I’m really starting to get into gold podcasts, and soon I’ll post a list of the ones I feel are best. As a follower of the precious metals markets, I have always looked to the savvy vets in the industry for their guidance, no matter if we are in a bull or bear market. Today I present to you a transcription of a podcast featuring precious metals expert David McAlvany, who joined The Investors Podcast to share his thoughts on what is going on with gold today. I have embedded a version of the podcast below.
What You Will Learn Listening to This Podcast
- Why value investors should consider gold if they deem the stock market overvalued
- Why investors hold silver and platinum
- How to determine the asset allocation of gold by the ratio to other precious metals
- How to use the Dow Jones’s ratio to the price of gold as a buy or sell signal
- How should gold be allocated in your portfolio when you plan for retirement.
The Investors Podcast Studies Gold
Speaker 1: You’re listening to TIP.
Preston Pysh: If there’s one asset class that’s had a really rough time since the middle of 2011, it’s been gold. At the deepest part of the decline, gold hit a hard bottom at the end of 2015, putting it down nearly 45% from the top to the bottom. Since the start of 2016, though, the prices increased by about 17% and many gold bugs are suggesting a big movement might be right around the corner. On today’s show, we have a leading expert in gold and then how the precious metal performs during credit cycles and how investors should think about its position size in their portfolio. Without further delay, here’s our conversation with the thoughtful David McAlvany.
Speaker 1: You are listening to The Investor’s Podcast, where we study the financial markets and read the books that influence self-made billionaires the most. We keep you informed and prepared for the unexpected.
Preston: Hey, everyone. Welcome to The Investor’s Podcast. I’m your host Preston Pysh, and as usual, I’m accompanied by my co-host Stig Brodersen. We’re super excited to have our expert in gold, David McAlvany here with us. David, welcome to the show.
David McAlvany: Great to be with you.
Preston: Well, it’s great to be with you too, David. Stig has the very first question, so fire away, bud.
Stig Brodersen: Awesome. David, previously on this show, we’ve covered what happens to the price of gold back in 2008, which was quite a concern to some of our listeners because what we saw was that the price of gold did fall with the initial shock in 2008, which might come as a surprise because typically, we hear that it’s a hatch, but then whenever we looked at it in the 18-month perspective, that market sell-off we saw on the stock market was not what was on the gold market. Actually, gold went up by 25% after the last crash.
My ungrateful question to you would be for you to predict and hear your thoughts on what can we expect if the longest bull market that we have seen now, what can we expect that, if gold suddenly crashed, what will happen to the price of gold?
David: That’s an important question. I think today, there’s an even greater awareness of counterparty risk and systemic contagion. When the market crashes again, there may very well be an initial decline in gold, just like we saw in 2008. In a period where asset prices are deflating, what you have is leverage players who will often try to keep a certain number of bets in play, and they can use their liquid assets to do so. Maybe in that initial timeframe, not recognizing that the investment backdrop has changed, but as that realization sets in, you have demand for an asset like gold, which is a financial asset but it’s outside of the financial system.
Those motivations start to move into high gear. 2008, we witnessed the soft patch of 90 days. As you rightly point out, it then rebounded pretty considerably. That followed on for about three years. There was immense strength in the gold market. I think in the next round, whatever the initial knee jerk response is, I do expect wealthy investors, family offices, hedge funds, individuals, to prioritize an asset, which is no one else’s liability. One of the things that we’ve tried to do since 2008, one of our newest initiatives with vaultedapp.com makes that very easy.
Preston: David, everybody’s got their narrative on why something like this might have happened. I’m just curious to hear your opinion on why it happened, and maybe more importantly, why it might happen again?
David: Well, I think that the clear path in 2008, 2009 was that a liquidity crisis morphed into a solvency crisis. In those initial phases of liquidity, people were scrambling for any source of liquidity they had. That is one of the interesting things about gold and silver is they are very liquid assets. If you need to use them, you can use them in short notice. Before it became a solvency crisis, liquidity was the key. That’s where that characteristic of gold and silver added to the short term volatility.
Stig: I’m really happy that you also bring up silver. One of the reasons why we’re excited to bring you on this show here today is not only talking about gold, we covered gold quite a few times, but generally, we haven’t talked about precious metal. Why would I as an investor have silver and perhaps even platinum in my portfolio?
