Podcast: Play in new window
- AI Providers Begging For Money & Energy
- Wall Street Chief Strategists Recommending Gold In Place of Bonds
- Register For Our Webinar – Click Here
“The revolution in AI is unlimited by the imagination, but very limited in the physical world. Then, energy demand outstripping supply, I think that alone flips the script on the AI revolution. The AI dream is a household energy nightmare.” —David McAlvany
* * *
Kevin: Welcome to the McAlvany Weekly Commentary. I’m Kevin Orrick, along with David McAlvany.
David, I’ve been doing a lot of reading on myth and narrative, and just looking at different cultures and seeing what are commonalities in mythology. Narrative is something often that helps us survive as a species if it’s a correct narrative. But if it’s a poor narrative, if it’s the wrong way of actually reading the room, it can kill you.
David: Well, like a thesis or a model, it just gives explanatory power to the facts that we see in front of us, the data points that we see in front of us. So we’re constantly trying to understand what is happening in the world, in the economy, in science, in all of these things. And so narrative is important. Mood or tone, if you want to think of those things as almost equivalent—maybe tone is the better word—I think these things tie together. There are several narratives which are shifting, and I would argue that the AI narrative is shifting. The bond market narrative has already shifted. And with these two goes a third narrative, the broader equity markets narrative, and we’ll explore these today.
Kevin: And I think about when the narrative shifted back in 1999 and the year 2000, when we had the tech stock bubble, basically. If you had dot-com behind anything, it was going to go to the moon, and there was no reason to worry about profitability. And when that narrative shifted, it went away for good, basically.
David: Yeah, and it’s not that there wasn’t truth in it, it just was that it got a little too frothy.
Kevin: And it was dot-com.
David: The mood and tone was so dynamic, and expansive, and all-encompassing, and unbound. That’s where all of a sudden there’s reality factors that kick in. And surely, we’ve benefited from the boom in technology and in the expansion of the internet through that ’90s period. It’s taken 20 years to catch up and rationalize all of the enthusiasms at that point.
So narrative justifies, narrative rationalizes, narrative paints the picture, it casts the vision, and it sells. Narrative wins over, and it takes away doubts. Narrative is the world, or some part of it, tightly and neatly packaged. It’s ordered, it’s organized in such a way that certain data points become sort of undeniable facts. And they, again, give us some certainty. It helps us understand the world that we’re living in.
Narratives offer explanatory power and a pathway for imagination. And in the end, they’re prescriptive. What are you supposed to do? Well, you buy the stock, you get the vax, you vote the issue, and the narrative leads you to that conclusion. In the end, it’s prescriptive.
Kevin: Well, and a lot of times it’s a framework that you can see whether it works or not. I mean, we use the triangle, the triangle with a third in gold, a third into something that would be more speculative like stocks and bonds, a third in cash. That’s not quite a narrative, but it’s a model, and it’s been a useful tool. But there are some models that do break down over time, and we’re always questioning whether we’re thinking right or not.
David: Well, in philosophy there are meta-narratives which are organizational story arcs that tie all of existence together. There’s sort of the unifying theories. And of course in a postmodern era there are also critiques and outright rejections of those meta-narratives. The postmodernist critique is not skeptical of the facts, but suspicious of the motives, and questioning what aspect of power is being forfeit or being foisted upon us.
A meta-narrative is simply a view of the world which is comprehensive. It’s descriptive of origins, it’s predictive of future states, prescriptive for choices we make in the here and now, and it includes the moral oughts. It also infuses meaning.
Kevin: Yeah. No, that’s where religion comes from too. I mean, we all have some form of religious meta-narrative, whether we admit it or not.
David: And narratives big, in that case, the meta-narratives are small. They carry a lot of weight until they don’t, and some narratives always do. And I think the meta-narratives, they fit that category. Whether you’re talking about religious faith and doubts that emerge and seem for a time unsolvable, or market narratives which explain so much, they justify so much. They rationalize so much until new considerations emerge.
When a shift occurs in a market narrative, there’s a rethink of financial commitments, and frankly, a reallocation of assets. Believers in a market narrative are buyers with a strong sense of justification for speculating on a future outcome which they expect to be highly rewarding. We’re talking about tailored arguments which curate data and selectively elevate some data points and suppress other data points.
