Your Questions Answered Part 1

Weekly Commentary • Dec 28 2016
Your Questions Answered Part 1
David McAlvany Posted on December 28, 2016

The McAlvany Weekly Commentary
with David McAlvany and Kevin Orrick

“So here we are circa 2016, and we’ve papered over the problems in Europe, we’ve papered over the problems in China, and we haven’t met these challenges with any real structural change or reform, in large part because we’ve had massive amount of central bank intervention precluding real declines in asset values and a wipeout of bad debts.”

– David McAlvany

Kevin: David, as we’re closing out this year and going into the New Year, I think it would be a good time for us to say thank you to our loyal, amazing group of listeners. I was just looking through these questions and answers that we’re going to be going through today and next week, and I’m just very humbled that so many real intelligent, connected, engaged people are listening to the show on a weekly basis.

David: There are quite a few new listeners and I’m very excited about that, but I’m also very grateful for the folks that have been listening five, six, seven, eight, almost ten years now. It’s been a great exercise for us, sort of continually vetting ideas, and as a part of our own continuing education process, exploring new ideas with new people and new guests, and keeping the conversation as broad as possible. But I hope that, and it appears from the feedback that we get from our listeners, old and new, that it’s a vital part of their own education process.

Kevin: Don’t you appreciate the constructive criticism? If there is something that we say and they say, “I don’t know that I fully agree with that, or could you elaborate further?” That’s welcome.

David: Yes, absolutely.

Kevin: Even though it’s not question and answer all year round, we would encourage those emails to keep coming.

David: I agree with that completely.

Kevin: Why don’t we go ahead and just go right into the questions. The format of the show will be very similar to what we’ve done over the last eight or nine years, which is, I’ll read the question to you, Dave, and then I think I’d like to just go ahead and chat with you a little bit afterward about what your thoughts are on each question.

David: And we’ll just reference the person who is asking the question by their first name only.

Kevin: That sounds good. This email comes from Brandon:

“Dear Dave and Kevin: I know you’ve reiterated that with both stock and bond markets overvalued now, it’s time to be in cash, and the best cash is ounces.” (That sounds like a quote from you, Dave.) “However, I have assets in a company 401k that has no precious metals options and only a money market for cash, which I know has recently been coerced into investing in government bonds. The funds available to me are bisector, and for each sector there is a managed option and a passive, or index, option. On a show some time ago I know you related a story of speaking to a woman on an airplane and explaining that while money managers might realize a market is over-valued, they wouldn’t sideline a client or their money for the fear that they missed out on gains of a market. Even if it’s going to become more over-valued, they don’t want to be out of it. On a more recent show you mentioned that with volatility coming, people were moving out of managed funds to the Vanguard model at exactly the wrong time. Could you please expound on the nuances of your view of the advantages and disadvantages of managed versus passive funds?”

David: On the first point dealing with the 401k allocations I think it’s important to look at overall asset allocation and see where your dollars are being invested. I think, generally speaking, we can talk about assets one of two ways, either liquid assets only, or in terms of total net worth which might include non-liquid assets as well, whether that’s a home, or rental property, or something like that in a real estate category. Liquid assets, we’ve talked about in terms of being divided in thirds – a third in stocks and bonds, a third in cash, and a third in precious metals. Again, that’s for liquid assets. If you’re including the illiquids, then you might do something a little bit different – 25% real estate, 25% stocks, 25% gold and silver, 25% cash.

And so that issue of having the money market option there in the 401k, that might be a reasonable option to make up a part of your cash allocation, whether it’s the one-third that we talk about in reference to the prospective triangle, or say, a 25% allocation if you’re talking about total net worth. And so, while I don’t particularly think the course for government bonds is going to be a healthy one over the next five to ten years, you can argue that in a money market fund, they’re going to be in short-term paper, and so you won’t see a lot of price volatility. Where you see massive price volatility in bonds and government bonds is at the long end of the curve. If you’re talking about paper that is dated 15-25 years, 30-year paper. This is where anything basically north of ten-year treasuries you’re going to see a lot more price volatility with a rise in interest rates.

Kevin: If a person is putting money privately into gold outside of the 401k, then that is going to give them an offset of a devaluation of the cash, or some of the bond volatility, anyway.

David: Right. So when I look at the asset allocation it makes sense to me to use the 401k dollars because you don’t necessarily have great options otherwise, to use that as a large part of your cash allocation that you’re thinking about your assets in total, retirement and non-retirement, and a part of that cash allocation can be made up by the mutual fund or money market mutual fund, as it were.

