The McAlvany Weekly Commentary
with David McAlvany and Kevin Orrick
Kevin: David, today we continue the “Best of” show, in which we go back and play clips from people that we feel have particular insights that we want to carry into 2013.
David: As promised, we will begin with Ian McAvity, and then move on to Bill King, and finally, with Marc Faber, we will end the day, and what we want to look at is not just the precious metals market, but as Ian begins the conversation today, a broader view of the equity markets, both here in the U.S., and globally.
Let’s go to our first clip with Ian:
David: Starting with the Dow-Jones Industrial Average, and the S&P 500. Let’s just begin with this. Other than counterfeiting, what could fuel the market’s rise another 15-20% from here?
Ian: I don’t see the market going much higher from here. I think we are basically in the vicinity of a very significant top. As far as I am concerned, the majority of the market really topped out back in 2011, and we have seen higher highs on some U.S. indices since then, but 13 out of 15 world markets that I track have not made higher highs in 2012, and some of the broader indexes in the U.S. have also not made higher highs, so as far as I am concerned, we are at the top of a cycle within this secular trend that really dates from 2000, and in my view, I think we are going down a lot more than people think.
I think we are going to go back and see the March 2009 lows before this is all done. It is not all going to happen in one stage, but to me, they have essentially extended this cycle by about 12 months, dragging it on and on, and we are going to pay for that on the other side, because the more you extend it in the one direction, the laws of physics take over and create the equal but opposite reaction on the other.
In my view, for the balance of 2012, I think people are way too optimistic and 2013-2014, I think, is going to be quite challenging. We have a global slowdown under way that is, in many respects, still accelerating. It was sort of ironic over the weekend, to see some data in which they were aghast that Spain’s government thought the GDP ratio was going to be 90%. I sort of chuckled, because that’s better than the United States, but the U.S. commentators didn’t bother to point that out.
Kevin: David, Ian has been very accurate in the past, and he does see a slowdown in 2013 and 2014. You hear the commentators talking about the stock market possibly having a new boost, let’s say, if Washington comes up with some sort of solution. But in reality, he thinks that at this point we’ve seen significant highs.
David: On the other side of that, he looks at the gold market and says that from a technical perspective, looking at the 50-day and the 200-day moving averages, there have been some very intriguing things that have happened in the latter part of 2012 that define the course for 2013. Let’s look at what he has to say on that particular point:
Ian: But the history of the gold 50-200 ratio has been very strong, and with very, very few false starts.
That is one of the reasons why I pay as much attention to it as I do, and, in my view at this point, we now have the 50-day moving average rising at a faster rate than the 200-day, and the 50 crossed up through the 200 about a week ago, to confirm that this little breakout of the downtrend line of the last few months is real. We have tested the 1550-1625 area three or four times over the past year, and we are now going in the other direction to try to confirm a breakout by going through 1800.
Go through 1800, go through 1900, and those are the two upside thresholds, and then basically, it’s Katie bar the door for a couple of hundred dollar moves beyond that. That has been the nature of this cycle when you look at the charts on a logarithmic scale. You have to think of it in percentage terms, or semi-log scale type terms. In my view, I think there is still a good possibility we see something like 2200 or 2300 before the end of this year. We are in the 4th quarter of the year already. I think we are that close to a significant change in character.
Kevin: David, one of the things that we talk about also is that timing is so hard to predict. We are looking at a cycle now where gold has consolidated for about 15-16 months. That is something that is not new. Over the last decade we have seen that happen – this is the fourth time. So as we go into the beginning of the year maybe we will start to see what Ian was calling for toward the end of the year.
David: And I think that is precisely what we will see. The change in character which he noted … no, we are not at $2100-$2200 here at year-end, but we may see that in short order as we head into 2013, because, again, from a technical perspective, we have cleared the decks. The consolidation is over and now we do see this change of character heading into 2013.
