Episode 10: Investing Principles for Precious Metals Investors

Ep10 - investing principles

This week’s episode is the result of many questions submitted by listeners. Such as: Should I invest in silver or gold? What are the main things I need to consider? Can you help me understand what the Fed is doing? Does it make sense to borrow in order to invest in precious metals?

Along the way you’ll learn:

    • Interpreting the gold/silver ratio & what history tells us
    • Key principles for the precious metals investor
    • Why the Fed’s actions punish the saver
    • Why you shouldn’t consider gold a money machine
    • How the paradigm shift of measuring the dollar in gold can be valuable in making investment decisions


Additional Resources

Episode Transcript

John Flaherty: Hello again and welcome to The Gold Exchange podcast. I’m John Flaherty and I’m here with Keith Weiner, founder and CEO of Monetary Metals. Today, we’re going to get into a topic that we’ve received a lot of questions about, and that is investing principles for precious metals investors. We are not going to give investment advice on this episode, but instead try to keep principles general in nature. For those who are brand new to precious metals investing, I invite you to download our free guide, available via the gold banner at the top of any page on our website.

Keith, I’m really curious, when did gold and silver enter your consciousness as something that might be a good idea to own? And what were ultimately some of the main reasons why you decided to acquire them?

Keith Weiner: So I was always aware, you know, I started reading Ayn Rand in the mid 1980s in college, so I was always aware of the idea of gold as, you know, something they can’t debase. But all during those years, obviously, as a poor college student and then working to build my own company, it wasn’t something I really revisited until I sold my company, which was a company called Diamondware. I sold that to Nortel Networks, August 19th 2008.

And I put the emphasis on the date because that was really just before the mainstream financial world went over, crashed and went over the edge into the abyss. Going through that, sitting there with one hundred percent of my wealth, essentially, in cash held in a couple of too big to fail banks. And every day reading the news – and big banks were failing. There was Lehman Brothers there was Bear Stearns, obviously, before that, Countrywide. There was so much going on.

At first I kind of felt a little bemused because I had had my transaction. I felt good. But then as the fall continued to progress and there was more and more, not just bad news, but crazy, crazy news of what was going on. You know, there was an incident where the secretary of the Treasury, Hank Paulson, called…I’m trying to remember what his name was, but he was the CEO of Bank of America. And Bank of America was in the process of acquiring Countrywide or Merrill Lynch…it was one of those acquisition deals.

During during the time of Bank of America’s due diligence, they discovered some, you know, what’s called a material adverse change. In other words, conditions at the company they were acquiring got worse. And they said, look, the deal’s off. We don’t want to do this anymore. This thing’s deteriorating by the minute. Imagine if you’re thinking of buying a car and then during the time you said, OK, I’ll come back next Friday with the money. And in the meantime, the car has been in an accident and you’re like, I don’t want to buy it anymore. I thought it was an intact car, now the frame’s all bent. So Hank Paulson summons this guy to Washington, D.C. on Friday evening, takes him into some basement room in the Treasury building. We don’t exactly know what happened, but to put it in Godfather terms, he made him an offer he couldn’t refuse. And so by Sunday, the CEO was was on the news saying, yeah, we’re going to continue with the acquisition after all.

So you watch all of us and feel like this is nuts. Is there an escape hatch? I mean, how do I – and Bank of America was one of the banks I had cash in at that time. And I’m just looking at that, saying, how do I protect myself? Where do you get out to? How do you escape this? And, you know, ding, ding, ding. Gold suggested itself as a logical place to be.

So for me, that was fall of 2008 and it was it was the crazy events that were occurring at that time.

John: Do you remember when the Cyprus bail-ins were occurring? Was that sort of a parallel event that surely would have spooked you and everyone else who was watching it?

Keith: So, it’s funny. I actually reached out to a gold bullion dealer in Nicosia, which is the big city, and such as it is in Cyprus, to ask him a few questions. And I wrote an article about it back in 2011 or something. That news story didn’t really circulate amongst mainstream anything in America. So unless you’re reading the alternative sites like ZeroHedge, you probably didn’t even know that happened.

The Europeans, especially in southern Europe, would obviously being much closer, would’ve probably been more aware of it. I reached out to this bullion dealer Nicosia, Cyprus, and asked him, did he know what was going to happen before it happened? Was there advance warning? And he said, you know, I tried to tell everybody, but they wouldn’t listen. You should buy gold, and he had that sort of tragic, sort of Greek sense of I told everybody they wouldn’t listen, woe is  me. You know, I’m Cassandra, kind of thing about him.

