Podcast: Play in new window
- Liquidity Flow Means Life Or Death For Equities
- War In Middle East: Oil Up Now + Long Term Bullish Thesis Unchanged
- Gold Drop Is A Short Term Rush To Raise Cash
“You go back to margin debt being at all time highs, $1.28 trillion. Investors are as bullish as they’ve ever been, and this is particularly retail investors. So the expectation is—whether because of AI, whether because of accommodative rates and the new Fed regime, which is promising to deliver even higher asset prices in the future via lower rates and access to capital—keep the liquidity game going if they can deliver. And that’s where I’d have some questions.” —David McAlvany
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Kevin: Welcome to the McAlvany Weekly Commentary. I’m Kevin Orrick along with David McAlvany.
David, this morning in the meeting you brought up something. One of my favorite subjects, strangely enough, is the Riemann hypothesis, which is a mathematical problem that still has yet to be proven, even though it’s assumed to be correct. And you brought up four items, and you said there’s a difference between an unsolvable problem and a solvable problem. And I’d like you to outline that, if you would, just for a moment, because I thought it was interesting. The solvable problems really boil down to will, and the unsolvable problems, like the Riemann hypothesis up to this point, boils down to intellect.
David: Yeah. I laid it out as the introduction potentially for our client call, which is this Thursday. And a multiple choice question: which of these problems is solvable? The Collatz conjecture, the Riemann hypothesis.
Kevin: Those mathematical conjectures and hypothesis, they’re not solved yet.
David: Or $162 trillion in unfunded liabilities, $68.97 trillion in current debt, if you’re talking about the gross number. And the last two theoretically are solvable. We can do something about it, but we lack the will to.
Kevin: Right.
David: So what I was describing is the Greek curse of akrasia, which is weakness of will. We don’t have the political will to deal with it. In fact, in the context of a democracy, it makes sense that our budget deficits will continue to swell as politicians continue to offer more and more promises to pay in order to collect votes.
Kevin: Yeah. It was interesting. I’ve been watching a lot about the war, obviously, that’s broken out. And one of the generals that was interviewed, a retired general on the news, he said, “War is just simply breaking the will of your enemy.” And that’s what we’re in the process of right now. We’re hoping from the West side, or the non-Iranian side, that the will of the Iranians, it’s going to break. But when you’re talking about debt in the trillions, in the tens of trillions, and we all have benefits that would be taken away if that debt was to be, let’s say, solved the hard way by paying it. Okay. Do we really have the will to win that war?
David: Yeah. And keep in mind, one of those numbers is a fairly conservative estimate. The unfunded liabilities at $160-something trillion. Larry Kotlikoff, when he was on our program a number of years ago, had already penciled the number at well over $200 trillion. So pick your number. It depends on what you’re counting into unfunded liabilities, there’s ways of goosing it, but a conservative estimate would be in the 160s.
Kevin: And it would take austerity with a capital A to actually pay that off, not more debt.
David: Oh, yeah. You’d have to increase revenue, you’d have to decrease your expenses considerably, and maybe even let down some of the folks who are in line to receive those benefits. Social Security being one of those things where maybe it’s means tested, maybe it’s you push the retirement age to 75, 80, 85. What is a number that makes sense? We penciled the numbers out originally when we created the program with a much lower life expectancy. So the math was in our favor then. The math’s not really in our favor now. Yet, there is a way to solve it. And it’s just a question of whether or not we have an economic or political will to do it.
Kevin: Dave, you’ve been studying reversion to the mean. You read Jeremy Grantham’s book, and his thesis is that everything returns to its natural market value at some point, a reversion to the mean. And yet right now, the volatility that we’re seeing in the market right now, that’s an expression of the need for unlimited liquidity, liquidity that’s going to have to be paid back because it’s debt.
David: Yeah. I would say the wild volatile swings in the market are an expression of an uncertain market direction. And so you’ve got people who are very positive. They’ll push it up a week, a day, a month, and then it gets pushed down dramatically, a week, a day, a month. And today I believe most critically, there is an uncertain source of liquidity. In fact, the scramble for liquidity is on.
You can see the hallmarks of that across all asset classes. And we could spend all of today looking at the Middle East, but there are, I think, other more critical factors in the financial markets. I’ll say that uncertainty exacerbated by Middle East conflict comes at a very inconvenient time for both the private markets and the publicly traded markets as well. And we’ll start there, and then circle back to the Middle East, oil and gold.
Kevin: Well, you outlined last week the liquidity problems that are already showing up in private equity. So I’d like to talk about that today, but let’s go ahead and start where the markets are most vulnerable, okay? Right now, it’s a liquidity need and a momentum need, isn’t it?
David: Yeah. Well, any bet that is leveraged is what comes under pressure first. So that’s where the markets are most vulnerable. Your leveraged speculative community has to unwind trades. Whatever they own, and own on leverage, is at risk when the market starts to move against them. And that’s in either direction. So leverage moves asset prices higher and faster, wind conditions are supportive, and it behaves like a trap door when the conditions change.
