January 13, 2016; Ian McAvity: The Death of the Petrodollar

The McAlvany Weekly Commentary
with David McAlvany and Kevin Orrick

“I have no doubt at all that at the end of the day all the debt that has been created, the currency turbulence that lies ahead, there is no question in my mind we are going to see meaningfully higher gold prices against the dollar, the euro, and the yen within the next 12-24 months. And I think the central bankers are all pulling on the chambers that are pretty much empty.”

– Ian McAvity

Kevin: The guest that we have today, Dave, our listeners have heard many times because he goes back, as far as friendship and sharing experiences with your father, all the way back to the 1970s – Ian McAvity.

David: It is a very small community of people who have been looking at the markets very, very critically, and have been writing about the markets, not for years, but decades, and in this case, close to half a century. Ian and my dad are both interested in the way the world works. Ian’s approach is a combination of fundamental analysis and also technical analysis. He is one of the charter members of just about every technical analyst society in the world, and is very, very highly regarded for his work of interpreting, what does this picture mean? Not as in sort of a Rorschach test, where it is much more subjective, but what do we know of history, what are the trends that play out the psychology of the market, showing up in lines and charts and graphs. So, it is always a fascinating conversation with Ian. We count it a privilege to have had him on the program every year since we started the program nearly eight years ago.

Kevin: What I love about Ian, too – it’s not just fundamental analysis, it’s not just technical analysis, but he somehow knows how to wrap it up like Will Rogers used to. He can say a single phrase and tell a decade’s worth of wisdom and knowledge.

David: (laughs)

Kevin: It makes you chuckle.

David: I think you know your subject when you can distill it down, and he can, to oftentimes things that are so pithy and one-lineresque, I am reminded of G.K. Chesterton, thinking, “That is the most quotable – I’ve got to remember that.” So, without further ado, our guest, Ian McAvity. Welcome Ian. Glad to have you back on the program again.

We have traditionally, this period of time, if you are looking at the stock trader’s almanac, or what have you, you wouldn’t want to bet against stocks in an election year, or the fourth year in a presidential cycle, yet it appears that 2016 and 2017 may have a lot in common with 2008 and 2009. What do you think?

Ian: I think they have got a great deal in common with 2007, 2008, and 2009 because in many respects the big bailouts of that era were much more driven by the Fed and the banking system than by the political cycle and I think that we are now basically perhaps on the fringe of the second half of the systemic challenges to the banking system. I am extremely skeptical about what I see, and when the Fed start to raise interest rates – or tries to raise interest rates – I don’t believe that they are going to get four interest rate increases done. I will be surprised if they don’t actually cut them sometime by midyear when the globally economy starts to really impact the U.S. economy.

David: So we had the Fed-driven, on the last go-round in 2007, 2008 and 2009, and you say less politically influenced, having been through a full cycle of decline and then “recovery” with that monetary policy offering something of a boost, what do you see in this political cycle? More fiscal stimulus? Or could you even go back to the monetary policy side with any real credibility?

Ian: I think we end up – in terms of the political cycle, the thing that amazes me is all of the honchos of both the Republican party and the Democrat party, I still don’t think they really get what the Donald Trump phenomenon is all about. He is basically reflecting Main Street’s anger with Washington and it doesn’t matter what party they are. Main Street has not been treated well by Washington under the two terms of Obama. And even when the Republican side controlled the various houses. And Main Street is mad. And that is what Trump is tapping into. And this political cycle is particularly interesting in the context of Hilary as to whether or not should be in jail rather than running for president, on the one hand, and Trump on the other hand, who scares everybody. So it is an amazing political cycle, but I think what we have started 2016 off with, this massive liquidation of financial assets tells us that the shadow banking system is coming under stress in response to all of the good words that the Fed is trying to issue, but the shadow banking system is heading for the exits.

David: So having the worst four-day start to the year in the S&P 500 index, specifically, going back to the very inception of that index in 1928, does that mean anything to you?

Ian: I know about the first day and the first five days and the January barometer and all that stuff, but I think what we are seeing right now is something a little different, in the context that upside volume and downside volume ratios basically peaked in 2014 when the Fed first started talking about tapering off the QE-3 stimulus, and they didn’t actually taper it off until a month later. But in essence, you have started to have a diminishing balance of on-balance buying. And most recently, accumulative on-balance volume buying has broken down in this four-day period. And I take that as a really serious technical indicator that we have completed the topping formation that has a lot of time on it. It’s a big pattern in terms of the volume.