David: Well, first, these other white metals, they diversify a precious metals portfolio. I think secondly, they do allow for a number of intramarket arbitrages, which allow for what we call compounding of balances. These are strategies that, in my opinion, strike at the core objection made of the precious metals, gold in particular, and silver as well, which is they pay no income. With well-managed, well-balanced precious metals portfolio, you get to address that issue completely via what we call more or less ounce income. I think lastly, these white metals have an advantage and a disadvantage embedded in them.
In contrast to gold, they are more economically sensitive. There are backdrops where silver and platinum and palladium will outperform gold, and vice versa. I think in the context of, I’ll just give you an example, of a rapidly declining global GDP, your white metals would need a very large influx of investors to supplement and replace the industrial demand, which presumably would be in decline in that kind of a context. Gold, by contrast, remains the metal for all seasons. It is, I think, by far the most reliable store of wealth, but what you gain with the white metals, which for us are a supplementary role there in the metals portfolio, what you gain is that intramarket growth opportunity to grow ounces.
Stig: Could you talk to us more about the historical correlation? You talked about that you would do that to diversify your precious metal portfolio, but is it a positive correlation in general, is it negative? What’s the magnitude of the correlation?
David: Well, I think if you’re talking about gold to equities, you’re talking about a non-correlation. Again, I think this is where, to some degree, you see a greater correlation with the white metals to your growth indicators in the economy, because again, these are metals that are being used up in a variety of industrial contexts. Gold is not that way. Gold doesn’t have very many industrial applications. On the one hand, you have a non-correlation, which is helpful with gold.
That does make it the metal for all seasons, and then you salt in or seed in some of the white metals into a precious metals portfolio for the opportunities that you have to gain on the differential between relative values of one metal versus the other.
Stig: Most of our listeners, they’re equity investors, but we also have people who would like gold or another precious metal as a hatch. This is a very difficult topic to cover in terms of asset allocation, because it depends. It all depends on us. We had Jim Rickards on the show before, he talked about up to 10% of your portfolio even as equity investor, we talked with other people who might say at 1%, 2%, 3%. What consideration and thoughts are you going through whenever you are finding the optimal amount of gold, as an example, in your portfolio, if you look at it as a hatch?
David: the ratios I think are very key there. This is one of the things that we keep in mind as we’re thinking about the optimal allocation. This is not for us, a dead asset in a portfolio. You watch the ratio between the two metals, gold and silver, and whenever the metals are in high demand, silver tends to outperform gold. It does offer more of a growth component in the mix. The average ratio between gold and silver is typically 30 to 40 ounces of silver have the same monetary value as one ounce of gold. The present ratio is about 80. What that suggests is that silver is very undervalued and is likely to outperform gold significantly.
Silver is interesting here. Just add this one caveat. When you’re talking about sophisticated money that’s seeking stability and asset preservation, it doesn’t typically put maximizing gains at the top of the list of priorities. Just for context, silver has that role, it may outperform, but when we see gold beginning to move, this is larger inflows and it typically is in the context of financial or monetary crisis. We can sometimes see a lag where demand for silver from smaller investors follows gold demand, which is typically from your larger, perhaps more sophisticated investor focused more acutely on assets stability, asset preservation.
Preston: David, on the show, we haven’t really talked about silver at all. This is really great that we’re covering some other precious metals other than gold. Let’s even go a step deeper and let’s talk about platinum real quick. The reason I want to talk about this is because when we look at the global production of platinum, 80% of the supply comes from South Africa and then with the remaining 20%, Russia plays a very large role in that 20%. My question is this: do you think that there’s a problem from an investment standpoint, that there’s a very focused amount of supply coming from only a few locations in the world? Is this an advantage or is this a disadvantage?
David: As an investor, I’d say that the opportunity that that opens up is volatility in that market. It depends on what side of the trade you’re on at a particular time. The two countries in question have routine episodes of political dysfunction. It does create opportunities, because it exaggerates the platinum group metal’s volatility. Again, it depends on what side of the trade you’re on when the dysfunction is revealed, but the volatility does allow for playing the ratio between platinum and palladium. We’re not as interested in the price performance, but looking at over time and allocation to the platinum group metals that allows you to basically leapfrog and go from a static number of ounces, playing the ratio to grow the total ounces that you have, essentially expanding your financial footprint using the volatility between them.
It’s an essence of forced value play where you’re constantly moving to the undervalued metal. Today, that would be platinum. As powerful as the supply dynamics are and the supply visibility issues are dealing with these two countries, South Africa and Russia, you also have a very unpredictable demand dynamic from the auto companies because you’re talking about a massive, massive demand for catalytic converters. Whether it’s for diesel engines or gasoline engines, and they’ll stockpile one metal for use and catalytic converters and then move to the other once supplies are eliminated.
