The McAlvany Weekly Commentary
with David McAlvany and Kevin Orrick
Kevin: David, this year we have produced three CDs. The third one, right now, is in production and should be out in the next six weeks. Today I would like to talk a little bit about why. You’ve had three CDs come out, the first one on Europe, the second on Asia. The third one is what we are going to talk about today in preview.
I do have some questions that are current right now with the markets before we get into that, so if we could address those first, I’d love to jump in after that.
David: Perfect.
Kevin: Okay. We are getting a lot of clients who are reading other writers on the precious metals, and they are saying, “You know, all these guys are talking about is manipulation, manipulation. Manipulation is keeping the silver market down, it’s keeping the gold market down.” David, this company, and your family, have been in the precious metals business for 40 years. Is manipulation playing a key role right now in the price, or is it just normal price maneuvering?
David: I would suggest that it has nothing to do with manipulation. There are, certainly, commercial shorts, and speculative longs, and a long, drawn-out battle between those who want to buy and those who want to sell, and then of course, that reverses, where you have short-term speculators who all of a sudden want to sell, and commercials that want to buy. There is this issue of one group being stronger than another, but these are pretty normal market dynamics.
More critical to me is the basic supply and demand fundamentals. Over the last 10-12 years we have seen a radical increase in demand, and that demand is relatively constant at this point, but one of the things we have also had is a radical increase in supply of metals.
Interestingly, the source of supply is from the elastic part of the supply chain, if you will, and what I mean by that is, mine supply, where miners are digging in the dirt, and processing ounces of gold, refining that into a product that can be bought by an investor or central bank, or for jewelry purposes or what-not.
That has been relatively constant, between 2500 and 2700 tons. There hasn’t been a huge increase, even with the vast increase in research and development, if you will, or greenfield projects, exploration, trying to bring new production into the fray. It actually has done nothing to increase the supply to speak of, just replacing old reserves.
Kevin: I remember John Embry saying that even though supply could possibly increase a little bit, it cannot possibly increase with the demand. We have seen, over the last dozen years, an average return on gold and silver, but gold especially, between 12% and 17% per year, so obviously, supply is not keeping up, but it is keeping up enough to keep it from going parabolic.
David: In the last year-and-a-half to two years, what we have seen is a major increase in scrap gold, scrap gold being grandma’s old jewelry. The gold watch that no one wears anymore, you take out the battery and have it melted down, processed, and you get paid 40 cents on the dollar, 60 cents on the dollar, but at least you have money to pay your bills.
What is the motivation of people taking their gold and selling it for scrap? It’s just that: keeping above water, so to say. You make your car payment this month. You get caught up on your credit card bills this month. It really is a Western-driven phenomenon. You don’t see it in Asia.
As my dad and I were talking over the last couple of days, he is just back from the Philippines, and you don’t see this there, although there are companies now heading to Asia to try to do the same thing, without very much success, because people who own gold there and wear it as jewelry are not particularly inspired to let someone else own it, particularly if is it being paid out at a discount. They know the value of gold.
Kevin: They do. But here in the Western world, I just talked to a client who said it was so sad. “As I am accumulating gold,” he said, “I’m watching these people who are trying to pay bills. They are going in and selling jewelry because they don’t understand the market. They don’t understand, actually, that they are giving up something of great value, for paper, just to get them through to the next week.
David: It’s a tragic scenario to be in, to be down to your last dollar, so to say, but this is what is driving the scrap gold market. The reason we are harping on this is because over the last ten years we have had supply from scrap gold, recycling if you will, go from 400 tons a year, to now 1900 tons. Remember, we mentioned mine supply has stayed relatively constant, between 2300 at the low ebb, to 2700-2800 at the high ebb, and on average, right around 2500-2600 tons per year.
Kevin: That’s a lot of bits and bangles, grandma’s wedding ring, or what have you.
David: But a 3-4 fold increase from 400-500 tons, to now 1900 tons, and we see these numbers now moving in reverse. Even here at the year-end of 2012, a minor decrease in scrap gold coming to market and by 2013 to 2014 we will have seen most of the recycling that we will see, moving forward.
