Mike Maroney Interviews Investment Performance Institute's Stuart Veale - January 2014
Stuart Veale and Mike Maroney
Portfolio strategist Stuart Veale discusses why it is so important for today's investors to diversify their assets and offers his advice on when and how to incorporate precious metals into a modern and strategic investment portfolio.
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Mike Maroney: Good afternoon. It's Mike Maroney here today with Stu Veale. The Author of a new book, "The Role of Alternative Investments in Portfolio Design." Stu is an expert in the financial markets. We are privileged to have him here today. I want to give Stu an opportunity to give you an idea of what his background is.
So Stu your bio was so long, it's tough for me to remember everything, highlight it for me.
Stu Veale: Ok, I'll give you the quick 20-second version. I spent 20 years in the securities industry, in a variety of sales, and management capacities. I then went out and formed my own training firm to do the securities training. I then returned to the industry as the head of Advanced Training for Paine Webber. From there, I became the head of Portfolio Design and Strategy for the national sales group at Prudential Securities. From there, I went out once again and formed my own trading firm called the Investment Performance Institute.
Mike Maroney: Interesting, I think Stu is a little modest. What Stu does typically, is he takes MBAs and basically teaches them about the financial market. Needless to say, many of these Ivy League graduates come from Wharton, Yale, Harvard, but Stu informs them about the reality of the financial markets, how they work, and the products that they'll be representing.
We're going to talk about one of those products today and that's alternative investment. I want to start off by asking Stu a question about the gold market. Needless to say, we've had a tough couple of years, but Stu has a great approach to looking at this investment and why now may be a great time.
Stu we talked last night about how gold is insurance. You explained to me why, now, may be one of the better times. Can you inform the viewers about this.
Stu Veale: Certainly, when markets move, no market goes straight up. Markets go through periods of retrenchment. They build strength again and then they advance. The last time gold took off, we went up, we had our 50% retrenchment, and then gold took off again. This time we've gone had, we've had about a 30% retrenchment, we may retrench slightly from here, and then again I fully expect gold to take off again.
There are a couple of reasons for that. The first one is that if gold goes any lower, the mines are simply going to shut down. Right now for a lot of months, we're right at the cost of mining. So if gold prices drop any further, it doesn't make any sense to mine gold at $1200 an ounce if it selling at $1100 an ounce in the market places. The mines will simply just shut down for a while until demand catches up with supply. Right now, I think, there is a very limited downside and a spectacular upside. If you look at all the other hard assets, farmland has doubled or tripled, rare cars--the auction prices are off the charts, rare gemstones--the prices are insane, and then modern art, no one can explain it, but modern art prices have quadrupled. The laggard at this point is gold. That's both bad news if it's laggard, if you own it, but it's good news if you don't own it or if you don't own enough of it you have such an opportunity to go in and get it. I think the only reason it's been a laggard is that governments, I think, have been actively trying to suppress the price of gold, because it's embarrassing for them when the price of gold rises relative to their currencies.
Mike Maroney: So gold is, kind of, like the canary in the coal mine. In essence, it let's the general population know what the stability or how the governments of the world are actually doing.
Stu Veale: I think that's a great way of looking at it, is the canary. It's an indicator of trust in the government. If you trust your government to maintain the integrity of your currency, then there's really no reason to own gold. I don't see many governments out there that are worthy of that trust today. Our government is printing money like drunken sailors, Europe is printing money like crazy, Japan announced that they are going to double the supply of their money, and every country's plan for expansion seems to be to lower the value their currency to increase exports. Well all that does is revert to beggar thy neighbor; I'll lower mine, so you respond by lowering yours, so you respond by lowering yours, and the cycle goes round and round. One thing they can't print more of is gold. By it's very nature, the supply is very limited. That's what gives gold it's appeal. That's why it's worked for 10,000 years. With a 10,000-year track record, I'm going certainly give it the benefit of the doubt.
Mike Maroney: Now, last night, we talked a little bit about government debt and interest rates. I found it absolutely fascinating what your hypothesis is as far as what sits out on the horizon. Can you embellish on that for us?
