EPISODES / WEEKLY COMMENTARY

Long Term Gold Bull Takes A Short Breath

EPISODES / WEEKLY COMMENTARY
Weekly Commentary • Apr 24 2024
Long Term Gold Bull Takes A Short Breath
David McAlvany Posted on April 24, 2024
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  • Western Investor Remains Absent From Gold Market
  • How “Rate of Change” Can Signal Tops & Bottoms
  • Ray Dalio, Stanley Druckenmiller, John Paulson Give Gold An Air Of Respectability

“I think Wall Street is licking its chops to step in substantively. Inflation’s not dead. Central Bank credibility is nearly so. With fiscal sustainability questions growing in the minds of professional investors, frankly, walking through an international relations minefield, you no longer need a tinfoil hat to be a gold buyer.” –David McAlvany

Kevin: Welcome to the McAlvany Weekly Commentary. I’m Kevin Orrick, along with David McAlvany. David, as we normally do before we record, we just had a meeting with the office. Robert Draper put these words on a sheet and he said, “Hey, does anybody recognize this song? It goes, ‘A little bit, a little bit of gold goes a pretty long way. Take a look at where it started from and where it is today. It came from the mountains crossed the oceans, got knocked down, kept going. In the end, you know you got to say, a little bit of gold goes a pretty long way.'” Now, he had altered the words. He said, “If anybody can recognize who did that song—” I think he said anybody over 50, if they can recognize that song.

David: Then I don’t qualify for the prize. I’m not quite there yet.

Kevin: I think he altered Weezer’s tune, “A Little Bit of Love” goes a long way. But nonetheless, we’ve been chasing the gold price the last few weeks. It’s been like, gosh, every day just going up. That’s not natural normally, and so sometimes it’s really nice to get a breath and just say, “Oh, today it finally fell some,” and that’s been happening the last couple of days.

David: We think about the perspective triangle and how we see gold as sort of an insurance component within a portfolio, a little bit of gold goes a long, long way.

Kevin: Yeah.

David: You’re right. Finally, we’re not chasing the move in gold and silver. For the last 30 something days, my advice on positioning has been to get started, but average in over time. The market should, under normal circumstances, retest the breakout between 2,100 and 2,200 before moving higher still. Silver, 26.80, getting back to those levels, what many would consider a breakout move for silver. Retesting those levels and you are ready to go further on the upside. Numerous news outlets where I’ve done interviews this year, I suggested that the breakout from 2,100 would take us to 2,350 to 2,450 before the year-end. Of course, that was kind of a first quarter prediction. My thought was that we would see that in the second half of the year and here in the second quarter, quite to our surprise, it’s happened very quickly.

Kevin: Yeah.

David: It came fast and furious. Bull markets are like that, and sometimes bull markets, like economic outcomes— I think it was Rudiger Dornbusch who said, “It takes longer to happen than you think they will, and then they happen faster than you thought they could.” There’s this sort of long pause, nothing happens, and then when it begins to happen, it surprises you.

Kevin: Well, you had used the term, under normal circumstances we should expect some of these corrections. Of course, under normal circumstances we should, but are these normal circumstances, Dave?

David: Yeah, it’s very curious that, in recent weeks, we’ve got some Wall Street folks saying, “I don’t think the Fed’s really in control.” That’s at least the suggestion. It’s the idea that they will have to exert more control so that the market does not take control. That’s yield curve control. That’s buying of bonds. In the 1970s, it was monetization of debt. Very inflationary, unfortunately. Are these normal circumstances? Kevin, last week we had a bond auction, ten-year auction. 38% went to market and most of the rest got stuck with your primary dealers, one of the worst bond auctions that we’ve had in quite some time. What does that tell you about the appetite for US Treasurys?

This is where I think yield curve control and the inevitability of higher rates and the struggle between who is determining the course forward— Is it the Fed and the Treasury manipulating things towards a desired outcome or is it the market saying, “Wait a minute, we have way too much supply and we’ll only take that supply if it’s priced appropriately,” which implies higher rates? That’s the conflict. The conflict is the market is already telling you higher rates are in the cards. Higher rates is what we expect, given an abundance of supply of debt. We’re just not interested in it unless it’s priced appropriately.

