2021 Your Questions Answered – Part 2

Weekly Commentary • Dec 28 2021
2021 Your Questions Answered – Part 2
David McAlvany Posted on December 28, 2021
  • Why is gold lagging as an inflation hedge?
  • Is Bitcoin truly digital gold?
  • Can the Fed Not Ever Raise Rates?

2021 Your Questions Answered – Part 2
December 28, 2021

“Today’s philosopher king may be Klaus Schwab from the World Economic Forum, or some other idealist with a vision for global betterment. The problem is, other people have ideas of betterment at a more granular level. It’s a constant struggle to see who’s directing history and so in that sense, I’m neither a pessimist, an optimist. I think we see development and we see uncomfortable points in history, but we also see adaptation. That’s the story of the last 4, – or 5,000 years.” — David McAlvany

Kevin: Welcome to the McAlvany Weekly Commentary. Now, I’m Kevin Orrick, along with David McAlvany. 

Well, week two of the question and answer program. Again, thank you listeners for sending such great questions in. This first question, Dave, I had to smile because there’s family history in this for 35 years, I’ve been drawing triangles with people and recommending a particular allocation, but what it really, in a way it resembles something called Harry Browne’s permanent portfolio. We’ve had a chance to actually see this work. So let me read the question and then, I’d like to hear your answer coming from the McAlvany family who all of these years has been looking top down on portfolio distribution. 

Okay. So here’s how it goes. “Thanks for your interesting program, for the end of the year Q&A, I was wondering if the old, ‘Permanent portfolio’ in allocation proposed by the late Harry Browne is still applicable today. Could you also touch on this: if this allocation is suitable for both your USA and your offshore clients? Wishing you all the best for Christmas and New Year. Kind regards, David”

David: Well, thank you, David. What I like is the balance between assets and the, permanent portfolio theory basically divides you into four categories. You’ve got 25% in Treasurys, 25% in growth stocks, 25% in precious metals or other commodities but predominantly precious metals, and then 25% in real estate. And I like that balance. I like how those assets play off of each other. 

The lesson learned is—if I can sort of introduce my own language—the lesson learned is in how to fill those buckets in a balance over a lifetime. And I think the studies on Browne’s four times the 25% allocation, they do work in other geographies, even though the original concept was for a US investor. It’s an all-weather approach and I think it does apply. So you just have to shift, instead of talking about US treasuries, US growth, stocks, et cetera, et cetera. You might be talking about Japanese bonds and Japanese stocks as an alternative. 

Oftentimes when I’m discussing wealth accumulation with a young client, I discuss four or five buckets to allocate to, and it’s really throughout a lifetime. It’s not a particular product. So not a financial product as Browne conceived of it, but rather a set of guideposts. And so over a course of 20, 30, 40 years of saving and investing, how do you operate and how do you guide your decisions? So you add to real estate opportunistically, you add to stocks and bonds opportunistically. You add to precious metals opportunistically. You maintain reserves in the form of short-term government bonds or other cash equivalents when there’s nothing that is of value. You may invest in your own business opportunistically. 

I’m less inclined to own a product that does it, and more inclined to operate through the decades with the idea that all four segments should be owned, not necessarily in proportion, and that purchases should be made when the price is right. So you make money based on what you pay for an asset. 

And so again, just as a young investor comes to the market and says, where do I start and where am I going? I think—conceiving of those four or five buckets, if you have the entrepreneurial bent as well for that fifth aspect—you look and you say, “Okay, I’m willing to do this, and now I have to make sure I can check the value box.” It’s not just a question of $4 saved equals $1 in each bucket. I want to be careful in terms of the value proposition. Am I paying too high a price? And should I be more patient before adding to that particular quadrant, if you will. So that’s my preference is to think in terms of the framework that the permanent portfolio provides in just adopt it, establishing disciplines for investing and personal guardrails, if you will, for when, and to what degree, you make financial commitments.