What’s interesting is that the purpose of buying gold, if you were in Cyprus at that time, the reason why you should have bought gold wasn’t that the price of gold was about to go up in Euro terms. My recollection, it didn’t actually go up. However, once the banking system collapsed in Cyprus, if you had a thousand euros in the bank, you couldn’t do anything with it.

You were basically trapped. You were screwed. But if you had bought gold, you know that gold would have been good. You could have gotten onto a boat. And obviously jobs, you know, dried up in Cyprus. I mean, the economy was a train wreck at that point. But if you wanted a job, you could have gone to mainland Europe. You know, any citizen of Europe can get a job anywhere. It’s just like moving from North Carolina to New York.

And you could have just paid for your passage on the boat with gold. You know, gold was accepted and gold would be accepted. So you were getting out of unsound credit, which was banking system credit in Cyprus into something that nobody questions, which is gold. And he said to me, nobody did it. He did not see an increase in his business selling gold in the lead up to that banking system holiday and then restrictions and then ultimately bail in.

John: So that’s why he was so frustrated…he was waiting for the spike in business and it never materialized.

Keith: Right….trying to make more money and it didn’t happen.

John: Right. So, Keith, do you favor gold over silver? I mean, is this just a case of Coke versus Pepsi or what are your thoughts there?

Keith: It actually gets into two questions, which is why are there two precious metals that both compete to be money? And then, which one do I favor at the moment and why?

The first one is a very interesting question, because usually these things are winner take all. I mean, given enough years or in the case of precious metals, thousands of years, one of them should have been, you know, not only dominant, but ultimately win.

And that’s not the case. And the reason is…..so gold is the most efficient commodity as a medium of exchange because its bid-ask spread – the loss that you take to buy and sell it – is narrower than for any other commodity. But silver actually has a role, and that’s because if you’re a wage earner and you want to set aside 10 percent of your salary to buy precious metals 2000 years ago, as today, if you wanted to buy gold with 10 percent of your weekly paycheck, that would be a very small amount of gold.

It would be easy to lose it in the lint in your pocket. And then it’s very expensive to buy very small slivers or wafers of gold. But for silver, you could get for 10 percent of your wage, you’d get three or four or five ounces, and a one ounce silver coin is, a nice big piece. So it’s more satisfying to hold it in the hand – to have a stack of silver coins – than to hold this tiny little wafer of gold. And much more economically efficient. The loss, the bid-ask spread on that quantity of silver will be much tighter than gold.

So silver was always the solution for wage earners that wanted to save. And that’s still true today. I mean, people want to hoard precious metals, they want to take it home. They don’t want to hold a banking system deposit of gold or silver, which isn’t even possible anyway today for the most part. But the price of gold and the price of silver fluctuate against each other.

And so there’s something called the gold-silver ratio that I encourage everybody to take a look. Charts of this available all over the place. And unsurprisingly, there’s kind of a cycle, right? So silver will never go to zero against gold. Silver will never get anywhere near the price of gold for a lot of historic and physical reasons, but they fluctuate in a range. And so back in the era, let’s say, before the 19th century….because governments began to distort things, even from the time of the founding of America, they began to distort it, and the Coinage Act of 1792 fixed the price of silver in terms of gold.

And whenever a government tries to price fix, you get distortions and you get perverse outcomes from that. But looking at the 18th century and earlier, there was a ratio of gold-to-silver that was about fifteen and a half to one. In other words, fifteen and a half ounces of silver to buy an ounce of gold. And so that’s the absolute low end on the gold-silver ratio. I think for modern times one should probably assume a low end of about 30.

And that’s where the ratio hit in March or April of 2011 when the silver price hit its absolute spike high. You had this gold silver ratio of about 30. So if the ratio was 30, you should favor gold. Because this ratio is only going to go in one direction. And that is gold is going to go up relative to silver. Or silver is going to go down relative to gold. And so at 30 you have no upside to owning silver, only downside. And silver being the more volatile of the two, that downside is a factor that should be considered.

And then the upside on the ratio, one might have assumed that the highest the ratio would go would be about eighty five. Until the last couple of years when the ratio hit…..it was well over 100. I want to say 110, maybe 120. I have to go back and look at my charts. It’s been a while and the ratio has been falling since then.

But anyway, so if the ratio is let’s call it 100 or even over 85, then silver is the better bet, especially if you’re willing to hold for some period of time, chances are silver will rise against gold. And it did. And now the ratio is closer to the low 70s. You know, today in the low 70s, preponderance would suggest, if there’s a reversion to the mean, which suggests the ratio would probably continue to fall, which means silver is better to own.

