December 2, 2015; Your Questions Answered 2015 – Part 2

Weekly Commentary • Dec 04 2015
December 2, 2015; Your Questions Answered 2015 – Part 2
David McAlvany Posted on December 4, 2015

The McAlvany Weekly Commentary
with David McAlvany and Kevin Orrick

Confidence is a very frail thing. Everything can be clicking and working and happy. One single variable can up-end everything. And it is this issue of confidence and stability – we assume that everything is fine, but it doesn’t take much to completely recalibrate the world that we’re living in.

– David McAlvany

Kevin: We start our second program on the questions and answers that our clients have given us. This is a restatement of a question we got a number of times having to do with manipulation in the market. It comes from Robert. He says:

How long can the big money interests keep manipulating the price of gold by selling short, and why is this process still legal?

David: Great question. I appreciate your frustration, too. The futures market has to remain, and it’s a very helpful and practical tool, and it does require that people be able to short a particular asset.

Kevin: We use it ourselves.

David: We do. We do, and that allows us to maintain an inventory, but not have the value of that inventory on our books diminish. We’re in a neutral position. If we own ten ounces long and we’re short ten ounces, we’re neutral. We own the ounces, but the fluctuation in price cannot hurt us.

Kevin: It’s a tool.

David: It’s a tool for us, and it was designed as a tool for producers. Those tools have been hijacked by speculators, and what they are looking for is one of two things. One is an asset exposure, nothing wrong with that, but typically, they will go to the futures market because it gives them access to the asset on a leveraged basis. So, put a dollar down and you have a five-dollar exposure. It allows you to have a small exposure with a large impact, either long or short that particular asset.

So the volumes have increased as speculation has increased, as a consequence of low rates. It’s not a surprise that the paper markets are being crowded by speculators, hedge funds, what have you, and it’s no longer the tool for the producer, or like in our case, serving the practical purpose of hedging an asset that is on our balance sheet.

Kevin: And sometimes those contracts will outnumber the actual physical metal by over 300-to-1, you brought that out last week.

David: 100, 200, have been the more normal numbers, but it has reached as high as 300-to-1, and we’re finding it across all commodities, not just gold and silver. So these are things that I think will find reform in the future as producers howl and say, basically, “We can’t do what we need to do because we’re being crowded out of the market by people who have no real long-term interest in the space.”

Kevin: But it cannot last.

David: So here’s a scenario: The Dow trades to 15,000. Just imagine this. The Dow trades to 15,000, it’s A) below the recent lows of 16,000, B) the Dow trading to those levels is the litmus that everyone watches and hangs their hopes on, C) investors respond to what they consider to be an uh-oh moment: “The Dow is going lower, and we don’t know how much lower it’s going to go.”

Kevin: They start buying a lot of gold.

David: They start increasing their precious metals allocations, this is pretty standard fare. And D) as the general public turns to increase their precious metals allocations, they discover that over the last five years 1000+ tons have been shipped to Asia and are no longer available at the snap of a finger or the click of a mouse. And I will tell you, in that moment, the game is up, the futures market becomes irrelevant in that time space.

Kevin: This ties right into the next question from Rob. He says:

It seemed a few years ago that the United States financial system was not going to make it to 2015. Yet, here we are, limping along, or charging boldly in the eyes of the naïve. I’m curious about what further tricks and techniques the federal government may yet have up their sleeve to further stall off the inevitable meltdown – interest rates, printing money, price controls, international manipulation, or something many of us have never really thought of yet? What further techniques are available to the government to push us into 2018, or even into the next decade, before the system finally collapses?

David: That’s interesting. We’re watching a decline in earnings, we’re watching corporate America run out of their bag of tricks, so in the real economy, there is growing evidence that they can’t push this off any further. But for the sake of argument, let’s say the government, not corporate America, is still trying to pull rabbits out of the hat. You mentioned price controls, Rob. That’s exactly right. Price controls would be one avenue to go down. It has failed in the past.

There actually has never been an instance where price controls have allowed a market to operate in a normal, healthy way. It’s actually quite destructive over time. You have regulatory interference, that could be limiting cash transactions, regulatory interference in the way businesses are operating, requiring certain things in terms of cash allocations, requiring product allocations for investors, that could be a specific percentage according to a “prudent allocation” into fixed income or stocks. That can be coerced. That can absolutely be coerced.

In World War I and World War II, it was sort of a passive-aggressive thing where they basically questioned your loyalty as a U.S. person. If you’re not buying U.S. government bonds, the question is, are you siding with the enemy? So that was a passive-aggressive way of saying, “You will buy.” But they could actually mandate it and say, “Okay, for pension funds, for retirement accounts, we’ve determined, we’ve done the studies (and of course, they can prove anything statistically, that’s just the nature of statistics, frankly) and here’s what you need to have in fixed income. Here’s what you need to own in treasuries, this is what you must own in corporate bonds.” They can force the issue, and buy time.

Kevin: One of the ways they can force the issue is by taking away people’s ability to choose what they do with their cash. You have talked so often recently about the cashless society. Wouldn’t that just be one more way that they could try to stall this thing?