Kevin: So perfect timing for the next question, Dave, this wasn’t even planned, but you talk about buying something when it’s undervalued. One of the great ratios of the last 120 years has been watching the Dow/gold ratio. Is the Dow overvalued or undervalued relative to gold. And it’s a long cycle, I mean, you may only get the undervalued Dow relative to gold once in a lifetime, but it’s dramatic. 

So here’s the question. “I am a long time listener who looks forward to hearing your podcast every Thursday morning. Here are my two questions: You’ve stated over the years that once the Dow/gold ratio reaches five to one, it’s time to start selling your gold position and gradually reduce it until it reaches one to one. Does this mean you’re still buying gold when it reaches five to one? For instance, the Dow/gold ratio was about six to one in August of 2011. Would you still add more gold to your position at that level, or would you stop buying when the ratio was higher?”

David: No, if I had established a position at the top end of the historic range, which would be sort of your 18 to 40, it’s a pretty big range, but that captures all the previous peaks. That is an 18:1 ratio in 1929, about 28:1 ratio in 1968, and a 43:1 ratio in the year 2000. And if I’d done that incrementally in that range, then the liquidation process happens in reverse. Incrementally at the bottom end of the range, I would be gradually coming out of those positions. And that’s what I would do until the cycle is complete. 

And this is the reality: Until that cycle is complete, you don’t know what perfect math looks like. And when the cycle is complete, it’s too late. Anyone wanting sort of a perfect number, like well, if we’re going to get to a one to one ratio, why wouldn’t I just wait and do it all then? Because you don’t know that until after the fact. So we implement a discipline on the buy or on the sell side, and I think to ignore that is to misunderstand or under-appreciate this functioning of the market. Nothing’s determined. We’ve been to 6:1 and that’s the end. We’ve been to 5:1 and that’s the end. We’ve been to 1:1 multiple times in the last century. And so there is a case to be made for getting to those ideal numbers, but it doesn’t mean that it has to happen. So think of the ratios as parameters rather than precise trading points. 

The incremental choices, though they’re not perfect, they are repeatable, and they don’t rely on variables that are outside of our control. And they certainly don’t imply that you have more knowledge than you actually do. So you could lay out the ratio according to frequency or likelihood if you like to think in terms of standard deviations. So if you’re within one standard deviation, you do nothing. You wait. If you’re within two standard deviations, a little wider range, then you’re incrementally taking some small actions. And then if you’re getting to extremes of three or more in terms of standard deviations, these are rare events and you want to be acting aggressively. So yeah, and to answer the question, there is a point where you stop buying, and there is a point where you stop selling. You just be aware of the top end and bottom end of the range.

Kevin: And this is the second part of the question from Glen. He says, “It’s my understanding that vaulted.com allows you to convert your fractional ownership of kilo bars into one ounce gold coins. How much does that cost, and how long does the process typically take?”

David: It’s what we call a dynamic de-allocation. You’re taking the ounces purchased in the form of kilo bars, and you buy those at a significantly reduced price per ounce, given the economy of scale—a 32 ounce bar—and also benefiting from our arrangement with the Royal Canadian mint, which removes a wholesale middleman markup. So you’re starting with the lowest basis imaginable and you’re then moving those cheap ounces into your preferred format, right? 

So when you do that, there are costs, and that’s the point of the question. You’ve got the commission on the transaction. That’s one cost, which is a few percentage points. But I think the biggest factor to bear in mind is the premium associated with a smaller product. You’re losing the economy of scale, you’re paying premiums that apply to that particular product, right? And then you’re also dealing with the current availability and market pricing of that product. 

So let me give you an example. Year-end is a classic case in point. The US Mint grinds their production down towards the end of the fourth quarter. And so you have a similar circumstance as you get towards the end of the year, where if buying of US Mint product is robust and supplies are low, then all of a sudden you begin to see those prices push higher due to short-term supply constraints. 

So going back to this idea, when you’re doing a dynamic de-allocation from kilo bars to other products, those are your categories of costs that should be accounted for prior to determining if that’s what you want to do. Again, as I mentioned, the mint shutting down. Wait a couple of months and you’ll find that some of those supply and demand constraints go away very quickly and that in itself can save you anywhere from five to 20% depending on market dynamic. So you’ve got the commission, which is a small piece, and then you’ve got the pricing of the product, which is really determined by the size—economy of scale, keep that in mind—and current availability or pricing dynamics. And some of that is just flat seasonal.