Kevin: Okay. So let’s talk about narratives. When the narrative of the past doesn’t match the narrative of the future, I think a lot of people would say, “Well, cryptocurrency, having a secret number have a lot of value.” That’s a new narrative. And so a person says, “Well, then we don’t want to bury our heads in the sand.” AI is like that. We’ve never actually had a machine that thinks for us. And so this AI narrative, people are saying, “Well, I sure don’t want to miss it.”
David: Well, and everyone does it. The AI narrative is a very strong narrative at present, and it’s representing trillions of dollars in build-out commitments. Executive promises, hundreds of billions of dollars in debt. There’s other narratives. The dollar debasement narrative. To have a thesis is to have a narrative. Then the question is, how well is your narrative supported or justified?
We have a narrative too, and it is a hard asset thesis, which we think is well-founded. Anybody who wants to explore that thesis for hard assets in the context of a monetary regime change should register for our webinar this Thursday. The link is in the show notes. It’s Thursday, 10:00 AM Mountain Standard Time. We’ll go about an hour and a half, and that will include Q&A at the end.
Kevin: Yeah, I think that will be definitely something not to miss. So let’s talk about a couple of narratives that are shifting. From a perspective that you’re looking through, you said you’re a hard asset narrative guy, and that’s true. That’s worked really well—well, I don’t know—for about 4,000 years. So it’s a good narrative. You’ve got other guys who believe in debt. The bond guys, they’re going to look through a different lens because they’ve seen bonds as a safe place to be when you’re not in stocks. I’d like to address that sometime in the show today.
David: Well, a financial market thesis works during a particular period of time, and doesn’t work in other periods of time. You even see this with economic theories where there’s great explanatory power that’s provided by Keynesian theory. During a period of time, you look back to 1974, the Nobel Peace Prize was awarded to Friedrich Hayek.
Kevin: More of an Austrian.
David: In the 1970s, all of a sudden, the explanatory power of the Austrian School of Economics made sense, and it had been hidden in the broom closet for decades. I mean, he wrote those theories in the 1930s, and yet they didn’t seem to apply. Keynesian theory had more application. And then all of a sudden you fast-forward to the 1960s and ’70s, and it doesn’t really work under a certain set of circumstances.
So you read one money manager that favors bonds, and the world looks different through his or her eyes. A different manager sees value orientation as the only way to invest, and thus opportunities become more visible through the lens of their valuation metrics. And I’m in no way against narratives. You just have to account for them. You must, as best you can, maintain objectivity even when narratives are to you subjectively meaningful.
Kevin: And you have to be honest when they change.
David: That’s right.
Kevin: If you’ve hit the iceberg, the Titanic is maybe going to sink.
David: Yeah. So just amending one thing you said, the hard asset thesis has been relevant for 4,000 years. I would say there’s punctuated periods where it is a winning strategy. Owning real things, I think, does have a justification through that 4,000 year period. But seeing benefit from ownership is really time specific, and I think that’s a time frame that we have now.
So again, if you can maintain objectivity, that’s key. If the factors that support a narrative turn out to be unreliable, or if they’re overstated or if they’re false, or if they’ve just reached their “sell-by date,” you have to be willing to course correct regardless of what your ego is driving you to do, or where your imagination has taken you, and the commitments that come out of that.
Kevin: I’ve been thinking about this change of narrative because I’ve got three friends who over the last few weeks have lost their job. I was just talking to— And it’s so disorienting because their narrative was to get up every Monday morning and do the same thing over and over and over. And I was thinking, “What do you do when you’re disoriented like that?” Or the loss of a spouse. There’s many things that change, and at that point you have to reconsider who you are and what you’re doing.
David: I love markets, and I used to study philosophy. Markets grade viability in real time, and they test a thesis by a collective vote. And you can tell if you’re right or wrong based on performance.
Kevin: Reality always does show up, doesn’t it?
David: Very quickly. And granted, the markets can often get things wrong, but fighting the markets can be very expensive. One of the trickiest parts of investing is figuring out if you’re accidentally right or right for the right reasons. And momentum can take things well beyond what is reasonable. So the idea of a narrative being sort of an operating force within the marketplace, we come back to this idea of there being a sell-by date. It can work for a good long time frame and then shift. So I think with momentum you have something that carries forward in sort of a positive feedback loop. Performance becomes somewhat self-fulfilling.