Kevin: Okay, but the second part of the question was talking about the view of the advantages and disadvantages of managed versus passive funds. David, being a money manager, what is your feeling on just this new move toward passively turning over funds during a period of time that may be one of the most volatile times that we have been in, in ten years.

David: It’s very interesting because the overwhelming evidence for a passive approach comes from the last five years’ performance where your big indexes have been driven largely by a few names, that is, a few companies, and the performance has been much better than your managed alternatives. In fact, if you look at the last three to five years of hedge fund performance, arguably, the best and brightest coming out of Wall Street to make a name for themselves and do their own thing, they have underperformed the market considerably over the last three to five years. How is it that the best and brightest, who for 20 years have outperformed the market are now underperforming the market?

And again, that overwhelming evidence for taking a passive approach also collects and concentrates here on the last three to five years, as well. Now, we’re going to predicate the future on the past, right? Wall Street has taught you that you shouldn’t do that, and I would agree. You can’t predicate future results based on past performance, and I would say that to say the last three to five years is an indication of that way that you should be investing, I would have a problem with that. If you look at bull market dynamics, if you are in a typical bull market, there are degrees of outperformance, or underperformance, in various sectors, and in various asset classes. And being thoughtfully engaged in that process, I think a money manager will do a very good job of that.

Now, there is a difference, though, between the bull market that we’ve just been through, and past bull markets, and that is that this one has been driven primarily by central bank liquidity, and there is less discrimination of quality, there is less discrimination of risk. And this is, I think, very important. Everything moves – everything moves – if a central bank is the primary support of a bull market. And so you see passive investing work very well in a context of central bank control, where actually – and I’m using discrimination clearly in the case of just looking at risk, and looking for quality, and a growth profile that is compelling, and holding risk and reward in balance. That kind of discriminating analysis has been useless for five years. It has not paid extra in terms of total returns for that extra work. And so, I would encourage any investor to back away and say, “Is it really true that in the last 100 years, doing extra work to understand risk and reward, and to understand the opportunity that is put in front of you, is not worth it?”

Kevin: Wouldn’t you say this last five years has been the grand experiment of central banks nationalizing the markets? That grand experiment cannot continue to work forever. It is driven by debt, it is driven by manipulations of the markets. They can only do that so long, but at this point, it is still important to continue to realize the value of measuring risk, or hiring somebody who understands that value.

David: Which goes back to your first comment, Kevin, which is that we are at the end of one of these experiments, not at the beginning, and the longer you stay in this game the more risk there is that I’m assuming in the market. We’ve talked about this in numerous ways, from various vantage points over the last year – price-to-sales – the stock market has never been higher. Never. Not in the entire history of the stock market. Price-to-earnings were about the third most expensive.

Kevin: Tobin’s Q.

David: Tobin’s Q, second or third most expensive market in history. So you would have to say, going into a period of time where I would assume that there is an increase in volatility – an increase in volatility – because that is typically what comes after a stretch of growth. You see the market breathe in and breathe out. It is normal to have periods of growth followed by periods of consolidation. And that period of consolidation, is that really the kind of environment that you want to be in on autopilot, which is where I would see passive investing being.

Again, if we’re talking about a low-stress way to approach the market, and we’re in the early stages of a bull market, and you don’t want to have to worry about paying extra money, getting a little extra performance, then I think passive investing has an interesting intrigue. But again, it is for its simplicity, not necessarily for how well it does.

Kevin: But you sure don’t want to be at the top of a market when that passive investing strategy is being employed.

David: There are three questions that you have to answer if you’re going to be looking at a managed option – who, how and why? And if you can’t answer who, how and why, I’m not saying that just any manager is better than no manager. In fact, no management is probably better than most management. But there are managers out there who do an excellent job. The who is important, the how is important. What is their methodology, and why are they doing what they’re doing?

Kevin: And do they philosophically match your world view?

David: The reality is, the who, how and why are irrelevant questions in this last three to five-year timeframe. So again, I’m being encouraged by the market and by current studies on passive versus managed approaches to basically check my brain at the door, and I think that’s a very dangerous thing to do. And yet, that is what has paid for the last five years, is to be disengaged, to not look at the fundamentals, and basically to allow central bank liquidity to float all boats.

Kevin: The next question comes from Joe. He says:

“A couple of questions for the McAlvany Weekly Commentary. Number one, with the world going more and more toward a cashless society, doesn’t this undermine the investment case for physical gold and silver? Wouldn’t gold and silver be outlawed, too?”