Kevin: Well, I can’t think of a better place to call. I give the 800 number every week, but we watch these markets, we see the premiums, and if a person wants to do dynamic de-allocation, let’s say from vaulted into some other product, we have an idea of which ones are too expensive and which are not at any given time. So yeah, just call the 800 number, (800) 525-9556, and talk to one of the advisors, and we’ll help you there. 

You know, the other part of the question, Dave was, how long does the process take? Can you address that?

David: Yeah, it’s actually a matter of days, and then just whatever time it takes for the product to be delivered. So yeah, I would say within a week to 10 days from the time you decided to convert ounces from a kilo bar to some other format, great, you can do that. Why we have Vaulted there as a program or product offering is because so many people have told us, we just have a temporary need to be in cash, but we don’t want to be at the bank. And so in that case, taking delivery of gold is not necessarily your best option. You may want something that is just a temporary position in gold as you then move to another real estate deal or move on to some other use for the capital. And so it really is there, Vaulted is this valuable tool for savings and banking as an alternative to those.

Kevin: Yeah, Dave, I’ve got a farmer, a client of mine. He’s also a banker. But every time he harvests, he moves money into Vaulted that he knows he is going to spend that next spring, from fall to spring. But he’s also continually dynamically de-allocating into something that he’s going to hold for a little bit longer. 

Here’s our next question, “Dear David and Kevin: First off, I’d like to offer you my sincere thanks and gratitude for over 12 years of education, wisdom, and guidance that you’ve provided to me through the Weekly Commentary. You both have a tremendously positive impact on my life. When I first came across your show as a young firefighter/paramedic striving to understand the global financial crisis to now as a middle-aged nurse anesthetist, trying to navigate an even more chaotic and dangerous period of history. I genuinely look forward to your weekly discussions and treasure your valuable insight. I especially enjoy your interviews with guests to the Commentary and the thoughtful way those interviews are conducted. 

“The questions I have for you I’m guessing are different than what you usually get at the end of each year. They relate to the tools you use to help guide your investment decisions at your McAlvany Wealth Management Company, which I have become a client of. Are you familiar with Martin Armstrong and his forecasting computer he calls Socrates? Have you looked into his economic confidence model, the ECM, and cycle theory? If so, have you found those tools helpful and accurate? He’s an extremely interesting person, and his life story reads like a Hollywood script. Thanks again. And I hope to finally meet you guys in Durango next year for the McAlvany Wealth Management client conference.”

David: Hey Adam, we look forward to spending time with you this next year as well. Thank you for your question. 

We are cycle geeks, we look at a variety of cycles from technical cycles to credit-related cycles, knowing that liquidity dynamics drive pricing dynamics, and there’s ebb and flow to that. There’s a reason for it. So I’ve often read Armstrong with curiosity, and there’s always something to learn. He certainly is clever. I do sit on the fence on that last point. Cleverness has defined many of his insights and the value-added contributions, but has also defined, I think, a few of the reasons for, unfortunately, his time behind bars. But the past is the past, and I think certainly that story has many sides to it. So, probably have most comfortably landed on the SEC’s facts and figures and timelines. I think there’s an element of creative genius to him, and I’m convinced that he does offer valuables insights and that his models work some of the time. And the challenge is that no model works all of the time. Yet, when that’s what you’re selling— And he’s been prohibited from managing assets anymore because of that past issue. He sells a model, he sells an idea, and he sells advice, although he doesn’t have to necessarily act on it himself or do that for clients.

Kevin: Well, and you have quite a few advisors. There’s Prechter, people want to be told what to do, but it doesn’t always work.

David: Yeah. I think when you’re selling a model, it has to be foolproof. But you and I have discussed this many times, no model is perfect. Models are helpful and they’re tools, but they don’t encompass everything that should be encompassed to work all the time. I mean, I love reading Elliott Wave. Prechter is one of my favorite analysts. He is a genius with a model that works, and it’s also wrong a lot of the time. So, I mean, you could say that of any model. You could say that of any number of things. 

