“Steer” Clear Of A Fake Bull Market

Weekly Commentary • Jun 07 2023
“Steer” Clear Of A Fake Bull Market
David McAlvany Posted on June 7, 2023
  • Looming Recession Does Not Support Current Market
  • Chances of June Rate Hike Drop From 70% To 30%
  • The Two P’s Of Investing: Preserve First, Profit Second

“Steer” Clear Of A Fake Bull Market
June 7, 2023

“If we think inflation is a problem that the Fed and Treasury are trying to solve, we’ve forgotten that inflation is a deliberate outcome targeted by almost every central bank in the world. It’s chosen. Getting to 2%, it’s not an accident, it’s desired. Ben Bernanke said getting to 2% may require running inflation at a higher level so that the years of below 2% inflation can be averaged out to that targeted number. So look, we’re running inflation a little hot right now, and that has, in academic circles, been an acceptable practice.” — David McAlvany.

Kevin Orrick: Welcome to the McAlvany Weekly Commentary. I’m Kevin Orrick, along with David McAlvany. 

You know those movies, Dave, where the train is just speeding along and only the viewer knows that around the corner the bridge is out, like “The Bridge on the River Kwai,” the Lone Ranger movie. I wonder if the stock market knows that the bridge is out. We’re seeing recessionary numbers over the next six months.

David McAlvany: Yeah, no, welcome to the new bull market. We’ve got the ISM services and manufacturing numbers both looking peckish. We’ve got retail sales here in the US, as well as in Europe, which are indicating recessionary levels. We’ve got the leading economic indicators, we’ve got factory orders, we’ve got equipment leasing surveys. Yeah, I would encourage you to go through Hard Asset Insights, written by my colleague Morgan Lewis, for some of the case built for recession being around the corner. But again, that’s not what you see in equities, is it’s welcome to the new bull market.

Kevin Orrick: The S&P 500 is up how much now from the lows?

David McAlvany: It’s rallied about 20% off the lows. Of course, it’s not showing those kinds of returns for the full year, but some are saying this is a new bull market. Why? Well, 20% off lows for what some consider to be the bar to reach, the affirmation needed for a new trend. Confirmation, if you will. There’s always room for discussion, and there’s always a requirement when you’re dealing with the financial markets for humility.

Kevin Orrick: Sure. Sure.

David McAlvany: If you don’t bring it, the market will serve it up. And there’s always a need for robust debate on all factors that drive both the financial markets and the wider economy. These are two different themes, but they do tend to coalesce most of the time. We do that today, we entertain the good and the bad, and see how it settles out. Last week we had astonishing numbers for the Nonfarm Payrolls, for the ADP Jobs Reports, for the JOLTS numbers, which tells you how many job openings there currently are. All the jobs numbers last week gave the market this energetic bounce.

Kevin Orrick: So what does the Fed do? I mean, are they going to skip raising the interest rate in June?

David McAlvany: Well, and that’s, I think— The move higher in equities was supported by several Fed executives, suggesting that we skip a rate increase in June. Skip. And why would that be?

Kevin Orrick: Yeah, because inflation’s not coming down.

David McAlvany: Yeah. Again, opinions vary, but allowing time to see if five percentage points increase in rates has been sufficient is the main argument. Just let’s see what is already in the pipeline. Like 30 days is really going to matter. Clearly, inflation remains untamed. That’s a reality we’re all dealing with. The skip strategy, frankly, it’s just not supported by data. But you have the Fed who has made this claim to data dependency, and lately it’s been more of a rhetorical tool used to support credibility than an actual process that they employ. More data implies monetary policy moves which are akin to science. That’s the appeal, is, look, we’re dependent on data. This is science, this is not monetary religion. If you look at the zeitgeist of our day, white coats, not white collars, are the reference points of faith in the modern era. So better to associate with the science of monetary policy, data driven, as we said, unless in reality that data doesn’t match the policy preference. Nevertheless, we’ve got the rhetorical tool as a trope, which remains useful even when disingenuous.

Kevin Orrick: Okay, so if you were to ask why they were raising interest rates in the first place, a couple of things, we had raging labor markets. I mean, everybody was employed. And we had inflation. The inflation was the biggie. We have raging labor markets, and we still have high inflation, and so why would they reverse their course at this point?