I’ll go ahead and give you the second question, and you can jump in, Dave. He says:

“Number two, as an avid listener to the Commentary and an avid reader of Don McAlvany’s Intelligence Advisor, I sense that Don’s view of the world is a bit more dire than David’s. Is my perception correct?”

David: (laughs) I think we’ll try to take both of those in stride. I think there are many reasons to own gold. One is as a cash alternative. A second would be as a growth vehicle. Third, as an asset which is private and portable. Fourth, one that became very popular during the global financial crisis is that gold is a non-encumbered asset. It is an asset that is in the financial system, but it does not have counter-party risk. So I think, in answer to Joe’s question, if we’re moving more toward a cashless society, does this undermine the investment case for physical gold and silver, I think it may undermine the second of the four that I just mentioned, which would be gold as a growth vehicle, because you may be dealing with a limitation in terms of your ability to liquidate the physical asset.

On the other hand, you may see an increase in capital gains tax rates, things like that which would dampen the role that it plays as a growth vehicle. As a private and portable transactable asset that you can take and use anywhere in the world, does it still have merit? Yes. As a cash alternative, does it still have merit? Yes, and you just have to be comfortable, probably, operating in the black market. And as a non-encumbered asset with no counter-party risk, does it still have its merits? Yes. So I would say, if you’re only focusing on it as a growth vehicle, then it may be impaired. But from the standpoint of one, three, and four, those other reasons to own gold from an investment standpoint, I think it is still warranted.

Kevin: Dave, can I just mention? Sometimes people think, “Well, gosh, it will be a cashless society. I can’t buy gold.” But actually, the way gold is purchased through us, it is already acting as if it’s in a cashless system. When someone buys gold from us, their check or wire comes into our bank account – that’s cashless – and when they liquidate gold later, we send a check or a wire back to them – that’s cashless. People will probably still be buying and selling almost everything that they currently are buying and selling, even in a cashless society. Gold just allows you not to be trapped in that system.

David: I think the question made me reflect on something that I haven’t in a while, which is an older book by Antony Sutton.

Kevin: Oh yes, The War on Gold.

David: I think it’s worth noting that the war on gold has been around for a long time, and arguably the war on gold started several centuries ago with the popularity of fiat money. So there has been sort of a negative bias against gold and silver for a long time. The cashless society is kind of an extension of the trend, a slippery slope, if you will, having gone from fiat to now something that is completely controlled and transparent, from a top-down perspective.

So this is the question I would have. If gold and silver are no longer relevant, then why is the asset not just ignored? If, in fact, it is very relevant, and is not only a signal, but is of deep importance, then I think you would see a movement against it. Because, again, if it’s irrelevant, it can just be ignored. But if it is relevant, in the financial system, and as a cash alternative, then I think you can assume that there will be a continuation of the war on gold.

Kevin: The War on Gold was written in the 1970s when the war on gold was very, very intense. Speaking of the second question, with Don, Don takes a more dire view, according to this listener. What is your thought on that? Don has actually seen a pretty intense war on gold and come out the victor on the other side.

David: Right. Gold is the antithesis to a command and control economy, and I think it is safe to assume that there will be a war against it, as there has been for a couple of hundred years. Don’s perspectives often tie to some things that are historical in nature, and sometimes even eschatological in nature. And that is probably the divergence in our views, as I prefer the historical cycles to something of a more apocalyptic nature. So Don’s focus tends to be on gold, and on the currents issues which could lead to crisis. His talent, I think, is putting the pieces of the puzzle together, and then being able to speak to what he sees with a prophetic voice. My focus has probably been more on what is next. That is not to say gold becomes less relevant. It remains relevant. But I think there are other asset classes that become more compelling at the right value exchange, and so I’m looking for the future value exchange, which means that I’m always looking forward, as well as trying to learn as much as I can from the past.

Kevin: I’ve worked for both of you, and you guys are a great complement to each other because Don, actually, is looking at how you preserve assets in the present, right now. You’re looking decades ahead and you’re thinking, “Okay, once we’ve preserved those assets, how do we employ them in something that is constructive for future generations?”

David: A part of that is because I’m hard-wired to think about future generations. My point of emphasis is on fixing problems, and really, that being from a grassroots level. Why am I unimpressed with a particular political outcome? Because I have been through enough political seasons to see that it’s kind of a game between the red shirts and the blue shirts and whoever is in office, what they have is an advantage of rhetoric for at least the first 100 days, and then actions have to be borne out. And so what I am more interested in is solutions from a grassroots level which individuals can put in motion and be in control of, not sort of harboring hope that this politician or that will be different this time, and sort of stand out above the rest in terms of the historical record.