You’re asking the question, Adam, about our mode of operation, and checklists are very important to us when we look at cycles. Certainly you’re going back into history and you have to have an appreciation for history and what happened such that you can create inferences, draw conclusions into the present or future. Our tendency, I think, is to search for explanations that relieve the tension of the unknown. And that’s one of the appeals of a model, is that it’s tight, it’s consistent, and it gives us all the answers we need to all of our apparent questions. 

I was the other day surprised to hear year from my 13-year-old, actually in a discussion on COVID, his observation that a lot of people want to be told what to do. And, I mean, it kind of surprised me. It wasn’t what I thought he was going to say in the context of our conversation. But that resonates at several levels. I think tensions exist for us emotionally and intellectually in areas where we don’t have answers or where uncertainty prevails. And magically, models often fill that explanatory gap and they relieve tensions. They gave us a greater sense of confidence that what we’re doing is on the basis of fact, when in fact it’s just related to a series of assumptions and it seems to fit elegantly.

Kevin: Wouldn’t you say guidelines are helpful, like in systematic theology, but they can also become a box?

David: Well, sure. I mean, theologians do the same thing when they approach metaphysical reality. It’s a model of thinking. It’s a translation. It limits the range of interpretation. That’s systematics. It’s helpful, perhaps, but it is very assumption-driven and it’s not particularly adaptable to complexity. Or, when we’ve made it adaptable to complexity, it’s still based on the complexity that we expect versus the complexity that may emerge. 

So if it’s possible to blend and hold various models in tension with each other, I think we can come to better insights and maybe even better decisions as asset managers. So I would just say this: Read on, but do so with caution. Just because I don’t think that no model answers everything and that any model that suggests that it can basically is selectively reporting its success in a very circular fashion.

Kevin: Dave, we had talked about some of these questions creating new synaptic connections. And this one, when I read this, I thought this was pretty creative. We talked about the FAANG stocks, right? And the tech stocks that are right at the top of the list. So here’s the question. “Hello David and Kevin, are the FAANG and mega cap stocks the new bond proxy, the place to invest?” Are the FAANGs— is this the new bond?

David: Well, there’s an element of truth to what you say. Many mega-cap tech stocks are treated like a bond alternative, with massive cash holdings and in rare instances even a dividend. Apple just under 1%, 70, 80 basis points. Intel just under 3% in terms of the dividend yield. But perhaps most noteworthy is how they trade sensitively to interest rates. The lower the rates, the higher the value, right? So negative rates correlating with record appreciation, you see both bonds and technology shares doing quite well. And when [higher] rates, or even the discussion of higher rates, come into view, tech is wrecked like a bond. So the proxy function is somewhat accurate if you’re talking about capital gain and capital loss, right? And insofar as bonds don’t pay you any income, hardly, today, tech doesn’t either—rarely do they. So in that respect, they’re also a bit like a bond proxy. Is it a place to invest? If you’re interested in shorting, yes.

Kevin: So well that’s sort of a quick answer there at the end, but yeah, when they come down, they come down hard, don’t they? Remember 1999? I mean, it’s a little different than the FAANG stocks, but ’99, 2000, the tech stock bubble. Yeah, that would’ve been a good short.

David: All companies that are in the process of redefining the world as we know it ultimately have a limited trajectory, and to the degree that they’ve gotten ahead of themselves in some sort of a moonshot, a rocket moonshot, they do ultimately come back down to earth, as we saw in 2000, 2001. It was a question of 60, 80, 90% declines.

Kevin: Yeah.

David: Do we see that this time around?

Kevin: Or total destruction.

David: Who knows? What we don’t know is what direction interest rates go from here. The student of history would suggest perhaps higher, which would suggest that the value of bonds and tech are inexorably tied to lower prices.