It’s a tightly held secret what they have and in what quantities. Again, the ratio between these two metals, we like to trade it. This is not something that you trade on a weekly basis. Sometimes it’s not something you even trade on an annual basis, it takes time. It can be worth the wait but you may wait for three or four or five or seven years before the ratio swings hard the other direction. Then when it does, it allows you to monetize. Again, not in dollar terms, but monetize in the growth in ounces, which again, for us is very significant if you can expand your financial footprint that way.
Stig: Let’s take a quick break and hear from today’s sponsor. Is there something that interferes with your happiness or is preventing you from achieving your goals? BetterHelp Online Counseling is there for you. Get help on your own time and at your own pace. You can schedule secure video or phone sessions, plus chat and text with your therapist. With BetteHelp, you’ll get access to licensed professional counselors, who specialized in depression, stress, anxiety, relationships, sleeping and much more. Anything you share is of course confidential.
If you’re not happy with your counselor for any reason, you can request a new one at any time and at no additional charge. Financial aid is available for those who qualify. Best of all, it’s a truly affordable option. [inaudible 00:12:25] Podcast Network listeners gets 10% off your first month with the discount code “Billionaires.” Why not get started today? Go to betterhealth.com/billionaires. Simply fill out a questionnaire to help them assess your needs and get matched with a counselor you’ll love. That’s betterhealth.com/billionaires.
This episode of We Study Billionaires is brought to you by Blue Bottle Coffee. Blue Bottle Coffee is dreamed by an obsession for fresher coffee. Roasted to order and ship within 24 hours. Yes, only 24 hours. With the Blue Bottle Coffee subscription, you get unparalleled quality. They work directly with farmers around the world to source the most delicious and sustainable coffees they can find.
Offerings include blends, single origins, and expressos. You’re in full control of the 10 different segments of subscriptions. What are you waiting for? You can start the free trial for just $5 when you go to try.bluebottlecoffee.com/westudybillionaires. That’s try.bluebottlecoffee.com/westudybillionaires. That’s a 12 ounce back normally $20 to $23, including shipping of your choice of a blend, single origin or expresso for just $5. Sign up now at try.bluebottlecoffee.com/westudybillionaires. All right, back to the show.
One thing I picked up on and please correct me if I’m wrong here. Whenever you’re talking about the value of say, gold, you don’t talk about it should be $1,200 an ounce or $2,000 an ounce. That’s not where your focus is, it’s more on how much another precious metal can you get for that ounce of gold. Is that correct? That’s how you– This is the part of your strategy.
David: Yes, I think in a different episode or epic and time, we might have to or get to look at it differently but we don’t have stable currencies today, we don’t have anything serving as the foundation for the euro, the yen, the dollar, the pound sterling, whereas the history of money has been gold as money. Then really all we’re talking about is how you spend your money in the value equation for spending ounces for acres in square feet and shares. I want to maintain that conversation and say that gold is money. It’s mistreated and misunderstood merely as a commodity.
Here again is the distinction between the commodity uses and the economic sensitivities of the white metals in this core role as money that gold has played through times. I would prefer to price things in gold terms and see the relative value between assets. Because quite frankly, my brother lives in Indonesia, for me to price gold in Indonesian currency today, what is the appropriate price? What is the appropriate price? We’re talking about $1 exchange rate of over 11,000 currency units compared to one, there’s a certain point, the numbers don’t mean anything, because we’re not talking about something with real intrinsic value.
I think that’s why I tend to price things on a relative basis because at a certain point, we’re living in a unique period of time. Post 1971, we don’t have gold as a monetary reference anymore. We’re talking about the post Bretton Woods era. The end of the Bretton Woods era divorced gold from any monetary usage at all. We still have it as a reserve at central banks, but this is the first time in world history that we have a monetary experiment without gold in the mix, where it’s not backing some currency out there.
To me, we’re playing games when we talk about the dollar value of gold. It could be 50,000 or it could be 500 and it’s really commentary on the strength of the currency itself, not necessarily the nominal value of the metal, if that makes any sense.