So really, what you have is, demand has increased over the last ten years. Supply has increased, as well, and in the last 18 months, even outpaced demand, with scrap gold being a major component, scrap gold being the only elastic supply of gold, and by elastic I mean where you can expand and contract like an accordion.
Now it, too, is in decline, and we see that as being the major price dynamic moving into 2013 and 2014, not because all of a sudden shorts are scrambling to cover, or because manipulation ends and the market forces are somehow beating out central bank forces. That, I think, is really a bit of a strawman.
You get down to the basics of the gold and silver market, and it has everything to do with supply and demand. Who is buying, who is selling, and is there more to be sold than bought, or is there more to be bought than sold? It’s really as basic as that.
Kevin: David, there is another dynamic we’ve talked about so many times in the form of currency wars, or just currency depreciation. Against the dollar, since the late 1960s, gold has appreciated 49 times, and against the British pound, over 70 times. It’s phenomenal. Maybe not so much against the yen, but it is still a ten-fold increase.
What we have at this point is the depreciation, which has caused the appreciation of gold. Do you see that kicking in to a higher degree at this point, as these currencies start competitively devaluing against each other?
David: Absolutely, and the timing of this kind of commentary couldn’t be better. Shinzo Abe is going to be the new Japanese leader, and basically, he has committed himself to full-blown reflationary policies. In other words, he is going to inflate. He said this over the weekend. “We have to get the economy out of deflation. We have to correct the strong yen. We have to create jobs and boost growth. That’s our mission.” This was at a press conference over the weekend. And we have the chief economist at Credit Agricole saying, “This is going to be Abe’s revenge. He has a rock-solid determination to push the Bank of Japan for more stimulus.”
Again, what he has watched is that the West has inflated, inflated, inflated, and has tried to foment a recovery via monetary policy, and he is looking at 20 years of frustrating economic policies, and he is basically saying, we are going the way of the West, and are going to slaughter the yen. You have to understand that this is going to end up slaughtering the Japanese saver and create a real conundrum for those who are sitting in Japanese government bond positions.
The real critical issue here is that a currency, where gold has only appreciated ten-fold since 1969, is about to step into overdrive, and in terms of an Asian benchmark, as Asians continue to see gold appreciate, not only in terms of renminbi, or the Thai currency, or what have you, now it is appreciating in yen terms on a more aggressive basis as a result of the destruction of the Japanese yen. This is going to be a very, very powerful dynamic as we head into 2013 and 2014. Again, we tend to think of gold in U.S. dollar terms.
Kevin: That’s the amazing thing. We seem to be so myopic, but in euros right now, gold has just been raging. There is no real correction occurring in euros, or Swiss francs.
David: Exactly. And that is where I think when you look at a broader audience, the U.S. audience has been supplying the world through scrap gold, with its former baubles. Now we have the world looking at gold in their own currency terms, not U.S. dollar terms, and see it appreciating, and that’s a trend that you can get excited about.
Again, you have this two-fold dynamic with gold, because on the one hand, if it is appreciating people buy it because it’s a growth asset. On the other hand, you have savers, people sitting in Japanese yen, or any other kind of sovereign paper, watching the destruction of their currencies, and that paper, in terms of the credit quality of that paper, you look at the Japanese yen as a perfect case in point. And they are moving defensively.
It’s not just an offensive move into gold, it’s also a defensive move into gold to try to protect the resources that they have. I think this is what a lot of investors don’t understand. When you are in a bull market in gold, it is driven by both greed and fear, and it is unique, because usually when you are looking at equities or real estate, or anything else, it is driven by greed alone, and it is really helpful to appreciate how powerful the dynamic is. When something gets a head of steam on the basis of greed and then ultimately is reinforced on the basis of fear, that is an unstoppable purchasing dynamic.
Kevin: Your dad has talked about, going back to the 1970s, he has said, “Look guys, gold may have appreciated over the last 12 years, but I remember the 1970s. It’s not appreciating because of fear. That’s not happened yet. When that happens, everyone will know.”
David: Another question is, do we put in place policies in 2013 and 2014 with the new administration here in the U.S., that reverse the course in terms of liquidation of grandma’s jewelry into purchases of investment gold, whether that is bars, or coins, or what have you? Do we see an about-face in the U.S. market? Because frankly, we’re the large supplier of scrap gold into the market.