So we have practically harassed you, our listeners, with a discussion on private credit and private equity since October of last year, because these are leveraged bets with very limited liquidity. When there’s no one in the market to provide liquidity, the dynamic of liquidity drying up quickly becomes an issue of solvency, and that’s what has been in the news in recent weeks.
We have both liquidity and solvency issues emerging in the private markets, and I think it is likely to spill over into the public markets unless we have some form of intervention, whether that’s verbal or an actual commitment from the Fed and the Treasury.
Kevin: Which could be very inflationary. And so unless we have some sort of bailout coming in, like for private equity, we’ve got probably higher interest rates, right? It costs more. So that’ll show up in the bond market, won’t it?
David: Yeah. I think the game for leveraged buyouts, what we also today refer to as private credit, it changed as far back as 2021, 2022. And as the bond market in 2022 experienced its worst year since 1753—
Kevin: Really?
David: —with a sharp rise in interest rates, the future success of private credit came into question. The whole business model, people should have been asking the question then, “How is this going to work with higher rates?” And the deals that were put together prior to 2021—referred to as vintage year offerings—were immediately under pressure, with the one benefit of not having to be marked to market immediately.
Kevin: They were able to hide behind— The real price was not actually available, right?
David: Yeah. They delay reporting three to six months. So delayed reporting in the first half of 2022 kept there from being a panic in private credit and private equity, particularly private equity. Those portfolios appeared to rise above the public equity market declines, and they appear to be differentiated. So people said, “Hey, this is why we own alternatives,” when in fact the opposite was true. There was still a degradation in the security of the underlying assets. It was just not immediately apparent.
Kevin: But the conditions are changing now.
David: And the primary condition of cheap credit, that is what has changed. So, through a variety of methods—payment in kind, evergreening, offering assets for sale to new entities controlled by the same companies— And there’s a successful exit. If you sell from entity A and it’s bought by entity B—but it’s not really an exit if you also own entity B. The question is, did you let your limited partners out and create a new class of bag holder limited partners?
Kevin: It’s like a shell game in a way, isn’t it?
David: Yeah. So those assets have been retained. They were not forced to be liquidated or marked to market. And of course, these are companies that are well past the intended exit dates. 32,000 companies on the books which were intended for— It was the equivalent in real estate to a fix and flip, and they’re still sitting there.
Kevin: They’re holding the property.
David: Yeah. So the hope is that rates come down, multiples improve, and that allows for an exit from those companies. So far, that has not happened at a material level. And as time wears on, interest payments are increasing the pressure on the underlying assets.
Kevin: Well, one of the reasons we don’t see this is, this is considered like shadow banking, isn’t it? It’s like shadow equity, shadow banking. We don’t actually see these numbers reported on a daily basis on a ticker.
David: Yeah. Well, one man’s problem is another man’s opportunity. And in this case, it was the same person. So private equity has a problem, so you just launch a new shingle, call it private credit. And so the pivot to private credit has been crucial for extending and pretending. Private credit is typically offered at floating rates, which, again, ratchets up the income potential to the private credit operator, even as pressures mount for the companies, the debtors that are in those structures. So private equity picked a source of liquidity that has a longer term time horizon, and we’ve talked about that since October as well.
Kevin: The insurance companies.
David: Insurance companies, exactly.
Kevin: Which, think about that, Dave, that’s the one thing everyone just assumes is without infection, but what you’re talking about is this is an infection that’s built into the insurance company system.
David: Yeah. Buying out insurance companies gave them an opportunity to avoid redemption requests by selling credit instruments directly into the portfolios of those insurance companies. So where annuity investors and policy owners, they don’t have a clue how their premiums are being invested. And frankly they have no control over the redemption requests, which, it’s a brilliant move by private equity and the private credit operators, but it’s a huge and it’s a growing systemic risk.
Kevin: One of the things that we know about insurance companies, though, is even through the depression, they have protected each other. They have really prided themselves in being able to self-regulate. I’m wondering, where’s the regulation on this, the self-regulation?
David: A number of regulators are asking questions about the quality of the ratings which are being put on this paper. And the indictment has been, these companies have done what is referred to as ratings shopping. You find somebody who will say, “It smells like AAA to me. You should be fine.”
Kevin: Let us buy you a steak dinner. We needed a AAA.
David: And there you go. You’ve got quality paper being put into these insurance companies. Where you see strain in the private equity and private markets today is through redemption requests, because not all those pieces of paper—
Kevin: Show me the money.
David: —not all of the IOUs are held by the insurance companies. A lot of them are pension funds, high net worth individuals, family offices. And when pensions and individual investors begin to ask for their money back, the illiquid nature of the underlying assets, that’s when it becomes a problem. So what we described last week as a liquidity mismatch—
Kevin: Right, the Blue Owl thing?
