Podcast: Play in new window
- Hot Money (Fickle Money) Absent From Gold Market
- Central Banks Providing A Structural Bid In Gold
- Register For The June 17 Webinar
“Under the surface of the markets, there’s a lot happening. If you’re looking at where the Dow, the S&P, the NASDAQ, AI companies are quoted, you would think that not only is all well, things have never been better. Those words, “never been better,” are a little bit like “this time is different.” There’s a cautionary tale in there. You should look around and see if there’s anyone heading to the exits. If anyone is not heading to the exits, it might be advisable to do so, at least with a part of your capital.” —David McAlvany
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Kevin: Welcome to the McAlvany Weekly Commentary. I’m Kevin Orrick, along with David McAlvany.
David, after listening to Morgan this morning, sometimes an axiom or something that you think is absolutely a fact is more like a theory, and then it breaks down to maybe a hypothesis and then it breaks down to just being pure error. As we look at today’s society and as we look at the markets, we can’t treat the dollar as if it was gold like we did back in the 1970s, right after coming off of the gold standard.
David: We can’t treat the 60/40 portfolio like it’s the standard for portfolio construction. There’s a number of things that are tried and true, except they’re less true and they’re still being tried. I think that’s an important thing to keep in mind. The world is quickly changing.
Kevin: One of the things that I love about the team you’ve put together though, Dave, is that they’re willing to rethink what they thought were axioms in the past and go, “Well, maybe that’s an error right now. So let’s rethink and let’s test all things and hold fast to that which is good.”
David: Yeah. Well, we’ve got an opportunity for you, the listener, a week out. The webinar June 17th is 2:00 PM Mountain Time. The title for the presentation is “When Old Assumptions Fray: Positioning for the New Market Order.”
Kevin: Well, and Morgan’s going to be talking, Philip Wortman’s going to be talking. Who else are we going to have on the call?
David: Robert will be on the call—
Kevin: Robert’s going to talk.
David: —and I’ll be on the call.
Kevin: So don’t miss that, that’s always a great way to hear from multiple perspectives what’s going on and what we’re thinking.
David: For those of you who are watching on YouTube, these are not new glasses. These are readers, it’s what happens when you’re 50-plus. I’m wearing my—
Kevin: You need cataract surgery. That takes care of everything.
David: Oh, I see. I see. Well, last week was interesting. Last week was a bruiser all around, particularly for precious metals and related shares. It is in my opinion, my strong opinion, that the metals’ multi-decade secular bull trend remains intact, and this is the kind of correction needed to tame animal spirits, to curb excessive enthusiasm on the way to considerably higher prices.
The massive move of 2025, which was a 2,800, $2,900 move, depending on whether you count spot pricing or futures pricing, it has corrected beyond the 38% Fibonacci levels nearly to the 50% retracement level. That was back in March. To touch the 50% retracement level, we would need to get to about 4,020 per ounce.
Kevin: So we’re not far from that.
David: Unpleasant as that may sound, this resets the trajectory for a further move higher, wiping out all of your late comer sentiment and opening the door to our anticipated eightfold move off of the 2015 lows at 1,050.
Kevin: Yeah, and it’s interesting. I want you to talk about open interest going forward because we actually, the open interest on those contracts dipped below that 2015 bottom when we hit 1,050. That was a great signal that it’s a good time to enter the market.
David: Yeah, we’re below those levels now, already open interest in the futures market at 332,000 contracts, 13-year low, bullish sediment in mining shares that’s reached less than 3% back in March, down from 100%. I mean, it was a sure win thing as we headed into December and January.
Kevin: 100%, yeah, sentiment, and now down to—
David: Dropped to three.
Kevin: Now we’re at what, seven, eight?
David: Currently sitting at 7.6. Revisiting the low single digits would, from a contrary indicator perspective, from that standpoint, would be the kind of environment from which a next leg higher would commence. Lastly, the daily sentiment index for gold has hovered in the low 30s, which is neutral to negative, and it has on rare occasions hit the single digits. Every time it has hit the single digits, it’s marked the lows prior to a recovery. We’re not there, but we are close.
Kevin: Right, but you are saying and you’re repeating that the actual structural theme of a bull market, you are bullish.
