The McAlvany Weekly Commentary
with David McAlvany and Kevin Orrick
Kevin: David, we are sitting here in Costa Mesa. We had a great dinner with clients a couple of nights ago, and there were some excellent questions that came up, some of the questions referring to just what’s happened to gold over the last three weeks. It would be nice if we could, for the listeners who cannot be at the Costa Mesa conference or the Seattle conference, to hear your responses right now on the gold market. What’s changed?
David: There are a lot of things. When you look at the perspective of where the U.S. was 40, 50, 60 years ago, move forward from the Bretton Woods agreement. The U.S., at the time, was 50% of world industry, and we had 90% of the world’s gold reserves. We had well over 22,000 tons. That’s been reduced to 8,000 tons, and of course that was why Nixon closed the gold window, that’s why we got very concerned, as the whole world had growing concerns, with the stability of the U.S. dollar. It was for good reason that they were scrambling and getting as much of those ounces or tons as they could, when they were.
There was a focus then on the physical metals, and I think we are moving back into a period of time when, just like the early 1970s, there will be again a focus on the physical metals. This is in stark contrast to what we have had over the last month, when the dominant theme has had little to do with the physical metals. It has had everything to do with the paper.
Kevin: And when you say dominant theme, you are talking about the pricing of gold, not necessarily the demand for gold.
David: The pricing of gold has been impacted by the futures market, and that is in stark contrast to what we have seen developing in the physical market. I think when you look back at world gold reserves being 90% in the United States circa 1944, to significantly less than that today, and there being a major departure from the world’s central banks owning gold, that is, Western central banks owning gold, and a move toward gold, not from the European or U.S. central banks, but the developing nations of the world, which have a much smaller percentage allocation to gold at present, and are increasing those allocations significantly. We are seeing a very similar, reminiscent, if you will, scramble toward the physicals, not unlike the 1970s. And I think, frankly, a lot of what is behind that is the fiscal issues and the monetary issues which were also concerning in the 1970s.
Kevin: I think it is interesting that you are tying this in with the late 1960s and early 1970s, because, in a strange way, gold was being manipulated. The paper price of gold was being held flat at $35 an ounce. That is an interesting concept, because actually, the outflows, or the deliveries of gold, were setting all-time records at that time. They ultimately had to break that artificial pricing by going off the gold standard, and then of course, the rest is history. $35 gold – that’s a long way behind us.
David: We are seeing massive amounts of physical metals, China and Hong Kong this last year bringing in 835 tons, and then fast forward to the Shanghai exchange, just in the first few months of 2013, 1000 tons of physical gold demanded off of the Shanghai exchange. And as we noted a few weeks ago, they actually ran out of gold and were taking special deliveries out of London and Zurich in order to meet demand. Literally, it was the first time, as far as I am aware, that the Shanghai exchange had to put, basically, a delayed delivery in motion because demand had outstripped supply, and in that context, had to resupply themselves, significantly.
Kevin: It is interesting, too, Dave, it’s not just the tonnage of gold that we are talking about, but even jewelry demand and retail demand, Shanghai is reporting a 108% increase this year over last year, and it was very brisk last year.
David: And it is no different in India – 800 metric tons last year, and we are seeing the same kinds of demand metrics for this year, as well. In the last four months, and this is the early part of 2013, we are seeing, on average, the daily allocations for gold, out of London, between 15 and 20 tons per day. There is a very different story being told when you compare and contrast the paper market, that is the futures contract market, versus the physical market.
Kevin: And just to bring it home, Dave, you would think that April would have been a discouraging month for gold buyers, and that quite a few people would have said, “Oh, it’s going down, they tell me it’s a bear market, I’m going to go ahead and sell.” But the U.S. mint, just in April, sold 209,500 U.S. American Eagles. That’s ten times more than what they sold last year, and actually, it exceeds every April since 2010, 2011, and 2012 combined. So people are buying physical metals with both hands. This really does remind you of 1968-1971.