If there is anything that is holding the price of gold back, it is the U.S. consumer, who is moving the wrong direction at the wrong time. This is where we see perhaps a change in dynamics, 2013-2014 here in the U.S., as people move from greed, those few who have played in the market up to this point, to fear, where people are concerned about the dollar destruction.
This is not just the Japanese who have an intention to create downside pressure in their currency, so as to, again, as Abe said, create jobs, boost growth, correct a strong currency, and fight the forces of deflation. That’s exactly what the world central bankers are doing! They’re fighting the forces of deflation. They are using strong currencies and butchering them. The yen stands as sort of the obvious one to take the big hit in 2013.
Kevin: It is interesting, Dave. This is why, I believe, you have three DVDs out this year. You did talk about the European situation. It was really raging in the spring of this last year. You talked about Asia, because that is going to play such a key role, as you are bringing out right now, even with the change in leadership, both in Japan and China. In this third DVD, just now you were mentioning currency devaluation, and I know you start the DVD by simply stating, “It’s the 100-year anniversary of the Federal Reserve System. What are the ramifications of that for a currency?
David: This is why three DVDs were necessary this year. We did three DVDs this year because we are in transition, and I’m sorry, but one hour of sort of a state of the union, trying to encompass everything that is occurring, when there is so much occurring and changing in real time, this is, I think, what is critical about keeping up with current events in this particular time frame.
We looked at Asia, we looked at Europe. Europe, particularly, because they’ve been in the crisis limelight for the better part of 36 months, three years now.
Kevin: That sort of gave the United States a break in a way, didn’t it?
David: And there is a good possibility that over the next 12-24 months, resolution of the crisis takes on a very different tone. I think we have mentioned this before, but when you look at a conglomerate, a large corporation that goes on a spending spree and buys all sorts of businesses to improve their profile in the marketplace, and then all of a sudden they realize that some of those purchases weren’t so wise, they are not all that profitable. In fact, what you have is losing franchises and a cash bleed, if you will, with still some winning businesses that end up subsidizing the losers. What that company, or corporation, has to do is cut the losers.
Kevin: You’re talking about Greece, Spain, maybe some others.
David: Exactly. And that’s where we see a major transition ahead, for those who are negative the euro, or even short the euro, “Oh, do beware,” because all it takes is one loser stepping out and the subsidies of the winners now get to show as profits, as opposed to an organization which is being run very ineffectively and has sand in the gears, so to say. I think you could see the euro rebound and the dollar fall dramatically.
Kevin: So, “dollar beware,” as well. If you’re holding the dollar, and it’s a choice between euros or dollars, you’re not recommending the euro right now, but you are saying it could happen.
David: I’m just saying that being short the euro is a dangerous proposition, because what you are talking about is a shift in policy, and we don’t know if it’s the ECB and the European Union that pressures these losers out, or if the losers, on the basis of political pressure, determine for themselves that they should go on their own and do exactly what Japan is trying to do.
This is why the currency wars thematic is so powerful coming into this next year, because we have Japan stating, out front, “We’re going to kill our currency in order to foment an increase in growth in the economy.” We see Greece, on the other side of the world saying, “If it works for the Japanese, and they are going to be successful, why aren’t we doing the same thing?” We have the equivalent of the golden cross, being tied to the European Monetary Union, we don’t have control of our monetary wherewithal.
Kevin: Bring me my drachma.
David: Bring me my drachma, or drachma II, whatever they should call it. And the same in Spain, and potentially Portugal. So is it on the political basis that they choose to leave? That’s a good question. We don’t know. But again, there are these transitions, and we would argue that the fuse is lit. Not in Europe, not in Asia, but the fuse is lit in the U.S. because all of a sudden the crisis limelight gets to shift and focus on U.S. dynamics, credit dynamics, currency strength dynamics.
Kevin: Price stabilization or destabilization?
David: That’s where we start this DVD, talking about the fact that in the last 100 years, we have lost nearly 100% of the value of our currency. 95% has been lost. Again, this is on the watch, we are celebrating the 100-year anniversary of the Fed in 2013. The Fed’s primary mandate was price stability. How are we doing? 95% value erased. Price stability. How are we doing? Do they make the grade? I can draw one large letter on the back of a page. It’s an F. The Fed has failed in their primary mandate.