David: Yes, I think negative rates and the cashless system go hand in glove. And so, about the time we start going to NIRP from ZIRP, that is, a negative interest rate policy from a zero-interest rate policy. If you can’t imagine it, go to Sweden or half a dozen other countries in Europe and it’s already in play, and I think you find the cashless monetary system shortly behind it.

I think one of the things that could also distract – and this is straight from Orwell’s playbook – what can distract the people is war. War solves domestic issues like nothing else. And so, about the time they run out of tricks, I think you can absolutely count on a major international conflict.

Kevin: This next question is from Sam, and he is asking what are your inputs as far as what guides this show? He says:

I listen to the show every week; I have for over five years now. I can’t help but wonder – do you guys listen to Alex Jones?

David: (laughs) No, never, honestly. I think he’s interesting, but no, we don’t listen to him. All of our inputs come from, I would say, half mainstream sources, half contrarian or not-so-mainstream sources, and we’re interested in the best data we can find, economically, financially, politically, geopolitically, where you have a combination of data and analysis.

And again, we tend to get more of our data from the mainstream and more of our analysis from the non-mainstream, because actually, if you look at the mainstream media there is not much analysis, it’s just facts, with spin – there is some spin, but spin is different than analysis. And so, no, we’re not listeners or regular viewers of Alex Jones, so I actually couldn’t tell you how much, if any, overlap there is in our views with his.

Kevin: As part of the inputs that you and I both read, Dave, you’ve convinced me to subscribe to Foreign Affairs for years now, and the Economist magazine. There are things that come in that are so mainline, mainstream, to me, propaganda, that it irritates me. But actually, you’ve encouraged me by saying, “Look, you need to read and understand what the true decision-makers are thinking and doing, whether you agree with them or not.” You’re not big on listening to a bunch of people who say the same things that you believe, Dave. You like reading and talking to the people who maybe you disagree with.

David: I think you’re right. Contrary views help us refine our logic and our rationale, and I think are very, very helpful. And they also reveal where we may have biases that are unjustified, and frankly, harmful.

Kevin: This next question I should probably read with a sound of disgust, because we’re all disgusted with gold manipulation, we’ve had a number of questions about it, but here we go again:

How can anyone predict the direction of gold and silver when the Federal Reserve and major banks are manipulating the prices through the paper markets? The supply and demand characteristics of the metals are completely useless.

David: They’re not useless. They are not currently relevant for the pricing of the asset, but they are, as we speak, creating a completely bifurcated market. You have the paper market where contracts are traded, you have the physical market where supply and demand actually do still exist and are relevant. And I think what you will find is that the next derivative collapse, or counter-party crisis, is going to separate the wheat from the chaff. These two separate markets are going to be seen for what they are, one having great value, and the other being virtually worthless.

So, I think this issue – it’s true with almost every commodity that trades with a contract via futures, they can be pushed around. And we use that market, as we mentioned last weekend, to hedge inventory. Not to play the price, but to hedge inventory. I think it’s very interesting to note, in Volcker’s memoirs, that he said, “I should have knocked down the price of gold.” And basically, what he was getting at is, there is a barometer of health in the economy. There is a reveal, there is a tell, if you will, in the economy, as to what is working and what is not, as to whether confidence is being built or degraded. And that tell is gold. And what he was suggesting is, if I can take away that tell, it’s a lot easier, using monetary policy, to drive an agenda.

Kevin: So never again criticize somebody who says, “Maybe there’s a conspiracy,” when Paul Volcker, himself, said, “I really should have conspired against gold.” (laughs)

Okay, next question. Steven asks:

What do you think the reasoning is with the IMF delaying the reserve currency proportion announcement to October of 2016, right before the 2016 U.S. elections? Is there any tie?

David: I think it’s coincidental. The timing delay had more to do with pushing for more reform implementation in the interim. It’s a little like dating and getting engaged. There is this period of time, it’s the last period of time where you can maintain expectations of change in a person, because once you walk down the aisle, practically speaking, you have what you have. So I think the IMF has been playing that and saying, “Well, we’re going to do something, we like the idea, we want you involved, but…” And again, it’s that expectation of reform prior to the deal being signed, sealed and delivered, walking down the aisle together.

Kevin: Question from Stan says:

Do you believe that just the election of a Republican president will result in some favorable economic developments apart from any laws that are subsequently passed by Congress and/or the executive orders that are executed by the president? Note: When President Reagan was first elected, the Iranian hostages were released within days because the Iranians knew that President Reagan meant business regarding the release of the hostages. My question is similar to that situation in that there may be certain people who know they had better change their economic control, manipulation, etc., when a Republican president is elected.

What do you think, Dave?

David: I think Reagan marched to the beat of his own drum, so he stands out in the field. When you look at fiscal change, I don’t think there would be any. The Republicans have proven to be, in many instances, more irresponsible than the Democrats.

Kevin: They spend just as much as Democrats, if not more.

David: The galling thing about that is that they have perfected the language of conservatism, but they are as fiscally irresponsible as the Democrats, which categorizes them, in my mind, as, generally speaking, liars.

Kevin: Okay but how about the geopolitical aspect?