David: Oh, very bullish. Very bullish. That’s based on a variety of macro factors which haven’t shifted at all. We are bullish, and I guess a part of our position as asset managers, we’ve already defensively trimmed positions. Now we’re patiently waiting to get to full aspirational targets. Averaging in at these levels and continuing to process around further lower support levels is what we would advise, whether it’s the physical metals or the kinds of things that we’re invested in on the asset management side.
Kevin: So the short term bulls, they’re not there right now.
David: No, they’re not.
Kevin: But the long term bulls?
David: The short term bulls, the hot money crowd, they’re on the run. Bears have the upper hand. That continues to be the case, but we’re getting very close to those lows. Again, strong support levels, and central banks like the People’s Bank of China are acting as if they can read our minds. In the past months they’ve added to their holdings for the People’s Bank of China. This is the 19th month in a row with 320,000 ounces, or roughly 9.95 tons, added most recently. So you’ve got investor outflows, which drew down about 2% of ETF holdings, still showing a net gain for the year of 17 tons year-to-date, sitting in aggregate of 4,121 tons. That’s just slightly off the record highs of 4,176 tons.
Kevin: Something you said in our meeting before we started this today was that right now in the precious metals market, the investor is somewhat insignificant. It’s the central banks, it’s the guys who are buying 19 months in a row, they’re the ones who are actually influencing the bottom of this market. At some point it can’t go lower because they’re buying every day.
David: Consistent buying for structural and fundamental reasons, for a whole host of reasons, which we’ll get to, and they pick up the pace when the price is lower.
Kevin: Oh, they love it.
David: People’s Bank of China trimmed back the pace of purchases as we got into December and January. Then with prices selling off February, March, April, May, they’re back to more aggressive.
Kevin: You know what the central banks are not buying? Technology ETFs right now.
David: Or Treasuries, for that matter.
Kevin: Oh yeah, they’re selling Treasuries.
David: Yes, but since January it comes as no surprise that as gold has sold off, technology ETFs have captured inflows, hot money moving from one trade to the next.
Kevin: Talk again about what you call hot money.
David: We’re talking about pretty significant inflows. 39 billion has doubled in the last two months to about 84 billion going into ETFs, actually leveraged ETFs.
Kevin: Wow.
David: That was the amount just going into leveraged ETFs on the AI trade.
Kevin: That’s on the one-for-one basis, then it leverages from there.
David: Yeah, two, three, four times.
Kevin: Wow, wow. So hot money, let’s go back and talk about hot money. You sometimes talk about value investing, that’s early money. Would you consider hot money late money?
David: It is. It’s the momentum crowd, and that includes some hedge funds. That includes a lot of investors who are probably less thoughtful about the world we live in and just looking at the screen and saying, “That looks green, give me some.” Part of the reason we remain unconcerned by the precious metals market volatility is that hot money is in fact late money, and it’s motivated primarily by momentum. Losing that audience is temporary, with a very firm base of central bank acquirers and long term holders more focused on structural changes around the globe. Gold is rising in recent years because the world is repricing trust.
Kevin: That was Morgan’s point. On certain things that we’ve assumed in the past, they don’t trust the dollar.
David: Yeah. I mean, it’s trust in sovereign balance sheets. It’s trust in reserve currencies. Gold is repricing trust in central bank policy and trust in paper claims. Central banks are not chasing yield, they’re buying optionality. They’re positioning and buying neutrality, and they’re focusing on final settlement. Wall Street’s higher price targets by year-end, they assume that private investors, that hot money crowd, they will eventually follow the official sector into the same trade.
Kevin: When we talk about central bank buying, for most of the years that I have been with the company, which is close to 40 years, the central banks had more US Treasuries than they had gold. Now that’s reversed. We’ve got central banks holding larger reserves in gold at this point, and continuing to add, and they’re subtracting their Treasuries.
David: Yeah, it’s central banks making critical decisions with billions in capital to address a rapidly fracturing world. First, they want reserve diversification. Gold recently at 27% of foreign reserves, again, these are the assets of central banks, versus 22% of those reserves held in US Treasuries. It’s evidence of that, again, this repositioning for a fracturing world. The March TIC data, Treasury flow data, showed China dumping an additional 41 billion in Treasuries and Japan dumping 47.7 billion in Treasuries.
Kevin: So there’s outflow with Treasuries and inflow into the central bank’s coffers with gold.
David: Right, reserve diversification. Certainly you could look at currency support in the case of Japan. In either case, we’re looking at a reprioritization and a reconfiguration of reserve assets for a different world.
