Podcast: Play in new window
- Silver breaks $34, $36, $38…soon $40
- More U.S. Equities owned by foreigners than U.S. Bonds – Historic first time
- If FED has to turn to Yield Curve Control, Gold will have no ceiling
“When you’re thinking about the big picture and how all these pieces fit into the larger puzzle, what happens with the critical minerals is one aspect, how the Chinese are buying or not buying Treasuries is another aspect. Where is the demand? Where is the supply for financial assets coming from? On this list, China is the critical bottleneck for 20 of the top 25 high impact, high probability critical minerals.” —David McAlvany
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Kevin: Welcome to the McAlvany Weekly Commentary. I’m Kevin Orrick, along with David McAlvany.
David, this last week, Powell spoke at Jackson Hole. And of course, everybody was waiting with bated breath. But the bond market may have taken what he had to say a little different than the stock market, so I’d like to talk about that today.
David: There was a day when no one knew the name of the head of the Central Bank. They lived in obscurity. Now, they have sort of rockstar status in part because it’s one of the ingredients you need for successful investing.
Kevin: We treat them like the daddy of the economy these days, you know?
David: If you know what they’re going to say, you can kind of glean the direction of the markets. The Powell speech at Jackson Hole had a little something for everyone. He said in the near term, risks to inflation are tilted to the upside and risks to employment to the downside. Nonetheless, with policy in restrictive territory, the baseline outlook and the shifting balance of risks may warrant adjusting our policy stance.
Kevin: So what he’s saying is he could be concerned about inflation or not about inflation—
David: Or he—
Kevin: —he could go into employment, right?
David: That’s right.
Kevin: Right.
David: So inflation could cause the FOMC to raise rates, but an increase in unemployment would instead cause them to reduce the target rate. And lastly, they are inclined to moderate the current restrictive level. That last part was all the equity investor needed to hear. Rates are coming down—
Kevin: Buy, buy, buy, buy, buy—
David: —and they did. Last week ended on a strong note. Downside pressure from earlier in the week was released. An upside squeeze ensued.
Kevin: As far as the possibility of lowering interest rates, everybody was waiting for that. And, of course, when you want to hear something and you hear it, it just doesn’t matter what the outcome is, does it? You hear what you want to hear.
David: Yep. And Doug Noland, our colleague—gosh, going on nine years—sent this to clients on Monday. “While stocks and corporate credit reacted enthusiastically to Powell, other markets signaled apprehension. The 5- and 30-year Treasury yield differential widened five basis points Friday to 112 basis points total—the largest term premium, steepest curve, since October 5th, 2021. Market inflation expectations, the five-year break-even rate, jumped four basis points Friday to a one-month high of 2.51% and to within three basis points of the high back to April 3rd, the day following ‘Liberation Day.’ The dollar index sank almost 1% in Friday trading while precious metals prices surged.”
Kevin: So I’d like you to talk a little bit sometime on this show about spreads and why widening spreads matter.
David: Yeah. Before coming back to spreads, I’ll mention my favorite part from the speech, which was the admission that overshooting the inflation target had not been effective.
Kevin: Right.
David: He said eliminating the makeup strategy, the idea of an intentional moderate inflation overshoot, had proved irrelevant.
Kevin: Isn’t that funny? You talked about that last week before he even said that. This whole averaging things out thing.
David: Yeah. Overshoot for a while since you undershot for a while and accept the average as mission accomplished on your 2% inflation term-
Kevin: I remember riding with a guy on a mountain bike ride and he made the funniest comment. He said, “I only average the trail. You’re on the right side. You’re on the left side.”
David: I think that was me because I am on the trail but mostly in between. There’s sometimes on the right, sometimes on the left. I tend to average a mountain bike trail.
Kevin: And that’s what the Fed was trying to do with inflation.
David: Well, really what Powell was acknowledging was that a policy shift of that nature was ill-timed. Given the COVID enhanced fiscal stimulus which fueled inflation, they said they’d stay light touch on inflation controls and take a slightly higher number. And the timing of it was most unfortunate, following the pandemic. Transitory inflation was not transitory. Moderate levels of inflation were not moderate. It was a big oops. And so, that probably in the speech was as close to an apology as you’ll find.
