that idea that either strength or weakness in the dollar there is an axiomatic move in the price of gold on the other side of that.

I think the more uncertainty we see in the global monetary system, back to this idea of losing hegemony, and the SWIFT system being redone or undone, if you have a disruption of the status quo, you, by default, are going to have a larger audience for gold investment. And metals may move lower. You could have spot prices tied to the futures contracts – you could have them move lower. But here is my final point. Investment demand being on the rise in this kind of environment, pricing of the asset can go lower because of what happens in the futures pit, but be aware that pricing in the physicals market can be well above the spot price, and that reflects a premium for available physical metal versus the paper position in the commodities pits.

The scenario that you are describing, and the question, it is a scenario that is a very good theoretical one for seeing – let’s just take your example, gold trading lower, but because of the chaos, the disruption to the status quo, real buyers of real metals coming into the metals market, and the physical metals market being strained where the premiums are such that it doesn’t matter. Prices goes down, you can’t buy it any cheaper in the physical market if you want to take physical delivery.

Kevin:That’s exactly what we saw in 2008. We could see it even worse this next time around.

Three weeks ago Christine Lagarde said, “You know, I think central banks ought to start issuing digital currency.” So this is what this question refers to:

What do you see and think about the message that Christine Lagarde put out to all nations about switching to a digital currency, and for our country, is she dropping a hint of major changes coming for the world, and will we be a total digital currency world?

David:I don’t know if we will have a total digital currency world, but I think she is dropping hints, so I think I would answer that with a yes. It reminds me of the goals of many of the financial elites, and that is, how to extract rents from every living being on the planet. Very similar, if you remember our conversations throughout this last year or so, with the idea of financial inclusion, the idea that India is pushing as they bring everyone into the banking system. And of course, it’s for their own good, but the justification, the advertising for it, the scare-mongering that accompanies it, is that you have to eliminate the black market, you have to eliminate all these evil things that happen with the use of physical cash.

The reality is that digital currencies leave a better bread crumb trail for the activity of the user. And if you’re managing a system, trying to extract rents, increase taxes, etc., you want those bread crumb trails. So today, if you look at the digital currency universe, you may say, “Well gosh, every user is anonymous.” That’s arguable. But I don’t believe anyone will remain anonymous, even if that could be accomplished today. If a government wants to spend the resources to track an IP address, they’re going to get it done.

So whatever can be hidden, I would argue, for those who feel like there is security in the digital currency world today, whatever can be hidden, whatever provides anonymity today, can also be discovered. And I think it’s just a question of time and materials.

Kevin:This goes back to the security camera question from Vietnam. It’s about control. And digital currency – going digital is not just for convenience, it’s control.

David:Right. And I think there is historical precedent, if you want to go back to Babel, this is really about the idea of building a better mousetrap, of creating a system and structure which is so efficient and so beautiful that it cannot be matched, and you can’t begin to measure the success of it.

Kevin:Your 12-year-old son the other day – they were in for your birthday and we were talking – has been reading Utopian literature. He corrected himself and he said, “It’s always dystopian. Utopia always moves to dystopia.” I thought, “Gosh, I wish I could think like that when I was 12.”

David:So for Lagarde to champion the digital currency is not a vote purely for technological advancement in the monetary realm. I don’t believe that for a minute. Ask this – like with the question on debt jubilee, is there a winner? Is there a loser? What are the political costs? What are the political benefits? So I think in this particular time slice, the benefits of digital currencies are broadly privacy related to the digital currency user. That is, I believe, a temporary benefit limited to this particular time slice. The ultimate benefit goes to those that can see the flow of supply and demand and extract value from the flow. So governments will co-opt the tech if it competes directly with them.

This goes back to Ken Rogoff, the conversation that we had earlier this year, Kevin, and the quote that we shared from his Project Syndicate article. “The long history of currency,” Ken Rogoff says, “tells us that what the private sector innovates, the state eventually regulates and appropriates.” In this case, the governing elite are beginning to see the value of tracking every transaction and eliminating any opt-out mechanisms.

