November 18, 2015; Tragedy in Paris & Our Crucial Response

The McAlvany Weekly Commentary
with David McAlvany and Kevin Orrick

“We know what the record is. We know what the record of success is in terms of big government stepping in to solve any problems. And so, I think if we are going to see a successful resolution to the crisis in Paris, and whatever crisis we may see hither and yon around the world, it is going to boil down to our internal orientation and the values that we live our lives based on.”

– David McAlvany


Kevin: There is no way we can start this show without talking about the tragedy in Paris. I had a number of clients ask me this week, knowing that we were going to be recording, “What does this mean? What does this Paris tragedy mean?” And not trying to be shallow, but they wanted to know, “What does it mean politically? Does it mean something for the markets? What does it mean for the way the international community, from this point on, responds?”

David: I think it is very interesting because it adds a new tone to the underlying currents of the markets, and of politics, both here in the United States and in Europe.

Kevin: What amazes me, though, Dave, is how few people can affect an entire world. If you look at these guys, there are only a few shooters, there are only a few bombers, and yet the entire world at this point is just shivering in their boots.

David: I think it is worth remembering that the impact of a few people can either be incredibly positive, or in this case, incredibly negative. So, not to play Pollyanna, but just as a few people can harm the world, a few people can absolutely change it. And I think this scenario in Paris was absolutely unnecessary, it was absolutely blind and misguided, it was absolutely cowardly and cruel. And in my view, as a man, I look at it as incredibly unmanly in every way. Strength is there to serve the purpose of protection and care and provision, not violence, not blind rage, not reckless savagery. So, I think the appropriate response is to end that criminality, to curtail it, to address the problem at its source. In essence, cut off the head of the snake.

Kevin: And why don’t we start calling it what it is? If you talk to anyone in the military right now who is in the Middle East, they understand who the enemy is. We’re just not allowed to say it on the news, we’re not allowed to say it in public, we’re not allowed, actually, to talk about it at dinner.

David: Yes, this is an Islamic problem, and there is no issue in talking about it in those terms when you realize that we had 300 years of benign Muslim existence, and that’s all we need is another 300 years of benign existence. And in every quarter where it is malignant, it needs to be cut out and destroyed. And the idea that you can have dialogue with insanity is insane, itself. And that is not to say that we shouldn’t have very constructive dialogue with Muslim quarters that are, as I say, benign. Now you are talking about a reasonable conversation with reasonable people. But where you find insanity, it is an insane project to try to reason and come to the table. That is not a place where dialogue can occur.

Kevin: We in the Western world have gotten comfortable, Dave, especially here in America – we’ve never been invaded, really, and we have two oceans that have protected us through the years. It is a real blessing, actually, that we have been protected to the degree that we have. But I look at these attacks and actually, a lot of times the response that we see from our government is how are we going to keep your sense of comfort and your sense of security and your sense of privileged life alive?

David: Right. More important than our external social, political, or even military response – it is the internal response, I think, that we have an individuals, and ultimately, as nations, which are really the expression of, or the composite view of our values and our orientation to reality at the national level. And it seems to me, and I would echo what you are saying here – it seems that behind our Western European and American response is a certain frailty. We saw it with 9/11, and we may see it again now. We cling to a way of life as if that is our identity.

Do you remember George Bush’s reaction? “Our way of life has been attacked.” That is close to a verbatim quote. And what was his reaction? We were supposed to go out and do our patriotic duty and spend some money. It seemed very trivial at the time – what does that have to do with anything? But get out and spend some money and at the national level we’ll implement the Patriot Act and protect the homeland so that your mall experience goes undisturbed. And perhaps it is a view of the good life, and experience of modern material success, but when we lose it, when we see it fade, we go crazy trying to get it back.

Kevin: Well, we seem to protect the wrong things. We’re trying to protect our ability to spend money. Like you said, when George Bush came out and said, “Go spend money, it’s your patriotic duty,” that’s another form of insanity. It may seem more civilized, but it is another form of insanity to say that we, as Americans, needed to go spend money. What that does is that just reaffirms that we are protecting something that is not worth protecting.

David: What it suggests to me is that we’re talking about an identity as a people which is false. Basing our identity on secondary or tertiary things – not only is that false, but it creates false crises in life. If you base your identity on being popular, for instance, then your life and your actions are dictated by that false identity and all it takes to maintain social status, to avoid disappointing others. Or let’s say your identity is based on material wealth, then you tend to fear and loathe anything that can reduce you or your wealth, and therefore the view you have of yourself as an important individual.

Kevin: So, what you are saying is, what we should value are the immaterial things, the things that are the bedrock of what our belief system is.

David: That’s right. The conception that we have of the good life – if it’s not grounded in immaterial things, it sets us up for, I think, false and unnecessary crises. We live in a world where, I guess if you brought this back to family dynamics, the fracturing of family has reduced the strength of our individual narratives, and it is those narratives that, I think, tend to transcend even seemingly unbearable tragedy.

