Podcast: Play in new window
- Why is gold lagging as an inflation hedge?
- Is Bitcoin truly digital gold?
- Can the Fed Not Ever Raise Rates?
The McAlvany Weekly Commentary
with David McAlvany and Kevin Orrick
2021 Your Questions Answered – Part 1
December 21, 2021
“You can accomplish all the benefits of above-market growth if you’re willing to adopt a value approach to investing. But that means you are never all in. So you don’t buy when things are overvalued, you build reserves. Reserves in ounces—to me that has a superior long-term record to reserves in dollars to reserves in euros to reserves in yen. You can be pragmatic with those currencies in the short run. But in the long run, the price of allocating reserves to fiat is a costly one.”— David McAlvany
Kevin: Welcome to the McAlvany Weekly commentary. I’m Kevin Orrick, along with David McAlvany.
Man, we got a lot of questions. I realize that you really apply yourself to this, but I’m looking at you right now, Dave, and your eyes are bloodshot and you’re just getting back. Literally it looks to me like you dressed in a tent. I’m sorry, I want everybody to imagine this. But I knew last night you went with some friends. Friends that you’ve gotten into trouble with in the past, as far as the danger that sometimes they put you in. You’re a risk taker, Dave. So tell us what you were doing last night before we start answering some of the questions that people have sent to us.
David: Well, my apologies ahead of time, if there’s a degree of incoherence in the answer. It might be because it’s been an interesting morning and certainly a very interesting night last night.
Kevin: Tell us about death sledding. What exactly is death sledding?
David: Well, I mean, it sounds more harrowing than it actually is. It’s two and a half to three-mile sled run that my friend set up. And then he can haul us back up either with a snow machine or a four-wheeler, depending on the conditions.
Kevin: And you got more than one run in.
David: Oh, I could have done that the rest of my life. I mean, we came inside, and I think my eyes are red in part because you get all the snow blowing. And when you’re being dragged back up the hill with a four-wheeler 30 miles an hour on the uphill.
Kevin: And it’s not the lack of sleep at all. I think you told me you got a full four hours.
David: Well, that’s true. It might be the sleep. Great friends, great adventures. And it’s a part of living a balanced life. My wife was out on the town with some of her best friends. And so all of the husbands of these other women were like, well, we should get together. Let’s just go. So we did.
Kevin: Death sled.
David: Yeah.
Kevin: Well, good. Well, all right. So Dave, we are entering, for the next few weeks, we’re entering what I think you and I would consider our favorite time of year. Not just because of the holidays, but because of the questions and answers. We have very intelligent listeners. We get a chance to see that throughout the year, just from comments that people make or calls that we get. But when we get these questions, we really don’t necessarily edit them. The question is, “Hey, please surprise us a little bit.” And that’s what our listeners do, they surprise us. And hopefully, some of the answers won’t just be expected answers, but surprises on the backside. So let me go ahead and start with one of the first questions that came in, Dave. And even my wife, I brought this question up to her and she said yeah. That is the question, what’s going on. And so here we go. The question came in from one of our listeners, “Why is gold not acting as an inflationary hedge and not able to break out, given all the inflation talk?” Why, Dave?
David: It’s a great question. So here’s a quick review on the official status of inflation. November 30th was the first admission by Jerome Powell that transitory was no longer an accurate description. And only in the December 15th FOMC policy comments was the T word, transitory, dropped all together. So prior to that, we have had the markets taking the lead from the Fed that you don’t need an adjustment in bonds or stocks or metals to reflect inflationary pressures, because it’s a mere blip on the screen, very temporary.
So the CPI rise from 1% to just shy of 7% has been blamed on supply chain bottlenecks, a low base of measurement off the pandemic numbers in 2020. And to date, the numbers have been underestimated. So underestimated by the PhDs at the Fed and by the vast majority of investors that have placed faith in the monetary oracles. These are the oracles of our day, officed at Maiden Lane. They are in Manhattan. So one explanation of why the metals have not seen higher numbers is simply that, judging by the official statistics, inflation was not an issue to be concerned with, nor would it become an issue to compel an investor to reposition a portfolio in light of it. That judgment is still hanging in the balance with a significant credibility reappraisal quite possible, if you look at the views of the Fed there.
Kevin: Well, an inflation isn’t always the reason a person buys gold. I mean, we have also possible instability based on Covid variants, that type of thing.
David: Yeah. And I’ll come back to this issue of whether or not inflation is here. But for the time being, statistics are being massaged. We mentioned this in past shows, but now we have talk of the Covid variants of concern, and that’s reintroduced downward pressure on commodity prices. That, coupled with the Bureau of Labor Statistics announcement of a shift in weightings for how the CPI will be measured as of January 2022, and we may well have seen the peak in official statistical measurement of inflation.
