Podcast: Play in new window
- Is A Gold-Backed Currency Even Possible?
- Will The Governments Of The New World Put Up With Independent Crypto?
- Is Silver Undervalued Relative To Gold?
“Everyone likes the idea of no recession, but we still have a good deal of sticky inflation in the system, services, wages and it can get a lot worse. So you want no recession, you’ll probably get more inflation, and then the Fed is going to tighten monetary policy. That would be like a cold plunge for the markets. This scenario of no landing, it looks good, but wait a minute because we may end up with an even harder landing thereafter as you’re dealing with the consequences of inflation coming back to bite.” –David McAlvany
Kevin: Welcome to the McAlvany Weekly Commentary. I’m Kevin Orrick, along with David McAlvany.
I look forward to this every year, Dave, our question and answer program, and we thank the listeners right off the bat. Thank you guys. The questions are always intelligent, and I always enjoy your answers to these questions, Dave.
David: Well, this is the week of Christmas and we hope you’re having a fabulous time with friends and family, and so thank you for letting us be at the periphery of that. Yep, let’s dive in.
Kevin: Okay, well, that sounds good. This first question is from Greg. He says, “it seems to me that going back to a gold standard would be close to impossible for any country if a country was to go back to an honest gold or silver standard using paper bills that could be exchanged for real metal. Theoretically, all the country’s physical gold reserve could be wiped out if people traded in the paper for the physical. If on the other hand you had a gold standard where the paper money was supposedly backed by gold, but the paper dollars could not be exchanged for physical gold, we have the history of 1933 forward that shows us how that can be corrupted.
“It seems the only way to have an honest gold-based monetary system would be to use the actual metal coins, but that would come with a huge number of problems for the current banking and governmental system. Not that they would want to, but is there any practical way for a government to use precious metals as a base currency in today’s world? I could go on and on with many other questions that would stem from this issue, but I’ll leave it here for now. I greatly enjoy and appreciate all of the McAlvany wisdom and your willingness to share it with others. Best wishes, Greg.”
David: Even with a completely gold-based system and coinage, we had Isaac Newton brought in to solve a problem, and the problem was that the money guild, the folks who were creating the gold coins, were shaving the edges, were shrinking the size of the coin.
Kevin: Nothing changes does it?
David: And creating a different version of inflation. There is nothing that can be done to stop humans from being humans. So starting as early as 1921, we moved from the gold standard to the gold exchange standard, and our currency was still backed by gold, but central banks were no longer required to actually move the physical metals back and forth. So we kept a version of that until 1971, except from 1933 until the ’70s, it was the individuals that could not trade or receive the metals. Ownership was limited. This is old history, starting in 1933, for individuals and households. We could return to the gold exchange standard where the currency is backed by gold, but where the currency is not exchangeable for gold.
In our current debt-driven system, the gold reserves we have would be an adequate backing as long as the mark-to-market price on gold was significantly higher, $10,000 an ounce, $20,000 an ounce, that number is debatable. While it’s feasible, particularly as we move towards a digital currency, I’m not sure that it’s desirable for one main reason: how the government views the free market winner, aka the speculator.
Kevin: Well, yeah, true. If you think you’re going to profit on the government revaluing gold, you better think twice.
David: So again, the gold exchange standard is something that we could go back to the original gold standard, given the structure of our economy, given the existence of our central bank, I don’t know that that is, but some version, some iteration might be.
Back to the speculator, the government would not be inclined to see a financial benefit accrue to the existing gold holders. Going back to the gold standard fits the category of “be careful of what you wish for.” A windfall profit tax would likely be introduced if there was a return to the US dollar gold backing. The governing class is not inclined to allow for huge benefit to accrue to what they consider to be the speculators.
And this is not conjecture on my part. I was on my way to an interview with Larry Kotlikoff at his home in Boston. He teaches economics at Boston University, and he was running behind. So I stopped into a used bookstore to spend some time, and it was about a block away from his house, and found a book on monetary policy. It was a compendium of essays on a variety of topics, and John Exeter was in there. Great guy. My dad knew him personally. He had been at the New York Fed in the 1950s and was in charge of gold trading, which put him in charge of a lot of the bank’s international dealings. Anyway, I bought the book to see what he had to say.
And in a different essay, there was the late ’60s discussion about what to do with gold. It had been pegged at $35 since 1933, and the idea of letting the market determine the price once again was being debated. Highly objectionable to these monetary policy makers was the idea that speculators could benefit in any way from the move in price. If there ever was a sense of us versus them, that was one of those moments for me. That was an event they were dead set against.
Kevin: Well, and it’s no surprise that you went and found a book on monetary policy while you’re waiting to do that interview, but what you’re saying is, this is feasible if the government was willing to freeze the price at a higher level.
David: Yeah, so it’s feasible, but at what price? Freezing the price of gold at a higher number makes the math work as the backing for our currency, just take out the speculator first, and we go back to sort of a fixed price for gold. Easiest means of doing so, and this is pure conjecture on my part, but I think the windfall profit tax, that’s what you could assume is part and parcel of a move like that.
Kevin: It forces discipline. Are they really going to want to be disciplined?