This is why I wrote the book, Kevin, The Intentional Legacy, because I think that family life is foundational to cultural change. If you look at the political system that we have, it suggests that there are macro solutions that need to trickle down to the micro level, and I would argue the exact opposite. I would say that there are micro solutions which will trickle up to the macro level.

Kevin: So instead of the government being the ultimate solution, the family is the ultimate solution, and then the trickle up approach is actually what happens from family up to the top.

David: That’s right. And I’m neutral in terms of being encouraged or discouraged on a Trump victory and the selection. It’s going to give some people the impression that all our problems can be solved, and that’s going to happen from a top-down. Again, where I would disagree is just that you can’t control that process, whereas you can have more of an influence looking at solutions from a grassroots level. So again, how does this tie into Don’s perspective versus mine? I think Don is very focused on the present tense, and where he does focus on the future it tends to be in terms of an end-times appraisal. My perspective on the future is very different. This is the only arena – I’m talking about family again – where the variables in play can be continually influenced by our choices. And that, to me, is very powerful, not only from a family cultural perspective, but ultimately, from a larger cultural perspective, as well.

Kevin: Dave, this next question is from Nathan:

“Eight years ago the housing bubble burst. As a result, the Fed has pumped a lot of money into the system. Now the stock market has been going bonkers. The real economy seems to be finally turning the corner. Some would make an argument that all the stimulus is finally starting to hit the real economy, and that there is a lot of upside ahead, both for the real economy and for the stock market. Others would make the case, like you do, that there are a lot of troubling indications and that all is not well, and that a downturn could be just around the corner. When you look at the current situation, what is it that makes you bearish instead of bullish?”

David: I’m always talking to the kids about differences between meanings of words, and I draw a big difference between the word intelligent, and the word clever. There are very intelligent men and women running some of the best businesses in the world today, but what has been driving success over the last several years is cleverness, not intelligence.

Kevin: And other people’s money. I hate to say it, but debt and other people’s money.

David: Well, sure. But when I look at the amount of financial engineering which has created the corporate growth which we have seen of late, I would say this is a very temporary success story, and it is not tied to what drives growth over longer periods of time. If you were talking about major productivity gains, if you were talking about demographic shifts, if you were talking about a commodity boom, there are things that you can categorically say drive corporate growth, drive economic growth, and what we have, in fact, had, is a tremendous amount of financial engineering.

Kevin: Like share buy-backs.

David: Sure. So if you look at the variables – and Nathan is right, we do tend to look at a certain set of variables – it is worrisome to me when what is driving earnings growth is share buy-backs, what is driving bottom-line growth for corporations, tax arbitrage, and just basically leveraging up their balance sheets. So again, when you look at the role that financial engineering has played, it is something that, again, goes back to that distinction between cleverness and intelligence. An intelligent approach to managing a business would be toward setting a trajectory that gives them 15-20 years of runway – future growth, future sales, future earnings, future accumulation of market share. And what we have right now is, again, leverage, tax arbitrage, buy-backs – things that you can put in the category of financial engineering. And that to me is, categorically, cleverness, which I put a lot less stock in.

So why are we bearish versus bullish? This comes back to an earlier question. There are periods of excess, and those periods of excess are followed by periods of deficiency. In other words, there is a balance between good years and bad years, growth and decay, or decline, if you will. And you can see that from a long-term perspective the stock market typically is up about 60% of a time in a bullish trend. It is in a bearish contractionary trend 40% of the time.

And the bearish side of me does tie to this. If you say that booms and busts are two sides of the same coin, we’ve been flipping the coin now for about seven years, and have been getting a bullish outcome, a bullish outcome, a bullish outcome, a bullish outcome. And that is not to say that you can’t have, theoretically, an infinite number of coin tosses which are all one way, but the probabilities of that, actually, are not real high.

Kevin: And you have to look at causes, and you’ve been pointing that out, the cause that that quote has been coming up. You can’t change the laws of physics in the long run, but a person can cheat. What they can do is, they can weight the dice, using a die instead of a coin. You can weight the die, and the die has been weighted based on quantitative easing and artificially low interest rates, and a lot of these artificial engineering mechanisms of share buy-backs – none of those employ a long-term foundational growth model.

David: So what makes me bearish instead of bullish? We can look at the U.S. and say that relative to the rest of the world, our performance is much stronger. But I look at the whole world as being interconnected. This is one of the consequences, for better and for worse, of globalization. And you have global trade which is in free-fall. So again, are we going to consider only the real economy in the United States, which I think is very difficult to do in an interconnected world?