Kevin: You were talking about repricing of trust, but it’s not just in the repricing, it’s in the repositioning, isn’t it? They want to know where that is. Remember about a decade ago that Germany asked for a fifth of their gold that we had here in America?
David: Right.
Kevin: Remember that was about 300 tons, if I remember.
David: That’s right. That has become sensitive. Central banks are concerned about trade fragmentation. They’re also concerned about custody, where in the world their assets are held and by whom. Settlement and seizure risk became something that was very front-of-mind for them following 2022 when the U.S. Treasury seized half of Russia’s reserve assets.
Kevin: Yeah. What a signal you send when you basically take away that security by weaponizing the dollar.
David: Yeah. It doesn’t take a PhD in mathematics to figure out that the U.S. has a fiscal credibility problem. And so this is another issue and motivation by central banks to say, “Maybe the reason we’re not interested in your paper IOUs is because we don’t think it’s the same kind of bet that it used to be.” Debt levels are high, deficits are untamed, interest expense continues to rise. And with rates creeping higher, interest rates creeping higher, so will the interest cost associated with debt being rolled over this year, which is about a third of the total.
Kevin: Well, the thing is, you don’t have a lot of alternatives because the U.S. dollar is the reserve currency of the world. But look at some of the other currencies that people have gone to in the past, like the British pound.
David: Yeah. Japanese yen, the euro. Our treasury is not alone. So when we think about the fiscal concerns or there being a credibility problem with various treasuries around the world, UK debt levels are growing at the fastest pace globally of any country. Well, with one exception, Botswana.
Kevin: Oh, Botswana.
David: Yeah, Botswana.
Kevin: There’s your option.
David: Japan sits with debt-to-GDP north of 200% and is on the horns of a dilemma. Support the bond market or support—
Kevin: Or your currency.
David: —the currency market. And so despite a $78 billion yen intervention last month, which was followed by a brief respite from decline, the yen is back over 160 to the U.S. dollar. Robin Brooks from the Brookings Institute says, what would be a bond market crisis without the Bank of Japan has morphed into a currency crisis. One way or another, Japan’s debt overhang is making itself felt.
Kevin: Yeah. So, one of the things that we watch and have been watching for years is, what is the opportunity cost of holding something in a certain area? And what we’re talking about is real rates of return, not nominal rates of return on interest. But what kind of interest do they have to pay to be able to save the currency?
David: Well, I mean, when you think again about central bank motivation to own gold or to own some alternative, central banks are keenly aware of real yields. News outlets in recent weeks, almost on a daily basis from the Wall Street Journal or the Financial Times or Barron’s, CNBC, Bloomberg, they’ve claimed that gold weakness in this period since January 28th is in anticipation of higher yields in the U.S. And it’s not higher nominal yields that matter, it’s real yields—
Kevin: It’s real.
David: —net of inflation.
Kevin: Well, and so that brings us to something that you’ve talked about for years. You read years and years ago the Summers-Barsky thesis, which said that real rates have to be substantially higher than what the inflation rate is for someone to sell their gold and buy Treasuries.
David: That’s right. So Summers-Barsky demonstrated decades ago that extremely positive real yields act as catnip to capital flows. And when there’s too much opportunity cost, it weighs on gold demand as capital migrates towards a positive yield, positive real yield. So, the opportunity cost of holding gold has to be significant enough to warrant a reallocation. But wait, we have PCE and CPI, both at 3.8% coincidentally. We’ve got PPI at 6%, and these are numbers—
Kevin: That’s producer price.
David: Yeah. The wholesale price index. These are numbers that match the level of the yield curve out to one year, and only provide 35 basis points of benefit against the opportunity cost of holding gold—35 basis points of benefit if you go out to two-year maturities, 76 basis points if you go out to 10 years. That is not a sufficient difference to be seen as real opportunity.
Kevin: That’s close to breaking even. And if you’re paying tax on that interest, you’re not. Yeah.
David: So if you measure against PPI, all yields are negative out to the 30-year mark on the yield curve. So, where do we go from here from the standpoint of real yields? We’ve repeated this over and over. PPI, the producer price index, bleeds into CPI and PCE over time. You’ve got wholesale cost inputs that ultimately get passed on through the consumer on a lag. Ergo expect a few basis points of positive yield to disappear by year-end as CPI and PCE get moved higher.