David: Maybe not, if you have a free-floating price at higher numbers, it’s also possible, but I think it would draw too much attention to our debt and deficit problems. This has been the benefit of fiat and reserve currency status. If you have both fiat currency and global reserve currency status, you can run those deficits without tears. There’s no real consequence to running trade deficits. Lose that global reserve status and trade deficits again matter.
Kevin: Yeah, and we’ve run our entire economy on deficits up to this point.
David: I think the primary reason Congress would not be inclined to return to the gold standard is that it shines an even bigger spotlight on the unsustainable nature of deficit spending and on a system that’s driven by excessive consumption. So both on the governmental side, fiscal, but also on the household side, a version of fiscal. So promising to constituents what you don’t have the money to pay for would create unwelcome attention, would quickly be reflected in the exchange value of the dollar. You really can’t, on any version of the gold standard, create an infinite number of promises without there being ramifications.
So you go back to the traditional rebalancing of gold holdings between countries when they’re running trade deficits and running trade surpluses, and that of course drives the occasional undesirable deflation from the rebalancing of ounces. And there you’ve got a subtraction in system liquidity. With that subtraction in liquidity comes deflation. With the deflation comes an increase in unemployment. Here, we ultimately are talking about lifelong careers of politicians, which would be at risk if unemployment becomes volatile. While I don’t mind that, they sure as heck do.
Kevin: Well just to point out that your heart is in the right place. I remember when you bought hundreds of Lewis Lehrman’s book on how to get onto the gold standard, I was at the conference in Idaho when you gave that out to everybody. You are a proponent.
David: Sure. Yeah. So I hope this isn’t miscommunicated, don’t get me wrong. I advocate for the change, and Lewis Lehrman has laid out a simple process to accomplish it. I think digital currency with gold backing allows you to decimalize a hard asset and trade down to a penny in any free market exchange for goods or service. So the implementation is feasible, and I think the digital currency aspect makes it easier to operate an economy on the gold standard. The likelihood, however, is very low given that our modern political system, it’s a political system of graft and grifting, and it depends on an endless supply of money and credit.
We’ve exaggerated the pre-existing problem of corruption and politics with a fiat currency, and I just don’t see a political operator voluntarily returning to a system that requires a balanced budget and delimits the promises that they can make to constituents.
Kevin: Political operators don’t have to. You can put yourself on a gold standard if your government does not.
David: Yeah. An example of that is we’re working on adding a debit card to our Vaulted program. This may be a year away, but that program closes the gap. It allows for savings and ounces to be directly fungible. That would be sort of a late 2024 prospect. I’d look at the Vaulted program as an expression of putting yourself on your own gold standard and to the degree that you can actually transact. That’s maybe just a pet project and dream of mine. I want to be able to walk into a Starbucks or coffee shop that serves legitimately good coffee and pay out ounces because the objection has always been, well, you can’t eat it, right? It’s ridiculous. You can’t eat dollar bills either.
Kevin: Right, or stocks or bonds or real estate.
David: Or a credit card.
Kevin: Yeah.
David: But if I can facilitate a means of exchange, and it’s directly from ounces on deposit to a hot cup of coffee, I’m going to feel like we’ve done a lot to move the needle to bring back something the equivalent of the gold standard, even if it’s not accepted.
Kevin: It’s the principle of the thing. You feel like you’re beating the man a little bit, don’t you?
Okay. Our next question is from Roger. He says, “Thank you for your commentary. I’m a regular listener and I appreciate the depth, the research, and the broad-based perspective. My question is about crypto assets. I’ve heard you speak of them and dismiss them because they will be overshadowed by the government version or perhaps outlawed, but I can’t help but think that you’re too confident. In this way, it reminds me of Blackberry’s confidence just before iPhone came out. Their logic was clear the iPhone was a data hog and could not succeed against the efficient and secure Blackberry, but they missed the larger point.”
“Crypto has increased in value where gold has not, and I have to wonder in our coming world where there is no financial instruments that are not tied to crypto, whether or not there would be a huge desire for crypto without controls. Perhaps to confirm is the latest legislation proposed by Elizabeth Warren? Why attempt to curtail what you’re not scared of? What are your thoughts in this area? They would be much appreciated, Roger.”
David: Well, I think, first to say, has gold not gone up in value? Perhaps not as much as crypto has in a particular timeframe, but the move off of the lows of 250 now to 2000, there has been a movement in gold, and from a technical standpoint, while the price may be sort of capped at 2100, as and when we break that barrier, gold doesn’t move 10% at a time. It tends to move tenfold at a time. So I think you will see significant movement in price. Now in a percentage term, does that compare with Dogecoin, Ethereum or some other cryptocurrency? Perhaps not, but I mean we aren’t talking about something that was created out of nothing and started with a fraction of a penny’s value and is now worth $5, $50 or $1,000 or whatever you can conjure.
Kevin: Your concern isn’t the crypto, your concern is the government.
David: Well, to the point of the question, I think my concerns rest on what is admittedly a cynical view of government power and the power attached to a monopoly on money creation. So I don’t think it’s really a dismissal of cryptocurrencies or crypto assets or the technology. Again, it comes back to the monopoly on money and the power within central banks. The central bank is an extension of governmental power, and they’ve been given the permission to manipulate or guide economic activity. Monetary policy and the dual mandates of currency stability and full employment are facilitated by controlling the supply of money. That’s how much is printed, and of course, with the quantity that’s actually printed, you’re talking about the associated seigniorage profits.
