Return To Real #5 - June 23, 2022
I began buying gold eight years ago, in 2014.
Back then my reason was simple. I had begun a new business with a dear friend, a gold brokerage firm called Advantage Gold, and felt it important that I personally owned the product we sold. Gold at the time was only that for me, a product.
What began as a simple transaction has since become a personal passion. I believe that every serious investor must own physical gold.
When I began, our attention was on building a business that provided investors a great solution on “how” to buy physical gold and precious metals. There are only two ways to do so, direct delivery and an IRA rollover.
The IRA Rollover
Advantage Gold’s specialty has been to educate investors on the process of owning physical precious metals for both direct purchase and inside an IRA. Purchasing metals within an IRA can be accomplished by creating a new precious metals IRA, or through what’s commonly called an “IRA rollover” which allows existing retirement account holders the ability to convert their accounts out of paper assets and into physical precious metals, all while maintaining all of the tax benefits of a traditional retirement account IRA.
This is a lateral, secure, and tax-free transaction.
Our attention to process worked and our firm very quickly grew. We have since become the gold standard in the precious metals industry and have been rated the #1 firm in the country by the independent review site Trustlink for the last six years.
IRAs were created to help replace a pension system that in the late 1970s became too expensive for corporations to continue funding. As fewer companies offered pensions, more companies began offering 401k’s, and more and more people adopted IRA’s. The big benefit of an IRA is the ability to grow a portfolio free of capital gains taxes. IRA stands for “Individual Retirement Account” and places the onus which investments to choose into the hands of the individual. It is for this reason that financial education is critical for individual success.
As I became an expert on “how” to buy gold, I became more and more interested in “why” to buy gold. Gold, particularly at that time, had been stigmatized as something that only crazy people who believed that the world was about to collapse would consider owning. Wall Street recommended owning stocks and bonds. The few on Wall Street who were open to gold insisted no more than 10% physical gold should be held inside a portfolio.
As I researched investing and the Wall Street recommended portfolio allocations, one of the first things I learned is that most people, like me then, have never really been taught how to invest. We aren’t offered investment education in High School or College. In fact, oftentimes the more successful an individual is, the less time they have to learn, the less they know, and the more they need to rely on experts. This is why so many people have financial advisers.
So the first thing I did was learn about the investment advisory space. As I began my research I learned there is little variation in the financial recommendations of most advisors.
This struck me as odd. How could everyone have virtually the same plan?
Wall Street tells us not to own...
The 60/40 Portfolio
I had watched my mother’s portfolio drop 50% during the housing collapse like nearly everyone else. This experience had made me skeptical. If most recommendations were to own the same things, wouldn’t that effectively tilt the entire boat to one side thereby making that very same strategy one that was ultimately likely to tip over?
More than anything, I really wanted to investigate why holding more than 10% of the portfolio in gold was considered a bad idea.
I am not a financial advisor. I have always suggested that before making any investment decisions one should consult with a professional. I also have tried to live my life by Ronald Reagan’s famous quote, “trust but verify.” This was the diving board I jumped off that has become a seven-year deep dive on all things financial and related to investing.
The next thing I learned was that, despite Wall Street recommendations to the contrary, gold had significantly outperformed stocks and bonds for a very long time. In November of 2014, gold was priced at $1160 per ounce and had increased more than 4X since the year 2000. Conversely, the S&P 500 had only risen 40% during the same period.
This was a 10X better performance owning the asset Wall Street tells us not to own!
What I learned was so simple that I can share it in one quick sentence.
When interest rates are low, stocks grow.
Why, you may wonder? The answer is quite simple. Leverage. When interest rates remain low over time the easiest thing to do is borrow money and invest using leverage. If I can borrow at 1% and then leverage that 5X to 10X then I can achieve a virtually risk-free return that is multiples of my borrowing costs.
Borrow. Invest. Outperform my debt costs and, voila, I can book great and consistent profits.
This Ponzi scheme reminded me very much of the way the housing market became a massive bubble. As long as houses continued to increase in value from 2001 through 2006, one could use their homes like an ATM machine. Many did and continued to refinance as their homes increased in value. This all works great until interest rates rise and the bubble pops.
Nothing has changed.
This same scheme is what most major corporations have done for the last decade under zero interest rate policies ZIRP of the Federal Reserve. Far too many companies have chosen to buy back their stock rather than invest in growth for the future. The short-term financialization offers incredible returns. As it became clear that the Federal Reserve would continue keeping rates at 0% after Ben Bernanke promised so in 2012, more and more companies did the easy thing, borrowed money and then bought back their stock.