Preston: Absolutely. I think that this is a common theme we hear from many of our guests that talk about gold being a reference point and base unit to understand how the value of goods and services have changed over time. David, let me ask you this. We’ve read a lot of reports over the past five years that China is trying to accumulate a large gold position. As they’re trying to grow that physical position, they’re obviously want the price to remain as low as possible as they continue to accumulate it. In essence, you have a really interesting demand dynamic happening where you have a very large nation on the buy side of gold, but they’re maybe trying to mass some of their participation in the public markets as an interest to keep the prices low. How do you think through this supply-demand situation that’s happening with such a large nation?
David: This is a fair distinction. We’re talking about two things in play at once. One is how gold is priced in currencies and the other is the supply and demand dynamics, the fundamentals of the market. We saw after 2008 and 2009 was a radical shift. Mass liquidations of gold held in your exchange traded products and a lot of those 400 ounce gold [unintelligible 00:17:27] bars went directly from London, to being reprocessed in Switzerland, turned into kilo bars, and then they disappeared into the Chinese market. I think there’s an assumption amongst investors today that when they snap their fingers and they’re ready to buy gold again, that the gold is there for them to buy.
I think they’re going to be very surprised to find at least that 800 to 1,000 tons of gold, which once an exchange traded products, it’s not coming back. It’s not coming back. It’s been removed from the physical market. The far more impactful issue in terms of pricing the gold market today is what happens in the futures pits. What happens via futures contracts where you have 50 to 100 times the volume going through “paper gold” compared to the underlying physical market. That you and I are very interested in the fundamentals of supply and demand, which go back to the physical and the limitations of the physical market.
There is this parallel market in the futures market, which far exceeds the physical market in terms of dollar flow. Frankly, some of the times when you see gold in an exaggerated move, moving down $50 or $100 a day, it has nothing to do with physical liquidations of the metal. It has to do with significant leverage being applied in the futures markets. A little bit off topic, but as it relates to gold and Chinese demand for gold, we have a story, which is I think, a very compelling story on the supply and demand fundamental side for gold. Yet that’s covered over in large part because price action is sometimes dictated in the futures bits.
If you only looked at the dollar price of gold, you’d say, “Well, this must be a very weak market for gold.” You’re right in pointing out the Chinese and the Indian markets, the Asian markets today have been incredibly voracious in their appetite for gold. I think as the Western world with Europe and the United States starts looking gold again as an allocation, they’re going to find that there’s not as much physical supply to meet their investor oriented demand.
Stig: If we look at the official gold, whenever I say official goal here, I mean, [unintelligible 00:19:39] funds, central banks and sovereign funds, we have around 35,000 tons of gold. What we’ve seen here all the past few years, even for longer is that you generally you see a shift from west to east in terms of the percentages of how gold is capped. What is the short term plan and the long term plan for why you see the east buying so much gold?
David: One of the phrases that I grew up with, my father used to teach me that, “He who owns the gold makes the rules.” That is the golden rule or the second golden rule. This shift from west to east is very significant. The short term play, I think, is in the metal’s price itself, where you see volatility in price ultimately emerging and there is gain potential there. I’d say over the next three to five years, that is the way to play it. If you’re looking at the 21st century, you’re really looking at the Asian century. You’re looking at both from real estate, the contribution of global GDP growth, it is not coming from Europe and is not coming from America.
It’s coming from emerging markets and it’s coming from the east in large part so I think you’re short term play, the metals represent a play on volatility and a play on uncertainty. As you see a power shift from west to east, that volatility and that uncertainty about who controls what and what the relationships will be as the dust ultimately settles, I think will drive the price of gold considerably higher. The long term play, if you’re talking about an allocation for 50 or 100 years, I think gold still has a place in that mix but from a growth standpoint, I think this is the Asian century.
Stig: What do you think the short term and long term play then this for the States and Asia? I’m specifically talking about Russia and China, who’s really been aggressive. You hear these arguments that short term, it’s a hedge against the dollar also because- especially for a country like China that has such a huge trade surplus, we’re talking a few trillion dollars that they can then apply into the American treasuries so it’s a hedge for them short term and then long term, some people are talking about if we were to see a gold standard one way or the other, they have a bigger say. Do you think these people are just very skeptic? Do you think that it’s an upside play that they have instead of a downside play?
David: I think for them, it’s a question of control. What you’re talking about is a gradual reduction of exposure to the Treasury Department. We think in terms of asset allocations, why we own something and what the gain potential is. There is a political motive here which goes far beyond economic or monetary gain. As you look at China and Russia and an increase in exposure to gold and a reduction in exposure to US treasuries– Very specific here, this is not a reduction in exposure to US Treasuries. The motive here is a shift in control because we have learned that our State Department is very weak compared to our US Treasury Department.