Kevin: Next question, “I’m a listener of your weekly podcast and always look forward to intelligent discussion and information in this world of propaganda sound bites. I live in Victoria, BC, Canada, and I have not seen so much division and animosity in my lifetime. It appears both our governments are creating this intentionally. The pandemic has given government a clean slate opportunity to create fear, lockdown society to avoid assembly, and collect data on everyone through vaccine passports. Basically, Orwell’s 1984 light as present. My question, there is obviously a world agenda. Where does it end?”

David: Yeah, I would say for thousands of years the city folk and the country folk have approached life differently, and agendas have always been pressed in support of self-interest and in alignment with a given view of the good life. You know, there was a point in time, and you can go back to The Wizard of Oz and see this review of the argument for silver. Believe it or not, there was a bimetallist argument embedded in—

Kevin: Dorothy was supposed to have of silver shoes, right?

David: And so as the story is told, you find actually the advocates of that time being the farmer, the country folk, who wanted inflation.

Kevin: Yeah.

David: They wanted inflation and they did not want gold. They thought gold was anti inflationary and they wanted the ability to inflate prices because that was good for commodities. And they were seeking their own self-interest. Well, it doesn’t matter if you’re the country folk or the city folk, everyone’s seeking their self-interest. Some people want to be left alone to live their lives. Some people want to ensure their view of the world is universalized. And that can run into conflict with folks that just want to be left alone, right? 

So we’ve often referred back to the Epic of Gilgamesh in our program as a first example in literature of the sort of centralized versus decentralized approach to social organization. And it’s like the central planners versus the laissez-faire economists, right? There’s just a contrast. It’s a different way of thinking, and both can give you a particular kind of results. So how do you weigh, measure, and value those results? There’s different language in every age to describe the spectrum. 

So for Plato, he loved the determined world by the technocratic elite. He fit nicely, conveniently. He personally fit nicely the description of the philosopher King. And Aristotle came along and there was a contrast. There was structuring of society and a view of the world which is very different. It was a reaction too. So you have action and you have reaction, and it doesn’t end—ever. The struggle is one for freedom and liberty. And the players involved are pushing to increase or decrease these elements to meet their own goals. So today’s philosopher king may be Klaus Schwab from the World Economic Forum or some other idealist with a vision for global betterment. The problem is, other people have ideas of betterment at a more granular level. Again, we had Plato that gave birth to Aristotle. I don’t think that this ends because it’s a constant struggle to see who’s directing history. And so in that sense I’m neither a pessimist nor an optimist. I think we see development and we see uncomfortable points in history, but we also see adaptation. That’s the story of the last 4,– or 5,000 years.

Kevin: All right. Next question: “First of all, congratulations on your amazing podcast. I’ve been a listener since 2013, not a decade, but approaching, but this is my first question by mail.” Well thank you for sending it. “Personally, I exited the financial system and have been on the sidelines with heavy allocation to gold and silver. With hindsight, clearly not the best decision, as I likely underestimated the deflationary forces at work, which counter the inflationary, monetary and fiscal policies since 2008. 

“I’m a huge fan of your switch concept,” Dave, that’s what you brought up last week, “which in Belgium, in my family, we call advocate of the devil. My question is QE: inherently inflationary or deflationary? My common sense says increase in money supply chasing after the same goods must be inflationary, but many experts who may understand the concept of reserve assets better, claim it’s inherently deflationary. I’m curious to a good switch argument that could describe how this is deflationary so I can open my mind more to this concept.” So, Dave, is there an argument for printing a whole lot of money, QE becoming deflationary?

David: Well, there’s always an argument, and that’s the point of practicing the switch. If you can’t put on the shoes on the other side of the argument, maybe you don’t understand your own position. So I’ll try, and we’ll see. 

I think—back to this issue of it being deflationary—I think this may depend on culture. If I argue for deflationary impact from QE, it would run something like this: QE, insofar as it’s targeted at bonds, suppresses interest rates. In some cultures, this causes a recalibration of what quantity of savings are needed to still meet the income expectations or needs of the saver. So for the saver that wants to match income generated with expenses in the context of QE, they’re being forced to a higher savings rate. So a larger capital base is still able to generate the same amount of income, just on a smaller rate of interest. So, in essence, higher savings rates depress economic activity, and could be argued as deflationary. 