Stu Veale: Right now, if you believe the government, things are getting better. I can tell you categorically they're not. They only seem to be getting better, because we're in the eye of a hurricane. It's been going this way and soon it's going to be going the other way. The reason for that is very simple. One, the government statistics are unbelievable at this point. They tell you that unemployment is down at 7%, but they don't count people that have given up looking for work. The real unemployment rate is closer to 20%. If you count people who are grossly underemployed, people with Master's Degrees who are driving cabs, people with Bachelor's Degrees pouring coffee, the numbers look even worse. They're even worse obviously in Europe, now in Greece, we're seeing a 60% unemployment rate with people under 25. If you don't get that first job, you don't get the second. If you don't get that second job, you don't get the third. You're going to have a whole generation of people who basically are going to be unemployed and unemployable. Then, what are they going to train the next generation to do? The statistics is one of the real problems that we face.
Mike Maroney: Now, currently the interest rate, based on the feds, is close to zero.
Stu Veale: I'm sorry, let me just interrupt for just one a second. There's one other point I wanted to make there which was to go back to the idea of the lull. Both President Bush 2 and Obama have benefitted tremendously, because interest rates have declined. So they've been able to issue literally mountains of debt, pain-free, because the cost of servicing the debt has actually gone down.
So the first of our problem is government statistics, which are just simply blatantly misleading. If you look at the inflation figures the government tells you inflation is at 2. Well, anyone who has been to a supermarket knows that's simply untrue. The groceries cost more and the packages are smaller. We can't rely on government statistics. The even greater problem that we're facing today is that with this decline in interest rates, it's a head fake. The cost of servicing our debt has actually gone down, and down, and down, while the debt has gotten larger, and larger, and larger. That's the dichotomy. That's where it makes it feel like things are ok. We haven't experienced any pain from the increase in debt, yet. When interest rates turnaround and go back up again and we have to pay real rates of interest on this $17 trillion of debt, then a massive percentage of our tax revenues are just going to go to service the interest on our debts. There will be massive cuts in spending, massive tax raises, and things will get very bad, very quickly. So we're kind of caught between a rock and a hard place, as is the whole West. Japan is in that similar situation. If rates in Japan go up 2%, 100% of tax revenues just pay interest. There's no money to pay for anything else.
So we're so leveraged up at this point at the Federal level, State level, City level, personal level, that there's no way these debts can ever be paid. As bad as it's here, it's actually worse in Europe. They are trying everything they can to paper it over.
Mike Maroney: What do you think the inevitable outcome is as far as the European experiment, the Euro:
Stu Veale: Well the Euro was poorly designed from the get go. The ECU, which was the predecessor of the Euro, was actually better designed, but George Soros, kind of, broke the Bank of England, which caused that to collapse. The idea that you can have all these countries share one currency and not be able to adjust the value of their currency, really means that these states have no way of regaining competitiveness. Greece and Italy are just not competitive against Germany. The only way in the past they could get competitive would be to devalue their currency, make their goods cheaper--less expensive in German terms, and that would then stimulate sales to Germany and put them back to work. Today, that option is off the table. So unless, Northern Europe wants to perpetually pay Southern Europe's bills, which I can't imagine that they'll want to do. At some point, it'll break up and may be break up slowly with a Northern Euro and a Southern Euro and then break up further.
Mike Maroney: With the amount of sovereignty debt being held by French banks, Spanish banks, Italian banks, what happens if, let's say Greece, walks away from the Euro?
Stu Veale: I think that was the only reason that Greece wasn't actually thrown out of the Euro to begin with. When it became clear that Greece's finances were purely falsified, they found fictitious numbers, they outright lied to get into the European Union. When that was discovered, I think that everyone's first inclination was to just throw them out. Well the problem was that the French banks owned so much Greek debt that to throw them out would mean that Greece would have no choice but to default. Which could then bring down the French banks and the dominoes start to fall. Where do you go from there? So, I think the decision was made to preserve Greece, not for because of Greece, but because we don't want France to fail and you start going down that road and it always ends badly.
Mike Maroney: So Greece would end up being the first domino.