When we want to change the world, we do it via the US Treasury Department. If they can reduce exposure to the US Treasury Department to swift into our financial machinery, that is a regaining of control, reduction of control from the west and a regaining of control in their own locale.
Stig: David, one of the other things I would like to talk about here today is gold and H whenever you are managing your portfolio. Some of the younger investors you have out there, they do not want to hold gold with the argument that they can recover if the market crashes. Then as you get older and it’s more about preserving capital and we talked about before, gold can be seen as a hatch so why would you have a hatch whenever you are nearing retirement? Then you also have the counter-argument that when you’re about to retire, that you need that cash flow and gold does not spin off any cash.
I’m curious to hear not only how you do it in terms of you personally but also what kind of considerations and thoughts should you have as an investor whenever you are thinking about gold in terms of your retirement?
David: I think it is a great point because gold should never replace the assets in a portfolio that do throw off cash flow. I think when we start talking about assets, they have an identity, they have a function, they have a role to play and gold serves a different function. For income, that’s the designated role of either a fixed income asset or a real estate asset. Gold provides something that, regardless of age, whether you’re young or old, I think a well-managed portfolio needs and that specifically is non-correlation. Gold is a far better asset to reduce long term portfolio volatility than, say, something like bonds. The classic pairing of stocks and bonds.
Note that both stocks and bonds are sensitive to some big macro themes like inflation and interest rates. In the most recent period of monetary policy largesse, where interest rates have been reduced virtually to nothing, both asset classes, stocks and bonds have gone to historic extremes, very high evaluations in terms of price. I expect that as monetary policy normalization sets in and the tailwinds which have helped those markets and the financial markets- again via accommodative monetary policy, as that becomes headwinds, I think once again, gold will shine brightly as a valuable component in a portfolio.
Again, if capital preservation, you talked about age and you talked about the role of income, well capital preservation, if that’s critical at any age, gold must be a component part. This goes back to your question earlier about an allocation and a percentage allocation. Our research in the ’70s and again this past year just sort of updating numbers and doing regression analysis, what we wanted to look at is the best optimal combination for a growth portfolio, stocks, bonds, gold and the optimal is actually an allocation of 75% to stocks, 25% to gold.
The bond market, I think has to be viewed in the context of longer-term interest rate trends because you may focus on the income component and what it provides for you but in this context here where we saw interest rates in the summer of 2006 get to 5,000-year lows, where do we go from here in terms of interest rates? I mean, the argument is we go for it a sustained period of time into a bare market and bonds which could trigger significant capital losses if you’re on the wrong side of that interest rate movement. Again, I think gold is a superior diversifier of risk and a reducer of volatility. It’s the metal for all seasons. In that context, I think it fits well in and if you want to call it, an all-season portfolio.
Preston: David, talk to us a little bit more about volatility. Earlier when we were talking while platinum, you mentioned that volatility could be used as an advantage but for other people, that’s also something that makes them test their temperament if you will. I’m just curious to hear more about your opinions on how volatility should be viewed with respect to gold.
David: I’m going to illustrate with my son. My son is nine years old and he owns 136 ounces of silver. This is what he saved from allowance and doing odd jobs and cutting lawns and things like this and he likes to save in silver. I also match his investment in silver so it’s a straight away 100% gain for him. He’s smart enough to do the math and he jumps on that very quickly. What I’ve showed him is that if he is able to play the volatility between gold and silver and basically go round trip from silver to gold and back to silver again, if he’s able to do that once a decade, he gave me his life span, he said, “I’ll live until I’m in my 90s.”
I said, “Okay. If you do this, what you’re doing is compounding ounces.” The way the math works, we know the parameters of the gold-silver ratio. You’re going to turn your 136 ounces, not buying another single ounce. When you’re in your 90s, you will have over 39,000 ounces. To go from 136 ounces, which in today’s dollars values is not a significant amount but to turn that into 39,000 ounces, the price of silver is secondary, the price of gold is secondary. This is a mechanism using the volatility between the metals to be able to grow the ounces. You know what? At nine years old, he gets it. I think the average investor does, too. That just makes sense.
Stig: Wow. Can I just say, for the record, it sounds like it’s a lot more profitable to be nine years old and do chores than when I was a kid.
David: The matching program does help.
Stig: I can imagine. Let’s talk about some of the other assets that we haven’t touched here so far in this episode. You talk about the importance of not having any correlation, perhaps even a negative correlation. If you look away from gold or silver or white metals, what kind of asset classes do you think would be important for you to look into as an investor if you are primarily exposed to stocks?