Kevin: This goes back to our discussions with guests and with each other about the price of capital. Interest rates study through the last few thousand years is fascinating, because these same questions have been asked by generations before us. But let’s go to gold for a moment, because we have had some sharp moves in price. What does that portend going forward?

David: Yeah. The moves in price, very short and sharp. Retail purchasers have, to some degree, been locked out, not because they didn’t have access to product but through the decades we’ve seen this repeatedly. Big moves are, in a sense, breathtaking and they become untouchable. When prices slow down, then you have buyers regroup. When prices retrench, if they drop back at all, buying resumes. People say, “Okay, well, I’m more comfortable here than I am chasing all time highs.”

Kevin: What about buying the dip?

David: Yeah. In bull markets, buying the dip is a favorite pastime. This will again be the case, I think, with gold. Where we could say gold weakness could extend, you look at, again, that debt problem. Last week’s bond auction and the struggle between the market setting price and the Fed and the Treasury trying to do so on the other side, and gold is this telltale. It is becoming the favorite way of expressing a lack of confidence in the Fed and the Treasury’s ability to keep a lid on a bad situation.

Kevin: Yeah. You talk about the free markets setting the interest rate. The quote from Michael Hartnett of Bank of America, where they cannot allow the markets to actually set the rates because, of course, they’re going to go up. Morgan was talking about that today. There are only so many places that the government politically can cut. I mean, you’re not going to cut the military, they’re not going to cut Social Security or Medicare, these big expenses. And so what are we going to do? Well, we can print money. It creates inflation, but if you’re the government, you cannot allow interest rates to rise right now because you’re already paying too much interest on all of that deficit.

David: Back to gold, you’ve got money that’s been sidelined, and it can now flow freely as the prices retrench a little bit. The best setup imaginable is unfolding. You’ve got the context there. It’s very supportive for an extended bull run. Context combines global geopolitical, global fiscal and monetary, and global financial markets, which, if you project forward, have many similarities to the 1970s. It’s a setup for much higher metal prices and, very importantly for those managing intergenerational wealth, a critical next step. I’m always thinking what is around the corner, whether that’s three years from now or 10 years from now.

Kevin: Are you thinking Dow-gold ratio here?

David: Of course, because the Dow-gold ratio, as sort of a next step, moving to the low single digits is a reasonable expectation. We’ve begun the shift already. We were just a few months ago in the 20:1 range, now it’s 16:1. I suspect that within a few years, we’ll take out the 6:1 ratio, which we saw during the global financial crisis, and we’ll arrive at 3:1, perhaps even 2:1. The gold buyer today prepared to hold the nose and tomorrow buy assets at secular lows will be rewarded handsomely. It’s a lateral move. It’s the move that history suggests comes at the completion of a cycle.

Kevin: I think of the moves in the gold market. Another thing that we talked about in the meeting are these critical numbers that are called Fibonacci numbers. I love talking to your son. One of your sons loves theoretical math. He loves to talk about the beauty of math. Not necessarily equations, but just the beauty. I think of the song I heard when I was a kid, Inchworm, “One and one makes two, two and two make four.” But actually with Fibonacci, the way Fibonacci is built is one and one makes two, two and one makes three, three and two makes five, five and three makes eight, eight and five— But the thing is it creates this beautiful, they call it the golden ratio. You can see in the markets oftentimes how a market will either rise or correct back based on these magical Fibonacci numbers.

David: Yeah, there is the possibility that we have something like that in the gold market. There is that uncanny nature of patterned behavior in various chart studies. If you apply Fibonacci numbers to the gold market, yesterday’s one has already become today’s two, 2,000, tomorrow’s three, and then on to five and eight. Don’t be surprised to see the complex Indian math play out in the gold market with up moves and consolidations gradually trending higher to those numbers, each in the thousands. 1,050 was the market cycle low in 2015, the end of the cyclical bear. We simply ran out of sellers in 2015.

