Fasten Your Seatbelts

How profound are the changes we’re witnessing all around us? Having been born shortly after World War II and having lived on several continents, I can unequivocally say that the transformations around me and the rapidity with which things shift seem unprecedented. Curiously, most analysts of current events focus on one particular segment without taking into account circumstances elsewhere. Unfortunately, that diminishes the usefulness of their studies. I think geopolitical, social, technological and economic realities are not only deeply intertwined, but also capable of affecting each other profoundly. Therefore, any useful inquiry needs to come from a macro perspective. In that spirit, let me briefly touch on each of these four areas, before turning to the challenge we all share: how do we actually navigate the constantly changing environment?

The geopolitical circumstances are grim. The Ukraine War in now past its 500-day mark and, judging by the U.S. administration’s comments, Washington opposes any peace talks that include Russia. In other words, the conflict will continue unabated, even though the West’s massive military support hasn’t resulted in any discernible progress. Tragically, the price has so far been paid by the Ukrainian population, not by the Kiev regime’s puppet masters in America and Europe. Meanwhile, the chances of a broadening of the war, including a nuclear showdown, are not insignificant. Add to that the constant escalation of tensions between the U.S. and China, which according to the G7 is now the world’s most “coercive power” and threatens to undermine the “international rules-based order”. The likely result of that showdown: years of frictions that could turn to open military and economic warfare at any time.

The social consequences could be severe. Change of this magnitude will affect not only financial markets, but also diminish the long-established superior Western standard of living. Germans, Brits and others are already learnings this lesson. Agreeing to U.S. sanctions against Russia has thrown millions of Europeans off their existential highs and into a situation where energy and food concerns are, for the first time in decades, a reality of life. America, with its superior  riches of natural

resources, hasn’t been hit nearly as hard. Even so, the country has many other problems—among them one of the worst income and wealth disparities in the developed world.

Rapid technological change will undermine opportunity and democratic principles. During much of the past century, social challenges to government shortcomings and monopolistic structures have often forced politicians into corrective action. With today’s uncompromising monopolies controlling more and more of the administrative and legislative side of government, such an outcome is more difficult to imagine. There is the added problem that the key transformative element in the monopolistic structure is technology. That, tragically, allows Big Tech excessive influence in all affairs.

At the Aspen Security Forum last month, Douglas A. Beck, the senior advisor to the U.S. Secretary of Defense positively gushed over private sector participation in key military decisions, welcoming the contributions from tech giants such as Google, Intel, Microsoft and others. Arguably, technology’s largest impact will come from the digitization of everything, a dynamic enthusiastically embraced by governments everywhere, which see it as a tool to monitor and control. And of course by now everyone is aware of AI, a productivity-enhancing tool that could easily replace humans in many industries. All in all, developments that will further undermine social stability.

The economy is in massive transition. A key development in the global economy is the gradual withdrawal by numerous nations from financial, trade settlement and payment platforms dominated by the United States. The globalization trend, which started in earnest during the mid-1980s and intensified well into this century, made it attractive for less developed economies to ally themselves with America or, at least, embrace the U.S.-controlled system while remaining politically unaligned. Washington’s more recent efforts to reverse globalization and its increasingly aggressive use of trade and financial sanctions (against not only military foes but also friendly nations) has done the reverse.

The official definition of a sanction is as follows: “A penalty that’s imposed by the U.S. government to attempt to alter the behavior of a country, group, or individual that runs counter to U.S. interests.” Well, guess what? Brazilians, Indians, Nigerian or Saudi Arabians have their own interests on their mind; aligning their behaviour with America’s is not near the top of their to-do list. The current BRICS summit in South Africa won’t change things overnight, but analysts seriously underestimate the effect an even gradual breakdown of the U.S.-dominated “rules-based order” will have.

Another rarely talked about change is that the Western consumption boom that has marked the past half century appears to be near its end. Kickstarted by the aggressive promotion of debt during the 1970s, consumption soon became the key economic growth metric and gained traction throughout the developed world. North Americans and Europeans, in particular, became accustomed to live it up today at tomorrow’s expense. Worse, consumer debt is only one manifestation of this principle. In numerous developed economies, corporate debt is at terrifying levels, as is the debt issued by governments. The outcome, according to all credible economic studies: debt levels are at unsustainable levels. Attempts to shut down accessibility to debt will result in massive economic dislocation, while efforts to prolong the trend will result in inflation and painful defaults.

America’s Sovereign Debt Rating Lowered

Not surprisingly then, the questions I hear most frequently these days concern debt. As one of our clients recently asked me, “Why is the dollar rising when the U.S. debt rating is being lowered? Isn’t that a complete contradiction?”

It’s not contradictory, actually, but I admit it’s ironic. Let me explain. As most readers will know, one of the notable events of the past month has been that Fitch, one of the world’s top rating agencies, has taken away America’s AAA debt rating. Given the terrifying increase in the nation’s indebtedness over a very short time-frame, such an adjustment is overdue. But then, why is the dollar strengthening? Chiefly,  because the lower debt rating will make it difficult for the Treasury to sell its bills and bonds without compensating investors for the additional risk they accept. In short, yields on U.S. Treasury obligations are likely to stay at elevated levels.with a recession consensus.

I should also add that the value of the dollar is dictated not only by America’s internal fiscal and monetary realities, but also by conditions in other key economies. Many analysts fail to take into account that capital flows are dictated by how nations compare to each other. At this time, relatively high U.S. interest rates make it attractive to park short-term capital in dollar denominated assets. Consider that the U.S. Fed Funds rate stands at 5.5%, compared to the European Central Bank’s 4.25% or the Bank of Japan’s -0.1%.