Kevin: So, the question would be, “Who am I? Where do I come from?” A lot of the things that you have been talking about with this Intentional Families mindset, the book that you are writing.

David: Right. What do I value that can’t be stripped away from me by change in the world around me. The family is the place that cultural values and personal identity are crystallized. And without it, identity is too easily confused with the pursuit of becoming a rock star, becoming a professional athlete, a television celebrity – I think you get the idea.

Kevin: Dave, this may seem a little elusive, but the older I get the more things start looking the same. I remember growing up, one of my dad’s favorite things to do was to go find unique little restaurants that had sprung up somewhere in Denver or wherever we were traveling – the mom and pop places where we could get something that we had never had before. And I think you grew up a little bit that same way. But now you go to these same places, and really, they’re just large chains. And driving through Southern California, you go neighborhood by neighborhood by neighborhood – they start all looking the same. It’s like cookie cutters. People are becoming like that. The distinctions between people, nations, what have you, are becoming less and less to where we really are not allowed to criticize, or even appreciate, differences anymore, because there shouldn’t be.

David: There are some ironies when we consider multiculturalism, the fact that there is a greater homogenization as we champion the politically correct version of multiculturalism, which does anything but celebrate true differences and allow people to say, “This is what your identity is, and that’s okay.” It seems to me that we are in a world with less of those intangible roots to our identity, so we see horrific events occur and we are tempted to ask those that govern to re-create some sort of a Shangri-La context, the context that we knew before the crisis which allowed for the pursuit of that false, and quite frankly, frail self.

Kevin: Remove the friction, basically, is what we’re calling for people to do.

David: Yes, the cars we drive, the restaurants we eat at, the house we live in, the music we access, our free time, the shows we watch – these are the things that define us to a large degree, and if those things are threatened then we don’t know what to do with the world. We don’t know what to do with ourselves. And the governing class loves to offer solutions of an external sort, a patch, if you will. But in my view it’s not helpful in getting to a more significant resolution of determining, number one, what your true identity is, as a person, first and foremost, then as a culture. And are we even allowed to have that strong cultural identity in a multicultural age.

Kevin: I think people are starting to become embarrassed about a strong identity, actually, because we want to be politically correct.

David: Multiculturalism, as we said a minute ago, homogenizes people more than it has, in fact, celebrated differences between them. And homogeneity, quite frankly (laughs), can be dangerous. I think of – we just had our first snow of the season and I’m very excited about getting into the back country and doing some skiing, but when snow is on the hillside, it homogenizes after being baked in the sun. And what happens is the unique crystalarity of each individual snowflake becomes just like every other snowflake as it melts and refreezes, melts and refreezes, it actually becomes ball bearing-like in its consistency and it is a massive source of insecurity for the rest of the year. I realize that is maybe an insignificant example of homogenization creating instability, but I think it is not a good idea.

Kevin: I think of a contrast, Dave, to the way the Europeans have reacted, the way the Americans have reacted. I think of Israel. I think of the Israeli people. You have been over there a number of times. In fact, you lived over there for a while. And my question would be, how is it that you have daily bombings, daily stabbings, daily shootings, in Israel, yet you have such a sense of identity in a people, and a lack of this operating in a surface fear.

David: I don’t know that they are hoping that a Shangri-La re-emerges, some perfect place where they can exist and have a perfect life. I think, perhaps, they are more reflective and philosophical, or historically in tune with hardship. I do think of the Israeli people as something of a counter example – crisis occurs, life goes on, you do what you can to prevent it, but still, life goes on. So what does allow for life to carry on regardless of stabbings, bombings, weekly rocket attacks, suicide missions? Honestly, I can only speculate, but it seems that there is a sufficiently robust cultural identity and an awareness of a shared narrative of the history of the people, that when bad things happen, panic is not the response. People are not shaken to their core. And again, this is just the way it seems to me. Because the core of those people is not defined by the expectation of ease or a conception of the good life, which is somehow neat and clean or safe.

Kevin: Well, let’s face it, the Utopian dream has led to millions and millions of deaths with communism. But look at Israel – six million deaths in what was a Utopian dream in central Europe. Now, freedom, Dave, is messy – we all know that. There is pain involved in freedom.

David: And there is the tension of bad things happening when you allow for freedom. Jefferson wrote, as he declared our independence from the British, “We hold these truths to be self-evident,” you know the quote, “that all men are created equal, that they are endowed by their creator with certain unalienable rights, that among these are life, liberty, and the pursuit of happiness.” And safety is not on the short list. Security is not on the short list. Life has always been a struggle, and how we respond to crisis defines the future of our culture.