David: Yeah. This forced Blue Owl to suspend redemptions for one of its funds in recent weeks in order to limit the damage from forced liquidations of those underlying assets. And you can see the appeal. If you just reflect on it, you can see the appeal of utilizing insurance assets as a source of funding for leveraged loans, for CLOs.
Ultimately, these are supporting private equity assets. Imagine a depositor base which can’t foment a run on cash. We’re always worried about bank runs. You go back to the history of the 1930s, and you had thousands of banks failing because depositors wanted their cash back, but the money had been loaned out. And so you had illiquidity tied to illiquid loans, and yet depositors wanted their cash back. And that difference, that is the classic—
Kevin: That’s the Jimmy Stewart moment, isn’t it, in It’s a Wonderful Life? But the money’s just not there.
David: But what a beautiful thing with the insurance companies because you can’t trigger a run. Nobody even knows. You can’t ask for your money back. So banks face a liquidity mismatch. In fact, that’s kind of implicit to their business model, which is why regulators are so strict about having adequate reserves. So that in the event of a run on deposit or cash, you’ve reduced the risk of forced liquidations, whether it’s of securities or longer term loans, doesn’t damage the loan book. There has to be a cushion. Private credit has no such cushion. And private equity has no such cushion. Insurance assets represent a non-runnable source of liquidity, and that’s of course why they’ve been flogging it, abusing it.
Kevin: So this takes me back to what we were talking about, breaking the will. Momentum in a way is a little bit like will. If you think about it, if you go, “Hey, everybody’s winning this war. You guys just need to come with us.” That’s fine until something looks like they’re not winning anymore. Okay, a liquidity crisis is a lot like that, too. It’s like, wait a second, we just ran past the enemy lines and now what’s behind us?
David: Well, private equity, the leveraged buyout game requires continual momentum. It requires new money all the time. You’ve got an original investor base, and somebody’s got to step in and buy those assets from the existing investor base. That’s the next batch.
Kevin: And that continues as long as you can keep borrowing, too, right?
David: Yeah. Continued activity is necessary. So the model is buy and flip, rinse and repeat. In some respects, the whole space reminds me a little bit of the shale patch, with leverage being a pillar to leverage buyouts. So it’s buy, baby, buy versus drill, baby, drill. And when you have decline rates in the oil patch, that starts to change the game. It requires that you continue to drill to keep production up.
Decline rates, like interest costs, I think they ultimately force the continued investment into new assets to keep the game going, requiring a continual flow of capital or access to liquidity in one form or another, either into drilling projects or, in this case, the turnover or churn of assets in the private equity portfolio. New capital allows for the exit of the old capital.
Kevin: Okay. So when that starts to wane, what happens to private equity?
David: You have a problem. Similar to the oil patch, when banks limit available credit for drilling projects, the investments come under pressure. I’m basically equating decline rates with the long-term negative compounding of interest, which is, again, when you think about private equity and how they’ve leveraged up these portfolios, the longer you hold the asset, the greater the bite of those interest payments becomes, you’re negatively compounding. And so optimally you’re trying to sell these portfolios in three to five years. We mentioned last week that we’re now up to a seven-year hold period, and that may get extended further.
Kevin: You remember the movie Wall Street back in the ’80s, the late ’80s. Gordon Gecko was into this rinse and repeat. You buy, you dismantle, you resell into the market, but he was not into long-term holding. And that was the whole theme of the movie. There is value investing that goes forever, like Warren Buffet.
David: And that’s a different model, which is that he is essentially a buyout company as well, but he operates with the intention of keeping companies on a more or less permanent basis and benefiting from the collection and the recycling of cash flows. Private equity is different in that buying out your private companies or taking public companies private is with the express intent of adding financial engineering, adding leverage and trying to resell those assets at higher multiples, pocketing the gains. So in an environment of decreasing interest rates, that financial engineering works brilliantly. This has built some of the great fortunes of the last 20, 25 years.
Kevin: When it gets cheaper, is what you’re saying.
David: That’s right. Which is why the best days of private equity ended in late 2021 and early 2022. As interest rates begin to increase, those days are over.
Kevin: Okay. So pricing that we’re seeing right now, like in the regular equity markets, not the private equity markets, are you thinking we’re near a top?
David: Yeah. We keep on harping on private credit in part because it is at the periphery of the credit markets. It is the shadow banking.
Kevin: You can’t see it.
David: It’s a way to finance deals and do it using unconventional means. And so when there’s problems within the credit markets, they don’t tend to stay isolated. They tend to spread. And so liquidity stress in one part of the credit markets often spills over into other parts of credit markets. That’s that periphery to core migration. So let’s review where the public markets are. We’ve probably put in a top in NASDAQ and the S&P and the Dow. Mean reversion would be normal. It should be expected in fact.
Kevin: So the ratios though are still very high. Okay. So we may have put in a top, but like we brought up Warren Buffett. The Buffet ratio right now, is it close to an all-time high or is it at an all-time high?
