The McAlvany Weekly Commentary
with David McAlvany and Kevin Orrick
“Today we talk about the enormously powerful concept of employing the Dow-Jones ratio. It truly could leverage your assets as much as 1700% to the upside in the coming years.”
– Kevin Orrick
“What we’re talking about is a very critical shift. We’ve not lost sight of a massive increase in purchasing power using real money to purchase other assets in the future. I think it is a great idea if you want to get to know the MWM team. This is a good time to get to know them. But for now, do I think a healthy precious metals portfolio sets you up well for the transition we anticipate in the next several years? Absolutely.”
– David McAlvany
Kevin: Dave, your book is out on Legacy, and we had mentioned a couple of weeks ago that you had recorded a program with Dr. Dobson. That recording is now available.
David: That’s right, for our website and for iTunes listeners, you can find the link to the James Dobson interview on mcalvanyweeklycommentary.com, and the post for this week’s show will have the link above the audio player. And for our YouTube listeners, you can find the link below the video and the description there.
Kevin: And I listened to that yesterday. I would recommend it, along with your book, to anyone who has a family, and that’s most of us.
David: It is interesting, I was reading one of the reviews on Amazon the other day, and she said, “I’m 77 years old, my kids are grown and gone, and I’m buying copies for each person in my family. It is more relevant to me now at 77 than it was ever before. I’m in a position in life to cast a vision and be an encourager.” It was just interesting because sometimes it’s, “Well, I’m 30 years old, I’m just starting out, and I want some ideas as to where I should go and how I should get this stuff done.”
Actually, in that sense, the principles and things we talk about in the book, I think, are timeless. They have to do with the individual making choices, and yes, that is relevant to sort of the wider audience in a family context, but it just boils down to an individual, too, which means you could be single, divorced, widowed – whatever the case may be – and I think there are some things there that would be helpful in terms of saying, “Where do I want to be?”
Actually, a lot of what we have to talk about in the Commentary today is imagining something that is an almost given, an almost certainty in the marketplace.
Kevin: Dave, having known you and your family for the last 30 years – your father, your mom, you, and the rest of your family – you have expressed, personally, a lot of your story. Dr. Dobson, when you were talking to him, you did the same thing. But I think about it – your family has been committed to putting a firm foundation in portfolios for years. We talk a lot about gold in a portfolio, and of course, gold never goes to zero. Well, legacy in a family – and this is what you’re trying to do in a larger sense – is like putting gold into that relationship.
David: Yes, to me, there is an accounting function. Where are we at? What do we have? What are we working with? And where are we going? Where would be like to be? And you are sort of connecting the resources of the now with the object of the future. Certainly, there are those themes within the book, but also, in terms of money management and some of the critical decisions that have to be made over the next 24-36 months, I think there is this interesting overlay. Again, what we do in the Commentary every week is similar. “Where are we at? Where are we going? Where are we at? Where are we going? Where are we at? Where are we going?” It’s a constant check-back.
Kevin: Why don’t we talk about that now? Let’s transition to the Trump plan, because a lot of the questions we are getting at this point are, “What would you say Trump is going to be successful at? What do you think is going to be a hindrance to him?” I know you just recently read the entire report that had been written this last fall on what made Trump different than Hillary.
David: We have strong credit expansion coming into the end of the year and beginning of this year. We have reduction in reserve assets held at the Federal Reserve. That, again, I think is in response, in part, to the rolling back of Dodd-Frank, and we’ll get into that a little bit. But I think the game plan that was laid out last fall by Mr. Navarro and Wilbur Ross, looking ahead and saying, “Here is what makes us different than the Obama and Clinton plans, and here is what we are going to do to create economic success.”
Kevin: How much of that was political, and how much of it is practical?
David: It was mostly political, not an economic piece. I found there to be about a 50/50 mix between sort of brilliant and needed changes, and sort of a dangerous misunderstanding about how trade and capital flows work. There was a part of me cringing as I went through the 50-page document, saying, “Oh, my word, this is scary. Yet another Ph.D. who just sees things from a particular angle, and it’s not the right one.” Now, I’m not saying that there aren’t improvements. Certainly, there are improvements in the plan, but it’s not perfect.
