The wrong way to read a falling gold price
When people complain that gold has dropped, my answer is simple: as a buyer, cheaper is good. Would you rather pay $5,000 for something or $4,000? If you truly prefer paying more, I have a house to sell you. People buy tuna fish and coats on sale, yet they refuse to buy gold on sale. That backwards thinking is a total mystery to me.
Calling gold "down" is also a trick of memory. Saving in gold started in the year 2000, when gold cost $256 an ounce. It now sits at about $4,100. That doesn't feel like down. Over the last 26 years gold has risen 8% a year, compounded, in US dollars. Looking backward is the wrong exercise anyway. What matters is what comes next.
Cash that quietly loses money
Gold does well when savers get nervous about keeping their buying power in normal savings tools. Take the US 10-year Treasury, the world's top benchmark for safe saving. It yields 4.6%. But the dollar it pays you in is losing buying power at roughly 8 to 10% a year, compounded. Do the plain math and you earn 4.6%. Do the real math and you lose about 4% a year. Put $100,000 into a 10-year Treasury and you get back the buying power of $50,000. A bad deal.
Gold, by contrast, holds buying power. That is exactly its job. An ounce of gold buys a very fine men's suit today, just as it always has, and it will still buy that same suit ten years from now. In dollars, that suit will probably cost $15,000 in ten years. My view is that the dollar will repeat its 1970s performance and lose 75% of its remaining buying power over the next ten years. Gold will keep pace.
A market share that has nowhere to go but up
Gold and precious-metals-related securities make up half of one percent of all US savings and investment assets. That is a pimple on an elephant's behind. The four-decade average share is 2%. If ownership simply returns to that average, demand for this asset class jumps fourfold in the largest savings and investment country in the world. That is what I expect to happen. The same case can be made sector by sector across the extractive industries; gold is just the one most people recognize.
The conservative case: downside is the upside
I build this from a cautious point of view. The claim is that your downside is upside, and the answer begins with "when," not "if." An "if" scenario exists too. In gold's last run of huge outperformance, 1970 to 1980, the dollar lost 75% of its buying power and gold rose 26-fold in price. It is estimated, though hard numbers don't exist, that in 1981 precious metals and precious-metals securities made up 7% of Americans' savings and assets, versus half of one percent today. If ownership went to 7% instead of the 2% average, there isn't enough gold on Earth to fill that demand. But I don't need the upside case to make my point. I only need the downside case, and I challenge anyone to knock it down.
What would actually make me sell gold
People ask what would make me sell. Here is the full list. You would have to balance the US federal budget. You would need the political will to pay down $40 trillion in debt. You would need the political will to fix $120 trillion in unfunded entitlement promises, measured at net present value. Someone would have to look me in the eye and say, "Yes, you paid into Social Security for 60 years, but there's no money, so you get nothing."
And you would need a positive real interest rate. If the dollar is losing 8% a year, I'd want at least 150 to 200 basis points on top of that. The 10-year Treasury would have to yield 10%. The first mortgage rate would have to be 12%. The prime rate would have to be 11%. How long would American taxpayers stand for that? The chance of these conditions appearing within ten years is, in my view, basically nil.
Why inflation raises commodity prices before the headlines catch up
Assets priced in dollars get more expensive in nominal terms as the dollar falls. Later in an inflation cycle, interest rates rise. When rates rise, the cost of building new productive capacity in copper, iron, and oil goes up. That favors the producer already in business. If adding new supply gets more expensive, less new supply gets added, and existing supply gets rationed by price.
This is the real 1970s lesson that most people miss. They blame the decade's oil price jump on the Arab oil embargo. They forget that society underinvested in oil for the 20 years before that decade, and that the cost of developing new supply rose exponentially because of inflation during the decade. The same forces are at work today, in the same way.