David: Yes, there could, perhaps, be change there, as well as, perhaps, moving toward a more coherent energy policy. I think, on the regulatory side, the regulatory environment, you have Dodd-Frank and Obamacare which are in place, and it’s going to take years to dismantle them, if it’s possible. And so, I would say, day one, there won’t be any change, and in the first 90 days of a new Republican-controlled administration, again, on the regulatory environment side, I don’t there is going to be much change either. It really depends on which one out of the lineup running for president…

And so, I would say, yes, it’s possible, if it’s a Christie, if it’s a Marco Rubio, there’s a number that I would say, “No, there’s not going to be any change.” Why? Because they’ve already accustomed themselves to what it takes to create a career in politics. And that is, compromise, compromise, compromise, compromise, compromise. I think I mentioned this last week, and maybe this is just me being politically cynical – if someone has been in office for very long at all, that disqualifies them from being in office anymore, again, because they’re there and intend to stay, and that’s problematic to me.

I suppose if it were a Ben Carson, a Carly Fiorina, a Donald Trump, you might see more change, but again, that’s in part because those are characters who don’t have ties to politics. They’re not looking at a career in politics, they’ve actually had other careers, and they tend to, like Reagan, march to the beat of their own drum, for better or for worse.

Kevin: The next question comes from William, but I also got this from a good friend of ours, Harold. Harold, you know who you are. He said:

If the Fed raises interest rates, how will this affect the price of gold and silver?

David: This goes back to the Summers-Barsky thesis. It’s not a question of direction in terms of interest rates, it’s a question of the threshold. The critical variable is this: What real rate of return is compelling to an investor? If you’re sitting there looking at a 5% rate of return and there is zero inflation you get to keep 5%. That’s attractive. And you might say, “Well, I don’t want to own gold, I’d rather earn 5% interest, it helps me pay the bills.” But if you’re getting 5% as a rate of return and you’re losing 5% because of inflation, that real rate of return is zero. And you have to look and say, “Well, even though rates have gone from 1 to 5, I’m still not benefitting from it,’ and if there is not a sufficient benefit then there is also not an exit from the gold market en masse.

Kevin: So the Summers-Barsky thesis basically says you have to have enough interest to be beating inflation, plus have a little above that for someone to sell gold and go back into debt.

David: That’s exactly right, so I would make the distinction again between the threshold of a positive real rate of return and the direction of rates, because again, you have to know what your inflation number is, and quite frankly, a realistic rate of inflation, CPI, PCE, take your favorite measure, the folks at the Fed would argue there is zero rate of inflation, that’s why, frankly, there is no cost of living adjustment for those living on social security this year because there is zero inflation. You tell me if the cost of living is staying constant. That’s another issue. Threshold versus direction is the distinction I would make. I’m not concerned about rise in interest rates, it’s that composite picture that is more important.

Kevin: This is another question coming up here that again deals with, is China replacing the U.S. dollar? Let me go ahead and read this to you from Steven. He says:

With the central bank’s competitive printing of fiat currency in a race to monetize their debt in deficit spending, doesn’t China emerge as the dominant reserve currency based on their gold acquisitions?

I mean, they have been buying thousands of tons, Dave.

David: First, it’s a question of the depth of capital markets, and that is still dominated by the U.S., and that is the primary limitation for the Chinese. The bond market in China is about a quarter of a mile wide and about half an inch deep. It’s just not sufficiently deep to be taking on a global role, even a regional role to a very large degree, so they need to deepen their capital markets before that happens. It needs much greater depth if they want to take on that global role and move beyond the region.

The IMF inclusion, we mentioned this last week in brief, but the IMF inclusion is step one, and it improves the perceived stature of their currency. Step two is that central bank allocations to the Chinese currency increase and you see a larger allocation in terms of reserve assets by central banks. And then step three is a continual increase in reserve asset market share, and as I mentioned last week, north of 10% it really begins to hurt the U.S. dollar.

Kevin: So you would say, nudging out the dollar slowly is more likely than China just all of a sudden replacing the dollar as the reserve currency. But all bets are off in war, or something that we can’t predict. In other words, you are talking about if we continue down this particular path, right?

David: That’s correct.

Kevin: Next question. This is from Robert:

What will it take for gold and silver to break out, and when gold and silver breaks out will it be pretty close to the end of our dollar, a world currency, or a war.

Well, that’s a pretty good question, Dave.

David: It will take a shift in sentiment. And first, I think, you have equities. The world is perfect today, right? Who needs insurance today? Nobody does. That’s the perception in the market.

Kevin: We’ve got the central banks.

David: That’s exactly right. That’s exactly right. Even with the bombings in Paris late this year, the reaction was a one-day decline in almost every asset class except gold, and then a reappraisal of, “But wait, the central banks are active and paying attention to this, so anything that needs to be done will be done, and so we’ll be just fine.”

