The McAlvany Weekly Commentary
with David McAlvany and Kevin Orrick
Kevin: David, today when I was shaving, I was thinking, this is the weirdest time of the 26 years that I have done this in these markets, as far as just the wrong pricing for everything. You have fewer and fewer participants in the stock market, yet it is hitting all-time highs. You have more and more demand for gold. We have supply issues for gold, yet the price is going down. Have the paper markets and the manipulations taken over so much that nothing really, actually, is priced correctly anymore?
David: The interventionism that we have seen from the world’s various central banks has basically become what we would call a liquidity backstop. We’ve talked about the Greenspan put, we’ve talked about the Bernanke put, and the fact that, really, markets can’t go down as long as central banks are actively intervening in the market. What they are doing is warping certain realties, and they are adding a tremendous amount of volatility to the market, both present and future.
We see, in the last week, emerging market volatility going off the charts. We have 3%, various equity markets in the emerging markets, down from 3-10%. We have, also, in the emerging markets, in the area of bonds, a literal freeze-up, almost worse than 2008 just this last week, bond market volatility, both in the emerging markets, as well as in Japan and in Europe and the United States.
And of course, we began to see some strange things, a massive spike in Portuguese yields on the basis of a change in Japanese policy. Yes, that’s correct, there is a connection, because it’s been Japanese money that has been going and buying European debt.
Kevin: So for the income-hungry people out there right now who want a little bit of safety, they could go buy Portuguese bonds and maybe get an income for what? A week?
David: Or if they don’t mind risk, they can just buy sushi?
Kevin: Mortgage rates, as well, though David. Talk about a liquidity backstop. When the government is buying every mortgage, how in the world do you actually know what the interest rates are supposed to be?
David: Those are about 4% now, they have been as high as 4.10%, up off of 3.6% at the lows, and at the same time, with all the interventionism we have seen, and the warping and twisting of realities that we have seen, you don’t have real economic activity. One of the things we looked at when we assessed Chinese growth and a change in growth trends was that electricity usage last year was dropping precipitously even while the Chinese government was claiming that there was even better growth in the economy. And again, electricity usage is dropping.
Kevin: So there was growth, but they were doing it more efficiently, or there wasn’t growth like they were saying.
David: Bloomberg has a great chart on waste carloads. This is just one of those subtle indicators that we are not buying, spending, using, and throwing away as much as we used to. We are at levels we haven’t seen since the recession of 2000-2001, worse only by one year than 2008-2009, that time frame. Waste carloads are very low. The U.S. economy is not fully in recovery. The S&P continues to be an anomaly, to say the least, because it is not supported by economic or fundamental realities.
We’ve talked about the divergence between copper and the S&P, and we’ve talked about the divergence between durable goods and the S&P, we’ve talked about the divergence in terms of S&P moving higher and consumer confidence moving lower. All of these three things not reflecting, really, something that investors can wrap their minds around and say, “This is reality. This is what I’m dealing with.”
Kevin: Most people who have equities watch the Dow-Jones Industrial Average, because that’s what everybody has in their mind, but in the S&P 500 there are some moving averages that the traders watch, and they know that if it is breached, it could be an issue. I think the 50-day moving average right now is still probably one of the key indicators, the direction of the S&P 500, is it not?
David: Yes, for the last 18 months it has come down, it has tested that level, it has bounced right off of it, and it has moved higher. It may be that we are seeing the end of that trend, in part, because each of the bounces off of the 50-day moving average have been fairly robust – 6-8-10% recoveries off of a correction to the 50-day. This particular bounce is lack-luster, you could say. So the question is, will we retest? Will that number hold the level of the 50-day moving average? And if it doesn’t, you should probably prepare for the worst.
Kevin: David, as I said, I was standing looking in the mirror this morning and shaving and realizing that everything is distorted. Now, I wasn’t talking about myself, of course.
David: (Laughter).
Kevin: Let’s talk about price distortions, like being at one of those carnivals where the mirrors are all different shapes and you can’t really tell whether you are tall, thin, fat, whatever. It’s not giving real data.
David: Exactly, you could be skinny as a rail, or look like a beach ball getting ready to be rolled down the street. It is distorted, and you have to step back, and once you do, the amusement is over, and this is the challenge. Today is anything but amusing. When we witness this sort of incestuous relationship between the Fed and the Treasury, which is distorting and distending reality, the trouble is, they are not only temporarily reshaping a view or a perspective, they are attempting to reshape how we all perpetually view the world.
Kevin: It is shame that the people who actually can see what is not distorted in the mirror, the people who are printing the money and actually redistributing it, are taking the savings of the person who doesn’t have the inside information. There are huge challenges for investors right now because they are having to look into this mirror and try to make good decisions, and it is purposely being distorted.