So the central bank has seigniorage profits plus the power associated with controlling economic activity via the supply and demand dynamics of money, and they also have influence over the cost of money over time—interest rates. So my confidence rests on the predictability of human nature and the low probability of power being surrendered from a centralized system to a diffuse or decentralized system.
To some degree the decentralized system of the gold standard—where international capital flows, savings rates, scarcity determined economic outcomes—that serves as a case study for what government no longer wants and they’re actively resisting. Why did the world move away from the gold standard? They didn’t like constraints and they liked control. They liked power. They actually liked something that they could move the needle on, versus sort of being subject to outperformance in another country where all of a sudden you’ve got gold flowing to them or underperformance in your own economy and gold flowing out.
Kevin: So a new word for government would be more control. They like more control, not less.
David: More control, not less is the governmental prerogative. Decentralization is antithetical to the current fiat system and the current central bank attentiveness to a full suite of tools to move the needle on economic growth up to and including financial repression. So you consider what are the standards for economic management, like it or not, and these are the tools that are necessary. You have to be able to change interest rates. You have to be able to control the supply and demand of money—control the supply, influence the demand—and of course price money in real time in terms of interest rates.
A fresh iteration of the fiat system could include crypto. That’s very much like the existing fiat system, but with a greater look through to the activity. What are you buying? Who are you buying it from? What assets do you now own? And of course you’ve got immutability within the blockchain, but I would tend to see the governmental co-opting of the blockchain as dangerous to individual freedoms and liberty, not as something that is allowed in the decentralized version. That to me is clear, it’s antithetical to the system of governance that we have today and the desires of the powers that be. So just a couple of bullet points that come to mind.
While government, and specifically Congress, no longer controls the money supply, they’ve delegated power to our central bank and that creates an alliance of interests. So the first thing that comes to mind, Congress, so government, but Congress specifically doesn’t control the money supply anymore. They delegated the power to central banks and our central bank, the Fed. That creates an alliance of interests throughout the economy, and that’s not something that is necessarily desired to be shifting. You can look at the SEC approval of this product or that product as it relates to cryptocurrencies, and this is not sort of the government endorsing an asset class as much as it is approving another means of speculation.
And you will see this with some frequency. The SEC is not there to keep gamblers from gambling themselves into oblivion. In financial firms, whether it’s BlackRock or Fidelity or other groups, they’re only too happy to see you trade yourself into oblivion. It’s the buys and the sells. It’s the flow of capital that makes them money, and they don’t care if it’s coming or going. They’re going to make money on the basis of flows. They don’t want stasis. And here you have an asset class that is volatile enough for there to be lots of buys, lots of sells. That represents a profit opportunity for your major Wall Street firms.
Is it their belief that this is going to change everything? I don’t think so. I think this is getting close to capital flows and getting your piece of the action. So the first point is, again, Congress has delegated the power. The power now exists, and this power has so many tentacles throughout our financial system it’s difficult to conceive of how we move away from that.
Then, stepping away from seigniorage, you would be asking the central bank to do that, and that is a big ask. That is a big ask. Stepping away from control over the money supply and influence over demand for money. That’s a big ask. Complicating the process of setting the cost of money—that is, interest rates—without being able to influence supply and demand.
It’s a huge hurdle, and these are all things that come to mind for me when I think about the power structure and the power structure that supports the status quo and fiat. Perhaps moving away from setting interest rates is assumed if you’re talking about a move to private digital currencies, but I think that too is a big ask. Then, of course you have the benefits that come from influencing commercial banking, from influencing the entire credit system, which the central bank has. In some respects, you’re talking about a system that relies on central bank decisions for a reference, a benchmark. It’s how we determine the time value of money.
What is the current cost of capital? What is the risk-free rate, all of these things would be hard to give up. So saying yes to private digital currencies is to say no or to reconfigure all of these things. And then lastly, there’s also an element of accountability and control between our central bank and commercial banks from a regulatory standpoint. Moving to privately created digital currencies really upends the entire banking system and the way we currently have accountability and control from the commercial banking system back to the central bank.
So I understand the interest in crypto as an alternative to our current money system. I like it for those same reasons. In life, we set expectations around what we know, and I’ve set my expectations very high for cryptocurrency performance as a speculative asset, but I’ve set my expectations very low as a future currency given the competitive interests it shares with one of the most powerful organizations in the world.
Kevin: I think that’s very well said. So as a speculative asset, treat it as a speculative asset, if you want to gamble on the price, gamble on the price, but don’t set that based on the fact that you’re going to beat the government at their own game.
David: Yes, that’s what I’m saying. When I say gamble on an asset, I’m not trying to denigrate it in some way or demote it to some back alley rolling of the dice.
Kevin: But speculate, speculate, that’s not a bad word.
David: Everything is a speculation.
Kevin: Exactly.
David: Buying a Treasury bill is a speculation. You have imperfect knowledge. Buying an ounce of gold is a speculation. Buying a share in a company is a speculation. Some markets are more reliable than others, and so pricing and volume and volatility reflect that.
Kevin: Just categorize it right. That’s what you’re saying.
David: Exactly.