David: Typically, policy shifts, thinking of monetary policy, can be a trigger for something – long-term positive, long-term negative. Let’s assume that the Fed believes their own B.S. and judges according to the CPI and according to the U3 unemployment stats, that we really do have a broad-based recovery. What does the continual lifting of interest rates portend?

Ian: They are pretending to be getting back to “normal.” The zero interest rate policy has been an extraordinary distortion of market forces for several years now. And I can respect them wanting to get back to something resembling normal where there should be a return on capital of some sort. But the problem is they have flooded the system with so much liquidity on the one hand, and so much of it is in bad hands, driven by bad motives. It is all basically robo-trading now.

The Fed really sort of painted themselves into a corner and they are trying to pretend to get out of it, but I’m not sure that they can, because it is not just the Fed at this point, you have the ECB and a variety of central bankers around the world basically mimicking the premise that somehow if they can get the stock market up that will trickle down and do something for the economy.

David: And it seems like on a broad base people are beginning to discount that. Certainly you and I agree that raising rates another four times in 2016 puts central bank policy on a collision course with the equity markets and risk assets in general. But all we have in the bag so far is a single rate move in December. You have said before, and I have heard it other places, too. Three steps and then a stumble is the classic description of what it takes to convince the markets that a real policy shift has occurred. Maybe you can talk to me about the stumble that you might anticipate and if we saw that, do they reverse course and instead take rates into negative territory?

Ian: Well, Europe did. Switzerland has. Part of the problem is they are still pretending to be trying to create some inflation and doing everything in their power to ignore the word deflation because it has such nasty connotations to the 1930s. In point of fact, what they have done is, they inflated asset values in a world that is basically experiencing deflation. And the stronger dollar is adding deflationary pressure to them. And to me, the old “three step and stumble” rule was when you had sort of long lags in monetary policy and they were not frequently, shall we say, managing, on a week-to-week, or month-to-month short-term kind of a horizon.

But really, going back to the tail end of the Greenspan era, the central bankers basically claim to be data-dependent. I think the S&P 500 is the most important piece of data in all of their deliberations. I think they are more driven by the stock market than they are by a lot of things they claim to be trying to monitor. And the premise of a central bank trying to manage unemployment and inflation at the same time, essentially, they have a mandate that can’t really be attained. The central bank really should be only concerned about monetary policy and a stable, credible currency. But somehow they feel obliged that they have a tap that they can turn on to create jobs. It just doesn’t really hold up. That is the game that we have been pushed into over the last 10-15 years.

David: The popularity that comes with being a master of the universe is something that seems addictive for the crowd, as well. But back to that issue of negative rates, if the central bank begins to get re-involved, do the equity markets start behaving as they did between 2009 and 2015?

Ian: I would be very surprised at this point. I think that the tide has shifted on equity markets globally. Again, most global stock markets peaked out a long time ago. Only the U.S. market kept on making higher highs up until the past six months or so. Most of the world peaked out in 2011 – some in 2011, some in 2013 and 2014. But in essence, I think we have started a global bear market, and the problem that the U.S. has now is that they have flooded so much of the world with so many dollars that that becomes the global money supply behind those markets. And when you have the majority of those smaller markets heading down it is almost impossible, I think, for one market to go against that trend, no matter how big it is.

David: Here in the U.S., if we are, in fact, in a decline economically now, which I would argue we are, and I think you would agree with that, this would be the third major decline economically, and/or in the stock market, in the 15 years since we started a new century, on a new millennium. In real terms we haven’t made any progress to get excited about.

Ian: Exactly. The great secular bull market, in my book, dated from the 1974 lows to 1998, 1999. 1998 was the bailout of the long-term capital management of major Asian market prices, and then the tech bubble kept on going into the beginning of 2000. But in essence, we have put in three very, very major speculative tops. The 2000 top was largely the tech bubble. The 2007 top saw more of a financial bubble. And the interesting part about the tops that we have been putting in for the last two years is that it is coming down to a debt bubble that is even touching into sovereign debt, where you have Greece, Portugal, Ireland, Italy, and a number of global countries where the sovereign debt has come into question. And in essence, you have had more money thrown at keeping this one going than ever before. And in many respects, if you think of somebody with a six-shooter, once you have heard six shots, you expect that the next one is probably just going to be a click on an empty chamber. I think that the central banks are rapidly running out of bullets that they can fire.

David: Well, that ties into what Richard Fisher, the retired Dallas Fed president, said recently. He said the Fed is a giant weapon with no ammunition. He went on to say that the markets are digesting a front-loaded rally which was compliments of the Fed. So, what would you expect, Ian? A contraction? Or just a flatline for a long, long time, the equivalent of the invisible crash that we had between 1966 and 1992.