Of course, our experience of inflation, we may experience different than a mere statistic. So people will have to decide for themselves how much credibility is left with the Fed and the Bureau of Labor Statistics going forward. I think gold pricing will reflect the migration of confidence and trust.
So recall the decade of the ’60s set the tone for gold and pricing of gold in the 1970s. And even as inflation was rising from 2% to double-digit levels, gold performance was not in a straight line. It did not go straight up in line with inflation. We went from 35 to 200, we dropped from 200 to 100. We then broke out to 400. And then in about a six-week period, more than doubled from 400 to 875. Said differently, it was a 5X move followed by a 50% decline, followed by another 9X move to peak levels. And that 9X move took it to about twice its inflation-adjusted price.
Now in the current context, we’ve already had a 6X move followed by a 50% decline. And I think we’re in the process of making what I believe is the largest dollar move in gold prices yet, likely to 2X the inflation adjusted price. That would put it at approximately $5,200 an ounce. And I guess the summary piece there is, markets do what they’re supposed to, but rarely when we want them to.
I think, also note that gold’s correlation with inflation is better on longer timeframes. The correlation is not helpful in short timeframes where you can have other dynamics involved in the pricing of gold and other assets. So the correlation is not helpful in short timeframes. Take, for instance, risk-on and risk-off dynamics. That can define a trading range in the short run and mute any connection to inflation as a broader macro trend. We’ve got risk on and you’ve got assets going crazy. And to some degree, because those asset prices are going crazy, there’s really little need for the protective dynamics or the safe haven appeal of gold in that environment.
Kevin: Yeah. And it’s interesting, my wife was giving a wink when she said, why isn’t it keeping up with inflation. Because we’ve got 35 years of buying gold and not really watching the price. And sure enough, it buys about the same amount of bread that it did 100 years ago or half of that time ago.
Okay, so next question. They are calling Bitcoin the digital gold. Just like gold, it has to be mined and there is a finite amount. Why wouldn’t you choose that over gold? And you wouldn’t have to pay for the storage either.
David: Measured in satoshis, which is the smallest increment of a Bitcoin, the ultimate number of blockchain parts is into the trillions, which is different than the commonly held view that there’s 21 million units, and that is indeed very limited. So again, you bisect and bisect again, you’ve got all of these sub parts to one particular Bitcoin. I would say that either Bitcoin is legitimate on its own merits or it isn’t, but the merits of Bitcoin are not the borrowed attributes of a tangible asset. It’s not digital gold because the language of mining has been borrowed or because the picture of the digital receipt is a fake one, an image of a gold coin with a big B on it.
It has its merits. Yeah, don’t get me wrong, I think Bitcoin does have its merits. But it’s not just because you’ve borrowed the language. It’s not gold. Indeed, the merits of an unchangeable ledger. I mean, for the most part it’s unchangeable. They’ve got a 51% rule where, again, you actually can change it, but it’s more and more difficult to all the time. So if you just say the unchangeable ledger, the permanent recording of a transaction, keeping that record pure because the data is distributed, that’s intriguing.
Just here recently, BHP Billiton used the technology to ensure an assay on a $30 million copper transaction with China Minmetals. This was just last week. So the digital ledger was useful in ensuring that this huge bunch of copper and the assay was consistent as the metal was moved from one location to the other, nothing was changed.
The digital ledger is useful, but thus far it’s not a currency substitute as much as it is an unchangeable database. And that in itself has its merits, it has unique applications also for public records. And we’ve already talked about that in terms of the way it’s been used, specifically in Estonia, to completely revolutionize the way that public documents are kept, and now are unchangeable.
You might say, well, why is that important? Well, because history shifts and the telling of history— He who counts the votes determines the outcome. Well, he who tells you the history also tells you what the next step in your future will be. And so they wanted to make sure that the public record stood and could not be disturbed. So you’ve got application for public records, you’ve got transaction verifications, but to assume it has the merits of gold is assuming too much.
Kevin: Well, okay, so bring up the storage part. The last part of the question was, and you don’t have to pay for storage.
David: As for storage, it is a reality, but I think you get what you pay for. Over the past 10 years, stolen cryptocurrency through breach and fraud tallies to just under $20 billion. The average incident value this year in 2021 is at $93 million. That’s per incident, $93 million.
Kevin: On average.