Kevin: So are you thinking this whole averaging idea is off the table?
David: I took them to mean that averaging the rates to get to target was off the table. That doesn’t mean that they won’t tolerate higher rates of inflation. There is a purpose served if you’re talking about managing debt levels. As balanced as he was in his remarks, that comment, which was implicitly hawkish, it does leave the door open to higher rates on the announcement of a nasty CPI or PPI print. I did not hear an explicitly dovish Powell and that’s, I think, what the market was saying, “No, no, no. That’s exactly what we heard, was explicitly dovish. Lower rates are coming.” Rather more of an implicitly hawkish Powell is how I would’ve taken it. But like art on a wall, maybe we all get something different from what we see. So the question is, how do you move from subjective interpretation of what he said to an objective conclusion?
Kevin: Okay. So—
David: And I think it’s data.
Kevin: If it’s data-driven, then, the Fed always has this balancing act as far as employment goes or CPI. Even stability of the currency, but we don’t have to go there. But the actual mandate, which data will he use?
David: With the September 17th meeting around the corner, that’s the question. Which data set is going to set the tone in the stock and bond market? And this will be important for late September trading and early October. Again, following that September 17th meeting, will it be the CPI-PPI-
Kevin: Inflation.
David: —inflation numbers or will it be the nonfarm payrolls numbers?
Kevin: Which is, yeah, employment.
David: I tend to think economic growth continues with inflation following on a lag because they’re very open to running things hot. Both the economy and inflation. It helps manage our debt burden. But I’d bet on number two as an excuse to cut 25 basis points, focusing primarily on labor force weakness. Some of the nonfarm payroll numbers, it needs to be said, will reflect immigration enforcement efforts. So maybe we can say, almost with a certainty, that we’ll have weaker nonfarm payroll numbers. But that will give cover for lowering rates 25 basis points. I think financial markets will continue to front run what they see as economic growth and have already built in the 25 basis points. If you look at how they count the probabilities, it’s an 84% probability of a cut—
Kevin: That’s pretty high right now.
David: Yep. And we’ll only be surprised by [unclear] factor in inflation later on down the road, when and if you see interest rates move higher. We’re talking about lowering rates 25 basis points. Then the question is, where do rates move? And I think that’s the key, is where rates move higher.
Kevin: Well, so doesn’t this take us back to the spread question? Because if the bond market doesn’t buy it, the rates are going to go up even if the Fed goes down.
David: Yeah. The real magic in Q4 2025, and I’d say the first half of 2026, will be if Fed policy, their rates, diverge from the long bond. So long-term interest rates. So Doug mentioned the five and 30-year Treasury spread. You can watch the two-year, 10-year spread as well along with the five and 30-year spread. That will provide… In that timeframe, I think it’ll provide actionable information. In the event that Powell and company initiate a rate-cutting cycle and the long bond moves the opposite direction, there could be real trouble. If mama bond ain’t happy, ain’t nobody happy. So a rise in the long bond and you can kiss this overvalued market goodbye.
Kevin: Do you remember a couple of years ago we were talking about the everything bubble, and we almost act like that’s not still around. But the everything bubble really is— I mean, any sharp object in the room could be very dangerous.
David: Yeah. Exactly. So by the time you get to mid-September, we’ve got bubbles all around us and the sharp objects may be presented by the bond spreads. First, the increase in spreads between the five and 30, then a meaningful increase in corporate spreads. And you get those two things together where stress in the long Treasury ends up impacting corporate credit, and the top in the equity markets is in. That’s at least one scenario where equities reverse —could even be an October ’87 style reversal. Not for a month, not a short-term thing, but for many months.
Kevin: And I was there for that October 1987 reversal, and it was completely unexpected. I mean, there were a few people writing about it. In fact, your dad did in August of ’87. But that thing happened in a couple of days, Dave. On a Friday and a Monday. It was just like, “Wow. A third of people’s assets were just wiped out.” So people might say, “Well, you’re talking alarmist, Dave. I mean, don’t you know things are different this time?” But the Buffett ratio is how high right now?