Kevin: So, you’ve got Yellen – dum de dum dum dum dum dum, right? (laughs)

David: Yes, so I think to the degree that equities are pricing in a perfect world, and insurance is unnecessary, again, you’re talking about a shift in sentiment. Looking at metals more specifically, if the world is imperfect, then metals are quite useful. So again, it is just when do people shift to the perspective of “All’s well and these guys have it under control,” to “Wow, they missed that one. Wow, their expectations came up short. Wow, they said that we would have X, Y, and Z, and we didn’t even get A, B, and C.” Again, it’s a change in perception, a change in control, and I think that’s when you see significant declines in equities and a major move higher in gold.

We touched on this in another question, but the reality is the physical markets have already shifted in the gold space and this is one of the reasons why I think the next leg in gold will be the most aggressive to the upside, because the physical supply and demand dynamics have already shifted, and no one knows it because everyone is looking at the paper price. You look at gold below $1200 and you’re saying, “It’s weak as weak can be.” What you don’t know is that the entire stock of gold which used to be available to you in the West has moved East, and when you want it, if you want it, you can’t have it at any price.

Kevin: It ain’t there.

David: That’s right. So I think you can find yourself going from $1,000 dollar gold to $5,000 gold very quickly, and by the way, that has happened before. It was three-digit numbers instead of four, but when we went from $100 to $800, guess what kind of a timeframe that took place in?

Kevin: It was very short.

David: Less than 18 months.

Kevin: This next question actually has to do with the physical demand for gold. Helen asks:

Is the American Eagle gold coin in greater demand and worth more than either the British sovereign king or the Dutch 10 guilder?

David: Helen, we’re seeing good demand for both. In part, there is an advantage with the smaller coins just because they are smaller; they are easier to denominate. The argument for many people, owning silver over gold is because of its practical nature, it’s easier to use some small fractional silver piece than it is a gold piece. The fractional size of the sovereigns and guilders is consistent with that theme of owning silver for practical purposes. So, we are seeing good demand for both.

Kevin: And the second part of the question is sort of an apples to oranges questions, I think, and that is:

Is the American Eagle worth more or less than the Dutch guilder or the British sovereign?

But really, it’s an apples and oranges questions, isn’t it?

David: On the surface, gold is gold is gold. But then when you look at the age, scarcity, and condition of the sovereigns and guilders, then actually, your American Eagles are worth less and your sovereigns and guilders are worth more, because again, you’re dealing with coins that have not been made for 100-120 years, and cannot be made again.

Kevin: And are uncirculated, if you buy them uncirculated.

David: Exactly.

Kevin: Here’s another question from someone who purchased gold back when it was really hitting its high, Dave. And I understand, I can feel the pain for these people. I’ve got 28 years behind my belt of buying gold, and so I’ve seen it go higher and higher even when it comes down from a high, but a person like Dick who bought four years ago when gold was peaking, he says:

I’m 63 years old and invested $110,000 in a gold and silver IRA four years ago. Currently my assets are hovering around $57,000 to $60,000. Needless to say, I am very disappointed and worried that within the next four to seven years I’ll face retirement in a very weak situation, as at this time, the opening of the IRA represented a third of my long-term investments. There is a sense of dread I feel, and I feel somewhat trapped and nowhere to go. Tell me again, Dave, that I didn’t make a mistake, and why.

David: Yes, I think this goes back to a comment we made last week, which is, to the degree that you have externals and a timeframe forcing a decision, then yes, I understand the sense of dread, I understand that completely. Dick, I think four to seven years is an ample timeframe. I would not be concerned.

Kevin: Yes, Dave, last week you brought out the fact that sometimes people feel pressure based on outside constraints. Timeframes can sometimes weigh in. And unfortunately, it’s really not the price of gold that’s weighing on the retirement question. Let’s just face it, the question about retirement is, you can no longer earn interest on your money – period. And so, let’s say that gold didn’t go down in his portfolio. He’s not going to retire in four to seven years anyway if he can’t earn any interest on it. So, I’m not trying to be cold here, but the government has taken away the retirement age person’s ability to retire right now. That’s a sad situation. It doesn’t have anything to do with the gold price. Now, things can change. You talked about the markets coming back in and reasserting themselves, so I’m just going to jump to the next question because I think this ties right in with what he’s asking. He says:

How much longer will it be, and what will bring about the manipulative chickens coming home to roost, and real prices soar? Will the Chinese succeed in a move to change the way gold is priced, and will that be based in Shanghai?

Dave, you’ve talked about this before, instead of the COMEX.

Finally, has the Fed’s change in gold to a tier-1 asset for banks been done rather quietly to pave the way for confiscation, like with FDR? Thank you, Roger.

David: Well, first of all, the tier-1 asset issue is more of a Bank of International Settlements issue, the central bank issue.

Kevin: That was BIS.

David: Yes. It’s not so much that commercial banks sit on a large amount of gold where it being categorized as a tier-1 asset would matter. Very rarely will you find a commercial entity holding gold as an asset. We’ve talked about Old Bullion. Old Bullion was Chemical Bank in New York City, and Old Bullion was the nickname, and lo and behold, back in the 1920s, 1930s, 1940s, they did have a ton of gold as their primary asset. That’s how they held deposits.

And people paid them to keep their money, and it was all in gold. That’s a unique thing and in the modern environment it’s the central banks which have it and they want to be able to recognize it as a certain quality of collateral. In essence, we’re talking about gold being a tier-1 asset to improve balance sheet flexibility, but it’s not particularly relevant to a commercial bank issue.