Ian: In essence, what they are trying to create is an invisible crash. They are trying to create some inflation to keep the illusion. And I’m just not so sure that they are going to be able to because I think that the bubble that is going to get popped is in financial asset prices. They changed the rules back in 2008, 2009 so that the banks didn’t have to account fully for a lot of the problems that were hidden in layers down in their balance sheets, and I still look at this mountain of hundreds of trillions of dollars of derivatives which they claim they have a valuation of metric on them, but when you look at the gross amount of the derivatives, just remember that a derivative is essentially a daisy chain. You don’t know who all of the parties are in that chain, and when one link breaks, suddenly that whole chain is contaminated, not just the little volatility ratio that they are measuring. So you have hundreds of trillions of dollars of these things out there and I don’t think anybody really understands the mechanics of them, or where the risks really lie. The banks have been enabled to essentially hide a lot of that.

David: And this brings back that interesting question, but what I was asking earlier about policy shifts, the Federal Accounting Standard Board, you have an accounting rule that was used during the context of the crisis to make banks look healthier than they were, and one of those regulations just rolled off the books – the debt valuation adjustment, or DVA. It is no longer going to be included in net income. So you have this subtle shift in how people account for loans that have soured. And they were actually able to take losses and turn then into paper profits in the context of 2008, 2009, with this FASB rule. It’s gone now. So again, it’s almost like you think everything is healthy, and you start peeling back the layers, and you realize, “Oh my goodness, inside it is still rotten to the core.” And we have just had these artificial things that have allowed us to perceive health and stability.

Ian: That is why I am referring to the bear market that I think has now started as part 2 of the 2008, 2009 because they didn’t cure much of anything. All they did was put it under the rug and push it off into the future. They kicked the can down the road. The problem is they’re running out of road.

David: So if it is a play in two acts, number one, the intermission seemed a little bit longer. It certainly was longer than I expected.

Ian: Basically, that is what QE-3 was all about. I think Bernanke panicked at the end of 2012, because that break that we had in 2011 was tantamount to what would have been a normal rebound off that crash. In 2012-2013 we would have been going into the next leg down. And QE-3 was basically brought in in a panic, QE-3 and then QE-4, because they started buying mortgage debt and then government debt, as well. They panicked to make sure that that leg did not happen. And to me, everything we have had in the stock market from 2013 into the middle of 2015 I refer to as the Fed QE-3 bubble.

David: So, let’s look at something kind of odd from the beginning of the year now. Gold and the dollar are rising at the same time as 2016 begins. This is different. It is positive for gold, but what is the broader significance?

Ian: This is the reflection of the FOREX turbulence that I think is building up. We have had this before where gold and the dollar have risen together in prior periods. And basically, it is a shifting of the gears in the relationship. If you think of the post Bretton Woods era as really being driven by three major currencies, it was the dollar on top, it was previously the Deutschmark, now the euro. All the histories that I show on the euro I just convert to the Deutschmark history. And then later on in the 1980s and 1990s the yen became prominent. So I think it was the “yes we can” currencies – the yen, the euro, and the dollar.

But in essence, so much prosperity was spread around the world that the rest of the world basically had real industrial revolutions of their own, and real growth and created real wealth, and they have governments that have built up a lot of reserves by exporting to the established world. And they have started to stand on their own two feet and resist what I call the old boys club. And particularly, after they threw Russia out of the international payment system after the Ukraine incident, that pushed Russia into working much more closely with China on essentially developing an alternate payment system which they are doing step by step, with the Chinese controlling it very effectively. And they are now attracting Saudi Arabia, they are attracting India. A lot of these major external holders of dollars are increasingly going to be working more closely with the Chinese and resisting some of the urgings of the old boys club, or what I call the old guard, or the colonial attitudes of the old establishment.

David: And that still is the Fed, the ECB, and the Bank of Japan which are the old establishment in terms of the banking community.

Ian: Yes, and the Bank of England. It always amazes me, the number of American financial experts that seem to have English accents tells me that there is a colonial attitude, still, behind a great deal of our American foreign policy and international monetary policy.

David: So what are oil prices signaling here. Near eleven-year lows for Brent, do you see more of a supply story, or does demand factor in as well if we have a slowing global economy?