David: Beyond the usual smoke and mirror games from Wall Street, you have the recovery narrative, and that is, of course, from the powers that be. This is a government that is desperate to prove that socialism is not a failure, that in fact it is a great success.
Kevin: Have we ever seen a centralized planned government, socialism let’s say, work in the end? It is not productive.
David: The Soviet Union is testament to that. You have central planning, you have price fixing at the Fed – no different. What it creates is downstream distortions. Look at what are high-powered reserves today, created by the Fed. This is the fuel for inflation that is coming. The average middle class family – are they benefitting from the liquidity infusions the Fed has had in play over the last 18-24 months?
Kevin: Not at all. Look at the sales at some of these retail outlets that “a normal person” shops at. They are dropping right now.
David: Same-stores sales down for Wal-Mart, down for Target – this is all in the first quarter – down for Kohl’s, down for Sears, down for Costco. Down for Costco! If you want to save a few bucks, buy big, buy in bulk…
Kevin: It’s a recovery in which nobody is actually going and buying anything.
David: It’s pinched, either from a lack of sufficient income, or from an increase in the cost of goods. That’s what’s happening. Budgets are being pinched on one of those two bases.
Kevin: Yes, but David, the opposite is true. You pointed this out in the past, that the high-end restaurants, the high-end retailers, like Tiffany’s, are not having a problem at all right now.
David: No, Tiffany’s is near its all-time high in terms of stock price. Saks Fifth Avenue is at a recovery high. It is about seven times better than it was in 2009, off of those lows. And the numbers are better, in large measure, because the stimulus in the system has already inflated the value of assets owned by the wealthiest Americans, those with a strong stock portfolio, and those with a big house. Listen, this is the same thing that has been communicated to the Bank of Japan. If you do as we do, you will find the same success that we’ve had. And we made mention of this a few weeks ago. The problem with that is that there is less than 7% of the Japanese public that actually owns equities, so even though the NIKKEI has been rallying – it has corrected in the last few days – but even though it has rallied better than 25% in the last 6 months, it has been to the benefit of foreign speculators and hedge funds, as much as it has, and even more than it has, individuals in the Japanese economy, who, on the basis of wealth effect, may then turn around and increase consumption spending and generate further growth in the Japanese economies.
Kevin: When there has been a devaluation of currency, whether it is here in America, or it is in Japan, or wherever they want to try to imitate this miracle that our Federal Reserve has supposedly brought about, has there ever been an exception, throughout history, when a lot of money has been printed, when you didn’t have devaluation of the currency, or – another word for it – inflation?
David: Axiomatic, would be the word to use. It follows that when you create these high-powered monetary reserves, inflation is in the pipeline, it is around the corner. There is a lag, and we will talk about that in a minute, but it is the Fed that has granted extra money for shopping, whether it is Saks Fifth Avenue, whether it’s Tiffany’s, whether it’s Barney’s in Manhattan, Main Street, meanwhile, is edging closer to stagflation. Those are the frustrating circumstances of stagnant wage growth, rising costs. This is what is compliments of the Fed if you are Main Street, as opposed to somehow connected to Wall Street, or frankly, you are part of the 1-2%.
Kevin: This behavior reminds me of a movie that I’m sure some of the listeners have seen, of a man who decided to try an experiment, to eat at McDonald’s every meal for a month. It was called Supersize, because, if they asked if he wanted to super-size it, he would super-size anytime they would ask. In the beginning he didn’t really notice any real change. In other words, he looked like he was eating well and things were going fine, but he started developing health issues, he started gaining weight, diabetes started to look like it was going to become a problem.
We see this in life, Dave. We see abuse. No offense to our listeners who smoke, but let’s face it. Why are you still smoking? We see how people die after they have smoked. We see how people die when they eat too much saturated fat, yet they continue to do that. And I think about the way the Fed behaves.
David: Lagging consequences.
Kevin: And the Japanese are now saying, “You know, I sort of like what I see. I think I’ll go ahead and order that Big Mac, and why don’t you supersize it for me?”
David: For years we have been gold bulls, and we still are. Actually, we are rather battered gold bulls, to be precise.
Kevin: We’re getting beat up right now, yeah.
David: But what we’d like to share, maybe, is a few insights that clarify, maybe they affirm, what the upward trajectories of the precious metals are. With 40+ years of daily trading the metals, I think we have a few things to either inspire, or at least in this case, if you are feeling like a battered gold bull, at least console.
Kevin: It reminds me of our interview with your dad a couple of weeks ago, Dave. He was able to bring insight from the 1970s into the dialogue and it is so valuable to go back and actually talk to somebody who lived, breathed, and went through the emotional ups and downs.
David: Particularly the 1975-1976 period, the gold consolidations, we have suggested that there are similarities to what we see today, 2012-2013. We have even asked whether the summer of 1976 and the summer of 2013 don’t in some way mirror each other, actually, in some fairly significant ways in which they are similar, then and now. We have Ben Bernanke working sort of his monetary wizardry.