And I also think silver, the silver price is showing a bit more momentum in the medium term. So silver is probably a bit better, but one should always be doing that in light of where the gold silver-ratio is.

John: Got it.

Keith: You know, I should add one other thing. We have some interesting charts on the Monetary Metals website that look at the internals of the gold and silver markets and the fundamentals of the two. And that can also….so not only should you be informed by where the ratio is compared to its historic cycle, but also looking at the fundamentals of gold and silver.

And that will give you some…it’s not really trading advice, but it’ll give you some indication as to which market is more in surplus and which market is more in shortage.

John: Great, thank you. So, Keith, for the average precious metal investor, what are some key principles to keep in mind?

Keith: You know, I think the biggie is that, of course, the dollar is always being debased. The Fed – and this is no conspiracy theory that you read on the Dark Web – The Fed publishes its official monetary policy. And that calls for – its kind of Orwellian – calls for price stability, which which doesn’t mean price stability. It means relentless two percent debasement forever.

So the Fed has a policy target of two percent. They want consumer prices to go up two percent per year and they measure the dollar against consumer prices. In August or September, I don’t remember what exact month, they loosened their policy stance and they said, “Well, two percent is still our target over the long run, but over the short run, we’re going to allow inflation to exceed that because, you know, over the last 10 years, we haven’t actually hit our policy goal – we tried to get the two percent and we failed. And so now going forward, we’re going to be even more aggressive. And if we start to achieve inflation we’ll be even more tolerant of it to make up for lost time.”

Which is disingenuous on so many levels, one of which is how exactly do they fail their policy target? And that’s because the Fed doesn’t really understand how it works. They can’t actually create the inflation that they think they can.

But from the perspective of anybody with savings to try to protect, The Fed is relentlessly trying to make the dollar worth less than it was. They’re trying to aid debtors in easing their burden by making the dollar go down in value so that whatever it is you owe, you owe less in real terms. That’s one of the reasons why people think about buying gold and silver. But the flip side to that is that prices are volatile. You cannot assume that just because the Fed is debasing, that if you buy gold today, the price will go up by tomorrow.

Maybe, maybe not. That’s just something to always keep in mind. What’s your timeframe?

John: Gotcha. So, yeah, I get into that a little bit. How does time preference – or how should time preference – come into play as someone is approaching this investment?

So time preference would be a different concept. In my previous answer, I’m just saying, if you’re planning to pay your taxes on April 15 and you’ve got a thousand dollars that isn’t doing anything between now and then, and you think to buy gold….it’s not a free money machine. And if you buy a thousand dollars worth of gold today, just a bit over half an ounce, that does not mean that by April 15, when you need to sell because you have to pay your tax bill, that the price will be up and that you will to sell it for $1100.

Maybe. There’s a lot of reasons to think that’s more likely than not, but there’s no guarantee of that.

So moving on to time preference. Time preference is the idea that it’s better to have a bird in the hand versus two in the bush. Or it’s better to have something today versus the promise of something – the same something – tomorrow. And so time preference leads to an interest rate. If you had a choice that I was going to pay you today or I was going to pay you next year – and I was going to pay you the same amount either way – you’d say, just pay me now.

If you’re going to pay me next year, I want you to pay me a little bit more, because even aside from the risk of whether or not the debtor honors his word, which is a risk, there’s also “it’s better to have something today versus tomorrow.” Everybody has to eat today. Everybody has to heat or cool their homes and put fuel in the car, for electricity to connect to the Internet and listen to a podcast from Keith and John.

And all those things are “today” things there’s a natural preference to value something that you have in your hand versus something that you will potentially, maybe in the future, have in your hand.

John: Gotcha. What about leverage? Should one borrow dollars to buy precious metals?

Keith: It’s a seemingly attractive proposition, right? I mean, the price of gold tends to go up because the dollar’s tending to go down. So borrow in the thing that’s going down in order to buy the thing that’s going up.

The problem is volatility. At the moment you put that trade on, if that happens to be a local peak in the gold price….so if you look at the long term graph, there’s local minima, local maxima. And then over time, the trend is rising. But in the meantime, you can have a drop.

As readers of my writings know, I’m not a fan of John Maynard Keynes. But he did say one thing that was absolutely right, and that is: markets can stay irrational longer than you can stay solvent.