Ian: I have had a view for well over a year that the oil price is going down to the 30s because the Saudis never forgave Obama for throwing Mubarak under the bus in Egypt, and when he started cozying up to Iran, basically, I think we’re back into a 1973-74-75 oil war where the Saudis are using the oil weapon in retaliation for American foreign policy moves in the Middle East, and it has become particularly egregious during the nuclear deal with Iran now. And I think the Saudis are putting the oil price down. When it was over 65 I was talking about the Saudis putting it down into the 30s to put the Canada oil sands, the Venezuelan oil sands, and the U.S. frackers out of business, in retaliation for America separating somewhat from them. And subsequently, we now see the degree to which supply/demand considerations are in there. But to me, it was driven largely by the Saudis in political retaliation. That, to me, has been the driving force on it. I think we are probably going into the mid to low 20s and there is no question it has done huge damage to the Canadian oil sands. I’m not sure what the Chinese are doing with the Venezuelan oil sands, we don’t hear much about it. And I am just wondering how much of all the junk debt that was floated to build the U.S. fracking industry is in American banks, and how much of it they were able to export into all the banks in Germany. I suspect that a lot of that debt has ended up owned by some of the smaller banks in Germany that become the dumping ground for Wall Street’s bad paper.

David: That’s an interesting point. One of the things that many companies will do is try to accommodate their models for short-term volatility, but like we have seen with the metals market, maybe things going beyond what was anticipated, at least from our vantage point, if oil stays down a considerably longer period of time, you have to roll your contracts for the oil majors who have been largely hedged to this point. You have to roll your contracts, and you really begin to face reality as time wears on. How long do you think the Saudis can continue to play that game while they are eating through their foreign currency reserves?

Ian: They are burning up their foreign currency reserves at probably a scary rate. My guess is that they are probably beefing them up a little bit in the context of probably shrinking the proportions of their foreign reserves to burn dollars, and they well be getting a little help from the Chinese. And they are going to start increasingly selling their oil for other currencies than dollars. The death of the so-called petro dollar has been under way for a while now.

The other element that I don’t hear many people talking about is the degree of derivative contracts that are outstanding on oil, and who actually has the risk on them. It is sort of amusing that when we were at $130 oil all of the airlines were slapping us with energy surcharges and all that kind of thing, but believe it or not, with the oil price under $40 you are still paying energy surcharges to the airlines. You are taking $90-100 off the oil price, but we still have to pay a surcharge? To what degree have the airlines shot themselves in the foot with some of their hedging? And how about the investment banks that advised them on buying these marvelous ways to lose money? They destroyed American Barrick with hedging programs and to what degree does a lot of American industry have a hedging problem that is going to come back and bite them?

David: So we have oil prices signaling something here. What are copper prices signaling?

Ian: Copper tells you, certainly, that global manufacturing is down. Again, the copper market got distorted because copper, in many respects, became a monetary instrument within the Chinese shadow banking system, and a lot of that stuff is coming back out again. But I go back to – there was a CFDC report, what was it, back in, I think, 2012 they reported it – and there was a period there in 2012 where J.P. Morgan, by itself, basically had control of any number of industrial metal markets through their trading and their long positions. In 2011 J.P. Morgan’s inventory of aluminum exceeded 3.3 million metric tons, which was more than half of U.S. aluminum consumption that year. What is a bank doing owning half of the national consumption of aluminum? What does that have to do with banking as opposed to being a hedge fund trader? And how many other markets have they been doing that stuff in? That is what concerns me, and what amazes me is we are continually told that the gold and silver markets are the only unmanipulated markets around, and every time the banks get caught manipulating a market they get a slap on the wrist and I suspect they keep doing what they were doing before. I think that there are a lot of problems in the oil market that can actually come back into the banking system as much as the supply/demand at street level. The biggest single mistake in U.S. fiscal and financial and securities markets policy, to me, was eliminating Glass-Steagall in 1999, essentially giving the major Wall Street banks the license to become casino operators. And we have not really heard anything about that since. I use the aluminum example, and you are talking about copper. At that time J.P. Morgan controlled 200,000 metric tons of copper, 100,000 metric tons of lead, 6½ million barrels of crude oil, plus more heating oil and gasoline and jet kerosene. And they also mentioned that they controlled tolling agreements at 31 power plants. The involvement of J.P. Morgan, Goldman, Morgan Stanley, that core group of derivatives issuers, they had their tentacles on everything in the commodity boom that has subsequently gone bust. And we just don’t know where the risks – where the cockroaches are going to start coming out from under the carpet. We don’t know where that is going to come from. I don’t believe that any of their academic professors from Princeton have got the correct formula for what the actual value of risk is. I know they don’t know.

David: Do we see any of those cockroaches beginning to emerge in the credit markets?

Ian: I think that they are starting to. I think we saw that again it was a way of exposing some of the structural problems to the whole ETF business, when you started getting this wave of redemptions coming out of the junk bond ETFs. There is a presumption that all those ETFs are perpetual instruments of liquidity, but you have a wave of redemptions coming out of them and suddenly the market makers are just not going to be picking up their phones because they haven’t got a market to sell it into. The breaks in the high-yield junk bond ETFs, I think, were really quite instructive, but the system is starting to come under a fresh round of duress.