Each culture needs to respond – and this is a key distinction – respond, and not react, or quite frankly, that false crisis born out of a very thin and frail identity, gives birth to a state apparatus that seeks to give us what we are asking for, safety and security, at the expense of liberty, at the expense of one of those intangibles which have defined our national identity here in the United states since, frankly, before Jefferson distilled it into words.

Kevin: I think of the pioneer spirit – my wife and I were watching the news this morning, and three-inch hailstones had fallen in the panhandle of Texas on Pampa, Texas, and I told my wife, “Pampa, Texas? My family pioneered and settled that town and named that town.” Now, we look back at that family, and I remember hearing stories about my great-great grandparents and how they had Indian attacks. They were facing so many things, but they had that American pioneer spirit.

And it just reminds me of what Ben Franklin said. Everyone has heard this one way or another, but he said it three separate times, and I’m going to say it three separate times, because it is worth it. Ben Franklin said, “They that can give up essential liberty to obtain a little temporary safety deserve neither liberty nor safety.” In another way he said, “Those who sacrifice liberty for security deserve neither.” And then the third way, he said, “He who betrays liberty for some temporary security deserves neither liberty nor security.” I say it three times because it’s true, Dave, you have to have one or the other, but we cannot give up our freedoms and our rights, and frankly, our national identity, based on an event in Paris, let’s say.

David: Or in New York, or in Washington, D.C., or in San Antonio, or Los Angeles. The reality is, we live with the tension of imperfect people doing imperfect things, and having the freedom to express themselves in inappropriate and uncalled for ways – that comes with freedom. But the choice is, would you have it any other way? Yes, we have laws. Yes, we have the ability for people to govern and create some sense of justice for those actions which are hurtful and harmful to other people, but that’s the rule of law.

Kevin: So Dave, this failed experiment that has really been put forward by, first America, and then Europe, to try to keep the economy from feeling any stress or friction, really going back to 2007, 2008, 2009. Wouldn’t it be ironic if this failed experiment revalidates itself in the name of defense against terrorism? You see what I’m saying?

David: Well sure, some sort of need within Europe as they struggle from a monetary, financial, even political perspective, to keep the Union together – it is interesting to see the need, or the perceived need, for a transnational security apparatus to deal with immigration as an issue, which is affecting every country in Europe, and ultimately, the threat of terror. Is that the tie that binds – a basic level of insecurity? Is that the tie that ultimately binds at the political or transnational level?

Kevin: Remember when we interviewed Otmar Issing, who was the head of the European Central Bank for seven years, one of the founders of the euro? He fully admitted that a monetary union would ultimately have to be followed by a political union. And he realized, also, that a crisis would probably be what would bring that about.

David: Right. So by all means, panic, because the government will be there to solve everything if you just given them the leeway to keep you safe. It certainly gives you reason to pause. Now, on this side of the pond, the Paris events may very well determine the 2016 elections. Certainly, they add to a social mood, and that social mood is negative, it’s dark, and it is fragile.

And so, I think the parties that convey calm, communicate confidence, speak very clear policy directions – they are going to stand out more in that context. I don’t know that nuance is going to be as important. Nuance is lost when the social mood shifts, and it moves toward something that is more inherently insecure. So that should be kept in mind, too, as you consider how the markets trade over the next three to six months. The social mood has shifted, and it can exaggerate a trend, in this case, a negative trend.

Kevin: Well, do you think, then – we’re talking politics, but as we look at the financial world, it has been glossed over with monetary policy. With quantitative easing, with the ZIRP, the zero interest rate policy, do you think that this social change, this mentality change, could also affect the security felt by this false artificial stimulation?

David: Yes, and you are seeing that in Europe. In Berlin, you have the “Wise Men of Germany,” as they are called, the Council of Economic Experts, five guys who were quoted last week as saying, “Monetary policy is leading to a buildup of risks to financial stability, which could pave the way to a new financial crisis. And what kinds of activities are they talking about? We already know the monetizing of all kinds of assets that Draghi has put in place, and Draghi continues to suggest that he is going to do more and more.

Kevin: Aren’t they even talking about buying municipal bonds at this point? So even saving municipalities.

David: It’s a trial balloon that was floated last week that the ECB may start buying bonds from the likes of the city of Paris and other regions throughout the EU. And yes, the wise old men should be paid attention to. They have seen history, they have studied history, and they have connected the dots between policies and their consequences.

Kevin: When you look at a chart of recessions, as far as what we would call an official recession, you see the little gray shaded area, and then you see the clear area, then you see the gray shaded area. About every seven years you see a recession. Now, it has been officially about seven years since we have seen a recession. I think the gray, shaded area has started and they don’t know what to do because they still employ the same techniques that they were employing when they were trying to get us out of the last one.