David: We were talking about a gold heist. This would make the news, wouldn’t it? It’s not the case. It’s not the case with secured gold vaults. Think about London, think about New York, think about Zurich, access is the challenge. Access is the challenge with a hardened facility. And yet, digital assets are on the other side of that. Access is the key. Digital access is, in fact, a vulnerability. And so, to me, that is one of the beauties of having an analog versus a digital asset. Another way of looking at it would be this way. Yes, I’m paying for storage for my metals, but my storage costs for a real intangible asset are far less than the property taxes I pay on my other tangible assets. Things like real estate.
Kevin: Mm-hmm (affirmative). There’s always a cost in something that’s real, but there’s a cost in something that’s also ethereal too, like the Bitcoin.
David: No, I guess one qualifier to that is the digital access part. If you want to remove your asset from connectivity, then it’s safer. I think what we’ve found is many people, like me, have a hard time remembering passwords. And that comes at a high cost too. Someone might not have stolen your Bitcoin, but if you can’t remember your login password, then you’re doomed. My son reset the password on one of our computers this weekend and we’re having to go through this whole rigmarole because he thought he could remember it. And he is a pretty sharp kid, and yet he couldn’t remember it. So now all of a sudden our whole system is upset because he couldn’t remember what he thought was unforgettable.
Kevin: So there’s nothing free, right? Nothing free.
Next question, “Dear David and Kevin, here’s a question for your show. Oil is still the backbone of industrial civilization, and we don’t really have an alternative that scales up as far as I can see—and others, such as Alice Friedemann of energyskeptic.com. And by the way, her work on feasibility of various sources is exhaustive. It sure would be great if more people in positions of power were systems thinkers rather than ideologues.
“What do you see being most likely for oil in the year ahead? Will misguided green policies and inflation lead to super spikes in the price, or will misguided health policies lead to an accelerated demographic die-off ushering in a long deflationary slide? Maybe both?
“Thanks for being voices of reason and sanity in an increasingly clownish world. Keep up the good work. Sincerely, Warren.”
Okay, so oil. Oil, that’s the question.
David: Yeah. I mean, oil is very sensitive to demand. And so any complication in the economy, Covid-related or some other unexpected demand detractor, would put downward pressure on the price. I think that’s fairly stating the obvious. But in this respect, my primary concern is one of policy interventions, which could in the name of public safety create a miniaturized version of what we had in March of 2020 and the crash in oil prices. I mean, WTI traded negative. That was unique to the Cushing contract, and it’s not what I have in mind. But certainly trading below $50 a barrel following a multiple-month lockdown, that kind of volatility on the downside can’t be ruled out.
Kevin: Well, what about politics, though? The politicians, at some point when people are not able to heat their house, are they starting to recognize the pushback?
David: Well, I think that’s right, they’re more and more aware of pushback against those policy choices. And yes, in the name of public safety, there is a mandate to do something. But now that’s weighed against, for instance, the protests in Europe, which— They’re now speaking loudly to the costs of a political nature. But I think you also count the economic impact, which is a reality of being vocalized by constituents. Additionally, you’ve got vast sums of money, which during the Covid pandemic were being handed out to balance and boost aggregate demand. And that too is a more challenging proposition now versus 2020 or early 2021 as inflation is flaring up globally. And that presents a new risk for policymakers to consider.
Kevin: You can’t always hide behind Covid, can you?
David: Yeah. On the one hand, we can see lower prices. On the other hand, their hands are somewhat tied. We’ve got restrictions, mandates, lockdowns. It’s just trickier now than it was in 2020 because you had the pandemic panic and that provided politicians with some cover, and they don’t have that as much. Now it is a weighing of costs and benefits. So perhaps that type of measure won’t be so universal. We do have the Dutch that are now in lockdowns for a month. We’ve got the British who are considering it post-Christmas. And looking into the New Year here in the United States with new cases, now 73% of them are coming from Omicron, according to the Centers for Disease Control. Early January, I mean, if we get past the holidays, case numbers are likely to be shocking, given the high transmissibility of Omicron. And then we have the ineffectiveness of vaccines at preventing transmission. So nothing can be ruled out.
I have multiple friends that are double and triple vaxxed and have it now. So it’s a bit of an issue. I have no idea what variant they have, but I presume it’s Omicron. This of course raises all sorts of challenges from a PR perspective for those who are promoting the boosters. So, I mean, you’ve got Pharma, which is defining more and more of the protocols for policymakers. And we’re moving quickly towards a crisis of confidence with this nexus of what’s working, what’s not working, and how hard do you press for further compliance in a world that’s not giving you the kinds of numbers that we were seeing back in 2020 when they would say, okay—and early 2021—we’ve got 96% chance of this working or that working.
Kevin: Well, if the vax is not stopping it from being transmitted, how about healthcare workers? Because if they’re all vaccinated and they’re still getting sick, what does that do?