Kevin: Dave, a lot of trades are done these days at lightning speed, sometimes 500, 600 trades a second going on, and they’re algorithmically decided. This was happening even before we had the talk about artificial intelligence. Those algorithms, though, don’t really take into account long history, do they? They’re trading on maybe what happened last month, what happened last year, maybe over the last three or four years. But long-term history, this is where we go back to, does an axiom become an error?
David: Yeah. The businesses, news outlets, and algorithmic headline traders, they don’t know a deep enough history to get what is going on here. Real rates and dollar vulnerability are something that central banks are keenly aware of. And central banks, like us, also have an insurance lens that we see gold through. It’s not merely a momentum money maker lens like the hot money crowd. Gold protects against both inflation and it protects against fiscal dominance, financial repression. These are all policy tools, which history will record I think as policy errors. So in essence, gold serves as insurance against policy error, which is again, it’s not lost on the central bank community.
Kevin: Right. Yeah. So you’re talking about central banks, and they do have to look at the long term because they’re also looking at the stability of the country for actual currency trading and currency reserves. So with that, though, the central banks are buying gold, selling Treasuries. We’ve said that earlier in the program. That seems to be a floor in this market. You want to pay attention to them instead of the hot money crowd, which is the late money crowd.
David: Yeah. I mean, the central banks create a structural bid in the gold market.
Kevin: It’s built in. It’s like a framework or a scaffolding.
David: For as long as they have reasons to be reallocating capital, which those reasons seem to be increasing over time, not decreasing, not diminishing. There is an appetite that hasn’t found its limits yet. This is why we’ve said central banks put in the price floor. So you’ve got investors, you’ve got ETF buyers. They add to cyclical upside in the gold and silver markets. They push the price ceiling, but the structural floor is established by central bank buying.
Some of those investors, when you think about the dollars that flow in on a temporary basis, they’re fickle, they’re flighty, and they’re already gone. And others are firmly fixed on the fundamentals driving this longer-term trend. Those are folks that probably prefer physical metals to an ETF holding. But we spoke last week about value investing, and just to return to that for a moment—
Kevin: The opposite of hot money investing.
David: Yeah. Value investors compound off a low basis, and sit uncomfortably at times through periods of unpopularity. And I say this regarding clients that we have helped steward wealth into the metals. Billions of dollars we’ve positioned in metals, and it’s worth many billion more today. They are compounding off of a low basis. And as an encouragement, as a reminder, the most powerful basis compounding comes at the end of the cycle. In essence, the best is yet to come.
Kevin: So, a discipline. And now this is a discipline that I’ve had to learn over the years. Used to be I would check my phone or I would check the computer, I’d see what the gold market was doing. Now I wasn’t managing money minute by minute, I was just buying every couple of weeks. But I’ve developed a discipline, Dave. If you’re not managing money professionally, you shouldn’t be checking the price all the time. It shouldn’t be the first thing you do when you wake up in the morning, right?
David: I’ve traded futures, I’ve traded options. I’ve invested in just about every financial instrument imaginable. And it’s interesting to see what happens to my own sense of time, depending on the instrument I’m invested in. I buy physical metals and I don’t think twice about it ever again. The price is the price.
Kevin: It’s long term horizon.
David: Right. It’s a long term horizon. Trading options and futures, I’m interested in the tick by tick change in the price. And I stopped trading options many years ago because I found it negatively impacting my perspective on everything.
Kevin: It was shortening it, turning it into just microseconds.
David: The only thing that mattered was today.
Kevin: Yeah.
David: The only thing that mattered was options expiration this week—
Kevin: So, what would you advise?
David: —or this month or this quarter.
Kevin: What would you advise for the person who’s wanting to consider themselves a value investor?
David: Yeah. Today’s market volatility is dizzying. Watch the price action of any asset every day or multiple times a day and it’ll drive you crazy. And my advice is: stop it.
Kevin: Okay. But like what would you say to the person who says, “All right, I’m not going to check it every day, but what should I be looking at?”
David: If you want to know when to worry, worry about the gold price when the Dow/gold ratio is three to one.
Kevin: Where are we at now? We’re 10 or 11, right?
David: 12.
Kevin: 12?
David: Yeah.
Kevin: Okay. Yeah.