David: I think it is worth noting, as we are through the third quarter earning season, yes, revenues were down, they were disappointing, but it was very interesting, when earnings were announced by a given company, the disappointments were met with an absolutely punishing and sharp decline, anywhere from 10%, 20%, even 30% declines in stocks that disappointed on their earnings. So again, the nature of the backdrop, what I am suggesting as a social mood, has shifted to the negative, and I think, really, what it reinforces for corporate executives is that they must play games with earnings, and they have to play games with the general public, too, by lowering expectations to then come in in the next quarter and beat those expectations and thus avoid the abuse in the marketplace. You won’t see a 10%, 20%, 30% decline.

Amazon is a perfect case in point. Amazon beat their expectations after suggesting a negative quarter, and then announcing a positive number instead, so they said, basically, “Listen, we’re going to lose money next quarter.” And then in the third quarter they came out and, “Oh, we made money.” What is interesting is that the third quarter they made a lot less money than they did in the second quarter but that doesn’t matter because they beat expectations.

Kevin: They lowered the perception is what they did.

David: They lowered the bar, and they are still a success as long as they adequately lower the bar. That’s what I’m talking about in terms of lowering expectations. I suppose if my wife thought I was never going to bring flowers home again, and then I brought them home once a year I’d be a hero relative to her expectations. But again, it’s just, have I lowered the bar to be that kind of hero? In the corporate world, that’s what they are doing, and they are treating you as that kind of patsy to believe it.

Kevin: Sometimes there are ways to look at a recession without actually looking at the normal GDP numbers. You can look at inventories; we’ve talked about that over the last couple of months. But you can also look – I’m thinking of the auto industry right now. Not only will they give you a loan, they will give you a loan for more than what the car is worth and you can pay it back in – what? Almost a decade (laughs).

David: Earlier in the year as we transitioned from the first to the second quarter, everyone started saying, “Well, we’re going to have a great finish to 2015, and a part of that was predicated on retail sales picking up, and a part of the retail sales picking up in the first half of the year was second quarter auto loans driving major purchases of automobiles. We have seen a huge amount of automobiles picked up over the last two to three quarters, and lo and behold, the financing has been easy, we have passed the one trillion dollar mark for the first time ever in terms of auto loans, and it certainly helps the retail figures for that period.

You know, Kevin, you just mentioned this. You can now borrow more than a car is worth, so if the car sells for 30 grand, you can borrow 40. You can extend the payments out as far as eight years. That’s insane.

Kevin: And then, don’t forget the rebates. There are still things that you get, even after getting your eight-year loan.

David: That’s right. You can get rebates, enticements if you will, some of them as high as 20% cash back, and it’s not exactly what you would view as a healthy market. Even with all these games being played, there in the month of October auto sales were a disappointment. And the whole retail sector is in the process of worsening.

Quite frankly, at this point, we would have to have a blowout holiday sales season absolutely beating expectations beyond anyone’s belief, to correct the trend lower, which is already in place. We know that Q2 auto sales overseas were not as strong as hoped for and that, of course, was hit hard by the fact that the dollar was rising. Now you look at the U.S. dollar continuing to rise at a near 10-12 year high, going back to 2003, levels last seen in 2003, and I think you are going to see the fourth quarter look even worse in the auto sector from that standpoint.

Kevin: And it’s not just the auto sector at all. Has there been anything that has pointed to retail sales growing anywhere in any sector?

David: Bespoke investments does some interesting research and they pointed out that not a single retail sales figure this year has been better than expected. They have all disappointed. So the increase in October was well below what was expected. We already know that the industrial sector is in recession. So again, if the consumer doesn’t step in and basically save the economy in the next six to eight weeks, we are going to finish with a whimper, not a bang.

Kevin: I had mentioned that when I was in college I was a toy store manager, and we did 75% of our business from Thanksgiving to Christmas. It was an amazing phenomenon to see that inventory.

David: What percentage?

Kevin: 75% of the entire year’s business was from Thanksgiving to Christmas. This is toys that we are talking about. It was a large toy store, a big name toy store. But one of the things we watched weren’t sales. We watched our inventory. And if our inventory wasn’t moving at the speed that it needed to, if that inventory started building, that was usually a precursor to a pretty bad year.

David: Sure. Well, business inventories increased in September, and they increased and they actually were expected to remain unchanged. You have business sales, which in September declined by 2.8% year-on-year, and you are right, we are seeing some suggestions that we will be launching into 2016 with some real economic challenges. We may, in fact, already be in recession.

Kevin: Okay, but let’s go back to something that we cover virtually every week – the stock market. Let’s talk about the Dow, let’s talk about the S&P. What are we looking for? It’s looking sort of feeble right now.

David: I’m fascinated by how much of a litmus test the Dow and the S&P have become, and it doesn’t matter the educational spectrum, whether you are very educated, whether you are uneducated, everyone alike references these indexes to gauge whether the economy is doing well or not. It seems obvious to me it is possible that the economic tide has already gone out and the indexes have the public complacently believing all is well.