David McAlvany: Yeah, labor markets remain robust, that’s for sure. In a nutshell, that’s what JOLTS back over 10 million and surprisingly strong Nonfarm Payrolls and ADP stats suggest. And of course, you have to factor in the seasonal adjustments, which do exaggerate the reality, but the headline numbers are still suggestive of a very tight labor market. And with that comes continued wage pressures, which is a part of the inflation issue. It’s a part. It’s one of the pillars supporting higher inflation. 

That should serve as a reminder to the Fed to stay the course and to raise rates in June. But as of Friday, the odds of a June increase have been decreased from 70% to 30%. So the greatest risk by far, I believe, is the loss of Fed credibility in the marketplace. I think those fates are being tempted on a monthly basis. Given last week’s strong market data, further Fed tightening I believe is justified. To suggest a skip in June, that rate increase in June, is to tempt a market melt up on the one hand and a credibility meltdown. And that’s really not a great combination for the Fed.

Kevin Orrick: Well, and speaking of combinations, when you manage money, you have to ask yourself a question involving two Ps, okay? Are you going to go for profit or are you going to go for preservation? When you’ve got a market, going back to the train going around the corner, the train is just raging right now. People are thinking, “Gosh,” like you said, “the new bull market in the stock market, jobs, the labor market obviously is very, very strong right now. But we have inflation, we have high inflation. Every statistic is telling us that there’s recession coming.” My question would be, of the two Ps, preservation or do you chase profit?

David McAlvany: Well, I think it’s a mistake to ever put profit as the primary. If you have money, your first motivation should be to preserve capital, and when opportune make it grow. But that qualifier—when opportune—means that sometimes it makes sense to sit on your hands or sit on the sidelines. In recent weeks, there was method, there was meaning, and there was purpose to discussing a range of perspectives on market behavior. We all must look at price action, what’s happening in the markets, up and down, we have to look at that through a lens, and choosing the right lens or data filter is critical. 

Back to those two issues, if you’re going to preserve capital, you got to have the right data filter and lens, the right methodology if you will, and, when opportune, making those dollars grow. Again, this is done through a lens. So Dow theory, technical non-confirmations, volume statistics, breadth studies, investor sentiment gauges, valuation studies are all indicators, meaningful on their own. We’ve been discussing them for many weeks now, but they begin to bring weight to an argument when combined. In fairness, and this is the nature of working in philosophy many years ago, for every point there’s a counterpoint, for every thesis, an antithesis.

Kevin Orrick: Your dad had a friend, you may have even met him too, this was a man from Romania who got off a train early before it did actually go off the tracks. There are times, aren’t there, when you get off the train and you get out of it, even if you’re going to miss— The fear of missing out is really a huge danger.

David McAlvany: I think the difference between our place in the marketplace and this man from Romania is he was probably responsive to a still, small voice, and we are forced to look at things through a matrix of some sorts.

Kevin Orrick: Technical.

David McAlvany: And so it is a combination of fundamentals and technicals and price action and then disciplines to respond to the reality that’s presented in the marketplace. From our perspective, the weight of argument continues to support the conclusion of a long-term equity market top being put in place in this period, late 2021 to the end of 2022. We’re putting in a significant market top. So the timeframe’s there—between ’21 and 2022—it just depends on the index under scrutiny.

Kevin Orrick: But you’re saying that was where the top was.

David McAlvany: That’s right. So therefore, a secular bear market remains intact, the next leg of which is likely to be relevant and painful for hope-filled investors within the next three to six months. This is where, again, we’re looking at financial market dynamics that do closely relate to economic variables. We’ve got a recession leaving its mark in the economy later this year. Again, I refer you to Hard Asset Insights on the mcalvany.com website. If you haven’t read this last week’s, I think you’ll find a compelling case for recession built there. But you’ve got bank lending conditions which tighten further as the year grinds on. You’ve got the consumer now out of stimulus money and dealing with ongoing inflation pressures pulling back on consumption overall.

Kevin Orrick: So if we are in a new bull market like some would like to think, the bear was awfully short. Wasn’t it?