David: Well, this is where valuations can be insightful into where you’re at in the cycle. Are you mid-cycle, are you end of cycle, beginning of cycle? And so we don’t know if, given the flaky nature of fiat currencies, if 50,000 on the Dow is a success story, or over 100,000 on the Dow is a success story. How much of the gains have come from dollar devaluation and just a repricing of assets? What you end up seeing in something like the Buffet ratio is kind of a true measure of value.
Kevin: Because it’s based on GDP.
David: Yeah. So you’re comparing capitalization to GDP. You could also look at M2. There’s a number of ways of slicing and dicing that.
Kevin: Or the Shiller, Shiller PE?
David: Yeah. Buffet ratio is currently 218%. Over 160 and you’re significantly overvalued. That’s overvalued territory, over 160. The CAPE, popularly known as the Shiller PE, which takes the 10-year rolling average of the price earnings ratio. That is considered rich if it’s over 20. And we’re currently north of 40.
Kevin: I think 16 is the mean, that’s just sort of the average on the price earnings ratio.
David: Yeah. If you’re calling for a middle point. So again, 20 is expensive, 40 is very, very rich. Margin debt in January hit its eighth consecutive record. It was up 4.4% in January, 1.28 trillion. It’s never been higher. And if you wanted to measure that against money supply, it just matched its all-time high reading. So both in nominal terms and then relative to number of dollars in the system— Again, these are things that tell you you’re at the end of the road. And going back to Jeremy Grantham for a moment, that notion that markets are efficient, he would say, absolutely not. What we have is overvaluation, undervaluation, and the market’s constantly fluctuating between those two points.
Kevin: The only thing that’s efficient is the mean, and it’s something no one really wants to remember.
David: Well, as long as you’re soaring past that on the upside, it’s great. Remember it over your shoulder in the rear view mirror, but this is where valuation metrics help you know how much is in the rear view mirror, perhaps instead what you have to look forward to, which is very low returns going forward if you’ve overpaid for assets, which, again, we’re just saying essentially you can account for all of these things in standard deviation terms. We’re well past the two standard deviation mark into the third standard deviation, which accounts for 99.5%, 99.9% of all time. In other words, there’s a fraction of 1% of time where markets have been more overvalued than they are today.
Kevin: So for the person with the 60-40 portfolio, you better be looking at 60-20-20, right?
David: Yeah. Well, and again, you go back to margin debt being at all-time highs, 1.28 trillion, investors are as bullish as they’ve ever been. And this is particularly retail investors. So the expectation is—whether because of AI, whether because of accommodative rates and a new Fed regime which is promising to deliver even higher asset prices in the future via lower rates and access to capital—keep the liquidity game going, if they can deliver. And that’s where I have some questions.
I agree with you that the 60-40 portfolio in light of stretched valuations and the higher probability reversion to the mean means that you could certainly suffer on the 60 part. And what happens in the bond market, that’s another story.
Kevin: Okay. So I’m going to bring in what a lot of people would say, “Oh, well, this is an unknown that we didn’t know was happening.” So let’s talk about from a market perspective. People can watch the news to see what’s going on from a kinetic perspective of the war. But from a market perspective, oil, okay, and some of the things right now that are directly influenced, what do you think?
David: Well, more than just moms and Mossad understand what was getting ready to happen. So did Iran. It’s been the last three, four weeks that they’ve been moving most of what they have in storage on Kharg Island, which is responsible for getting close to two of their three million barrels of production a day out and distributed to the world. They’ve put them on tankers and they wanted it off the island. So—
Kevin: So they were preparing ahead of time.
David: They were preparing. Now I don’t know if they were preparing for a first strike themselves or if they were preparing for what they were kind of feeling. I don’t know. So inner conflict in the Middle East, you’ve got Monday’s notable shift in the global bond market. If I’m looking at anything, it’s pretty natural to see war in the Middle East impacts the price of oil and potentially natural gas.
Kevin: Sure.
David: That’s volatility that’s pretty paint by numbers.
Kevin: But you’re also looking at interest rates, bonds.
David: The bond market is very interesting. Oil moved higher following the attacks on Iran, and the implication of higher oil is that inflation could well surprise on the upside.
Kevin: Which pushes interest rates up, long-term interest rates.
David: Instead of seeing a safe haven bid for Treasuries, which should take interest rates lower. All this week you’ve got the UK, German, US yields going higher.
Kevin: Which is unusual because when war used to break out—
David: It’s a safe haven bid.
Kevin: —interest rates would drop.
David: And so maybe the conjecture is that this is not a short-term engagement. Because a spike in the price of oil, if it lasts for three days, 12 days, 30 days, 60 days really doesn’t filter into real world economy. It takes time for elevated oil prices to filter through and for the inflationary effects to be felt.
