Podcast: Play in new window
David looks at why private credit may be setting the stage for the next major financial break. They walk through the growing risks in insurance portfolios, private equity, and commercial banking, and why more of that exposure may be finding its way toward everyday investors. The episode also covers recession pressure, energy shocks, interest rates, and the kind of volatility that makes markets harder to read by the day.
- Private Credit Is Being Offloaded to Unsuspecting Bag Holders
- Volatility In Markets Wear Out Money Managers
- Gold & Silver Thresholds For Next Move Up
“So yes, I mean, it’s not unreasonable to hedge production. Whatever commodity you trade in—if you’re a farmer, and wheat’s coming to harvest and you like the price today and you’re not sure of the price tomorrow—maybe you hedge it. Now, what happens if the price continues to go higher? Well, that might be lost profit for you. In this case, because you’re dealing with complex derivative products to create those hedges, it is the equivalent of meeting margin calls. Hedging protects from downside losses, but you can get hurt badly in a rising market.” —David McAlvany
* * *
Kevin: Welcome to the McAlvany Weekly Commentary. I’m Kevin Orrick along with David McAlvany.
David, sometimes you meet people on the plane— I think you should just fly all the time. We had a conversation last night. We were talking about your latest flight this weekend. And can you tell us a little bit about the person that you sat next to?
David: A gentleman who’s been making movies with Pixar for a long, long time.
Kevin: I love Pixar.
David: And responsible for guiding the process for a number of my favorites. Toy Story, Up, epic tales and really beautiful character development—things that you take a big risk on when you sink a budget into one particular story and have not set it up for a series. And I can just tell this guy loved storytelling.
Kevin: Well, it’s interesting, too. I could not get the Up—the little waltz in Up, that little theme—I couldn’t get it out of my head after that. I was singing it this morning, singing it last night. Yeah, Pixar, what an amazing way to create good in a world that right now is just totally volatile. I think about this ceasefire, and to be honest with you, Dave, did you really believe that there was going to be a deal?
David: The ceasefire was over before it began. You had Iran that did not open the Strait of Hormuz. I don’t think they were planning on it, nor have they shifted course to relinquish their nuclear ambitions. So I mean, the key things that we need to see not happening. US, Israel, they will not bring Lebanon into the discussion whatsoever, in part because Israel has to consider the Trump administration’s pulling back in June of 2025 before anything was settled or meaningfully accomplished.
And so I think what we have is sort of military peacocking to a large degree. With the Iranian military and missile capabilities left largely intact from June until sort of the March period. And Israel wants a dramatic shift in the balance of power in the Middle East. Iran, in order to be a neutralized threat, there’s a lot more that has to be done from their perspective. And so you step into this discussion, you step into the ceasefire and a negotiation, and it’s not clear that anybody really wants anything to change. It makes more sense that the US wanted to go through the motions of negotiation to prove that no agreement was possible and that diplomatic efforts had been made. And of course, who did they send over? They sent over the anti-war vice president. So when it fails, you’re left to do what? Keep the current course on track and continue targeting various places in Iran.
I certainly see the will for the White House to end it soon because of the political implications and because of the inflationary impacts that are being priced into the markets. But from the standpoint of how you negotiate, I think you could take the whole lead-up to the ceasefire as a case in point for what not to do.
Kevin: Yeah. Well, and the thing is, if you are going to continue at war, you’ve got time to restock, and the Chinese possibly are planning on sending more weapons in. And I was talking to my wife this morning, though. You can only be wrong once on the nuclear thing. And so when people question what’s going on, we don’t really have full knowledge of what’s going on, but I can tell you what, I don’t want them to have a nuclear weapon, whatever that is.
David: Yeah, I think that makes sense. If Israel can negotiate a disarmament of Hezbollah directly with the Lebanese government, which is being discussed, I think that would be real progress. And the distancing of the Lebanese government from Hezbollah, I mean, that’s been in play. You just need to see a more assertive role played by the Lebanese government to deescalate that situation.
To your point a moment ago, will Iran use a ceasefire as an opportunity to re-arm, to receive military supplies from the Chinese? That’s very likely, because they are winning in the sense that they are surviving. And as long as they’re surviving, time is their friend. Not necessarily ours, but time is their friend.
Kevin: Right. Well, a certain degree of chaos is what they actually would like to have because of their belief system. And so escalation seems like that’s— How do we not see a larger scale war from this point forward?
David: To come back to what you just said, chaos being a part of their belief system, it’s not implicit to Islam, but it certainly is implicit to a version of Shia Islam, which sees chaos as a necessary step to bringing the Hidden Imam back. And so the Twelver Sect is a very unique brand of Shia Islam. And to your point, we’re dealing with a belief system that sees chaos as necessary to their end-time scenario, the end of all time and the return of the Imam.
Kevin: So a negotiated settlement almost is counter to that, right?
David: Yeah. I think if they can just sort of keep their hand on the dial and dial up when they want it and dial it back, but not make it go away, controlled chaos is to their benefit.
Kevin: So Vance came back with no deal.
David: No deal in Islamabad, so the blockade begins and the crude oil price yo-yo continues. Does the US have the resolve to stop or sink an Iranian or a Chinese tanker? I mean, that’s what’s come to play.
Kevin: I hope that doesn’t have to happen. Yeah.
David: I mean, what degree of escalation will be tolerated now that we have tankers and warships playing a maritime game of chicken? In some sense, the blockade is an extreme form of escalation. When you ask someone to stop and they don’t stop, what do you do then?