Rising costs are hitting miners now, not later
Gold miners are seen as leveraged bets on the metal, on the idea that costs stay flat while the gold price climbs. Costs are not staying flat. They are rising already. All-in sustaining costs keep climbing. Open-pit mines are very energy-hungry, so an oil price increase doesn't hit three years out; it hit three months ago. Mine-building inputs are also rising, and they are priced at roughly 10% compounded. A billion-dollar mine built today costs $1.1 billion a year from now. Anyone discounting a mine's future cash flows has to raise the input costs they're using by at least 10% compounded.
How the money reaches the junior explorers
A junior with real gold in the ground should rise with gold. A junior sitting on "moose pasture" with nothing in the ground has no reason to rise, even in a rising gold market. So how does money reach the tiny explorers? Through exhaustion of everything above them. If demand for precious metals and related equities reverts to its average and quadruples, there isn't enough supply. Gold gets used up. The best of the best gets used up, then the best of the rest, then the single-asset producers, meaning their market caps get bid away. A bull market has been described as trying to force Hoover Dam through a garden hose. Only when the biggest and best are exhausted does capital reach the tertiary assets, and nothing is more tertiary than junior explorers.
The price response there is truly insane. You endure long droughts and exquisite risk, and it takes a lot of labor to take advantage. But when you get paid, which is a once-a-decade event, and you were positioned ahead of time, you get paid in spades. My rule for that risk: allocate only what I could lose completely without it changing whether I have breakfast. In return, young, hardworking teams might deliver me a 10-bagger. I won't buy a whole company like Palisades, because owning it all would obligate me to keep funding it, and I won't do that.
Gold is savings, silver is speculation
I save in gold and keep my cash liquidity in US dollars, but I save in gold. Silver is different. Silver is a speculation. I bought silver because it was hated, not as an investment. My reasoning was that if the hatred faded, silver would bounce. Having watched many cycles, I also knew for certain that any precious-metals bull market would be led by gold first.
Then, when momentum in gold pulls the generalist investor into the precious-metals silo, leadership shifts to silver. I don't know why it happens, and I'm not smart enough to explain it. I just know that in the prior four precious-metals bull markets of my life, that's what happened. So I expected one bump when the hatred faded and a second bump when leadership rotated to silver. Both happened.
Selling into the hyperbolic chart
A third thing happened. In early January we faced a hyperbolic chart. Canadians call it a hockey-stick graph. The backside of a hockey stick is just as steep as the front, and it's far less fun when you're wrong. The rule: when a sector chart goes hyperbolic, you always sell it, no exceptions, unless the spike comes from a company-changing news release. When I saw silver lock limit-up every single day, experience said sell. The reasons to own it had been used up. As a speculation, silver now had less upside relative to downside than other speculative assets, and I was holding a hyperbolic chart. So I sold.
Where the money went next
After selling silver, I asked what speculations looked more attractive. I took some money completely off the table and bought physical gold, which I count as savings. The only other asset class that felt as hated as silver had been was oil, so I put 25% of the money into oil stocks. I put 50% into silver stocks.
The logic on the silver stocks: if I was wrong and silver kept rising, the stocks would gain. The silver stocks were priced as if silver were $42, while silver itself was $85, so I had a cushion. If silver traded sideways, I'd make nothing in the metal but could still make money in the stocks. If silver fell, the built-in discount meant I'd lose less in the stocks than in the metal. That is a far more sensible bet than holding an asset whose reason to own had disappeared.
Why most silver miners are worthless
Asked whether silver miners still trade as if silver were $40 or higher, my answer is blunt: most silver miners today are valueless. Some silver mines are extraordinarily marginal, and they compete against companies that produce silver for free. If you run a big copper porphyry deposit, extracting silver just means bolting a silver-recovery unit onto your existing mill stream. The mining, grinding, and processing are all already paid for by copper. All you do is pull the silver out.
So a primary silver producer making silver at $35 an ounce is competing with BHP making silver at 50 or 60 cents an ounce. That's an ugly business. Before buying a silver miner, you have to work out the net present value of its silver stream, how that value is likely to change, and how much risk it carries in a falling silver market. Your competition isn't only other silver producers; it's recyclers and copper miners. Rising silver prices don't automatically mean rising mining profits.