Kevin: We’ve got a question from a relatively new listener, it looks like, from Jason. He said, “I found your podcast yesterday and have listened to your latest episode. I need to hear more episodes. So far, I believe you are a happy medium between fringe finance and MMT. I have a couple of questions which I’d love to hear your thoughts. Number one, can you please go over your ways of analyzing a gold company? Number two, how does someone newer to the space identify the individuals selling snake oil? I’ve been investing in real estate since 2005. I survived the global financial crisis of ’08. But instead of trying to survive the next cycle, I believe the gold space will be a way to at least maintain and possibly thrive when capitulation takes hold in real estate and broad equities. I’m trying to learn how to value these companies. Thank you, Jason.”
David: Jason, we’ve done many programs on Modern Monetary Theory, MMT, which might shed light on where we fit on the podcast spectrum. I explore the archives and enjoy—there’s almost 850 of them now. I might self-describe as a contrarian traditionalist or as an avant-garde sentimentalist, which doesn’t necessarily help you with placement on the finance continuum, but it may be sufficient to express my love for history, but also the sort of rigorous curiosity which occasionally takes me beyond conventional thinking on money and finance. We did a 90-minute presentation in October which explores our investment thesis.
Kevin: It was a webinar.
David: I think this is where I would encourage you to go, Jason, and you can see how we explore our investment thesis and the processes and the disciplines that inform our portfolio management. I would start there because without processes and disciplines any asset class can kill you, and even if it has great prospects, how you engage it and how you disengage it, it’s really, really important. So I agree with the idea of thriving, when you’re thinking of the gold space, there are preservation aspects which the physical metal are clearly geared towards, and there are wealth creation aspects within the mining sector.
It’s hard work, it’s fraught, and not everyone is good at it. So risk, in some respects, in most respects, outweighs reward. It’s a space you have to be careful with. In a nutshell, we want to see—if I’m going back to the ways of analyzing a gold company—we want the best geographies, the best assets, the best management and project development teams, the best production economics, the best balance sheets, and what we’ve done over a course of time is identify the longest-lived mines in the best mining jurisdictions, and the most intriguing up-and-coming development projects, and to do that has been a full-time job. If you don’t have the time, if you can delegate to a group like us, that’s great.
Perhaps an index suffices, and you just get a general exposure to the space, which is fine, too. There’s plenty of gold mining indexes.
Kevin: But you shouldn’t own them all the time, right?
David: No, I would remember the 90/10 rule. Physical metals have a role in a portfolio 100% of the time. So let me come back to that distinction because asset preservation and physical metals are a very distinct, not only goal objective, but also a very different animal altogether. Physical metals have a role in a portfolio 100% of the time, but when I talk about the 90/10 rule, 90% of the time you don’t want to own the miners. There’s a higher probability of wealth destruction. 10% of the time there is a wealth creation potential which is compelling.
Last part of the question, snake oil salesmen, promoters. What you would be listening for and looking at is the super high-energy, unrealistic about the challenges of mining, really no experience in hard rock mining, unable to answer detailed questions because they don’t have sufficient mine development background. You want to find somebody who’s kind of boring and really fixated on rocks, geologist, a mine operator, someone who is content solving logistics and trying to save a penny here or there so that their production costs are coming down regardless of what happens to the price of gold. If someone begins a presentation by talking about how high the price of gold is going to go, it means that their project is dependent on the price of gold and not the efficacy, the efficiency, or the professionalism with which they manage their operation, which means they’re just there.
Which famous writer talked about gold mines being a hole in the ground with a line of copper to the bottom.
Kevin: I don’t remember the name, but I will tell you this, the snake oil salesman, Dave, I’ve known some guys who own gold mines and they’re very enthusiastic, but they don’t know it’s snake oil. A lot of times they die broke. They don’t see themselves as snake oil salesmen. They’re not really dishonest people. They’re just very, very, very hopeful.
David: Yeah, the bottom line is if you’re interested in the space, the economics have to work at gold prices that are $500 lower than the current price. Now, if somebody is presenting it and is only talking about gold going higher, that’s because they require—
Kevin: Because they need it.
David: —higher gold prices because the economics of their project don’t work otherwise. So find a clean operation in a clean jurisdiction with competent people involved. You find that that’s actually all you need in life in almost any sphere. Let’s find somebody who’s a doer and not a talker.
Kevin: Dave, you’ve been a real proponent of making money in real money. So, this ties right back into the next question from James because it has to do with the gold:silver ratio that’s weighing something of value against something of value. From James, he says, “I’m a longtime listener to the Commentary. I enjoy learning from your insightful discussions and comments. I’ve been slowly adding precious metals to my portfolio, and I would like to know how I should be deciding between gold and silver as I continue to add to my ounces. The case for gold to increase to much higher levels is well laid out in your Commentary, but does the gold:silver ratio indicate that silver has an even larger increase potential going forward? Thank you for your time and spending the time and effort to help with your dedicated listeners. James.”
David: Let’s talk about the ratio. Our old friend Ian McAvity— MácAvity, McÁvity, we go back and forth on that, don’t we?
Kevin: Yeah.