As you get to the end of a time frame, closer to the sell-by date, it’s eventually a trap. The sell-by dates are very, very important. So if you’re unwilling to consider what’s driving performance and whether it’s sustainable when performance begins to move against you, you may be in the position where you’re losing money. So we just cleaned out our Airstream over the weekend. The travel cupboards had a few items which were at one point appetizing, but as we checked the sell-by dates, some of them were 2020, 2022. You can go ahead and try eating that if you want.
Kevin: Yeah. Well, that’s your test. Remember you said that philosophy and markets, there’s a provable test. And I guess if you get sick after eating that stuff, that test is showing you something.
David: Well, certainly one of the tests for truth within the realm of philosophy is if an idea is livable. Does it lead to human flourishing? It is, in some sense, like a performative test for truth. So things that you don’t want to do, you don’t want to join the cult of the crash test dummies. That will, over time, prove itself an error in judgment.
Kevin: Right.
David: Human flourishing is not banging your head against a wall.
Kevin: Right.
David: So, I mean, livability, viability, the performative test is healthy.
Kevin: So let’s talk about narratives that I think we’re all experiencing right now. This AI narrative we’ve talked about, we’ve mentioned bonds. So let’s talk about the viability of these narratives, because some would say that this is changing pretty quick.
David: Yeah. I think the AI narrative is already unraveling.
Kevin: Okay.
David: And the faithful will not see it that way. And certainly those who are most enthusiastic about it, leading the charge, they own the companies, whether they’re private or public.
Kevin: But you’re talking about the financial AI narrative. In other words, you’re not saying AI’s going to go away. You’re just basically saying right now it’s not making any money.
David: Yeah. Sam Altman’s recent podcast interview was telling. 13 billion in revenue. He argues there’s more than that, but as a non-public company, conveniently, he does not have to disclose how much more. He gets to promote his narrative in the context of opacity.
Kevin: Well, and 13 billion sounds like a lot until you figure out what his commitments are going forward.
David: Yeah, giving him the benefit of the doubt, let’s double his revenue to 26 billion. That still does not support his 1.5 trillion dollars in commitments. [Unclear]
Kevin: So running a business that’s earning, he says 13 billion.
David: Let’s give him 26.
Kevin: But his commitments are over a trillion.
David: Yeah. 1.5 trillion in spending commitments over the next few years doesn’t make any sense. Yes, there is an arms race in AI and across the tech landscape to not be left behind, but this kind of math is categorically absurd.
Kevin: Yeah. Okay. Well, and then I’ve also heard about the energy requirements. I mean, can we possibly even fuel this AI progress that we have right now?
David: Well, this is where imagination comes up against the hard, cold facts of the physical world. The energy required to meet the data center demands already in queue is now problematic on two fronts. One, the grid won’t support it. We don’t have the capacity. By 2030, we’re talking about a quadrupling of energy needs for AI data centers, and this is according to the International Energy Association, the IEA. So the scaling of AI faces a material challenge which cannot be addressed on the time frame that matches investor expectations of a positive return on investment. Altman suggests that the US needs to add a hundred megawatts a year of electricity capacity.
Kevin: So let’s put that in perspective, because for most people, including me, I don’t think in megawatts.
David: Yeah, a hundred megawatts a year, and this is, say, for the next decade, that would require, if you’re thinking about nuclear reactors, 84 new reactors a year.
Kevin: Per year. Wow.
David: Or 125 gas, this is natural gas-powered plants, or 400 large utility solar farms.
Kevin: And this is per year.
David: That’s right.
Kevin: Yeah. Yeah.
David: This has to be put in place. This is infrastructure to meet the energy demands that Sam Altman thinks is where we’re going. This is what we’re going to build. This is what we’re committing to. Again, the cold, hard facts of the physical world make this an impossibility. And yet people are pricing the AI revolution as if it’s just a question of gettin’ ‘er done.
Kevin: Yeah, but what if we build windmills? Remember Cervantes and Don Quixote? What if we build windmills instead of fighting them?
David: It’s very different if it’s onshore versus offshore.
Kevin: Yeah.
David: But to create a hundred megawatts of energy using windmills, it’s 33,000 windmills if it’s onshore, 10,000 new turbines if you’re talking about offshore wind turbines.
Kevin: That’s incredible.
David: That’s per year.
Kevin: And you’re talking about nuclear reactors, we’re talking about gas plants. Obviously this is way beyond what we can do, but is it any wonder that Bill Gates has come out just recently and gone, “I don’t think climate change is as big a deal as I thought it was before”?
David: What are the implications of rebuilding the grid?
Kevin: Yeah.