Stu Veale: The first domino and there was so much cross ownership that would cause French banks to be suspect. Well, the French banks' debt is, of course, owned by Norway, Germany, Italy, etc., so then they become suspect. Banking, especially when this age of fiat currency, is when they're not backed by anything, is purely the basis of our faith. I mean, it's just blind faith. When people don't have faith in the currency or faith in their trading partners the commerce just simply ceases to exist.
Mike Maroney: Now, since Bretton Woods, the U.S. dollar has been the reserve currency of the world and in essence have we perpetrated the ultimate scam on the rest of the world by papering them with worthless dollars?
Stu Veale: I don't know it I would call it a scam, but it's certainly been a remarkable benefit to the U.S. After the collapse of the Soviet Union, we became the world's dominant super power. As the world's dominant super power, everyone around the world wanted to own our currency. You could go to the poorest family in South America, poorest family in Central America, when I say poor, I mean, corrugated aluminum hut, and in the backyard they have a $100 bill buried that was their emergency money. Now, they gave us oil, natural resources, textiles, labor, all sorts of wonderful things. We gave them a piece of paper and they buried it in the backyard. Now, that's a pretty good deal for us and if when you think of the number of people from around the world who own some dollars and all we've given them is green pieces of paper and they've given us all sorts of valuable commodities and services in exchange for that, we've been living way above our means. Even when that stopped the BRICS (Brazil, Russia, India, and China) were willing to absorb huge quantities of our debt at ridiculously low interest rates, because we were the world's remaining super power. That will allow us to finance our lifestyle way beyond what our means should have been. Like everything else, that game is about up.
Mike Maroney: Now Stu, what happens if the rest of the world looks at the reserve currency, the U.S. dollar, and starts to move away even if they drop down to a 50% level or if the IMF creates an SDR (Special Drawing Right currency) and the rest of the world doesn't need to own dollars to settle transactions, what could happen to the U.S. dollar?
Stu Veale: Well the first thing that would happen is, if no body wants to buy U.S. dollars, basically in the form of U.S. debt, the U.S. government would have to then raise the interest rates that we're willing to pay to entice people. If somebody solvent wants to borrow money from you, you lend at one rate. If somebody is risky, you lend at a very different rate. As the rest of the world diversifies away from using the dollar, and we're seeing that at an ever-escalating fashion, it's only a matter of time until U.S interest rates have to rise. Now when U.S. interest rates rise, then a greater and greater portion of our tax revenue just goes to service the debt. That's what this whole quantitative easing thing was all about. Was that by the Fed going out and buying up our debt it was able to issue bonds that are effectively artificially low interest rates. Then they'd sell them to primary dealers. The Fed would buy them right back; basically we're just printing money.
Mike Maroney: So the Fed has tapered $10 billion dollars, it was $85 billion dollars per month, now it's $75 billion dollars. Many people talked about the tapering as the beginning of the end, as far as quantitative easing is concerned. What it sounds like to me, in order to keep the interest rates at a low level, the Fed may be forced to continue to print at an alarming pace. Is that correct?
Stu Veale: Will be interesting to see what the Fed does. We just had an unemployment number that was absolutely terrible, 74,000 jobs in a holiday season. Most of those jobs were seasonal, and we're seeing in the papers today, their companies are, of course, letting those people go, and the jobs that were created were either government jobs, which are net negatives, or very low income jobs, not jobs you can raise a family on. So it will be interesting to see if the Fed continues to taper. Aside from that, remember that the Fed now owns about $4 trillion dollars of U.S. debt and U.S. mortgages. Those are generating huge amounts of income. Now that income can also then be used to go out and buy additional debt. So on the one hand they can say we're tapering by another $5 billion, but then using the interest from all of their existing bonds they've already bought. Then go out and buy new bonds that dwarf what the tapering affect is. So it will be interesting where the Feds cash flows really go off the current holdings.
Mike Maroney: Now obviously, if interest rates were to let's say go back to somewhat of a norm, maybe 5, 6%, based on $17, $18 trillion dollars in debt 6%, we're talking about over a trillion dollars in interest. That's nearly half of what the government takes in. How can we sustain ourselves?