Kevin: It reminds me of Arthur Burns in the 1970s, Dave.
David: Exactly, that was his predecessor in the office of Federal Reserve Chief, and he had the immediate impact in terms of Arthur Burns’ monetary policy of positive response in the equity market, inflation-neutral, although that is arguable depending on how you count inflation. Coincidentally, in the 1970s, there was this point in time when central banks around the world would not allow the dollar to depreciate further. You have five central banks coming in and making sure that the devaluation we saw in the early ’70s was arrested in the mid ’70s. So Arthur Burns looks and says, “Look at this. I mean, come on.”
Kevin: They’re going to come in and intervene, they are going to buy the dollar…”
David: “When are they going to make me Sir Arthur Burns?”
Kevin: The genius of printing money.
David: Exactly. I made the equity market go up. There is no inflation. The dollar is stable. Someone, someone, hand me the laurel wreath.
Kevin: What do we remember Arthur Burns for?
David: He lit the fuse. And so has our “Arthur,” that is, Ben Bernanke. Ben will be remembered as the man who set the fuse alight, the U.S. debt market, specifically. They’ve been building steam, they’ve been progressively moving higher in price for the last 30 years, and they needed somebody to jack them up even higher, and now push the market from its roost. There are a number of people in the bond market, not only Bill Gross, but others now joining the chorus, including Dallas Fed President, Richard Fisher, saying, “Listen, the bond bull is over. We have a different financial landscape ahead of us in terms of the cost of capital. That’s what we can expect in the future.”
Kevin: And let’s look at the flip side of that one. Someone says the bond bull is over. That means that the drop in interest rates is over, because when bonds go up, it’s interest rates going down. So for the person who doesn’t necessarily invest in bonds or understand that, your ability to borrow at lower rates is just about to go away.
David: Going away.
Kevin: Yeah.
David: The dollar has been in decline for decades, so we can’t put responsibility for the dollar’s demise on Ben’s shoulders. That would be to let Mr. Burns, Mr. Greenspan, let these guys off the hook, because they’ve certainly contributed to what we’ve made in terms of the dollar mess.
Kevin: But could we credit them with some inflation when it finally does occur? He’s going to be known for that, isn’t he?
David: We can credit him with any acceleration in the rate of inflation. Irony is sweet. The articles that today laud Ben Bernanke, whether it’s Bloomberg, or others in the financial press, point out this is a sort of wizardry, his brand of wizardry. It’s just different this time. You’ve got money-printing, you’ve got monetization. You’ve got the general expansion of credit along with the ballooning of the Fed’s balance sheet.
And lo and behold, it has not created what it always created in the past. In fact, this is a miracle of management to be remembered for all time. Again, I say irony is sweet, because today we can inflate a currency, but we do not reap any inflationary outcomes in the prices of goods and services. Unfortunately, this is his legacy. This will be his legacy, one of the few things that he is remembered for. The financial press is not connecting the dots. The financial press is in the business of selling advertising, not understanding the realities, the relationships between high-powered monetary reserves and an inflationary outcome, not just for the man on the street, but every man, Main Street, Wall Street, everybody dealing with inflationary consequences to bad monetary policy.
Kevin: Well, Dave, the financial press – this is show biz. Let’s face it. You’re on three times, sometimes four times a week on national TV. They don’t want to hear your deep insights. They just want to hear little sound bites to keep people watching.
David: And the frustrating thing for investors is to suffer through the lag time between the two – the actions which do create inflation and the reality, at least the social recognition of that reality.
Kevin: Dave, can I make a suggestion at this point? Last week’s guest has a site called pricedingold.com, and he has a great chart over on the right you can click that basically shows the half-life of the dollar, and it follows a very, very regular chart. But you also see that it vacillates up and down above the curve, so you can see that sometimes you have inflation, sometimes you don’t, but overall, the half-life of the dollar shows this inflationary trend.
David: And when we talk about Arthur Burns and the disconnect between his monetary policies and the inflation of the late 1970s, and the monetary policy of Ben Bernanke today, and the disconnect between that and the inflation which is immediately around the corner, again, the lag relates to the nonmonetary element in the equation, and I think this is what a lot of people don’t appreciate. The nonmonetary element in the equation is crowd psychology, this is the social acknowledgement of a real state of affairs, and this goes well beyond John Williams and his reporting at shadowstats.com. We know it exists. We already have inflation. The critical juncture just ahead is when people’s investment decisions are altered to reflect what they already know, what they are dealing with in their family budgets, that is to say, the rising cost of everything.
Kevin: I’ll tell you what. You’re talking about inflation, and one of the best ways to measure inflation is the way Volcker measured inflation back in the early 1980s. Volcker is seeing through this right now. Volcker is the guy who had to come clean up after Arthur Burns and it was very, very painful, in 1980, 1981, 1982. Those interest rate hikes, the recession that we went through, those were the first Reagan years. Volcker had something to say just recently about this.