Kevin: I’ll tell you, it’s worth talking to an awful lot of different people, because people do have different opinions, and we are talking about strong market practitioners, David. And of course, we don’t want to neglect silver. Silver is something that comes to mind when someone thinks of gold, but usually, when we are talking about gold, we are talking about each one. Let’s go ahead and see what Ian has to say about that particular market.
Ian: I have done a lot of historical work on the silver-gold ratio because, in essence, when you have a heated up gold market, then silver becomes gold on steroids, people revert to its monetary history, even though it doesn’t really have an official monetary role any longer. But I still think that it trades on its monetary history and in essence from 1984 to last year, it had been locked in a broad range that was, I would say, roughly 45-to-1, silver was rich relative to gold, and anything over 80-to-1, silver was cheap relative to gold.
On that run to $50 that we had back in 2011, it got to about 30-to-1 on the futures, and in my view, as a technician, that breakout occurred at around the 60-to-1 level, so I have been working on the hypothesis that last year’s move probably broke it out of that old 45-80 range, and may have set up a new range going forward, at which we may see 30-to-1 as an extreme, where silver is ahead of gold, or 60-to-1 where silver is cheap relative to gold.
On the recent correction period when the prices were lower, we were in the 55-56 area, which is where I started to really feel the 55-60 ratio was going to be a good opportunity entry level for the silver market. If you go back prior to 1984, when silver/gold was 45-to-1, silver was cheap relative to gold, and at the extremes it was as little as 15-to-1. Eric Sprott, who has been a promoter of a couple of the large new ETFs in recent years, keeps talking about it going back to 15-to-1.
I am not anxious to see that happen because when it has happened in the past, it has been very sharp and very brief, and I’m not a big fan of looking for moonshot kinds of things that might be the end-of-a-cycle kind of move. But I would recognize that it is entirely possible we may see 15-to-1 at some point in the much later stages of this cycle. For now, though, I’m working on a practical range of 60-to-1 silver is cheap, 30-to-1 silver is probably a little rich.
David: Like Ian’s last comment, what we are really talking about is a change in character, from a bull market in gold which is moving through a period of consolidation and finally going to higher numbers, and this change of character between gold and silver, an internal dynamic in which silver was outperforming, and then stepped back, and is now likely again in the mode of outperformance again. As that ratio shrinks, the smaller the number, the greater the outperformance for silver, as counterintuitive as that may seem.
Kevin: David, one of the things that I really enjoy about working here with our clients, with the philosophy that we have, is measuring things in relative value. We talked about it in the last program, measuring gold relative to the Dow, not the currency, measuring silver relative to gold, because granted, gold and silver typically move up together in the long-run, if you step back from the chart, but there are some profits to be taken if you go with one or the other, based on the ratio.
David: In the next interview with Bill King, we start with the idea that market prices are not reflective of today’s larger economy, and the importance of relative values is really brought home with this particular reflection, because when you are looking at prices and assuming that it is communicating something real to you, you have to realize that things are not always as they seem, and having the perception of true value, according to relative value, is absolutely imperative.
Let’s go to the King interview:
David: In our family, I’m the optimist, and I’m not seeing it. I think the market has it terribly wrong, it is woefully complacent. We have had somewhat disappointing earnings, and yet we find ourselves above 13,000 on the Dow. If you take out the financials, we are at all-time highs in the S&P 500. What am I not seeing here, Bill? Does the market know something that I don’t, or is the market just dead wrong?
Bill King: It’s not a question of the market being dead wrong. The market is reality. That’s what the prices are. But what is different is that the stock market no longer reflects economic activity. It is not a gauge. For centuries, it was a gauge, a barometer, of the economy. That all fell apart over the last decade or so because we had a huge divergence. It’s a game, it’s a casino parlor game, and it is largely because of the easy money. That is what has perverted the stock market.
That is what is vexing the Fed. If you remember, when Bernanke was taken to task by Congress about what QE-II did, the first words out of his mouth were, “It got the stock market up.” It had nothing to do with the economy, and in fact, it hurt the economy by getting inflation roaring in 2011. That is why we haven’t had any more QE, because they are scared that they are going to not do anything for the economy, but that they are going to boost inflation.
