Should I Hedge My Gold Position With Bonds? Mike Maloney

Key Concepts

• Hedging: Strategies employed by investors to mitigate potential losses in their portfolios.
• Deflationary Period: A sustained decrease in the general price level of goods and services, often associated with economic contraction.
• Inflationary Period: A sustained increase in the general price level of goods and services, leading to a decrease in the purchasing power of currency.
• Fiat Currency: Government-issued currency that is not backed by a physical commodity like gold or silver, but rather by the government that issued it.
• Debt-Based Currency: A currency system where money is created through lending and debt.
• Real Rate of Interest: The nominal interest rate minus the inflation rate.
• Quantitative Easing (QE): A monetary policy whereby a central bank purchases predetermined amounts of government bonds or other financial assets in order to inject money into the economy.
• Tariffs: Taxes imposed on imported goods and services.
• Precious Metals: Gold and silver, historically recognized as stores of value and mediums of exchange.
• Base Metals: Industrial metals such as copper, aluminum, and nickel.
• Monetary History: The study of the evolution of money and monetary systems.

Discussion on Investment Hedging and Market Outlook

This transcript captures a conversation between Mike and John at the New Orleans Investment Conference, focusing on investment strategies, particularly concerning hedging and the outlook for various asset classes.

John's Question on Hedging

John, an investor from Australia, poses a question about the importance of hedging for investors, especially in case their primary investment thesis is incorrect. He specifically inquires about potential hedges such as a 5-10% allocation to long-term US government bonds or a pro-US dollar position. These hedges are considered as a safeguard against a massive deflationary period, similar to those experienced after the Great Depression or in 2008, which caught many investors by surprise.

Mike's Perspective on Gold, Silver, and Bonds

Mike expresses a strong conviction regarding gold and silver, suggesting that central banks, particularly those in the East, are actively placing a "floor" under these precious metals. He views bonds as potentially dangerous assets, citing the repeated downgrading of the US credit rating. Mike attributes this to what he perceives as "reckless government spending," which he believes will continue to erode the credibility of bonds over time.

While acknowledging John's consideration of a 5-10% hedge, Mike shares his personal investment philosophy. He recounts how he was once advised against investing more than 10% in gold due to its volatility. However, he ultimately decided to invest 100% in gold and silver, considering it fully diversified by holding both. Mike states that he went "fully into gold and silver knowing the fundamentals underneath it" in the early 2000s and that for a decade and a half, precious metals were his sole investment. He emphasizes that this strategy has proven to be the "number one performing asset of this century," attributing this success to the cyclical nature of markets and the current cycle where gold and silver are "really shining."

International Investors and Currency Hedging

John follows up by asking about the relevance of hedging for international investors, specifically those in Australia. He explains that when his clients buy long-term US government bonds (e.g., via an ETF like TLT), they often employ currency hedging. This means that even if the Federal Reserve engages in unlimited Quantitative Easing (QE) and devalues the US dollar, their investment performance is primarily tied to the price movement of TLT, without significant currency loss. John questions whether such a hedge might be more sensible for non-US dollar-based international investors.

Mike acknowledges this possibility but points out historical currency fluctuations, such as the Australian dollar being at par with the US dollar in the past. He argues that it's not always the US dollar that is being destroyed in value, but rather other currencies, like the Australian dollar, can depreciate faster. He uses the analogy of "skydivers" to describe national fiat currencies, all falling at different rates relative to gold and silver, which remains "in the plane."

Australian Dollar and Commodities Boom

John agrees that the Australian dollar has been weak but presents a counter-argument. He suggests that during a commodities boom, the Australian dollar tends to strengthen due to increased demand for base metals and energy. He highlights Australia's significant uranium reserves, which, despite government restrictions, could contribute to the currency's strength in an inflationary global environment. John clarifies that this is his "5 to 10% hedge thesis" and not his base case.

Mike's Outlook: Global Economic Slowdown and Financial Crisis

Mike agrees with John's observation about the potential for the Australian dollar to perform well in certain scenarios but reiterates his primary forecast. He anticipates a global economic slowdown, exacerbated by tariffs and trade wars that disrupt international trade. He provides a personal anecdote about delays in acquiring mobile chicken coops from Poland due to uncertainty surrounding the constitutionality of tariffs, which has halted business development and job creation.

Mike believes that tariffs are a significant factor, and other triggers will emerge, leading to a global financial crisis that he expects to be "worse than 2008." This crisis, in his view, will result in an economic slowdown, reduced construction (real estate projects, houses, apartments), and decreased manufacturing (cars). Consequently, he predicts that base metals should fall due to a lack of demand. Simultaneously, gold and silver are expected to be in high demand. He notes that while Australia has significant gold and silver reserves, its economy is heavily reliant on mining base metals. Therefore, as copper, aluminum, and other base metals decline, he does not foresee the Australian dollar gaining strength. Mike admits that his expertise lies in monetary history and precious metals, and the broader economic outlook is an "educated guess."

Central Bank Actions and Fiat Currency's Inherent Flaws

Both Mike and John express concern about the current actions of central banks. John agrees that the upcoming crisis will be worse than 2008 and "very different this time." He highlights the historical necessity for central banks to maintain interest rates 2-3% above CPI to ensure a positive real rate of interest. However, he observes that inflation is bottoming and starting to trend upwards, yet central banks are already initiating interest rate cuts. He notes that it typically takes 18-24 months for rate cuts to impact consumer inflation, leading him to be "very concerned" about the future.

Mike concurs, stating that cutting rates "causes inflation to pick up even more." He believes central banks are trapped, having exhausted their tools, which he likens to having "a toolbox of a bunch of hammers." He describes the process of money creation not as "printing" but as "typing numbers into existence," emphasizing that the US dollar is "nothing but a number supply" and that the supply is "infinite."

Mike reiterates his long-held view that the mathematical foundation of national fiat currencies, especially debt-based ones, makes it impossible for them to store value over the long term. He argues that they "always have to fall in value, lose value over long periods of time" and therefore "are not money." He advocates for referring to them as "national fiat currencies" and asserts that only gold and silver have proven to be money over the last 2,500 years. He acknowledges that gold and silver have experienced periods of poor performance, such as from 1980 to 2000, but since 2000, they have been the best-performing assets, second only to cryptocurrencies, which he identifies as the first new asset class in approximately 900 years.

Conclusion and Appreciation

The conversation concludes with Mike thanking John for his insightful questions. John expresses his gratitude to Mike and also to Dan, who is behind the camera for the "Hidden Secrets of Money" series. John states that he makes Mike's series a "mandatory starter pack" for any new client in Australia, recommending it as essential viewing for anyone wanting to learn about money.