Kevin: Right.
David: And what are the implications in terms of Chinese relations if we’re cleaning up an oil spill—
Kevin: Well, and you have guns.
David: —in the Strait of Hormuz?
Kevin: You have very big guns in a very small area, and you have a lot of oil in that area.
David: Yeah. Supplies are normalizing to a degree. You’ve got the 600,000 to 700,000 barrels per day production that were offline when the east-west pipeline was damaged, and Saudi Arabia is back online with seven million barrels a day flowing through that pipeline circumventing the Strait of Hormuz. You’ve got other Gulf exporters that are not as fortunate.
Kevin: Yeah. But with the price of oil, you talked a week or two ago about crack spreads, the difference between the actual oil and the product that comes out of it, whether it’s aviation fuel or what have you. You would think right now that profits are way up. You mentioned something to me, Dave, that the volatility is actually costing a lot of money.
David: Yeah. So that fits the category of unfortunate. So the margins did widen for the refiners over the last four to six weeks, and that was our discussion on crack spreads from a few weeks ago. The spread between the crude price and the refined product, that’s where the refiners do stand to have sort of a windfall. Phillips 66 managed to be net short 50 million barrels of crude and refined products.
Kevin: They were hedging, right?
David: Instead of harvesting massive margins, they’ll be hit by a $900 million pretax loss on those derivatives. And the company had to post three billion in collateral to cover the paper losses, and will have a most unfortunate first quarter report. So yes, I mean, it’s not unreasonable to hedge production. Whatever commodity you trade in—if you’re a farmer and wheat’s coming to harvest and you like the price today and you’re not sure of the price tomorrow—maybe you hedge it. Now, what happens if the price continues to go higher? Well, that might be lost profit for you. In this case, because you’re dealing with complex derivative products to create those hedges, it is the equivalent of meeting margin calls, posting collateral.
Kevin: Right. Send some more money to keep this hedge going, right?
David: Yeah. Hedging protects from downside losses, but you can get hurt badly in a rising market. And this is, as we talk about the yo-yo, this is a manic market with mind-numbing volatility. Very difficult to navigate. Phillips 66, of course, is large enough to ride that out. $900 million is a drop in the bucket, but smaller refiners have gone bankrupt doing what they thought was prudent. As recently as 2022 that happened, where the same scenario happened, they just didn’t have a big enough balance sheet.
Kevin: And don’t you think that that’s based on leverage? When you’re talking about margin calls, this is all done on leverage. Now, if you own gold, one of the things that you’ve talked numerous times about is that gold is a great hedge if you actually own the gold, not with margin.
David: It’s one of the reasons why I like gold as a hedge in a portfolio. It’s no one else’s liability. You don’t have a banker coming and saying you need to postmark collateral. Of course, that implies that you have no leverage in the trade. I mean, if you have two times leverage, five times leverage—which, you can do that in the future’s market—well, you may be getting collateral calls or marginal calls.
Kevin: Send us money. Send us money to keep the hedge. Yeah.
David: When we talk about it being a hedge, I grant you it’s not a direct hedge, like matching an oil short to a long oil position. But within a portfolio, it is a useful tool for hedging that doesn’t carry the same forced covering dynamics you find with derivatives—again, options, futures, credit default swaps, things of that nature.
Kevin: Why don’t we talk a little bit about growth right now, Dave, because we’re not in a recession, but a recession or a market downturn could really change things pretty quickly, couldn’t it?
David: Yeah. I just finished a book by the chief economist at ExxonMobil, and he makes the case that how we view recessions and the things that precede recessions are mistaken.
Kevin: In predictability, is that what he’s talking about?
David: In predictability. And I think the biggest takeaway is that if you want to look for things that are predictable, it’s energy shocks and it’s war. And those two on their own, individually or together, do cause recessions.
Kevin: Always.
David: Let’s say 85% of the time. I mean, almost always. He’s statistically on the spectrum of purest and would not probably say always. Close enough.
Kevin: But we have, right now, an oil shock and war, and the war continues.
David: And we already had a weakening GDP set-up here in the US prior to this. So you go back to Q4 of 2025, we came in at half a percent growth quarter over quarter. You had seven tenths expected, so a disappointment in terms of the growth rate. The third quarter growth was at a stronger pace, an annual pace of 4.4%, Q4 tallied to 2.8%. So partially to blame for the weakness was the government shutdown, alongside a slowing consumer segment in terms of consumer spending. You had a decline in the fourth quarter.
But to see declining GDP coming into an oil shock and war, you have to wonder if that doesn’t put some concern in the hearts and minds of the folks at the Fed, because on the one hand they’d like to accommodate with lower rates if in fact the economy is slowing, but because of the nature of what’s happened in the month of March and carrying through into April, with energy being on the scene and with inflation pressures rising, there’s a real catch-22. And that’s also why we have this sort of yo-yo effect in the broader markets is because they’re trying to read: what will the Fed do? Will there be greater accommodation, no accommodation at all, or by the end of the year interest rate increases from the Fed?
Kevin: So you have the Federal Reserve going back and forth on this, but you also have Trump talking, and that seems to affect the financial markets, which also plays into this as well.
David: Yeah. And so going back to Q4 and the consumer weakness, the consumer on that front last week in the University of Michigan sentiment numbers, April came in at 47.6 versus 51.5 expected. Current conditions disappointed at 50.1 versus 53.4 expected, and future expectations—
Kevin: So people are expecting a downturn?