Kevin: When you get 5% out of 100% on a test, that’s a 95% failure rate. That’s what you’re saying for the dollar.
David: That’s the point. We are in an environment where, because it has taken 100 years, no one seems to have cared. No one cares that what you could buy for a dollar back then now costs you 20 dollars. This is where we are also at a point of political and social transition, because as long as you have wage inflation, along with price inflation, nobody really cares, because you went from making a dollar a day to making 20 dollars a day, so who cares that things cost more? But when you have stagnant wages, that’s where you begin to see social instability and a great frustration with this basic level of inflation that doesn’t even make its way into the CPI. This is the frustration.
The second point, and this is a critical issue to come and address this next year is taxation. We have, as a country, gone from basically zero income tax to a system which had a 2% flat tax, and then to 7% as the highest rate of taxation, going back to 1913. Remember, and this is more than coincidence, we went onto the Fed-managed currency system the same year that we introduced the graduated income tax. Yes, it did start with the highest rate of 7%, ultimately went as high as 91%.
Kevin: But it’s a foot in the door. It’s like anything else. You start the Federal Reserve and maybe you don’t print money for a while. But then they print, then they print, then they print, and then, of course, we have a failure of the currency. Same thing with taxation. You start with a little bit and you say, “Look, it’s not going to be much more than that, I promise.” And then the next guy comes in, and then the next guy.
David: And we see these same dynamics hitting the gold market here in 2013 and 2014 in a very powerful way. When you look at a real rate of return, and I know this is old hat for most of our listeners, but a real rate of return is what you keep after taxes and after inflation, so why do we focus in on price stability and taxation? Because these are the two variables that drive a real rate of return, and determine whether or not you are positive or negative, in addition to any growth that you have seen in an underlying asset.
You earn 10%, but inflation is 5%, and you pay an extra 3% if you are in the 30% tax bracket. It means, basically, you have 2% as your real rate of return. Does that compute? That’s the challenge that investors have, and as long as you are in a low-to-negative real rate environment, people tend to say, “Listen, you know what? The risk and the reward do not balance. We don’t see there being enough reward for the risks in the stock market, bond market, or what have you, or even the cash market, and we think we should be in something that is a time-out, if you will, out of the fray, and that is why gold does very well in a low-to-negative real rate environment.
Kevin: David, you’ve brought this up before, and it sounds very complex, but it’s not. What you just explained was the Summers-Barsky Thesis, which was, if you don’t get enough money, go somewhere else. These guys were saying, if you’re not going to get a real rate of return, people go to gold. It’s trackable with history.
David: Again, in anticipation of this third DVD, which will be available to view in the next couple of weeks, for those who are interested, we also look at politics. We aren’t partisan in our judgment here, particularly when you roll the clock back and remember that we’ve had an expanding government budget since 1954.
1954, under Eisenhower, was the last time we actually had shrinkage in government spending. This is a very important dynamic to keep up with, because if you are assuming that Republicans are somehow conservative in their spending, then you have your head buried somewhere, and I hope it is in the sand, because this is ridiculous. To have that appraisal, that the Republicans are fiscally conservative, you’ve been absent for the last 50 years, or more.
Kevin: I’ve got a bumper sticker that says Republicrat. “I’m all things to all people.” Actually, I lie, I put no bumper sticker on my car. (laughter)
David: No, I know that. But the thing is, again, this isn’t a partisan prejudgment or appraisal. The reality is that we have had growth in government under both the Republicans and the Democrats and it really reinforces something, and this is a key theme in this year’s final installment of the DVD. We’re dealing with a political class, and it’s a political class that maintains something of a charade.
We view there being a conflict — we, the hoi-polloi, view there being a conflict and a winner, every time we go through a two-year or four-year election. “Who’s winning? What are the differences?” There is very little difference between the Republicans and Democrats, but the showmanship that goes on, and the billions, now, that are spent in proving that there are differences. The reality is that government continues to grow and the political class continues to define their importance in terms of a percentage of GDP, which is absolutely off the charts.