To get back to your point. The stock market is a separate game from the economy now. It is trader-driven. It is computer trading, high-frequency, it is proprietary trading desks, because by and large, over this whole post-crisis recovery, the average investor has been taking money out. They keep taking money out, and there might be some judgment there on the economic prospects and what is going to happen next, and the bigger issue is that people are liquidating to keep solvent, or to maintain living standards, or just to prevent their living standards from falling further, and this is what happens in a very difficult economic environment.
People use up their resources, and that is the major issue that we are facing right now, is that this recovery has been so bad that the people that were savers, or were able to hang on, are exhausting their resources. It is one thing to use resources to build for future growth, it is another thing to use resources to survive. This isn’t a supposition or a guess. Anybody who has talked to accountants, especially accountants that do a lot of business with small business people, this is what we have heard for over a year.
The people that were smart enough, or lucky enough, to survive the crisis, have just been holding on, holding on, holding on, and they are exhausting their resources, in both maintaining their businesses, and in maintaining their household standard of living. And if we don’t start getting this economy cooking really well, we are going to have really big trouble in 2013.
Kevin: David, what Bill is talking about is quantitative easing, which, if course, is an action of the Federal Reserve. It is something that creates money in the system. But it isn’t just the Federal Reserve, which we have pointed out in the past isn’t government – they try to act like government, but they are not government – but our own government is doing the same thing, let’s face it. They are manipulating the markets, they are coming in and creating an artificial environment for the economy.
David: And for an investor or a business manager, it is a challenge. How do you play when you don’t understand the rules, as they are being changed, even in the midst of play? And that is Bill’s next point, on central planning.
Bill: And that is another reason why people aren’t playing. We have unprecedented central planning and government intervention in the economy in the marketplace, whether it is GM stuffing cars into dealers, and government … GM car sales were up 76% in June to government, and they didn’t lay off, and one reason we are getting some better economic data in industrial production and jobless claims in July is that normally every year in July automotive workers get laid off because you do your retooling for the new models.
They did not do that this year. It is strictly political, to make the unemployment and the industrial production look better for the election, because we know car sales stunk, inventories are building up everywhere, globally, so this is largely a political move. Again, once the election passes, this will all disappear and we are going to have to pay a price. We see the Treasury telling Fannie and Freddie they are going to have to liquidate their portfolios 50% more next year. Right now they are told that they could have to liquidate 10% a year, next year it is going to 15%.
Why is this important? Because Fannie and Freddie own repossessed properties. They kept them off the market to make housing look better, to not suppress prices, to not create a problem. There are a lot of things that have gone on to make the economy look good for the election.
It’s not just this president. It goes on every election year. That is why we tend to get these kind of plays in election years, but then, after the election, in the ensuing year, everything falls off. This year, everybody understands this financial cliff thing. It is going to hit in 2013, the tax hikes and the budget cuts, unless something is changed. People see that, but a lot of people aren’t paying attention to all the gimmicks that are done to dress up economic data, to make things look better, all these little games that are being played because it is an election year.
Also, there is a lot of spending that is done in an election year, state and local government, hiring people for campaigns, hiring people wherever they can, for the same reasons, for political reasons. There are a lot of workers, a lot of campaign expenses going on, that will boost employment, will boost spending, all this money that is raised in the campaigns, all this campaigning will disappear shortly. You see how bad the economy is, but this should be a great year because it is an election year, but it’s not. We have to worry about what is going to happen in the next year.
The stock market, again, is divorced. It is a trader’s game. The same thing happened in the summer of 2008. We had the Dow-Jones transportation average, which is supposed to be the most sensitive economic barometer, make it to an all-time high in July. The U.S. was at least two quarters into recession, if not more. How could that happen? It’s not supposed to happen. The stock market is supposed to lead. Well, it was a trader’s game then, and it is even more of a trader’s game now.
David: Bill’s next comment takes the 2008 crisis and puts it into a different perspective, basically saying that it was a foreshock, that the real event is still in front of us and it is related to our debt markets.