David: There’s a growing negativity amongst consumers, which generally gets reflected in their penchant to spend or to save. And so the consumer sentiment numbers were at record lows going back to 1952. So consumers are expecting inflation over the next year. They expect it to run hot at about a 4.8% number over the next year. And as always, this particular number, they break out Independents from Republicans and Democrats. And Republicans are pretty rosy, things look good. And to be frank, it’s a very surface-level appraisal. Our guy’s in office, everything will be fine.
Kevin: Right. That’s normal, isn’t it?
David: Independents, you see more negativity. And then when you get to the Democrats, it’s as if the world is coming to an end. And so when we look at that 47.6 versus the 51.5 expected and the lowest level of University of Michigan consumer sentiment calculations going back to 1952, it is skewed by Democratic negativity, but balance it out and it is still the worst number that we’ve seen in all of the time that that statistic has been kept.
Kevin: Going back to the 1950s. And like you said, that does affect spending, whether Democrat or Republican or Independent. But if the GDP is shrinking right now, disappointing, we’ve got a lot of debt that needs to be paid. I mean, tax receipts, we can’t see tax receipts dropping right now.
David: Yeah. I mean, fiscal health is a part of the equation, and again, a part of the constant yo-yo. For the first six months of the fiscal year, the US government has taken in two and a half trillion in tax revenue, but they’ve spent 3.7.
Kevin: Not keeping up.
David: No, I mean, it’s a $1.2 trillion budget deficit if we closed out the year today. The CBO expects 1.9 trillion as the full year deficit, but the current run rate is at a $2.4 trillion number. And that’s with no recession. That’s the current run rate.
Kevin: That’ll blow us past 40 trillion this year.
David: Yes, but in all fairness, tax receipts typically pick up in the last six months of the year. And so I think we can assume that will be the case. But I mention recession because that would skew the back half of the year. It could keep the deficit run rate on target to 2.4 trillion. So I mean, frankly, it’s recession or market correction or both, because then you’re looking at cap gains, tax receipts, which are in decline as well if you have a loss in equities, bonds, real estate, things of that nature.
Kevin: Well, and the thing that has really been showing its ugly head is private equity and private credit. Private credit right now is not going to go away.
David: No, the Bank of England has already asked just how much systemic risk is in the private credit sector. Now you have the Federal Reserve asking the same question, especially how much spillover or exposure exists in commercial banks and insurance companies. And I think we already know the answer for that. That’s something we’ve been talking about for months now.
Kevin: Well, and insurance companies, they have a captive audience. People own insurance products without knowing what’s inside. And one of the great things about insurance over the last 100, 150 years is that they haven’t had to have government regulation because they regulate themselves. Can they continue this with the private credit that they have on the books?
David: Yeah. I have friends that own an insurance company, and it’s amazing. I mean, they’re able to own timber and oil and gas rights and gold and silver and a whole bunch of things. I mean, they’re really able to manage what I think is an amazing portfolio, but not all portfolios within the insurance space are created equal. Of the six trillion in assets within the insurance complex, at least a trillion are in private credit or a combination of private credit leveraged loans and loan instruments to business development companies. So bank lending growth in recent quarters has been roughly 40% to those private credit conduits.
Kevin: Wow.
David: And of course there’s some backstory there. You go back to Dodd-Frank and the limitations that were put on commercial lenders to limit risky loans, and that just created a new venue for high risk loans to be taken care of. Demand was still there. It’s just that commercial banks couldn’t be direct lenders to that space.
Kevin: Thinking about Dodd-Frank, I can’t help but go back to our guest who you’ve had on numerous times, Richard Bookstaber. And he said, “Whenever you have these regulations come in, it’s the go-arounds that create the next crisis.”
David: Yeah. And I think in essence, what Bookstaber was saying is that you solve one problem in the context of one crisis. And those solutions codify the flows of capital going forward, which end up creating the next series of problems. Say private equity, private credit, they’re going to be in the center of the next crisis. And the contagion effects, if you will, or the daisy chain effects are into commercial banks to a small degree, into insurance companies, a very large degree.
Because just like my friends that have a portfolio of very creative assets in their insurance company, the private equity groups have bought the insurance companies so that they could do the same thing and place very speculative— I mean, remember private credit is like high yield—what used to be called junk—bonds. It’s just on steroids. It’s the kind of paper that cannot be financed in a bond offering it’s of such low credit. It cannot be financed in the publicly traded markets. So it’s done—
Kevin: So it’s privately.
David: Shadow banking is essentially what it is, and it can be handled in the private markets. That’s the trillion dollars that’s sitting is a time bomb in the insurance portfolios.
Kevin: It’s very attractive. I know I talk to clients who say, “Hey, I’m getting 12% on this asset.” And it’s like, “Well, are you getting 12% safely?” Well, of course. Yeah. I mean, they don’t really know exactly what’s bringing that about.
David: It’s also worth noting that commercial banks—when I mentioned that 40% of their loan growth has been into private credit conduits—they have found a workaround. They’re not lending directly to the companies that would be a high-risk endeavor. There’s one step removed. They’ll give the money to a private credit operator. The private credit operator will arrange the loans, and on that basis they get to play. They’re essentially matching the letter of the Dodd-Frank law and getting in on the action indirectly.
Kevin: Okay. So what does the SEC say about this? I mean, regulation—talking about regulation—this is outside of that, isn’t it?