David: Well, again, this is a question about oil, and I just want to point out that the healthcare system stresses are likely to be the worst we’ve seen yet. Not because of deaths or hospitalizations, but because of healthcare workers testing positive despite vaccination, and being unable to work for a period. So there are pressures for policymakers on both sides, and oil as a result is short-term vulnerable.
But I think there’s also long-term opportunities implied in that. Given that decarbonization is not a fait accompli, and it’s going to take years, if not decades. It’s going to take a societal willingness to absorb higher costs. Or maybe another way of looking at that is a lower standard of living universally accepted to accommodate the cost of implementation. So while we can argue on the one hand lower prices for oil, I think we can also argue on the other hand, higher prices for oil.
There is the new commodity in play, it’s not a new commodity, but a new application. Copper has found a new dynamic for the decades ahead. And if decarbonization is going to continue, then demand on a global basis for copper, I think, is going to be a wave of the future.
But here is the other piece. In a mad rush towards decarbonization, pressures are increasing on the energy sector to move to more bio-friendly alternatives. So supply limitations resulting from insufficient project development, that’s where you have a factor. And it’s already here—that’s what’s suggested by Warren’s question—which takes crude prices to significantly higher levels. It would not be unreasonable to trade over $100 a barrel in 2022.
Kevin: Well, but what about capacity from the Middle East?
David: It’s still there. I mean, you have excess capacity still coming back online from OPEC and the Saudis. There’s still additional supplies that can be brought online from Iran. And I’m not sure the US can boost production to previous peak levels. We were at roughly 13 million barrels a day, currently sitting about 11.7 million barrels a day. And to be honest, that surprised me. I thought 10, 11, but here we are pushing to 12. So who knows? It requires massive spending to get back to those 13 million barrels. Why I would be skeptical that we get there is because it does take a massive amount of investment in drilling. And there’s less willingness from the current US administration to extend permitting to allow that drilling, to expand it. Certainly on federal lands, it’s gone. So additionally, you’ve got capital which is not as cheap, not as accessible to oil companies as it was a few years ago.
Kevin: So even if it’s $100 plus a barrel, it’s not easy to bring those rigs back on?
David: Well, I mean, the drill-baby-drill atmosphere which brought rig count to between 1800 and 2000 rigs, I think that’s behind us. Today, we’re sitting at less than 600. That includes both oil and gas rigs. The low was 339, that goes back to May of 2020. Again, pandemic lows. We’ve got March, April, May. The whole industry is adjusting to negative pricing. Very curious. So we’ve recovered from that. We were at 339, now we’re pressing 600, but we’re still 50 to 65% below previous levels. And we’re nowhere near the all time highs of a rig count closer to 4,500 back in the early ’80s.
Kevin: So what you’re arguing is higher oil prices.
David: I would argue for greater upside prices in crude. Number one, because the production pipelines are inadequately filled and the majors are very focused on the drumbeat of war pulsing from the environmental and climate change crowd. And number two, investors often turn to oil positions of one sort or another. Could be the futures market, could be oil companies. A variety of ways to position in oil as sort of another inflation hedge, which will periodically, over the next few years, add a speculative pressure to the price above and beyond the actual supply-demand dynamics.
So I think volatility can be the friend of a long-term investor where price swings move outside of a normal range. And so my encouragement to you, if you’re thinking about oil, is just building positions when prices are under pressure, lightning those positions of elevated levels within a much wider band of pricing. And I think there’s opportunity there to bear in mind.
Kevin: Next question, Dave, “Hello, I’m one of your customers and faithful podcast listener. My question is about extreme weather impacts on markets, regardless of the reason for such weather phenomena. I would like to hear it factored into the macro discussion. I listen to many financial podcasts from macro thinkers, many introduced through your show or similar bubble watchers. I find little reference to the impact of record-breaking floods, drought, and fire around the world. I follow climate science along with macroeconomic issues, and find them in different silos. As a commodity investor, I find this frustrating. Thanks for expanding my worldview. Susie.”
David: The first thing that comes to mind is the challenges faced in California. In recent years, the fires have been intense. And I don’t know if that’s exclusively related to climate change, it certainly is a factor, but surely you’ve got some forestry mismanagement involved as well. And so there’s ideas that determine policies and the way we implement. I think forestry has been done a particular way. And perhaps in retrospect, we’ll look and say it could have been done differently. So there is that factor.
But if you look at this move towards decarbonization, I think to myself, the plight of PG&E in California and the reliability of electricity in California brings into question this notion that we can quickly move away from oil and carbon sources of energy and move towards a pure electrified system, when they’re having a hard time dealing with electricity just under normal circumstances.