David: Yeah. I think there’s internal factors to the market which argue for putting in a long-term top, and there’s outside factors as well. Buffett ratio hit 213% this week. Price to sales, I believe, is an all-time high. December 2021 was the previous peak at three times. So here in August 2025, we take that number out with a 3.25 times price to sales ratio. So NASDAQ market cap compared to the M2 money supply, we just passed 176%.
Kevin: What were we in the .com bubble peak?
David: Yeah. 176 versus 135, 135% at the .com bubble peak.
Kevin: Wow. Wow.
David: The Shiller PE, we sometimes refer to it as CAPE, Cyclically Adjusted Price Earnings, that remains 12% below the 2000 record. But a minor blip in earnings and the ratio high will be taken out in two seconds. Now, I jest. It won’t be taken that in two seconds. A 10-year rolling average doesn’t react that fast. But when you see that number move north of 40 and 45, at that point, if you’re not hedged or very liquid in cash positions, you don’t know what you’re doing.
Kevin: Last week, you took your eldest to college, and there’s a cost. There’s a cost to education. You’ve got three more coming behind him.
David: That’s not semesters. That’s kids.
Kevin: That’s kids. That’s right. Many, many semesters. We won’t even calculate that. But the cyclically adjusted price-earnings ratio is a little bit like the cost of tuition, isn’t it?
David: Yeah. Think of it as a tuition indicator. The higher the number, the more expensive the tuition which will be paid by market participants. And then the question is, of course, is anyone learning? You may pay the tuition, but did you pay attention to what was in class? Hopefully it’s not lessons learned the hard way, but in a momentum-driven market, that’s usually how lessons are learned.
Kevin: Okay. So Dave, we’re getting just within a couple of months, I can’t believe it, of a lot of stores getting out their Christmas decorations and starting to sell for Christmas. How are we going to finish the year on the markets? Do you want to make any predictions?
David: If I were to guess, long bond yields are going higher alongside a weak dollar with equities reacting to these circumstances and moving considerably lower. I think there is a reasonable probability that’s how we finish the year. And just a note on gold and silver: in that context, you could very well have a flight to quality with gold and a contraction in the gold/silver ratio back towards 60 to one with silver outperforming.
That would put silver in the $50 to $60 range versus its current $38, $39 range. So some fireworks on the downside in the number of markets, but also some potential fireworks on the upside too. And I think this is worth keeping in mind because here we are, September, the probabilities of cutting rates by 25 basis points are 84%.
The Fed cut rates in January of 2001, which buttressed market upside for a few weeks. It was great, but that led into a 50% decline. And again, recalling the Fed cuts in September of 2007, you got a few weeks of positive upside. So when you think, “Okay, well, this is great. This is exactly what we needed for the next up leg,” well, again, positive upside in stocks following September 2007, and then you entered the 50 to 60% equity sell-off.
Kevin: So let’s look at that again because we were in the nosebleed section on the markets, the equity markets, especially both in 2001 and in 2007. The markets were euphoric that the rates were going to continue to go down, and the rates did go down. And then of course, what’d you say? The 2001, that was a 50% decline after that a few weeks later. And 2007, what was that? That was more than 50%, wasn’t it?
David: Yeah. But I think that’s why it’s important to keep those valuation metrics in mind because it’s not like, “Oh, the Fed starts a rate-cutting cycle, and lo and behold you end up with a bear market.” No, I think it’s more in keeping with a situation, with a context where valuations are as high as you’ve ever seen them before. And that’s the context we had in both of those cases, 2001, 2007, here in 2025.
Kevin: And this is where the bond vigilantes come in because we have to go back to spreads, the spread on short-term versus long-term bonds.
David: The generally bullish approval of a rate cut— I think you’ve got to broaden your scope to include spreads. If there’s no move in spreads, and again, this would be between, say, junk bonds, what they now euphemistically call high-yield bonds. If there’s no move in the high-yield-to-Treasury spread, if there’s no move in the spread between the 5 and the 30, you have more equity upside.
But spreads move. If they begin to widen, equity players will exit the room. And momentum in that context swings the other direction. So pressure on the long bond, this is where you end up with not a passive policy posture, but the Fed getting active, and the Treasury in cahoots with them saying, “What do we need to do to smooth things out?” I think if you get very much pressure on the long bond, that encourages yield curve control, where—
Kevin: How do they do that? Okay, so yield curve control is basically trying to counter what the market is saying.