David: What do you have to do in terms of copper consumption, in terms of an infrastructure build-out to meet not only growing demographic demands for more energy? Because we do have population growth globally. It’s beyond that.
Kevin: I do know the solution, though. In fact, I saw the Matrix, the first Matrix movie, with your dad, your brother, Scott, Rex, and Larry. I remember we were in Pittsburgh, we were on a conference tour, and when we saw Matrix, it’s like, “Wait a second. They’re using all those human bodies for energy.”
David: As batteries.
Kevin: Yeah, as batteries. Maybe they had something there.
David: Well, again, the hundred gigawatts. The hundred gigawatts. Did I say megawatts earlier? I meant gigawatts.
Kevin: Yeah, I think you did say.
David: That’s a thousand times difference, sorry.
Kevin: Okay.
David: Yeah. We’re talking gigawatts, not megawatts.
Kevin: Okay. I still don’t think in mega or giga, but thank you. It’s more energy than we can imagine.
David: Yeah. Well, this is new capacity that needs to be built per year. So the revolution in AI is unlimited by the imagination, but very limited in the physical world. Then consider the permitting for each of these alternatives. Energy demand, outstripping supply, I think that alone flips the script on the AI revolution.
So that’s issue number one. And the cost associated with a hundred gigawatts is, best case, 150 billion a year, with a two to three year time frame. If you’re assuming nat gas plants, that’s from permitting to build-out and completion and being in service. It’s a two to three year process. For nuclear, lot of upfront costs, 900 billion to $1.2 trillion. That’s per year.
Kevin: Again, per year.
David: But the development times stretch for that from anywhere from four to 10 years. And again, that depends if you’re doing small scale nuclear versus large scale. It’s a little faster with the small scale, but it’s still four years minimum.
Kevin: But you can count on nuclear staying pretty consistent, whereas, I mean, solar and wind, you’ve got to have the wind blowing or it’s got to be a sunny day, right?
David: Faster to market, cheaper to build. But the maintenance costs on an ongoing basis are pretty high. And what you’re talking about is intermittency—
Kevin: Right.
David: —where you don’t have the reliable— I mean, this is the issue with the renewable side is it’s just not as reliable as you need it. Now, a few weekends ago, we went to Moab, Utah. We drive through Monticello, and at the base of this mountain, there’s six or seven windmills, and they’re total eyesores. Something I wish I’d never seen or have to see again. I don’t consider it to be some sort of technological beauty or feat. Very unappealing to me. So thinking about 33,000—
Kevin: Per year.
David: —per year.
Kevin: Per year added, yeah.
David: It’s a little bit crazy. The second issue is that we’re driving up competition for energy.
Kevin: Well, yeah, I know the brownouts. That’s what I was going to ask you about. I mean, we’re already having brownouts.
David: Yeah. In this context, you’ve got more demand than supply, energy costs as a household budget line item will continue to march higher. Across the country, 2025 year to date increases in energy costs, 10% is a minimum, 70% in some geographies. 70% increase. That’s the 2025 reality across the country in terms of an energy—
Kevin: Wow. That’s now. That’s now.
David: So the AI dream is a household energy nightmare. And what is the political will for that? What is the political will for that when inflation is not something that any politician can suffer for long? And frankly, historically, that’s triggered huge political change.
Kevin: Well, you were talking about going to Moab, but we would make trips over to Lake Powell. Remember Lake Powell? I mean, it’s full of a lot of water, but Lake Powell has just been reduced so dramatically. And so I look at the West right now, we’re running out of water without AI. From what I’ve understood, AI takes an awful lot of water for cooling.
David: Yeah. It’s a small percentage of the total water that we use in the country, but it’s still a lot. And certainly in water critical areas, it makes it impossible to consider building data centers.
Kevin: So we couldn’t probably have a data center here with as dry as we are.
David: It would change our life here.
Kevin: Yeah.
David: Yeah. I mean, that’s a third issue. Quantities of water required for cooling data centers. A data center complex today uses an estimated 160 billion gallons of water a year for cooling. It’s a lot of water. Each new hundred gigawatts take between 50— There’s different technologies, but a minimum of 50 million gallons of water a year, somewhere between 50 and 250 million gallons a year. Perhaps technological innovation reduces water demand in the years ahead. But for now, it means that data centers are a major pressure point, particularly in water-critical areas.
Kevin: Okay. But there’s another factor because our grid, from what I understand, is just aging. Can the grid even support this?