Kevin: You like the tax cuts and the trimming back of regulations, that type of thing.
David: Exactly. You have energy reforms, tax cuts, trimming back regulations. Those, I think, are additive. And their approach to trade is the area that brings the most economic benefits, but it’s also the one that I think is the most flawed. I love their ideas of renegotiating certain agreements. The VAT is a no-brainer, the Value-Added Tax, which is applied to most imports the world over, which acts as a trade subsidy for those countries’ exports and creates sort of an unequal playing field. I think that is a no-brainer for renegotiation.
Kevin: Didn’t they talk about the trade deficit being the main reason that we have slow growth? It seems that they ignored the debt burden.
David: I think you have to weigh and understand the costs involved when you’re setting your goals. So, there are some added benefits in this whole plan, but I don’t think they are accounting for some of the costs, and that does show up when they start talking about the trade deficits and the assumptions about eliminating the trade deficits, I think, are too simple, and could, in fact, have the opposite from intended consequences, undoing the benefits found elsewhere within the plan. They are saying that our trade deficit is primarily responsible for slower growth in the period from 2002 to the present.
There are a couple of things that they ignore: One, if you’re looking at the simple GDP equation, then exports and imports do factor in, and so the deficit, just looking at it as a simple math equation – yes, they’re right about that. But they ignore the enormous burden which debt has within this picture. Debt isn’t mentioned in the plan that is described as a fiscally conservative plan, in part, because I think they’re planning on adding more debt into the equation over the next several years.
Kevin: So, you think they may have purposely ignored the debt just because they’re going to have to add to the debt to do the things they’re saying.
David: Yes, but also, the way they focus on the trade deficit also ignores the relationship to economic growth and consumption by our trade partners on the surplus side of the equation, so we create deficits here, or if we have a deficit, that is balanced out by a surplus somewhere else in the world, those surplus dollars do represent a major amount of economic activity in that part of the world, and you could go back and say that from 1980 to the present we have had roughly a ten trillion dollar – if you’re looking at all of our cumulative trade deficits – ten trillion dollars of dollar capital flows into the emerging markets, which has represented massive growth in the emerging markets.
By the way, they have taken a lot of those dollars and been consumers also. So when we look and say, “Well, we would like to reduce our imports and increase our exports to get rid of this deficit,” one of the things that we’re also doing at the same time is we’re going to be decreasing our exports because they won’t have the same capital to be purchasing our goods with.
I know that is complicated, but again, it’s this idea that they’re leaving something out of the equation. It’s like, “Well, if you take this number out, then it’s all good.” No, no, no, if you take that number out, there are domino effects the rest of the world over, and it is not a 1-to-1 relationship where if you reduce the trade deficit by a dollar we’re going to increase GDP by a dollar. That’s not the case, because there is a massive toll to be felt on our export side, and that doesn’t even deal with the capital account, that is another whole issue that relates to the trade deficit which they leave completely untouched.
Kevin: You remember, Dave, the book that Jacques Rouffe wrote back in the 1960s. It was a series of articles that had been published in magazines. Of course, he was the advisor to Charles de Gaulle. He warned of deficits without tears. Remember that?
David: Yes, that was basically the idea that you could run these deficits and in a post Bretton world, that is, after the delinking of the dollar to gold, which happened in 1971, we can now run deficits and there is not an immediate consequence. When there was gold in the monetary system, these trade deficits balanced each other out. It was a fascinating thing.
Kevin: Yes, but now we’re going on half a century off of gold, so the tears are starting to come.
David: In theory. So, in theory, let’s say that running trade deficits is very unhealthy and it creates all kinds of malinvestment and distortion within the global financial system. In practice, we are now dependent on those capital flows, and those trade imbalances, as much as we don’t like them – to take them away would be to have significant ramifications for global dollar liquidity, significant ramifications for interest rates here in the United States. It could impact global economic activity very negatively. And again, like I said earlier, that feeds back into the export side of the equation. So, I just think that Navarro and Ross don’t see it.