Kevin: And don’t you think, Dave, we’ve just experienced about a year-and-a-half of incredible energy, and our own emotional energy just watching the political scheme unfold? But what you are saying is that it really doesn’t matter much in the end. Granted, maybe Obama is going to spend a little bit more than a Romney, or anyone you would name. But the bottom line is, we cannot pay the bills that we are racking up right now in Washington.
David: We can’t, and there is really no desire to cut back, because when you start cutting spending, what you are doing is disenfranchising a particular voting base, and so whose voting base do you want to disenfranchise? The Democrats are comfortable cutting the Republican voting base off because they know there are ramifications, a negative reinforcement, if you will, or a negative feedback loop for the Republicans, if they win.
If the Republicans win and they can cut back on social programs, and upset a Democratic voting base, guess what? There is a negative feedback loop for the Democrats, and it reinforces the power circle, if you will, in the Republican sphere. The reality is, the only place they want to cut is where the opposition holds its greatest values and wants to see greater government spending.
But, ultimately, you know what you’re looking at? You are looking at two sides of the same coin. They love to spend, and they love to take your hard-earned money, mine too, and reapportion it, and hand it out, so that they can establish themselves as a political elite. Is there some competition? Sure? What is their goal? Service to the country?
Let’s just put this simply. No. They are more concerned about their own political legacies, personal political legacies, than serving the country. We don’t have citizen statesmen who are willing to serve two-year or four-year terms. No. We’re talking about lifelong politicians, people who see their ability to create dynastic power and wealth. If you look at the number of people who came into politics in the 1960s, 1970s, and 1980s, who are still there, and look at their balance sheets when they started, and now, and it’s a racket.
It’s an amazing racket. And if you are not a Bill Gates, or if you are not a Michael Dell, and you can’t come up with something unique, interesting, innovative, then just go to Washington, because there are billions, if you can get in front of it. There are trillions, in terms of the tax take and the reapportionment, and if you can get in front of one of those government contracts, that’s essentially what they’ve done, is hand out those government contracts to friends, even with family members involved.
It is the worst form of whitewashed corruption, and it’s on a scale of the first world and second world, in terms of their form and style of corruption, again, just on a more whitewashed basis.
Kevin: David, let’s just take that out of the picture for a moment, because it’s so incredibly frustrating. Let’s say all of a sudden, someone rides in and they say, “You know what, we’re going to be benign and benevolent, and we’re going to solve this problem.” We still have programs that everyone looks at and says, “Boy, we don’t want to cut that.”
We’ve got Social Security, we’ve got Medicare. We’ve got defense spending. Those are key, key areas, and if you look at each one of those you say, “Gosh, I don’t see where we can cut that.” But now, we have a fourth element that is overwhelming even those huge three, and that’s the debt that we took out. Now we have to pay interest on it.
David: This is an important element in this last DVD, sort of a post-election synthesis. No one is willing to make the major cuts. Social security, Medicare, defense spending, and as you mentioned, interest on the national debt. Social security is at about 17.9 trillion, in terms of the deficit. Do you understand what I am saying? 17.9 trillion dollars is what’s missing for that program to pay for itself.
Kevin: They borrow from it every single time we run out of money.
David: Medicare requires, on an annual basis, 500 billion dollars from the budget, and it’s under-funded. If you thought Social Security was upside-down, and close to 18 trillion was a big deal, hold onto your hat. Medicare is behind by 86½ trillion dollars. Combine those with the current debt and you’re talking about a 121-trillion dollar problem. We’re in the red, big-time.
Just set that aside. Say that the government is going to do a good job sorting out how to figure that particular piece out. Understand that we are currently paying, in terms of our interest component, 30 billion dollars a month! 30 billion dollars a month, as an interest payment on the debt. That doesn’t pay the debt off. That’s our “minimum payment.” We’re running a 360-billion dollar a year number, and what’s amazing is that if you just go back to normal interest rates, that interest-only component jumps to 90 billion.
Kevin: It reminds me of credit card spending because you really aren’t paying off the principle. You may send your 500 bucks in a month, and find out that 450 of it is based on interest, and 50 is working toward the principle.
David: Remember, when I say 90 billion, I’m talking about on a monthly basis. That’s a trillion dollars a year, or basically 42% of all current tax revenues. This is what has me petrified. Just for the sake of argument, assume that the yahoos back in Washington can sort themselves out with Social Security, Medicare, and the current debt, somehow getting their arms around it.