Kevin: Next question. Edward asks:

Does it really matter at what price we invest in gold? As the price goes up, and the price comes down, it’s a controlled paradigm to make gold look as though it has no real investment potential with the outlook of protecting or restoring real value just to keep us in the fiat money system. How long can this go on? In other words, how long can they control gold and keep us thinking that the dollar is gold?

David: It’s interesting, people look at the dollar and they should appraise it the same way they do gold.

Kevin: Back in the old days you could.

David: That’s right. I think it’s better to view the gold price as the constant, rather than the dollar, and see therein dollar volatility as the issue. It’s weak, it’s strong, there are times to own it, there are times to sell it. Is it at a high, is it at a low? Are there times that you want to own more or less of it? More important than price is a value equation, and that is, what can you do with those ounces? You will walk into a store anytime this week and you’ll look at something on the shelf and you’ll say to yourself, “I am willing to part with the dollars in my pocket for that.” Or you’ll say to yourself, “I am not willing to.”

What you’re watching in real time is a value equation. There is a reason for you to get rid of dollars for that thing. When and if it’s cheap enough, or it means enough to you, you will part with your dollars for that particular asset. And so I think the same applies to gold. More importantly, when you’re thinking about the controlling paradigm and how gold seems to be irrelevant in the modern era, it’s that the most constructive paradigm is to look at gold as cash. And yes, there are times when you would spend your cash. It’s just a question of the value on offer.

Kevin: This next question – we get this a lot – he says:

Why is it when you purchase gold coins such as a one-ounce American Eagle, you pay a premium on that coin, and when you sell them back you’re not offered any of that premium back?

That’s a good question. I don’t know how accurate that is, though, because there is a premium in an American Eagle, generally, when you sell it back, as well.

David: That’s right. You have the wholesale market premium, which is, if you’re buying direct from the mint in case after case after case after case, that’s 500 coins per case, the mint is charging a premium for the fabrication of the product. That stays attached to the coin, with the exception of a dollar or two, depending on whether it’s in the secondary market or direct from the mint. There is one other fee that has to be accounted for and that is the commission that you pay for transacting the business. You don’t get the commission back, but you do get the wholesale premium back, and that wholesale premium in the case of Eagles is basically the equivalent of the mint premium.

Kevin: Sure, and the mint usually has a certain amount of money built into the coin. It can be the Royal Canadian mint, the American Eagle, what have you.

David: Yes, so you capture the wholesale premium, but you don’t recapture the commission, that’s correct.

Kevin: The next question comes from Allen, and he says:

Should Christians be prepping for hard times now by stocking up on precious coins, dry foods, seeds for gardens, a supply of wood for heating, bullets, etc.? If not now, when?

David: Well, like having a gallon of water and a blanket in the back of your car, which is common in Southern California, these are all practical considerations. They don’t put you in the category of being a prepper, it just means that you think about the world and know that sometimes it doesn’t operate in a perfect fashion, and you want to have option B, C, or D in the case that it doesn’t, on your watch. So, I think you address your practical considerations and then you move on. Does that make sense? To me, I look at those issues and I already have my dry food, I have some seeds, I have plenty of wood. Bullets? For sure. Precious metals. These are things that I probably thought about five, ten, 15, 25 years ago.

Kevin: But you don’t think about it every moment of every day.

David: No, absolutely not.

Kevin: You basically take the time to say yes. It’s a little like anything else. If you’re putting together a will, that type of thing, you don’t think about your will all the time, but you do need to take time to get it together at some point.

David: Appreciate where we are in history. This is a unique period of time in history where we have become accustomed to not thinking ahead, whether it is just-in-time inventories, whether it is ordering a book from Amazon and getting it the very next day, the shelves at the grocery store are stocked on a daily basis with food that comes in on a daily basis.

But we should think ahead, to some degree, and I think this is going to look a little bit different for everyone, how you look ahead and what needs you address, but just very helpful to realize that this is the first time in history where, because of transportation, because of technology, because of communication, we’re able to do things on a just-in-time basis where we do not think about tomorrow. And I think that leaves us with a certain blindness.

Kevin: There’s a vulnerability there.

David: There is a certain vulnerability. So, just appreciate where we are in history and address it, and then go back to living your life.

Kevin: This next question from Gail:

My husband and I are debt free and we own our own home. We have a lot of savings and it’s almost all in cash, CDs, money markets, and fixed annuities. I do not feel like I’m being a good steward with our money, though, and my husband and myself do not seem to have the stomach for the stock market. We have a large monthly income to take care of us, but sometimes I feel like we should be investing in something. We also have a small portion in gold and silver. We’re in our early 70s and my husband is still working. What is your suggestion?

David: Well, first of all, my hat is off to you. The idea of being debt free, having saved, having put yourself in a position where you have lots of financial options and very few financial constraints – that is a very clean approach, it is a low stress approach, and if everyone did that, including our government, I think we would be looking at a very, very different future. So, well done, hat’s off to you.