But literally, when we had the swoon just six weeks ago in the equities market I had conversations with countless people who would say, “I’ve been really concerned.” And six weeks later the stock market is up and, “Yeah, we really think this is going to be a good year.” And literally, their sentiment, how they feel about everything, from what they are going to spend for Christmas to, you name it – whether they think they are going to get a pink slip or not – it ties to the Dow Industrials or the S&P 500. And so, as go those indexes, so goes sentiment.

Kevin: So, if retail sales are down, and we are actually in, probably, a recession, one of the things I think of is, a company will sometimes scale back one of its greatest expenses, which can be advertising dollars, but advertising dollars play even a larger role these days in our economy because of social media. You don’t just have television anymore, you have Facebook, you have YouTube. Advertising seems to play a much larger role these days, and so if we are in a recession do you see that getting cut?

David: Corporate advertising dollars are easy to cut. That’s an easy cut to make. And of course, in this little period of time we have had some companies that have become sort of bellwethers within the bellwether. People look at Facebook and Google, and are very interested in not only the social media aspects and the search engine aspects, but a lot of their daily time on the computer is oriented to these kinds of companies, forgetting that these are the kinds of companies that rely on advertising dollars almost exclusively, so you have bellwethers within the bellwether indexes, which are incredibly, incredibly sensitive to a shift in economics, because again, ad revenue – that can be shut off in a heartbeat. And how quickly can companies like that – again bellwethers within the indexes, high-flying today – how quickly can they lose 60-80% of their value? Twelve weeks would do the trick.

Kevin: You were talking about a litmus test, a stock valuation. Amazon amazes me. Just before we started recording this morning I was handed a package. Of course, I got my latest book from Amazon, it is sitting here on the chair. I will probably get two or three in the next few days, I went on a spending spree on Sunday.

David: Tell me, the First Concepts of Topology, the Geometry of Mappings of Segments, Curves, Circles, and Disks. Can I ask why?

Kevin: (laughs)

David: I’m not asking why on Amazon, I’m asking why that particular book.

Kevin: It’s the mathematics of shapes and something just tells me that I need to know something about that. But going back to what we were saying, there are a lot of things purchased on Amazon, but the shares right now are 900 times the earnings. That’s incredible.

David: The trailing price earnings is 925.

Kevin: And 14 is a really solid company. If you are buying, 14 times earnings is about the level you want to buy at.

David: Yes, you are getting a deal on Amazon. If you are buying the shares, you are paying for close to a thousand years’ worth of earnings (laughs).

Kevin: (laughs)

David: Which, you know, you like math – look at it this way. This is the new math. New math of the 21st century – we’re thinking big and we’re dreaming of a future, and you are paying today for 900 years’ worth of earnings on Amazon.

Kevin: And that was the lie of the tech stock boom in the late ’90s. They said, “The economy has changed, you don’t have to look at PE, price earnings, anymore.” But let’s just look recently at what happened back in the crisis of 2008 to Amazon.

David: Sure. When retail sales started to crater, they may have been an alternative venue from brick and mortar, but in 12 weeks they shed 60% in the bear market of 2008. It took more like 18 months for them to travel from $112 a share to $6 a share back in 2000-2001, so 18 months to lose 95% of their value. But there are companies which everyone is very keen on today which are very, very economically sensitive. Again, retail orientation, the advertising space. Yes, the average investor, let’s just say this, a little tongue in cheek: “You can sleep comfortably knowing that those kinds of shares only represent a small percentage of the holdings that your money managers and mutual funds have for you.”

Kevin: Which, you’ve got to be kidding, because that’s actually the majority of what they are holding.

David: Yes, you’re right. They are some of the top holdings for mutual funds and hedge funds. Of course, you can add Apple and Netflix and Tesla to the mix, and therein you have a couple of trillion dollars in market cap that is very economically sensitive and vulnerable to snap in sentiment.

Kevin: And we’re not just talking about some of the newer tech companies. Look at the Old Blue, IBM. We’re talking the blue of the blue of the blue for tech stocks, and they’re just continually declining in revenues.

David: When you think of blue chip, if it relates to technology at all, yes, you have to bring in the big blue, and IBM reported its 14th consecutive decline in revenues. They are now at levels that we haven’t seen in 13-1/2 years, and – oh, they are also under SEC investigation for how they recognize their revenues, which really is not a surprise given that that company, in particular, classically, they are the master masseuses when it comes to the accounting games that can be played. If it has been done, IBM has done it. They know how to massage anything in any different direction. The SEC is interested in knowing just how they have massaged their revenue recognition.

Kevin: Well, not just IBM, I mean, something tied to IBM as far as the creation of the microchip, that type of thing. “Intel Inside” is what it says on the outside of the computer, but Intel, they are struggling as well.