I think we will eventually run out of buyers in the gold bull market that we’re in now. But as I’ve said repeatedly in recent months, the Western investor remains absent from the gold market. The Western institution as well. So we have a lot of buyers still in queue theoretically. I work with two Wall Street firms advising on endowment assets, and they just can’t make sense of owning gold. They’re loath to do anything but traditional stocks and bonds. When they venture away from the 60-40 portfolio or maybe it’s slightly massage those variables by a few percentage points, they’ll move into alternatives. That’s hedge funds—usually leveraged positions, ironically in stocks and bonds—and private equity and private credit. Merely variations on the same theme, but gold is not on their buy list.

Kevin: Yeah. And I think that’s where we need to make the distinction. What I was talking about were minor corrections in Fibonacci, and you were talking about actual price levels 1,000, 2,000, 3,000, 5,000, 8,000. And when you’re in a bull market, you are going to have corrections. I mean we’re two or three days into a gold correction right now, which from a normal condition standpoint, like you said, is long overdue. But these may not be normal conditions. The question would be, where does the market run out of steam altogether? I mean, where does that happen? We’re not anywhere close to even the entrance of the market buying, and it’s been rising.

David: Gold’s correcting two days into that, three days into that. Perhaps we should reflect on the difference between a correction and a market peak level where you’ve got exhaustion, exhaustion at the end of a longer-term secular trend. A market runs out of steam altogether at some point, and of course that is a retrospective observation with any particular asset. But there are general characteristics that apply. Energy in a market builds over time, with an early investor following being somewhat contrarian. That small base then gathers momentum typically when Wall Street decides to take an interest in whatever asset class it is.

And from that point forward, momentum quickly picks up because you’ve got the product creators and the product distributors getting busy. Then, as Main Street joins the bandwagon, the MOMO—momentum—becomes FOMO. The last investor pays what had been an unimaginable price just a few years before, and then it’s over.

So you go from the Maverick to Wall Street to Main Street, that’s the pattern of adoption. And the pickup and momentum is measured by the asset’s annual rate of change. And it will often, as it picks up steam, be increasing 100% or 150% per year until it goes parabolic. And of course you look at that kind of a thing on a chart, it’s unsustainable. The reason it’s unsustainable is because you run out of buyers.

Kevin: Right. And that fear of missing out, that’s the thing that almost always is the signal that you’re getting near the top of a market, when everybody’s buying because of the fear of missing out. Is there an example today? Taking gold out of the picture here, is there an example today that we can look at where we see that exhaustion coming?

David: I think Nvidia fits the pattern. If you were amongst the true believers and you had a vision for what that company could be, just a decade ago it was a $5 stock. And it had its first spectacular early move from $5 to $70. Then of course you’ve got the harrowing decline from $70 back to $35, a halving of value for Nvidia. Next up, you had the move from $35 to $350.

Kevin: Wow. Tenfold.

David: And it’s followed by a decline of over 70%. That was as recent as 2022, a 70% decline. Very few current owners can imagine such a fall from grace. But you get the peak of $350, which coincided with the peak of the everything bubble, again late 2021. And then the declines which followed. And of course you had the 30% declines in NASDAQ companies in 2022, but the most severe losses came in the specific companies that had become most popular. Nvidia was no exception. From $350 to a close of close to $100, there’s your 70% loss for those who came late to the cycle, late to the party. Now we’ve got the final mad rush, $100 at its low most recently, and the share price moved under $1,000, $975 roughly, in March. Again, spectacular, parabolic, while exceeding the 100% rate of change that we were talking about earlier.

Kevin: And you bring up rate of change. That’s the thing that’s important because you have to have more and more buyers. The bigger this thing gets— Anytime a market’s rising, you have to have more and more coming into it. And that rate of change is how that’s measured. When the rate of change starts to slow down, a lot of times that probably does signal exhaustion.