David: Worry about the Dow gold ratio at three to one when hot money is crowding into gold, and that’s sort of with reckless abandon. Again, gold is unique in this way. The panic into gold is usually for the preservation of capital, not usually to capture upside gains.
So, what we saw in December and January was opportunistic buying by hot money. It was not what you see characteristic at the end of a bull market when there’s a broad base of holders, whether it’s central banks or investors, and now there is an external or exogenous catalyst for interest in gold. Could be a currency concern, it could be debt market concern, it could be fragility within the financial markets themselves. It could be concerns over counterparty exposure and risk where you just need to own an asset that isn’t going to zero in the context of everything else being questioned on that same basis.
Kevin: It’s like a life preserver on the Titanic.
David: Again, we haven’t seen that kind of traffic into the gold market at all yet. So again, the panic to preserve capital, that’s very different than the energy and interest that we saw December, January, the fourth quarter, beginning of the first quarter of this year, which was very much the hot money crowd. So I would worry. I would worry when the cocktail party banter includes conversations about Barrick and Newmont mines.
Kevin: When your friends are saying, “Hey, what do you think about gold?”
David: Instead of Nvidia and semiconductor stocks.
Kevin: Right.
David: So, speaking of Nvidia, does anyone at the cocktail party today care about Nvidia setting up SPVs, special purpose vehicles, to buy their own product and book them as sales?
Kevin: Yeah.
David: You can look this up, Valor Compute Infrastructure. The last time we had a fabulously popular Wall Street darling pulling those shenanigans was Enron.
Kevin: I have a good friend that I go to church with who lost everything in Enron. He lost his entire retirement.
David: I have a good friend who was trading natural gas for Enron, and when they moved to trading dark fiber and wanted to create their own contracts for this new thing, this internet craze was taking hold, right? And you needed to be able to trade fiber optic capacity. And Enron was experimenting with this, and then they started to create these special purpose vehicles to do all kinds of crazy stuff, sort of out of the purview of, well, of everyone.
Kevin: But they were buying their own shares.
David: Do you know what he did? He sold every share of company stock and quit his job. It was an absolutely bold move.
Kevin: Wow.
David: And he had colleagues that had 100% of their retirement tied up in Enron shares. That went to zero. So I think there’s a lot of investors today dancing with the ghost of Jeffrey Skilling. If you don’t know the names Bernie Ebbers, Ken Lay, Jeffrey Skilling, you wouldn’t recognize those ghosts as ghosts, and you might not recognize the accounting gimmicks that a company, unsustainable, last gasps of bull markets either.
Kevin: Those were the days, Dave, when you were just entering the stock brokerage industry. It had to make a huge impression on you as you were watching that.
David: Absolutely. Absolutely.
Kevin: So let’s go back to the Dow/gold ratio because you were saying at three to one we need to start thinking about moving from gold, some of it, go over into the stock market. Being at, you said about 12 to 1 right now.
David: Yeah, 11.79.
Kevin: Okay. So where do we go?
David: The Dow/gold ratio this morning, 11.79. The gold and silver bull market has another leg higher, which corresponds to the Dow/gold ratio landing in the low single digits. If you want a trigger for selling or reducing your metals exposure, that is it.
Kevin: It always has been.
David: Yeah.
Kevin: Yeah.
David: Three to one is what we landed on prior to the Russians invading Afghanistan, and with the assumption that they would march through the Middle East, control the Saudi oil fields, you had 747s loaded with gold exiting the Middle East on its way to Switzerland. That panic into gold—because they were going to lose their cash flowing assets in the Middle East—
Kevin: That’s what you were talking about earlier.
David: That drove the Dow-gold ratio from an economically viable and explainable three to one to a panicked one to one.
Kevin: Isn’t that amazing?
David: And so I don’t know that we have a setup—
Kevin: When gold equals the Dow, that’s one to one.
David: And maybe we don’t see that. Maybe we don’t see that because, again, it took this external geopolitical event, the Russians invading Afghanistan, to take it from a three to one based on economics to a one to one based on geopolitics.
Kevin: Who were the guys, who were the investors that were heavily invested in precious metals and commodities that moved—they saw that and they moved out? What was the name of that guy?
David: The Bass Brothers.
Kevin: The Bass Brothers.
David: Yeah. The Bass Brothers had hired a Goldman Sachs alum to advise them on their asset allocation strategies. And they had ridden the hard asset theme hard through the ’70s and ’80s.