David: The liquidity that is implied in an open-ended fund isn’t necessarily there when the underlying assets don’t have market makers that are willing to back them to the hilt, is essentially the lesson.

Ian: Exactly. And the other problem in the bond market is, traditionally, in times of stress, the first true haven that money would flow to in a financial market would be into government bonds but the problem is, the Feds bought most of them. The Fed owns most of the government bonds at this point, so you haven’t even got that much liquidity in a lot of government issues.

David: Going back to gold for a minute, we have had central bank demand for gold, which has been on the increase, jewelry demand, which is more or less predictable year to year – it doesn’t change a tremendous amount. What do you think are the circumstances that drive investor gold, which is kind of the swing vote in the market, back into a favorable position with gold?

Ian: Because of this increasingly short-term focus robo-trading, all the algorithmic trading that goes on, trends, in a sense, become self-sustaining to some degree. There is no question that the algo-traders have gotten themselves in to the mindset that a strong dollar means a weak gold price. And they trade the ratios between gold and other metals, as well. But to me, the biggest thing, and the most simple definition of trends is, it is one thing to put in a bottom and do some basic, but you still have to produce some rallies with a higher high. And there certainly has been pretty concerted efforts that every rally we have seen in the last three years has been blown out of the water.

And what is extraordinary is that the way some of those tops have been put in is by a massive seller stepping into the market at 10:30 at night just before Hong Kong opens when everybody else in the world has gone to bed and all of a sudden somebody is selling 5,000 tons. If you are trying to maximize your proceeds you don’t wait for the single least liquid moment of the day to hit the market, and yet that is what we have been going through for the last couple of years.

To me, the real evidence that the game has changed for gold will be when we get a meaningful higher high which is probably somewhere up in the high 1200s, 1320s, somewhere in that range. There is no question we are seeing some promising action in recent days. And we have seen some encouraging action with the gold mining shares bottoming and holding their low when the gold price itself made a slightly lower low. That has historically been a pretty bullish indicator in the cyclical bottoming process. It doesn’t say that we go to the moon tomorrow, but it is a bottoming indicator.

There is bottoming evidence building, and what worries me is the group that I call the javelin-catchers, every time we get any kind of a bounce at all, suddenly you get a rush of people saying, “That’s it, here we go, gold is going back to $1800 or $2000.” I refer to them as javelin-catchers because I remind people that javelin throwing was an Olympic sport but javelin-catching never had enough survivors to mount a full team. And in essence, the bottom-pickers, I think, are just a little ahead of themselves in the short term. I think we are in the bottoming process. I still wouldn’t be surprised if we saw one stab under $1000 just to really pull everybody’s chain one last time.

But I have no doubt at all that at the end of the day, all the debt that has been created, the currency turbulence that lies ahead, there is no question in my mind we are going to see meaningfully higher gold prices against the dollar, the euro, and the yen, within the next 12-24 months. And I think the central bankers are all pulling on the chambers that are pretty much empty.

David: You mentioned the gold miners and their performance relative to gold as a positive sign in the market. Silver has yet to really confirm that. What are your thoughts on silver and the gold/silver ratio?

Ian: I am probably going to be putting something out in the next 24 hours, the piece that I did last night. I was running out of time and energy to do a piece on silver, but I am even more bullish on silver out running. But at the same time, silver will tend to lag on the turn. But then once it gets going it becomes gold on steroids. We have had multiple bottoms in the silver/gold ratio when you have been in the 78-80 area, which is where we are back to now. And you get any kind of positive sentiment going in the market and you are going to see the gold/silver ratio back up to 40, which implies that silver is going to outperform gold by a factor of 2. I love silver, but again, there is no rush to buy it tomorrow morning. I think by the time we get the gold market going, silver is going to get its track shoes on and it will be surpassing gold probably toward the end of the first serious lap that we do on the upside.

David: So with the track shoes in mind, curiously, we also have platinum in a ratio to gold which you would have to go back to 1980 for the equivalent sort of discount to gold. Does that make gold expensive, platinum cheap? What else would you read into the charts, looking at platinum?