But the bond market responded immediately, and I think that’s a critical development to watch. Higher rates lead to a tightening of liquidity across the financial markets. And so this is where all of these things are interconnected. It’s not just what’s happening in the oil market vis-a-vis the Middle East, it’s also what’s happening in the bond market and the knock-on effects that that has into both private equity, private credit, and the public markets.
Kevin: And, at the same time, a scramble for liquidity in other areas.
David: Yeah. So if you needed a catalyst for negativity in US equities, you now have one in the headlines. And of course, we already had a catalyst from AI, projections of white collar job losses, prognostications of software companies unable to compete with the tools provided by AI. Tech specifically, I’m thinking of software very acutely, under pressure from a reassessment of the implications of AI development.
Now you have war. And time will tell, but the potential of interest rates increasing at the long end of the curve, that is what the bond market is pricing in at present. And if that continues, I think it’s even more impactful than, on a lag effect, the inflationary impacts. They’re tied, obviously. They’re tied together. But what I’m thinking about the increase in interest rates, yes, it’s driven by inflation, but the increase in interest rates has far more dramatic implications for the whole structure of the financial markets on a global basis.
Kevin: Because it makes money expensive. Now, when money’s expensive and you need it, okay, you’re going to look at your most liquid items. And one of the things that we’ve seen in the past, like in 2008 when the stock market— All of a sudden there was liquidity that was dried up. Gold. You would think that gold would have initially gone up. Most people would have thought that, but gold went down because it is so liquid.
Actually, that’s sort of the knock on the price. People sell the most liquid asset that they have, whether it’s cash or gold, to raise liquidity. And so let’s talk about gold because gold’s in a correction right now, at a period of time where people are like, “Well, why aren’t people just piling in because of the geopolitical risk?”
David: First of all, you sell what you can. So that’s what is most liquid, what is liquid. And you also sell what has significant gains.
Kevin: That’s true.
David: So if you need liquidity—
Kevin: Gold’s got huge gains.
David: Right. So your leverage players, these are the ones who feel the change in interest rates. These are the ones that are most exposed. And when there’s volatility, if it moves against them, they have to act fast to manage their P&Ls. And to do that effectively, you look at any asset, it could be large cap stocks. And obviously the big winner from 2025, 50, 60% gains in gold, 150% gains in the precious metals miners.
Kevin: You’re not selling because you want to, you’re selling because you have to, and it’s the best thing to sell at the time.
David: Leverage is a huge part of that. So increased or spastic volatility forces your leveraged players to act. It’s not a real read on those markets. It is a current condition, but it’s also something that tends to pass. Thinking about gold, if liquidity dynamics are shifting, you may be in one of those awkward interim periods where Wall Street speculators are gathering in as much liquidity as they can, and gold is an excellent source of liquidity.
Long positions in gold are cut to shore up cash on the balance sheet. That is a normal occurrence if and when you enter a phase of deleveraging. So we don’t necessarily have to go any further in the process of deleveraging. It really does depend, what do we hear from Kashkari this week? What do we hear from Waller? What do we hear from the Kansas City Fed? There’s a number of Fed speeches already on schedule to be delivered. Their speeches may be being revised right now to make sure that we don’t have dysfunction become a feature versus a bug.
Kevin: Well, with gold, though, we were already in a technical correction. That had already started before the war.
David: Yeah. Already in a corrective phase for the precious metals, started at the end of January. And as of last week, the pre-war, we were signaling a completion. But broader market considerations and liquidity needs can flip that script at any time, for a time. So I think it’s short-lived, but it’s obviously uncomfortable. The metals are either finishing off their corrective phase here now, or they’re in for a more extended decline. I don’t think this is the end of a bull market, but a market subject to deleveraging pressure nonetheless.
Kevin: Well, this could be a buyer’s opportunity with these corrections if you look at the long-term trend.
David: Yeah. I think what I’ve seen amongst metals analysts, some of the best in Europe, is that we’ve seen a healthy recovery off of the January and early February lows. Silver reached a 61.8% retracement level and that’s—
Kevin: That’s the Fibonacci number.
David: That’s correct. That’s the level at which it corrected off of. We’re in that correction now. And they’re looking at a variety of measures, whether it’s momentum or relative strength, we’re already getting back to an overbought level. So to see things calm down, that was and is predictable. Do we catch more downside momentum? I don’t know. We’ll have to see. I think that when you look at the broader equity markets, this is where I would be concerned. We’re at the end of a bull market in equities.
Kevin: So Nasdaq, S&P.
David: And we’re midstream in a bull market in precious metals. So again, if you count the buyers and count who has been coming into the markets, you’re fully invested. You need more buyers, and yet there are no more buyers in equities.
Kevin: So be a Buffett with gold, right? Which is the longer-term hold. Okay. And you don’t want to be leveraged right now in these markets.
David: No, I would not be leveraged in these markets. But when you look at the equity markets, and again, coming back to Buffett, there is a good reason for him to be sitting in the largest cash positions ever.