David: Kevin, do you remember our conversation with Otmar Issing? He was very hesitant to offer any critique or criticism of the European Central Bank, because he figured he had had his day in the sun, eight years as leader at the European Central Bank, and he was not in a position to, in any way – or he didn’t want anything he said to compromise current ECB policy, or to be taken as criticism, or somewhat undermine those who were in power.
It’s very interesting, because I don’t know that we have the same kind of decorum today. In the last 30 days here in the States, we’ve had Greenspan, and we’ve had Volcker, step forward and say, “Listen, about this radical monetary policy that is in place today. You have to be careful with the consequences. You don’t know when sometimes you are dealing with fire, you don’t want to get burned. Be very careful here.” They are still couching what they say diplomatically, but the fact that they are out in the public square – this is Volcker in a recent speech at the economics club of New York, and I think this is probably his most direct public opposition, if you want to call it that, to current Fed monetary policy.
He is not naming names, but here is what he said. “Credibility is an enormous asset.” Of course he is speaking of the Fed. “Once earned, it must not be frittered away by yielding to the notion that a little inflation right now is a good thing, a good thing to release animal spirits and to pep up investment. The implicit assumption behind that siren call must be that the inflation rate can be manipulated to reach economic objectives. Up today, maybe a little more tomorrow, and then pulled back on command. Good luck with that. All experience demonstrates that inflation, when fairly and deliberately started, is hard to control and reverse.”
Kevin: I think it is interesting that if you read through the rest of that speech, he is very careful to say that Ben Bernanke is very capable and he has many, many tools. So, of course, he couched it politically, but the things that he is saying right here, when he is saying, “Good luck with that,” that’s a little like the guy who is about to base jump and you say, “You know, I want to go on record ahead of time to let you know that this is a bad idea.”
David: “Odds are, you’ll survive, but you’re taking risks that are, frankly, unnecessary.”
Kevin: Right.
David: Keep in mind, these kinds of speeches, it’s not like the topic is preassigned. You choose your own topic. What’s on your mind? What do you want to share? But listen, if we’re getting ready to come off the rails, it’s important that you be on record saying, “Listen, I said this was a bad idea.” And in fact, he has said it’s a bad idea. We look at the recent Fed record of easy money policies and we look at the crashes that followed, and we have easy money policies in the late 1990s, which led to the tech bubble. We had the easy money policies in response to the tech bust, which led to the housing finance bubble.
Kevin: And can I just say? Greenspan, just like Volcker, is a public figure, and he exited stage left just before the financial crisis. If you will recall, Greenspan, they called him the Maestro, they wrote a big book about him, he had created this bubble, and then he exited just in time to say, “Hey, I think this might be a bad idea.”
David: I think he called himself the Maestro. (laughter)
Kevin: (laughter) He might have, yeah.
David: Ah yes, he stood in front of a mirror, too, and there was no distortion of reality.
Kevin: Of course not.
David: Inflation of self. Egotism.
Kevin: Mirror, mirror, on the wall.
David: If you follow the 2008-2009 bust, and the Fed, yeah, they’ve staked their claim on a recovery story, but the thing is, they’ve done this a dozen different times, whether it is talking about green shoots, or this quarter we’re expecting this amount of growth. They’ve over-optimistically assumed that we were in recovery a number of times in the last 4 to 5 years.
Here’s what’s really telling. The assumption has always been by economists that we would have this pent-up demand coming back into the economy. So everyone tightens their belts in the context of the recession, and then you have this resurgence of buying, pent-up demand. Guess what? Pent-up demand, on average, is 6-7%, in terms of major purchases, and we are less than half of that today, in terms of pent-up demand coming back in and seeing consumers step in and buy. The consumer is absent. The consumer is not doing what he is supposed to do, and these are the worst numbers that we have seen in a post recessionary period since the end of World War II.
There is this optimistic assumption that we have arrived, recovery is here. We’ve had QE-1, 2, 3, 4. We’ve had Twist, now we’re discussing taper instead of discussing what was 6 months ago, 12 months ago, an exit strategy from the 85 billion dollars in bond purchases. These are extraordinary monetary measures, and frankly, even if they just taper, let’s go back to that word. Even if you reduced it by 15-20%, you still have extraordinary monetary measures, something that we haven’t seen in any period in financial history.
Kevin: And David, you are talking about 7% being normal pent-up demand. 7% is what we are adding to the GDP right now with quantitative easing. So if they took it all the way, still, do you see what I’m saying? The pent-up demand does not replace quantitative easing. You’ve said it’s at half of that right now.
David: We find ourselves today with a growing audience. Let’s step back and say, “What is reality?”
Kevin: Or is this the new normal?