Ian: I think that platinum is a very expensive industrial metal where gold and silver are still monetary metals in the minds of Jane and Joe six-pack all over the world. Part of the problem I have with platinum – there is no question platinum is in a very bizarre situation, particularly because of the problems in South Africa, which is where most of it comes from. The one challenge to platinum – I used to track the platinum to gold ratio but I stopped doing it years ago, when they shifted the focus over for a lot of the pollution devices in cars to palladium, because for a few years we thought that there might be some way of trading back and forth between the platinum and palladium ratio, and whenever one got out of line the automakers would shift back. But then I talked to a guy that was a metallurgist, and he explained that once you switch over to palladium, you are never going back to platinum. It is a very different, more expensive process. So I gave up on the idea of ever trying to trade the platinum/palladium ratio. The problem with platinum is it is such a tiny market. I really don’t pay that much attention to it anymore.

David: Let’s talk about allocating capital in the context of competitive currency devaluations. By implication, if gold is increasing in the context of dollars, yen, and euro, that says to me that all three of those currencies probably, along with a host of others, are in decline. What are your risks, what are your considerations, what is your advice when it comes to investing in the context of a competitive currency devaluation?

Ian: Competitive currency devaluations have been going on for some time and the biggest problem that I see is an awful lot of people think that they want to get into a currency that they have never owned before and they start viewing it as a trading chip. Years ago when it was popular, everybody in America wanted to boast about having a Swiss bank account. But when you actually talked to an awful lot of them they had never been to Europe before. And yet, when you asked them about it they would say, “When a crisis hits, I want my money in Switzerland.” And I would say, “That’s a long swim in a crisis.”

To me, a lot of the currencies are not really appropriate for people that aren’t globally inclined. And for Canadians that go down to the southern states for warmth, the snowbird crowd, it makes sense for Canadians to own some U.S. dollars to cover their winter expenses. And similarly, I think, the proximity of Canada to the U.S., it makes sense for Americans to travel north to maintain some balances in currencies they actually use. And I am very concerned about the viability of the euro with this sort of radical Islamic invasion of refugees that are coming in, because there are divisions that are unfolding in Europe that are really quite scary to watch. The separatist movements, independence movements, that are starting up in Spain, and the Scottish incident last year will be returning. I am just very concerned about the political structure of the European Union and the European monetary system so I’m not sure that I would be going to Europe at this point.

The Canadian and Australian dollars are going lower as long as the export commodities are going lower. The Canadian dollar I would be interested in buying at 62 cents, not at 72 cents. I think we are going down into the low 60s again where we were back in 1999 to 2001. But for the most part, for most individual investors, I wouldn’t get too caught up into the currency arena, because I know that a lot of smaller short-term traders get sucked into a lot of these highly leveraged internet FOREX trading systems that invariably are just going to cannibalize your capital, because there is going to be volatility where you are going to get hit with margin calls in the middle of the night and that kind of thing where you are going to be just liquidated out. I still trust the Swiss system from a longer-term stability point of view, but again, they are caught up right the middle of the potential vortex of whatever is going to unfold in Europe.

The problem the dollar has, and this is the strength that the dollar has right now – you have heard me use the line for several years that basically, the dollar is the best-looking horse in the glue factory. It is winning because everything else looks worse. And the problem with it is that the U.S. can’t afford to have the strong dollar get much stronger because then it starts to severely impact the earnings of all the U.S. multinational companies. And basically, a strong currency exerts a deflationary force, and the last thing that the Fed wants is any more deflationary forces on the U.S. economy.

David: Well, certainly as we have looked at the numbers coming through the last couple of quarters, it looks as if we are at the end of a profit cycle with U.S. equities, so any additional pressure would be unfortunate at this point for the U.S. equities markets. When you look back at previous profit cycles, and then look ahead, what we might have in the next 12, 24, 36 months, what do you see?

Ian: Basically, we are into a global slump, and that global slump is not going to turn around quickly. China put us on notice that they were transforming their economy to building domestic consumption, and they are having a hiccup at this point. But the rest of the world just assumed that China was going to be this perpetual vacuum sucking in every commodity on the planet. And China for two years talked about making the transition that has now surprised everybody. The world had plenty of notice that this change was coming. And there is no question, they have all sorts of problems that are starting to pop up on them. To me, the biggest surprise is that they haven’t had more problems because of the amount of extraordinary growth they have put on over the last decade. They are going to come through it, and I think probably the biggest difference is that three to five years from now China is going to be economically stronger, where most of the mature world is sort of hoping that they might be relatively where they are now three or four years from now and how they can sustain it. The emerging markets made real progress over the last decade. They are giving some of it back, and they are going to give a little more of it back over the course of the next year or so, but they have made progress where the rest of the world has not really made much progress at all. We have just buried ourselves in more debt problems.

David: So there is a wide acknowledgement of an industrial recession globally, here in the U.S. as well. What are the odds that we contain that and keep it from spreading? And keep it just in the “industrial sector?”