David: That’s right. You step in and you’re buying particular issues of Treasuries in order to suppress the interest rate.
Kevin: What does that do to gold?
David: Well, on the one hand, monetization of debt—if you go back to the 1970s—monetization of debt was one of the things that triggered real grave concerns about inflation. We’ll see if it’s different this time, but if we get yield curve control, there is the potential gold has no ceiling, no ceiling.
So the administration’s enthusiasm, and I listened to Bessent in a couple of interviews here, the administration’s enthusiasm for stablecoins—again, this is in the world of crypto—tied to Treasuries, may be a ploy to get a new Treasury buyer in the market. And if you can sop up enough supply with this new buyer, might give the Treasury and Fed the latitude to focus their monetization on a particular part of the yield curve.
Kevin: So what they’re hoping for is new money coming into the markets based on the thought that the stablecoin is a way to get into crypto but still have US dollars, right?
David: Yeah, correct.
Kevin: Yeah. So let me ask, we’ve been talking a lot about the United States, but bond markets are international. How about globally?
David: Yeah. So if you look at the global bond market, there are some interesting things happening. We had the no confidence vote in France, and probably not a surprise to see interest rates rising in France, and, very intriguing, catching down, if you will, in terms of price catching up in terms of yields to the Italians. The Italians are notoriously-
Kevin: Dangerous.
David: When it comes to fiscal issues, yes.
Kevin: Yeah, dangerous.
David: But I’d say notoriously fun as well. So if you’re the first guy to pull out the credit card, right?, like, “I got this,” that’s the Italians. They’re in for the late nights, they’re in for the second or third bottle of wine. They’re in for trouble, ultimately, if you’re thinking about fiscal situation. Just go back in time, the Italian lira converted to the euro at 1,936 lira to the euro.
Kevin: There’s your confidence vote right there.
David: That was in 1999. The French had learned a few things through the hyperinflation of the 18th century. They have not always managed things well, but certainly second-largest economy in Europe. They’re a respected adult in the room. The French franc, a less abused currency, came into the euro at 6.55 to one. Again, that’s in 1999. So the contrast in currency conversions tells you a lot about each country, past tense.
Kevin: Okay. Yeah, there was a huge gap back then.
David: Yeah, yeah. And so it just told you, boy, the Italians are kind of reckless, and the French, less so. The interest rate today tells you more about the future of those countries. So again, you begin to see how the market is pricing in risk. Rates in France are now near to surpassing the Italian borrowing rates.
Kevin: Which means they’re having to pay more to get people to loan them money.
David: Yeah. And of course, as both fiscal and political concerns mount, Italians borrow at the expensive end—for Europeans—3.6% for 10 years versus the French at 3.51. These two countries maintain a fairly high spread—back to that spread—to 10-year Bunds, the German paper. And it’s fascinating because you look at Greece, Spain, Portugal, three of the contributors to the PIGS acronym, going back to the global financial crisis and the euro debt crisis in 2011.
They’ve made considerable fiscal progress via austerity, and it’s the Italians and the French that are actually paying up to borrow money. And because of that austerity, Greece, Spain, and Portugal are priced as a pretty reasonable bet. And again, you just look at the spread, their debt relative to Bunds, and you see the risk premium built in. The point is, French and German rates are generally the best in Europe, and these two economies lead the euro bloc, but the rates in France are moving higher and at a meaningfully faster pace than most other European geographies.
So like the UK, the USA, and Japan, rates increasing at the long end of the curve are an indication that bond investors are a tad on edge. Yes, it’s a combination of debt levels and interest rate costs and political dysfunction, country by country, idiosyncratic nature for each of those. But those longer-dated government bonds are where prices matter as a signal. Long bonds offer a depth of market insight.
Kevin: Okay. So all eyes right now seem to be on artificial intelligence and tech. Where does Nvidia play into this as far as just modern investing on momentum investing?