David: Well, the SEC is giving the equivalent of a papal blessing to the asset class. At the same time, Department of Labor has approved retail purchases of private credit instruments into individual retirement accounts and 401(k)s.
Kevin: Ah, hand the bag to the people. There you go. Bag holders, right?
David: That’s just the start. Meanwhile, meanwhile—and this is where it gets really interesting if you start putting all of these factors together—Wall Street last week launched the CDX Financials index. Wall Street firms are launching what is essentially a credit default swap index that bets against private credit fund managers like Apollo and Blue Owl and Ares and KKR.
Kevin: Wow.
David: So just let those variables settle in.
Kevin: So you play the index a little bit like playing the don’t come line on craps, right? It’s basically you bet on the loss.
David: Yeah. You get to bet on everyone else’s loss, and you’ve participated in the distribution of these products. So you’ve got pension and endowments, high net worth individuals who are exiting the space. These are the redemptions that we’ve talked about. And these companies are basically saying we’ve got to cap redemptions because there’s too many requests, and it would compromise the integrity of the product.
Kevin: We’re closing the doors. You can’t have your money back yet.
David: So you’ve got gating in the face of pensions, endowments and high net worth individuals seeking the exits. You get the SEC and the Department of Labor inviting retail into the space. And now you’ve got Wall Street setting up the big short, the equivalent of the big short for private credit.
Kevin: Funny you bring up big short because—
David: How do you think this ends?
Kevin: Oh my gosh, that’s what I was going to say. You bring up the big short, that’s how it ends. I mean, if you’ve seen the movie, this takes us back to that time period where the big short is the retail investor holding a bag of something they can’t identify. It’s like reading the ingredients on a Twinkie. You don’t know what it is, but you know it’s a Twinkie.
David: Right.
Kevin: Right?
David: Well, if you get enough dumb money into the private credit space, you do arguably have, ultimately, the political excuse for a bailout. Right now nobody wants to protect high net worth individuals and pensions. Like you’re on your own, you’re a sophisticated investor, you knew what you were getting into.
Kevin: So you’re talking like AIG back in the old days, right? The big bailout.
David: If you can get retail investors who don’t really understand the complexity of these debt instruments, ultimately when it goes south, that’s where you’ve got the political will to do something from a regulatory standpoint. So without retail involvement, private credit faces a lack of new funding for deals. They face less political leverage in the event of carnage. And you’ve got the retail as bag holder, which is all too common a theme on Wall Street.
Kevin: Okay. So that takes me back to the Securities Exchange Commission. What do they say? I mean, we know that regulations sometimes can create a problem, but without regulation, you’ve got— Right now, this is shadow banking, like you said. So what do they say?
David: Yeah. Paul Atkins is the SEC chair. This was an article in the Financial Times this week. He’s saying that private credit is not a systemic risk.
Kevin: Well, that makes me feel good.
David: The Bank of England says, “We think that it is, and we’d like to understand just how much of a systemic risk it is.” You’ve got the Federal Reserve saying, “We’re concerned that there may be spillover effects into the commercial banking and insurance industries from private credit, and we want to understand the systemic risks.”
Kevin: But the SEC says there’s not one.
David: There’s not a systemic risk.
Kevin: Oh, good. All right.
David: Maybe he would know. Maybe he does not. Paul Atkins, of course, this is his second tour of duty at the SEC.
Kevin: I remember that name from long ago.
David: His first tour spanned 2002 to 2008 as a commissioner.
Kevin: Oh, the big short time.
David: So yes, he was regulating investment banks as they cranked up and mass distributed CLOs, CDOs, and other exotic— And of course, if you look at the global financial crisis from a postmortem perspective, these were toxic, right? Exotic is kind of fun.
Kevin: Twinkie ingredients, but they were deadly.
David: Yeah. It tastes good. Might kill you.
Kevin: Yeah.
David: But let’s just talk about the taste good. Of course it tastes good. We’re talking about higher returns, tastes good. So he oversaw the distribution of investment mouse traps, had no problem with it then, sees no problem with it now. If you needed an anti-testimony, if you needed an anti-testimony, he is it. Atkins says they’re okay, and retail should be comfortable entering the fray. I think it’s very much time to run away, in my opinion. Or, shall we say, be tempted to join the Wall Street insiders prepping to short the space.
Kevin: Okay. So for the average guy who’s got an insurance product, like an annuity, all right, these products may be in that annuity. That may be why the insurance company is paying higher rates.
David: Yeah. If you want to do an investigative research on your own, if you own annuity products, just look at who owns the insurance company. And if it is owned by a private equity group, I think you have to consider the high cost of exiting the annuity, which can be a five to ten percent penalty to get out of the product. You don’t know what your downside is. You don’t know how to calculate the risk on the other side. Would you take a 10% haircut to save 30, 40, 50% of your retirement savings? That’s a tough call, and that’s going to have to be done on an individual basis. But you got AM Best, who, like Moody’s and S&P, will do reviews and ratings and things like that. AM Best published a report on Friday, it’s covered in the Wall Street Journal, finds that insurance companies that sell annuities hold more risky debt today than they did in 2007.
Kevin: Well, more than right before the global financial crisis.
David: And does it surprise you that the annuity portfolios they have under the microscope also hold more investments sold to them by affiliate companies, private equity? So private equity sells private credit to the captive audience of annuity investors. Do they know that they even own what they own?
Kevin: Right.
David: Was there consent? No annuity portfolio manager— This is where insurance has kind of a free rein to invest as they see fit. A broad enough mandate to do what they please. So what are the legal ramifications going to be if and when those bets are unwound?