Buying back stock is the most rigged game ever.
Assume there are four shareholders in a company at a valuation of $1 million dollars. Each share is worth $250,000. If the company then buys back one share, the three shares remaining are now worth $333,333. This incredible 33%% increase in share price occurs without adding any value or changing anything else on the company bottom line.
It’s magic. No effort required.
Is it any wonder that nearly every CEO in America has used this financial engineering to increase their company share price, especially since oftentimes their own compensation is directly tied to the share price of their firms? Naturally, so long as the Fed was committed to keeping interest rates pinned at zero percent then the financial engineering accomplished through leverage meant that stocks and bonds would likely only go higher.
Which is precisely what stocks and bonds did from 2011 through 2016.
Rising Rate Sink All Boats
However, in 2016 the Federal Reserve began raising interest rates. This action put pressure on equity markets until Donald Trump’s corporate tax cuts propelled Wall Street’s real profits. Without Trump’s tax cuts and deregulation, Wall Street would have faltered in a big way.
Trump, it turns out, helped the Federal Reserve look like geniuses. They seemed like they had everything under control as stocks rose in the face of monetary tightening. Trump’s first few years in office convinced people that maybe we could “normalize and get the Fed Funds rate back to its historical equilibrium of 5%. If so, the extreme ZIRP policies of the central banks had worked.
The Fed was so confident that, in addition to raising rates in 2018, they began removing assets on their balance sheets.
By this time, I personally felt I had a much deeper understanding of how markets really work. Valuation indicators in 2018 had hit historically high levels. I saw something different than most. While everything looked good on the surface, I saw a Federal Reserve increasingly tightening monetary policy into overvalued markets. My research told me this is when markets have almost always faltered.
This is when I began buying gold much more aggressively. I was so passionate about sharing what I had learned that I even wrote a book about it called, Gold Is A Better Way (And Other Secrets Wall Street Doesn’t Want You to Know).
I put the conclusion on the cover so there would be no mistaking the position. I believed that gold would dramatically outperform stocks and bonds from 2018 through 2028 for two main reasons.
The first is that gold is mostly seen as a non-correlated asset that underperforms when stocks and bonds do well. This was also my own personal experience. While stocks and bonds exploded higher from 2014 through 2018, gold prices remained stagnant. What I had begun buying in 2014 at under $1200 was still under $1200 four years later. My certainty about gold moving higher was based on a simple concept. I figured what had been good for stocks and bad for gold from 2014 through 2018 would reverse as the Federal Reserve raised rates and reduced their balance sheets.
There was a second piece of research that inspired me to buy more and more gold.
I learned another contrarian rule. Most people believe that rising rates are bad for gold. My research showed otherwise. Typically the Fed is forced to raise rates to slow down inflation. The expectation of higher inflation makes gold more appealing and why during rate hiking cycles in the past, gold prices have actually increased, not decreased.
Not only was I certain that stocks and bonds were headed lower as the Federal Reserve raised rates, I was also certain that gold prices would rise for the exact same reason. Of course I am not a financial advisor. The book I wrote and the actions I had personally taken were presented as such. My opinion, not financial advice.
It turns out I was right. Really right!
In the fourth quarter of 2018 stocks and bonds plummeted in unison. This occurred as the Federal Reserve raised rates and reduced their balance sheet. When the GIB book was published in August the price of gold was $1194. By the end of the year gold prices had risen nearly $100 while the equity markets had fallen more than 15% and bonds had lost nearly 9%.
The chain of events helped propel the book to become a national bestseller and Advantage Gold the highest rated precious metals firm in the county.
But it is what happened next that truly got me “all-in” on gold.
Rather than stay committed to the balance sheet reduction and rate hiking plan, when faced with the pressure from stocks and bonds and significant losses, Powell “pivoted.” Not only did the Federal Reserve announce they were ending their rate hiking cycle, they also began buying back bonds on the balance sheet. I believed this one move signaled “checkmate” for the US dollar. The dollar game was over as I could tell, it was just a matter of moves to checkmate.
At that time I began putting every investable dollar I had into gold. I took my personal portfolio from a 20% allocation in precious metals to over 80% allocation. I made a commitment to buy gold every month. I didn’t do this because of fear. I did it because of greed. I believed gold would be the obvious winner.
The reason is simple. It also applies to my outlook from here.