But you do have the potential for massive economic activity coming into the next two to three years of a Trump administration. And to me, it is very much like the Chinese circa 2010-2011 where the central bank stimulus was four times greater than ours relative to GDP, and it did drive some economic activity. I would argue that it drove more malinvestment, but that was still economic activity, and we’re likely to see the same over the next four years.

Of course, our transition is away from central bank monetary policy and toward helicopter money, which is your fiscal policy spends, and we’re moving back toward, again, something that will drive economic activity. But what is the difference between economic activity and malinvestment? You get to find that out after the fact, not before. And I think, going back to this idea of classic Keynesian demand management, which is what we’re going to get with fiscal policy spending. The question is, will Keynesian demand management work in this period of time? We know that certain economic models do work in certain environments, and is this going to be more or less like the 1970s? If it is like the 1970s, and you have an inflationary bias over the next three, four, five years, then I don’t think a Keynesian demand management program is going to work. It’s not going to give you positive results.

The caveat here is that while we can see a short spurt of economic activity, that doesn’t necessarily mean that we have follow-through in terms of a long-term growth trend. And it doesn’t necessarily mean that the stock market continues to march higher. Buy the rumor, sell the news is a pretty classic Wall Street mantra, and we’ve had this notion that we’re going to cut taxes and there is going to be massive fiscal spending, and a lot of that has been priced into the Dow at 20,000. Sell the news means, once we see the projects that are going to be proposed and they’re being initiated, maybe they’re disappointing in terms of their net effect, which means that we got way out in front of our skis in terms of the stock market being priced where it is.

Kevin: Well, as an indicator for the economy, don’t be fooled by the stock market hitting new highs. We’ve learned that over and over and over.

This is an unusual question, Dave, and I think it is an interesting question. I think, probably we ought to look at the next five, six, seven decades, if you’re talking this direction. But listen to this:

“Howdy, David and Kevin. I enjoy listening to your Commentary because you keep a real perspective on evolving trends. The cost of getting into space is dropping. Mining and returning it home will not cost as much considering artificial intelligence and robotics. What are your thoughts on the balance of scarcity in metals as we enter the space age? Best regards, D.J.”

David: I think one of the things that would have to change significantly are the technologies involved in mining. Today it is an issue of scale. When you look at a successful mine operation, the scale is absolutely staggering. Consider even just the size of the trucks involved in moving material from one place to another, where the trucks, themselves, are three to four stories tall, where a single tire on that truck is a $100,000 tire. It is a scale that boggles the mind. So to try to reproduce that in space, I think, would be a challenge. I think you could see small-scale success, and that would be possible on some sort of an interstellar basis, if you will.

Kevin: If I can just comment on this, Dave, space has always been an interest to me, and we’re still at about $10,000 per pound to loft a pound into space. So even when the astronauts on the ISS are picking their Thanksgiving meal, it is tens of thousands of dollars as they just loft a single meal up there. Now, that doesn’t mean it is not going to change, but there is still a high cost to get into space. The other thing, too, is when you look at the mineral richness in space, granted there are asteroids that have various minerals, sometimes even precious metals in them, but it is estimated, they have just found that about every 100,000 years, per 100,000 stars, there is a single impact of two neutron stars, which supposedly creates gold.

Of course, we won’t go into all the physics of it but the atomic elemental scale, you can get into the heavier elements as you start having some of these cataclysmic events in space. But you figure, 100,000 years, 100,000 stars, the odds of actually getting to that are very, very low, and actually, Dave, the thing that is more valuable than anything in space right now, and far more valuable than if someone found a lot of gold or platinum, is actually just water. Because you can manufacture fuel to go to mars, you can manufacture air. You can actually have the water that it takes to give to astronauts, or just the basic mechanisms. Water is an amazing thing, and so water, actually, is what they’re going for, at least in the next couple of decades. It is fascinating to watch, and they are finding water right now. It’s just very, very expensive to get there.

David: You’re really addressing a more considerable issue, which is that gold and discovery of gold remains an exploration problem. And the odds of discovery are significantly lower in space than here on earth. So even if you could overcome the exploration issue, you still have the issue of scale. Frequency of trips back and forth, the weight involved, $10,000 per pound, and maybe it is reduced to $1000 per pound, it still has to make sense in terms of the all-in costs, and that is a long way off. So perhaps if we’re thinking about sort of a 100-year perspective, there are a lot of things that have changed between now and the end of the next 100 years, which make it more feasible, but it’s difficult to imagine, from this vantage point.