And in fact, I think they’re probably getting criticized for it. I saw the new CEO out this week saying, “Look, nothing’s changed. We do continue to invest as we have. The models haven’t shifted.” What I read between the lines there is that people are uncomfortable with them not being fully invested, having such a high percentage in cash.
Kevin: Look what we’re missing. Right.
David: Now all of a sudden with a market correction, it starts to look genius. But looking at market over-valuation, I think you’re primed for a minimum 25% correction.
Kevin: Really?
David: And potentially a 40 to 50% decline in the S&P, Dow, and Nasdaq.
Kevin: Wow.
David: What makes me think this is liquidity-driven is that the moves lower have been blind to asset class distinction. It’s just a mad scramble for cash. So Brent Crude is up from the close on Friday. It was trading at 73 on Friday, trading at 83 early this week, roughly a 14% gain. And oil producers are flat to down, flat to down.
Kevin: Wow. So even though oil’s up, the producers, they’re being sold right now for liquidity.
David: Still dealing with a scramble for liquidity. That suggests that in spite of the commodity breakout, credit stress is manifesting. And public markets are, across the board, shaky. Policymakers may be sidelined. And if you wanted to know where the real stress for your leveraged speculator is, it’s when will there be a form of intervention, whether it’s verbal or otherwise.
And if there’s hesitation on the part of the Fed or Treasury, that’s where real stress— You could see it snowball, and so the leveraged speculator has to take their leverage seriously and de-risk. But that concern with policymaker intervention, that opens up broad market concerns. And so, again, we come back to the necessary conditions for an equity market advance are dissipating quickly. Liquidity is the key to both the public and private markets, and without it, all kinds of bad things happen.
Kevin: And you were talking about margin debt, how high it is right now, but the confidence to go out and take more margin debt has got to be also backing off at this point.
David: Well, coming back to this: liquidity is key. My preference has been and will continue to be gold ounces as a superior form of liquidity.
Kevin: Right. And then cash behind that.
David: The problem is, you don’t pay your bills with ounces, and your margin calls aren’t paid in ounces. So you have to move $2 in order to keep your other bets afloat. So even if your liquidity preference, like mine, is for gold, if you’re a leveraged speculator, sorry, you’re selling, you’re raising cash to make a cash payment and keep the balance sheet afloat.
Kevin: I’ve had to do that. I’ve had to do that when the kids went to school. I had to sell gold to pay for school. Okay. Now that was a different kind of—
David: Liquidity crunch.
Kevin: —liquidity requirement. Yeah, nonetheless.
David: Well, for today, it would seem that complex structured products are lacking liquidity. So you’re seeing BlackRock, you’re seeing Apollo, you’re seeing KKR, you’re seeing Texas Pacific Group, you’re seeing Blue Owl. They’re under pressure and the market as a whole is scrambling for liquidity.
You can just remember the margin numbers we talked about earlier. How confident was the investing public earlier this week, last week, two weeks ago when we got the most recent margin numbers in, buying stocks on margin, right? 1.28 trillion in previously over-confident betting, and this week it’s getting a wake-up call.
Kevin: Okay. So let’s talk about this, though, the differentiation of, let’s say, selling gold short-term to raise liquidity versus selling large cap stocks. What would be the difference longer-term? You had talked about how the stock market probably has peaked. The gold market is probably halfway through—or even less—its bull market. So those stocks that are being sold right now to raise liquidity, maybe the blue chip types of stocks, they may not be rebought.
David: Well, the AI narrative has helped prop up the stock market indices very well.
Kevin: Right. Mag 7.
David: And so that narrative has shifted, and if you look over the last two to three weeks, it has shifted dramatically. It has shifted dramatically. Now all of a sudden, what is your faith based on and what is your confidence grounded in? This was the revolution, productivity revolution, technology revolution, economic revolution.
We had folks in the White House saying, “This AI is what’s going to deliver 15% GDP growth.” Well, I don’t know exactly how that happens when the Anthropic CEO says, “Yeah, we’re going to negatively affect 50% of white collar jobs.” Okay. So I’m sorry, GDP is still predominantly 68% consumption based. If you’ve got white collar folks who don’t have as much work, don’t have as much pay, don’t have as much consumption, how are you propping up— Where’s it coming from?
Kevin: I think you do the matrix, is what you do, is those people who lose their jobs just become batteries to run.
David: Plug them in.
Kevin: Yeah, just plug them in. They can just become batteries to run the energy for the AI system.
David: Maybe that’s the modern day miracle.
Kevin: I think that’s how we get the GDP growth.
David: Well, we keep on talking about one of the biggest issues, the revolution that needs to occur with renewable energy, think of wind and solar, is that we have no reliable way of storing them.
Kevin: Batteries.
David: Yeah. Well, at least in the matrix, they are producers of energy. Maybe we can figure out how to store as well.
Kevin: I think we’re going dark here, but it feels that way.