David: Yeah. I said two factors. That would be number four. The costs discussed do not include grid upgrades. So you’re talking about transmission, transmission lines, storage of power and energy, and grid reinforcement, which would be tens of billions a year per hundred gigawatts.
It’s one thing to be an enthusiast about the AI revolution and say, “These are the dollars that we’re committing. 1.4, 1.5 trillion over the next several years to build out this radical transformative as we move towards general intelligence, and the ability to solve things like cancer.” The aspirations are fabulous.
Kevin: Right.
David: I don’t have a problem with AI. I do see issues with this physical constraint.
Kevin: Right. Well, it reminds me, I’ve told this story before, but when I was a little kid, I had that story on my little Fisher-Price recorder that I would put the album on, and it was called The Big Oven. And the guy had the biggest oven in town, and he ended up having to feed that oven entirely with his house until he had nothing to run it with. And so, in a way, AI is a big oven. Now, maybe there’ll be some sort of technological breakthrough, like fusion. Let’s say fusion technology comes on board and it’s a clean, high energy producing technology. But at this point, it seems like it’s irredeemable.
But you’re talking also about debt, Dave, and I’m going to bring bonds into the discussion because our government is a little bit like AI. I mean, right now we can’t fund our government much longer with the debt that we have. So, how about the bond market?
David: Yeah. Again, you’re dealing with sort of natural limits, and so if it’s in the physical world, you’ve got significant natural limits to the AI narrative. Within the financial world there are limits too. And we’ve highlighted the national debt issue. You’ve got the Peterson Institute that notes the move from 37 to 38 trillion was the fastest rate of growth in US debt outside of the pandemic.
Kevin: Isn’t that amazing?
David: It’s the fastest rate of growth at any point in US history.
Kevin: And we went into World War II and World War I, and the Peterson Institute is basically saying that this is the fastest rate of growth—other than the pandemic, and that’s always the exception to the rule.
David: Yeah. You’ve got Goldman Sachs CEO David Solomon this week reflecting on $38 trillion in debt, and he says there will be a reckoning. Again, this is the financial market limitations. We’ve highlighted the absurd $2 trillion annual deficits that are only typical in the context of war or financial crisis, and yet now this is what we’re normalizing.
Kevin: So, the metaphor for that, though, okay, we were talking about the power that it takes, the physical limitation of power for AI. There’s only so much energy. GDP is a little bit like that power for our ability to fund our debt. Isn’t that similar?
David: Yeah, you have to have economic mechanics that are creating enough excess to service the debt.
Kevin: So, productivity, GDP, gross domestic product.
David: And you’ve got several bond mavens who are looking at this fiscal position as untenable, it’s unsustainable. Debt-to-GDP north of 120% and rising. You know what happens to government spending in a recession. So, God forbid we have one in the context of our current commitments. We’re spending 2 trillion more than we have. You go into recession, now you’ve got a decrease in tax revenues. You’ve got a decrease in GDP.
Kevin: Yeah, but what about the revenues from Trump tariffs? I mean, aren’t we going to have a windfall there?
David: Again, if we assume some point on the horizon we have a recession, then you get interventionist spending, which can pop that debt-to-GDP figure to really big numbers.
So, there’s a reason why deficit spending is reserved for emergency circumstances, and now it’s not even thought of as an emergency spending. Again, it’s been so normalized. We just spend more than we bring in and we don’t really think anything of it. It’s been normalized.
And with that, I think there is a shift in perception as to credit quality. This is very consequential for US debt financing costs going forward. It gets to the heart of what Jeffrey Gundlach was suggesting and what Mike Wilson from Morgan Stanley has suggested: reduce your bond exposure, increase your gold exposure.
Kevin: What does that say about the bond market, which was always— That’s the safe place you were supposed to be able to go?
David: It says a lot, but in the context of fiscal largesse or lack of fiscal constraint, you have issues emerging in the bond market. Now, you mentioned tariffs. Should the Supreme Court negate the Trump tariffs, that’s another two to three hundred billion that was going to be counted as revenue. It’s gone.
Kevin: Well, wasn’t Trump going to give us all 2,000 bucks? That was going to be 500 billion. So, he was going to get 300 billion for tariffs.
David: Yeah. Well, it’s means tested, so not everybody will get it.
Kevin: Okay.
David: But best estimates are that that would be a four to five hundred billion dollar dividend tariff.
Kevin: You thought about what you’re going to do with your 2,000 bucks, Dave?