David: Well, isn’t that the question? You have a growing audience, mainly in Asia, of investors who, the levitation of assets. Is this the new normal? Can you do this forever? Is this what we have missed in the alchemy of old? You don’t need to own gold, we can create it out of dirt? That was the magical dream of alchemy for thousands of years, is that it actually was not a scarce item. You could turn dirt into the precious metal.
Kevin: Here’s the irony. You said it was the Chinese who were thinking this. Paper came from China. Paper currency originated in China. This whole alchemy that you are talking about, the replacement for gold is paper? Maybe this is happening.
David: Yes, and there are limits to what the Fed can do, and this is what is being questioned by a growing number of investors, primarily in Asia. Importantly, what are the consequences to what has already been done? In the short-run we have – well, again, this is the majority of investors, I guess I’m thinking about those in the West, who have determined that the Fed, the Bank of Japan, the ECB, the Bank of England, have kept everything under control, that they have solved the problems, that there is no more upset to the markets of tomorrow because they have it well in hand. Inflation is well anchored.
Kevin: Well-anchored. That’s right. Been says inflation is well-anchored, don’t worry about it.
David: And growth is a near certainty. Honestly, I finished reading three dozen Bloomberg articles this morning, I felt myself feeling, almost convinced of the same thing, that growth is inevitable. It was almost like saying the Pledge of Allegiance, and singing My Country Tis of Thee, and all of a sudden I just felt welling up inside of me this sense of, “Things are getting better, much better.” All as a result of reading Bloomberg. And heck, the majority may be right. And frankly, if they are, Kevin, who needs gold?
Kevin: Dave, strangely, sometimes you sound like your dad, and sometimes, as in this particular case, you’re not sounding like your dad, because one of the things that he, over, and over, and over, said was that the majority is almost always wrong.
David: And I think that is written into my DNA. So there we are with gold. Yes, suffering in price, suffering a shift in sentiment. Again, not a universal shift in sentiment. So the negative sentiment has been amongst Western money managers, asset managers, and they’ve boldly just stood up and said, “Listen, if the Fed’s playing the music, we’ve got to get up and dance.” And so it is the fund managers, and the hedge funds here in the United States and in Western Europe, that are now fully invested. In fact, they are as invested in equities as they were at the peak in 2007 just prior to the crash.
But on the other hand, you‘ve got the East, and that’s a different story altogether. Our liquidations of gold have been their purchases, at what they have considered compelling prices, and this, I think, in retrospect, will be one of the great West to East wealth transfers in all of history, and it is done in the belief that Ben Bernanke, let’s just call him Ben B., and Arthur B. (Arthur Burns), are not, themselves, playing from the same book of tunes.
This is the irony. It’s the same song, it’s the same dance. We’ve been here, we’ve done this before. And it’s only people with a sense of history that are saying to themselves, “Yeah, I think gold makes a good bit of sense right about now.” And anyone with a lack of appreciation for history who is saying, “This is great. Not only is it good, it’s getting better. Look at what the central banks of the world are doing for us. It’s time to party.”
Kevin: Dave, something I learned one time when we were traveling in New York. We’re from the West, it’s pretty dry here, but when you travel to other parts of the world, like New York, the weather can change instantly. I was watching when we were getting ready to film one of the DVDs, a lot of the New Yorkers, though it was a beautiful day, were walking around with umbrellas. They all seemed to have umbrellas, and I was thinking, “Do New Yorkers just do that? Do they just walk around with an umbrella?
David: A fashion statement of sorts.
Kevin: And I will tell you, from that point forward, we had three days of downpour. I remember having to buy several umbrellas, because the wind was so high that it just tore them up. I thought about that at the time. I thought, “You know what? Just because the weather is sunny, if you are a local and you know to carry an umbrella, if you’re from outside, you’d better get one.” Gold is like that. People are carrying umbrellas, but they are in Asia right now. The Americans have left them at home.
David: For the contrarians, yes, we would see being very near a low in price. You have the time frame of over 20 months of a correction. You have general sentiment, which is ugly. You have the price, which has corrected a sufficient amount to be consistent with all the past corrections within the context of this bull market. Maybe we retest the lows in the low 1300s, that can’t be ruled out, but we shift toward gold’s strong seasonal trend in July, heading toward August, September, October…
Kevin: Which are typically good months for gold.
David: And here’s maybe an insight. If you’re a battered gold bug, or maybe just a gold owner, resentfully so, maybe you’ll revel in this. When you look at who owns gold, and what bets are being made on the price of gold, you actually have a near-certainty as to its next major step. So this is good news, I would consider, and I think would indicate that we are moving, not only higher in price, but considerably higher. And I would look for the beginning of this, if it’s not July, then certainly August, at least on this appraisal. Look at this: Commercial interests – these are the miners, these are the manufacturers – these are guys who, let’s face it, are on the ball in terms of the direction of the market they operate in.