Kevin: Well, and you bring that up. Lake Powell, they almost had to shut down for boating here over the last year because it was emptying out. And it goes right to what you’re talking about, California usage of electricity.
David: I did my last triathlon at Lake Powell five years ago. They discontinued it. The boat ramp is now too long. You have to climb over rocks to get down to the water level. I mean, it’s a small and perhaps insignificant token, but to Susie’s point—
Kevin: But that’s environmental, what you’re talking about.
David: Yeah. Well, and like I mentioned in response to Warren’s question, the unexpected demand detractors. That’s where, if you’re talking about commodities, here we’re also at the mercy of unexpected supply detractors. So whether it’s corn or soybeans or wheat and the soft commodities, weather-related shutdowns that may impact mine production in South America or in China. I mean, we had two of those things happen this last year in the remote regions of Jiangxi province in China, this is April of this year.
Kevin: Didn’t that affect blockchain and Bitcoin production as well?
David: It was fascinating. Fortune magazine highlighted this when they looked at a coal mine which was shut down in China. Again, major rains, flooding shuts down the coal mine, and it reduces the feedstock for a particular coal power plant. And that short-term elimination of energy production cut global Bitcoin mining by a third. So the article pointed out that Bitcoin today is a creature of fossil fuels, principally coal. But the point being, weather had an impact.
Kevin: That’s interesting, how that ties in the last few questions. Doesn’t it? You’ve got Bitcoin, you’ve got weather, you’ve got energy, you’ve got macro environment.
David: And then, I mean, a company that we follow closely, Newmont. Newmont Mining out of Denver, Colorado. They’ve got the Boddington Mine in Western Australia. It was dealt a major setback with heavy rains earlier this year, which caused the company to lower production from that project by 140,000 ounces. I mean, if you do the math, 140,000 ounces times close to two grand an ounce, you’re starting to talk about real money. Now, I mean, they produce six, six and a half million ounces. So this was 17% of Boddington’s annual production, but this is a small piece in the overall puzzle for Newmont.
So there is that reality of heavy rain. In reality, a part of the production decline was exaggerated by those rains, which made transitioning. And this is worth, just in fairness, it made transitioning to an entirely autonomous hauling fleet more difficult.
Kevin: I’ll never forget Durban Deep. Durban Deep was the stock in South Africa that was going to win. And sure enough it flooded.
David: Durban Roodepoort was a rude awakening.
Kevin: Yeah. That cost me the— I could have had a car, I had a bike. That’s what the stock dropped to.
David: 401(k) to 201(k).
Kevin: Yeah.
David: Well, I mean, so this is an interesting issue in and of itself, the autonomous hauling fleet. It’s a major move amongst the commodity miners that the folks who are digging the dirt for iron ore and copper and gold and silver, and it was one factor among many in this complex innovative transition. So the rain is falling, they’re having a difficulty transitioning to this autonomous hauling fleet, and it causes the loss.
As a side note, my son was asking the other day what jobs are going to be left after mass implementation of AI and robotics. And it’s a good question. He’s starting to think about college, and I think it’s a very reasonable question to wonder what the future looks like. Not only your future, but the context that you are moving into. And it’s clearly one that the drivers at the Boddington Mine are now asking. They’re out of jobs. You can go back to the December 2015 issue of Foreign Affairs magazine. And I liked reading Foreign Affairs, I still read it, it comes out every couple of months. And it just gives you an idea of who some of the influencers in terms of public policy, what they’re thinking and maybe why. But Klaus Schwab wrote an article back in December 2015, and it was on the fourth industrial revolution.
Kevin: He’s the Great Reset guy. Isn’t he?
David: Yeah. Champion of the Great Reset, now the Great Narrative, which critics would describe as the legitimizing story for technocracies. Again, I don’t know that his intention is to usurp the free markets and freer human actions. But there is this issue of the fourth industrial revolution. The rise of the machine is here. That was a part of the Boddington Mine. And I’m getting a little off course, I’m digressing. But it’s a continued story. You can find the same kind of thematic in Project Syndicate. Schwab wrote another piece, 2019, the year ahead for 2019 in Project Syndicate where he’s, again, addressing the Great Reset. This is not conceptual. This is not tinfoil hat wearing or somewhat—
Kevin: He is very open about it. Yeah.
David: Right.
Kevin: It’s not a conspiracy.
David: Yeah. The problem is, and this is stepping well outside of the Foreign Affairs article or Project Syndicate. But if you end up with a bunch of people who are unemployed as a result of the move in of machines, the question is now, what do you do with the surplus population? Sounds like a question from the Christmas Story.