David: It’s this weird thing where it’s an adoption cycle which exhausts itself. And so when you look at charts, the overbought daily charts for Nvidia, the overbought weekly charts and the rarely seen but overbought monthly charts, that’s what it’s signaling. Signaling exhaustion and the last buyer’s already in. Energy is already dissipating. The rate of change has already slowed. The last buyers have already turned into sellers. And it’s just important to remember, all parabolic charts resolve themselves. Infinity is never possible because of the finitude of buyers driving price. Now we have earnings reports this week which will either revive speculation in the short term or cold shower the latecomers with a less than sort of Buzz Lightyear future. You remember his, “To infinity and beyond.”

Kevin: “To infinity and beyond.” Yes, Buzz Lightyear.

David: Well, we could get our cold shower this week. Literally when the last buyer is in, the price discovery process moves to finding a bid at lower levels. $975 in early March to $760 more recently, we’re already down 20% off the peak. But you still have the faithful, the true believers. AI faith and conviction still burns bright. Do we see a total of a 50% to 70% decline? It’s possible. In fact, I’d say it’s likely.

Kevin: Yeah. Going back to rate of change. As you see a market grow, in a way, if you apply that to sound getting louder and louder and louder. I’m a trumpet player, and if it says forte, already a trumpet may be too loud for most people in the room. If it says double forte or triple forte, it’s too loud for everybody. But there is a point where you can’t go any louder.

David: Right. So you’ve got that slowly gathering audience. That’s where the initial stages begin. The rate of change increases as the public learns what only a few had previously appreciated. So you’re picking up speed. And when the public is fully committed, the last buyer’s in, the price drops. At some point, buyers have to turn to selling to capture gains. And as momentum flags, you’ve got more buyers questioning staying pat. And that’s where you begin to see momentum pick up on the downside. For tech, and Nvidia specifically, the AI narrative has been, it still is powerful, but the narrative depends. That narrative depends on the precondition of loose financial conditions, including the easing of interest rates.

Kevin: Well, we have seen that rate of change and market highs and market lows, they do have certain characteristics. The market high you’re talking about here with Nvidia is that you just run out of buyers. The market lows that we’ve experienced, I mean Dave, think back over the last seven or eight years in gold, market lows that we’ve experienced have to do with running out of sellers. There’s a point where there’s just nobody left to sell.

David: That’s right. So when an asset has been left for dead, frankly, unless it is dead, it becomes very interesting. Market lows are similar to the dynamic we were just talking about, just in reverse. Last seller’s out of the way, there’s no more overhang of unwanted inventory, and the price discovery process finds a higher asking price. That was December 2015 for the gold market.

Kevin: And that’s what I love about the triangle, Dave, because we can’t always predict market highs and lows. But if a person is basically saying, “Look, I am going to keep a third of my portfolio in precious metals.” Then you’re basically getting rid of it when you’ve got more than a third, you’re going in when you’ve got less than a third. You balance your triangle using a different strategy than trying to pick market lows. And I’ve got a lot of clients that put gold in at the low in 2015 without knowing it was the low.

David: The early adopters in the current gold rush, you could argue they were coming in about 10 years ago. Interest was minimal in 2015. By December, the threats of European debt crisis were gone. You still had the Germans who had lingering concerns about fiscal stability, but they’ve always been that way. Well, at least in the last 100 years. When you mess something up so catastrophically that it leaves social scars, you’ll have those lingering concerns.

On the other hand, you had the French, the Italians, the Greeks. They had already returned to toasting their respective cognac and grappa and ouzo and their glasses were lifting high in honor of Mario Draghi’s Italian, his Goldman, his Mandarin success. The festive spirits revived, and think about that environment. The gold buyer anywhere in the globe seemed mismatched to the world just saved by central bank genius and through Treasury largesse.

Kevin: Will we ever forget what he said? We will do anything, basically. At all costs, we’re going to save the market.

David: Draghi had killed fear in the marketplace, and you’re right, it was with that unbound promise to do whatever it takes.

Kevin: Whatever it takes.

David: And the global financial crisis was over. And the last sellers in the financial markets had been purged in early 2009, and that opened the way for an advancing market. But it wasn’t until 2015 that Nasdaq prices finally returned to the previous levels of the year 2000.

Kevin: Isn’t that amazing? It took 15 years for the Nasdaq to get back to where it had dropped from during the tech stock bubble popping.