Kevin: This next question comes from Jim:

“David and Kevin, Article I, Section 10 of the Constitution prohibits the states from making ‘anything but gold and silver coin a tender in payment of debts.’ Is it not unconstitutional that we’re not using gold and silver as money? Are we, the United States of America, not a state, as well? I would hope the constitutional lawyers have discussed this question, but I’ve never heard or seen any discussion along this line.”

Dave, Article I, Section 10 of the Constitution. My memory is that it keeps the states from manufacturing their own money except for gold and silver. What is your comment on that?

David: I think, one, you’re talking about a congressional responsibility to create our money, and that control has been delegated to the Federal Reserve by Congress. Instead of the creation of gold and silver as our coinage, they have allowed the Federal Reserve to make Federal Reserve notes. I think one of the issues, when you’re looking at Article I, Section 10 – it has to do with how we pay debts. When you read it line by line, there is a prohibition against states creating their own legal tender, and that is a part of the issue.

Kevin: Right, their own paper money – legal tender.

David: Yes, and then there is a requirement that debts be paid in gold and silver. So the issue there is that our founders had an understanding that fiat money was a fraud, and that you could create an infinite amount of it. And if you were allowed to pay off your debts with fiat money it would undermine the credibility of a credit and debit system.

Kevin: Boy, good thing that hasn’t happened, Dave, since we’ve gone to a fiat system, huh?

David: Yes, I think Article I, Section 10 is a prohibition against a state signing its own treaties, it is a prohibition against coining its own money, it is a prohibition against granting titles of nobility. I can’t remember all the things that are listed there, but there are things that it says that you cannot do. And the point on gold and silver is that debts need to be honored with something of more or less constant value versus inflatable fiat.

Kevin: That’s the concept that we see in the Bible of just weights, just measures. That is how things were supposed to be paid.

Next question from Bruce:

“David, do you think a third political party could arise out of the populism of the Trump victory? I personally would like to see this. There really is little difference between the Republican Party and the Democrats. Do you think there will be a third party, or have we already experienced that, Dave? Trump is not really a Republican, is he?”

David: There was something of sort of a third party move with Trump. He essentially hijacked the Republican Party temporarily. So an interesting thought experiment is, in his second term, perhaps, as an incumbent, Trump runs on his own party.

Kevin: The Trump party.

David: Yes, “To hell with the Republicans. I don’t need you.” And whatever he calls it, it won’t be the Bull Moose Party.

Kevin: But it might be the Bull Something Party.

David: Yes, it could be the Bull in the China Shop Party. And that he will have a good record of sort of preparing for. But I think to eliminate the math conundrum of a third party you need both a second liberal socialist alternative, and a second conservative constitutionalist party, because what you are going to have running the fear in the minds of the voters and the electorate is, “We’re going to be throwing away our vote. We’ve just divided the conservative vote and you’ve got a unified liberal vote, and you can’t win. You cannot win if you divide the conservative vote.

So the fear of math – the only way you solve that is by having more than just a third party, but probably a third and fourth party. And so that could be interesting. I think when you look at what Bernie Sanders represented, which was more of a socialist-leaning liberal than a centrist-leaning liberal, it says that there a good number of people out there that would have voted for a third party liberal candidate, and we already know that there are plenty of people who would vote for a third party conservative candidate, and then a bunch of people who, again, would feel like, “I’m not throwing away my vote if, in fact, the math works, dividing by four instead of dividing by three.”

Kevin: Next question from Bruce:

“If the elite are planning to basically destroy our economy so that they can control us, is it possible to do what Doug Noland suggested in the Commentary, to get back to capitalism and to get central banks out of the financial markets? I realize this is conspiracy thinking but I believe it’s real. I’m not a fatalist, but don’t you think that it would be difficult until we expose this dynamic?”

David: I think there are earlier stages of the economy that were not as finance-centric, and there might be future stages that, again, reduce the prominence of the finance sector which we see today. And the reality is that Trump is going to have a difficult time re-engineering D.C.’s interactions with the markets.

Kevin: Right. We’re already seeing the implications with Goldman-Sachs and some of the guys still in the picture.

David: Yes, so what does that look like? Does he allow for freer markets? My lingering fear, and you and I have had many conversations about this, Kevin, is that the wheels come off in our over-leveraged financial system while “Mr. Business” is in office, and that ends up creating a stigma against free markets for at least a generation. I see that there is a tremendous amount of hope tied to entrepreneurial problem-solving, and I see that America can not only be great, but greater, if we allow for entrepreneurial problem-solving to be a part of the reconstruction and the re-orientation of our economic life.

Kevin: So you would hate to see false blame go to Trump, necessarily, because of when he came into the markets, and when they came apart?