Kevin: All the way up.
David: All the way up. Rainwater advised that they move to cash, and they sat in cash for 12, 18 months clipping a 16 to 20% coupon. There is interest rates like—
Kevin: I remember those days. Yeah.
David: And then he advised that they move to equities. They bought the Dow and your large cap stocks in 1982, and—
Kevin: We were just off of that one to one ratio. Yeah.
David: That’s right. So they converted, elevated, inflated, if you will, hard assets into depreciated and cheap paper assets and rode the next paper bull market from ’82 to the 2000s.
Kevin: And this is what you’re talking about right now when we’re watching the Dow/gold ratio.
David: Yeah. By the way, the operational leverage in the associated shares, if you’re talking about gold and silver, they are the place for growth, the growth play of the next several years. I think the commodities will reflect an insurance bid, for the reasons previously mentioned, and they are the safe way to be in that market. There’s far more volatility with the producers, but companies digging up that product, they are the growth play.
Corrections off of peak levels in January, they’re shaping up to offer a great basis to compound off of, whether it’s the shares or the physical metals. Of course, we’ll let you know if something changes there. Perhaps we will have world peace emerge. We may have liberal democracy prevail. We may have a new period of a geopolitical cohesion emerge. But until then, I think it’s safe to assume that geography matters.
Kevin: So one can hope, but still buy gold.
David: And one can buy gold and keep their eyes open. Things can change.
Kevin: Sure.
David: And things can change for the better.
Kevin: I hope so.
David: It’s safe to assume at this point that geography matters, that choke point premiums are a thing. We see that in the oil markets and I think we’ll see that with more commodities as well. Being in a tier one geography is going to matter a lot more in the years ahead.
Kevin: So explain that, the tier one.
David: If I own gold in Bolivia, if I own gold in the Democratic Republic of Congo, Cobalt—
Kevin: You’re talking about gold mining.
David: Yes.
Kevin: Gold mining. Yeah.
David: Or Cobalt in the DRC. That’s very different than having the same asset exposure in Canada, really anywhere in North America. And the geography that appreciates and practices, respects, the rule of law.
Kevin: Contract law. Yeah.
David: Yeah. So again, we’re talking about choke point premiums. We’re talking about an era of sanctions and tariffs. We’re talking about an era of weaponized currencies. These are issues we not only face, but I think we’ll continue to face. We will continue to assume that supply chain fragmentation and prioritization of national interests. This is something that is an established trend, not just something we experienced in the fourth quarter of 2025 and now we’re onto clean capital flows and a reintegration process in the world. We’re talking about resource competition that is going to define the hard asset space in the years ahead.
Kevin: What happens if we shrink? I know that they’re already revising GDP down, and we’re in an election year so there’s a lot of lying going on about unemployment and GDP. We always go through that. But if we start to see actual growth shrink in these countries, what’s that look like?
David: The U.S. is in a substantially better position in terms of risk of recession. Part of that is because we are net exporters of energy, and much of the world are very dependent. So if you created an energy dependency ratio, you’d say these are the countries that are most at risk. And we’re at the bottom of that list, not at the top. Nevertheless, we have seen, as you mentioned, a curtailment of growth in the U.S. In late May we had a revision lower in Q1 GDP from 2% to 1.6, and the Atlanta GDPNow has slid from 4%—the estimate for Q2 GDP—it has slid to 3%.
Kevin: Which is a 25% difference between four to three.
David: Yeah. As GDP estimates shift lower, I think we do need to watch our debt-to-GDP figures. We need to watch stock market capitalization-to-GDP. We talk about the Buffett ratio often. These are numbers that can blow out. We had a similar dynamic to that in the late ’90s and early 2000s that occurred with PE ratios. Earnings began to fade even as prices ripped higher, and the PE ratios blew out to all-time highs, ringing the equity bell, so to say. Q1 earnings have been solid, no real concern there, unless we’ve seen the peak. In fact, you could argue that corporate earnings have never been better. Typically, when you’ve had a never-than, it’s worth keeping in mind kind of where you’re at from a historical perspective. It may never have been better, but is it sustainable, and on what basis?
Kevin: So I was down in Phoenix about a month ago for Mother’s Day, and I saw all the data centers that were being built. These are the largest buildings I’ve ever seen. I thought the buildings at NASA where they had the Saturn V— These things are gigantic. And I read yesterday that data center expansion, this tech spending, has exceeded everything we’re putting into roads and bridges and infrastructure. So is this a boom that could continue?
