We Study Billionaires - The Investor’s Podcast Network - TIP387: Precious Metals Masterclass w/ Tavi Costa

Starting point is 00:00:00 You're listening to TIP. On today's episode, I sit down with Tavi Costa to get his take on the macro environment and why he believes precious metals will outperform in the near term. Tavi is a partner and portfolio manager at Crescat Capital and is one of my favorite resources when it comes to precious metal research. In this episode, we also discuss the four pillars of inflation, the risks of de-globalization, especially from China, opportunities in gold, silver, and palladium, and a whole lot more.

Starting point is 00:00:28 Tavi is a wealth of knowledge and this conversation was a lot of fun. I hope you enjoy it as much as I did. So without further ado, here's my interview with Tavi Costa. You are listening to The Investors Podcast, where we study the financial markets and read the books that influence self-made billionaires the most. We keep you informed and prepared for the unexpected. Welcome to the Investors podcast. I'm your host, Trey Lockerbie, and today I've got with me Tavi Costa. Tavi, welcome to the show.

Starting point is 00:01:09 Thanks for having me, Trey. I'm super excited to have you on because we've been talking a lot about inflation on this show. And I know you have a very succinct outline or guideline for inflation. I've heard you describe it as four pillars of inflation. So I'd love to start off with you just walking us through what you think the four pillars of inflation are. It really used to be three. And one of them is really a long-term one. So I explained that.

Starting point is 00:01:34 But the three main ones to start with is I believe that we're seeing with the fact the Reserve right now is a wealth transfer from the government to the people. I can see that on the data very clearly. Unfortunately, a lot of people are not focusing so much on the data because there's so much inequality issues. But what we're seeing today is a very large increase in net worth of individuals, especially in the bottom 50% of the population. It really is happening across the entire parts of the society. But the bottom 50% is one that calls my attention at least because it's highly linked to the increasing value of the market, but also the policies that we're seeing so far on the fiscal side. From my understanding of the emerging markets that have had a lot of

Starting point is 00:02:17 those policies in place with the focus for the bottom 50%. Usually what we see is a large increase of demand of goods and services. That is not to mix with the roaring 20s thesis at all, but I think that that fits into the inflationary narrative. Number two, we have some of the supply constraints. We've done a lot of research going back to the 1919 Spanish flu. And what we saw back then was that raw materials became rare. So we wrote a paper in December of 2020 about the issues that we could potentially see in regards to the supply disruptions. Well, that kind of happens until now, but what is next after using that as a roadmap? And what we see there is that the next step would be a large increase in wages and salaries. As cost of living begins to rise, you start to see

Starting point is 00:03:05 the demand from workers to also want to be paid in higher wages and salaries. In fact, back in 1919, after the Spanish flu, we saw that one out of five workers was engaged in a labor protest back in those days. And so I think there's a high probability that we may see that. Right now, we see job openings at much larger levels than we see of unemployed people. And so it's a matter of time. And if you look back since the 70s, we've had a secular decline in wages and salaries growth. And that has been one of the structural changes that I think would really feed into the inflationary thesis and become, I think it's going to look like a wage, a spiral growth, like similar to what we saw in the 70s. And so that's the second pillar, which is also linked to

Starting point is 00:03:51 some other issues in regards to natural resources in terms of the supply side, where a lot of folks are seeing this as the likelihood of things, especially in the logistics side, improving quickly when I actually am in the other side of that camp, given the fact that we've had a large or long period of time of underinvestments in mining and exploration of natural resources in the U.S. and globally. And so the third pillar of inflation has to do with the monetary and fiscal policy and the monetary dilution that we're seeing from central banks in order to allow governments to spend money in terms of fiscal spending.