David: And I think when we reflect on this, we have certainly entertained the question, “Do we expect to see gold go up in our lifetime?” Fast forward, and let’s say that you are 70 years old. Let’s say that you are 75 or 80 years old, and asking the same question, “Will I see gold go up again in my lifetime?” I think the answer is, in fact, yes. What we are on the cusp of is a major divorce from the pricing of metals in the paper contract world, and the real price of the metals in the physical market. And I think what everyone should assume is that there will be, heretofore, premiums to be paid for any physical product.
Kevin: It was an amazing thing, Dave, a couple of days ago we were looking at the premiums on kilo bars coming out of Dubai. A kilo, of course, is the cheapest way you can – kilos, 100-ounce bars, or 400-ounce bars. That is usually the big money, just putting something into storage, and the 50-cent premium on kilos is sort of standard in Dubai. The kilo bars were selling at a $6-9 premium before any commission was put on top. That is just the premium on the bar from the wholesaler.
David: That’s very telling because the kilo bar is just, frankly, a bar. There is nothing particularly interesting about it.
Kevin: You don’t barter with it, let’s put it that way.
David: Exactly, and it is actually in the smaller items where you are seeing the premiums really move higher – smaller items, down to silver dimes, quarters, and 50-cent pieces, where we have seen premiums as high at 15-16%, currently hovering between 10-12% over just the raw silver content. And these are products that generally have zero premium – zero premium.
So when you are dealing with the basic Economics 101, supply and demand, what you are seeing is demand outstripping supply, and it is not indicated by the price, because the price is being ramrodded or bullied by that paper contract world. Can that happen over and over again? Can that be a state of affairs which continues? This is where I begin to guess that there is a dichotomy, a stark contrast between the two markets, one which trades at one price, and the other which trades at a dramatically different price, based on the physical metals and premiums which apply to it.
This is a very interesting point in time. It is what, in the world of gold, in the world of paper contracts, you could call backwardation, where you have the front month or the gold which is easiest to take delivery of, trading at a premium over the future months. But you can take that concept of backwardation and assume that we are moving toward a more or less permanent state of affairs, with the physical markets being priced differently, being treated differently, in the open market, because people want the real thing, and not just a contract which says that at some future date you may have it at a certain price.
Kevin: I know, David, that you are a student of history, and if we were to just go back in a time machine and ask when this has happened before, we saw it with the Greeks back in the B.C. period of time, with silver when the Greek government was debasing their currency. We definitely saw it in the Roman period of time. Julius Caesar paid all of his troops in real gold, and somehow all the troops of the other generals wanted to work for Julius Caesar.
But you go 300 years after the birth of Christ and you get to a period of time where the outlying Roman areas were accumulating gold because they saw the debasement of currency. I was reading in Winston Churchill’s History of English-Speaking People, and he said, “In the early 20th century they found a huge hoard of gold in England, which at that time was a Roman protectorate. They were using Romans coins, but they saw the debasement, they started accumulating physical gold, nondependent on what the money was actually doing. I think we have seen this throughout history where you have a certain set of the populace realizing that there is something wrong, they start accumulating, and it is due to the debasement of currencies of various governments in the past.
David: If you talk about the journey from Caesar to Diocletian, by the time you get to the 3rd century A.D., you are dealing with a denarius, which at one time had close to 100% of its content in silver, to right around the turn of that century, 300, virtually no silver at all. And it was in rapid decline those last 50 years. That last 50-year period from 250 to 300, you had more of a change in terms of the emperors, the number of emperors in that 50-year period, than at any other timeframe in Roman history.
Kevin: So you see social upheaval along with the inflationary pressures.
David: Exactly. People are clamoring for an explanation. They are not happy. They are willing to blame people at the top. They are willing to, frankly, blame just about anyone, and it is interesting that by 301 you have Diocletian putting in price controls and assuming that he can step in and control the market.