David McAlvany: Yeah, well, the Financial Times contributor John Authors, he puzzles over this, that a bear market would end in 195 days. Again, this is off of the lows in October. It’s very short when considering that the average bear market is 318 days. The long and hard to bear markets stretch over 678 days as it did in 1929, or 761 days as it did in 1946. The recession of the early ’70s and the accompanying bear market was about 630 days of financial market pain. Now, granted, some bear markets have lasted less than the 195 days we just went through, or less than the 318 average, but consider this: consider the massive uninterrupted growth from 2009 to 2019 and the asset boom that was further exaggerated by COVID stimulus thereafter. The everything bubble resolved in a very short timeframe? In our opinion, that’s just not likely. Busts, while they’re not equal to booms, there is a degree of proportionality, and this simply doesn’t fit. So remain cautious, continue to prize cash and short-term instruments, and look for the strong portfolio support of precious metals as a safe haven.

Kevin Orrick: And it is hard to do that. A couple of years ago everybody was talking about crypto. Now, the fear of missing out is in AI. So it can slant. I mean, you really have to tame your emotions.

David McAlvany: Well, sure, it’s a mosaic that we look at, and it’s a combination of fundamentals, which matter. We pay attention to fundamentals, individual company fundamentals, the corporate sector and debt that’s flowing or not flowing into that sector. By the way, big outflows from investment grade and high yield bonds last week. But then there’s also technical patterns, and technical patterns sometimes are like that loud cackle in a crowd. I’ve heard somebody with just an absolutely obnoxious laugh. That loud cackle can steal attention even in a noisy room, if only for a few seconds. I think the cackle comes from the recently energized individual investor watching the average gain of the seven leading stocks, now up 44% year to date on average.

Kevin Orrick: Those seven, huh?

David McAlvany: Yeah, on average. So that’s five times that of the S&P 500 according to Bloomberg. And then, of course, you’ve got the most spectacular—or if you want to think of it as a spectacle—NVIDIA is up 250%.

Kevin Orrick: Right, AI.

David McAlvany: It’s higher on a momentum run fueled first by AI positivity, and now it’s temporarily boosted by the fear of missing out. I think if there’s something from market history that’s worth remembering on this point, rarely is late stage FOMO rewarded for more than a moment, because it’s easy to forget that trades and trends are different. And though at times they can move together, they’re easily confused. AI may be a long-term trend, but the trade is already worn out.

Kevin Orrick: You brought up last week that NVIDIA is selling for many multiples of years of full sales and then—

David McAlvany: Yeah, it’s insane.

Kevin Orrick: It’s an insane thing.

David McAlvany: Exactly, we’re talking about insane pricing metrics. The hottest AI name now trades at 38 times price to sales.

Kevin Orrick: And that’s just sales, that’s not earnings.

David McAlvany: Yeah. So we’re soaring past 195 times earnings. 

David Trainer is referenced in a recent Grant’s Interest Rate Observer. He demonstrates using a discounted cash flow model to value NVIDIA. He says to justify $380-plus per share, NVIDIA must grow revenue at about a 20% annual growth rate while improving its net operating profit after tax margin from 27.2 to 44.5%, and return on invested capital, improve that from 34% to 778%. Priced to perfection? How about priced for fantasy?

Kevin Orrick: I’m sure it’s riding a wave—a hundred foot wave if you’re NVIDIA’s CEO. But what do you think he’s thinking? What would NVIDIA’s CEO be thinking right now as far as how long it would actually take to break even on those shares in annual earnings?

David McAlvany: Yeah, I think he’s probably thinking, “What turns this smile upside down? I can’t imagine. We are on top of a goldmine.” That’s generally the fantasy mindset that a CEO gets stuck in. 

I do think that there is some sobriety in the C-suite, and so there’s little that you can do once prices have run away from you. The CEO, for instance, and co-founder of 1990’s rock star Sun Microsystems, he asked the question in 2002—again, this is sort of the postmortem after his company has gone through the meat grinder— “What were you thinking?” That was his question, “What were you thinking when Sun reached a peak valuation of 10 times revenue?” 

This was in a Business Week interview, and he was quoted as saying, “To give you a 10-year payback—10-year payback—I have to pay 100% of revenue for 10 straight years in dividends. That assumes I can get that by my shareholders. That assumes I have zero cost of goods sold. That assumes zero expenses, which is really hard with 39,000 employees. That assumes I pay zero taxes, which is kind of illegal, and that assumes with zero R&D for the next 10 years I can maintain the current revenue run rate. Do you realize how ridiculous those assumptions are?” That’s what Scott McNealy, CEO of Sun Microsystems, said in the aftermath of the price collapse of Sun Microsystems.