The Fed was only able to get interest rates to 2.4% before having to abandon their hiking plan. Higher rates in a highly levered economy pose significant recession risks. Every recession of the last 50 years has been caused by the Federal Reserve tightening monetary policy too much.
Not surprisingly, when the Fed pivoted, stocks and bonds resumed their march higher. Once again, as risk appetites had returned, gold prices again went sideways. I used the opportunity to buy as much gold as I possibly could. I was so excited about what I could see coming next that I held a live gold summit where I presented the thesis for my next book,
The Great Devaluation.
If I had to sum up TGD into one concept it would be this: There is
one certain rule
that the Federal Reserve has followed in every recession over the last 40 years; when faced with a recession the Federal Reserve lowers interest rates by 500 basis (5%).
Every time.
I wasn’t sure what was going to cause the next recession. Only that when it came we would see the Federal Reserve forced to lower interest rates. Remember though that interest rates were only at 2.4% which begged the obvious question:
How do you take 5% from 2.4%?
The simple answer is negative interest rates. However, my research also showed me that the Federal Reserve was loath to lower interest rates below zero percent because it was too obviously a bad thing. If interest rates offer a negative 3%, who would keep their money in the bank? It forced me to consider what the Federal Reserve would do when the next recession hit.
I believed it is highly likely that by the July Fed meeting that equity markets will be significantly lower. More importantly, as that occurs, we will see more and more recession warnings. Just two days ago, in a leading story from the Wall Street Journal, we were notified that recession odds have jumped to 44% in the coming 12 months. [3]
We have good reason to believe that recession warnings will get even greater as we move through summer. In today’s highly financialized world, the stock market has in many ways become the economy. A major downturn in the equity markets will only usher in a faster and more aggressive recessionary environment.
Ok. Are you with me still?
It’s now time for the September Fed meeting on September 20th.
Equity markets, as I can see, will have likely been battered down as the Fed has been forced to continue raising rates. The good news is that CPI numbers may look like they are falling and that the Fed’s policies appear to have tamed inflation. In reality, all that the Fed will have really accomplished is beating down risk assets. There is nothing to suggest that higher rates will alleviate food and energy shortages.
There is, however, much to suggest yields at 2.25% are going to be a massive headwind for the economy.
Which leaves us with the following forward look.
Just as they did in 2019 after stocks and bonds fell out of bed the Federal Reserve will indeed need to pivot. They cannot raise rates into a recession. In fact, this as we know is when they need to cut rates by 500 basis points.
As the pivot is forced gold and silver prices will likely explode higher. Gold prices rose roughly 20% when the Fed was forced to pivot three years ago. Silver prices rose even more from $15.24 in March of 2019 to $19 by September just five months later.
This is why I keep buying gold and silver. I believe they will perform better than stocks from here. Much better. I also believe gold will outperform bonds. This is true for the short and long terms.
If I am right and the Federal Reserve is forced to abandon their rate hiking cycle because we are headed toward a recession which necessitates cutting rates by 5%, they will be forced to do so while inflation remains highly elevated.
Their choice then will be to save the economy or save the dollar. They will choose the economy and abandon this rate hiking cycle as I see it. This is when the dollar likely falls significantly. It’s why Stanley Druckenmiller said “I will be surprised if sometime in the next 6 months, I’m not short the dollar.” [4]
Consider bonds in this scenario.
Who wants to buy a bond that is yielding 3% when inflation is double that?,
These are some of the reasons I continue to buy gold. They only begin to cover what I believe must come next. As the western world is forced to pivot to lower rates to save our economies from deep recessions, all currencies will likely devalue against gold, silver, and other hard tangible assets. This pressure only gets greater as Putin and Xi Jinping coordinate to create more shortages in the energy and food sectors.
This is not only a recent phenomenon. Gold prices are up 7X since the year 2000. The S&P 500 is up 2.6X, bonds are up even less. This means that long-term investors who purchased gold 22 years ago have seen nearly triple the returns to owning stocks and bonds.
It all led me to the following conclusion.
In a growth environment, you want to own stocks, in a debt environment, you want to own gold.
1999 was the last year that the United States ran a budget surplus. Since that time, our debts have risen roughly six times. Is it any wonder that gold prices have risen accordingly?
Please hear me. This isn’t financial advice. This is math.
I began this personal story by explaining that I am not a financial advisor. It’s been my personal approach to trust but verify. I suggest everyone who reads this consult with your investment professional before making any financial decisions.
As you do, however, be sure to ask yourself one very important question. When has Wall Street ever advised you to sell?
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