David: Now deceased. He used to frame the volatility in the ratio as an indicator of where we’re at in a bullish or bearish trend. As a reminder, the ratio is simply taking the spot price of gold and dividing by the spot price of silver. So real bullishness in the metals in his mind was demarcated by a shift below 65, with a great trading range there between 60 and 40. 40 on the ratio implies a reasonable point to begin shifting from silver to gold. So the market has and will occasionally go into the 30s. Of course, you have the in-ground ratio of 15:1, and the Hunt brothers’ extreme, also 15:1. That’s never something that Ian counted on. It was an outlier. Theoretically, it’s possible, not highly probable.
So you have the ratio today of 83:1, 84:1, right in between there, and it shows silver as very undervalued relative to gold. Ratio rarely goes to 100, and only during the COVID lows did we see it peg 125. Never before, never before—
Kevin: It was an anomaly.
David: —had that number occurred. But in the triple digit range the move is as mandatory for the investor, like you should be adding to silver the closer you are to triple digits, and that’s a mandatory move, just as you would at 15:1, at the other end of the spectrum, both of those are outliers. The decisions are a no-brainer. You shift and you shift a significant number of ounces.
Kevin: Well, in the frequency of those trades, Dave, it’s not day trading. We’re talking about maybe once or twice a decade, but it’s so substantial when it happens. It’s like a free doubling of your money.
David: Yeah, round trip, if you started from silver to gold and then back to silver, you could potentially see a round trip once in a decade, but if that means that you’re doubling your ounces once a decade, that means that you’re through the process of compounding ounces, through this kind of a trade, following the rule of 72. That means you’re— It’s essentially earning the equivalent of a yield of 7% per year. That’s in keeping with what stocks have done over long periods of time. If you want to go back to Jeremy Siegel’s Stocks for the Long Run, he’s always talking about this sort of 6, 7% magic number in equities. Set it and forget it. Don’t trade in and out, just own it for the long haul.
You could make the same case with gold and silver, only you have a hard asset—something that can’t go to zero, and you can trade up, if that makes sense. So what the ratio implies is that when it moves from 83 today to, say, 40, silver has outperformed by 54%. It can look a lot of different ways. One asset may move more than the other. They may move at the same time. Gold may stay flat. So let’s just say that as an example. Let’s say gold stays flat today at 2036.
Okay, so the ratio, for it to go from 83 to 40 with gold staying flat, silver would rise to $50.90. Or gold could move higher, let’s say to 22.50. That would imply a 40:1 ratio of $56. If you take a more aggressive gold price over the next three years, let’s say $5,000 an ounce for gold, ratio remains the same. $5,000 an ounce for gold, 83:1, silver is at 60 bucks. 5,000 for the gold price, 40:1 on the ratio implies silver at $125. So from here to $5,000, gold is a two and a half times gain, and if the ratio remains constant, you’ve got the equivalent gains.
If the ratio shrinks, as it usually does in an aggressive bull market, then, at 40:1, instead of a two and a half times gain in gold, you’ve got a five times gain in that second scenario. So when you’re choosing an allocation, when you’re setting up a portfolio in metals, if growth is the priority, and that’s a key decision up front, if growth is the priority and greater volatility is acceptable, you look at the ratio, not the price, as a guide. And the ratio today argues for silver being a buy with greater upside potential. We never recommend an all in bet on one or the other metal based on the ratio.
What we would do is skew an allocation to a higher percentage. In this case towards silver. That would make sense with the ratio between 80 and 90 in that range.
Kevin: Well, and it might sound like it’s a really cumbersome process. I mean, imagine a thousand-ounce bar, Dave. They’re the size of a shoebox. They weigh over 60 pounds. That’s pretty cumbersome, but you’ve added to the Vaulted program a silver option.
David: Well, so you look at a variety of products, but to play the ratio as tightly as possible, you want to buy low premium products. You don’t want to buy higher premium products. You’ll always pay more per ounce for the smaller products. Of course, on the other end of the spectrum, you get the economy of scale with a larger product, 1,000 ounce bar. So Vaulted silver, that program allows you to access 1,000-ounce bar pricing for any dollar amount. So for instance, instead of a one ounce silver eagle, like the coin, I own them, I still buy them, but when I’m trading the ratio, I want to maximize the ratio, and the numbers matter. Okay?
So an eagle today, I’m buying it from the wholesale market, add a few percent to the cost to keep our lights on, and I can deliver that to you at $28.50, 29, right in that range. That places you at an implied ratio of 70:1. 83:1 is where we are just looking at spot. So I’m going to give up 13 points if I’m trying to ratio trade with silver eagles. I don’t want to do that. The 1,000-oz. bar price, if I add in a commission and everything else, 25 bucks, 25.05. That includes the transaction costs. That is an implied 81.15 silver ratio, gold:silver ratio. Buying the higher-cost one-ounce product takes out 11 points on the ratio and reduces your future ounce gains considerably when you make the move back to gold.
I hope that makes sense. Perhaps you prefer delivery, okay? Great, fine, 1,000-ounce bars, you don’t want to take delivery of those. Always look for the generic ounces or the larger bars up to a 100-ounce bar size to maximize the ratio trade tomorrow based on a more compelling cost basis today.
Kevin: So it goes back to what we’ve talked about. Figure out what it is your goal is. Your goal, if you want silver in hand, buy one ounce American Eagles or Canadian Maple Leafs.
David: Or rounds at a cheaper price.