Kevin: Right.
David: I think this is, if you’re looking forward to Bookstaber 2.0, how do you solve this problem? Well, part of the reason why it’s difficult to get clarity on how much risk is in the insurance business is because each state has its own insurance regulator. The ratchet forward, if we look back to—is it Robert Higgs?
Kevin: Yeah.
David: And sort of this notion that government grows and encroaches—
Kevin: Leviathan.
David: —in the context of crisis and then never recedes. Well, welcome to a federal insurance regulator being birthed. I think that’ll be one of the net results because there’s going to have to be a way to create coordination where coordination does not exist today. You’ve got dozens of insurance regulators, and way too many shenanigans that can be played on a state-to-state basis. It’s essentially a small scale version of regulatory arbitrage where what you can’t do in one state you can do in another. Well, that’s where we need to have our insurance company then.
Kevin: Right. Well, and private equity is a mismatch, and so is private credit, for the longer-term insurance type of product. It’s built for shorter-term speculation.
David: That gets to the nub of it. What could go wrong? The issues with retail distribution of private credit instruments are many. First of all, you’ve got long-lived assets that are being put into short-term perceived-liquid structures. As you open up the 401(k) space and people can buy with the click of a mouse, something that has a very complex legal structure behind it.
Kevin: And it could be sold at the click of a mouse—or not.
David: Except the underlying product trades by appointment. It doesn’t have the same liquidity as click of the mouse.
Kevin: Yeah.
David: Like this is, as some people have described, the difference between liquidity flowing in versus illiquidity flowing out. Like a four lane highway as you want to get in, but it’s like a goat trail coming out, on a high mountain pass. It’s single file, take a number. Maybe you go, maybe you don’t, maybe you get your money.
Kevin: Well, an analogy would be the Strait of Hormuz. The key of the Strait of Hormuz is its narrow exit, right? Narrow entrance and exit.
David: So the second issue is the level of sophistication required to understand the underlying assets, which is a very high level of sophistication. And that’s another mismatch with the retail audience. So you’re creating products which are inherently complex, for a general audience that doesn’t have the experience with financial complexity to be able to navigate it well. Again, it’s a mismatch. I think the third and final is, the tide is already going out.
Kevin: Right. You’ve been bringing that up. I mean, money’s already exiting that space, or trying to.
David: You can look and say, “Oh, well this is just a vintage issue. It goes back to 2021, ’22 and sort of the everything bubble, in which case those vintages are the ones that are underwater.” Well, I’m sorry. It’s $3.8 trillion that are basically unsaleable assets, 35,000 companies, which were intended to be fixed and flipped, and the private equity groups can’t do it.
Kevin: And now, we’re going to put it into 401(k)s and IRAs from an unsuspecting investor, basically.
David: Yeah. It’s unsaleable to astute investors who are running the numbers, but it’s eminently salable to a blind audience that doesn’t know better.
Again, how does this end? The first wave, if you think about how this developed, you’ve got the first wave into private equity, and the first wave of liquidity was the original limited partners. The second wave comes along, and this is where you’ve got some unsaleable product. That’s all right. We can do what’s called secondaries, and we can launch, just repackage the companies that couldn’t be sold through an IPO. And nobody was standing in line wanting to bid a higher number and drive the multiples up.
Kevin: But this still was not the general investor that we’re talking about.
David: Right. So the second wave is known as secondaries, where unsaleable assets are repackaged, resold, getting the original LPs—the original limited partners—out, and putting new limited partners into what is still a hot sector, just not as hot as it was.
The third wave is retail. And this is in essence like plating three week old leftovers from an unmarked Tupperware container in your refrigerator. It’s been sitting there neglected in the fridge. You can call it cuisine, but the risk of food poisoning has been rising every day the leftovers sit there. It’s not the kind of thing that Rolaids and Pepto-Bismol are going to solve, at least in terms of what happens next.
So when the public gets sick, that’s when the SEC gets to look back at the original recipes. And if it’s Atkins, he’s going to say “there’s nothing wrong here” because he’s looking at the original recipe, and he’s going to determine that everything was cooked to perfection. But what’s not factored in is that time equals decay.
Kevin: Just like Atkins 10 years ago or 15 years ago.
David: What he missed was what happened as things got out of hand at the end of that cycle.
Kevin: Yeah.
David: Front end of the cycle, he’s probably right. It’s just another creative way to slice and dice and make a little bit more money for Wall Street—CDOs, CLOs, all the rest. So there may be a case— I think this may be a case that’s less like leftovers and a little bit more like roadkill. That’s what’s being served. I’m sure your stomach will just be fine.
Kevin: So don’t put roadkill in your 401(k). Don’t get sucked in on this. One of the things—
David: Or three week old leftovers. It’s just, again, time equals decay. Know where you’re at in the cycle of things. When it was first served, it might have been delicious. Day later, still probably fine. Three weeks later, you should probably throw it out because if you don’t, you’re going to be throwing it up.
Kevin: Well, okay. So thank you for the analogy. All right. But interest rates play into this. We’ve talked in the past. I play and I mock you for reading 500-, 600-page books on interest rates, but really the reason you read that is because the cost of money is so critical to this. And so that could really factor in at this point, too, because this is all kept going by debt.
David: Yeah. So if you can buy time and if you can create a narrative of hope that rates are going to be coming lower—and, in fact, lower GDP and higher unemployment is good news for your Wall Street operators because it forces the hand of the Federal Reserve to lower rates and get them out of the bind, which is refinancing debt.