I am not saying that Ben Bernanke is the modern-day Diocletian, because Diocletian then went on to instigate in 303 one of the greatest slaughters of Christians on the planet. I certainly don’t think that is in any way related to Ben, but what you do see is a massive devaluation in process. You do see a tremendous amount of political and social upheaval, and you do see a tremendous amount of political turmoil in which the emperor seat is changing over, and over, and over, and over again, and it is very common for politicians, ultimately, to scapegoat and point a finger.
In 303, that is exactly what Diocletian did, instituting what we know as one of the great persecutions of Christians. That was the 3rd century. If you fast forward you find the same sort of social disruption, the same sort of blame-casting, if you will. This was an actual, literal witch hunt. They were searching for the cause, Britain circa 1550s to 1640s, a good 70, 80, 90-year period where the years of highest inflation translated into the greatest number of witch trials. Literally, there was this social need for purging, if you will, looking for the evil spirits, trying to figure out what is the cause of pain and suffering. It certainly could not be the fact that during that period of time the currency was being destroyed. It was being destroyed, but that is beside the point.
This goes back to John Maynard Keynes and his famous quote dealing with inflation when he says that by the continuing process of inflation, governments can confiscate, secretly and unobserved, an important part of the wealth of their citizens, and by this method, they not only confiscate arbitrarily, and while the process impoverishes many, it actually enriches some. And certainly, Kevin, I think we can see that today.
Kevin: We see the bubbles all over the place.
David: Asset price inflation in the context of a currency devaluation. He goes on to say, it actually enriches some. Those to whom the system brings windfalls become profiteers who are the object of hatred. The process of wealth-getting degenerates into a gamble, and a lottery. Again, this sounds very reminiscent of what we have today. And then you have John Maynard Keynes anticipating what we have seen today, but also reflecting on history, some of what we are talking about in relation to the third century and in the 16th century. “Lenin was certainly right,” he says. “There is no subtler, no surer means of overturning the existing basis of society than to debauch the currency.”
I think that is a key point that Keynes is making. We are talking about an erosion of society, not just an erosion of currency and purchasing power. “The process engages,” he goes on to say, “all the hidden forces of economic law on the side of destruction, and does it in a manner which not one in a million is able to diagnose.” That problem of diagnosis is why the Christians were blamed in the 3rd century. Why? There were witch hunts in the 1550s, 1640s, 1650s, 1660s. Then you fast forward to the French Revolution, and this is a story that Andrew Dickson White tells very well, Fiat Money Inflation in France. It is an absolute must-read, and by the way, it is only about a 120-page commitment, so it’s something you should not only have in your library but have well-read.
Kevin: It’s a classic.
David: It is a classic. But what he looks at is this period of 1789 when the French Revolution was beginning, and also, at the same time, you have the currency devaluation in play, a massive inflation, in fact, one that tears at the fabric of French society. By the time you get to 1793, just a few years later, 1793 is literally when the heads began to roll.
Kevin: That’s when the guillotine was definitely in action.
David: 17,000 heads of nobles were rolling.
Kevin: The slaughter of the nobles.
David: You go from debasing a currency to debasing society, and you can blame the Christians, you can blame the witches, you can blame the nobility. You can even fast forward to a more modern period, 1919-1924, the Germans dealing with the Versailles war reparations and the forced devaluation of the currency. Havenstein was doing what he thought made the most sense at the time, which is, if you need more money, just print more money. If there is anything that sounds very, very familiar today, whether we are talking about Mario Draghi, we are talking about Kuroda, are we talking about Ben Bernanke, are we talking about Mark Carney of the Bank of England. All of these guys are basically pulling a Havenstein move and saying, “We need more money, we need more liquidity.” That’s fine, just print it.”
The problem was, obviously there was a lot packed into that period, 1919-1924, a very intense period, post-war, where you had a people who were humiliated once, but were in the process of a second humiliation, a second intense humiliation, and who lost their currency, the market was destroyed, fortunes were overturned, and what you have in that context, where you had great inflation, both in Austria and in Germany, you also had a tremendous amount of blame, a tremendous amount of the equivalent of a witch hunt. “Who has done this? Who is responsible?”