Kevin: Yeah, but it’s getting a little— It’s getting dark. So let’s go back. How about a drought and coffee prices?
David: Yeah. I mentioned South America as well, and Brazil was another case in point in 2021. Drought in April in Brazil hit the corn and coffee markets, with prices soaring in both of those commodities. And then coffee was pushed even higher in July as— I mean, Brazil is world’s largest coffee producer. So they had their crop damaged by frost in July. Remember they’re on the other side of the equator so their seasons are different.
Kevin: Yeah. I read an article that said that Brazilians right now are having to go to other places to get their hot drinks because they can’t even afford their own coffee.
David: So take Susie’s question one step further. If weather events impact soft commodities in particular. And we’ve talked about the industrial commodities as well. You have the majority of the global population that cannot afford basic provisions to feed their family. So governments are then tempted to keep the peace, keep people happy, subsidize costs. How do you subsidize costs without an infinite money machine?
You can increase taxes. And again, if you want to maintain social stability while collecting votes at the same time, then all of a sudden you could see, in this light, climate change is something of an opportunity for political capture. I don’t think this point is lost on social planners in any country, and I don’t think this point is lost on social planners even at a global level.
There is a pressure point here. And anytime you have— it’s almost a dialectic in short form. You’ve got a problem, here’s a solution, and we now have a new world. The problem is the problem. Weather events are impacting soft commodities. We can see that, we can look at the pricing dynamics, we can count the acres destroyed or non-harvestable, and the impact from that. But how do we respond?
And again, this comes back to policy measures, the policies that get implemented. That’s where I think we see some opportunism, and are probably somewhat skeptical in terms of the best way to go forward.
Kevin: And unintended consequences from those policies.
All right, next question, “David, great job on the Weekly Commentary. I’m a long-time listener and haven’t missed a week for years. My question has to do with asset allocations. Having listened to and read many experts in Austrian economics over the years, as far as the discussion on preserving wealth and asset allocations, the consensus seems to be that a 10% gold allocation will make up for stock market losses if or when the overvalued stocks revert down and precious metals go up due to their undervaluation.
“Let’s say that scenario plays out, which appears to be the assumption, and total assets measured in dollars remains the same, i.e, wealth and dollars is preserved due to the precious metals value increasing in dollar terms to offset the stock market loss. Wouldn’t the investor still be worse off because of the lower purchasing power of the dollar because the investor has the same number of dollars he started with? If so, shouldn’t the investor have more in precious metals to offset loss in dollar purchasing power, which most experts appear to miss because they are thinking in absolute dollar terms after the correction?
“Since the average financial advisor puts little or no assets in metals, does suggesting a 10% allocation, which would seem crazy to most uneducated investors, open themselves up to lawsuits or not have enough diversity should the precious metals go down, or do they think that 10% is going out on a limb?” So I think the question, Dave, is, what percentage in precious metals? What good does it do and what should it be?
David: It brings to mind a couple of things. It relates to the financial advisory community and the way that this whole issue of asset allocation is regarded. There’s another question that follows, but let’s start there.
A metals’ allocation is to most financial advisors a dead asset. And so you go back to the classic Warren Buffett, Charlie Munger view on gold. What’s being produced? Where’s the dividend? How is it valued off of cash flow? Well, there’s none generated. So in their view, it’s not worth owning. And there are fair points there. But look at a chart of Berkshire Hathaway and notice that it sells off just as hard as the S&P 500 or the Dow indexes. Because that’s all it really is, is a fund. A basket of companies that bobs up and down with the business cycle and general economic growth.
So the advice to avoid gold is advice fixated on one aspect of long-term growth. And I think here is an improvement on Buffett’s approach, if I can be so bold. 10% is a reasonable number if somebody is counting their total net worth. Total net worth. And wondering how to balance metals positions alongside real estate you live in, you use a couple of times a year, you rent out. So you’ve got metals’ positions, real estate, privately owned and operated businesses. You may be the entrepreneur and that’s one of your investments. Financial assets like stocks and bonds, cash. These are buckets, so to say.
But a financial advisor is typically not balancing all of those assets. Real estate is out, again, private dwelling being an example. Private enterprises don’t enter into the asset allocation. The mandate the typical financial advisor is plugged into is a growth and income mandate. And Buffett’s view is that gold fails on both counts within that mandate. You can view gold as an insurance mandate, and now all of a sudden the conversation shifts immediately. But let’s, for the sake of this discussion, let’s leave it in the growth and income conversation for a minute.
Kevin: It reminds me when I first came back in ’87. Your dad said he ran the numbers back in the 1970s as far as percentages needed. And that’s something that the business, now in its 50th year, is getting a chance to look back and say, hey, does it work?