David: I think we certainly have had the data center boom—coming back to earnings for a minute—the data center boom is driving equipment and supplier earnings significantly higher.
Kevin: It’s got to be.
David: The hyperscalers, and I think this continues as long as the hyperscalers are spending hundreds of billions to build out capacity. What’s interesting is, those hyperscalers also have an earnings benefit because, from an accounting standpoint, those are costs that are not being recognized immediately.
Kevin: They haven’t had to pay for it yet.
David: Which exaggerates the positive look at their earnings. Of course, on that basis, their share prices are being driven crazy as well. So companies like Google, not only spending more on compute capacity than they’re bringing in in revenue, but they’re tapping the debt markets for tens of billions of dollars. They’re issuing tens of billions in new shares to generate the extra cash needed for the same purpose. And so I think the setup in semiconductors couldn’t be more extreme in the opposite from energy. We’re building what, in past periods of infrastructure booms—and this is one—may well be overcapacity. When you look at energy, we’ve under-invested for 10 to 15 years, and the demand has not diminished. As much as the Green Revolution was suggestive of being at peak demand for oil, that has not been the case. We continue to see demographic growth and the 1 to 2% increase in demand every year—
Kevin: Are you guys going to talk about that on June 17th?
David: Yeah.
Kevin: Some of that, that we’ve got a lot more to go?
David: We will. Yeah. And it match that steady increase in demand with supply that is changing. It’s not just supply that can be disturbed by geography, which is what we’ve seen with Hormuz, and of course we have this trend towards nationalization of interests. So if you have it, maybe you don’t send it out, or if you send it out, it’s at a premium. If it’s going through a particular geography and people don’t want it to get to its destination, they can charge fees along the way.
Kevin: One for you, two for me, one for you, two for me. They’re holding back some because, like you said last week—
David: The toll system in Hormuz could just as easily be the Chinese doing that through and around the South China Sea. They claim the whole space is theirs. And you’ve got trillions and trillions of dollars, both of goods and energy supplies, flowing through there. If it’s good for the Iranians to charge a toll, maybe it’s necessary to charge a toll for safe passage through the South China Sea. There’s supply constraints and new added costs that aren’t necessarily associated with each marginal barrel of production where geography is absolutely critical. All that is very different than what we have with the semiconductors where we’ve seen this before. Yes, today hyperscaler demand seems insatiable, so semiconductor companies are responding. What are they doing? They’re ramping up production.
Kevin: They’re spending their money, but they’re also borrowing money. You brought that up over the last couple of weeks.
David: Yet the likelihood of excess data center capacity is increasing, which suggests that the semiconductor production ramp-up may look like past episodes of cyclical boom and bust in the semiconductor industry. There’s a lot of people that aren’t going to want to hear that as we have semiconductor companies joining the ranks of the trillion-dollar market cap crowd. We’ve got 14 companies that are now trillion-plus in market cap, and a good number of those are semiconductor companies that are up only 1000% in the last year. So you could say, “Well, what are they really worth?” Well, given the current data center demand, maybe they’re worth a trillion. If data centers are overbuilding for compute capacity, well, we may have an issue. There may be overproduction of semiconductors, and this may be one of the greatest big shorts of all time. I’m not recommending that. But Fred Hickey of The High-Tech Strategist, he recalls, “Since the early 1960s, there have been 14 boom-and-bust semiconductor cycles, and I’ve experienced at least 10 of them. None of them,” he says, “can compare to this one.”
Kevin: Wow. So this is the biggest of all now. With that being said, okay, this is a huge boom, but when we look at private equity and private credit, some of these guys are gating redemptions right now. So when you see two totally contrasting things going on—you were talking about the difference between the overbuild, possibly, of the capacity of tech versus underbuild of oil—it seems to me like we’ve got an extreme going on right now where you’ve got this gigantic boom, trillions of dollars in these companies, yet private equity is saying, “Hey, you can’t cash out right now. We’re going to gate this.”
David: Yeah. It’s interesting because we originally saw issues in private credit, and the first justification was, look, AI is a real thing. It’s changing everything. And yeah, your software-as-a-service companies, we financed a lot of software business, and it looks like that was going to be a bad bet. We financed too much of it. So private credit was giving their mea culpa, too much went to software, but that’s the only area where we misstepped.