So if you borrow – and I wouldn’t say to people to do it, I wouldn’t necessarily say not to do it – I certainly say go in with your eyes open and be very, very careful. But if you do it, be mindful that the price can drop. And to set stop orders and be really careful in how you manage that trade.

John: Right. I think if you asked anyone who has shorted Tesla in the last year, they can resonate with that Keynes quote.

Monetary Metals has put together an interesting white paper about the benefits of allocating gold in one’s portfolio. Will you please share some of the highlights of that paper, that document?

Keith: Sure. So, most of the major banks, their private wealth groups have done research over many years looking at what if you began with a baseline, a standard portfolio of 60 percent equities, 40 percent bonds. And then you looked at the performance just strictly in dollar terms. You looked at the performance of that portfolio over many decades. You get certain measures.

Obviously, there’s total return. But there’s also volatility. And volatility matters because if two portfolios got the same return over, let’s say, a 10 year period, and one was more volatile than the other, most investors would choose the less volatile portfolio. And particularly investors looking at drawdowns. Right? So let’s say you put $1000 in. And 10 years from now it’s going to be worth $10,000. And that’s great. But there’s going to be a moment next year when it’s worth goes down to four hundred dollars and then eventually goes back up. What are you going to do when it goes down to four hundred dollars?

Is that going to be good for your blood pressure? Are you going to be tempted to sell? Are your wife and family going to be beating you about the head and neck with a wet noodle? You can measure not only returns, but drawdowns, volatility, sort of volatility adjusted return, or Sharpe ratio. And so what these banks found in their research was if you put a small slug of gold, let’s say four percent….so a tiny portion of the portfolio, you put that into gold.

What that does is it reduces volatility, reduces drawdowns, slightly enhanced returns, but not I mean, obviously at four percent, it’s not going to do that much overall, but the returns got slightly better as well. OK, great. And that’s an argument that a lot of people make for owning gold. And maybe for retail investors, if they’re going to own gold by taking it home physically and storing it under the floorboards, as it were, then those numbers are accurate.

But if you are a bigger investor, let’s say you’re talking about a few hundred thousand dollars worth of gold, it’s not really advisable to keep that kind of wealth at home. I mean, you can’t insure it. You’re now at risk of home invasion if anybody finds out about it, obviously fire, flood, all those kinds of things. And so in that case, you have to store it at a professional depository. And when you do that now, you suddenly are paying – we made an assumption of 50 basis points, 0.5% per year in storage costs.

And when you do that, then the scenario with gold in the portfolio gets a bit more sour. It certainly drags down returns. Volatility and drawdowns are a bit worse than the other scenario. And when you do that, and you plot that, I guess you’d call that making a steel man. So a straw man argument is when you mischaracterize your opponent’s argument in order to easily knock it down. A steel man is when you go out of your way, you bend over backwards to make the strongest possible argument for your opponent and then say you still overcome it.

So if you steel man, you know the argument, “you should have gold in the portfolio” and you put in the the cost to carry, the storage costs, . You can see why certainly institutional investors don’t generally put gold in the portfolio. And then we did a third series where we ran the data and said, what if you didn’t pay to store your gold? What if instead, obviously if you invest it with us, we pay interest on gold, that’s our whole point of our business.

What if you were earning interest on gold? Then what do the numbers look like? And unsurprisingly, drawdowns got even smaller. Volatility was even less. Sharpe ratio was improved. And of course, total returns for the portfolio just run way ahead of any other version of the portfolio. And so interest is the key. Essentially the conclusion of that exercise: interest is the key.

If you have to pay, if you get negative interest on your gold, it’s not so attractive. If you get positive interest on it, it becomes pretty sweet.

John: That’s great stuff. We’ll put a link to that paper in our show notes, I guess if you’d like to have some fun, you can share it with your investment adviser and ask them why they didn’t bring this to your attention earlier. Right.

Keith, can you draw a distinction between investment and speculation? And then tie this to what you’ve said about gold? Yeah, so obviously, the tie to gold is pretty simple, a lot of people buy gold hoping for the price to go up.

Keith: This is one of those contentious areas. And everybody hears these words  speculation and investment, and has sort of a gut, gestalt feeling as to what they mean. And usually people try to define it in terms of how much perceived risk there is, so “speculation” is a risky investment, and then there’s investment in whatever it is you think isn’t risky.

Some people think Tesla is a surefire thing to take over the world, or Apple, Google, treasury bonds. But I define it a bit differently, thinking about it in economics terms. And that is, if you are financing productive activity. So if somebody wants to produce something that means they’re going to either increase the production of something that’s valuable, or they’re going to produce something new that’s going to be valuable. They’re making the world a wealthier, better place for humanity, and they’re making money.