Kevin: I just wonder if some of the hedge funds, talking about the stock market, have been listening to the Commentary (laughs). We’ve been concerned that so much money has been going into the stock market, but the hedge funds seem to be backing away this last week or two. Now, the average retail investor is just all in. They’re buying the S&P like it’s candy.
David: Yes, I know. Within a 12-hour period I looked at two conflicting Bloomberg articles, one which was, “Look, retail investors have never been happier, they’re pouring in. And, oh, by the way, they’re not hedging they’re exposures at all. In other words, they don’t think anything can go wrong from here, and prices can only go up. Within 12 hours there was also a Bloomberg article noting that hedge funds are getting rattled by the high valuations in stocks, and they’re reducing U.S. stock exposure, they’re increasing gold exposure in the last few weeks.
So, on the one hand they’re confident that Trump is going to deliver on economic growth, so they’re keeping certain exposures to things like base metals, the industrial metals, which would be highly economically sensitive, for the better. But they also appear unclear on the timeline for delivery, on all of those policy promises, so they are cutting back on their stock exposures.
Kevin: This is hedge funds you’re talking about?
David: That’s right. Different than the retail guy. So, I found myself agreeing with parts of the article, obviously, on the valuation side, that stocks are getting expensive. And yes, truly, there is a lack of visibility on when and how Trump will push through his market objectives. If the market begins to move against Trump, he is going to actually have some added headwinds to implementation on those policies. So again, it is sort of ironic that last week we were seeing the biggest retail investor flows into the S&P 500, specifically, the ETF, that represents the S&P 500, in about 36 months. And it was what was described as retail panic buying.
Kevin: I hate to say it, but the retail buyer is almost always wrong in their timing. Let’s just look at seasonality for a moment.
David: But I think that is important to note because buying panics do come at a market extreme, and I’ll leave it to you to guess which extreme that is.
Kevin: (laughs) And I hope it doesn’t happen. I hate to see the headwinds hit Trump this early on. You would like to actually see things hold together so that we can see some of these policies come together. But we’re coming into a season, Dave – they have always said May to October is the time not to be buying stocks. We’re in March right now, but we’re moving into that period of time when the stock market doesn’t do very well, historically.
David: You’re right. The May to October period is considered the weakest period of the year. It is the most common timeframe to see sell-offs in the equities market, whether it is a correction of a 10-20% variety, or the more severe bear market moves which typically are 30-40%. And the question would be, could that come a little early this year? We have a move by the Federal Reserve the middle of this month. They could potentially raise rates.
They’re talking about it, they’ve certainly verbalized that and have prepared the market well for another 25 basis point increase mid March. And if that were to occur that would bring the Fed funds rate to a nice round 1%. The bond market is really not behaving like it sees a clear path to economic nirvana. Yields have been moving sideways since we had the election pop. We moved big-time back in November/December, and they have kind of stabilized and they’re just moving sideways now.
Kevin: One of the areas that a lot of people watch is mortgage rates because just about everybody owns a home or is buying and selling a home. So, how does that play out for mortgage rates?
David: Let’s say the ten-year gets goosed by about 25 basis points. The Fed funds rate comes up 25. Everything across the curves gets bumped up 25. And to see a 30-year fixed rate mortgage also tacking on, let’s say, 25-50 basis points, when the Fed makes its next move, we’re getting to an interesting threshold in the mortgage finance space, because the next move higher brings the 30-year fixed mortgage to roughly 50% above its lows.
Kevin: Right. So, historically it is still low, but it’s coming up.
David: Yes, and as it gets to these thresholds, it may be enough to reshuffle the deck, sort of determining who can afford what as a new home buyer. So, you have the March rate hike, but the other issue right smack dab in the middle of the month is the debt ceiling. The ceiling was determined back in 2015, and here we are March 15th up against it again. So, I’m guessing that, like the last debt ceiling debate, it will be straightforward, it will be nonpartisan, there will be no rancor in the ranks.