And the rise of anti-Semitism. The new party, the National Socialist Party, 1923, was basically the genesis of the party, the worst part of the hyperinflation between 1923 and 1924, and within ten years you have Hitler rising to power, someone who was going to re-dignify a people who had been utterly taken advantage of (that’s the way they felt at the time), and abused, and humiliated, and he was going to restore some sort of national pride. But the question was, “Who was to blame?” It was the Christians in the 3rd century, it was the witches in the 16th century, it was the nobles in the 18th century in France, it was the Jews in the 19th century. Will it be the 1% today?
Because the argument that we would make, and make strongly, is that we are in a similar period of currency devaluation. The problem is, this time we are not talking about a particular country, we’re not talking about a particular set of leaders, we are talking about a nearly universal…
Kevin: It’s the whole world. David, the Swiss franc was the last currency that had gold backing it, and they pegged to the euro a few years ago, so we are in a fiat-complete world at this point.
David: And it’s fascinating to see what happened, when the Swiss did, in fact, have what we would call a de facto devaluation, pegging to the euro. Their stock market took off. By taking off, I mean well over 50% from when they decided to do that.
Kevin: So the S&P 500 going up 30% in the last couple of years is nothing compared to the Swiss, but it’s all based on just printed currency. These are not real moves.
David: This is the same thing that we have in the NIKKEI today. You have “Abe-nomics,” and this new leadership, political leadership, and leadership at the Bank of Japan, which is paving the way toward greater wealth? Is that the real question? Is that what is being created here? New wealth? Or are we talking about creating a crisis of confidence, one which has unintended consequences? I think for a student of history to see that there is more at stake than just the decline and devaluation of a currency, you are really talking about tearing at the fabric of society.
Kevin: David, something we were looking at just recently was the rapid increase of inflation when it actually hits. When it turns into high inflation and then ultimately, hyperinflation, it usually starts in relatively calm single-digit numbers. In other words, in Germany in the 1920s they were running at a 3-6% inflation rate before it went into the trillions by the time it was done. But if you look at the chart, it just goes vertical. It’s like a hockey stick. So, are we talking right now about possibly having a hyperinflationary moment, rather than a steady increase of inflation?
David: I think it is certainly reasonable to assume that the pieces of the puzzle are in place for just such an event to occur, and this is what is challenging. In the past, we have had various places that you could go as a safe harbor, as you mentioned, the Swiss franc. The Swiss franc was a “hard currency.” Where are the hard currency nations today? At best, you can say, “What about the Australian dollar? Surely they have vast natural resources backing their currency and their economy.” You can make those kinds of arguments, but there is nothing technically backing the Australian dollar.
Kevin: Right. Just because there are resources in the country it doesn’t mean they are not printing money.
David: No. That’s correct. They may be printing less than we are today, but that is what is so deceptive. In a world of floating currencies, all you have is a relative gauge, and it literally is like taking vitals in a hospital. If you’re in a hospital, something has gone wrong. You may be in better shape than the man or the woman in the sick bed next to you, but the fact that you’re in the hospital to begin with, it should be no comfort that you are doing slightly better than someone else. You need to get to the point where you are not in that position at all.
Kevin: David, I think we should go back and look at the peak on gold, going back to August of 2011, and say, “What has changed since then that would cause gold to go down? Have we decreased our debt? Have we stopped printing money? Have we stopped quantitative easing? Has the U.S. credit rating actually risen?”
It’s just the opposite, Dave. In August of 2011, the U.S. credit rating, which was the bastion of safety, went from AAA, to AA+. We have created another 2 trillion dollars on the already substantial debt that we have, in that time. We have quantitative easing right now at 85 billion dollars a month, minimum. They may talk about tightening it up every once in a while, but it’s only talk. We always see the numbers coming out higher. So you have more and more money being printed, you have more and more debt, yet the paper markets – I feel for our clients who are looking at this. Our retired clients have already been absolutely beaten up in the interest markets with repressive interest rates. Yet, you have Mario Draghi over in Europe saying, “You know, everybody needs to have an open mind toward negative deposit rates.”