Kevin Orrick: Well, and that was when it was 10 times revenue.

David McAlvany: That’s right. NVIDIA is trading not at 10 times revenue, but 38 times trailing 12-month revenue. Jim Grant points out that this is, of course, a 380% premium to the valuation that inspired McNealy’s rant about Sun Microsystems, right? Sun— You may not even know it. I mean, it’s a part of a conglomerate today, it’s a part of Oracle. It doesn’t even exist today, but Sun was valued at nearly $200 billion. The company disappeared in 2010 into Oracle’s asset base. They bought it for $7.4 billion.

Kevin Orrick: It was worth 200 before.

David McAlvany: A 96% reduction from its euphoric peak. So when it sold to Oracle, it went for about $9.50. In the tech wreck, I did buy Sun Microsystems between two and four dollars a share on its way to 10. But remember, 10 was not nearly the $65, $70 that gave it that $200 billion market cap. This is decimated. Do you realize how ridiculous those basic assumptions are? Again, just to quote McNealy from 2002, “In a 10 times revenue number, do you realize how ridiculous those basic assumptions are? You don’t need transparency. You don’t need any footnotes. What were you thinking?”

Kevin Orrick: Right. You brought this out last week, too. It’s not the technology that you’re questioning. AI is going to be here from this point forward, right? But it’s the insanity of people just throwing any amount of money at the shares.

David McAlvany: That’s right. It’s the way investors engage with the opportunity and the growth and development of a particular idea as it becomes reality. Every revolutionary technology shift has been met with an initial moonshot, enthusiasm that had no bounds, and then there’s a subsequent reality check. Go back to RCA and the launch of the television. We’re talking about various technologies through the ’30s, ’40s, ’50s, or any of the incumbent tech giants today. They had the hype in the ’90s.

Kevin Orrick: And what happened to them, I mean over time?

David McAlvany: Then they uniformly, uniformly gave back 70 to 80% of the FOMO gains, the fear of missing out gains, from that era. And only after the evolutionary sorting of the early 2000s’ bear market did the strong emerge to fight back and to actually survive. It was the same with RCA in the ’30s. The evolutionary sorting and the debacle of a secular bear market has yet to test, has yet to reveal the 2020s survivors. At this stage, we don’t know who emerges from a complete liquidity freeze. We don’t know who emerges from financial conditions which will be unforgiving to the unsound business balance sheet or the enterprise that needs time to sort itself out. The market today is saying that you’ve got 195 years to sort yourself out.

Kevin Orrick: Yeah, because the earnings, that’s how much it’s selling over earnings, NVIDIA.

David McAlvany: Yeah. Time to meet projections, 10 years is a lot of time. 38 years is a lot of time. 195 years is a lot of time. The nature of tightening financial conditions is a little bit like a runway shrinking in front of you prior to liftoff and prior to gaining adequate speed to provide for ample lift. Given enough time— I don’t know if you remember the Spruce Goose.

Kevin Orrick: Oh, sure. Powerful.

David McAlvany: I remember going to California seeing this monstrosity.

Kevin Orrick: It did take off, Dave.

David McAlvany: Right, given enough time, even the Spruce Goose could fly. But NVIDIA, as it’s currently priced, needs decades to catch up to its current price structure. How much runway does it have? That is a market-determined factor. And to go from speculative FOMO to risk off, I think what you’re looking at with a company like this is catastrophic blowup of investor expectations. Because today you’ve got people buying it, 38 times sales, and assuming that it is going even higher. It can double, triple, quadruple from here. 

This was last week’s point. Today it’s a trillion-dollar company. Tomorrow it’s a two or $3 trillion company. How do we get there? I think what you’re looking at is the afterglow. Afterglow is that light that lingers once the sun has set. I think we’re talking about a credit super cycle that has set like the sun, and only the afterglow remains. The afterglow shines deceptively on too many companies that have yet to realize their time is up. It’s getting darker by the minute, and there is nothing to reverse time. Zero.

Kevin Orrick: You talk about fundamentals. Fundamentals do matter, but you also talked about the cackle in the room—the technicals. What do the technicals say?