Now, I think that’s true, but only to a degree. And again, only in limited cultural environments. So I’m going to switch back to probably a position I’m more comfortable with, which is that QE does have the effect of driving rates lower. The flip side is that it drives prices higher. That’s the other part of the equation. And the natural response to high prices, frankly, if you’re looking at the human spirit, is envy. It’s often fear of missing out. So a speculative frenzy and an upward price spiral can be triggered by QE, which at least with reference to asset prices is inflationary.

Kevin: Which makes the most sense to me. Oh, he asks, second part of the question, “Can the Fed actually raise rates? If so, how can the government sustain its debt payments?”

David: The Fed can raise rates some, but not much. We’ve got inflation running 6 to 7%. And the Taylor Rule implies an interest rate set close to 9% with that in mind. We can’t do that. I think the interest rate red line is with the 10-year at about 3%, which is double what it is currently. It’s 1.4, 1.5 currently. And so with a 10-year Treasury at 3%, with mortgage rates at 5%, there’s where I think you begin to see hemorrhaging within the financial markets. 

Perhaps they have latitude. Again, sets 150 to 200 basis points, and even that is going to because headaches, that’ll because headaches with investment grade debt, that’ll because headaches with high yield debt. The government can still pay its bills, though. And the argument is that the government won’t miss a debt payment because all they have to do is extend their fleecing operations. It’s the shakedown of the savers. So for US creditors who might be concerned about being repaid, they know that there is a lot of catch-up for US Tax rates to get to the higher global levels—for US rates to be competitive with what the global rates are. So for the time being, no one worries about sustainability of debt payments. 

I’d say there’s a lag between a rise in interest rates and a shift in tax policy, and that is a danger zone for the bond investor. But rates can, as we know, take on a life of their own, which I think we’ve almost forgotten in an age of command and control dynamics in the bond market. We’ve gotten used to price controls, and we tend to think of them not as transitory, but as permanent, and they are reality until reality is reset. Think of the black markets as a response to any period of government-determined pricing. I have a couple of books on the shelf that deal with black market pricing during World War I and II in Great Britain and in the United States. And it’s interesting to see how the market works around. It discovers ways of dealing with that and exploiting opportunity in spite of suppression.

Kevin: We got a chance to see that when we went to Argentina—the work-arounds. And they didn’t call it a black market, they called it a blue market. It doesn’t sound quite as bad, but that was the only way they could survive. Okay, so continuing the question, “Can the Fed actually not raise rates? If so, and the Fed stops buying Treasurys, who will still buy them?”

David: Well, they are limited. What is unlimited is the power of suggestion. The Fed can talk and as long as they maintain market credibility, that they’re talking is a bigger stick by far than the actual power to raise rates or keep them where they are today. So that, I think, can the Fed actually not raise rates? Yeah. 

Then the second part of the question is who will still buy them? Pensions, endowments, banks, anyone who is running a trade surplus with us who has that set as a condition of trade. We often think in one dimension, in economic dimension, and forget that politics is writ large. Our conversation with Mr. Calomiris—Professor Calomiris—looked at how laws are determined to allocate capital, determine flows of capital, and appoint who wins and who loses. And when we look at bubbles and we look at how we have financial crises, these are very much by design. And they are the intended or unintended consequences, however you may argue for it, of policies which have been put in place. But those laws were drawn up and the allocation of capital was specifically to select constituency groups. 

Why would it be any different when you’re looking at who will buy Treasurys? Why would it be any different to say California Teachers’ Pension will own 10% in Treasury bills, that banks, if they’re going to receive a certain rate at the discount window or through some other arrangement with the Federal Reserve, must own a certain percentage of Treasurys? Bank portfolios, endowments, pensions, and again, any country that runs a trade surplus with us. We can have as a condition of trade that they own our Treasurys too.

Kevin: So compliance is required? What you’re saying, it’s not optional. Compliance is required. That’s a possibility with Treasurys.