Ian: That would be unusual in my book. I would be surprised.

David: We would agree.

Ian: Globalization was a wonderful thing for a while, and it basically kept on going and accomplished a lot on a global basis, but once it gets into a period of turbulence, that turbulence is like a nasty hangover. You can’t wish a hangover way, you have to go through the process. And the problem is, back in 2008, 2009, they didn’t really let the markets clear. A lot of that mortgage debt should have just gone up in smoke. It shouldn’t have been bought by banks and sustained and maintained. There was just this reluctance to let a market clear out, that has just, in a sense, kicked the can down the road and causing a bigger problem when it does surface. As things slow down we are going to see them try to kick the can further down the road. I don’t know what rule changes they are going to come up with this time, but for sure, they will try.

David: And this brings up back to sort of Act Two in the play we know as Global Recession/Depression. When you look back at the charts you see some interesting relationships from 1966 to 1982. That was a pretty rough period for stocks, and it was a great period of time for gold. So, if you are looking at the Dow-gold ratio, that was a period of out-performance for the metal. You increased your purchasing power pretty considerably. There was a two-year period in there that was very rough for the gold-owner and great for stocks. I’m wondering if we have just lived through an extended version of 1974-1976 where there was no joy in Mudville for the gold owner those couple of years, and the stock investor looked like a genius, temporarily.

Ian: Well, think back to what was happening. When the gold price was liberated in 1968-1971 it was at $35 an ounce. The first run took it up to $200 an ounce, or $199, on January 1, 1975. That was the day that Americans were allowed to buy gold that was not numismatic. The right to own gold was restored in the U.S. And I was operating in Canada and we were all waiting for the American buyers to come storming in on January 2nd of 1975, but somebody forgot to give them the phone number, because the gold price topped out just prior to that and then proceeded to go from $200 right back down to $103 in mid-1976. In many respects, that was a very strong period for the equity market, and a very poor period for gold. That is really what that corrective period was.

And I agree with your analogy of that 1974-1976 correction in that great run in the Dow-gold ratio. And I think that that is what we have been in since 2011. It has been much more extended, and it has been extended in many respects because the QE-3 and all the extraordinary measures that Bernanke threw into the system. But at the same time, to me, when you look at it, the ratio basically retraced about one-half of what had moved, and it seems to be stalling around the same levels that it was in back in 2006. And in a sense, on the run up, 2006 was a fairly material breakout point. So we ran into resistance, we haven’t turned the ratio yet. I think that we are still headed sometime in the next two years, the way I refer to it is, 20/20 vision from 2020. I think we will have seen a crisis that will have taken the gold ratio back to something like a 2-to-1 ratio.

David: So those are the kinds of extremes that you would ordinarily associate with a crisis. We got as low as a 6-to-1 ratio in the global financial crisis circa 2008 and 2009, and then that number has reversed course, again, similar to the way that the Dow-gold ratio reversed course in 1974-1976.

Ian: Bear in mind the other extreme on that was when gold was flat on its back in 1999-2000. You could take one unit of the Dow and get 45 ounces of gold for it. That was really the beginning of the modern gold cycle, and to me, that is the cycle that we had this tremendous run-up, and we are still in the corrective mode, and I think that we are still, in the next few years, headed back down to that 2-to-1 ratio. That would be the other retreat.

David: So gazing into the future, your 20/20 vision sees sometime between 2020 and 2025 on the calendar, something like a Dow-gold 2-to-1, maybe even 1-to-1.

Ian: Exactly. We have been below 2-to-1 three times: 1896, 1932, and 1980, and is anyone going to try to tell me that the financial mess that we have today is less than any of those prior crises? I just don’t see that this isn’t the greatest financial crisis in the history of mankind when it starts coming unglued.

David: So looking at the categories of danger, we have been talking about great financial crisis immediately ahead – financial crisis and economic crisis, there are some inter-relations, but looking at the greatest categories of danger, what keeps you up at night? Economic? Financial? Cultural? Political? Martial? What would have you concerned?

Ian: I would say geopolitical in the Middle East and Europe, and the fact that there is a crowd that is almost trying provoke a war. My biggest fear, when I see the riots in Paris and in Germany, there is a divisiveness that just has too many shades of the past. It makes me really uncomfortable. I have never been more uncomfortable in my memory. I remember having some Jewish friends in Europe when the Russians rolled the tanks into Prague about 20-odd or 30 years ago. And watching some of the stuff I’ve been watching on the international news in the last couple of weeks is just really spooking me.

David: Who wins in the context of military conflict, if there is someone trying to provoke a war?

Ian: Cockroaches will be the only survivors.