Kevin: At a lower level.
David: It has to be financed at a lower level, otherwise you’ve got a credit doom loop. So final note, you’ve got Bloomberg on the 9th of this month, noting that leveraged loans—business development companies primarily linked to software and technology—it’s roughly $330 billion in debt that needs to be refinanced or repaid through 2028. It’s a decent chunk of it which is in the private markets. So rates are trending higher.
The risk here is particularly for software companies that are now coming to terms with AI obsolescence. Again, it’s not everybody, but if you look at where private equity has loved to play, where you’ve got infinite upside with a scalable model, this is the beauty of SaaS [software as a service]. You create one product and then it can be distributed across the entire business ecosystem, the entire retail ecosystem. And you’ve got high upfront development costs, but then you’ve got margins which are in the 80%, 90% range, and then you just start adding users, except that AI all of a sudden throws a bit of grit in the gears.
Who needs those companies when you could just ask Claude to create the same platform for you and within a one-week period of time have your own software suite that does the same things that you’d pay through the nose for through the software platform on offer yesterday? So what’s the value of the debt for those software companies?
You have to assume greater pressure and natural rising rates for those companies. If they don’t get a Fed—it’s not a bailout, but it’s a Fed accommodation at an extreme level—you are talking about major hemorrhaging. Granted, it’s only 330 billion in a world where we’re more impressed by trillions. But you go back to 2008, 2007, and it was the small failures that represented the widening cracks that became the global financial crisis, a $400 million hedge fund.
Kevin: Bear Stearns.
David: Or two.
Kevin: Yeah.
David: 400 million bucks. Who cares?
Kevin: Right.
David: So we could say the same thing. 330 billion bucks, who cares?
Kevin: But it was the crack in the dike.
David: And the cracks are widening.
Kevin: Yeah. You know, Dave, we have a client that owns a manufacturing company. He told me the other day that he’s getting two, three, four calls a week to buy the manufacturing company for private equity. They don’t really care what they’re buying. He knows what they’re after. So when you talked about AI or what have you, I don’t know that the private equity, the guys who run them, even care. They’re just trying to gobble up as much as they possibly can. So it’s a strange period of time because it’s becoming— Like a snowball rolling down a hill, it’s becoming larger and larger but it’s becoming less liquid.
David: Well, they’re trying to buy cash flows at a low enough multiple that they can turn around and flip them for a higher multiple.
Kevin: Right.
David: And a part of the modeling there assumes what they have had the benefit of over recent decades, lowering interest rates. The game doesn’t work as well when cost of capital is increasing. And cost of capital can go up for a variety of reasons. Inflation is certainly one of those reasons, but, similar to the extend-and-pretend game going on in private equity here in the US, where, again, the primary becomes the secondaries and then gets fed to the general public, there’s a different version of extend-and-pretend if you go across the pond. African governments who are today unable to meet rising interest costs are asking Wall Street to get creative and help them structure relief, and it’s coming in the form of total return swaps.
Kevin: What is that?
David: It’s basically like borrowing against your own liabilities. That’s one way of looking at it. If you’ve got a bunch of debt and you’re like, “Well, what if I took that debt and gave that debt to you as collateral against a new loan, a lower interest rate loan? Sure it could be variable, but our assumption is that rates are going to go lower, not higher. I just can’t make current payments.”
There’s a lot of issues here, but short-term solutions can sometimes come at a much larger and higher cost later on. What banks are cooking up this time is, again, basically low interest adjustable rates on a preexisting Kilimanjaro of debt, and how does it work? You pledge your bonds and other collateral for another layer of financing to reduce your interest expense overall, and that’s of immediate benefit to you. But if there’s anything that causes the underlying collateral to deteriorate, all of a sudden your costs spiral out of control.
Kevin: How is this any different than putting credit card debt on another credit card and then putting it on another credit card? It’s just using debt to go into more debt.
David: Extend and pretend.
Kevin: Yeah.
David: You’ve got similar structures, somewhat similar structures were used in the early 2020s—2020, 2021, 2022—and they blew up pretty quickly as soon as rates started moving higher. You’ve got litigation ongoing between US banks that offered, again, I’d say similar products to state pension funds. Talking California, Illinois, Missouri, Michigan, Pennsylvania, many others.
What might be a trigger for underlying collateral to decline in price? And this is where, if you think about what causes a bond price to go down, anything that triggers interest rates to go higher. So if you think 2022, regular listeners know the answer. An increase in rates puts downside pressure on bonds. And if those bonds are serving as collateral, then your death spiral begins, and the next round of litigation begins as well.
What would the litigation be about? Were the risks properly disclosed? Was there a lack of understanding about the true complexity of the products? In fact, you’ve got these pension fund managers who made that case in their litigation against Goldman Sachs, Citigroup, and Barclays, who settled in 2024 for like 46 million bucks, not a huge amount.
Kevin: It’s a drop in the bucket compared to the size of what they’re doing.
David: And compared to the fees that they collected.
Kevin: Yeah. Not even a slap on the hand.
David: No, it’s a good business risk. You’re like, “Well, we’re going to get sued for this?” But we can make a lot of money up front. And what we pay in fines and fees, in litigation, it’s just no big deal.”
Kevin: And don’t worry about it because we’ve got a guy in the SEC who didn’t see it last time.
David: Right.
Kevin: Right?