Kevin: Well, we hear about debt ceilings, but let’s just look at, how quickly do we run out of money each year? When I’m making an income I have to be able to make, from beginning of the year to the end of the year, what I owe. The government doesn’t really have to do that, do they? They only have to earn a small portion of what it is that they owe, or what they spend.
David: There are a couple of ways of looking at it. One, their burn rate is about 75 billion a month. So, with the 200 billion that we still have in cash, from tax receipts, that means that we’re out of money by mud season. You know, the snow is melting here, it’s spring, it’s not quite summer (laughs), there is stuff on your boots.
Kevin: So, we run out in the spring.
David: That’s right. And the reality is, the stock market doesn’t really need a catalyst like one of these to decline, but you could see extra stress in the stock market as it relates to the sort of political wrangling over what is going to be funded, what is not going to be funded. Will Trump use that as an opportunity to play hardball on certain topics? You don’t have to roll the clock very far back to remember – sorry I was being so tongue in cheek – but how completely partisan, how completely obtuse and unhelpful Congress was being when it was dealing with the debt ceiling last go-round just a few years ago.
So, you throw an increase in rates into the mix, the debt ceiling debate into the mix, the mainstream media which hates Trump and would love to skewer him and roast him and serve him to a bunch of cannibals for lunch. They hate him. So, what does that look like in terms of the mainstream media’s presentation of the facts from March to April? That’s why I say, that whole adage of sell in May and go away (laughs) – maybe we should be paying more attention to the Ides of March.
Kevin: Since we’re talking about a potential decline in the Dow, I think it would be worth going back through what you look at relative to gold. The Dow-gold ratio is so important. I know people sometimes say, “Oh, well, I’ve heard this before.” You really can’t repeat it enough.
David: My brother, who is a scrappy guy who lives out in Asia, likes to say, “You fight like you train.” He trains five days a week. He just got his brown belt in Jiu-Jitsu. Last time I wrestled with him he broke my ribs. I love him.
Kevin: Keep in mind, he’s a missionary, but he’s no weak missionary.
David: I think he likes to think of himself as a businessman, which is more properly what he is. He just happens to live a different kind of life in the context of running three or four businesses internationally. All that to say, you fight like you train, and there is this Dow-gold ratio which is very important for actions that need to be taken in the next 24-36 months. I think we’re now in the final stretch. I wish I had the imagination that Bert Dohmen does, for a 30-year bull market in gold, and he may be right, in which case I’m going back to school, which is great. I love to learn.
But I tend to think of resolution to the problems within the financial market, and getting to a point of pain being more contained to a two to three-year period. And so, again, sort of stretching out a bull market an extra decade in gold? I don’t know. I would like to see that, but I don’t think we will. This Dow-gold ratio becomes very important because there are actions that gold investors and silver investors need to be preparing to make if they want to benefit the most from the asset that they have today.
Kevin: And this is not higher calculus, Dave. Why don’t you explain again what it is?
David: Several weeks ago we were discussing the Dow-gold ratio. Last Friday I was sitting with a young couple. We were at our Wealth Management Office, and we looked at charts and had a general conversation with them on buying value. I explained that if I got hit by a bus there was a pretty decent road map for them if they just looked at this Dow-gold ratio chart. We’ll put this on our Commentary site so you can see what I’m talking about. But I sometimes wonder if I talk too frequently about these details. Lo and behold, just last week, Friday, a client asked me if I was still bullish on gold (laughs).
Kevin: Now, this client listens to the Commentary.
David: I know. But I thought to myself, “No, you don’t cover them too much, maybe I just need to be more direct, more explicit. Yes, and I’ll work on that. Back to the young couple. You may get to take advantage of the key swings in sentiment during your lifetime, that is, going from the extremes of greed in the marketplace to fear in the marketplace, and you may get to do that, if you keep a birds’ eye view of market sentiment.
What I explained is that they were very fortunate to be young enough, and with some resources, to take advantage of the ratio now, and perhaps one other time in their lives, maybe 20-30 years from now, when the ratio is again at a significant inflection point. They are both very bright. We looked at the ratio move back in 2011 when it got to a 6-to-1 ratio.