David: Bonds, real estate, gold, cash, these are your standard buckets if you want to think of them in terms of a receptacle to fill over time. Ideally, you remain agnostic to the individual asset classes and you let price action in those markets kind of tell you where you should be going. If you have a diversified portfolio, what you then have- let’s say, for instance, growth inequities, that will end up feeding your gold position and vice versa. Why? Because if you’re routinely rebalancing, what that forces you to do is always buy value. You’re selling the appreciated asset in part and buying the undervalued asset in part.
To me, a lateral move today from equities to gold would be brilliant right now. The ratio between gold and the Dow Jones Industrial Average sits at 22:1. When the cycle of growth in gold is complete, that ratio should be around 3:1. Frankly, it’s not uncommon to get to a 1:1 ratio where with the price of gold reflects the sticker price of the Dow Jones Industrial Average. Typically the 1:1 ratio happens under very strange geopolitical circumstances with sort of an economic and financial chaotic backdrop. Imagine your gold ounces as funding a 20X increase in equity exposure. I don’t care what the asset is. I’m interested in the value play and the value exchange. On the basis of the Dow Gold ratio, we’re talking about from current vantage points, 22:1, it makes sense to be exiting the Dow, it makes sense to be owning gold with the idea of coming back into equities at a 3:1, 2:1, 1:1 ratio. The ratios are a way of valuing gold. I think another way– I also like Paul Tudor Jones, his approach to valuing gold is where you take gold and compare it to global money supply. Let’s talk about the gold into ratio. On that metric, gold is at present about 50% of its historical average. Appropriately priced gold according to that Paul Tudor Jones model, should be around $2,000 an ounce.
It’s the undervalued asset. You always seek the undervalued asset. If you’re deploying capital, that’s what you want to do. Do I want to chase the real estate market now with interest rates being raised within? Well, as interest rates increase, the value of real estate decreases. Real estate, in some respects, over a long period of time, behaves like a bond instrument, very interest-rate sensitive. Both bonds are vulnerable to rising interest rates after being at historic lows. Year 2016, the 5,000-year low we talked about earlier, real estates in the same boat.
Stocks, we could talk about the overvaluation in stocks, but I’m very concerned that we’re just talking about mean reversion. For me, the opportunity is in volatility. The opportunity is in playing the differential between assets, which again, favors gold in this environment.
Preston: David, the mean reversion here between the Dow and the price of gold right now is around 22. You suggested that you would go back into stocks when it was around two or three. My question would be, what’s the mean? As we look at things from a historical perspective, help us gauge kind of your left and right limit as you’re talking about this.
David: The volatility is fairly extreme. Going back to 1999, the ratio was as high as 43:1. The previous peaks, if you’re talking about bull market peaks in equities, you saw the ratio at roughly 28 and I think the one prior to that was closer to the low 20s. As time has gone on and as monetary policy activism has, I think, increased the confidence of investors, you see more extreme valuations in stocks. Then on the other side, the ratio has consistently dropped to about a 3:1 ratio. For me, the scaling-up process, remember we talked about rebalancing? I think the rebalancing begins at 6:1, 5:1, 4:1, 3:1. I might have a few ounces still to exchange for shares in the Dow as we get to a 2:1 or 1:1 ratio.
The average through time is sub 10. The average through time is sub 10. At 22:1, you’re still- it’s overvalued. Not as extreme as we were in 1999 in real money terms, but this also speaks to the strength of gold through this period of time. Everyone is thinking that gold has been very weak here because it’s sold off 35% from its $1,900 level. In reality, if you look at the new highs in the Dow, we were at a 43:1 ratio. At the last peak, we’re only to 22:1 ratio. The Dow has not taken out its old highs in real money terms. It’s only about halfway to its peak in real money terms.
Stig: This might seem extreme for some equity investors. Everything in finance moves in cycles. You mentioned that the ratio right now might be 22:1, in 1999, it was more than 40. You talked about the mean version and going back to 2 or 3 before it then bounces back. It sounds like you would suggest that you would then sell off some of your stocks, perhaps for gold. What’s the ratio here? I know again, it’s a tricky question. You’re talking about holding even more gold than stocks or is it more like if you have an 80% exposure to stocks, now you have 70% or 65%. What are the ratios here we’re looking at?