David: Yeah. This week, Nvidia is a tone-setter, a tone-setter. At a $4.4 trillion market cap, the company is just shy of exceeding the entire Japanese stock market, roughly a trillion dollars left before they close that gap. And everybody owns it. It’s the poster child of the AI craze.
Kevin: It’s the future, Dave. It’s the future.
David: Nvidia is already, in terms of market cap, larger than the UK equity market as a whole, larger than either the French stock market or German stock market in their entirety. So earnings are out this week. It’ll either be fuel to the fire for speculation within the equities markets or water to the flames. It is, as I said, a tone-setter.
You have the potential for melt-up dynamics, particularly with markets reading the Powell comments as dovish. Again, he was far more balanced than the market is reading. But that’s how it was read, and that’s how they’ll spend not only their money, but the house’s money.
So we’ve talked about, we have exceeded the one trillion mark in terms of margin borrowing. By the way, that one trillion mark, just for perspective, you’ve got about a trillion dollars in total credit card debt in the US. Think about that, Americans use credit cards a lot.
Kevin: And yet margin debt on the equities market is the same as credit card debt for the consumer.
David: That’s right.
Kevin: Wow.
David: So investors are that confident at these kinds of valuation metrics. And again, hey, if Nvidia is turning the world upside down and inside out, more power to them. That’s how they’re operating, is that this is an incredible revolution.
There was about an eight-page, nine-page article in the Financial Times and some pull quotes from a book. This gal has looked at various revolutions, the Industrial Revolution, and all these things that basically took the flat line of GDP growth and per capita wealth, flat line from, I mean, go back to Ancient Greece and Rome up to 1700, and then all of a sudden we have vertical movements higher. So really the wealth that we know in the world today is from these revolutions in the last three, four hundred years.
And she makes the case, guess what else comes with the revolutions? Over-investment and a collapse in equities. Whether it was the rails or the radio or coal and steamships, there is something that is so enamoring about this new narrative that there is an unlimited amount of money coming into that narrow space, and it builds something which is truly transformative. The problem is, there is a tremendous over-allocation of capital, a tremendous over-capacity created, and a tremendous comeuppance for those early investors.
Now we’ve got just the largest companies, just the largest companies investing in data centers and AI capacity growth, $750 billion over the next two years. Best estimates are 3 trillion over the next four years, $3 trillion. Again, it has all the hallmarks of one of these great revolutions, which is great until somebody has to pay for the over-commitments on the front end.
Kevin: Dave, I think about limited resources when I think about what you’re talking about, like these data centers. Brownouts are starting to become a thing here in the United States. It’s an amazing thing. Remember the ladies from South Africa who came and worked here for a while?
David: Yeah.
Kevin: They were talking about the regular brownout schedule in South Africa. Now they just couldn’t produce enough energy. Here in America, we’ve got all these trillions going toward artificial intelligence and data centers and mining of cryptocurrency. One of the things I think we’re probably getting ahead of ourselves on is do we have enough natural resource? I mean, you and I talk about gold and silver and commodities and that type of thing, and even the USGS goes in and looks at critical minerals, but what about energy, just the ability to run these centers?
David: Yeah, that in itself may be a policy pin that pops the AI bubble where people are dealing with energy bills which are on the rise, and it has nothing to do with an increase in the cost of natural gas. Natural gas is actually on the decline right now, so your input costs and your energy costs should be coming down. They’re moving higher because you’ve got demand that goes well beyond household demand. It is data center demand. So this AI craze is pushing data center demand, is putting constraints and real pressure on energy demand, and prices are rising, so we all are paying up for the AI advancements.
Kevin: Well, my mother-in-law lost a bunch of food out of her fridge because they’ve got these regularly scheduled brownouts, and when the power came on, she didn’t check, but it popped the GFI.
David: Yeah. So just a final note on silver, switching gears a little bit. We are bullish. I think our listeners know that. Breaking out over $34 per ounce was significant. A break above 40, which is eminent, opens the return to all-time highs. The near term probability is that that occurs between now and year-end, so add another $10 to the silver price, a decent move between here and year-end. Great full-year performance.
Kevin: Well, and on the USGS, when they look at scarce minerals, silver was added this time.