Kevin: Again, that is the Dow divided by gold’s price. It was 6-to-1 in 2011.
David: We considered whether that was representative of the panic, fear-based buying in gold, and the panic selling in stocks that you generally see with a very low number in this ratio. By that point we were, of course, two years after the global financial crisis lows, and here in the United States the stock market had already begun to recover. So, arguably, there was no panic selling in stocks.
So, one side of this equation – again, we weren’t seeing the normal psychological profile for the ratio to have been at a bottom. In fact, we were in the midst of a rebound in stocks. Barron’s was writing generous articles – this is, again, back to 2011 – on why gold was the most reliable investment in anyone’s portfolio. Again, that was not exactly fear-based buying, they were saying, “Look, it’s been up 12% per year over the last decade, we think everyone ought to own it, blah-dee-blah.”
Kevin: And this was in 2011 when gold was temporarily topping out.
David: That’s right, and Barron’s is probably a good sign of an intermediate top if they’re giving positive publicity to gold. Just to be honest with you, Kevin, if you want to know when the ultimate top in gold is, look for positive articles on gold in The Economist.
Kevin: (laughs) They’ll be late to the game.
David: (laughs) They never have anything positive to say about gold. So, when they turn bullish on gold, you can expect another 25-year bear market in gold, because they are the very, very, very, very last to turn bullish. I think this is important because what brings the Dow-gold ratio to 3-to-1 or 2-to-1 or 1-to-1 is the right emotional intensity on both sides of the asset spectrum. Fear is the common denominator between the stock seller and the gold buyer when you get into those low numbers of 3, or 2, or 1-to-1.
Kevin: Let’s talk about the last time we were at 1-to-1. That was in 1979 when the Dow was a little above 800 points and gold was a little above $800. That was the last time we were at that 1-to-1 ratio. I think we should go back and look at the 1970s for a moment, Dave, because you have pointed to a strange, repeating pattern that just seems like a coincidence but it might be something to look at – where gold was in the early 1970s, and where it ended up.
David: Yes, and then by 1982 when stocks started their move higher, the Dow-Jones and the S&P and the NASDAQ moved higher for two decades on almost an uninterrupted basis from 1980 to the year 2000, and it took the Dow-gold ratio to 44-to-1. So, from 1-to-1 to 44-to-1, it was a good thing to be in equities during those two decades. And we’ve seen the ratio come down from 44, down to 6-to-1, which I mentioned earlier. When I look at the ratio today and see it at 17-to-1…
Kevin: It says, “Buy gold, still, and wait to buy stocks.”
David: It does, but it represents the same kind of moves we saw in the counter-trend in the mid 1970s. So, we’re talking sort of the 1974-1976 period. Two years, 1974 and 1975 where gold was going down, ultimately, 1976 where gold started to turn up again. Again, look at the pattern. $35 is where the market started, went to an interim high of $190, corrected to $105, and then from a $105 low in 1976, started moving up toward $875.
Kevin: Let’s say that again. It started at $35, shot all the way up to $190. Then it lost almost half, and then it went on up to $875. The reason we’re talking about dollar numbers right now is because it led us to, ultimately, a 1-to-1 ratio on the Dow.
David: Yes, that two-year period of falling from the highs of $190 down to $105 – that was no picnic.
Kevin: But $1900 down to $1050 was no picnic, either.
David: No. In fact, all you have to do if you’re looking at $1900 and $1050, just lop off that last zero, and it’s almost an exact repeat of what we had in the 1970s. We saw the ratio reverse in the 1970s from 3½ on the low side. It bumped all the way up to 8½ – that’s the Dow-gold ratio – and then ultimately collapsed from 8½ to 1 at the very end of the bull market. Fast forward to 2011, 2015, we did move from $1900 to $1050.
Kevin: Right. A very similar move.