David: Yeah. As you know, we’ve been in business as of 2022 for 50 years. Back in those early days when my dad ran the numbers, and we’ve double-checked the math in recent years, the improvement to Buffett’s value investing—the improvements, I’ll say plural. They are as follows—if growth is your primary objective, back test these to your heart’s content: 75% stocks and 25% gold, with a year-end rebalance.
Selling a part of the appreciated allocation and buying the cheaper asset gives you far superior returns. You can bury the returns of the S&P 500 with that as a process. What you’re in essence doing is lowering your cost basis on a market decline, using funds from the appreciated part of your portfolio.
I think we agree that volatility is real. That’s the nature of the market. People are trying to determine the value of assets and so they fluctuate up and down. How do you manage through that volatility? Well, Jeremy Siegel would have said you just buy stocks for the long run, be patient. And I agree with that, as long as your allocation gives you sufficient buying power in a market decline to avoid being forced to play the patiece game and just wait for a return to your original basis.
So market declines are inevitable. Gold has consistently acted as a safe haven asset. And in the process of rebalancing, you’re able to benefit from an expanded share base with an improved basis, cost basis. So when stocks are soaring, you can do the exact opposite. When stocks are soaring and you rebalance, you’re simply translating a transient form of wealth into a permanent store value.
Kevin: Don’t you think a broker also would like to think positive most of the time, and the market sometimes deals negative? And this is where you have to defend yourself, even if your financial advisor doesn’t like to talk negative.
David: Well, and I think having a significant allocation to gold should be a part of a financial advisor’s advice. But number one, metals in physical form usually reduce the fee income from the assets that are directly “under management.” So there’s no surprise there’s little advocacy from that standpoint. A little less income.
Most financial advisors do, to your point, want to focus on the bright side, appreciation. Where are we going from here? How are we reaching your financial goals? And growth is certainly a part of that, not volatility. Discussion of volatility could lead a potential client to simply stay out of the market if things go up and things go down, where are we in the cycle? Most financial advisors would say, I don’t know. And so just buy and hold and hope for the best.
Kevin: Well, a lot of times they’ll just say, well, if we’re not in stocks, we’ll just go to bonds. But that doesn’t always work.
David: No. And I think the financial advisors, let’s not forget, the financial advisors provide Wall Street with the power of distribution. They’re the sales force for the stocks and bonds, which Wall Street issues for its corporate clients. It’s the means of funding operations—
Kevin: You got a chance to see that when you were a stock broker.
David: Sure. So sales and a positivity bias go hand in hand often. And it’s not a surprise that gold as a hedge doesn’t make the conversation. It’s a part of volatility. It’s a part of that conversation. It is a part of the hedge approach. And this is why I think it should be a part of every financial advisor’s advice. If a financial advisor understood that in the life cycle of a client’s assets under management there would be less downside vulnerability following, again, that process of rebalancing annually, and would provide greater long term growth than any index oriented stock allocation, I think they’d recommend it. I truly think they haven’t done the math.
So as for the question of loss of purchasing power, this is like the first question we discussed. Gold is an imperfect inflation hedge in real time, but it’s a more or less perfect inflation hedge in the fullness of time. To illustrate, the Turkish lira has traded to all-time lows this year under a misguided policy of lowering interest rates, even as inflation rages. So loss of purchasing power was at one point north of 40% for 2021. And I got a text from a colleague saying, “Look at the lira today, it’s up 30%. What a wild ride.” In one day. So is gold reflecting this in real time? Well, I can tell you that gold in lira is holding nicely. For the average saver who’s trying to maintain some deposit in a Turkish bank, which would you rather have? Lira in the banking system or ounces outside of the banking system? So in this respect, I see gold as a reserve asset. Use your reserves opportunistically and accumulate reserves as often as you can, maintaining that willingness to redeploy reserves. I think that’s really key.
Kevin: Here’s a continuation, same listener, same letter to us. Question number two: “Aren’t these experts when they talk about asset allocations to gold and silver talking to the typical person with some savings, but basically living paycheck to check, which is probably the majority of the people listening to them?” So the question is, how much money does a person have to have in savings to start looking at gold?
David: Well, I think one of the reasons we launched the vaulted program was to make accessible gold in the format of savings. Where it can be an alternative to a bank account and you can own $5 worth of gold or $50 worth of gold or $5 million worth of gold. The buying and selling is easy. The movement into and out of a bank account is equally easy, and it’s supposed to have that functionality as a basic savings tool. And this becomes very critical in many parts of the world where you begin to see very high rates of inflation.