Stu Veale: That's just it, you can't. They're going to have to try and find ways to keep interest rates artificially low and that's the big problem again. You said it, "We're between a rock and a hard place." If you keep these interest rates artificially low by keep printing money, that results in inflation and people's buying power goes down and down. Remember when Paul Volcker wanted to bring inflation out of the economy; he raised interest rates up to double-digits. Well double-digit interest rates, right now, would bankrupt the government. Meaning you're talking about $17 trillion on the books and another $10 trillion off the books and you're paying 10% interest on that, that's deal up. The government yelled and screamed about a 5% sequester, they'd be looking at a 50 to 75% sequester and then you're going to have real cuts in social services, you're going to have massive tax increases, you're going to have a greater amount of social unrest as program after program gets eliminated, the wealthy will find some place to go or some place to hide. There's no rosy outcome to this.
Mike Maroney: It's not a pretty picture is it?
Stu Veale: No, it's...the one thing about math is math doesn't lie and there's just no way mathematically that we can get ourselves out of this mess. Our debt relative to our GPD is almost as high as it was at the end of WWII. At the end of WWII, we had a tremendous advantage. The rest of the world was in ruins. We were the only remaining manufacturing firm and for the next 20 years we basically rebuilt the world and all of that the wealth flowed to us. Now, our debts are at the same level, but the rest of the world isn't in ruins. So what's going to pay that off? There's no mechanism as there was at the end of WWII that's going to allow us to get out of this debt.
Mike Maroney: Now is the fact that the rest of the world is basically printing right along with the U.S. is that the one thing that's maybe propping up the dollar for the short term?
Stu Veale: Yes, everything is done on a relative basis. What's going to make this next crash worse is it's not one country. When Ireland had their famine, the people in Ireland suffered terribly. A million escaped to the U.S. and elsewhere. Greece had their problem and again Greeks are escaping to other places. When this crisis hits, it's the whole West because we're all interrelated now, we're all in the same boat. Ford's European sales, Mercedes U.S. sales are fully integrated. So it's going to be an entire collapse of the West. I don't think there's really going to be any place to go. It will flow over into the East, but when it all collapses at once there's no place to go.
Mike Maroney: I heard an interesting quote. It’s…mathematics is like gravity; it's non-negotiable. What you spoke about is that math doesn't lie, why can't more people see what's happening?
Stu Veale: I think they can see what's happening. I think two things. One, they're either grasping at straws. I think Bitcoin being the prime example of that. Bitcoin, to me, is the third sign of the apocalypse; it's right up there with tulip bulbs of the tulip bulb mania in Holland. People are desperately looking for something else, but they just don't know what, necessarily, to gravitate too. The government has been so negative on gold, because it embarrasses them that I don't think they understand the 10,000-year history that gold has of preserving wealth and acting as an insurance policy against poor government policy. There's no society that has ever survived a fiat currency for any length of time, because the politicians will always spend more and tax less to make themselves popular and kick the can down the road to the point where it collapses. Gold is your protection against that. It's an insurance policy and that's the way I view it. I buy life insurance so that if I get hit by a car my family is protected. I buy disability insurance so if I get stricken my family is protected. I buy gold because I can see my government is dysfunctional and I require protection. I really wish I didn't have to buy it. If my government was functioning fine, I would take that in a heartbeat and get rid of my gold, but the reality is, if anything, it's getting worse and so I feel gold is just a necessity.
Mike Maroney: That's interesting because if you look at the stock market, the stock market is making new all time highs. The SMP hit a low back during the 2008, 2009 crisis, ironically right around 666. We've seen an astronomical move, I know you're a student of Graham and Dodd, you know how to value stocks, the old principals that we used to use, based on all of those, obviously, things are pretty out of whack. When you talk about insurance, in essence, as the stock market goes up and gold goes down, it makes that insurance that much more valuable, but even cheaper.