David: Sure. They are at the heart of “Techlandia,” if you will, and they have had five sequential quarters of increasing inventories. In other words, they are not moving product as they expected. So what happens next? If you are not moving product as expected, here are the dominoes that begin to fall. First you have trouble with your margins, then you take a significant financial hit, and as you begin to disclose that, then you see your share price that trades lower in sync.

Kevin: Dave, we talked three weeks ago about a conversation that you had with a very large hedge fund manager that was moving out of shares into cash, and then frankly, into gold. I am wondering, is this happening amongst some of the other hedge fund managers, as well?

David: We know about the purchase in metals, specifically gold, by Druckenmiller, but there are a couple of others – David Tepper with Appaloosa comes to mind, and I think, two or three others in the last 90-120 days – who have been taking every rally in the stock market and dumping stock, to lighten the load of equity exposure, specifically, U.S. equities, and the concerns that they have cited – revenue concerns, earnings guidance being lower, interest rate trends – these are all reasons that they have been moving to cash. We are talking about very significant positions, increasing their cash component north of 30-40%.

Kevin: And these are very successful hedge fund managers that tend to buy low and sell high. But low – let’s face it with gold, it hasn’t dropped dramatically, but it has dropped 13 out of the last 14 days, Dave. So, when does this end?

David: Bill King, who is a regular guest on our commentary, and an analyst and money manager out of Chicago, points out that the low point and the turning point in gold, what would be described as a bottom in the price, has occurred roughly every 15 years. He just mentions January 30, 1970, March 1, 1985, August 27, 1999, and frankly, we are very near another one now. In a few weeks we will be discussing this with Mark Faber as he joins us as a guest on the program and he has pegged $1100 as a good price to be buying. Although we may be finding a bottom, gold is not necessarily going to re-emerge into a sustainable uptrend until the Fed has lost credibility, and until confidence, which is a very, very fragile thing, is shaken.

Kevin: Isn’t it odd that we, also, are watching the Fed, and we are watching the loss of confidence in the Fed being an indicator for the price in the paper market of gold to go up. Yet, this last quarter, Dave, the demand for coins and bars, again, it was huge. It was a couple of hundred percent over last year.

David: That’s right. From the World Gold Council, third quarter, supply/demand numbers were compelling, very bullish, in terms of demand for coins and bars here in the United States in the third quarter, up 207%, and that’s on par with purchasing volumes that we haven’t seen since the global financial crisis. There are other categories of demand which also grew in the third quarter. Again, I come back to that sort of issue of the Dow as a litmus test. The market is down and in the third quarter that’s when the market was down and gold demand was up considerably. The Dow is up right now and market demand for gold is off significantly.

So, here in the first part of the last quarter of the year, yes, we are seeing a decline in volumes here in our office, and certainly as we touch base with others in the industry. And to me, it is one of those things, again, where I think investors are reading too much into the Dow. It has become a place where money can be spent to manipulate sentiment, and keep sentiment positive. And again, I think gold and negativity is the flip side of that. But you are suggesting something as well, which is that we are dealing, really, with the paper price of gold that has been considerably weakened, because we do see a dwindling supply of available physical gold.

Kevin: Right. We get a chance to watch that now in the interest rates markets you can sometimes see the reality of the economy coming back in, too. We talk about the markets being managed, and I will tell you, personally, it’s quite disheartening. I was asked, “What event will actually move the markets the direction that they should go in?” Right now I can’t name a single event that would mean the return of the free market, but the free market always returns, even in a communist society, the free market always returns. They are always defeated by the free market. I read a quote a couple of days ago in a report, and I thought, “I should have remembered this quote.” One thing you can always say about gold is, whatever the old high was, it will be broken in the future. That is a truism for gold. It is amazing, you can’t say that about anything else.

David: Well, surprise happens in places that you least expect it, and I think inflationary expectations have been pegged very, very low, and we might very well have a surprise in that area.

Kevin: But the bond guys are looking for higher inflation, aren’t they?

David: Well, they are. And Goldman-Sachs is suggesting that bond traders have actually set unrealistically low expectations for inflation, and that core inflation may be one of those surprises in 2016, an increase in core inflation. And that brings me back to King’s thought that maybe we’re at a 15-year low in gold – 1970, 1985, 1999, and here in the year 2015. King might be right about the bottom in gold consistently occurring every 15 years.

Kevin: Dave, you have been good about interviewing people who maybe don’t necessarily see things exactly the way we do, from the Council on Foreign Relations’ Benn Steil. He was an interesting interview because when you are listening to what I would consider the elites are saying, like at the CFR or through foreign affairs, you get an idea of what their motivations are and what their expectations are, and he has been talking about monetary looseness and that we haven’t been this loose monetarily since 2011.

David: Right. I think he does a great job of pointing out what has been fuel to the fire for any sort of economic and/or financial activity, and specifically, financial activity driven by excess liquidity in the system. Now, what he does is, he looks at net global liquidity and says, basically, the Fed in the United States might be tightening, but in aggregate, as you said, we haven’t been this loose since 2007 or 2008. So, if you are thinking in terms of net global liquidity from all sources, then the ECB’s activity, the Bank of Japan’s sort of print all-out, then actually, there is quite a bit of liquidity in the system today.