And you could have said, two years ago, that does not include the United States. Here we are stuck at one or 2%. Now, nearing closer to 10% in official numbers and probably well north of that unofficially—as we said, if we counted CPI the way it was counted back in the ’70s, we’d be between 12 and 14%—well, then yes, it’s relevant. How do you denominate your savings? I do believe in a gold position within a portfolio balancing out the growth aspects within a stock portfolio. But here we’re talking about a particular tool. Again, a tool for the common man who can have next to nothing in gold, which for him could be very sizable and very significant.
Kevin: Okay. So he continues the question. He says, “For the wealthier investor who wants to preserve wealth and has lots of cash on hand and can wait out downturns in the metals markets, wouldn’t a higher percentage to gold and silver make more sense? Since most asset classes beside the precious metals are way overvalued by standard measures and therefore a risky investment, if the excess wealth is not in precious metals, where would you suggest to put it?”
David: Well, I would recommend a higher allocation to metals, and that can be framed either from the standpoint of maximizing growth, as we just discussed, or from the standpoint of maintaining a reliable store of value. And dollars, along with every other fiat currency, in my opinion are not reliable. I mean, in the short run, currencies seem very reliable and they serve a purpose as a means of exchange.
But think about this. Think about our official monetary policy targeting 2% inflation. We’ve taken that idea, we’ve legitimized it, we’ve exported it to the world as a reasonable monetary management tool. In the long run, fiat currencies are wholly unreliable. You’re only getting your pocket picked 2% a year. It seems like it doesn’t even hardly matter. But you do the math—time value of money calculation on 2% or 4% or more. And all of a sudden you realize that, yes, as a means of exchange, it’s reliable. But as a store of value, fiat is less and less so by the day.
So that’s a wealthy investor extending resources through time, where time is of the essence. As in the longer timeframe, wealthy investor is going to clue into the monetary game and be aware that his or her savings are simply grist for the economic mill. So I think a balanced perspective on growth and a reasonable strategy and discipline for managing volatility require an increase in reserve assets and, as we discussed earlier, the willingness to rebalance that reserve across other asset classes.
So if you see gold as a dead asset, you’ve forgotten what it does for you as a reserve deployed on occasion opportunistically. In that respect, I think Buffett and Munger are simply showing a preference for dollars over ounces. Think about this, we have our preferences too. It would be for ounces over dollars. But look at the imperative of building reserves. Even at Berkshire Hathaway, $149 billion, new record. That’s their cash position. Will they rebalance out of cash and into shares during the next bout of market volatility? The answer is yes.
Kevin: Mm-hmm (affirmative). Sure.
David: But I think they share, the two of them, share a faith that I don’t. And it’s faith in the monetary managers or the monetary mandarins of our day. You can accomplish all the benefits of above-market growth if you’re willing to adopt a value approach to investing. I agree with Buffett’s basic premises. But that means you are never all in. So you don’t buy when things are overvalued. You build reserves. Then the question is, reserves how denominated?
Kevin: In cash or gold.
David: Reserves in ounces. To me that has a superior long-term record to reserves in dollars, to reserves in euros, to reserves in yen. You can be pragmatic with those currencies in the short run. But in the long run, the price of allocating reserves to fiat is a costly one.
Kevin: Let me ask, Dave, some would argue that 149 billion in cash is too much, but Buffett also buys real things. Remember when he bought the railroad?
David: Yeah.
Kevin: He’s hedging. Right?
David: That’s right. No, he is, and I think that’s a great observation. He looks at many of the purchases that he makes and there is some inherent inflation protection. And yeah, some critics would look at $149 billion in cash and say it’s too much, particularly as inflation creeps towards 10%. And I would say, it’s not too much as a reserve, as long as you’ve chosen the best denomination for those reserves. What is excessive in this case is the faith in the monetary priesthood. So let’s not forget that most central banks decry gold as irrelevant. This is the message that you hear from the creators of fiat: Gold is irrelevant for our monetary system. But it’s still one of their largest and most critical reserve assets.
Kevin: Well, Dave, these are great questions, and obviously we’re going to have a few weeks of needing to get through all the questions that came in.
Thank you. Thank you, the listeners, for sending the questions that you have. It’s inspiring just to see that you’re not only listening, but you’re thinking and actually making us think about things maybe we haven’t thought about before. Dave, did you find that when you were looking through the questions? It was like, wow, this is going to spur new synaptic connections.
David: Oh, there’s a whole host of questions that I am nervous to even step towards because they’re big questions and they’re well thought through and the implications are significant. So I deeply appreciated the time and effort that each of you put into your queries. We’ll do our very best to answer these questions for you, or at least point you in a proper direction.
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, 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 express 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.