David: Knowing where you’re at in a cycle is pretty important. 15 years later, the latecomers in the tech boom, they had waited for daylight and were finally at break-even. And by the time technology serves— You realize they had at that point, quintupled off the lows of 2009 just to get above water. No one saw, in that environment, no one saw the need to own gold. December 2015 was the exhaustion point for gold sellers, and it was the starting point for this cycle’s maverick.

Kevin: And the maverick is still the only guy in, other than the central banks and, say, the other countries. How much interest is there right now, speaking of how many buyers are in this gold market, even though it’s been rising, how much interest actually from Wall Street is there now?

David: Yeah, I think there are more people than the mavericks. If you count the protest vote amongst the central bank community.

Kevin: True.

David: And the investor in China who is looking at the existential threat that exists from their own government. But if you’re measuring by Wall Street interest in gold, you’re exactly right. As recently as 30 days ago, 75% of Wall Street professionals claimed to have 1% down to 0% invested in gold. That was according to the Bank of America investor survey. I would say that Wall Street remains on the sidelines. You could say, okay, well you’ve got the futures market speculators. They’re the tip of the Wall Street spear, and they have come into the market. But that’s a substantial presence within a leveraged position in the metals, which has only really taken shape over the last 30 to 60 days. So those are the COT reports we often refer to, the Commitment of Traders reports.

And so, we are beginning to see a shift. We’re beginning to see a shift. So far it’s been the central banks and the Chinese buyers, which have, to some degree, altered the script we talked about a moment ago from previous cycles: maverick speculator to Wall Street distributor and then Main Street finale.

That’s been altered by, think of them as market interlopers. We got a nice bump in price from price insensitive buyers. Central banks don’t care what they’re paying. They’re allocating a certain percentage of assets out of dollars, yen, euros into ounces, and it’s not optimized for the perfect price because capital gains are not their primary motivation. Again, think of it as a protest vote. So now we get to see how Wall Street responds.

Kevin: And typically, you’re going to see Wall Street, their main motivation is greed. So, if you have two sides of the coin, there’s greed and then there’s fear. The greed investor, like an Nvidia investor, it doesn’t mean you shouldn’t make money. But it’s actually you’re there to make money. Whereas what you’re talking about, Dave, central banks, Chinese buyers, they’re not there for the greed factor. They’re there for the protection factor. So if a bull market in gold can carry higher, who will be the next round of buyers?

David: Yeah. I think Wall Street is licking its chops to step in substantively. Inflation is not dead. Central bank credibility is nearly so. And with fiscal sustainability questions growing in the minds of professional investors, frankly walking through an international relations minefield, you no longer need a tin foil hat to be a gold buyer.

Kevin: Well, in the last few years you’ve got a few guys who have never been known for tin foil hats. These are the mavericks. These are the professional investors who have been talking about and quietly accumulating gold.

David: Yeah. I mean, Ray Dalio, what was this quote from maybe six months ago? “If you don’t own gold, you don’t understand economics.” Stan Druckenmiller backing up the truck to buy some gold miners here in recent weeks. John Paulson, who’s, since he shorted mortgage-backed securities with $25 billion and made a hefty sum, has been invested in gold and gold miners. They have all given gold an air of respectability amongst Wall Street followers. They were the first movers from Wall Street in what I think is the second segment of this precious metals bull. If you look at Wall Street, no one wants to be different unless someone doing something different works, and then no one wants to be left out of being different. It’s very interesting.

Kevin: Right, right. FOMO.

David: Yeah. So yesterday’s skeptic really is tomorrow’s fervent buyer. There are a lot of fervent buyers still being incubated at present, and I think Wall Street will define the next leg in the gold move, with Main Street shortly to follow. It’s the retail, it’s the Main Street investor who will be irrationally driven by greed and eventually fear.

Kevin: Wouldn’t you say gold is unique in many respects, but especially in the respect that the way the market moves, it could be moved by greed or it could be moved by fear? Sometimes when I’m talking to my clients, I have to remind them what their motivation was when they bought, because sometimes they can get the two mixed up.