David McAlvany: It’s possibly a contagious cacophonous cackle. I mean, this is where there’s still price action which must be respected. The ceiling of 4,200 on the S&P 500 has been broken. A rally off the October 2020 lows has now exceeded 20%, and it remains to be seen whether the concentration of energy in just a few names—we mentioned the seven earlier, now up an average of 44%—if the energy concentrated in those names spreads to a broader list of names. But Friday’s impulsive 3.6% gain in the Russell 2000—again, this is an index of much smaller companies, small cap companies—this was a one-day expression of hope in the market that breadth would improve and more names join in the bull market, which up to this moment has been a bull market in less than 1%. Actually, a fraction of that.

Kevin Orrick: But you’re saying the breadth is spreading at this point.

David McAlvany: Yeah. But again, the bull market has been in less than 1% of all publicly traded companies. Will it spread? Was Friday an indication of what is to come? If indeed a new bull is being birthed—quite frankly, small caps fill a typical role as leader in a new bull trend; that’s historically been the case—breadth may improve, momentum may build. We may take out previous highs. But I would argue that economic fundamentals ultimately have to support a bull market or it’s just like a sugar rush. Endurance for a short time can be driven off sugar, but lasting health cannot. It needs more substance. This still has the feel of a countertrend rally, one that nevertheless is gaining momentum to the upside.

Kevin Orrick: But you talked about the Federal Reserve and the possible loss of credibility. If they’re not fighting inflation anymore, then what about the credibility loss of the dollar itself? There’s a lot of talk right now, and European countries like Hungary are making statements that they’re preparing for a monetary transition. Well, do we have a monetary transition? You’re not a bull in the dollar, but you’re also not an immediate bear in the dollar losing its reserve currency status.

David McAlvany: Yeah, Larry Summers was saying that, yes, we could potentially skip the June increase of 25 basis points, but only if the July meeting is 50 basis points. So we’re going to have to make up for it somewhere because we’re not done fighting inflation yet. So if you want to pause, great, but it’s not a pause which should imply completion. Fed credibility is tied to this whole issue of rates and the June skip. To skip June is to err on the side of adding fuel to a market melt up, right?

Kevin Orrick: Yeah.

David McAlvany: We’ve already talked about tighter bank lending standards. That in fact could become irrelevant if leveraged speculation takes the wheel and runs over—literally, like a Mack truck—runs over the risk averse, blows up any financial tightening the Fed had intended via its rate increases. If this happens, Kevin, it’s the death of credibility. This is, I think, what’s really critical here when we’re talking about the dollar as king. We’re dealing with the creator of the dollar and the management of the US dollar system which may take a significant credibility hit. The dollar is still king. The dollar is still king. The arguments for its eminent demise ignore the structural differences that exist between the gold-backed reserve currencies of the past. And if you went back to the Dutch, if you went back to the British, when you’re talking about the reserve currency, a part of the faith and trust that the global community had in these currencies had nothing to do with government policy or monetary policy prerogative. They had their hands tied by a gold standard.

Kevin Orrick: They were receipts for gold, but now we’re fiat. We’re completely fiat. There is no gold.

David McAlvany: That’s right. So you can’t really compare the old structures with the new structure. Today we have a fiat system. It doesn’t really have an analog. And now you’ve got global imbalances, and those imbalances depend on our currency and economy to function as it does. You may not like it, you may be a critic of it, but you always have to be aware of the trade-offs that come with change. If you want something different, there may be benefits and there may be drawbacks. So what’s the penalty if you choose to change?

Kevin Orrick: You had me read a book years ago by Thomas Kuhn, and he talked about how long it takes for scientific theories and revolutions to actually take place, because it’s hard to break the old ideas. Humans just don’t like change.

David McAlvany: Well, and a part of the reason it’s hard to break old ideas is because what he describes as textbook knowledge. You’ve got a generation which is educated along certain lines that this is the way the world works.

Kevin Orrick: And they have to defend their thesis.

David McAlvany: That’s right. And so you end up with a bias within the ivory tower or the various areas of education around the world, and that bias continues to perpetuate whatever problems are within the system because you can’t see the world through a different lens. You’ve already adopted one solid set of lenses, and that is how you see and interpret all fact.

Kevin Orrick: So would you see the dollar as that kind of bias at this point? Just common usage of the dollar is probably going to keep it in the king seat for a little while longer.