David: That’s right. Out this week, the USGS offered its new methodology for determining critical minerals, and silver made the list this year for the first time. I think the paper is worth slogging through. I wasn’t going to go through it because sometimes 42 pages and lots of calculations is rough.
Kevin: What’s 42 pages of boring to you, though, Dave? I mean, I’m sorry, you—
David: But it actually, I thought they improved their methodologies, and there were some interesting insights. You end up with two lists within the list. You’ve got the high cost, which is measured by impact to US GDP, high cost, high probability of supply chain and production disruption. There’s that list. And then a list of high cost, low probability assets. So again, everything’s on kind of a continuum, but the most relevant pieces of the list are on the high cost and high risk side, if you will.
Silver, platinum, palladium, copper, potash are in that latter category, high cost, but low probability. And of course, it’s the first category that we are up in arms about, literally, from a Department of Defense vulnerability standpoint. The first category encompasses minerals you’ve never heard of, but which are vital to semiconductors, guided missiles, our space program, search detection and navigation instruments, and interestingly enough, petroleum refineries as well.
Kevin: We better be keeping the BRIC countries happy. The C in BRIC is China, and that’s a big part of what you’re talking about.
David: Yeah. When you’re thinking about the big picture and how all these pieces fit into the larger puzzle, what happens with the critical minerals is one aspect. How the Chinese are buying or not buying Treasuries is another aspect. Where is the demand? Where is the supply for financial assets coming from? On this list, China is the critical bottleneck for 20 of the top 25 high impact, high probability critical minerals.
Kevin: That is amazing, 20 out of 25 of the critical minerals.
David: Yeah. And it’s a longer list, but they rate them according to high risk, moderate risk, low risk, and of the roughly 25 high-risk minerals, all of the high probability, like 100% we’re going to have a problem here, all with China.
Kevin: Well, the other countries aren’t necessarily great to look at either as far as them controlling those minerals.
David: Exactly. In terms of high probability and high risk, you’ve got South Africa, you’ve got Russia, you’ve got Canada. They’re also on the list. With Canada, potash makes the list, and there’s a couple of other things, but China accounts for a cumulative impact nearing $20 billion to GDP, which if you’re talking about the numbers from this critical minerals list, it’s actually small potatoes relative to 25, $30 trillion economy.
What that figure doesn’t include is the risk of our ability to maintain a healthy growth in arms and munitions, to be able to create trucks, to continue to feed what we have in terms of production of modern materials, whether it’s cell phones or flat screens, and one could argue that we don’t get those domestically manufactured anyways.
But in essence, we need China to rearm, which is a really strange consideration when you look at this critical minerals list. Even our conflict with and the contribution we’ve made in terms of arms and munitions to the Ukrainians, we are unable to replace those stocks without the Chinese. And as the Department of Defense has noted, critical minerals, mostly rare earths, but also a longer list of commodities, if it’s not a question of production in China, then it’s a question of, they are the primary processors of the raw material.
Kevin: You look at the power right now of at least the threat of tariffs, but in a way, what would you call that, I guess holding the mirror to tariffs? If you’re controlling the minerals and you can’t rearm without China, that’s a potential tariff in itself, isn’t it?
David: Well, your point earlier was fantastic. If we’re not paying attention to the BRICS and our relationship to the BRICS, if there’s not some deference in those relationships, some decorum and sophisticated diplomacy, we win on the one hand and we lose massively on the other.
Kevin: Well, and you’re talking about economic and financial market vulnerabilities here in the United States. Right now, we’re talking from a position of power because everything’s hitting all time highs. What does it look like if we do have an October of 1987 downturn and it involves not just the stock market, but the currency?
David: Yeah. Well, I mean, just one final point. We’re familiar with the idea of resource nationalism, and in this case we’re talking about the processing bottlenecks, which are even more critical than the producing bottlenecks. So resource nationalism could be where country raises the taxes or permitting fees or whatever for access to metals that are in their country. But what if they don’t allow access to the metals at all? That’s what we’re dealing with, is not just an economic constraint, and that’s I think where the USGS is unable to really address things. It’s out of their lane, if you will. They’re looking at the economic impacts. What about the geostrategic impacts? And that’s not in the scope of the paper.