But that may change. Key parts of the U.S. economy are showing signs of weakening—after all, the country has experienced a massive rise in interest rates within an extremely short period of time. Moreover, economic challenges abound not only in the United States, but also in much of Europe and, more importantly, in China. A serious ‘economic accident’ elsewhere could easily worsen the pain experienced in America. Either way, my guess is that the economy is headed for weak spell and that the Fed will be forced to lower rates. That, in turn, will do two things: it will put downward pressure on the dollar and aggravate key components of price inflation.

Shouldn’t Gold Be Rising?

In such a scenario, shouldn’t gold be rising? The answer is yes, but for the moment, the dollar is still strong and gold has a history of negative correlation with the dollar. But, as I said in response to the previous question, I strongly believe that a weakening U.S. economy will force interest rates and the dollar back down. Meanwhile, price inflation is likely to bounce back, driven primarily by a rebound in energy and food prices. We are not quite there yet, but the combination of a topping or weakening dollar and reacceleration of inflation could soon make for a dream environment for gold.

Better yet, gold, after a tedious range-bound period, is entering the seasonally strongest part of the year. August is a historically strong month for global bullion prices (see chart), but our hope for a major move is centered on the November to February window, which typically brings consistent price strength.

To state all this in simple terms:

  • The U.S. is now on a highly destructive trajectory. A two trillion dollar annual deficit that equates more than 8% of the country’s GDP is beyond alarming. And so is a total government debt/GDP ratio of close to 130%.
  • The dollar’s displacement as the world’s premier reserve currency will be a gradual affair, but the incentives for foreign central banks and investors to diversify are now steadily increasing.
  • Gold’s progress has been held up by the strong dollar. On the other hand, it is an asset that is real and not just someone else’s liability, and it holds an unrivalled position as sound money throughout monetary history. That, to me, makes it the logical alternative to atrociously debased fiat currencies, which is why I continue to advocate for an overweight position.

How To Invest In Gold?

“How to invest in gold?” asked a reader a few days ago. Those five words took me right back to the late seventies, when I used them as a title to my first published book on the subject. Many parts of my opus are dated, but a few things haven’t changed. So, specifically, what gold investments do I recommend?

Let’s first revisit our consistent recommendation during the past few years: we’ve held 15% of total assets in segregated, physical gold. Not gold equities, not gold certificates, not ETFs, but physical gold. This has been a successful strategy. Physical gold has not only outperformed the key gold stock indices, but it has also been a potent portfolio stabilizer during a volatile time in financial asset markets.

What about the coming year or two? Again, I would bet more heavily on physical metal than gold stocks. While it’s true that some of the major mining companies generate attractive cash flow in the current gold price environment (good examples are Agnico Eagle and Barrick Gold), even the best managed miners are not invulnerable to cost pressures. I’m particularly concerned with the possibility of a rebound in energy prices, which could hurt profit margins. One way to avoid that problem is to buy gold-focused royalty and streaming companies. The two major names in that space are Franco Nevada and Wheaton Precious Metals. Still, while we periodically buy and resell gold producers and royalty companies, our core position is in physical gold.

How should you hold physical gold? Most investors turn to bank-issued gold certificates or ETFs, but in most cases access to physical metal is difficult and costly. Worse, numerous issuers back their paper promises with a promise of gold delivery from a counterparty. The counterparty, in turn, often covers its liability through a promise from yet another party. If any institution in this chain fails to deliver, the entire chain collapses. In other words, most certificates and ETF’s represent the issuer’s promise to deliver metal to you when requested.

The bottom line: if you are buying gold as a hedge against systemic uncertainty, you’re best off buying and holding physical metal that you can readily access or liquidate. That means taking delivery yourself or buying metal and keeping it at a storage facility—or both.

When it comes to storage arrangements, it’s key to pick a stable jurisdiction that does not have a history of intervening with private gold ownership. To us, Canada is a desirable storage location. It has a major gold mining industry and, through the Royal Canadian Mint, manufactures the world’s best-selling gold coin. Limiting private gold ownership is simply not in its interest. We offer a fully segregated and audited gold safekeeping facility. For details on how our program works, send us an e-mail at

What About Stocks And Bonds?

No investment commentary would be complete without a reference to equities and bonds.

The stock market’s recent performance has far exceeded our expectations. Put differently, our defensive posture has caused us to underperform. Yet, the warning signs we saw a few months ago are still there. Stocks are for the most part overvalued and the rally has been far more pronounced in the technology and communications sectors than in most others. In fact, many of our holdings (typically corporations with a strong balance sheet, an enviable competitive position and strong sustainable cash flow) have not done much during the past few months. We believe that will soon change, as the market will lose some of its froth and more defensive choices will start to outperform.

As to the bond market, we’ve been avoiding it for roughly three years—shunning anything but the highest quality issuers, sticking to very short duration, and keeping overall exposure below 10%. Is it time for a change? We’re still cautious, but we also realize that a peaking of interest rates could change things in favour of bonds. What will really matter is whether the weakening of the economy we expect will manifest in the context of still meaningful inflation (i.e. a stagflation scenario) or whether price pressures will miraculously recede and give way to deflation. Both are possible, but in our opinion the former outcome is more likely. That is why we will continue to stay on the sidelines of the bond market, while watching developments closely.

Which goes back to our basic theme for these turbulent times: be open to multiple outcomes and adjust to new developments as they arise.

Best regards,

Peter Cavelti