Kevin: Yeah, but if you want to ratio trade, bars at the cheapest price possible makes a lot of sense. Okay, this next question is from Brian. Dave, in the past, we’ve gotten questions that were three pages long. It took half the program to read them. Brian, it’s a single sentence, here we go. Love it. Brian says, “is it really possible for us to have a soft or no landing from this situation or is it merely a fantasy?” That’s the question.
David: Thank you, Brian. Thank you.
Kevin: Yeah.
David: Financial conditions are extremely loose. Of course, that’s contrary to the Fed’s commentary on the topic, but if those loose conditions feed back positively into the real economy and stimulate demand, a soft landing is possible. A no landing scenario is hard to imagine, but the power of reflexivity should never be underestimated. We talked about that a little bit last week in our Commentary. Reflexivity is sort of the notion of a feedback loop where some positive data or some positive input creates more positive data and more positive input, and it kind of creates a life of its own.
So we have such incredibly loose financial conditions. Bloomberg financial conditions indexes is the lowest it’s been in three, four years. And this is after over a 500 basis point increase in interest rates. So the Fed’s view is we’ve got tight conditions, I would say absolutely not, and it’s corroborated by Goldman Sachs, the Bloomberg Financial Conditions Index. These are loose conditions, those feed into— if they do feed into the real economy, you do have the makings for a soft landing. Loose financial conditions alter behavior, just like tight financial conditions do. So the looser the conditions, the crazier the behavior in asset markets, and the bolder the consumer becomes.
Kevin: Okay, so Dave, and I’m embarrassed to say this, but I’ve landed planes more than once on the same try. Okay, I’ll hit and then, I remember when I was first getting my license, I hit and then I ballooned, and then I hit again and it was harder. And then, I hit again and it was harder, and I was off the runway. So when they’re talking about a landing, we may not just land once.
David: Well, that’s a good point. You touch down and it’s a little bumpy and you’re like, “All right, that wasn’t so bad,” as you ballooned. Just remember, don’t keep your tongue hanging out of your mouth, even though—
Kevin: I got grass in the wheel wells, okay? And I’m thinking that could happen here. I mean, we may land and then bounce, and then have much worse landing coming up.
David: Well, so the concern for me with a no landing scenario—so no recession—is that there is a second feedback loop.
Kevin: A balloon.
David: Which relates to inflationary dynamics. If a no landing scenario emerges, you’re talking about support for that resurgent inflationary dynamic, which would, in turn, over time, force the Fed to reconsider cutting rates, and maybe even force them to tighten again—which, you think about the domino effect there, you’re talking about unhinging the debt markets, unhinging the equity markets. Everyone likes the idea of no recession, but we still have a good deal of sticky inflation in the system, services, wages, and it can get a lot worse. So you want no recession, you’ll probably get more inflation, and then the Fed is going to tighten monetary policy.
That would be like a cold plunge for the markets. So, again, this scenario of no landing, it looks good. Maybe it is like you’re touched down just a little bit, but wait a minute, because we may end up with an even harder landing thereafter as you’re dealing with the consequences of inflation coming back to bite. We talked about that last week too in the Commentary, the comment from Bill King where inflation comes in waves.
Kevin: Right, part of the reason I ballooned was because that wing kept flying, okay? Every time I’d go up, the wing kept flying, and so I’d come back down the wing kept flying. Inflation is a little bit like that. It can continue to come back in waves like we saw in the ’70s.
David: Inflation comes in waves. That would be a wave that would likely surprise in the upside. Third waves do that. I’m rather uncomfortable with the setup because a sequential wave of inflation may hit at a time when fiscal pressures are mounting. We haven’t forgotten, government debt rollovers to the tune of 14 trillion dollars over the next few years. Government deficit spending in an election year may make the bond market quite skittish, and that takes rates to highly consequential levels. Painful, I think, for the markets.
Kevin: Our next question from Jeff. “This morning I listened to the McAlvany Weekly podcast. During the podcast we were encouraged to submit questions. Here they are. Do you see the stock market and residential real estate market correcting? If so, do you have any type of timeframe when you see this happening? Number two, if you’re anticipating the stock market and real estate market to correct, how fast and how steep do we anticipate the correction? Thanks for your time, Jeff.”
David: Let me blend those two. Corrections in equity markets, yes. Valuations are high, and with the enthusiasm unleashed by the Fed, mid-December, the equity markets are going higher. I would guess that earnings as we get into the first quarter begin to fade while prices accelerate to the upside. So you look at measures like the Shiller PE, and you return to three standard deviations over the mean from the current elevated levels near two, and prices, prices of equities, you’re now talking first quarter, even first half of the year, but maybe just limited to the first quarter, prices are at that point in rarefied air.
Bullish percentages of investors are high, but not yet in the nosebleed territory. So we could get there as fast as the next 30 days. If you look at the Dow Jones bullish percentage index, get that into the 90s, and then I think you’re on the countdown to sell-off. I think we’re 78% bullish today, but it can go as high as 90, 95%. What we’re looking at is how many buyers are left, and there’s still some buyers, so prices are going higher. They feel like they’ve got the wind in their sails, the Fed at their back, et cetera, et cetera. Then you think about the VIX, the volatility index. It’s moving towards single digits. That would be a confirming signal along with the bullish Dow Jones, bullish percentage index, and of course the Shiller PE blow-off to a three-standard deviation.