Just the interest only, not increasing our debt a dime, we still have the benefit of artificially low rates set by the Fed, and that is what factors into a 360-billion-dollar-a-year interest payment. If they lose control at all, interest rates begin to rise at all, again, we move toward half-a-trillion to a trillion dollars in interest alone. And that’s the kind of thing which is the vortex you cannot get out of.
Kevin: And talking about the Federal Reserve balance sheet, that is leveraged 50-to-1, so when you are talking about just small moves in interest, it can wipe out the entire principle.
David: And I guess the reasonable question is, will the Fed lose control? Let’s say the Fed doesn’t lose control and they keep rates at a low ebb. We still have this issue of currency wars, where on the basis of competitive devaluation, everybody, the Fed, the Bank of Japan, the Bank of England, the ECB, they all want to create jobs, boost growth.
Kevin: Who can print the fastest? That’s what they’re asking.
David: Exactly. So you begin to see weakness first in the currency sphere. Once you see weakness in the currency sphere, there is a natural departure, a natural stepping back away from the assets that are denominated in that currency. So who’s winning the race to the bottom, in terms of the currency wars, ends up defining what those debt markets look like.
Do we see the debt markets cracking because they’re weak of their own accord? We’ve talked about this in past weeks. The Fed’s buying 90% of all Treasuries today. So they step up the pace. Believe it or not, they can step up the pace. They could buy 100%. And it is then, at that point, a completely artificial market. They can do that.
Why would the Fed lose control? It’s when you have to not only absorb the 100% of new Treasuries coming to market in order to fund the government, but also have to absorb the Treasuries which are out in the marketplace which are now being liquidated, not on the basis of credit concerns, but on the basis of currency devaluation concerns, which is directly at the center of the Fed mandate, well, as they understand it. Again, 95% loss of the value over a long period of time, and in fits and starts, it really gets going.
We can think of certain periods in the 1970s where we saw, ’78-’81, close to a 50% drop in the value of the dollar in just a few short years. So again, it ends up being currency crisis which drives interest rates higher as people try to avoid losses in the currency and start moving out of the paper. I think, frankly, that our credit rating is much lower than S&P and Fitch have it, and probably even lower than Egan-Jones would have it. So are we truly a AA credit today? Probably not.
Kevin: What is sad about that is that we have talked about taxation without representation, several hundred years ago, and we put off those who were taxing us without representing us. We have to say, the people who are going to be raising the taxes are representatives that were voted into office, but the Federal Reserve was something I never voted for. No one is ever asking me about the taxation of inflation, which is actually the most subtle tax of all. John Maynard Keynes said that one in a million understand that, but it is, it’s a tax.
David: That’s why I think the sophisticated investor today is looking at one thing, primarily. Not what is my rate of return, but what is my real rate of return? Because then you’re factoring in taxation, which is definitely policy-related, and very significant, coming into the 2013 to 2016 time frame, but set aside taxation and any policy or partisan issues related to taxation, you still have inflation, which is the other component in determining whether or not what you thought you made was what you actually made and got to keep.
I think that is where we are coming into a period of time where a growing audience of investors is going to be more vigilant, not with their rate of return, “Oh, yeah, I made 6-7% this year.” They’re not counting in taxation, they’re not counting in inflation, and they need to. You need to shoot to stay even, if you can, in this environment, not taking outsized risks, and if you can make money above the real rate of inflation, by all means do it.
Kevin: And that takes us to another point in the DVD that you are putting out. You’ve talked about the markets coming up. Markets may not always be sophisticated, they may not always be educated, but over time, as it has been said before, the market does what it’s supposed to do, just not when you want it to, or when you think it’s going to do it.
David: I think that is a great way of looking at 2012. Looking at the gold market, let’s start there. I think we are going to continue to see a migration of frustrated investors dealing with the Fed’s interest rate manipulation. They’re using QE, and Operation Twist, and a variety of other things, pushing rates below a natural level. That’s just talking about the gold market here in the domestic space.