David: Following from a rise of $350 base, and that has been no picnic – a 45% decline from the 2011 peak to the December 15 lows. Note that the lows were over a year and three months ago, but the remarkable symmetry coming out of the bear market in gold in the early 2000s, and the decline that we completed in 2015 – it compared to the 1970s – what it says to me is that nothing has changed in terms of what drives the market – people.
People drive the market, and people have not changed all that much in 1,000 years. Bankers were financing wars and bailing out fiscal irresponsibility 500 years ago. You had men who were betraying men for a few pieces of silver 2,000 years ago. You had manias and panics and human behavior which really haven’t changed through the centuries, through the millennia, or even through these cycles, because people have an interesting and a somewhat spasmodic relationship to money and assets. They’ll kill for it one moment, and the next, they will sort of dump that asset that they’re willing to kill for as if it was worthless, leaving it for dead.
Kevin: What we are talking about is actually animal spirits – human emotions.
David: (laughs)
Kevin: If a person reviews the Dow-gold ratio enough times to eliminate the emotional reaction, that is what you are really talking about here.
David: And why I mentioned to this young couple that this is something of a road map should I get hit by a bus, is that the Dow-gold ratio cuts through the emotion of greed and fear. And using basic math takes the temperature of the markets.
Kevin: And it is so hard, Dave – I don’t care how long you’ve done it – it is hard to ignore your emotions when there is blood in the streets.
David: We know people love stocks right now, and don’t see the use of owning gold. And all that changes in an instant, because that’s how fast greed turns to fear. You have yesterday’s bullish justification, which is tomorrow’s bearish justification. And the prime mover, and the difference between that timeframe and the next is how people feel. It’s fascinating.
So, for the ratio to decline from the current 17-to-1 to 1-to-1 – that represents a 94% decline in the ratio. Looking at that differently – this might be more helpful – if you own a portfolio of gold ounces today, and you’re converting them into high-quality U.S. companies sometime in the next two to four years, at a ratio of 2-to-1, or even a 1-to-1 ratio, you’re talking about increasing the shares that you own by 900%, or in the case of a 1-to-1 ratio, over 1700%.
Kevin: From the level that we have here.
David: That’s right. So this is where the conversion is key. Most people lack the emotional fortitude to do the right thing at the right time when it comes to investing. You should always do something at a market extreme. The problem is that most people do the wrong thing. So, gold achieving a 1 or 2-to-1 ratio – let’s look at this in real terms today. Let’s say that stocks stagnate at these levels – 20,000-21,000 on the Dow – and they don’t rise any further and they don’t fall any further. What that would imply is that gold price trades as high as $10,000.
Kevin: Okay, now let’s take it a little different. Let’s say the stock market loses half of its value. Gold doesn’t have to do that to get to that 1-to-1 or 2-to-1 ratio.
David: A typical bear market move, if you’re looking at the bear market move from the 1970s forward – 40% decline. A correction is 20%.
Kevin: So, let’s look at that. That would be a little over 12,000 on the Dow right now.
David: 12,500 or 12,600 – something like that, relative to what it is today. And so a ratio of 2-to-1 would put gold at $6300 an ounce. It’s the ratio – not the price – that matters. Of course, it’s the price that drives the ratio, but people often ask me, “What price do I think gold and silver are going to get to?” It doesn’t matter.
Kevin: Right. It’s how many stocks does it buy? How much land does it buy? How much does it buy, as these things fall?
David: That’s right. And too much information is lost in translation when you’re in a fiat currency system. So the better way of getting perspective on the meaning or the significance of price is to look at the price relative to another price. That relative valuation is what you get with a ratio. So, you have exponential growth, not in capital gains, not by moving to cash, as much as in moving to other assets. Basically, what you’re doing is, you’re compounding the expansion of value on one side of the equation, with compression of value on the other side of the equation. And this behavior occurs at the end of a cycle.
Kevin: And this behavior – you’ve been waiting a couple of decades for this, Dave. This is not a new story for us. This is something we’ve talked to clients about for many, many years, saying, “As we move toward this ratio, please be willing to exit some of your gold.”
David: Right. We’re not talking about a liquidation strategy, we’re talking about a reduction strategy.