David McAlvany: Well, I think people underestimate how the dollar and the US dollar system and being fiat has allowed for the current global system and current trend towards globalization. We may talk about de-globalization to some degree today, or even de-dollarization today, but again, these are not things that are fait accompli. To change the functioning comes with trade-offs, and that would be far more grave—losing the dollar system would be far more grave—than a global depression. Rebalancing the imbalances that exist may be desirable, but to some degree they’re politically impossible because you’re talking about a change within emerging markets, which would be catastrophic. We’ve never had exactly this setup before. The hard conclusion for some to swallow is that in spite of being hated, the dollar system being resented in many parts of the world, there is no alternative to the dollar. This is, coming back to Kuhn, problems remain problems, and no solution can be adopted until complete regime change occurs. An alternative paradigm has to stand in for the existing system, and no such system exists today.

Kevin Orrick: But China and Russia and Iran, some of these countries are at least looking that direction over time.

David McAlvany: Exactly. They may be searching for an alternative, but the alternative doesn’t exist today. Some have even suggested that cryptocurrencies are the wave of the future—again, the non-central bank digital currency variety. I think folks who go down that road don’t understand the complexity of the current account and assume that global finance is a little bit like buying a pack of gum, a little bit of money changing hands there and there, and it’s just that simple. No, it’s really not. Capital flows, the depth of markets which is required to maintain the system as it is—again, it’s not necessarily a healthy system that we have, but the alternatives come at a very high price.

Kevin Orrick: Well, and we gave a guarantee. In 1944, the guarantee of the dollar was that it would be a reserve currency asset that would be backed by gold. And so what we’ve done is we’ve redefined economics to where we default on our debt all day long every day in the form of inflation. It’s just a regulated default, but it’s a default.

David McAlvany: It’s a regulated default. We’ve done it before. We did it back in 1933. This is when gold was made illegal and the dollar gold exchange rate was flipped from 20.67 cents to $35, so essentially a 65% devaluation of the currency overnight. And then when Nixon closed the gold window in ’71, we did the same thing. Only this time it went from $35 to free floating in the global markets. First it was $190, then it was $400, ultimately $875. But if you just wanted to pick where gold ultimately settled in, you had basically a 90% devaluation from 35 to 400. It was a catastrophic decay in purchasing power for gold. The dollar’s loss of reserve currency status is not the real story to be concerned with. The immediate concern is that, knowing this, the Fed and the Treasury knowing that there is no alternative to the dollar system today, the immediate concern is that the Fed and the Treasury deliberately abuse the position of the US dollar and do what has been done before, default in the only way that can’t be fought or challenged in a court: via inflation.

Kevin Orrick: And John Maynard Keynes said that that is the tax that one in a million understand.

David McAlvany: That’s right. Inflation. If we think inflation is a problem that the Fed and Treasury are trying to solve, we’ve forgotten that inflation is a deliberate outcome targeted by almost every central bank in the world. It’s chosen as a tool of redistribution, as a tool of economic stimulus, as a tool for dystopian demand management. Getting to 2%, this is a goal. Inflation is a fact and a factor which we have to keep in mind as something that—it’s a choice. It’s not an accident, it’s desired. 

Ben Bernanke said this a few years back. He said getting to 2% may require running inflation at a higher level so that the years of below 2% inflation can be averaged out to that targeted number. So look, we’re running inflation a little hot right now, and that has, in academic circles, been an acceptable practice. Again, do you think this is a problem the Fed and the Treasury are trying to solve? You are a part of a scheme of redistribution, economic stimulus, dystopian demand management. You are in the matrix.

Kevin Orrick: And yet so many people are still focused on growth of their money, and they don’t even see the shrinkage of their money. Think about it, if they went off the gold standard, which they did, I have to be on my own gold standard for protection.

David McAlvany: No doubt. I’ve finished reading a retired Goldman Sachs alum. This was from the Alphaville section in the Financial Times this last week. A great little piece put together, about a 22-page piece. He was head of currency trading at Goldman Sachs from 2004 to 2008. He talked about the fear of dollar implosion which has had three distinct waves over the past 23 years. Each of them has been supported by data only to have resolved themselves. Lo and behold, the dollar is again being discussed as this thing that must simply go away. It will go away, there’s an inevitability to it. But he recalls, to the chagrin of academics like Eichengreen and Bernanke and Rogoff and Blanchard, that the dollar has not died or lost its status in spite of their speculation that it would. In fact, the dollar’s exhibited strength, particularly during periods of global distress. 