What we implied earlier, in terms of a move in gold in terms of yen, that’s a totally different market, but it is a similar driver. You have a bank which is determining what all assets look like. Listen, maybe Japanese equities will do very well in the context of a declining yen, but you are going to be taking a risk in terms of global growth dynamics. It doesn’t necessarily mean that demand for available products being manufactured, even if they are more competitive, is going to be off the charts.
Global aggregate demand is something that may still be pressured in 2013, and so I think there is point and counterpoint for the idea that Japanese equities are the way to go, and I would probably end with a counterpoint and say, you know, listen, the risk still doesn’t justify the rewards, but gold in yen terms is an interesting thing.
Kevin: David, we’ve talked about gold, we’ve talked about currencies, but bonds, that is really the largest market in the world. The bond market represents debt, it represents interest. Strangely enough, the bond market has not been a bad place to be up to this point.
David: And before we talk about bonds, I think just one more thing on equities and stocks, it’s just going to be very difficult to see the S&P’s earnings surpass what we had in 2012. A great year for earnings? No doubt. What we have is the cumulative benefit of all the cost savings put in since 2008. Company chiefs finally got on the stick and started cutting staff, cutting expenses, cutting expense accounts.
Anywhere they could, they have been saving nickels, dimes, and quarters, and as any wise investor knows, this is where you make fortunes, in nickels, dimes and quarters. They’ve positioned themselves to be doing very well in this environment. It’s still going to be down to aggregate demand and growth in the overall economy as to whether or not they are able to increase their earnings as we head into 2013.
We see significant headwinds, still, in the global space. Europe is not fully in recovery. Asia is not in recovery. The U.S. is really not in recovery. When you look at prices, let’s say the S&P and the Dow today, their current levels. Whatever they are at this particular snapshot, they price in 2012 earnings.
Kevin: That’s the amazing thing, David. It’s great earnings, yet we’re looking at a stock market that is about the same level that it was in the year 2000.
David: It hasn’t gone anywhere in a decade. The critical point here in 2013 is that if the numbers don’t improve in 2013, it shrinks. Then you are going to see a drop in equity prices in 2013. Why? Because you have to beat the expectations, you have to beat the number. If we made $1.00 last year, we need to make $1.05. If you made $2.00, you need to make $2.10. And if you disappoint, and you don’t make $2.10, and it’s more like $1.95, now all of a sudden the prices that you see in the S&P and the Dow all of a sudden are overestimating.
They are assuming too much about the growth dynamics of 2013, and that’s where we think you could see a negative “reappraisal” in the stock market with prices heading lower, 10%, 15%, even 20% in 2013.
Kevin: Okay, David, you’re sitting with a normal financial planner who is trained in the old school of financial planning, and he says, “Okay, David, if equities are not going to be a great place to go, then bonds.” I’m bringing bonds back up, and for the simplicity of it, when interest rates go down, bonds go up. When interest rates go up, bonds go down. It’s like a teeter-totter or a see-saw, like we’ve said before, artificially low, but they don’t seem to want to move up.
David: What is the perspective that most investors have? They are cash-starved, income-starved, and rather than stay in cash, earning 0.25% or less with their bank, they’ve moved into high-yield funds, they’ve moved into mutual funds, which give them a broad array of maturities and credit qualities and gives them what they want in terms of a 2, 3, 4, even 6% yield.
The problem is, as you said, if you step back and look at the bond bull market which has been in place since 1982, a 31-year bond bull market, you realize that these income-starved investors are moving from the frying pan into the fire, at exactly the point where the bond market is exhausted, prices are as high as they’ve ever been because yields are as low as they’ve ever been. You have people clamoring for them.
In fact, over the last four years, there has been a migration out of equities, over a half-trillion dollars out of equity mutual funds, and those same dollar figures going into bond mutual funds. It’s unfortunate, but this is the way most investors operate. They don’t see the big picture and they operate on the basis of what they need, not on the basis of what the market is doing and what they should be doing in light of what the market is doing. They make their personal dictates and expect the market to care.
Kevin: David, lest the listener become too depressed listening to this, there are things that they can do, and I know that is really why you produce the DVDs. The DVDs are not meant to frustrate and confuse and make a person angry. They are actually a call to action, so, are there things that you cover in the DVD as to what a person can do about these various issues?