David: In other words, charging you for giving money to the bank? Or certainly, banks having to pay interest on what is held at deposit at the central bank? Excess reserves. They are trying to do everything that they can to create a recovery, and it’s coming very hard. They have not been able to do that thus far. We don’t see it in Europe, we don’t see it in the United States, we don’t see it in China.
And here’s the problem: Where is the engine of growth? To some degree, you have some growth in the developing countries, but if you look at how the flow of funds and the flow of capital occurs, there is still too much interconnectedness between east and west, between the developed and the developing worlds, and when you are dealing with a crisis of confidence, or a crisis in credit in the developed world, there are – there always have been, there always will be – consequences in the developing world, as well.
Kevin: One of our very valued client couples, a couple of nights ago at dinner, brought up a great point, that they feel like they have been stolen from. They had saved and saved and saved, with the thought that they could earn interest. That interest not only has been taken away, but the value of their currency, even if they sit at 0%, is devaluing. This is the second element of it, though. Not only have they been stolen from on the interest rates and the value of the currency, but right now, at least temporarily, in the paper markets in gold, they feel like the only bastion of safety that they had is now losing money as well. Even though a lot of people are buying physical gold, gold temporarily, right now, is down. For the retired person who is not earning interest, who doesn’t have safety in currency, now they are starting to wonder if they even have safety in gold. How would you respond?
David: I think the reality that they are dealing with is not some sort of subjective reality, it is the reality, big-R reality. We are talking about a world in which there is inflation. I practically got into an argument with Trish Regan on Bloomberg the other day because she said, “Where is inflation? You show me where there is inflation. I don’t think it exists. What are you talking about? You say inflation is everywhere. The statistics don’t say it’s there at all. The burden of proof is on you to prove that there is any inflation.”
I, of course, tried to keep my cool. But yes, it’s everywhere. The only places you don’t see it, as I mentioned, is in candy bars and cereal boxes where the size of both are shrinking and they’re charging the same so they are at the same price as they were before. There is inflation, and that is a form of theft. Acknowledging that there is some sort of a grand heist is important. Understand that your underlying sense of frustration is normal. You should be feeling that way.
I think where you have to be careful is who you blame. That is the point. In centuries past it has been easy to find a scapegoat and blame someone who is not actually responsible. Meanwhile, there are parties responsible and this is where the grand experiment with interest rates is part and parcel of the money printing and the inflation that we are seeing directly from the Fed, because the Fed is setting those interest rates at a ridiculously low level.
So you have that repression of interest rates, which is the second form of theft. Income that should be going to savers is not going to savers, it’s going to augment and subsidize the national debt. Your income is going to the government. What should have been your income on your savings is going, yet one more form of monetary redirection, from you to them.
Kevin: With artificially low interest rates.
David: That’s exactly right. This is a period of time when everything is screaming bullish in terms of the fundamentals for gold. Technicals are screaming bearish. And the question is, which do you put more stock in? The fact that the world is going broke rapidly, not just the old version of Mark Twain, “How did you go broke?” “Slowly, then all at once.” We’re already in the all-at-once stage. We’re dealing with desperate measures by central banks all over the world, trying to coordinate efforts and make sure that they don’t lose control.
This is where, I think, when you are dealing with desperate measures, you have to keep a cool head. You absolutely have to keep a cool head, and don’t be surprised. If they will steal from you via inflation, if they will steal from you via interest-rate or financial repression, they certainly will do everything that they can to discourage you from owning gold, the only alternative to the banking system and the dollar-based system that we have today, the world monetary system.