Kevin: So let’s go back to silver because that’s something that we invest in all the time, especially with the ratio where it is right now. The USGS has included that on the critical minerals list. So where are we at on that?
David: Yeah, I mentioned silver because it’s a new addition to the critical minerals list. The only real relevance is that North American production is likely to be fast-tracked. And not for silver, but for things like aluminum and copper, maybe even the platinum group metals. Silver is only concerned if our relationship with Mexico is challenged because they’re a huge producer and we import a tremendous amount from them. The impact to GDP is not high. The impact to price of the commodity could be, but the paper notes that— This is some of the things that you glean through getting through the 42 pages.
Canada, between 1989 and 2023 had prohibitions, quotas, and licensing requirements on critical minerals eight different times during that time frame. So these things do happen where we need a mineral, but all of a sudden we either don’t have access to it or it’s on very different terms, and as an input cost, it goes through the roof. South Africa and Russia have only done the equivalent of that. Again, prohibitions, quotas, licensing issues with six commodities, and that’s on four occasions.
Kevin: Yeah, well, I remember the Russian-South African thing with palladium. That can cause quite a disruption.
David: Yeah, absolutely. So cost is of primary consideration in the paper. What is more important than the cost is the ability to function in a high-tech world without access to these critical minerals.
Kevin: So actually our relationship is the risk because we’re talking China.
David: Yeah. The risk is China, China, China. How we engage with China diplomatically and economically and via tariffs determines if we can function independently or if we can function because independently isn’t in the cards today. That’s the point of this list is actually we’ve got huge vulnerabilities in part because we’re not independent.
It wouldn’t surprise me to see this administration lower the EPA limitations to processing capacities. This was done in Utah with the company that Rio Tinto manages there, and so we went from sort of a 95% dependency to a 7% net swing the other direction, where we started exporting— I forget if it was copper sulfates or something, but it was dramatic when they were able to bring in the processing capacity.
But again, our constraint in recent decades has been the EPA will never, ever approve, because you are talking about the processing of minerals which require— How should we say? It’s not the cleanest business, which is one of the reasons why we’ve outsourced all of this to China. We don’t care if it happens there, as long as it doesn’t happen— This is sort of a NIMBY—not in my backyard—type thing. Nobody wants to approve it, and the EPA wasn’t willing to, either.
Kevin: But that’s sort of a luxury type of item. I mean, what do you think under the Trump administration, if we needed it, would the EPA relax those regulations?
David: I think that’s coming. I think an increase of strategic reserves for many of the items on that list should be expected. I don’t think that impacts gold and silver in any way, but judging by the importance of platinum and palladium for auto manufacturing, a concerted effort to stockpile the white metals may become a reality. Frankly, we can’t make light trucks and utility vehicles without the flow of product from Russia and South Africa with those two particular minerals.
Kevin: And that’s the R in BRICS, right?
David: And the S in BRICS. So how we treat the BRICS will be more impactful in the years ahead. Brazil, Russia, India, China, South Africa, these are places with a growing unease with US dollar hegemony, with a declining appetite for US debt, and with a stranglehold on a long list of critical strategic minerals.
Kevin: Okay, so let’s shift back, because now we’re talking about the foreign markets. We talked about the foreign bond market. We’re now talking about our vulnerability, really, to the BRIC nations as far as critical minerals. But we have a new vulnerability, Dave. It used to be that if we had foreign investment, it was in US bonds. At this point, I think the foreigners are buying more equities than they are bonds, huh?
David: There’s an increasing concentration in US equities. Again, it’s a vulnerability as it relates to foreign ownership of US assets. For many decades, it was the bias in favor of US debt, and a lot less traffic, a lot less capital flowed into US equities. But in recent years, this year in particular, the preference has flipped.
At present, there are, call it $9 trillion in US bonds, which are held by foreigners. Nine trillion in bonds held by foreigners. That number has traditionally been larger than foreign ownership of US equities. No more. Now, it’s 11.5 trillion, that’s the tally of equity exposure today versus the 9 trillion in debt.
Kevin: Has that ever happened before?