Stu Veale: Well, there's the old saying everyone says they want to buy low and sell high. The reality is that very few of us brains that are actually wired to do that, it takes discipline. Rothschild sums it up best, "You want to buy stocks when there's blood in the streets." There was actually blood in the streets of Athens and some of the rioters set a building on fire and 3 people unfortunately died. So there was literally blood in the streets of Athens. You couldn't give Greek stocks away and since then the Greek stock market has been the best performing market. When you start talking people wondering when you want to buy low, it's when there's problems and they just resist it. The natural inclination is to buy high and panic and sell low. Now, the stock market's high, because there's been no place else to go. You'd have to be out of your mind to buy bonds at these levels. So as the Fed has pumped more and more money into there it has to flow somewhere, so it flew into modern art, it flew into rare cars, gemstones, but the vast majority went into the stock market and it's hit astronomically high multiples, and astronomically high levels, and don't get me wrong it's been a great year. That's the reason why nobody ever went broke taking profits. You want to now rebalance. Sell what goes up and buy what goes down. In my personal situation, I try and keep it a 50/50 mix. Since the stock market took off last year and gold's down, I'll sell some stocks and I'll buy some gold, a little balance. We'll see what happens this year and just keep it balanced, I think, at 50/50 you'll be just fine.
Mike Maroney: You talk about the West. Obviously, they're printing money at an alarming pace; alarming massive trade deficits. Then when you look over at the East you see China running surplus, holding on to massive amounts of excess dollars, but they're the ones that are buying the gold. You would think maybe it would be a little bit different. Why do you think that's the case?
Stu Veale: They're buying gold, because they don't want to hold paper dollars. They see what we're doing as clearly as we see what we're doing and they're the ones who are going to bear the brunt of it. If we massively print up dollars, we'll do what happens in Zimbabwe, we'll pay off our debt to the Chinese, but a dollar will buy what a penny buys now, in which case they just got robbed out of 99% of their wealth. They don't want to hold dollars while we're doing it through a period of quantitative easing. They want to spend those dollars. They want to get something that is truly of limited supply, something that has worked over 10,000 years. They've been the huge buyer of gold over the last few years. Hundreds of tons of gold has flowed through Hong Kong into China and that gold is never coming back out again that is going into their central banks reserves. They're also buying operating companies all around the world. They're buying hard assets, farmlands, operating companies, but primarily they've been putting it into the precious metals.
Mike Maroney: So in essence, they're taking paper, turning it into real money, causing a major supply demand issue, because the demand for physical is through the roof, the supply is beginning to diminish, but prices are going down. Great opportunity for them, but we can't seem to see that opportunity as well. What can we do to get people at least a little bit excited about the current position that gold sits in?
Stu Veale: Well, I think the first thing is that people have to understand the way money works historically and the way it works today, and it's not a 2 minute conversation, which is a reason I wrote this book. It, kind of, walks them through the history in why gold has worked and why it should work again in the future. Everything else has gone up, farmland has gone up, diamonds has gone up, modern art has gone up. Gold prices have gone down and that's because the fact that the government has been suppressing it, it embarrasses them when the price of gold goes up. The bad news is the government suppressing the price of gold. The good news is you have a second opportunity to get in or to buy more. So, I'm taking full advantage of the opportunity to one, rebalance, sell what's gone up, buy what's gone down. Then take the fact that since the government has been kind enough to push the price down for me, it made an opportunity to buy low. Gold is down almost to cost of production. So you're downside is virtually eliminated. If gold goes much lower the mines will simply shut down, they won't be able to produce gold for a profit. If they shutdown, of course, then the new supply goes away. The number one law of economics is supply and demand. The supply will go down and the demand is going to be ever increasing. So, I've slept like a baby through this 30% decline in gold price and I view it as a blessing not a problem.
Mike Maroney: I'll tell you what…Stu deals with MBAs. He teaches them about the products in the financial markets, but when he writes his book he makes it so that even I can understand it. So I can tell you this... this book should be read by absolutely everyone that's interesting in owning any sort of alternative investment. It gives you the ins, the outs, what you need to know, what you need to look for, absolutely tremendous. Stu thank you so much for stopping by.
Stu Veale: Thanks for having me. I appreciate it.