The orientation that we have to allocating assets, precious metals, cash, real estate, stocks and bonds, we tend to reference the perspective triangle, and if you’re not familiar with the perspective triangle, it is nothing more than a back-of-the-napkin way of allocating assets and giving each segment a job to do.

Kevin: Right. So, the base is the insurance job; it’s your gold and silver basically.

David: Yes, exactly. So, as an insurance job, that’s the mandate, precious metals fit that bill. The cash and cash equivalents, where it sounds like, Gail, you are, predominantly, that’s what we would call the liquidity mandate. It’s there to pay bills, it’s there to take advantage of opportunities, it’s there to be a blessing to someone else. Liquidity – you can write a check and it serves a significant purpose thereby.

Growth and income on the other side – that’s where I think you’re talking about a gap, Gail, and growth and income, precious metals as an insurance, liquidity – cash and cash equivalents, these things work well, almost like a team. They each do different tasks at different times and complement each other. So having some of each, I think, does strike a cord on the note of stewardship, in part because we don’t know the future, and as an investor, if you can begin with that basic posture of humility – we don’t know the future – it does require some degree of diversification because we don’t know the future.

You’re positioned in such a way today, predominantly in cash, as if you do know the future, and that future includes a very stable U.S. dollar. When you see a position that is all cash, again, all anything assumes that you know more about the future than you do. If you were all in gold it would assume that you know more about the future than you actually do. So I think that the perspective triangle allows you to take a balanced approach, an approach that complements the theme of stewardship and is supported by this notion of, with humility, we don’t know what tomorrow brings, and we want to cast our bread on many waters.

Kevin: This is a question you love, Dave, because most people who are selling gold and silver are always talking about why you should buy, but you start with people as to when to sell. Aaron says:

Thank you for your great weekly commentary. It’s clear for all the fundamental reasons you’ve discussed over the last year or so that it’s time to buy precious metals right now. But my question is, can you give me some telltale signs of when in the future would be the right time to sell them to maximize profits – not too early, not too late. I don’t want to sell my gold at $3,000 an ounce if it’s going to $5,000 after that. What can you do to help me on that?

David: Number one, you have to understand that the higher the price goes, the larger the risk of government caring about the asset that you own. So by the time you make the decision to sell at the peak, which by the way, you don’t know what the peak is until after the fact, but assuming that you could know $5,000 was the peak, as you got to $4,872 I think you are going to run into issues in terms of an increased tax burden. So, the longer you wait, the less you’re going to get to keep anyway.

I would say that to the degree that you’ve purchased incrementally, you sell incrementally, and at $2500, $3500, $4500, you are selling 10-15% of the asset in question. And so again, you sell 10-15%, the price moves higher, you sell another 10-15% of what remains. The price moves higher, you sell another 10-15% of what remains. Now, that incremental question again, whether it’s $2,000, $3,000, $4,000, $5,000, $2500, $3500, $4500 – I’m not saying there is magic to the number that you pick.

Kevin: No, but there’s a ratio that you like to look at, Dave, called the Dow-to-gold ratio, and that has been a great indicator as to when to start selling that first third, and then that second third, and that third third of what’s left over. Explain that just briefly right now, if you would.

David: Right. That’s one telltale. It’s one telltale, and if you want a dozen, then you would go to

Kevin: Yes, the Vollum site.

David: Look at every asset under the sun priced in gold, and as your purchasing power in gold gets to a maximum historical level, then yes, you should be buying those other assets and taking advantage of the fact that gold has boosted your purchasing power. The Dow-gold ratio is that very thing. It just happens to be with two things that we’re commonly familiar with – the Dow-Jones Industrial Average, and an ounce of gold, and how much of a cross-section of the Dow do you get for one ounce of gold? And this ratio has bounced around for several hundred years, and as you get to low single digits, 3-5, for instance, you find that, yes, you should be getting out of gold and into equities.

What is an equity? What is a stock? It is a representative piece of paper, it is your proof of partial ownership in the land, plant, and infrastructure of a company. It’s real stuff that you’re a partial owner of. The fact that you have a piece of paper representing your ownership doesn’t mean that all you own is a piece of paper, it just is a representation of your ownership. What is the real stuff that you own? The underlying assets, the land, the plant, the infrastructure, the intellectual property – all of those things. And my suggestion is when you get to a 1, a 2, a 3, a 4, a 5 – 5 and under on the Dow-gold ratio, this is a time when you should be incrementally exchanging your stuff for their stuff.

Kevin: And the way that’s figured is you just take the Dow-Jones Industrial Average and you divide it by the price of gold. At this point it’s about 15, something in that neighborhood, but if you divide it out when gold starts really rising or the Dow starts really falling, you can get down to those ratios – 5, 4, 3, 2, 1, that’s when you probably should start considering switching a little gold for a little bit of a company, right?

David: That’s exactly right.

Kevin: This next question actually is about FATCA. This is from one of our Canadian listeners who has lived in America on a green card for 21 years. She says:

Is FATCA designed to save, or bail out, bankrupt America?

David: I think FATCA is designed to “protect” America, which is in actual point of fact the slow process of social and economic strangulation. So, Kathy, if I were in your shoes, I don’t know that I would be considering the naturalization process.