I think over the last two years the use of cash – if you’ve been to Europe in the last two years, just understand that operating a business there is changing. Cash is scrutinized. Banks ask questions about every cash deposit, every withdrawal. There is not enough data related to cash. And digital provides data, system-wide corralling, and ultimately, I think digital provides control. So I’d love to talk this over with Ms. Lagarde because perhaps her intentions are different, but how the financial system, how the political system, above and beyond Christine Lagarde, treats this – again, I think it’s how the political system would use such a move, in my mind, in the final analysis, which would be dystopia.

Kevin:Maybe we should put her on the McAlvany Weekly Commentary guest list and make a call over there. I think you would enjoy that conversation.

David:I’ll see if she says yes.

Kevin:Next question:

Hi David and Kevin. I love your Weekly Commentary, haven’t missed an episode since I started tuning in four years ago.[Well, thank you. Thanks very much, that’s awesome.] I have a question for you regarding real estate. I’m sure, just like many of your listeners, the majority of my wealth consists in the equity that I have accumulated in my home. How do we best protect that equity in the coming recession? Many experts are talking about a global bubble in real estate, and where I live in Vancouver, Canada the bubble seems to be even bigger than the global average. If you could please give us your opinion on the best strategy to protect the equity in our homes, I’m sure that many of the listeners would appreciate it. Thanks. Tristan.

David:Frankly, without selling it, it’s not possible. And so maybe the question is – is this the time to own, is this the time to rent, or is this the time to get philosophical about the loss of equity. Because you can say, “Look, I’m just not willing to create a move like that, a disruptive move.”

Kevin:You may love the house. You love living on the lake.

David:In which case you had better get philosophical about watching the value of your home ebb and flow. There is a possible solution, which is to create something like a sinking fund for debt against your property. This applies if you have no debt against your property. You just think of it theoretically as more of a hedge. But I did this back in 2009, using the sinking fund concept.

During the last global financial crisis you had Fannie Mae and Freddie Mac – they were right in the middle of the chaos. You had home lending, which was a huge part of the credit excess in that period. Home prices declined by 30-50% here in the United States, and certainly the rest of the world saw its fair share of losses, as well.

Perhaps this go-round the declines are more modest because it is not specifically a mortgage-backed securities bubble, it is a bubble in everything. But maybe, just for the sake of argument, maybe the declines are more modest. Gold was up $1,000 an ounce through that timeframe, 2009-2012, and I chose the sinking fund concept in 2009. That was the year we bought our house.

Kevin:That was good timing.

David:So ounces, again, bottom at $900. They move up $1,000. Put them in kilo bars – again, the Vaulted program is ideal for that kind of thing. It is a cash equivalent, it has a specific use and function, it is going to be used for something else. You use those ounces as an offset to dollars in debt, and over the last nine years, basically, I’ve discounted the debt using current gold values here at $1250, I’ve discounted that debt by 38%. So that’s a strategy that has worked for me thus far. Now, if I had really been on it, I would have liquidated the bars at a $1900 gold price and paid the house off.

Kevin:Right. But who would have known?

David:Hindsight is 20/20. I would have the house debt-free playing that little market arbitrage. But the downside in real estate, and the potential decline in equity could, to a degree, be offset in a bullion gold position. I really don’t think about the white metals here because they are too volatile for that sinking fund concept. But I go back to my first answer – without selling it is not possible to lock in your equity.

You may be able to create an offset. It requires some liquidity to do that, and what I chose is dollar-for-dollar allocating to gold set right next to my debt, so essentially, I was debt-free on the property, and I’ve just played the bank over that percentage, and have discounted the debt by 38%. Ultimately, I think I will discount that debt by 75% or more and I won’t be quite so slow to act next time, exiting the kilo bar position and paying off the note.

Kevin:Dave, this next question is asked by a thinking millennial trying to figure out his student loan at this point. The question starts:

Student loans are owed by Americans and they now total 1.5 trillion dollars. The amount of interest paid on these loans hinders the millennial generation and inhibits the affordability of first-time home-buyers. [Boy, are we seeing that.] I have heard some financial experts say that there is a possibility the student loans would be forgiven [This is a form of that jubilee, Dave.] in order to stimulate the economy after an economic downturn. I’m a millennial in that same boat, paying back student loans each month. I’m considering taking most of my current savings and applying it to the loan that has an interest rate of 6.55%. I figure paying down debt accumulating at 6.55 APR would be more effective than keeping it in a 2% savings account. The only two shortfalls I foresee are, one, student loans would be forgiven in the future, or two, the opportunity cost of applying savings toward my principle is greater than that 6.55%. What are your thoughts on student loan debt and its forgiveness during tough financial times, and also your thoughts on a future opportunity cost on cash savings once equities reach a favorable PE ratio?