David: That’s right, and you get false attribution when someone is elected at a market low, and you get false blame when someone is elected at a market peak. So my concern remains, that we are in this period where capitalism may actually be blamed for the suffering that is in sort of a second round of a global financial crisis. And if capitalism is blamed, then not only do central banks gain the upper hand, but central planning gains the upper hand for multiple generations.

Kevin: The next question comes from Mike:

“Back when silver and gold were hitting their last highs in 2011, and gold was $1900, the Dow-gold ratio was 4 or 5-to-1. Why did we not get out of gold and go into the stock market, which has gone up since?”

Now, Dave, did we ever really get to 4 or 5-to-1?

David: Not quite. We got close. 6.36 was August of 2011, and so let’s call it 6-to-1 at the outside. In answer to the first question, well sure, we should have. Hindsight is 20/20. Should we have gotten out at $1900 and be buying back now at $1100? That would be brilliant. There were a number of things that were not clear at the time, and in fact, have not changed in the interim, and that is – is Europe fixed? The ramifications of over-lending and bad decisions in terms of credit quality – have those problems been addressed in Europe?

The answer is no. And as we got to 2011, of course, June of 2011 was when we were at sort of the worst point of emotional crisis in Europe. Here in the United States things were getting marginally better and relatively better because we went into the crisis first, and so things looked a lot worse in Europe than they did in the United States. China looked to be the brightest light coming out of the global financial crisis because as we mentioned in reference to one of the earlier questions, China spent four times, relative to their GDP, what we did in the aftermath of the global financial crisis, and all the economic statistics showed that on that basis they were recovering much faster. And the dialogue amongst folks at the Financial Times and the Economist and a few other papers was that, in fact, command and control dynamics are more important than capitalism in this era, and we have a lot to learn from China because the free markets actually should be trusted less and the minds of the politburo should be trusted more.

So can we hatch our own version of the politburo? That was actually being discussed in 2011. Critical of capitalism and very much in favor of command and control dynamics. Again, looking at central bank activity on the largest scale ever witnessed in history relative to the size of the economy, they were orchestrated by the Chinese. Well, now we have 20/20 hindsight on that issue, as well, and we see that, in fact, they are struggling to main their growth trajectory, and they have massive debt issues which have yet to be resolved, which means that what they, in effect, did in that 2010, 2011, and 2012 timeframe in China was paper over a significant problem.

So here we are circa 2016, and we’ve papered over the problems in Europe, we’ve papered over the problems in the United States, we’ve papered over the problems in China, and we haven’t met these challenges with any real structural change or reform. What typically happens in a market cycle is that bad bets get wiped out. It is almost like a mis-managed forest. You get too much undergrowth which leads to too much tender, which leads to a bigger burn than you would have had otherwise. But guess what? Even then you have the possibility for rebirth, regeneration, and new growth. And we’re not in that position today, in large part because we’ve had a massive amount of central bank intervention precluding real declines in asset values, and a wipeout of bad debts.

Kevin: Well, 6-to-1 has never been a goal, 5-to-1 has never been a goal. If you really look at market tops, going back to 1896, the 1-to-1, or 2-to-1, has typically been the top of the market. That is what we’ve seen. You have to remember what you’re target is. 6-to-1 would not have been a target. That would not have been a trigger.

David: No, that’s exactly right. So 4 or 5-to-1 become more compelling, if you’re heavy gold, to start a reduction process, but not necessarily get out altogether. You go back to the crisis of 1907, we were just above a 2-to-1. As we headed just into the Roaring ’20s, but still sort of on a war footing, in 1915 we were at about a 3-to-1 ratio. In the context of the Great Depression, by February of 1933 we were at about a 2-to-1 ratio. I think we touched down in the high 2s – 2.-something in 1932, and then in February of 1933 we were at a 2-to-1 ratio.

But if we look at the most interesting period of time, if you’re looking for a parallel to the present, the 1970s to 1980 period, 1974 we hit a 3-to-1 ratio. That was off a peak of 27 or 28-to-1 on the ratio, sort of January 1966 was that peak. It declines to a 3-to-1, and then it backs up to over 8-to-1, and it looks like the bull market is over, everything is done, you should have traded out at 3-to-1, and lo and behold we find ourselves at a 1-to-1 ratio – 1.29 by the time we get to January of 1980.