And so, whatever their fixation was from the standpoint of models or theories, in practice, price action proved them wrong. This is one of the things, when you manage money, it doesn’t matter what your theory is, price action forces humility. You have to respond to price action or you will get rolled over. We do think we are in a bear market, and perhaps this is the rally back in the context of a bear market if we’re talking about equities. We do think that the long-term story of the dollar is not a great one. But you can’t assume that the death of the dollar is what is happening right now. The dollar strength, again, it’s exhibited strength during periods of global distress. I can imagine, can you imagine one, two, maybe a half a dozen or dozen different kinds of global distress on the horizon?

Kevin Orrick: Yeah, hard to see.

David McAlvany: I’m not a dollar bull, but I’ll tell you what I am. I am a gold bull. But to assume the dollar is dead takes things too far. The academics thought they were onto something. They fixated on the current account imbalances from 2005 to 2007 and drew a line, connected dots, and said, “Here it is, the inevitability of this demise of the dollar.” Whoops, didn’t happen. Now it’s de-dollarization and a growing number of voices globally that say, “Yep, it’s going to happen.” The reality is, you may want change, but what’s the price of change? The reality is the surpluses that the emerging markets enjoy are the other side of our deficits. To do away with the dollar system would have grave political consequences throughout the emerging markets. It would upset the entire world as a result of considerably reduced economic activity, massive unemployment. Getting rid of the dollar fits the category of: be careful what you wish for.

Kevin Orrick: But there’s still care being taken. The central banks are still buying an awful lot of gold.

David McAlvany: Well, yes, they’re buying gold, and a part of it is on the de-dollarization theme. A part of it is this insulation from geopolitical conflict which they see on the horizon. It remains amazing to me, if you talk about the average investor here in the US, people see gold and they say they want to stay geared exclusively towards growth, maybe growth and income, and ignore all pet rocks. Gold’s been derisively called nothing more than a pet rock. But when the long story of growth in the financial markets is punctuated with radical downside volatility, bear markets, with gold remaining—for hundreds, I mean, if you’re going to stretch it back even thousands of years—remaining the only reliable form of cash which allows for greater long-term growth and a massive reduction in portfolio losses, people lose perspective.

Kevin Orrick: Well, Dave, you and I, last night, we were talking about that mix. If a person has all stocks versus a person having a mix, maybe 25% in gold, what a different outcome it brings.

David McAlvany: Well, granted, look at gold today in the world of fiat currencies as more of an insurance policy. But I think if you were to look at it and frame things differently, just from the standpoint of growth, how do you maximize growth if that is as an investor what you’re trying to do with the capital that you’ve saved—excess capital. Maximizing growth is not a 100% equity portfolio. It’s not a 60/40 bond stock portfolio. Maximizing growth— We did these numbers in the late ’60s, early ’70s, redid them when we launched Vaulted, our gold savings app, a few years ago, and it’s just around 75/25—75% stocks, 25% gold. And you rebalance once annually so that if you take a hit in your stock portfolio, gold classically has swollen in value and you have the opportunity to lower your cost basis and add to shares in your equity portfolio with that annual rebalance. And vice versa. If gold’s not doing well, stocks are doing well, you take some gains and you refortify your ounce position.

Kevin Orrick: When you ran the numbers, I mean, you outperform in the long run—

David McAlvany: 100% equity portfolio, a 60/40 bond stock portfolio. It’s one of the best performing asset classes unless you’re talking about alternatives like private equity or hedge fund management. If you’re just talking about growth within the equity space, equities plus gold, that 75/25 mix, it is magic.

Kevin Orrick: Well, and it goes back to the two Ps, because if you’re not preserving some of your profit, you’re in trouble. You brought up Sun. Look at all the companies— You brought up RCA. RCA, that lasted— But think of all the radios and TVs, the various companies that no longer— They’re just a memory in the rear-view mirror.

David McAlvany: There’s first order questions, second order questions in science. There’s first priorities in relationships and secondary priorities in relationships. If you ever take the secondary factors and make them more important than the primary, you sometimes lose the primary and the secondary, both. So we come back to that issue of, you focus on preservation of capital and, when opportune, you make it grow. Those two factors are really important, and this is where I think that 75/25, that blend, or a mindset of: Even to grow, you still have to keep things in reserve. It can’t be 100% throttle to get the best, or optimized, results.