David: By all means, and it starts with what we can be doing politically, and that’s not get out and register with Party X. I borrow from one of C.S. Lewis’s ideas where he is talking about the need for good philosophers because there are so many bad ones, and basically to say we need more statesmen because there are so many bad politicians, and really, non-statesmen, in Washington today.
I’m not saying to go out and get a political science degree and then you are going to change the world, but we have to reappraise how we approach politics and how we approach the world of ideas, and as there has been an agenda, if you have seen Curtis Bowers’ video, The Agenda, which is a documentary that details how the political left, really the socialist, almost communist left, has influenced the educational system, and ultimately, politics. You need to realize that it took place, not in a four-year period, but it took place over a 40-50 year period.
Kevin: It was the long plan.
David: And I think there is a different view that we have to take, a different appraisal and commitment that we have to make, in terms of change in this country. Can it be done? Yes. Can it be done in two years? Of course not! Can it be done in ten years? Probably not. Can it be done in 50 years? Maybe, and it just is a matter of who is putting their hat in the ring.
So I am very intrigued to see what happens over the next 20-30 years, and the change in dynamics in terms of commitments. You were talking about specifics. That is general politics, big ideas, very specifically. We started the year by saying, “Listen, if you don’t own silver, you should own silver.” Relative to gold, at the time, we were close to a 60-to-1 ratio, now we are at a 50-to-1 ratio. Sorry, we were right. The benefits – gold is up 10-12% for the year, silver is up 17%, almost 20%. It outperformed. We were right.
We still think that trend is going to continue as the gold-silver ratio shrinks from 50-to-1, even 2-to-1, if you are lucky to buy at those kinds of numbers. Again, this is a relative relationship, comparing gold to sliver, and we think that ratio will continue to improve from its current 50 and change, down to even a 30-to-1 ratio, here in the short run.
So, outperformance on the silver side, with greater sensitivity to inflation, global inflation, and domestic inflation, coming into 2013 and 2014. People, I think, are going to quit focusing as much on a deflationary tail risk and more on an inflationary tail risk as we come into the next year.
So, the other areas that represent under-valuation, the old 20-dollar gold pieces are as cheap as we’ve seen them in 20 years. They represent a value. They’ve come up in price. The premiums have begun to expand again, even if marginally, and we think that is going to be a trend. Again, that is consistent with the changing dynamics here in the U.S., of investors selling gold in order to make payments, and new folks coming in to buy because they are concerned about negative real rates, they are concerned about taxation, they are concerned about the confiscatory nature of government in terms of taxation. That trend should continue.
And we did mention in the first DVD, on Europe, that we thought the companies that bring precious metals out of the ground also make some sense, and of course, you have to have a cast iron stomach. As gold has been basically flat for the last 16 months, they’re down 30-40%.
That’s what is meant by having a cast iron stomach. They don’t necessarily perform in lockstep with gold. When they do move, they are compelling in terms of their growth dynamics, and we think we’ll see some of that over the next 12-24 months. But really, I would advise that should be done carefully, with risk mitigation in mind, and with real care given to that kind of a portfolio add-in.
Kevin: David, for people who are listening to the program who haven’t even seen the first DVDs of the year, what is the best place they can go to right now to see those DVDs?
David: A couple of things. If you want to watch it online, you can go to YouTube and look at it. Just type in, “The Fuse is Lit, McAlvany.” You can search for it and find it, it’s pretty easy to find. Alternatively, I know that I, personally, like a DVD. I don’t like sitting down in front of my computer and being locked in there, I want to choose when I’m going to have some popcorn and a glass of wine and sit down and watch a movie.
We’ll send you the DVD for free. We set up a landing page, orderdvdnow.com.
Kevin: orderdvdnow.com, no spaces.
David: And you can request the European, the first DVD. You can request the Asian Ascendance DVD, just leave it in the comments. I think the page is marked for the European disk.
Kevin: And you pre-order the third.
David: By all means, if you want to pre-order, if you don’t think you are on our list and are going to receive it automatically, by all means, request it.
Kevin: And that’s free.
David: That is free. We’ll send out the hard copy. Digitally, it will be available online before the hard copy, because we want it available to you the first week of January. So if you want to watch that online, by all means, just get in queue, and we’ll follow it up with the hard copy about 2-3 weeks later.