Kevin: These are the guys who have to hedge their bets to be able to stay profitable while they are out mining gold.
David: Commercials have lightened their short positions. They are actually increasing purchases of gold in the futures market. And prices are at or near the cost of production. For any of the guys, this is considered a value. What I’m talking about is, let’s say gold, at $1400 today, has a cost of production of $1400. It’s a little bit lower than that, but let’s just call it that. You have nothing to hedge. You have no profit margin at all. You’re worried about surviving. There is no reason to short gold to lock in your margin because you have no margin.
Kevin: So if gold were to drop to $700, you couldn’t produce.
David: No, you’re out of business. But let’s say your cost of production is $300. Now you’re talking about the difference between the cost of production, $300, and the current price of gold, $1400. There’s an $1100 margin which needs to be protected. For you to short gold as a commercial interest, all you are doing is locking in your profit of $1100 dollars per ounce. The reason you are not seeing a lot of commercial shorts today is because you are so close to the cost of production. They don’t have enough margin to protect for it to be worthwhile shorting the market. In other words, “Where’s the downside? All we have is upside, or we’re going broke.” That’s basically the attitude, and on the other side of the equation, you have the speculative shorts – these are individual investors that have increased their short positions to levels greater than what we saw in 1999 to 2001.
Kevin: As a reminder, 1999 to 2001 was the bottom of the gold market.
David: The lowest prices that we had seen, coming off of the peaks at $875 in 1980, all the way down, that downtrend all the way down.
Kevin: So these guys could not have been more wrong.
David: Again, we have seen spikes in speculative short interests. If you want to look at the Commitment of Trader’s Reports, that is published by the CFTC on a weekly basis, if you are looking at those reports, what you see now, and over the last several weeks, is a spike in the speculative short category. Why is this important? Because it has always preceeded major moves higher in price. Is it July? Is it August? You have to say, “Well, when are these goons going to throw in the towel? When are they going to say, ‘We’re not getting what we wanted in terms of further down-prices, and now we have to cover and buy back our position, in order to cover those short positions.’”
Kevin: Something that strikes me as interesting, Dave, Roubini, a highly respected economist, came out last week and said that gold is in a bear market, it’s going to drop down below $1000, but what they didn’t tell you when they were playing that interview is that each time gold hit a bottom right before it moved to a new high. You’re right, the speculative shorts had huge positions. But then Roubini had publicly come out in 2008, 2010, and said, “This is it. Gold’s over. It’s a worthless investment.” So when you listen to someone who “is highly respected,” you probably ought to go back, especially these day with the Internet, you can google the quotes and see whether they were right anytime before.
David: Over the last 60-90 days you have seen this building of the short position, and that has helped drive the price lower. Covering the short position then comes in competition with a natural number of buyers, and this drives the price crazy. This happened in the summer of 1976. This happened, not only from that point, but all through 1977. When prices were not only recovering their previous peaks, but setting new all-time highs, finally going on to ring the bell at $875 an ounce, 750% higher off of those lows. It also happened, more recently, 2005, and again in 2008.
So remember that while volatility on the downside is not fun, for a veteran of the last ten years, I would suggest that your memory of past painful experiences is not all that clear. That’s because you’ve had a displacement of pain with something that has been greater, proportionally. The pleasure or the benefit of the recovery, and that has been immediately on the heels of this spike in short, speculative interests.
So what do we have to look forward to? I think the rally coming off of the spike in speculative shorts in 2005 – that was nothing short of 70%. Over the next year, in 2008, you had an immediate move higher of 60%, but actually beyond that first year of 60% growth, it went on, it extended to about 109% gain. So the first part was short covering. The second part was momentum which carried it from there.
Kevin: Let me just clarify. You are staying that the guys who are usually wrong, the speculative shorts, right now are in more than they have been in any other time, other than these other lows.
David: Yes, they are more short the market than they have been in decades. What is important here is that they are more long – guess when they were more long than they had been in decades?
Kevin: Probably at $1900.
David: Oh, fall of 2011, so again, we’re not talking about a cast of geniuses here. The commercials, frankly, know their business. They know when to be long, they know when to be short. They know when to cover, and they know when to protect margins. That’s really not what we are seeing in the marketplace today. We have speculative shorts at levels we haven’t seen in decades, and we are closer by the day to a short-covering squeeze. And what are we witness to? We still have Wall Street badgering the gold-owner. We have the Fed confusing all markets as to the fundamental rationale for pricing, and not just in gold, but virtually every asset class, just like the house of mirrors. All reality is what it is, but it can be grossly distorted to the naked eye. You have to look past that distortion.
Kevin: Strangely, though. We were talking about the advantage you have if you are not looking into the distorted mirror, and you get a clear signal. And of course the insiders who can print money and know what is happening ahead of time. That’s one of the groups that get that information. But the Chinese – look at what is happening in Asia. India is having to raise the tax on gold buying and tell their people to stop buying it, because they see what is going on.