Bill: But now it has become apparent to anybody who is thinking, that debt is not the crisis. The crisis is still in front of us. In 2008 it was that the financial systems in the world were collapsing from years of abuse, over-leverage, lax regulation, fraud, you name it. That has gone on for decades, because that was the new economy. That was producing money, whether it was producing tax revenue or producing graft and donations to Congress, they allowed this to go on. So when it blew up, they could not allow this to blow up and take everything down, because the culpability would be put directly on Washington, D.C. and New York, the financial area. They were working together.
What we know has happened, here, in Europe, and elsewhere, is that sovereign governments bailed out the financial systems to prevent political revolution, if not some harder revolution. In so doing, they have bankrupted themselves. That is the moral of the story in Europe. The big banks have bankrupted themselves. Because of that, everybody is going all in. They can’t stop this game, because we will get political revolution. The whole system is coming apart.
For most people that are alive today, the big hook that Wall Street held over everybody’s head, and it was actually two-fold, was “Yeah, things could get bad, but the Fed is always here to save you. They will always be able to print money and save you.” The second is the government. The government can always save somebody. They may choose not to. That is the consideration. Do we let Lockheed go under? Do we let certain industries go under? Or do we save them?
But now we are at the point where government can’t save. They have to save themselves. For everybody alive today, that is the big issue, and that’s why we saw the surge in gold over the last four years – actually three years. It’s been flat for a year and there is a good reason why it’s flat. But in the aftermath of 2008, every very important person that I talk to, including heads of Big Five brokerage firms, CEOs of Fortune 500 companies, these types of people, all were buying gold in 2008 and thereafter. That was their haven, because they understood what was going on.
Why hasn’t gold gone anywhere over the last year, even though the banks are pumping? My main thought is, there are two reasons. One is that it goes back to the concept of using up your resources to stay alive. A lot of people, especially the wealthy people, have gotten all that they needed, there was a panic in, and now the gold market is digesting all of that. The other issue is that the Fed, for all the talk about doing QE, and we’re going to pump money and save everybody, they’re balance sheet is flat on the year. Their asset level is actually down 17 or 20 billion from a year ago. That is the reason gold has lost its mojo, and silver is even worse, because silver is more of an inflationary play. For all the talk, and all the nonsense going on, the Fed is pretty much unchanged here.
That begs a really huge question. Why is Wall Street so excited? You see what the Fed is doing. They sent out the doves to say, “We’re going to give you QE if things get worse.” They’ve been saying this for over a year. We have the same idiots out there saying, “Oh, you’re going to get QE next week.”
For a year, major brokerage firms, ex-officials of central banks, and especially this one guy from the Bank of England is running around town who has been saying that they are going to give us QE for over a year, and it has not happened. One thing they have been able to do is not even do the QE, threaten to do QE, that’s what this whole summer rally is. It is the threat of doing QE.
Remember how they were saying you had to get it, you had to be in here, because they were going to give it to you in June. Oh, that didn’t happen, they were going to give it to you in August. Oh, that didn’t happen, they are going to give it to you September 12. We’ll see, I doubt they are going to do that. They don’t have to do it, and that is, I think one of the things that is going on. Because it is only traders – it is a thin market – they can give you the threat of easy money, and they are keeping the game going, but they are not giving you the QE.
Kevin: David, it is interesting, that interview was about four months ago, and sure enough, Bill was right. We are coming to the end of the year, and the Fed’s balance sheet really was only up about 3.27 billion. What he was talking about is a phenomenon that is hard to understand.
David: In Bill’s final comment, he is talking about gold, not as an inflation hedge, but as a bet against government, and we will see that this next year.
Bill: I think we will see gold take off. I think we will see that kind of dynamic because they are going to think he will try to inflate or confiscate. People don’t quite understand gold. It is partially an inflation hedge, but it doesn’t really do as good a job as other assets do against inflation.
David: Not priced in real time. No, it doesn’t track on a day-to-day basis, by any means.