David: But interestingly enough, I mean, you’re dealing with pension fund managers who, one of their claims was that they didn’t understand the complexity of these products. Pension fund managers.
Kevin: Right.
David: How about the general public? Again, we’re talking about African nations. Columbia’s done this. Nigeria’s doing this. There’s a bunch of African nations that are doing this right now with the total return swaps. But Barclays, these guys paid 46 million in fines as a settlement. It’s a different list of banks doing the same thing all over again. But again, when you count the fees collected to finance billions, or in essence refinance billions, calculations are easy. Net of fines and penalties, there’s too much money involved not to rinse and repeat and do it all over again. So you think, “Well, maybe Wall Street didn’t learn its lessons.” No, they did learn their lessons. They learned the lessons—
Kevin: They just didn’t cost too much.
David: This is where what they learned during the global financial crisis is you can absolutely privatize gains and socialize risks.
Kevin: Yeah.
David: Because the risks ultimately are going to be borne by society, which is irrelevant to you as you’re managing a P&L, as you’re bringing in income from these deals. Privatized gains, socialized losses.
Kevin: Let’s go back to hedging because we saw even last fall and into January the difficulty of hedging sometimes in the market. We saw that in the physical silver market especially. Remember that? The 747s going back over to London. Phillips 66, they were doing just normal hedging. That’s good business. If you’re long a product, you go short on it, right? But the cost of that sometimes can become debilitating.
David: Yeah, you’re right. We took some losses last year hedging inventory. We don’t play games with inventory, but we chose to hedge in the spot market. And it’s—
Kevin: Neutralizing a position is what you’re doing. You’re neutralizing it.
David: Yeah. We just want to be neutral.
Kevin: Yeah.
David: But the overnight lending rates on the hedge went to 200%.
Kevin: Yeah, 200%. That’s amazing.
David: Yeah. It didn’t feel amazing.
Kevin: You had to un-hedge at that point, right?
David: Yeah. And that’s where, as risk mitigators, we manage risk in a portfolio, and thinking specifically of our physical metals inventory, but being a risk manager of that risk means that you have certain disciplines in place, and you don’t let those losses get away from you. And you certainly don’t operate on the basis of hope. We shut it down very quickly and took minimal losses in the grand scheme of things. But again, Phillips 66, like the hedges we discussed earlier, it made sense that they should hedge some of their production.
Kevin: Sure.
David: But hedges can work against you. In the case of options and futures markets, there is a way to exit the hedge and end the pain. Short covering is exactly that. Someone is short, prices move higher, they decide to cut their losses, they buy back the asset to cover the short position.
What’s interesting, though, when you think about what banks are putting together for these African countries, in the case of interest rate swaps or total return swaps, you have a contractual obligation which is highly flexible and customizable on the front end, but on the back end is not liquid. It is not liquid.
So you start accruing losses. How do you cut it off? How do you make it end? You really don’t, outside of an outright default. So the trade goes against you. The pain doesn’t end. You can’t make it stop. It’s like you just have an endless amount of margin calls unless you just back away and say, “We’re defaulting.”
In essence, what banks are helping these African countries do is setting the stage for an inevitable default. No harm, no foul, they’ll collect their fees on the front end and hopefully be able to own a bunch of the collateral.
Kevin: They know it’s going to happen. Yeah. Okay. So let’s talk about the last few weeks, because obviously—
David: Seriously, lots of harm, lots of foul. I say that tongue in cheek.
Kevin: Did you say no harm, no foul?
David: I said no harm, no foul. It’s all harm. It’s all foul.
Kevin: But it’s socialized, like you said. Don’t worry about it. It’ll be social.
David: That’s what I really meant is they’re not worried about it.
Kevin: Right, because it ain’t them. It’ll be you holding the bag.
David: They get paid day one.
Kevin: Yeah, that’s right. It’ll be the little guy. Okay. So the volatility in the market. The markets right now, people like to think, “Oh, well, I’ve got some predictability. I can look forward. I can make this long-term investment.” But volatility, how do you hedge right now, Dave?
David: Yeah. I mean, in our office meeting, I described it as kind of FOMO squared. You’ve got fear of getting mowed over and fear of missing out. And so this yo-yo of volatility is back and forth, exhausting investor psychology between, “I don’t want to get taken out. I remember 2022. I remember the global financial crisis. I don’t want to get mowed over again. On the other hand, I don’t want to miss out on gains.” So this flip-flopping on a daily basis, kind of across asset classes, last week was amazing. Tuesday, we’ve got West Texas Intermediate, the US crude contract, it hits 117. That’s Tuesday. By Wednesday, it’s back to 95. Biggest drop since COVID.
Kevin: Quite a swing.
David: But it can bounce right back. I mean, it’s endless. Massive reversals followed that last week. Rallies in bonds, massive short-covering rallies in equities across the globe, with bonds too. Apparently the risk-on, risk-off dynamics are making for a global uni-trade. We’re either on the downtrend, yo-yo comes to mind, or on an uptrend as the string is wound back into the toy.
Kevin: So when you talk about a uni-trade, let me stop you for a sec, because a uni-trade, you’re just basically saying it’s going to go up or it’s going to go down together, and it doesn’t matter what the asset is?
David: Yeah.
Kevin: Okay. And that’s what we’ve been seeing.