Kevin Orrick: Well, and so often you being an athlete, Dave, you’ve referenced how important it is to have reserves. Remember the book we read about the triathlete, and he likened reserves to a matchbook, 24 matches in a matchbook. And he said, “You want to be very careful when you’re doing the Ironman how often you burn one of those matches. You’d better have a couple of those matches left when you finish.”

David McAlvany: That’s right. Out of the gates you can’t give 100%. It’s a question of measured results and measured effort. It’s a question of what you’re feeding your body as you go.

Kevin Orrick: And financially, gold is the ultimate reserve.

David McAlvany: Yeah, it is. One of the things that we’ve chosen to add to our Vaulted program starting at the end of June is a silver component, an amazing relationship.

Kevin Orrick: We already have a long waiting list of early risers, they want in.

David McAlvany: We have 3,000 investors who would like to own silver in the Vaulted program yesterday. Yeah, if you’re interested in that, explore the Vaulted app or go to vaulted.com, and you can certainly register for the early adoption. Cheapest silver bars, I would argue, on the planet. Our relationship with HSBC in London gives us a first position in terms of inexpensive bars, and it’s something to pay attention to.

Kevin Orrick: That’s going to be launched fully over the next month.

David McAlvany: Yeah. The caveat I would have with that is that silver is not gold, and I like gold as the ultimate reserve, as you put it. Silver is not gold. It is more of a growth asset. I think about silver like some other industrial metals which are showing that the global economy—coming back to the leading economic indicators and the ISM services and manufacturing, the retail sales and some of the things that we mentioned earlier that would argue for recession. Copper is telling you something very important. Crude is telling you something very important. OPEC over the weekend agreed to keep the cuts, 3.66 million barrels per month, off the market and keep those in play until the end of the year. Saudi—so this is Aramco—Saudi Aramco decided to cut an extra million barrels in July. Remains to be seen if they’ll extend that to August, September, October, or the rest of the year. But this is worth a lengthy discussion because Aramco’s choice to cut in July mirrors a global concern over tepid demand. There’s not enough demand to support pricing in the crude oil market.

Kevin Orrick: That’s called supply side economics.

David McAlvany: They’re trying to control the supply to match up with demand. Copper markets are telling you the same tale. And again, go back to HAI, Hard Asset Insights, from the weekend, Morgan explores the copper market very persuasively. 

But you have this growing case for recession. I love silver, not as much as I love gold, but you have to be aware that it is an industrial commodity. Sometimes the trade between the two, between gold and silver, is done most effectively because the difference in pricing reflects the difference in quality of asset. Silver doesn’t have the same quality as gold. It will tend to be more volatile, one direction or the other. It creates an arbitrage opportunity, and hopefully that’s something that can be facilitated, either directly with our company or through Vaulted or what have you. But very excited about the Vaulted program. Would encourage you to look at it and explore what that represents.

Kevin Orrick: Well, and I would encourage the listener to call us. We’ve been around 51 years, we’ve seen silver high and we’ve seen silver low relative to gold. It’s worth a discussion with one of the associates here.

David McAlvany: I can’t help but mention these issues which drive demand to gold which don’t have as much to do with inflation and are reflected in central bank purchases. We have Chinese aggression. We have Xi Jinping who wants to push the limits and knows he can today with a weak US president, with compromised business dealings, with growing indications of corruption and graft, with what appears to be the FBI doing a marvelous job covering the tracks for the current president. I mean, this is absolutely mind-boggling. 

But the destabilization that we’ve seen in the global sphere with Russia invading Ukraine, with the potential conflict between the US and China, there are many reasons to consider reserve assets and how you position in the marketplace that have nothing to do with the fundamentals of the stock market, that have nothing to do with price-to-sales or price-to-earnings ratios. All of these things are neat things that we play with. They’re tools of the trade. But they can all become low lights. They can all become less important. They can all become drowned out by the drumbeat of war. 

I think that is something we’ve got to keep in mind. We are in a more precarious place in terms of global relationships, international relations, than in any time since the Cold War. Do you want to be embracing a “new bull market in equities” with the risks that linger out there? “Welcome to the new bull market,” some are saying. I’m going to doubt it a little bit longer.

Kevin Orrick: You’ve been listening to the McAlvany Weekly Commentary. I’m Kevin Orrick, along with David McAlvany. You can find us at mcalvany.com, M-C-A-L-V-A-N-Y.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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