Kevin: Just give us some time.
David: As it turns out, there’s more than software companies that they’re having to mark down, a whole lot more, and we would be remiss if we didn’t mention that contagion—contagion is now a thing—moving from private credit to private equity.
And specifically, I’m thinking about the capped redemptions, so this is investors who are wanting their money back, and private equity was the first to say, “Well, you asked for 6, 8, 10, 15% of the total assets that we manage, and we’ve told you that you could only have five in a given period of time, so we’re going to cap it at that. And so those of you who are still asking need to stand in line.” That was private credit. Now it’s private equity.
Kevin: And you’re saying that’s a contagion. It’s becoming contagious and it’s getting more rapid, more often, more frequently.
David: Partners Group out of Zug, Switzerland— If you’ve never heard of Zug, Zug is a fabulous place to hang out if you’re trying to minimize your tax burden. A very interesting fact about Switzerland is each canton in Switzerland will compete for your business and negotiate with you with lower rates of taxation. And Zug happens to be—
Kevin: The number one.
David: —the number one place, or, in other words, the lowest tax rate in all of Switzerland. So you’ve got Partners Group, which is headquartered there. They’re limiting withdrawals from their flagship European fund. They’re also limiting withdrawals from their flagship US fund. And this is not an insignificant group of asset managers. $185 billion private equity shop. It’s decent size. So by no means insignificant.
So back to private credit, the Wall Street Journal ran an article last week discussing the massive increase in executive- and board-level insurance coverage for private credit operators. This is like your E&O insurance.
Kevin: What do they see coming?
David: Well, insurers are preparing for a wave of lawsuits and regulatory actions in the private credit industry. And they’re now—
Kevin: They’re seeing the wave.
David: Oh, yeah. They’re seeing it.
Kevin: It’s coming.
David: So you had Cliffwater, which was added to the list of private credit funds limiting withdrawal requests. Redemption requests hit 17% in the second quarter so far. And again, this is not a small group. 31 billion is their flagship fund. That was followed two days later by Blackstone’s flagship $79 billion fund, which has had to hold the line at 5% of withdrawal requests.
Under the surface of the markets, Kevin, there’s a lot happening. And if you’re looking at where the Dow, the S&P, the NASDAQ AI companies are quoted, you would think that not only is all well, things have never been better. And I would just say again, those words, “never been better,” are a little bit like, “this time is different.” There’s a cautionary tale in there. You should look around and see if there’s anyone heading to the exits, and if anyone is not heading to the exits, it might be advisable to do so, at least with a part of your capital. There is a lot changing within the structure of the rates market, with interest rates in particular. We talked about Summers-Barsky earlier.
Kevin: Right. Could it be a remnant of the past?
David: Well, and that’s what my colleague Morgan Lewis suggested. He said, “Yeah, that’s all well and good. Summers-Barsky does make sense, and yes, it does take real rates of return to draw people away from gold in the kind of environment we have today—”
Kevin: But what if you don’t trust the dollars that are paying the interest?
David: What he was basically suggesting is that, different now than the 1970s—or the ’80s even—when we had one, two, maybe even $3 trillion in debt, is that Volker could raise rates to double digits and create a very appealing—again, sort of catnip to the capital markets—draw away from gold and into the paper markets and into Treasuries.
It’s a very different proposition when rates are rising in this environment. With $40 trillion in debt, it takes something that is unsustainable and compounds the unsustainability. It highlights that higher rates in this environment are very different than higher rates in the 1970s and ’80s. It is not a destroyer of the gold theme. It actually underscores and reinforces its importance because you’re talking about the rot being noticed and drawn into the limelight for investors to say, “Wait a minute, if 40 trillion is unsustainable with a 3.37% interest rate, it’s catastrophic at a 5, at a 6, at a 7, at an 8% rate.” So rather than higher real rates being the kiss of death to gold, higher rates—nominal, and even real, rates—in this environment are the kiss of death to the bond market, which is like jet fuel to this particular gold market.
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You’ve been listening to the McAlvany Weekly Commentary. I’m Kevin Orrick, along with David McAlvany. You can find us at mcalvany.com. And don’t forget to check on our June 17th call with the team. You can find it in our notes on this show. Just go ahead and click on that and sign up. Listen, it’s free. And you can call us also at (800) 525-9556.
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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.