The investors who finance that…their profits on the investment come from part of the profits that come from the new production. The entrepreneur is creating something, and the investor is getting part of that creation. So economically, investment is a very good thing.

Speculation, is, let’s say you buy a house…or let’s say your parents or grandparents bought a house in 1962 and they paid $22,000 for it. The same house today might be selling for  $2 million if it’s in the right location.

But nothing’s changed. It’s still the same little 6,000 square foot lot, it’s still the same literally brick and mortar and and wood structure. Maybe somebody’s put in new granite countertops or something, but it’s the same house. In that case… now, obviously, somebody bought it to live, in those days, nobody was buying houses to speculate, or very few. But today, people can buy houses, wait a few months and then flip them, and count on the fact that house prices are rising at quite a ferocious rate at the moment.

And so in speculation….whether you buy gold, whether you buy Bitcoin, whether you buy houses, whether you buy equities, whether you buy 1982 Rothschild Cabernet….no, it wouldn’t be Cabernet, it’d be Bordeaux or whatever. Whether you buy fine old whiskey, whether you buy Picasso paintings, whether you buy antique Ferraris….it’s the same action. You buy the thing, which means you fork over some of your wealth to the seller. And the reason why you do that is you expect the next speculator to fork over an even larger amount of his wealth to you.

So you buy Bitcoin at, it’s almost a bizarre number to say, for $40,000. And you do that because you expect the next speculator to buy it off of you at $80,000. Assuming that you take your initial capital investment back out, you take your $40,000, and let’s say 10 percent as your as your profit. You know, that leaves you thirty six thousand dollars in gain. Your gain comes from somebody else’s wealth, but it’s converted to your income, as a process of conversion of one person’s wealth through another person’s income.

If you look at the biblical story of the prodigal son, there’s a really important parable there. Which is you shouldn’t want to….and in fact, I think very, very few people want to….spend their life savings or their family legacy. Because it’s pretty clear if you’re doing that, that you’re just eating yourself out of house and home, literally. But if, through indirect mechanisms, through markets, people are happy to consume someone else’s life savings, which is coming to them as their income, that’s their rightful profit.

And so I make this distinction and say investment is when you’re financing something productive and the profit comes from that productivity. That increase in productivity and speculation is when you’re simply betting on the price action and your profit comes from the next speculator’s wealth.

And when you look at it that way, you realize that the destruction is actually occurring on the way up. I mean, everyone realizes if you’re the last guy to buy at the absolute highest price. So if you bought silver in early April, I think it was 2011, and you paid $49.80 an ounce or whatever it hit as the absolute top tick, everyone understands that within a matter of weeks as you’re staring at a $30 silver price that you’ve lost $18, or a third of your capital is gone. But, it’s more subtle and people don’t think about the losses are actually occurring on the way up.

John: Keith, that’s that’s some deep stuff, I think. I think it takes a little bit of concentration to really get to the bedrock of the point you’re making about capital being destroyed on the way up in a speculation.

So, before we close, can you just comment on any other principles you’d like to highlight?

Keith: I think the overarching point of all this is that it’s the dollar that’s going down. And so I use the analogy, suppose you’re on the deck of a ship and the ship is tossing around in stormy seas, which represent volatility of markets.

And the ship is also sinking. It has a hole in it and it’s taking on water. And that represents the fact that the dollar is being debased. Looking at gold from the dollar’s perspective is rather like being on the deck of this sinking ship in a stormy sea, looking at the lighthouse saying that the lighthouse is volatile and the lighthouse is going up and down and mostly up. It’s an artifact of having the wrong vantage point.

And so rather than looking at gold as going up and saying, well, gold is $1850 roughly today, I would encourage people to measure the dollar in terms of gold and say it’s the dollar that’s going down. And that the dollar is roughly 16.8 milligrams in gold, is the current price of the dollar.

Will the dollar go up or down from here? I’m sure it will do both, but the trend is largely down because they are succeeding in debasing it.

John: So, yeah, you often talk about the paradigm shift that has to occur and it’s fun to watch with Monetary Metals investors as they get their monthly statements and see their gold and silver balances rising. And yes, we do the courtesy of extending to the dollar price, but to watch those ounces slowly accumulate a return is definitely this paradigm shift that I think we’re trying to promote. That’s all the time we have today. Thank you for joining us on The Gold Exchange.


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