David: Well, I won’t get any.
Kevin: Oh, okay.
David: But keep in mind, four to five hundred billion is a tariff dividend from something that today is producing two to three hundred billion. I mean, it’s almost like, “Wait a minute, is anyone checking the math?”
The reality is he’s not likely to hand out anything. It’s, I think, a bit of a political ploy to say, “Support the tariffs, and across the country you should support the tariffs. There’s something in it for you if you do.” Create a little bit of pressure on the Supreme Court as they’re going to— This could be a huge benefit.
Kevin: Here’s your loaf of bread, and the circus is tonight.
David: But consider the inflationary implications of a pandemic stimulus 2.0. Right? We got to 9% following that fiscal stimulus, and he’s talking about something on par. It’s not well considered in terms of the implications, the knock-on effects, when inflation is something that ultimately drives interest rates even higher, and upends what he hopes for, which is lower interest costs and lower interest rates. What he’s suggesting is, when you dig into the math, it, too, is absurd.
So, you get the Supreme Court negating the tariffs, and it disrupts the current calm in the bond market because at least there’s two to three hundred billion more coming in a year. Revenue is revenue, whether it’s coming from outside the country or inside the country. Revenue is revenue.
Kevin: Yeah, but, okay, so you said it disrupts the calm in the bond markets. Is it calm right now in the bond market?
David: Yeah, I mean, it depends on where you look. If you’re looking at tight credit spreads and declining rates, yes, but I think there’s beginning to be a shift. We’ve seen the shift in the private credit markets already, and certainly tensions rising with the fraud and the disappearance of several billion dollars with First Brands and the failure of Tricolor. People are beginning to say, “Hey, wait a minute. Should we check our loan covenants?”
There’s some caution which is emerging. Not all is calm. The repo markets are beginning to behave like they did in the fall of 2019, which could further shift the lack of volatility in bonds, increase the volatility, in essence. So far, this is the secured overnight financing rate that’s not behaving well. That is the rate that replaced LIBOR after the LIBOR manipulation scandal back in the, I think it was the teens, and then they ultimately replaced it in 2023. You’ve got QT ending. That was a notable announcement from the Fed from that last meeting.
Kevin: If QT ends, do you think we’re going to have QE soon?
David: I think it’s reasonable to assume that QE is not far around the bend, whatever they call it, and my guess is that they deny it. We have had a number of Fed execs basically say, “Oh, well, this isn’t QE.”
Kevin: Pay no attention to the printers behind the curtain. That’s right.
David: But I think 2026 is likely to be the year of the bond. The government bond. And the Federal Reserve will be, in that context, the buyer of last resort, buying stability in the bond market, which comes at the expense of the US dollar.
So, we’re at natural limits, financial limits, and that gets to play out in the years ahead. Coming back to the Mike Wilson shift in asset allocation from 60/40 [60% stocks/40% bonds] to 60/20/20 [stocks/bonds/gold], you really have to think about how profound that is to say the safer part of your portfolio, you can’t rely on it as being the safer part of your portfolio.
Kevin: Well, put this in perspective, too: when has Wall Street ever recommended a 20% allocation to gold?
David: Never.
Kevin: Yeah.
David: Never.
Kevin: Never.
David: Right.
Kevin: Yeah. What’s up?
David: Yeah, so with inflation north of 3%, with services inflation being 3.6%, if in fact we have QE and that’s rolled out in 2026, the bond market will have yet another reason to throw a fit. Bond market volatility is certainly something to watch.
So, interest rates volatility, losses in fixed income, I think that’ll surprise many people, and I think we should reflect back on Gundlach and Wilson. It’s DoubleLine Capital CEO and Morgan Stanley CIO shifting portfolio recommendations to a much smaller bond position and a much larger gold position. They’re looking at the road ahead and course correcting in advance of the bumps and the rocks and the drops on the fixed income trail. We’ve talked about that in the context of mountain biking. If you’re focused on what’s under the tire, you’re going over the handlebars. You have to keep your eyes ahead on the trail, and you naturally adapt to the contours of the trail if your eyes are sufficiently focused on what is ahead.
Kevin: And these guys want to be on the right side of this trade.
David: I think they’re looking far enough down the road to say, “We can accommodate, we’ll manage the bumps and rocks and drops just fine, but this is what is required—this is what is required to do so.” The MOVE index, this is how you measure volatility. You’re familiar with the VIX index.