David: (laughs) Resilient little buggers aren’t they?

Ian: (laughs) You can’t kill them.

David: Even after you step on them.

Ian: You might appreciate one of the lines that I’ve come up with in recent years. I finally have figured out, in the evolutionary Darwinian chain, as to where cockroaches came from. And I finally think I’ve identified the link. I think they are securities lawyers.

David: (laughs) Aha. Well, we appreciate your thoughts, missing Deliberations on World Markets on a consistent basis, but know you have had a couple of busy years and look forward to you republishing at some point. When you are ready to launch that we will let our listeners know so that they can benefit from your wisdom.

Ian: I will be writing something. One big change that I have suggested for years, and I know philosophically you’re in the same camp, in the context that the true value of gold is that it is the ultimate intergenerational wealth transfer mechanism, in terms of the longer-term preservation. It is not a trading tool, it is longer-term wealth preservation, the purchasing power of preservation. One of the points, with some of the rules they have put in now about holding larger quantities of gold, I have recommended to an awful lot of people that the best thing a grandparent can do for the grandchild is at every Christmas, birthday, anniversary, or special occasion, just put another one-ounce coin into a pickle jar for that child, and I bet that in 10-15 years’ time, or when that child is going to college, that pickle jar probably will go father toward paying for the college education of the grandchildren than any other financial instrument that is out there. We don’t really know what the deflation/inflation consequences are going to be, or what the currencies are going to be, but holdings of small gold is what I have really shifted my focus over toward.

And the other point I wanted to make, if I can get one little plug for the one entity that I am involved with is Central Fund of Canada. We were upheld in a challenge of the Alberta Supreme Court where the nonvoting shareholders tried to give themselves votes and the Alberta court turned them down. Central Fund of Canada is gold and silver, 45 ounces of silver for every one ounce of gold. And I have been the champion of the silver component of it because of silver volatility. And when I see Central Fund trading in the area of a 9-10% discount to that asset value, if somebody is worried about a 10% correction in the precious metals prices from here, it’s already priced into the Central Fund shares. I am a director and very much involved in it, I own the stocks, so I am completely biased and speaking from a long bias position. But in the current climate it strikes me as something people should be paying some attention to.

David: Well, and as a professional asset manager, we use Central Fund of Canada, and it is a very useful tool. And you are precisely correct, when you look at a 9-10% discount on a closed-end fund, you can factor in and give yourself a cushion for any further decline in the metals price. So if you wanted to buy sub-thousand dollar gold today, you can do that via CEF. If you wanted to buy closer to $12, $12.50 silver, shave off 10% and whatever your number is, that is where it is at today, so buying that at a discount, the nature of a closed-end fund is that it does trade at premiums as well. And I think that the value of having that as a closed-end fund can’t be overstated.

We do appreciate the last couple of years, your defending the position. CEF was recognized as sort of a gem and another firm wanted to own it outright. I think you did a good job defending its status for a U.S. investor because it gives us a number of intriguing benefits.

Ian: It has been an interesting battle to observe the pressure that somehow an ETF has a daily tracking mechanism, yet there is a very long history of closed-end funds as a very useful investment tool for money managers because they typically will trade at a discount in that asset value on a fair market. And they have typically traded at a premium of that asset value in the subsequent bull markets. So in a sense, the closed-end fund is the most conservative way of building in a little precious metals leverage in the right market climate without having to use margin or taking that much more risk. The challenges being that somehow or other the ETF model tracks on a daily basis, to me, Central Fund was designed for investors, not for traders.

David: That’s right.

Ian: It is an investment instrument. And so, to me, there is a battle under way in the market for the continuing existence of the closed-end fund structure. I think it is a very important structure to protect.

David: Particularly with the metals. When you look at having a position in metals, number one, it offers you some geographic diversification, number two, it allows you to see an asset mature from a short-term capital gain to a long-term capital gain, which you don’t have with a number of other products. So truly, what you have just hit on is very important, precious metals being, number one, an intergenerational wealth preservation tool, and I love the picture of putting a coin in a pickle jar each year, and having something to show for it. Your kids, grandkids, being able to cover their expenses and look at something like a college education as a very reasonable expense priced in gold. And as you mention, your status with Central Fund of Canada.

Thank you for the work that you have done in the metals markets, and in the markets in general, analyzing world events and their impact on a variety of asset classes, as you head into your mid-70s, you’re looking back at a lot of years, a lot of gyrations, a lot of interesting changes, and we will be very interested in the wisdom that you share with us in the years ahead as you continue to publish your thoughts and share them with our audience. It is greatly appreciated. Thanks for your time.

Ian: Thanks very much, David.