David: What is radically happening in India is that there is so much gold being imported in the first part of this year that it is radically distorting their trade balances to the point where everyone is saying, if we don’t clamp down on this, if we don’t change the rules, if we don’t increase taxes, if we don’t do something, our trade balance is going to be completely out of whack.
The Chinese this week, surprise, surprise, they approved, not one, but two gold exchange traded funds. These were exchange-traded products just like GLD, SGOL, CEF. These are your proxies for the price of gold. Metals backing them, but, lo and behold, they want to do the same thing in Shanghai.
Kevin: And where are those metals coming from, but the crazy, stupid, distorted West right now?
David: ETFs in the west send their gold to the East for products, for Chinese investors to buy, and again, have the proxy for the metal. You can buy it and sell it with a mouse click, if you are in Shanghai, Beijing, or any other city in China. Gold outflows from the U.S. and European ETFs… The bright side here is that they are stabilizing, so you are not seeing the radical outflow that we saw on the first 90-120 days here in the U.S. and Europe. In that circumstance you had ample supply, in fact, overwhelming supply, and inadequate net demand. Central bank demand was strong, but ETF liquidations were overwhelming.
That set of circumstances, obviously, is leading to lower prices. That is turning over. The next 90 days, you are going to be looking at inadequate supply and ample demand, along with higher prices. So keep your eye on the path ahead. If the future price of gold is of interest to you, it is also worthy of note that there has been a massive pickup in insider buying at your precious metals miners. These are insiders, folks that are either going out of business, or they are looking and saying, the worst is behind us, now it’s time to load our personal boats with company shares that no one seems to appreciate. When insiders are selling, take note. We’ve talked about that over and over and over again. When insiders are buying, take note. They know something about their markets. This is their future. This is their retirement. They’re either crazy, off their rocker, and on the way to the poorhouse, or they’re right, and we’re near a turn in the market.
Kevin: You had brought up that George Soros had been loading up on miners, so he had that going, and he would be considered, necessarily, an insider.
David: Just the old frustration of Bloomberg reporting and CNBC reporting that Soros sold, sold, sold, sold, sold 2 ½ million dollars worth of gold. Meanwhile he bought, bought, bought, but that did not go announced, 25 million dollars’ worth of call options on the junior miners in the same period of time. He decided to take something that was a fairly stable and boring investment in the metals and make it a lot racier and a lot primed towards immediate recovery and growth in the miners, and I say immediate because call options have an expire-by date. On top of that you are talking about the part which is most charged, in terms of growth, the junior miners.
Kevin: How about China, though? Again, the Secretary General of China…
David: (laughter).
Kevin: … the China Gold Association, said, “You know, I don’t think this dump that you guys did may have had the impact that you wanted.” What was the quote?
David: “The dumping recently of holdings in gold exchange traded products by overseas investors may not prove to be a wise move.”
Kevin: That was an understatement. They just continue to rake it in. You were talking about supply being ample out of the ETFs, Dave. We’re talking about 400-ounce bars. I’m sorry, I don’t buy 400-ounce bars. In fact, we sell a lot of gold. I’ve never sold a 400-ounce bar. The average person is going to go up to maybe a kilo. But these bars, there was a lack of supply of everything smaller than those 400 bars.
David: I was on a mountain bike trip over the weekend, just a quick ride before breakfast. I was observing a few things and it just had me thinking about lots of things. I have observed over the last decade that investors very often just don’t know themselves, and they are subject to internal pressures and emotional influences, which put them at odds, frankly, with any real long-term investment success. They are greedy when they should be cautious.
This goes back to those sort of speculative longs who are buying at the top of the market, and they are cautious when they should be greedy. Most investors today would say, “Well, we’re just not interested in gold, or we assume that the price is going even lower,” when they should be buying. I think you know what I mean. When we are facing an existential threat, and many investors feel this way, “Will I outlive my money? Will my portfolio run to zero?” When you are in those circumstances and you are experiencing either frustration or fear, the tendency is to respond on the basis of personal feelings to that visceral threat. Fundamentals in the market, even if they are out there, get crowded out by the feelings. Objective fundamentals get crowded out by the feelings in the world of subjective threat and survival.
Kevin: Dave, this decline between 2011 and 2013 has hurt, but if you look at the chart, it is similar to declines that we have had in the past right before, as you have pointed out, large moves to the upside.
David: Yes, so fixating on numeric loss, not to ignore it, but let’s just say that if you fixate on it, you’re going to be crowding out other realities. Recall that 2005 and 2008 period. Yes, we saw precipitous declines, 25-30% decline…
Kevin: Sounds the same, yeah.