David: We structure things in such a way that they’re self-interest. They say yes on a voluntary basis or they will suffer.

Kevin: Or they will volunteer.

David: That’s right.

Kevin: Okay. Continuing the question. “What are some common investment portfolios with gold as an integral part? This is not investment advice. I know Harry Brown’s permanent portfolio, but besides that, my searches have come up blank. Is this really all there is, or are there other well-known portfolios or strategies that incorporate physical gold and/or silver?”

David: That’s interesting. We’ve had two references to Harry Brown. Well, I think in reference to this question, it’s symptomatic of being at the end of a credit cycle where the validity of stocks and bonds and real estate is obvious. You can only win. The direction of prices is only up, and a generation of investors who’ve come of age post-global financial crisis have only seen that kind of track record. And so there is a requirement here of extrapolation. And if you’re willing to extrapolate what has happened over the last 10 years and extend that into the future, then that’s the impression you’re left. 

Gold, in my opinion, will be incorporated into every reasonable investor’s portfolio as the cycles shift and as we turn from greed to fear. You only have to return to 2011, when Barron’s finally capitulated, this is Barron’s magazine, finally capitulated and turned from being perma-bearish on gold to bullish. Now their timing was impeccable. It was the top of that cycle for gold. Their editors noted that the decades-long outperformance of gold versus equities was not only noteworthy, but action needed to be taken. They advised everyone should own the most reliable asset on the planet, buy gold now, $1,900. 

Meanwhile, the next four years, it slipped 2,050, right? So their timing was really driven off of an emotional extrapolation. It’s working, therefore it must work. And that’s where we’re at today. You don’t find investment allocations to gold because what’s working is still working. Why would you change what is working? And so, again, investment portfolios, they reflect what worked, not what will in the future work. They’re backward, not forward looking. And frankly they’re very consensus driven. So Wall Street either universally disregards an asset, has moved on and is out of love with it, or they move towards it like one giant mob. So this is a really important indicator, just in terms of the sentiment related to gold. I think you could take heart that gold at 1,800 is not overpriced. It’s not being driven to crazy levels by a maddening crowd. In fact, Wall Street hasn’t even looked at it for a decade.

Kevin: Yeah. Next question, “Many of us make investment decisions based on fundamentals, and have been caught off guard by the lack of logical market response to QE infinity, especially how well the bond market holds up. We still assume that there will be a day of reckoning and a return to fundamentals. What if that day never comes, and the new normal is somehow sustained? What would an ante-mortem look like? If I had resources, I would do an ante-mortem exercise and assume we are 10 years from now asking where had it gone wrong. Have you ever done such an exercise? And what insights did it give?”

David: So I think one of the things we struggle with here is there is reality outside of us. We believe that there’s reality outside of us. And then we have these explanatory theories for that reality. So if you look at the history of science, different approaches have been taken, and the theories of explanation, many of them have been overthrown and are no longer regarded as valid, right? So there is this notion that maybe this time is different. And I guess the question would be, what is wrong? Has reality shifted? Has it changed somehow, or has our operating model and the theory that we engage, is it useful or no longer useful? 

Your choices still have to align with what you see as reality. And it is absolutely questioning whether what you see and what you’re dealing with is reality. But in the end, you have to operate without undermining your basis for thought and analysis. If your paradigm is flawed, then change it. But if your paradigm is not flawed, then you have to get comfortable being uncomfortable, even if there’s aspects of that reality which you can’t explain. So we base risk on what we know about the world. And when someone presents us with an altered view of the world, I think it’s fair to engage. It’s fair to weigh it. So this is a little bit vague, but I think we become so results-oriented that when something is working that we don’t have an explanation for, we tend to think, well then, we’ve got to change our mind altogether, on the basis of those results. 

Let me give you something very concrete here. Something can work and it doesn’t make it ideal. I can increase growth within a corporation by levering its balance sheet. On the upswing, it makes all the sense in the world, and anyone who operates on a more conservative basis, doesn’t take on debt, may not survive. I may capture market share, drive them out of business, and win not only on the growth side, but then on the next cycle, have some downside protection because I’m the last man standing, the only company in that area. 