Bill: No, but gold really is a bet against government, and that is why the big government people hate gold, because it has always been an encumbrance, throughout history, back to the Greeks and Romans. It encumbers big government and wanton spending, and it is a hedge against politics, it is the biggest hedge. So if Romney wins, gold is going to have a tough go for a while. Again, it depends on what policies show up.
I don’t think we have seen the long-term peak in gold because we have too much in the world that has to be resolved, such as the U.S. debt problem. Let’s face it. And the reason why the big money, no matter who wins, is going to keep some portion of the gold is because we don’t know how the debt problem is going to be ultimately resolved.
There are three ways to get out of it. One is totally improbable at this point, and that is to grow the economy. The debt is so large now that studies show it actually is an economic encumbrance now. You just can’t get it going. Just as in business, if you can have a good business, you take on debt to expand, and you can grow your way out. But if you take on so much debt that there is no way you can pay that payment, then you have to cannibalize your business. That is what is happening now to sovereign governments all over the world.
So now you are left with two solutions, and we have talked about this before, you either can inflate or you can default, and every government tries to inflate. We have been doing this for decades. Eventually, you hit the point where you either jump to hyperinflation, or you just default, which is what Russia did in 1998, which a lot of state municipalities are going to have to do because they cannot print money, but that is what nobody knows.
Nobody has an idea what this end game is going to look like, so you have to have a good hedge portfolio right now, and flexibility to move once policies start appearing, and once things start happening. That is what is going to make this even more problematic. You don’t know from country to country what their policies are going to be or how their legislatures are going to vote and what policies are coming this way. But we do know there is a major debt problem in Japan which nobody is talking about, which is even a bigger debt problem than Germany, and there are a lot things there that have to be resolved.
That being the point, we all know the basis of financial assets are government bonds, and if you start questioning the value of government bonds and the ability to pay it back, that’s where the real crisis will be, as you see in Greece, Italy, on and on. If that starts spreading to France, then to Germany, then to the U.K., Japan, and the U.S., that’s the game-changer.
Now, the big money, over big periods of time, and the big private money plays it masterfully because they don’t care about what their performance looks like month-to-month, quarter-to-quarter, even year-to-year, they just want the big trend right. The big money is made moving from real assets to paper assets. In the 1980s, that was the game. If you go back to the 1970s and look at the wealthiest people in the world, people like Daniel Ludwig, and it was oil, gas, shipping, real estate. Names like Kluge, Howard Hughes and his real estate, and Hughes Tool and these industries. Marvin Davis. Worldwide. The Ellsbergs, the Bronfmans in Canada. It was resources and real estate.
David: But they had to make the transition.
Bill: Right. By the 1990s you had the Gates and the Buffets, the tech guys, and Larry Ellison, but it was a paper profit. Who played it right? The Bass Brothers did.
David: The Bass brothers made the transition.
Bill: The Bass brothers were a Texas family of oil/gas/real estate. They had the insight to see that something was happening with Volcker and they brought in Richard Rainwater from Goldman, and they brought in a convertible arbitrage team from Kitter and they played it masterfully. They made so much money in the 1980s, they effectively dropped out of sight in the 1990s. They did a little bit of RTC buying and they just disappeared.
The point is, you have to move your money from hard assets, whether it is real estate, oil, gas, gold, or whatever, to paper, and then you have to make that transition. In the last decade, gold and commodities took off, and outperformed stocks, by far. Here is the problem if you go to the ’80s. You have to be liquid in transition periods. In other words, the Basses couldn’t just go and buy stocks like crazy in 1979 and 1980, they would have gotten killed. They transitioned, they got out of their oil and gas, got liquid, did some nibbling around the periphery, and then when the move appeared in earnest, they could go. When the Hunts went bankrupt, and other people similarly went bankrupt, they were ready to go.
That is why I cannot emphasize enough not to get too doctrinaire, don’t make too big of a commitment either way right now. Have a nice, balanced portfolio so that if something happens very quickly, you are in a position where you aren’t going to get killed, but also you have a position to play through this transition, because we aren’t anywhere near the end game yet. We are getting closer, no doubt, and that is going to be very tough to navigate.