David: … before short covering, and the natural buying which came into the market, which took the price to new highs. This is the issue of how quickly we forget past pain, but how easily we are consumed by anything in the present which is painful.
Kevin: David, you were talking about a mountain bike trip. We live in a mountain biking community, and Ned Overend is the legend around here. He was the first World Champion Mountain biker. He wrote a great book, has done a number of videos on how to mountain bike, but one of his key, key issues is, don’t look at the front of the bike, look down the trail. Don’t look down at the obstacle right in front of you because it’s already too late, go ahead and continue to look at where the goal is. I’ll tell you, Dave, that is an amazing exercise in faith, but it changes your riding.
David: I finished the mountain bike ride this weekend, and I was explaining to my boys how when you fixate on a root, or a rock or a tree, it almost guarantees a direct encounter with said object. There is one particular turn on my favorite trail. It is a very sharp turn. It has a nice, sandy patch at the outer edge, and the more you look at the sandy patch, the more there is almost a magnetic draw to it. It is a self-determining, self-defeating outcome. I have crashed there many times, trying to avoid it, but you know what I was doing? I was giving it my full attention. To avoid the crash, you have to look beyond that point in the trail, steer your self-control around it. Your eyes go, and your body follows.
Kevin: That’s exactly right.
David: Which is tough because you’re looking at the point of threat, and you actually have to leave it behind, and your natural instinct is to focus on what could damage you, perhaps irreparably, head-over-heels, so to say, a superman is what they like to call it in biking parlance.
So to avoid the crash, you have to look beyond the point, you have to have your eyes directed to that point around the curve, and lo and behold, you get there. It’s no different with investing. Fixating on an obstacle versus the road ahead leads to, shall we say, disappointing outcomes. Fixating on a risk variable, frankly, determines the outcome. Fixating on a risk is not what you do to get by a risk.
Kevin: And it’s not just with risks that there is an analogy, Dave. There are so many analogies, and there are other sports that apply, but let’s face it. You’ve got to keep peddling. It can be painful sometimes, but you’ve got to keep peddling. (laughter)
David: Yes, the same is true. If you freeze up and don’t keep on peddling, you lose momentum and any obstacle that is in front of you, you now have an inability, just in terms of the laws of motion, to overcome it. I came home from the ride and I said, “Boys, listen. This is really important. What is on the horizon is more important than what is 2 inches in front of your tire,” and I’ve found the fastest way over the handlebars is to fixate on 2 inches immediately in front of me. Where you set your vision determines how much you over-correct, and the likelihood of you not encountering well the obstacles you have to your success.
Yes, you have a novice on the trail which will, if you want to imagine, average the trail, he is on and off, and he is over-correcting and this is what you see with a novice. His movements are erratic, he’s dodging every obstacle. A more experienced rider on the trail is looking farther ahead. The obstacles underneath you, you actually naturally adapt to, and you pass over very quickly, as long as your vision rests beyond the point of threat.
Kevin: David, you are equating this horizon with holding onto your gold and accumulating more, because the natural outcome is that we are going to have inflation, we’re going to have a devaluation of the dollar, but don’t freak out with the price right now.
David: Gut sentiment in the gold market reflects a bike wrapped around a tree. (laughter) It’s been a disaster. Look at the Holbert Gold Newsletter Sentiment Index. It hit a record low of -43 last month. Record low. -43.
Kevin: That’s a prescription for Prozac, is what that is. (laughter).
David: Well, sentiment is broken, so if you’re feeling like a battered gold bull, so is every other gold bull. There is only the difference between those who hold fast and those who throw in the towel. And throwing in the towel is most common, guess where? At the lows.
Kevin: At the bottom.
David: At the lows. Never, the highs, when it would make more pragmatic sense, but you have the errors of optimism on the upside, and the errors of pessimism on the downside. Remember, the market just doesn’t care. It doesn’t care about your personal circumstances, it doesn’t care about your needs, it doesn’t care about your wants, it doesn’t care about your income expectations. It is a reality unto its own.
You need to keep peddling, and that’s going to keep you from falling off the bike altogether. You have to realize that the market is what it is. It will do what it’s supposed to do, when it wants to do it, not on your own timeframe. Whether it is July, August, September, our date with destiny – $3000 an ounce, $5000 an ounce. Is it this year? No. Is it next year? No. Will we have to stretch our time horizon to 2016, 2017, or 2018, to see a $3000, $3500, $5000 gold price? Sure.
So with that in mind, if we keep our eyes on the prize, you are telling me it actually matters to you that there is a $30 dollar dip in the price of gold on a given day? Or let’s say there is a $300 dollar dip in the price of gold in a five-day period. On it’s way to $5000? You care? You actually care? This is navigating the trail with your eye two inches in front of the tire. I can guarantee where you’re going – straight over the handlebars. No more, no less, that’s where you’re going. You have a date with destiny. It’s just a very different destiny than the rest of us share.