So it’s a very fair question, Mike, and the issue is, 6-to-1 was never an exit point, never even a reduction point in our world, in our perspective, 3-to-1, 2-to-1, 1-to-1, certainly, looking at the past as predicate to the future, to some degree, we expect to find the last and final leg of a secular bull market in the precious metals, and that remains ahead of us. We had the first leg which was from 2000 to 2003. That took the ratio from the 40s down to the 20s. The second leg of the bull market in gold took the Dow-gold ratio – this was 2005 to 2011 – took it from the 20s down to 6. But again, where you find a 3 or a 2 or a 1-to-1 ratio is when the public comes into the market. Why has the public not come into the gold market yet? Well, in part because you had a fantastic PR campaign proving to the world that everything would be fine. We saw that in Europe where Draghi said, basically, “I will do whatever it takes.”

Kevin: Which meant printing money.

David: And it relieved the tensions within the market. It allayed the fears in the market, but has done nothing to fix the problem. So the problem remains and now central banks have more obligations, banks and corporations have more obligations. The whole world is more leveraged today than it was prior to the global financial crisis, and leverage was the issue in 2008 and 2009. So where are we, and where are we going? We do think we have the third leg still ahead of us, and I can’t think of a single instance in market history, and this would be commodities markets, stock markets, real estate markets, markets of any kind, where the public does not ultimately come into the market.

And so, that does mark the last phase of a bull market. Did we begin that in 2016? We may very well have begun a transition from a cyclical bear, 2011 to the present, not unlike the cyclical bear that we had from December of 1974 through 1976, about a 2 to 2½-year bear market in the 1970s before that final blow-off phase when the public most certainly did come into the market, and was fully invested by the time January 1980 rolled around.

Kevin: The next question comes from Johann in Australia:

“I have not missed one podcast for a very long time now. I really appreciate and enjoy the program. Thanks for the hard work you put into it. I realize those things don’t just happen, but it takes dedication and hard work. Question: I hold physical silver, and am a true believer in holding the real stuff and not paper silver or gold. Recently, I have learned of, and that you can own real gold with them and have a debit card so that you can use it for transactions. I have family in South Africa and need to transfer money from time to time to assist family members. Transfer costs are high and I was thinking of using GoldMoney, but it scared me that it might be paper gold and not the real thing. Is it the real thing, and is it safe to use and invest in?”

David: There is an interesting backstory to GoldMoney. Jim Turk is the founder of GoldMoney, and he recently sold that to a Canadian company who have sort of consolidated the digital gold universe, and so they have three parts that are now one part. Turk’s company was very intriguing. They did sell real physical metals, and you gained ownership in a fractional way, in a 400-ounce good delivery bar. It’s very difficult to take delivery of a 400-ounce good delivery bar, so if you ever did want the gold there was a cost to convert and things like that. I believe that it still is that way. I haven’t tracked the new GoldMoney, but assuming that it is similar, I would believe what Jim Turk set in motion is pretty legitimate. Next year we are, as a company, offering something similar. We have preferred a different custody location and we have preferred a different product mix, giving a little bit more flexibility to the person who has the asset.

Kevin: And you’re staying away from the 400-ounce bars and moving to something much smaller.

David: That’s right, preferring kilos instead. So there is something that I think we’ll be discussing probably June of next year in that regard, and for the same reasons. We look at physical gold and we say, we would prefer to have physical gold in our possession. That is taking metals outside of the financial sphere, making the asset private, and putting you in direct control over the asset, with no counter-parties involved, with no layers of technology being helpful to you from the transactional standpoint, but also harmful to you in the event that the lights go out.

So there are advantages and disadvantages to this, and what I would prefer to sort of position this as – when you think of GoldMoney, when you think about our offering in 2017, I prefer to think of it as a substitute for a savings account or a banking alternative, where you may choose to designate your ounces or your cash in ounces. And a part of our program next year, you will be able to decide if you want market volatility or not. In other words, do you want a hedged gold position or do you want a gold position that fluctuates every day with the price of gold?

Kevin: And it doesn’t replace the physical gold ownership. Like what you’re saying, it replaces the cash side. Do you want cash to be in fiat, or do you want it to be in gold?

David: That’s right. So if I choose a cash alternative and replace my savings account or bank account with kilo bars, but then hedge that position where I have no price change in the position, it does cost me something to do that. But then I can have an ounce position that doesn’t fluctuate in value. And you can treat it like a cash position. How? Through the same mechanisms – a credit card or a debit card which transact to an actual account. So that, to me, does make sense.

There is a role for gold as a cash alternative, and accessing it through 21st century technologies, so I like the concept of transaction-friendly approaches. We’ve looked at our competition in that space, potentially, and have said we can actually do something better, and so that’s what we’re going to do. I have no high criticism of GoldMoney, I just think we can do something even better in the process.

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