Kevin: Right. You always want to have about a third of the portfolio in gold.
David: Just to clarify, we are talking about something that is not to happen today, but is supposed to happen two to three years from now, not on the basis of a calendar that we are pre-setting, but on the basis of a ratio. So maybe it’s three to four years, maybe it’s one to two years. The timeframe is not clear on when we get to a point of panic where people are ditching stocks and buying gold, and the ratio is at 2-to-1 or 1-to-1.
Kevin: And lest we be accused of not ever talking about silver, when you say gold, you’re trying to simplify because of the ratio, but there is another ratio that needs to be looked at right now, Dave, and that is, how much silver can you buy for an ounce of gold?
David: I try to keep things as simple as possible in my own mind just so that I can keep track of the relevant decisions that need to be made right now. So, I like round numbers, I like efficiencies. So, gold reaching those kinds of numbers relative to the Dow – actually silver out-performs, handily, what gold does. Again, it’s driven by ratio. But you can assume that if the Dow and gold are trading at a 5, 4, 3, 2-to-1 ratio, that’s also an environment where silver and platinum have out-performed gold.
You have the white metals which are oftentimes like high-octane gold. Silver is still in the neighborhood of 70-to-1 – that is, 70 ounces silver, 1 ounce gold. And it should be accumulated. The ratio of silver to gold essentially doubles your gold position. So, if you like two times your current gold ounces, you need to own some silver today. I think that’s pretty straightforward.
Kevin: But not all silver. You balance it out.
David: Yes, because silver has some weaknesses that gold doesn’t have. Gold tends to be a metal for all seasons and can perform in the context of both inflation and deflation, whereas silver is sort of super-charged for growth in an inflationary context, and gets squashed in a deflationary context. So, if we are heading into an inflationary environment, that 70-to-1 ratio will shrink considerably. 30-to-1 is the average over the last 100 years. We might even see a 20 or 15-to-1 gold-silver ratio, which means that in a metals portfolio, that is serious horsepower.
Kevin: It basically doubles your gold position when you swap back.
David: That’s right. Last thought on the Dow-gold ratio. It was one of the critical charts that had me moving into gold in 2001 and 2002. Why do I come back to it? There is a little nostalgia in it.
Kevin: You were at Morgan Stanley. You were in stocks until 2001-2002.
David: That’s right. So, a stock jock who is being told by my boss, Fred Martin, that I should be selling this or that, the flavor of the week at Morgan Stanley.
Kevin: And you’re looking at this ratio saying, “I don’t know that I should be doing that.”
David: “I think I need to own some gold.” And actually, my clients ended up owning a lot of gold shares circa 2001 and 2002. Look at the charts. It was a good time to own them. Gold, of course, was in the bottoming phase. So, I’m working at Morgan Stanley. Tech stocks were the rage. That ratio, that chart, was instrumental in my moving from California to Colorado to join our family business and actually take a hiatus from equity and bond trading to focus on precious metals. It was also instrumental in the creation of our wealth management business, now nearly ten years ago, because on the other side of a fat gold position is a rather large reallocation to equities and other assets, and MWM was designed to, at some point, assist in a reallocation from ounces to shares.
Kevin: MWM stands for McAlvany Wealth Management, which didn’t exist until ten years ago, but you created that, Dave, for this reallocation based on the Dow-gold ratio.
David: My dad and I had a conversation in 2005 and it went something like this. “Dad, when we get to the very end of a bull market in gold, is there anything else that we would want to do with these ounces?” And the conversation was pretty clear, we would treat gold as a superior cash position. And if the world is selling at a discount, then that’s when you do put some of those “dollars” to work. So spending gold in exchange for other assets does make sense when you get to the end of a bear market in stocks, a bear market in real estate, a bear market in anything, assuming that gold has done its job, preserved purchasing power, in fact, increased purchasing power, for the asset.
Kevin: And that’s where you get the leverage. You were talking about anywhere from 900% to 1700% increase in the amount of shares that you can purchase based on where we are right now with the Dow-gold ratio.