David: Well, to your question, you sell what is most liquid in a market where liquidity is scarce. Large caps, that fits the bill; gold and silver, that fits the bill, unfortunately, today. Short-term pain, I think it’s very different than the equation of long-term gain, particularly with the metals. We are in a structural bull market with many years ahead of us.
Kevin: Okay. But what about private equity, private credit, and crypto?
David: The same can’t be said for the S&P, the Dow, the Nasdaq, crypto. We spent four years watching bitcoin march from 68 to 126, and it was less than six months for it to get cut in half. The bloom is off that rose. The bloom is off the rose. The enthusiasm for crypto is now facing an uphill battle. I saw that the man with the smartest IQ on the planet—
Kevin: Right. I saw that too.
David: Yeah. Was calling for, I think it was either 268- or $278,000 bitcoin.
Kevin: By February of 2026. Whoops.
David: It’s March.
Kevin: Yeah. Now, it’s March.
David: Well, IQ counts for something, I know, but it doesn’t necessarily help if you’re trading crypto.
Kevin: Yeah. I will say this, though. I’ve had clients who made money in crypto who converted it to gold ahead of time and they saw through it. They understood what they were in and they converted it to something real.
David: I think it’s a different story. Their best days are behind them. That’s not the case for hard assets. That’s not the case for metals. And more important than short-term upward gains in oil, this is where I would draw a key distinction. The war was never part of our energy thesis.
Kevin: You mean you guys’ management thesis?
David: Yeah.
Kevin: You were in for a longer term. Yeah.
David: It’s supply and demand driven in a way that short term disruptions to supply are today. It’s obscuring the real facts. There’s a war premium and that war premium can be resolved if we have peace tomorrow, that $10 gain is gone.
Kevin: But that can be noise in the form of—
David: It absolutely doesn’t matter. I’m talking about long-term supply issues. Non-OPEC growth as of March is done. Market watchers care about the events in the Middle East because of OPEC production. And that certainly matters over the next 30 days, 60 days, 90 days, 120 days. And to the degree that infrastructure is damaged and you don’t have exports from Iraq or Saudi Arabia. I mean, yes, it’s impactful, but that’s not the driver of the energy complex over the next three to five years. And that’s where the fundamentals are setting up brilliantly. I am not bullish on oil because of what’s happened from Saturday to the present.
Kevin: Or the Venezuelan thing earlier.
David: Correct, correct.
Kevin: Okay. So let me ask you a question, though, because you talk about three to five year thinking. I think a question in a lot of our listeners’ mind is, how much cash is appropriate right now? How much gold is appropriate right now? Using the longer term aspect, okay? Not talking about short term volatility here.
David: Yeah. Well, where I think it’s important to keep a level head is, first of all, metals don’t face any form of existential risk.
Kevin: Right.
David: Therein, you’re looking at a very different kind of uncomfortable. So we have price volatility. I think it’s largely driven by a scramble for liquidity from leveraged speculators. Okay. Well, that’s one version of uncomfortability.
Kevin: But some of this stuff does face an existential threat, right?
David: Yeah.
Kevin: It may not even be around in five years.
David: Every operator, every publicly traded company that has a lot of debt on their balance sheet, which is a form of leverage, they are at risk. So unleveraged companies face volatility, but not necessarily existential risk. Again, it’s just a question of making less money, but being able to live and fight another day. When you have debt on the balance sheet, you may not make enough money to satisfy your creditors, and that’s your solvency issue.
Kevin: I’m thinking 26 years ago about BlackBerry. BlackBerry was the stock like the current AI that was going to go forever. Where is BlackBerry these days? They faced an existential threat and they didn’t exist.
David: Well, so the question remains— I mean, in a broader market liquidation, everything gets sold.
Kevin: Right.
David: Quality, non-quality. At the end of the day, the question remains, what is the right level of cash? And then I would say the right level of metals as well. Last week, as a management company, we were willing to increase our exposure to precious metals on the basis that a strong technical breakout had been registered. We had the highest monthly close on record for silver, weekly and monthly close. Very strong signal going forward. Okay?
Kevin: But you had to pivot when you saw different conditions.
David: This week we have to reverse that.
Kevin: Yeah.
David: It’s not a problem. If the facts change, you’d better, as well.
Kevin: Let’s talk about gold stocks, then. Okay. You were talking about oil producers and how they actually fell or they stayed sideways while oil went up. Right now, we’ve got gold going down. How do you feel about the guys who actually pull it out of the ground?
David: Yeah. Well, it’s a different kind of leverage. It’s not like the speculators we were talking about earlier, but they do have operating leverage to the underlying asset. And as the price goes higher, their profits and free cash flow increase pretty considerably. And of course, if you see diminishment in the commodity price, their free cash flow diminishes as well.
If you’re asking the question about what existential risk is there to price volatility, it’s a question of thresholds and how far away from those thresholds we are. So you’re all in sustaining costs cover everything from company operations to—which is kind of your general and administrative expenses to the cost of oil as you’re moving big Caterpillar trailers, trucks around and things like that.