The interesting thing is that I thought the global economy had gotten past the point of crisis. That is certainly how it has been advertised, and yet the “powers that be,” the central bankers/central planners, are certainly willing to accommodate the global financial system with liquidity that is on par with what we saw in 2007 and 2008. So, why are the crisis measures now surpassing 2007 and 2008 levels. Maybe the answer is, “All is not well.”

Kevin: It just means that the emergency measures – you know, this patient that is on life support has not really revived. Now, from Benn Steil’s perspective, I think he still holds out hope. I think he is actually saying, if I read this right, that I guess this looseness is probably just going to provide more liquidity for the economy.

David: And I think we should hold that hope, but it comes back to what you said a moment ago about the market re-emerging. These kinds of activities submerge the free market and our greatest hope is allowing them to operate on their own without artificial stimulants. And so, Steil argues that these banks, the ECB and the Bank of Japan, specifically, they end up purchasing different assets than the Fed and they may be more effective in liquefying the private markets, much more effective, because again, they are willing to embrace a broader range of assets.

Kevin: I’ve seen the notes in your books, I’ve seen the notes in any kind of report that you read, you are continually scribbling on them, and a lot of times you are debating. So, let’s pretend right now that Benn Steil was here. What would be your question for him on that outlook?

David: I would probably counter his perspective with a couple of things. One, that raising rates in the U.S. will affect U.S. bond yields, and that is going to improve the relative attractiveness of U.S. bonds, which in turn is negative for the rest of the world, because again, one of the things that he is suggesting is that this excess liquidity overseas is going to some sort of a floor for the emerging markets. And I would just say that, well, to the degree that there is an improvement in U.S. bond attractiveness because of higher yields, that is going to represent something of a sucking sound of liquidity from the rest of the world.

The second thing I would say is, as we were discussing last week, equities, that is the stock market, would be negatively affected by rising rates, via what we were discussing in the last program, the discounted cash flow models, as individual companies are reassessed, given a higher interest rate into that modeling. And quite frankly, as go the U.S. indexes, so go the global indexes to a large degree.

Kevin: Yes, and don’t corporate profits also suffer here in America as the dollar rises? If you raise rates, the dollar goes up.

David: Well, that is going to be, I think, the third point of contention with Steil. I would say that if the dollar continues to strengthen, then you have steep declines in U.S. corporate earnings beyond what we have already seen, and that becomes a double whammy for the U.S. large caps. So, while he tends to see some lemonade, I think I’m still tasting just the lemons.

Kevin: Well, and you may be tasting a little copper in your mouth as well.

David: (laugh)

Kevin: Because Dr. Copper usually tells you the direction. If you are starting to see a revival you are going to see it in copper, and we’re not seeing that in commodities at all.

David: Right. It is difficult to argue for economic strength fostered by more and disparate bank liquidity is net global liquidity when you see the Bloomberg commodity index at a 16-year low. The Bloomberg commodity index is at a 16-year low. Oil last week, that is, West Texas Intermediate, dropped by 8½ percent, a pretty big decline for one week. Copper was down 3.6% last week. Zinc is at a six-year low. Gold and silver are weak, too, but not nearly as weak as the more economically sensitive commodities, which is telling you something important.

Certainly, vis-à-vis dollar strength, the precious metals are holding up alright. But if you watch the broader commodities, and I think you need to here in the next few months, for significant downdrafts, this is not going to be supply and demand related, but you have select commodities which are going to be very volatile into year-end once you get into January, the first week or second week of January, the Goldman-Sachs Commodities Index, which ties out to about 60-65 billion dollars’ worth of commodities positions gets re-weighted.

It was interesting, over the weekend I had a very informative conversation with a man that produces commodities in Africa – his offices are in London – very intrigued by his comment that no commodity with a contract attached to it, as a futures market contract, is behaving in line with supply and demand.

Kevin: Isn’t that amazing?

David: Fundamentals are being trumped, or trends exaggerated, by the paper trade of those commodities, so you have the ratio of paper to physical in the gold space – that was a surprise to him as I shared to him that it had reached over 320 paper ounces for every one physically deliverable ounce at a recent peak. But that kind of trading is occurring in other commodities, as well.

And he was giving me some insight into the copper market because he owns some copper mines and has tens of thousands of employees across the globe. And his copper operations – he actually sees the supply/demand dimensions improving, and yet the price is still going lower. Why? Because again, whether it is Goldman-Sachs, or J.P. Morgan, or any of these trading houses, they are more than happy to trade the paper side and direct the price regardless of the physical supply and demand dynamics.

Kevin: It is interesting to listen to the view of someone who actually mines it and brings it out of the ground. He sees that as an asset.