David: It’s a funny asset. Very unique in that it can be both an excellent long position, appealing to greed, capital gains, and also represent the premier means of shorting confidence and money mandarin credibility. Again, it’s an expression of fear and a system breaking down. So uniquely it sits at the intersection, sort of the pinnacle of greed and fear.

Kevin: Would you say that’s because there is no other counterparty that gives it value? You really don’t need anyone out there to tell you that they’re solvent for your gold to be solvent in your hand?

David: Well, there’s the contrast between physical metals versus the producers. And in that there’s a seeming contradiction in positioning for a bull market in gold. It can be driven by greed, it can be driven by fear. Physical bullion is superior by far to capture the insurance expectations of an investor. I’m not talking about maximized gains on leverage, I’m talking about knowing that you get paid. There is no counterparty to physical gold. And so, the insurance characteristics of the physical metal are compelling as a defense. Fear is a key driver for physical bullion. Greed is a key driver for the producers of bullion and investors to adopt that as an investment strategy or an expression. The option-like gains embedded in the producers, those appeal to the investor seeking gains, not just asset and purchasing power preservation.

Kevin: This sounds like a really important contrast that we need to continue to talk about because sometimes people will call, through the years I’ll have someone call and they’ll say, “Oh, gold is just not performing,” and I’ll be like, “Really? It’s been going up?” And they’ll say, “Well, yeah, but I’ve got gold stocks.” That’s different.

David: Yeah. And this goes back to the conversation I have repeatedly with these boards and looking at the endowment assets. When I’m talking to the Wall Street guys at these firms, they would much rather own gold shares when what I’m arguing for, what I’m making a case for—

Kevin: Is the physical.

David: —is the physical so that you are reducing the total risk to a portfolio. And they’re like, “Well, the best expression of that is going to be your producers.” That’s a different animal and it serves a different purpose.

Kevin: And you’re not—

David: They are complementary.

Kevin: I was going to say, you’re not against going in at this point into the producers either.

David: No. The contrast between producers and the underlying product is fascinating. You can have bullion increase in price as investors migrate out of risk assets. Again, that’s fear driven. And the producers, at the same time you can have them decline in price in sympathy with broader market weakness. You can also have investors recognize a compelling margin story unfolding where higher prices in the underlying asset improve the producer margins, and sometimes it improves them exponentially. So share prices, it doesn’t take very long for share prices to price that in.

But this is like, again, you go back to what’s driving one versus the other? Financial market conditions can send the two related plays in opposite directions at times. And so, being clear about what you own and why you own it is absolutely critical. We may see that again. If global financial conditions deteriorate to the point that leveraged speculators and hedge fund managers are forced to unwind all their bets, it will include certain exposures to those producers.

Kevin: Last fall, when you had the meeting for our investors at McAlvany Wealth Management, I remember the key element is that a lot of these mines, you’re calling them producers, a lot of the mining shares have really cleaned up their books to where, if they have cash flow, more cash flow coming in from higher prices on bullion, they’re already set to jet because they cleaned up after the lows from 2015.

David: This is a really fascinating context because at present your major producers have an all-in sustaining cost of, let’s call it $1,450.

Kevin: That’s a production cost?

David: Yep, that’s all of their costs. That’s managing the firm, that’s digging the dirt, that’s diesel costs, that’s everything. And so at current gold prices, that’s roughly $850 margin. Do the math. That’s about a 60% profit margin. So, fundamental improvements to cash flow, and dividends, alongside the strengthening of balance sheets, they will reach a tipping point which investors can’t ignore. So, if today it’s sort of 50, 60% profit margins, those can explode higher with the gold price. We believe they will. We’re positioned accordingly with the very best-in-class companies that have taken years, they’ve even taken decades to assemble those assets in the safest jurisdictions with the very best operators.

Kevin: Yeah. It’s so important to realize, we are in a mining area. You can go take the mine tour up at Silverton, and I’m sure you have, David. Hard-rock mining is very, very difficult. There are a lot of variables that go into this.