Kevin: Next question from Steve is:

The election in 2016, in my opinion, will be the most important election in decades. Of all the candidates, who would make the best president?

Dave, you have avoided endorsing anyone, but who would make the best president?

David: Well, again, I’m tired of politicians, and in my heart of hearts would love to see someone with the qualities of a statesman, that is, someone who is not necessarily there just to build a Rolodex and ultimately monetize it. We’ve seen that with the Clintons, we know what that looks like, you can start with zero wealth. If Hillary were to win, by the way, she would be the first billionaire to have been in the White House. She is not a billionaire today, but she already went from zero to 120 million, and I can tell you, to go from zero to 120 million is a much bigger deal than to go from 120 million to a billion. She’s almost there. All she needs to be a part of the political billionaire class is to be elected as president.

I’m not interested in anyone, on either side of the aisle, who wants to be a politician and somehow monetize the benefits of having been there. So who am I looking at? I like Ben Carson. I wish there were different things that he had that he doesn’t have, but there are things that he has that I like. The bar that I would like to raise is that the people running the show are more like you and me, and less like professional career politician specialists. We have a world which is dependent on specialists – money mandarin specialists, banking specialists, investment specialists, of which I am one, and quite frankly, I like a world in which you have professionals who are willing to engage in politics and then go back to their professions. So again, I would love to see, outside of the judiciary, that same expectation.

Kevin: Steve continues, and he says:

With all the protesting against free speech, how long do you think we will be able to continue receiving the McAlvany Intelligence Advisor?

David: Forever (laughs). More concerning is the idea of fairness. It’s the idea that we must have equal representation of all viewpoints, or no viewpoints can be expressed at all. And so, I think free speech will be there. The Internet has been a workaround to traditional media outlets, and yes, there is a move to control the Internet, and there is a move, not by governing what can be said, but by governing what has to be said in addition to, and the reality is, you’re still dealing with time constraints. So, if it takes me two minutes to say something, that means I have to create another two minutes of content which is the equal and opposite viewpoint.

Kevin: So the McAlvany Intelligence Advisor might become the McAlvany and Rahm Emmanuel

David: Encyclopedia.

Kevin: (laughs)

David: It used to be 28 pages. I don’t think anyone is going to read a 56-page McAlvany Intelligence Advisor.

Kevin: The last part of Steve’s question says:

In Don’s 40 plus years of experience and knowledge of world affairs, how long does he think the Federal Reserve note will continue before we return to a sound money?

David: Steve, on your point of how long the existing Federal Reserve note continues, and do we return to a sound money system? First, I think you have two to three years for the dollar to remain as it has in its post Bretton Woods era since 1971. And we are seeing a change. It’s a slow change, but it is a devolution in the value and importance of the dollar. The second part is, could we return to a sound money system? And I think what that assumes is a complete discrediting of the Fed, and that may not occur without a significant fight. Kennedy would probably speak from the grave on that issue.

Kevin: Now, Dave, you’ve raised the specter of conspiracy and we don’t talk about the Kennedy assassination on this program.

David: (laughs) Well, certainly, but introducing sound money ideas, the timeframe between when he started down that road, and his assassination…

Kevin: Was several months.

David: Intriguing.

Kevin: Next question Brent asks. This has to do, Dave, with the price discovery mechanism. Every commodity has a price discovery mechanism, and it’s usually supply and demand. Of course, right now it’s the paper market setting that, but here’s what Brent says:

What do you believe will be the price discovery mechanism that will set the price of gold and silver? Since an event of this nature, like a discretization of the current price discovery is going to be needed, what will set the price discovery mechanism after that?

David: I think you need to watch premiums. Premiums on product are one very telling aspect in the marketplace. It doesn’t matter what the price of metals are, quoted in the paper, you need to know what the actual street value is. And then I would also watch delivery delays. To the degree that you are seeing physical product not delivered in a five to ten-day window, if it’s taking one month, two months, three months, if you’re paying a price and it’s not deliverable for six months, again, these are indications that not only is the old system of price discovery from the futures market broken and irrelevant, but we’re moving away, the transition is occurring. So, you know the transition is occurring when you see premiums on product continuing to rise on the basis of pure supply and demand. And again, when delivery delays are required to accommodate new product coming from mines and being fabricated.

Kevin: Dave, we saw this in 2007, even before gold was coming up, 2007 and 2008, gold actually had a pretty substantial drop during that period of time. But we also saw incredible supply problems. There was a lot of physical metal being purchased, and the premiums were very, very high, yet gold price didn’t necessarily react to it right away. It turns out it did, it ultimately shot up to 1900 after that.