David: I think, again, the optimal allocation is probably 75% to stocks and 25% to gold. I’m leaving out real estate, I’m leaving out privately-owned businesses. I’m leaving out a lot of things that could factor in. If you’re talking about a reduction in equities and trying to balance those two asset classes, I think a 25:75 mix is a good mix. The kind of volatility that you see in equities– Take the 2008 and 2009 period. If there was a 25% exposure to gold, you would have offset the majority of your losses. You had best case scenario 35% down if you were in the emerging markets and other equities, you had 65%, even 70% down in the 2008, 2009 period.
Gold was marching higher by 200%, 300%. It covered a lot of the losses that you had and that’s the key when you’re looking at growth through time. You don’t want to take any big hits. If you can reduce the downside volatility by having something that replaces losses on the equity side and that would be gold in that volatile environment, and you have the discipline of rebalancing, you’re taking your gains in gold and you’re buying stocks at a low value, which would have been 2008, 2009, the Dow gold ratio was at 6:1, off of a 43 peak.
That reallocation process is what feeds, again, dollar cost averaging into position at significantly lower levels. At the end of the day, if you’re going to play these ratios, value, value, value. You’re a value investor.
Stig: I would like to talk about Black Swans here, David. Value investing or gold price, whatever we talk about, one thing that, as investors, we must consider is the probability of a black swan happening. As our listeners know, this is a current term. It actually goes all the way back to the second century, but it was commonly used in the 16th century London as a statement of improbability.
Like, this is a black swan, this is not going to happen. It just made a lot of sense at the time whenever people said that because back in England and Europe, for that matter, no one had seen a black swan. The rest is history as they say. We actually do have black swans in Australia. It is not as impossible as it might seem just because you haven’t seen it before. That’s the premise of talking about black swans. What has history taught us about black swans and gold?
David: Black swans, as you say, these are unexpected events and they can emerge not only in the world of finance and economics, but they can be of a political or geopolitical nature as well, with direct consequences as a negative feedback loop into the economy and financial markets. To the degree that a hypothetical black swan causes uncertainty, gold wins. Investors shift to gold in context of uncertainty. This could be the uncertainty of political continuity.
It could be the uncertainty of price performance and equities moving forward, which again, as we suggested with current valuations, and the current levels that that’s possible. Uncertainty and to a degree, fear, drive the price of gold. They drive the price of gold to the upside.
Preston: David, help us understand a little bit more about how you think of an uncertainty. Some people look at the market today and say everything’s blue skies and there’s nothing to worry about. Then you have others that suggest that the fundamentals are flashing bright red lights. Help us understand this idea of uncertainty.
David: In this environment, I think it’s very interesting because roll the clock back to 1999. We had a market crisis in the United States, which focused on overvalued technology shares. It had ramifications for our economy, it had ramifications for the whole financial system but it really was centered in the NASDAQ. The monetary policy solutions brought the economy back and brought the markets back to life but did create the next bubble. The next bubble was in mortgage finance. The MBS market and the ABS market goes bananas into 2006 and 2007. Then we have the crisis of 2008 and 2009.
Again, monetary policy intervention shifted things from the quasi-public markets in the mortgage-backed securities arena to sovereigns. This is where it gets very interesting because I think we’re dealing with a kind of bubble that is rarely seen. It’s a bubble in government finance. It’s a bubble in sovereign debt. In a financial crisis, you want to know that somebody has the solution. You want to know that somebody has a fix for the problem. Whether it was NASDAQ, Alan Greenspan stepping in, or the chaos of 2007 and 2008, the appropriate parties stepping in then from a variety of central banks from around the world coordinated effort to save the system from the global financial crisis.
Today, it’s moved so far up the food chain, that the question of who solves the problem and if they use the same tools as they did in the last crisis, the mortgage-backed securities triggered global financial crisis, do they have the wherewithal to do it? Will it be as effective? What will it take in terms of central bank balance sheet expansion to solve the problem this time? Is it US Central Banks or the Fed? Is it expanding the balance sheet from 4.5 trillion to 10 trillion? Is it the European Central Bank expanding from 5.5 trillion to 20 trillion? What’s the solution? Is it sufficient to bring certainty back into the equation?
Stig: I love that you say that. It really reminds me of this quote by Ray Dalio where he says, “If you don’t own gold, you know neither history nor economics.”
David: I agree with him.
Stig: David, clearly you have a wealth of knowledge whenever it comes to gold and other precious metals. Where should retail investors start if they want to learn more about this? Do you have a really good resource, perhaps a really good book that you can recommend that we can all dive into to really understand the market mechanics a lot better?