VIX getting to a single digit, maybe even 10. That’s a helpful signal of market complacency, coupled with a turning point. A turning point really in volatility from low to no volatility to incredibly high volatility. Price volatility too.
Kevin: Yeah, I wonder. I mean, Fed accommodation, easy money accommodation, that’s going to factor into it too.
David: Yeah, chiefly depends on how accommodative the Fed remains. So more rate cuts, enthusiasm remains. If it’s radical rate cuts, it’s sanctioned speculation. The markets will love it. If that gets put on hold or if inflation re-emerges as a concern at the Fed, and they’re not cutting rates, they’re not keeping up to the expectations of the market in terms of when or to what degree they should cut rates, then you’re talking about a lot of traders. They’re going to have to reassess where they’re at, and they may feel like they’re a little too far out over their skis.
So again, the language from the Fed, the activity from the Fed, you get January, February, March. If they’re not doing something, they may not do something, because keep in mind it’s an election year, and if they don’t do it early, they might not do it at all given the fact that it’ll be cast as election interference as you sort of gin up the economy or gin up the markets coming close to that November date. So there’s a little bit of pressure on them to do something sooner than later. If they don’t, then all of a sudden that moment of truth, where speculators are like, maybe we’re out a little too far over at the end of our skis.
Kevin: Yeah, but you’ve got a meltup going on right now—
David: Meltup today.
Kevin: It’s a casino. What happens in Vegas stays in Vegas, and then it spreads.
David: Stock markets are melting up today. That kind of price action is not characteristic of a new bull market. It is characteristic of massive derivatives trade and short-term speculative bets. I agree, it feels like a casino out there with the dollar value of options trading relative to underlying assets very unhealthy. Bear in mind, we’ve already had the big decline in 2022. NASDAQ off 22%. S&P off down 19, and the Dow off 10, which did nothing to sour investor sentiment. So when you look at the characteristics of a bear market, you’re talking about breaking the soul of the man in the street. Never, or at least for a decade, they just swear it off. I don’t want to be back in that asset.
Kevin: That has not happened.
David: No, the enthusiasm with which Joe and Susie lunchbox are back in the markets. It’s really amazing. So bear in mind, we had the big decline in 2022. Sentiment is intact. Subsequent declines tend to have a more radical impact on sentiment. It can be far more severe, and this is oftentimes how long-term market tops play out. The secondary declines are the deadliest, and remember, with inflation the backdrop market speculators don’t know when, don’t know if the Fed will step in with countermeasures to support the market because to do so may be to add inflationary pressures. So that inflation figure is kind of key, and the Fed will have to cue off of that.
How aggressive can we get in supporting the market? That lag in response from a decline in market pricing to the Fed stepping in to help, that lag in response is critical to the depth of the decline which is possible. Now, the question that Jeff asks, timeframes, well, the context for market instability is already set, so timeframes? Tomorrow? Six months? What we see, though, is very interesting. There’s a minimal amount of hedging that’s in place today. So any reason for the markets to decline, you now have people who need to get the hedges on, they need to protect on the downside, and that can exaggerate in itself, that can exaggerate downside.
Plain and simple, it’ll likely be event driven, and that’s not predictable. Now, once a decline begins on whatever basis it begins, whatever event that may be, how steep, how deep. 35% takes you to 24,000 on the Dow. We’re unlikely to see anything like we saw in the 1929 stock market crash. It’s an 89% decline, leaving 11% value. It would imply 4,000 on the Dow. I wouldn’t think that that’s in the cards, in part because you’ve got the interventions of the Federal Reserve, and they’re polished. They’re willing to promise the sun, moon, and stars. The Mario Draghi “we’ll do whatever it takes.” They could have some version of that.
How effective it is remains to be seen. If it’s believable, if they still maintain any credibility, that’s a different question. We are further down the road, and we are in a very different context than Draghi was 2012 to ’13. Let’s just imagine the bull market move from the lows of 2009 to some sort of a peak, whether it was a 2021, 2022 peak or the current numbers, new highs, a 50% retracement. This is common. This is not something that anyone would be afraid of. 50% retracement of that bull move would put you at 21,000 on the Dow. That’s 42% lower from current numbers.
Kevin: Okay, so Jeff’s second part of the question. You’ve answered the equity part. Okay, the market part. How about real estate?
David: It’s different. Real estate is different. Residential real estate is the most unaffordable for households in all of US history. Of course, from my vantage point, it’s difficult to see it remaining that way. Unaffordability is based on price and rates, so rates could fall or prices could fall, but something’s got to give. If I said five years out, this is where— again, the structure of markets is interesting. There’s much greater frailty within a highly liquid market. You don’t get the price feedback loop and the positivity or negativity in retail pricing of residential properties the way you do in stocks. I mean, it’s instant feedback. Second by second, you can see the tape change, not the case in real estate. But if I said sort of five years out. Five years out, I think Treasury rates will have settled into a range between 5 and 7%. We could spend an entire commentary, debating the new range of rates.
Kevin: So where would that put mortgage rates?
David: Mortgage rates closer to 10%.
Kevin: Okay.