David: So you want to hedge your risk. So you want to hedge your risk in the metals. So you want to hedge your risk in equities. You want to hedge your risk in bonds. Market starts moving against you, you cut your losses. That represents more buying in those asset classes and it’s manic to the upside. What do you do then? You don’t want to get mowed over, so you hedge again. And that hedging process brings the price back down. You may even get some momentum on the downside. It’s violence in both directions. And every day’s volatility is set in motion by maybe the most unpredictable factor in the markets today.
Kevin: I know where you’re going with this. Yeah.
David: Donald Trump.
Kevin: What is Donald Trump going to say next? And he uses that to his advantage, Dave.
David: Except that I do think that there is wear and tear psychologically among retail investors.
Kevin: Oh, sure.
David: And even institutional investors, professional traders. If you get 3 to 5% volatility in either direction every day— Volatility is your friend if you’re playing it. At what point do you have to say like, “How do I do this every day? I’ve got to be on the right side of the trade.” For most of us, we don’t have insider information. I suppose if you’re close enough to the White House, you could be short oil just before an announcement. Actually, there was a trader who put $52 million in play hours before.
Kevin: Good timing.
David: And oil drops and he makes $173 million on the trade. Was that skill? Was that luck? Was that inside information?
Kevin: Right.
David: I mean, for those of us who don’t have inside information, it’s exhausting.
Kevin: Right.
David: It’s exhausting. Because fundamentals are not in play. There’s larger concerns, whether you’re talking about fiscal concerns or long-term supply and demand dynamics, which are very relevant as you’re setting up an investment thesis. In this kind of volatility, a thesis, any thesis, is on hold.
Kevin: All right. Now I’m sensing why we talked about Pixar, not just because you sat by the guy, but because in the movie Up, he explained to you that the director, who was selling that particular story to Pixar, talked about just getting some balloons and floating away. And I’m sensing right now that you’re getting exhausted with the volatility. Do you want some balloons?
David: I would like some balloons. And this is not some sort of subtle suicide pact. I mean, I’m not wanting to just disappear out of existence. It’s just an emotional psychological expression of enough is enough.
Kevin: Well, and in that same movie there’s squirrels.
David: We love fundamental analysis. We love technical analysis.
Kevin: Squirrel. Squirrel. Squirrel. That’s what this volatility is.
David: That’s all it is.
Kevin: Yeah.
David: That’s all it is. It’s Dug the dog with an attention span of two minutes tied to a news cycle, which is just whipsawing his head back and forth from one squirrel to the next.
Kevin: I can see the appeal. I see the stress in your face. The volatility. And when Donald Trump does talk about something, it does change the market.
David: Rates sank, bond prices rose aggressively. By Monday, reversed course again with rates rising, bonds selling off. Interestingly, the only bond yield that seemed to stay stubbornly high was the Japanese 10-Year, the JGBs, Japanese Government Bonds, pegged around 2.4%. A level that, for the Japanese, represents a very high interest rate, and actually the highest going back to 1999. Of course, that sounds low to us.
Kevin: Right.
David: If you’re thinking of financing your debt and you don’t want to do credit card debt at 29% or private credit lending at 12 to 18% or high yield bonds between 6 and 8%, 2% sounds pretty good, 2.4%. But then you have to factor in debt-to-GDP at between 230 and 240%. Doesn’t take very many basis points to bankrupt the Japanese when they’ve got more than a Kilimanjaro.
Kevin: They can’t have rates rise, period.
David: No.
Kevin: Let’s talk a little bit about gold before we finish up, Dave, because I know China has been a net buyer. I mean, there’s some numbers coming in right now showing that interest has not waned, necessarily, on the gold purchase.
David: Right. It was a modest amount, five tons, 160,000 ounces of gold, for the month of March. It was the 17th month in a row, and so Bloomberg’s coverage of the PBOC March purchases— I think what is interesting to me, in a word, is consistent, right? They’ve been consistent buyers every month for the last 17 months.
Kevin: Well, they’re moving toward something. They’re moving toward the gold recycling versus the dollar recycling.
David: Volatility aside, they’re playing a long-term game, and owning the asset makes sense. I recommend the same. I’m not a seller at these prices. I’m a buyer at these prices. Gold and silver have in recent weeks been sucked into the uni-trade. One day up, the next day down. There’s two factors that we are looking for on the asset management side that should serve as confirmation of the uptrend gaining momentum. One is looking at gold versus the XAU, which is the—
Kevin: That’s the stocks.
David: —gold miners index.
Kevin: Yeah, gold miners.
David: Where the miners break out in terms of performance relative to the metal. And that represents a new dynamic.
Kevin: And we’re close, right? We’re close right now to that.
David: Within a few basis points of performance. That would be healthy confirmation. And this goes back to a conversation we had in 2024, basically saying, “Look, we need to see the miners outperform. We need to see silver outperform.” If you’re looking for confirmation of the gold thesis, and you want to see gold moving off the 2,000, 2,500 level, you need to see these things in complement.
Kevin: And then it happened, and then it happened.
David: Right. And so the first demarcation is gold shares pulling ahead of the metal itself, which it’s on the cusp of doing. It doesn’t mean it has to do it this week, but it could happen today. So we’re close to that.
The second is that silver getting back above its 50-day moving average would be very constructive from a technical perspective.
Kevin: Where would that be? Where would that put silver?
David: Between 79 and $80, which, again, we’re right at the threshold. These are positive shifts that, with modest follow-through, open the door to the next round of price appreciation. Michael Oliver has noted the importance of these breakout levels. And so we watch and we wait and we continue to stack our ounces.
* * *
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.