So on the downswing, this is where it becomes really important. On the downswing, the basis of success—that leveraging up—could also become the basis of my demise. So again, if we limit our engagement on the fundamentals and say, “Well, it just isn’t working now. Maybe I need to rethink everything.” I would just say maybe the fundamentals are less relevant in this part of the cycle, but that’s not the end of a relevant time slice. We’ve only seen a part of the equation. Does that make sense?

Kevin: Yeah. Well, it reminds me, we both have flown airplanes, Dave, and when you pull back on the stick, the plane rises—if the power is there. Okay. But if you pull back on the stick—

David: That’s a problem.

Kevin: —you can also stall spin. And so, like you said, just because something works sometimes does not make it ideal all the time.

David: Well, and a very personal example, family business, my wife’s family business decided to go into telecommunications after being in wholesale electrical distribution for 120 years. But to do that and to have exclusive contracts with a number of telephone companies, it required a huge loan. A huge loan, and Bank of America accommodated. But lo and behold, 2001, 2002 rolled around, and we not only had chaos on the other side of the Enron debacle, which hit the whole energy space, which in their electrical distribution business was key. But then we had the collapse of WorldCom, and that complicated factors for many of the telecommunications companies. 

And here they were, sitting on inventory that they couldn’t sell in 100 years at the pace that they were selling it in 2001 and 2002. And it was a great idea. They took on a ton of debt to grow the business. And the immediate response was, look at how we’ve doubled, tripled, quadrupled our profits, but the company is gone today. The company went bankrupt because of something that gave an immediate result which was perfect. 

So how do you measure things in time slices? And perhaps our perspective is just too shrunk down and all we care about is the immediate. You have to be aware of a longer-term timeframe to really adequately measure what we’re dealing with. And to me, I cannot let go of fundamentals. Yes, I’m willing to reassess perhaps a different view of reality, and see, “Do they not make sense anymore?” In the end, we come back to, I think, the difference between laws which may apply to nature and the history and theories of science, but equally specific laws within economics.

Kevin: This is why, Dave, the Commentary, you’ve never made it a tip for the day kind of thing. Here’s your tip for the day. What you really have done is you’ve looked at thousands of years of economic, political, and geo-strategic history, and said, “All right. How does this factor in? Where do the fundamentals— What are the repeating truths?” Because truth never changes, right? But it does repeat and it undergirds the current history.

David: And from that, we can surmise that the fundamentals never make sense at the end of a cycle. So take some comfort in knowing that this is not the first time that we’ve seen an irrelevance of fundamentals. And it’s a little bit like, “The Gods of the Copybook Headings.” Do you remember how that ends? I highly recommend you take the time to read Rudyard Kipling’s, “The Gods of the Copybook Headings.” He also has a great poem on cigars, but that’s for another day. He describes cigars as dusky beauties, like only Kipling can. And I’ve never felt more emotional attachment to my humidor.

Kevin: And your wife is jealous. Yeah.


As it will be in the future, it was at the birth of Man
There are only four things certain since Social Progress began.
That the Dog returns to his Vomit and the Sow returns to her Mire,
And the burnt Fool’s bandaged finger goes wabbling back to the Fire; 

And that after this is accomplished, and the brave new world begins
When all men are paid for existing and no man must pay for his sins,
As surely as Water will wet us, as surely as Fire will burn,
The Gods of the Copybook Headings with terror and slaughter return!

Kevin: You’ve been listening to the McAlvany Weekly Commentary. Now, I’m Kevin Orrick along with David McAlvany. Join us next week for another series of Questions Answered by David. You can find us at mcalvany.com, M-C-A-L-V-A-N-Y.com. And you can call us at (800) 525-9556.

This has been the McAlvany Weekly Commentary, the views express should not be considered to be a solicitation or a recommendation for your investment portfolio. You should consult a professional financial advisor to assess your suitability for risk and investment. Join us again next week for a new edition of the McAlvany Weekly Commentary.

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