Kevin: Right.
David: It’s puts versus calls that tell you kind of anticipated volatility in the stock market. The MOVE index does the same thing for bonds. It was recently at 66, of which the creator of the index—this is Harley Bassman—was interviewed by Jim Grant, and for perspective, he equates 66 in the MOVE index to the VIX being at 10 or 11.
Kevin: So, hardly registering.
David: Yeah, well, exactly. There’s no volatility, except that a contrarian read on that translates to a big move higher in volatility just around the corner. An ultra-low VIX reading always precedes a major market downturn. You’re seeing it through the lens of psychology. It’s sort of max complacency being a hallmark of an end-of-cycle dynamic.
Kevin: So, what you’re saying is low volatility precedes max volatility.
David: Right. Yeah. And he gave some functional ways of using the MOVE index, which I thought were helpful. You take the MOVE index, whatever the number is—today it’s around 79—divide it by 16, and it gives you the rough daily volatility in the Treasury market. So, it was 66. 66 divided by 16 is four, so that’d be four basis points movement in the Treasury on a daily basis. Now it’s 79 divided by 16 would be just about five basis points in daily movement. And so the larger the number, the greater the volatility in Treasuries. April 8th, when we were going through the tariff mayhem, the move index was 139. Divide by 16, you’re at 8.5, 8.7 in—
Kevin: So, you’re talking about interest rate volatility, which goes back to the bond market.
David: Interest rate volatility, the bond market doesn’t have a tolerance for it. If it’s volatility on the upside, well, that’s a problem. I think it’s worth noting that interest rate volatility is particularly a problem for leveraged players in the bond market. One of the things that Doug Noland and I talked about last week is this huge US Treasury position in the Cayman Islands where hedge funds are using Treasuries as a part of a leveraged play into other assets.
Kevin: Many multiples of leverage. Yeah.
David: Up to 70 times leverage. 75 times leverage is I think what Doug said last week.
Kevin: Yeah.
David: That’s interesting, isn’t it? When you think about how you manage volatility in a leveraged portfolio when the underlying asset starts to misbehave or behave outside of a volatility parameter that you can handle. That creates a forced de-risking or de-grossing of a portfolio, which in essence is liquidation of those assets. So if you’ve got a trillion and a half in assets, 2 trillion in assets in bonds sitting in the Caymans, and forced liquidations, this is why we come back to this notion that the Fed will, in 2026, be the buyer of last resort for the Treasury.
Kevin: It reminds me of when the carry trade comes apart, obviously, the carry trade is supported by currency stability. What you’re talking about is, this is a carry trade based on interest rate stability. It’s similar.
David: That’s correct. And we’re on a narrative track today, and the three narratives that I think are breaking down. But, yeah, volatility in currencies, the Japanese yen would be a perfect case in point. The greater the volatility, the less viable the borrowed funds in yen are to fund carry trade investments in other geographies.
Kevin: And there goes Barings Bank. We’ll never forget that, but, okay, so let’s go to the stock market because that is the 60% part of the portfolio.
David: But just outside the United States, global debt— You’ve got sovereign debt, which remains an issue here in the United States, but cumulative global debt now tallies to 341 trillion. 251 of that is considered conventional bonds. 91 would come closer to fitting the category of shadow banks. That in itself is a little bit scary.
Kevin: 91 trillion in shadow banking?
David: Yeah. You don’t have all the details, and it doesn’t trade regularly.
Kevin: But you can’t measure it.
David: And if there’s a problem with it, you’re now dealing with, what are the loan docs? 300 pages, 400 pages, 600 pages? I mean, these are complicated investment structures, and it’s a huge percentage of global—
Kevin: Who’s liable?
David: Yeah. Well, global GDP is 120 trillion compared to 341 in debt. That’s a 280% global debt-to-GDP figure. And we’re back to: how much debt can we support? It seems more viable on a global basis because you’ve got suppressed rates elsewhere, not as high as the US. So we’re spending close to 20% of our revenue on interest payments.
You look at global debt to GDP. Estimates are now that we’ll come in closer to 20 trillion—20 trillion in interest payments on that debt. These are questions of fiscal viability and financial market limits in the same way that AI is limited by energy capacity and the growth of that capacity in a time frame that is relevant to a positive return for current speculators in that space.
Kevin: So when you worked on Wall Street, you saw that Wall Street makes its money two ways. It either figures out how to issue debt for a company or it issues equity. So let’s talk about the equity. The broad markets right now—the pricing in the broad markets, the stock market. What are your thoughts?