David: Nope, 11.5 trillion, that’s roughly 17% of total US equity capitalization. Never before has there been this kind of concentrated positioning in US equities by foreign capital. Perhaps it continues. There is a case to be made. You’ve got us dynamism. You’ve got the rule of law. You got a host of other advantages that apply to the US markets that don’t uniformly apply in other markets. So there are certainly reasons to invest in US companies, but imagine a world where the dollar slips in value, and the US equity volatility increases and encourages outflows versus inflows.
Kevin: Well, and that’s what the Trump administration wants. I mean, Bessent has been pretty open about it, and other advisors, that they would like to see a weaker dollar.
David: Yeah, and I guess the question is, what are the thresholds? We talked about, a few weeks ago, thresholds in the debt markets. What are the thresholds for foreign currency volatility or devaluation? This year, I think, is a case in point. US dollar weakness tallies to -10% year to date. Look at it this way. You need an equity return. You need stocks to go up a +10% to break even. -10% on the currency, +10% in the equities, it’s a wash. If you get a 10% drawdown, 10% decline in equities, and you’ve got a 10% decline in the US dollar, for your foreign investor, that’s a 20% decline after accounting for currency reconversion.
Kevin: How long do you stay in play?
David: That’s what I’m saying. It’s a dollar question, but it’s also a market volatility question, because when you combine the two, all of a sudden, the grass ain’t greener, and all of a sudden, repatriation makes sense. So you’ve got over 20 trillion in US dollar assets, 11.5 of that in volatile equity positions. What are the pain thresholds where foreign capital exits? Is it further dollar weakness that precipitates it? Is it a sell-off in US stocks? Is it a loss of confidence in Fed independence? Not all of the bond exposure, by the way, is in Treasuries. So again, we go back to that conversation about spreads. When spreads widen, your riskier bonds—riskier in terms of duration risk or credit risk—your riskier bonds drop in value. So yields rise, prices decline.
Kevin: Yeah. So pursuing a weaker dollar policy, which may save us some money as far as this whole reserve currency thing that they’re trying to move away from, but that could also incite sales, basically.
David: It may be the pretext for liquidations. Again, weak dollar policy we’re looking at from a trade standpoint. But from an investment thesis standpoint, foreigners are unlikely to act on that unless or until they get the double whammy of a currency and market weakness. Then your downside momentum, if you’re looking at the broader markets, US equity markets, your downside momentum is exaggerated by that exit of foreign capital. It’s worth keeping in mind that equity ownership has never reached these levels before. Investors, as long as they stay happy, it underscores a stable capital environment. It’s a growth environment. But if you get angsty investors, now you’re creating an unstable base for capital.
Kevin: So you talk about happy investors, but the way I’m hearing this, Dave, and the way I look back in the rear view mirror is you just have to keep the long bond guys happy. Let’s say Powell lowers rates and the long bond guys, the bond vigilantes, go, “No, I don’t think we’re in an environment where that’s going to work long term.” It sounds like all bets are off at that point.
David: Yeah. The one caveat to that is if you’re able to implement yield curve control at the long end of the curve and mute the signal coming from long bonds. Long bonds are going to tell you what you need to know unless they’re not telling you anything at all because the signal has been muted. In that case, do you know what you look at? You don’t look at the long bond, you look at the gold market.
Gold will tell you when yield curve control is kicking in, because again, if you’ve imagined a ceiling on the price of gold, you’ve basically said business as usual. You bring in yield curve control and a buying down monetization of long-term debt. Whatever you imagined as a ceiling, you can throw it away. You can throw it away. It’s a totally different environment.
So what if Powell satisfies the desires of US-based equity investors by pursuing lower rates? But lower rates not only are not well received by long bond investors, but foreign capital allocators diverge from the domestic capital allocators, particularly because they’re acutely aware of dollar devaluation. I think that kind of scenario would set up year-end 2025 as one for the record books.
Kevin: Yeah, but trust has to be intact.
David: Yeah, I mean, trust is built over time. It’s broken in a moment. You watch bonds, you watch currencies. Both are a measure of trust. Trust remaining or trust waning, which is why we continue to watch them, because we need to see if trust is intact. And if trust breaks, I’ll be frank, you’d better already own your precious metals.
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Well, 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.