Yes, the gloves are off, there is a fight for survival. Statists of all persuasion would like for you to throw in the towel, and to make sure that you leave with your tail between your legs, selling the last few ounces that you may have, admitting defeat, and their victory.
Kevin: David, what you were talking about, fundamentally, it’s screaming a bull market in gold. Yes, with the amount of sales in physical gold we talked about, it’s screaming a bull market, but until the gold runs out, the paper guys seem to be winning, and that’s what you are talking about on technical charting. The technicians watch chart. They say, “Oops this is a bull, oops, this is a bear,” and they look at it that way. Fundamentals, though – we just now talked about history. You could have looked at technical charts anytime during the Roman Empire, during this period of time, 300 A.D., you could have looked in England in the 1500-1600s, in France right before the hyperinflation there. You could have looked at the charts in Germany.
That’s what I was saying. If you looked at the chart, technically, it didn’t look like there was going to be hyperinflation, and then there was a collapse. So the chartists are right, let’s say 90% of the time. And then there is that 10% complete revaluation of things, where you go back to fundamentals. If you can actually survive until the fundamentals kick back in and you are right on the fundamentals, that’s where wealth is transferred.
David: Let me just qualify that in terms of there being a technical bear market, because frankly, we do see a tremendous amount of repair in the charts even as we speak, and you could actually argue that things have not been this oversold, or this attractive, in the 12-year period that we have been in a bull market.
Kevin: Even looking at just the charts.
David: Yes, just looking at the charts – daily, weekly, or monthly charts – actually, it’s quite constructive. Now, the break that we saw below $1530, that, obviously, was not constructive, and that’s what I mean. Technically, you have a sell signal at that $1530 level. We’ve already found our feet. We’re on $1320, $1330, and we have a rebuilding of price in the mid $1400s. You are going to have a series of battles to “regain territory” as the price of gold moves higher.
Kevin: So it’s not without a fight that gold will go up.
David: It’s not without a fight, but $1485, $1530, back to $1600, and then back to $1780 or $1800. These are all areas where you can expect to see not only some resistance, but even short-term sell-offs, but we are going to regain this territory, and I think we’re going to regain it fairly quickly.
Again, what you are dealing with is a banking system that is struggling to recoup. You are dealing with a fiscal system that is struggling to stay alive. You are dealing with a monetary system that, for the time being, people still have confidence in, and this is where things can surprise very dramatically, very quickly.
When you are dealing with a monetary system that is already being challenged, like it was in the late 1960s and early 1970s, you can see a trickle become a flood in terms of people wanting to get out of paper and into real things. Sophisticated investors all over the world who are basically saying, “Listen, I’d rather have real things. Give me farmland. Give me a chalet. Give me fine art. Give me an extra case of Chateau Lafite from 1982.
Kevin: Just don’t give me a bank account in Cypress.
David: Don’t give me a bank account in Cypress. And in fact, what we have learned from Cypress is the fact that we might not want any significant bank accounts anywhere in the world because we realize that depositors have been and will be abused. So the question is, where do you go to opt out of the system? Where do you go to opt out of the banking system? There is only one place that allows you to be portable, to be private, to be completely controlled, out for a time, being re-engaged at some point in the future, as and when things become more interesting and more stable.
Kevin: And for the clients, Dave, that don’t drink wine (we do have clients that don’t really care much for wine), what you are saying, actually, is the one place is gold, not necessarily Chateau Lafite.
David: Right. Precious metals continue to play a vital role in a portfolio, and to realize that the fundamentals have never been more supportive, I think, is absolutely imperative. The rest of the world is getting it. Not only are they getting it intellectually, but they are getting it physically. They are taking delivery off the exchanges. We have never seen this kind of traffic come off of the London Metals Exchange, come out of COMEX, come from ScotiaMocatta, come out of J.P. Morgan’s stock of precious metals.
We are seeing a turning of the tide in favor of the person who owns physical metals, and this is the period in time, that for all of the reasons that you’ve held it in the past, as an insurance policy, you certainly want to continue to hold it today.