Kevin: So what would that be per ounce of gold?
David: Yeah, the industry costs of production are in the neighborhood of $1,700 for gold.
Kevin: Really?
David: And if we keep it in round numbers, let’s say roughly $20 for silver, silver producers.
Kevin: That’s the kind of business you want to have. It costs you 1,700 bucks to produce something that’s still 5,000 bucks.
David: Right. So margins are strong. They remain way above any other time in history, even if you assume much lower prices in gold. I mean, if we took another $1,000 off, $1,200 off the gold price, $3,800 gold, $50 silver.
Kevin: You’re not predicting that, but even if we did, right?
David: That’s correct. I’m not predicting those numbers, but just want to first make clear that physical metals don’t carry that operating risk. They also don’t carry the leveraged gains—two to two and a half times the gains—in a rising market. The operators are trading near all time highs as a reflection of very solid margins. If you cut back those margins, you’re still talking about margins that they’ve never recorded in company history. Take $1,000 off the gold price.
Kevin: Really? This is the highest margin they’ve ever had.
David: They’re cranking free cash flow. And so I think you see an overreaction within the miners, which is natural because you start to extrapolate. And this is the problem with any market. A small decline may be a big decline. How do we know it’s not a big decline? Well, we don’t know. Except that we’ve got fundamentals which do argue for a very supportive macro picture for the metals.
And I come back to where we started, whether it’s the Riemann hypothesis or Collatz conjecture or the two very solvable problems that we don’t have the will to solve. A part of the reason why there is longevity to this move in the metals is because on a global basis we have gorged on debt and we have to ultimately pay it off—not likely—with a growing—
Kevin: We don’t have the will, but we’re going to have to ultimately pay it off somehow.
David: You could default on it, which is a game changer for the financial industry as a whole, and would be an extinction event for the financial world, because one man’s liability is another man’s asset, and you’re talking about the financial players, they treat those IOUs as their assets. So you default on the debt. Guess what happens to the assets, it goes to zero. You’re talking about insolvency for the financial system. Not tolerable.
Kevin: Right. So the question is, how do you keep the game going?
David: You keep the game going by running inflation. You keep the game going by devaluing your currencies. And this is why central banks, this is why high net worth individuals, family offices, and smaller scale investors too, with the— You don’t need Mossad-like insight, you need mom’s insight. What is the grocery bill this month?
Kevin: Right.
David: Well, I can tell you that a year ago, I walked away with two bags and today I’m walking away with one for the same money. And so the reality of inflation and the backdrop that we have, I think, is and continues to be incredibly supportive for the metals. This is, as we’ve talked about many times, a monetary regime change and a shift from a focus on US dollar hegemony to a more diverse monetary structure globally, and it favors gold for many reasons.
I see the correction which began in January—which may continue or may be over—as something that is a stop off point on the way to considerably higher numbers. But if you run with price assumptions of $3,800 gold, $50 silver, respectively, for the metals, margins are robust enough for the producers to pay down their debt. And a lot of them have already moved to a net cash position. They’ve got enough that they could be debt free now and they can return profits in the forms of dividends and share buybacks. In other words, lots of volatility, no extinction event.
Kevin: Don’t be distracted by the noise.
David: Yeah.
Kevin: Stick with the fundamentals.
David: Yeah. Very different story if you’re talking about junior miners, if you’re talking about exploration companies, how long a correction extends is material for someone that has no cash flow.
Kevin: Right. Right.
David: There is an important distinction.
Kevin: This is why you need analysts.
David: Not all companies are created equal. Not all companies have the same balance sheet, have the same access to assets or in the right jurisdictions, et cetera, et cetera. So the macro setup remains firmly in place for a move to $8,000 gold, $200-plus silver. Very interesting. In the context of this correction, you’ve got Bank of America, which has migrated their three-month prediction for the price of silver to $150.
Kevin: From here?
David: Yeah.
Kevin: From here? That’s their three-month prediction?
David: Citigroup between, I think it was 135 to 309 within this calendar year.
Kevin: Wow.
David: So very common to see Wall Street firms begin to migrate north their price expectations when prices are trending higher, not so common to see them calling for higher prices—
Kevin: When you’ve got a crash or a correction.
David: In the middle of a correction.
Kevin: Yeah.
David: Are we to assume that this is the end of a bull market in metals? Enough Wall Street firms have now had their attention focused on the supply-demand fundamentals, particularly on silver, to start looking at 135, 150, even $300 an ounce.
Kevin: Six years of deficit on the supply-demand.
David: Yeah. That doesn’t make this week any easier to swallow than it does the final days of January, but, nevertheless, this is where we find ourselves.
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You’ve been listening to the McAlvany Weekly Commentary. I’m Kevin Orrick along with David McAlvany. You can find us at McAlvany.com, or 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.