David: Right. So, as bullish as I am on gold today, what we’re talking about is a very critical shift. It will be one of the most critical shifts an investor can make, whether that’s ounces to acres, ounces to shares – you fill in the blank. But we determined a long time ago, as a company, to coach and to lead our clients through one of the most challenging and yet, what we view as one of the most lucrative transitions of this generation.
We’ve not lost sight of a massive increase in purchasing power using real money to purchase other assets in the future. I think it’s a great idea. If you want to get to know the MWM team, this is a good time to get to know them. We want to help. But for now, do I think a healthy precious metals portfolio sets you up well for the transition we anticipate in the next several years? Absolutely.
Kevin: Dave, over the last five or six years we’ve lived in sort of a quasi-fog as far as the quantitative easing that was printed didn’t really get to the market. In fact, I read something just recently that said that 70% of all the quantitative easing just turned right around and went into excess reserves at the Federal Reserve System. So, we have yet to see that money enter the market. Now, that’s going to create velocity increase, it’s going to increase, not risk of inflation, it just will create inflation.
David: Right. And this does relate to Trump’s economic plan to, at some degree, he has talked about reduction of regulations. A part of that is eliminating certain elements of Dodd-Frank. So it’s no surprise that we are beginning to see excess reserves of depository institutions finally being reduced. Bank lending will increasingly put those excess reserves at the Fed into the economy instead. For the last five years, Kevin, you and I have referenced those reserves as a source of future inflation.
Kevin: Yes, you likened it to almost water behind a dam that has to flow over at some point.
David: That’s right, liquidity that is sitting there, and it will flow if it finds a channel through. So, what was really broken over the last several years was the transmission mechanism from the commercial banks into the economy. And I think that’s what we have now. Trump represents the fix-it team, if you will, for that transmission mechanism. He represents an up-tick to velocity of money, where the money in the system is going to see a higher circulation. He represents an increase in inflation via an already tight labor market, and a pressure for rising wages.
Kevin: And velocity dropped over the last five years way, way down. In other words, the amount of times a dollar bill changes hands in a single year dropped down to almost one, when we were used to twice that.
David: Yes, so velocity will have its own inflationary impact. Rising wages and on-shoring will have its own inflationary impact, both from the wage side and from an increased cost of goods, If it is, in fact, our aim to manufacture more things here in the United States, we’re going to pay more for those same things.
Kevin: It is also going to take some currency war types of actions, don’t you think? Because we can’t have a real strong dollar and be able to sell overseas.
David: Right. Well, that’s where the Trump administration also represents an up-tick in relational uncertainty. If you look at our trade partners, if you look at our geo-strategic allies, what we have done is, we have basically left the door open for a simultaneous currency war, and a war on cash, one focused externally in a bid for trade competitiveness, and the other internally in places like the EU, Singapore, we’ve talked a lot about India, Australia to a lesser degree, Taiwan is looking at some cashless moves, and who knows, even the United States. It depends on the Fed’s involvement, moving forward. If we do, in fact, have a return to zero rates, that could invite the elimination of cash as a form of financial corralling and capture here in the United States.
Kevin: Right. That’s what Carmen Reinhart told us was probably going to happen. You have to create a captive audience if you’re going to go back down to zero rates.
David: So, the excess reserves, I think, are an interesting sort of fuel for the inflationary flame. And I do think that there is a shift, whether it is amongst hedge funds, individual investors, frankly, folks all around the world who do see, also, this possibility of both currency war and war on cash. In all, I can’t think of a better time to buy and to hold precious metals.
I go back to a question that was asked toward the end of the year in the Q&A. Someone said, “Listen, you said early in 2015 it was a time to buy gold stocks. I did. I sold them June or July, made a fortune. And I’m wondering if it’s time to buy again.” And I said, “Yes, but….” That was kind of my answer.
I think my answer today is a little bit different. Mining shares, again, I think they’re putting in a second low, like the low that we saw in December of 2016. We’re close to another, and I am starting to get very enthusiastic about those purchases. I would, in fact, say, in full disclosure, “I’m a buyer.”