Kevin: David, this is why Bill King is a regular guest of ours. He brings so much insight. One of the things that I think is so important is the timing of exit strategies. That is something that you have brought out. When do you go from commodity to cash, like we talked about with the Bass brothers.
Marc Faber is a person that we also have on a regular basis, and to put those in contrast with the two, you have these guys continually looking at the market. They are practitioners. They have to make something work, because this isn’t something that is just academic exercise or theory, they are actually having to make money.
David: In that last clip with Bill, there were a dozen things that we could sit and talk about here for the next five hours. We are just going to have to let that sit and digest, but there is a tremendous amount of value just in that last 2-3 minutes.
The next conversation we have is with Marc Faber. Perhaps you can explore what takes place in a re-evaluation of risk, an asset previously believed to be safe, and now scorned, for instance, GSE’s Fannie Mae and Freddie Mac paper, which were truly the gold standard in the fixed income space, giving you the best benefits of high income and the government guarantee. What does it take for perception to switch from something being safe, to now being a risk asset?
Marc: This is a very good question, because let’s say we have kind of a gold standard, and sound money. In other words, you have an environment where money is not being printed in unlimited quantities, then obviously, traditionally, the safest asset is to own cash, and Treasury bills, and then government bonds, and then municipals and corporate bonds, and then equities, and the most risky are basically commodities.
But in the current environment, looking ahead ten years, let’s say we were to go on a holiday for ten years and then we came back. I think it would be very risky to put all of our money into cash and hope that the purchasing power would be maintained over the next ten years. I think it will go down substantially because we have negative real interest rates and these negative real interest rates will continue.
Under normal conditions, cash and government bonds are safe. But in this environment, in my view, they are no longer safe. Now, what is the safest? Is it gold? Is it real estate, at these depressed prices? Or is it equities? That we don’t know for sure. But I am quite sure that over the next ten years bonds are not a particularly desirable, nor a particularly safe, place to be positioned in.
Kevin: David, what Marc Faber is saying is almost exactly what Steve Forbes was saying last week, that bonds are not the place to be, because when you invest in bonds, you are saying yes to the government, yes to government debt, and that might be the best place to be.
David: And this final clip deals with the dysfunctional nature of government, not on a partisan basis, but just looking at the growing leviathan and saying, “They need more and more, they will be issuing more and more IOUs, they will be printing more and more money, and the whole thing is a bloody mess. You cannot put stock and faith in this very dysfunctional government.”
Marc: We would have to reduce, in the Western world, the involvement, and the share of government in the economy, as a percentage of GDP. We would have to reduce that very meaningfully. U.S. spending is about 45% government related. It is a very large portion. And that is with full economic growth.
At the same time, and this is really the work of Mr. Obama, we have an increasingly cumbersome regulatory environment, which just makes it very unappealing for any business to expand, especially the medium-sized and smaller businesses. They are faced, or confronted, with a huge increase in regulatory costs, and so they say to themselves, “Why would we hire under these conditions? Why would we expand under these conditions? We had better not do anything.” I think that both under the Republicans and under the Democrats we have structural problems that neither party will solve because of the dysfunctional nature of the U.S. government at the present time.
Kevin: David, there are, again, so many things that we were not able to listen to that were valuable, but these clips bring out the little gems, and this is something to do each year, at the end of the year, to go back and say, “All right. How do we evaluate what we have heard, what we have seen, what we have done, so that we can do more the next year?”
David: As we head into January, we will include some of these kinds of clips from Michael Pettis, John Taylor – the economist from the University of California Berkeley, Richard Duncan, Russell Napier, Ambrose Evans-Pritchard, and a couple of our other guests, because frankly, there are too many gems, and we have to. We just simply have to. There are too many valuable lessons to learn, and points to be made, before we transition into thinking about 2013.
As we head into 2013, we will have our anticipations there, a program that is designed to just look ahead and say, “What do we expect?” That we will have in early January, and we will look forward to that.