David: And so we have this issue, the scarcity of metals, which is not obvious, but nevertheless is a real factor in the market today. And again, it’s not relevant in today’s pricing, but it will be the primary reason for price explosion in the future. And a part of it is this: It’s not like we’re running out of 400-ounce good delivery gold bars or 1,000-ounce silver bars, there is plenty of product. And it’s not as easy as you might think to convert 1,000 ounces of silver into one-ounce silver rounds or a 400-ounce good delivery bar into fractional gold coins. The mechanism for doing that has gone away. Because of the cyclicality of the gold market over the last several decades, basically, your biggest refiners have disappeared or been refashioned to deal with just industrial metals which is a more reliable business for them. So you have this strange world in which we have large format product, but it’s not accessible to the general public because no one’s stepping in and, say, in the case of a 400-ounce good delivery bar, signing up for a 450-500,000 single unit purchase. So, on the one hand, there is plenty of gold and silver today, on the other there is this radical scarcity and it can’t be solved.

Kevin: Yes, the small stuff is almost gone and the big heavy bars that look like paperweights are everywhere.

David: And there is nothing that we can do to convert them. It’s just not that easy.

Kevin: This next question is counter-intuitive, Dave, from Dan. He says:

A newsletter writer who I read says the Federal Reserve will begin to raise rates, and this will be inflationary because it will increase monetary velocity by causing banks to begin lending money which they are currently sitting on. He also says that this will be good for gold. What are your thoughts on the likelihood that the Fed will raise rates, and if so, will this be inflationary, and good for gold?

David: Can they raise them? And if so, how far can they raise them? Keep in mind how leveraged the system is, and for everyone who has been borrowing at low rates, there is a term set to those loans, and when the term is up the money has to be paid back, or the loan has to be rolled over, at the new higher rate. What does that do to the earnings of the corporation? What does that do to the earnings of an individual? What does that do to the revenue and earnings of a government as they have to adjust to higher rates, you’re talking about an issue of solvency.

The second part of that question, yes, Dan, if you are adjusting the yield curve, increasing interest rates, you would make bank lending more attractive to bankers.

Kevin: And velocity would increase.

David: One question, however, is who is going to borrow, who wants to, and which comes first, the chicken or the egg?

Kevin: So, velocity maybe doesn’t increase. In other words, you can be inspired to start lending money out, but if you don’t have people who can borrow, then velocity doesn’t increase.

David: As a business owner I might borrow money to grow my business, but that’s on the basis of seeing opportunity. If my appraisal of the economy is a negative appraisal, there is no way I am going to borrow more money going into a tough patch, or if I’m still existing in a mediocre economy. So, just because loans are now available and more profitable for banks does not necessarily mean that someone is going to be there on the other side to take them.

The second part of that is, who qualifies? Because even though the bank may be offering the loan, you’re still dealing with industry regulations and strictures which you don’t know who would, in fact, qualify. Is there a greater number or lesser of people that do qualify?

Kevin: You’ve brought this up before, we have 4 trillion dollars just sitting in reserve at the Federal Reserve and it really has not made its way into the economy. Obviously, this newsletter writer is saying, with higher interest rates that money could start making its way into the economy.

David: Now, the biggest hit to gold in the last six years has been deflationary expectations. And that’s not necessarily a clear or accurate understanding of gold in the context of deflation. I would beg to differ with the deflationists on the value of gold in the context of deflation. I have 600 years of history to support gold being a good asset to own in the context of deflation, but what you generally see is street traffic into gold on the basis of a change in inflationary expectations. It doesn’t matter what inflation is doing, it matters what inflation expectations are doing, and if people think there is going to be more inflation tomorrow than there is today, which is the opposite of what we have today, people thinking there is going to be more deflation, then you have positive traction for gold, an increase in trade, more people buying it. And so, I would tend to see an increase in rates not as negative for gold – we talked about this in another question, it’s a threshold issue, not a directional issue, and if rates are rising on the basis of inflation, it’s the change in inflationary expectations that would be driving more people into gold, not away from it.

Kevin: Before we wrap the show up I want to invite our listeners to continue to listen because we are going to continue with the questions and answers in a few weeks. Wrapping up, I just think this change in expectations – this is the major theme of all these questions – when do things change? When do the people lose control who have been controlling the perceptions. And it seems that we’re ripe, Dave, for a change in expectations. It could happen any time.

David: Kevin, confidence is a very frail thing. It’s a very, very frail thing. If you want to look at it in the context of a marriage relationship, everything can be clicking and working and happy and an insinuation, a negative word, a disastrous action – one single variable…

Kevin: Can tip the apple cart.

David: Can up-end everything. And it is this issue of confidence and stability, we assume that everything is fine, but it doesn’t take much to completely recalibrate the world that we are living in. It seems a very far-off thing, but actually, it doesn’t take much at all to break confidence.

Kevin: Yes, because this confidence is built on a false perception. It’s built on paper. It’s built on zero interest rates, it’s built on quantitative easing, and it’s built on manipulation of the markets to manipulate perceptions. So that sounds to me like this marriage that you are talking about is on very, very shaky ground.

David: I agree.

Stay Ahead of the Market
Receive posts right to your in box.
Jeffrey Christian: There’s A Lot Of Upside To Gold
Greg Weldon: Silver Looks Good Here
An Interview With Charles Goodhart
The Economic “Sweet Spot” Reversal
Gold Will Play A Role In The New Monetary Regime
Apple Mentions A.I. & Gets Free Pass On Falling Earnings
Global Discord: Paul Tucker Interview
Currencies are Tattletales
Double your ounces without investing another dollar!