David: Again, something has to give, whether it’s legislation that changes the parameters for institutions who are holding single-family homes, that’s been a very popular thing, and we’ve got hundreds of thousands. It may very well be millions of homes that are today owned by institutions and they’re just collecting rent on those homes. Is it possible that legislation changes and a single-family home has to be owned by single-family and not an institution, not a Wall Street firm? Maybe it’s that. Maybe it’s something like unemployment increasing to the point where people are forced to move and forced out of their lower interest rates from years past. That will create supply. Those houses will ultimately come to market, and of course these prices will swing both directions—in that instance, lower.
How low? 25% off the peak? That doesn’t seem unreasonable to me. Current average single-family home, $430,000. Giving up 25% would take you to 320. This is not a catastrophic loss. It’s a significant loss, and would accommodate higher interest rates. Price declines in residential real estate are frankly like watching paint dry compared to price declines in equities. That one aspect I come back to, though, the one aspect that has changed since 2006, ’07 when we had the last run-up in real estate, the increase in institutional ownership. Now, there are huge blocks that can come to market overnight.
Kevin: And you need buyers or the price drops. Our last question, it’s strange, Dave, what a difference a week or two makes with Powell, the pivot. This question almost sounds out of sorts. It’s like, what is he talking about? Inverted yield curve, possibility of recession. So it’s amazing, the change.
David: We do still have an inverted yield curve.
Kevin: Yeah.
David: Right?
Kevin: Yeah.
David: But recession is off the table.
Kevin: Off the table.
David: Yeah.
Kevin: Can’t possibly happen. So here’s what John asks. He says, “Long time listener, since silver was around $31 an ounce. My question is, according to the inverted yield curve, it looks like we’re headed toward a recession. If the debt market starts unraveling, how will that affect the stock market, hard assets, the US economy, the global economy? According to CNN, it looks like the government is borrowing just to pay the debt.” That’s a question from John.
David: I first thought is how long term a listener was that the $31 on the move from 25 to 49.
Kevin: Or the Hunt brothers? No, no, no. We were—
David: No, just a decade ago.
Kevin: Okay, that’s right.
David: Just a decade ago.
Kevin: That was 2013.
David: Or was it the move from 49 to the low teens?
Kevin: Right, silver’s volatile.
David: It is. It is. Well, and answer to the question, debt market’s unraveling, affecting the stock market, hard assets, US economy. John, it’s all one trade. It’s all one trade. The correlations have increased, and due to the highly leveraged nature of the financial markets today. If there is a significant unraveling in the debt markets, I mean, unless it’s just like this small slice, a siloed piece of the debt markets, I think you’re talking about the ripple effects being seen in the equities markets and beyond, but certainly to the equities markets. Part of that is with higher rates comes at a transformation of how you do your discounted cash flow models for how you then should appropriately price the asset.
So stocks will be impacted negatively by higher rates given the DCF models. As for the US and global economy, there’s a lot of complex interrelations between US interest rates and the flows of capital globally. I think what you can say with confidence is that higher rates in US government bonds would accelerate a US fiscal crisis. Would that necessarily curtail US economic growth? Well, as we’ve seen even this year, we’ve had higher rates and we’ve had higher rates of growth. So are they antithetical to each other? I mean, right now, we’ve got World War II-scale deficit spending. Of course, there’s no recession.
Kevin: And no World War II.
David: Unemployment rate is at 3.7%.
Kevin: Yeah.
David: Interest expense is at a record level compared to revenue, debt to GDP statistics which are considered well past the threshold for ongoing stability. We’ve already passed them. It’s interesting. The unraveling of the bond market would just take what is already in motion and accelerate it. So we’ve already got the mountain of liabilities, and that’s negatively compounding. You’re talking about compounding negatively at a higher rate, at a faster pace, makes things more acute in terms of a problem fiscally, just a faster timeframe that may have currency implications. The US dollar may come under extreme pressure. It really has to do with the credibility of the Fed at that point, because as we’ve seen here recently, low rates have meant lower dollar.
If it’s the Fed setting lower rates, I think you’re talking about a lower dollar. If it’s the market setting higher rates, you could still have a lower dollar, not because it’s more attractive, because there’s more concern—
Kevin: There’s fear.
David: —about the credit system. Exactly. Exactly. And all this may be relatively better or worse than the developments that you see around the world. As bad as our situation may be, there are likely to be cases that are far worse. So we might be—as our friend Ian McAvity [used to say], again, bringing him back into the conversation—the best looking horse in the glue factory.
That brings us to hard assets. The difference between hard assets is that some are sensitive to economic supply and demand, some are insensitive. So economically sensitive/relatively insensitive hard assets, that distinction is important. If it’s consumable, then it’s economically sensitive. It could be oil, it could be copper, it could be timber. If we’re not building houses, guess what? You’re not going to have as much demand for timber. Gold is insensitive. Gold is less sensitive compared to almost every other hard asset, where it relates to a demand dynamic, tied to global economic strength, tied to global economic activity. Those things do drive the price of hard assets, and it’s one of the reasons why, to us in the years immediately ahead and as we launch into 2024, gold for us is the king. It’s the king of hard assets.
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Kevin: You’ve been listening to the McAlvany Weekly Commentary. We want to thank you for sending your questions in. Dave, it is always one of my favorite programs. You can find us at mcalvany.com. And you can call us at 800-525-9556.
This has been the McAlvany Weekly Commentary. The views expressed 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.