David: I’m reading a biography by Norman Keevil, autobiography, and he’s one of the second generation, third generation owners of Teck Resources of Canada, Never Rest on Your Ores. I don’t necessarily recommend the book unless you’re just interested in digging in the dirt. But, fascinating little vignettes, and it just reinforces this idea to me that hard-rock mining is difficult. Whether it is for coal or copper, cobalt or gold or silver, it is all difficult. Doing it well requires a lot. Delivering projects on time and at budget, that is always a challenge. So, if you’re going to plan the space, you must have the best, or the risks you’re taking are unbound.

This is where part of what we focus on internally is risk-adjusted returns. This is really key to us. You can play the space and merely roll the dice and occasionally get lucky. Generally speaking, that’s kind of a 50-50 deal. There are odds to everything in rolling the dice. If you’re at the craps table, okay, your best number to get is a seven, well, as long as you’re playing a certain line in the game. Otherwise, that is the highest probable outcome and the numbers are set against you. What I’m getting at is, if you can’t do the research, if you can’t plow through 10-Ks and annual reports, if you can’t sit through investor conference calls, if you don’t have the capacity, you probably shouldn’t play.

Kevin: You pay guys to do that here.

David: Right. Sure. But again, the best may not actually have the best return in the sense that—and again, we come back to this notion of risk-adjusted returns. We want the very best possible returns while accounting for the risks in play. For instance, if I wanted to buy a company— This is a great example. I can buy a company today with exposure to uranium in Kazakhstan and my rate of return may be better there than my rate of return in Canada, but if you adjust that position for the risk that you’re taking, now you see that you can’t just chase the possible positive outcome. You have to account for all the things that can go wrong. And I’m not as inspired to invest in Kazakhstan as I am in Canada. So, there’s the number of things that factor into that risk-adjusted return, which are absolutely critical.

Kevin: Well, as you balance your portfolio, see, this goes back to the triangle. If you are capturing gains in something that has no counterparty risk and make sure that you maintain one-third of your overall portfolio in physical gold, then the left side of the triangle, that’s the base of the triangle. The left side of the triangle is what you’re talking about, Dave, where you’re basically trying to figure out where do we take the risk, and you can because you’ve basically laid the base of the triangle.

I had a client that I’ve had for many years. We had a conversation the other day. He’s adding physical gold right now, and I said, “All right. Now, you realize what our strategy is, long term?” And he goes, “Yeah, absolutely. We’re watching the Dow:gold ratio.” So, he’s laying his foundation now with the idea that instead of the Dow:gold ratio being in— It was at 20 to 1 just a few months ago. Now, it’s at what? 15 or 16 to 1.

David: 16 to one. Mm-hmm.

Kevin: But we’re on our way down to, like what you were saying, we got to six to one back during the global financial crisis, but we didn’t get to five, and to three.

David: The nature of the perspective triangle is this recognition that rebalancing is absolutely critical.

Kevin: We call them triangle updates, and we rebalance.

David: And having maximum limits set to the different proportions is helpful as a reminder that an action needs to be taken. We’ve had many different cycles in the 50-odd years that we’ve been in business and doing this where we may let profits run, but there is still this cognizance of the fact that you’ve got to pare back to that maximum one-third. We have, certainly, clients that only have 5% or 10% or 15%, a much smaller allocation, so they don’t have an equilateral triangle. They have an isosceles. Fine, but what you lose with the isosceles is the ingrained notion of what’s next.

The rebalance function is absolutely critical, and we’re getting into a period of time where I think we’re going to have the best of both worlds—contraction in the value of financial assets and expansion in the value of hard assets, and specifically the king of hard assets, gold and silver—that is going to play as a tremendous opportunity. Price is less important than ratio, and if you don’t understand that, that’s something that we need to explore more fully because that is the only way to maximize this kind of strategy on an intergenerational basis.

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Kevin: 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 you can call us at (800) 525-9556.

This has been the McAlvany Weekly Commentary. The views expressed should not be considered to be a solicitation or a recommendation for your investment portfolio. You should consult a professional financial advisor to assess your suitability for risk and investment. Join us again next week for a new edition of the McAlvany Weekly Commentary.

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