David: Well, from a valuation perspective—we talk about this regularly—you’re three standard deviations from the mean, which means we’re more expensive today than we have been 99.95% of all recorded history. That puts you in the nosebleed section, if you’re wanting a different word picture.
Kevin: Expensive is the word.
David: Expensive is the word.
Kevin: Is the word.
David: So these are not sustainable levels, although manias can go a lot longer than you expect them to.
Kevin: Right. The narrative doesn’t change instantly usually,
David: But it’s difficult to disconnect the AI narrative from current equity market dynamics. Breadth in the last week has hit lows we haven’t seen in 30 years. So breadth is a measure of how many stocks are participating.
Kevin: It’s very concentrated right now.
David: Yeah. So narrowing breadth is a negative. Bob Farrell, famed investor from Merrill Lynch, said years ago that markets are strongest when they are broad, and weakest when they narrow to a handful of blue chip names.
And Kevin, this is where we’re at. AI is where the money is flowing—in the narrowest of fashions. So that I think is sufficient to say, when people realize that the AI narrative is not sustainable, they’ll realize that actually the broader markets have not participated. And there is a lot from a valuation perspective, there’s an air gap between prices as they are today and as they are more reasonably reflected in the market.
Kevin: So maybe this sounds like an overreaction, but it sounds to me like Wilson, who’s calling for 60/20/20, I think maybe he’s a little low on the 20—that is, the gold part. I mean, the gold market right now is a hedge against what you’ve been talking about.
David: But isn’t it fascinating that he would not reduce his equity exposure, but he would his bond exposure?
Kevin: Who does he work for, though, Dave? Yeah, who does he work for?
David: I think it’s that it’s more reasonable to take a risk on dynamic growth than it is on ossified debt and a structure that is simply not sustainable. So when you look at how much debt is in the market today, US and global, it’s just flat not sustainable. There’s not enough horsepower in the US economy and in the global economy to support it. That’s a dead bet.
Kevin: But he didn’t reduce the stock recommendation.
David: No, I think you’re continuing to bet on innovation. You’re continuing to bet on some version of capitalism. Maybe it’s corporatism in its current iteration, but I think there is a more reasonable bet to say we’ll survive, in some form or fashion, with creativity.
Kevin: But don’t forget your gold, 20% in gold.
David: But don’t forget your gold. I think it’s more of a commentary on the risks implicit to the bond market and what has previously been considered the anti-fragile asset in your portfolio. Now, gold is required to bring in that anti-fragility into a portfolio structure.
Kevin: For the listener who has a financial advisor, it would be good for them to go and ask what they think of the 60/20/20, because a lot of these guys have not changed their narrative.
David: No. In fact, I was on with an endowment group that I consult with a couple of weeks ago and I mentioned Mike Wilson’s 60/20/20, and the asset manager is Morgan Stanley.
Kevin: Same company.
David: Same company. And they’re like, “Well, we don’t really subscribe to that.” I was like, it’s an interesting setup, where, if you’re looking at the food chain—much further down the food chain—they’re saying, “No, I don’t think so.” What that suggests to me is that the adoption cycle for the generalist investor into the gold market has not even begun. It hasn’t even begun.
Kevin: You’ve said it’s under-owned at this point.
David: It’s expensive, but it’s under-owned. So you can’t argue $4,000 an ounce is expensive, but it’s under-owned. And where gold goes next I think is a function of dysfunction of the bond market. It’s a function of disappointed expectations within the AI narrative.
And where you begin to see higher rates, you also see greater headwinds to equity performance. And so these valuation setups within equities are very vulnerable given the fact that rates are, in all likelihood, going higher. And I’m not talking about 25 basis points lower because the Fed sets short-term rates there. I’m talking about the market voting. I’m talking about the market voting on the mid to long end of the curve, taking rates higher.
This is where your corporates are financing, and so as they roll over their debt, it’s going to be at higher numbers. If your interest expense goes higher, your earnings, your profitability go lower, and your share price has to follow. Does that make sense?
Kevin: It does.
David: So we’re at this interesting inflection point. People don’t see the market as weak because equity performance has been stellar. However, we talked about breadth.
Kevin: It’s concentrated.
David: Worst or narrowest breadth we’ve had in decades.
Kevin: And it’s tied to AI.
David: Right, which is not sustainable.
* * *
Kevin: 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.