David: I think for your listeners who are, let’s say, studious, I would say Roy Jastram’s book, The Golden Constant. It’s an excellent book. For those who are interested in understanding not only price action, but also social dynamics in periods of financial market compression, this is a different way of looking at it. You can look at the numbers, I think the social dynamics are also very interesting. I would recommend for that Adam Ferguson’s book, When Money Dies. Adam Ferguson’s book is excellent. Lastly, although it’s a book that’s quite dated, Anthony Sutton wrote a book called The War on Gold. Particularly chapters three through nine, they give very important context for the investor who’s considering gold as a long term allocation. You mentioned Ray Dalio, let’s say his context, he creates this all-weather portfolio where gold is a component part.
Preston: David, thank you so much for taking time out of your day to talk with us. This was really a fun interview. I was definitely interested in talking to you because this is a topic that I’m just personally paying a lot of attention to right now. We want to give you the opportunity to tell our audience where they can learn more about you and your business. Please give them all the details. Folks out there, if you can’t remember everything that the David’s telling you, we’ll be sure to have links in the show notes so you can quickly access some of the links that I’m sure David will talk about.
David: I think best place would be vaultedapp.com. That is a window into our latest project. We saw a need in the market for transparent and straightforward way to approach gold investing, especially for a younger generation who may be newer to the gold market. In Vaulted, our program is an easy to use web-based application that reinvents the way people invest in gold. We embrace the key value through the development process that of transparency and in working directly with the Royal Canadian Mint, I focused on a product that is conflict free in terms of the gold and creates buying and selling through that vaultedapp.
Again partnering with Royal Canadian Mint, which gives you a reliable storage partner and the flexibility of also not only working through the app, but if you wanted to take physical delivery, you can securely ship via FedEx. vaultedapp.com is our latest iteration to address a global market for gold owners who want the ease of something on their smartphone, but the reliability of someone like the Royal Canadian Mint.
Preston: David, real fast, I’m sorry to interrupt you but talk to us real quick about holding a physical position domestically or internationally. This is something that I’m just curious about, because I’ve heard different interpretations of this. I’m just curious to hear your thoughts.
David: Do I think you should have it diversified in many geographies? Yes, I do. This particular program focuses on Canada. Majority of our investors, frankly, are North American, and they like the fact that it is someplace else. It’s not in the US, but actually they can get to it. It’s not on the other side of the pond. Frankly, as we’ve talked to a variety of Indian investors as well, their sense of geography was they would never have any metals in Singapore ever, because they look at the geography and they know how vulnerable it is.
Again, you’re talking about the land mass itself. They would either prefer some place like Canada or Switzerland, where historically going back to World War Two, Hitler had the intention of coming through Switzerland to take the goal to be able to fund his efforts, but he knew that it would delay him by six months, because look at the geography. The geography is limiting. That was a value to someone who wanted to store assets there.
Preston: Okay, just one more question. What about the debate that you’ll sometimes hear people will have, whether they should keep it in their house, whether they should keep it in a safe or whatever other things you hear people suggest you should do with physical gold. I’m just curious to hear your thoughts. Real fast.
Davie: Well, I think you’re talking about degrees of skepticism and concern, and there will be a whole spectrum of people who would say, “Absolutely not. Don’t keep it in a bank,” or people who would say, “Surely that’s more safe than having it my floorboards or home safe.” Where are you on that continuum? My view is that we don’t know the future precisely, we can create some probable outcomes. If you don’t want to take a big hit in terms of the resource gold, which is legitimately outside of the financial markets but is a financial asset, if you want to mitigate the risks, spread the risk so that any one point of jeopardy is not a total issue of jeopardy for that allocation.
Preston: Fantastic. David, thanks so much for coming on the show. Stig and I really enjoyed the conversation and this was really a lot of fun.
David: Great to be with you. Thanks so much for the conversation. I really enjoyed it.
Stig: All right, guys, that was all that Preston and I had for this week’s episode of The Investor’s Podcast. We see each other again next week.
Speaker 2: Thanks for listening to TIP. To access the show notes, courses or forums, go to the investorspodcast.com. To get your questions played on the show, go to asktheinvestors.com and to win a free subscription to any of our courses on TIP Academy. This show is for entertainment purposes only. Before making investment decisions, consult a professional. This show is copyrighted by the TIP network. Written permission must be granted before syndication or rebroadcasting.
Come back soon to GoldIraAcounts.com for more news on gold investing.