David:Great question, and obviously, part of that we covered a little bit with our comments on student loans and debt jubilee earlier. So, similar to the jubilee question, let me skip over that part as answered previously, and focus on part two, the opportunity cost. Well, one thing on debt forgiveness – it’s a huge potential political scheme. And the probabilities seem to be higher from now until 2022. So you look at the current populist trends globally and in the United States, you have the rise of non-establishment political coalitions, non-establishment parties, potential for third parties, or new versions – Bernie Sanders, Donald Trump – these are expressions of something happening within our society.

I think whoever offers it up – this idea of debt forgiveness – whether it is Bernie Sanders or Donald Trump, or someone, somewhere else on the political spectrum, like Trump capturing a larger part of the labor vote in 2016 – it could be a defining political present, political gift, that is given to that constituency, and again, as I mentioned earlier, swing and election thereby.

Opportunity cost – think of it in timeframes. Over a one-year timeframe there is not much opportunity cost. In fact, 6.55% is the winner. If it is a short timeframe, pay it off. You’re not judging the future, you’re judging more of the short-term present. I feel a little bit differently if you’re talking about a three to five-year period. I would have a preference for metals. I would watch, not just the price of the metals, but I would watch the Dow-gold ratio.

Long-term, the Dow-to-gold ratio of 5-to-1, or 4-to-1, or 3-to-1 on the ratio – this would be very, very intriguing. Begin shifting toward equities with a lower price earnings multiple in mind, as you noted in your question. But in the process what you would be doing is, you would be utilizing the Dow-gold ratio, and there is the possibility of expanding your financial footprint 4X – four times – before buying stocks at a nominal discount.

So again, you take the Dow and divide it by the price of gold. Today it is right around 20-to-1. We began this journey in the year 2000 at a 43-to-1 ratio, and in the fullness of time, with a low PE ratio, that is, low-priced stocks relative to earnings, and gold at higher prices, you’re looking at sort of the perfect exchange – 5-to-1, 4-to-1, 3-to-1. May see lower numbers, but for your purposes, from a 20-to-1 where we are today on the ratio, to a 4-to-1 or a 5-to-1, you are talking about a 4X increase in purchasing power and getting what you wanted in terms of cheap stocks when the PEs are revealing that.

Kevin:Again, so many questions can be answered in a different way than just how much money can you make, and when do we make money? It’s what are you trading it into? What is your exit strategy? What is your goal? Is your goal more ounces of gold? Is it acreage, like we talked about before? Is it stocks?

David:Part of the reason is because we look at the value of the dollar with a certain critical eye.

Kevin:With skepticism.

David:There is a goal to deflate the value of our currency to take away its purchasing power by 2% a year.

Kevin:It’s a stated goal – 2% a year is the stated goal.

David:It’s a stated goal. So when I look at the dollar, I don’t look at it as a long-term store of value. I see it as a short-term liquidity vehicle, not a long-term store of value.

Kevin:It reminds of the video game, Frogger. You would hop onto different floating lily pads to get across. The dollar is one of those lily pads.

David:Perfectly acceptable, just don’t stay too long or you’ll lose the game.

Kevin:(laughs) That’s right. Well Dave, where did the time go? We’re only halfway through these questions, so next week we will have to pick up on this.

David:And probably pick up our pace.

Kevin:I have to admit, I love the question coming up in the beginning of next week’s program.


Kevin:I’m just baiting people right now, but I think everyone needs to hear the answer to this question, as well as the question.

David:From a fellow Philosophy grad studying the markets, and sometimes when you are reading charts, you’re not wearing a pinstriped suit.

Kevin:Stay tuned next week so that you can hear why Dave said that.

Recommended Posts

Start typing and press Enter to search