David: And so I asked him, “You know, your business is not where it was two, three, four years ago. Is there any place that you think makes sense to batten down the hatches? Is there any place that you think represents good value?” And he thought gold, in the ground, that is, miners that control the stake, but have a resource in-ground, he basically said, “None of the in-ground resources are being counted as if they have any value at all.” And he represented that to me as one of the best values in the market today.

Kevin: Which is amazing, because so much of a bloodbath has been in the mining shares. But is it possible that there is enough blood in the streets at this time that a person should consider that?

David: What is considered good value six months, 12 months, 24 months ago, was assuming that some value was assessed of the in-ground resources, and what he is arguing is that, actually, that is being completely ignored at this point. You can find really good assets and you are getting the in-ground resources for free. So, they are basing the value of the company on current cash flow and their ability to service debt and whether they will survive a commodity cyclical downturn, but they are not looking at in-ground resources. So, for the man or woman of patience, of conviction, and probably with a cast iron stomach, yes, it is very cheap. And to my chagrin, it seems to always get cheaper.

Kevin: Well, it is sad that I even have to bring this up because if supply and demand isn’t really affecting the price of gold or copper, or what have you, anything that is traded on paper, then what we have to do is, we have to go back to a statement you made earlier in the program, and that is, gold is going to stay down until people lose confidence in the Fed. So let’s look at the Fed. What changes are coming in the Fed? Not just the interest rate changes, but the people who are making the decisions?

David: The cast of characters continues to shift, and as we mentioned maybe three months ago, this is not following the advice of William McChesney Martin, who said, “Please, do yourself a favor. Don’t hire academics, and certainly, don’t hire economists, to run the Fed – maybe to crunch some numbers and provide insights for you, but the reality is, the decision-makers need to be nonacademics.” And it is interesting, next year we are losing Concha Lakota (sp? 45:13 ). He is at the Minnesota Fed, one of the super-doves, and he is being replaced by a Goldman-Sachs guy, the wunderkind, Neel Kashkari.

Kevin: You never hear of Goldman-Sachs at the Fed, do you?

David: Oh well, you know – according to the Wall Street Journal, starting next year, 14 out of the 17 Fed officials will be either academics or Goldman-Sachs alumni. While I’m grateful for a little real world experience, I’m not sure that a Goldman man ever quits being a Goldman man. It’s a little like the CIA. Do you ever really get out? Do you ever really retire?

Kevin: (laughs) Dave, as we wrap up, I just want to go back to that individualism that we’ve talked about before. I think we need to, all of us, start growing a backbone, that maybe we’ve softened up, or allowed to be softened up, through today’s culture. What I mean by a backbone, I’m not just talking about political and social, but I’m also talking about spiritual and financial. We need to find out those intangibles and stand by them. Let’s just take the markets as an example. If they don’t represent reality, then we need to have enough backbone to move away from them until they do.

The same thing with politics. Instead of trying to play these politically correct games and call an enemy something other than what he really is, we probably need to step up to the line and start taking action based on what our value system says we should. And so, Dave, as we do these programs and try to inform people of the real numbers, we’re not telling people what to do, we’re just saying, “Look, if the social experiment that, right now, is very, very unhealthy, is trying to tell you that it’s healthy, you, for your own sake, have to move away and protect yourself.”

It’s a little bit like Paris. Now, no one that I know of knew what was going to go on in Paris. But if you did, you probably would have acted differently. There is this young man – I don’t watch much TV, but I do watch dancing with the stars with my wife – and one of the young men who was on that Paris train a couple of months ago, who took action when he saw the Kalishnikovs come out, and the terrorists start to take over that train – what did this man do? He and his two other friends took action. They thought as individuals and they removed the threat. He is just one good example of an American thinking for himself at the right time.

David: It’s an example of just being tough. And I think we explored that with the example of the Israelis earlier, but life goes on. You do what you can to prevent crisis, but unexpected things always occur.

Kevin: And don’t you teach your kids that by making them take cold showers in the morning? You turn it over to the cold for a little while so that they learn, like Patton said…

David: This, too, shall pass.

Kevin: (laughs)

David: I don’t know if Patton said that, but this, too, shall pass. And when you are uncomfortable, what do you do? You do the next thing. You don’t sit down and cry, you don’t forfeit, you don’t quit, you don’t hang up the cleats – you do the next thing. And having something of a toughness to you, I think, is absolutely necessary. And I think we may see that in the French, I certainly hope we see that in the French. It would be a catastrophic disappointment if what we saw instead was big government stepping in to solve yet another problem.

We know what the record is. We know what the record of success is in terms of big government stepping in to solve any problems. And so, I think if we are going to see a successful resolution to the crisis in Paris, and whatever crisis we may see hither and yon around the world, it is going to boil down to our internal orientation and the values that we live our lives based on.