Starting point is 00:04:26 And that goes back to the idea of especially the mandate of the Federal Reserve, where a lot of people focus mostly on the employment picture and inflation stability, where I think it has all to do with the suppression of interest rates and why we're seeing such a need for real rates being negative right now. The Federal Reserve has a mandate, in my opinion, of reducing the cost of capital, given the fact of where we are in regards to the leverage ratios from the government, corporations, and other parts of the content. And so I think that that really feeds into the monetary dilution side of the basement of the fiat currencies that we're seeing is the third pillar that is so important and it will likely continue to be the case given the fact that the imbalances, the macro imbalances have not changed at all since the pandemic or since the global financial crisis have really unfolded back in Norway. The fourth pillar, which I think it's a long-term sort of a lot of implications that we'll

Starting point is 00:05:24 see developing the following years and perhaps a decade or so from now has to do with the China situation in the U.S. And that, in my opinion, is the de-globalization patterns that we're seeing. Started really with Trump. At the beginning of that, we saw the idea of using tariffs as a way of tackling the situation and tariffs and imported products from China. And that shifted now with the idea of it seems like a fiscal arms race between China and the U.S. And the idea of a lot of countries, not only the West, is to, instead of using tariffs, is to use fiscal spending domestically to allow companies through subsidies and domestic companies to compete with Chinese companies.

Starting point is 00:06:06 And I think this is clearly a pattern that we may see to continue, but it will lead to this transition away from China being the manufacturing plant of the world will be inflationary, in my opinion. Once we move towards automation and some other important technological advancements, I think that that will certainly taper down a lot of the inflationary issues that may be created by this de-globalization trend. But I do think that the first reaction of this in the markets would be very inflationary. So this need to move capital away from China from a fiduciary standpoint to a company standpoint of behavior of what we see in terms of executives in general of trying to avoid. avoid building up manufacturing plants in general in China, I think will have inflationary implications in the long term. So those four pillars are all acting, in my opinion, in a very strong way

Starting point is 00:06:59 today. And it's very different with what's being priced in in the markets. It will create a lot of opportunities. This reinforcement of owning tangible assets in a time when any investor is really struggling to find investment alternatives to that yield more than inflationary expectations will force investors to buy tangible assets, in my opinion. And that also feeds into this inflation thesis. So it's a lot to unpack. But in a nutshell, that's sort of what the four pillars of inflation would look like, in my opinion. I want to touch on the cost of goods and wages piece a little bit more. We all have heard that inflation can sometimes beget more inflation, right? Just based on a psychological factor where it can kind of create more of itself. What I'm kind of

Starting point is 00:07:45 curious to understand is as companies increase their cost of goods, then people need to buy those costs of goods. And so therefore, they go back and demand higher wages to go afford those cost of goods. But now that the companies are paying higher wages, they have to go back and increase their cost of goods to afford those higher wages and so on. So is there sort of a, I don't know if you'd call it negative or positive feedback loop happening here? But is that something that you kind of watch unfold using some kind of metric? Well, look, I think there's a lot of good things and negative things that will come out of this like any other economic development. One of them is what you refer to, which is the large focus on margins.

Starting point is 00:08:22 We've seen so far in the last decade or so is this focus on top line growth where sales have been, you know, the priority to a lot of executives that run companies to really pursue. And with the increase of inflationary forces and cost of capital as a result, becoming more expensive, I think we'll create a need for bottom-line. improvements. And so the security selection process of investments will have to, my opinion, shift towards prioritizing margins and improvements in profitability, which is something very different. You know, that's the old school fundamental analysis has been out of favor for so many years. And I think that's about to come back. Going back to your point, it's certainly a psychological

Starting point is 00:09:06 shift inflation. And when the gene is out of the bottle, it's difficult to do with it for a few years and decades. Some countries have not had these issues for decades. The U.S. was lucky back in the 70s of having the capability of raising rates significantly using monetary policy in its favor to reduce inflationary pressure. But who lived through the 70s knows that it was a very difficult time to reconcile the issues with cost of capital as a whole. I don't think a lot of the companies that exist today in the U.S. in today's environment would actually be able to exist back in the 70s if we have interest rates at the levels that we saw back then. Now, the issue with cost of goods and services, number one, I think it has to do a lot with the problems of skilled labor has been

Starting point is 00:09:53 a problem for so many years. And the thing that is mostly attracting me to the natural resources, industries, and why I'm being so involved with this is the difficulty of finding skilled labor in that sense. There are no geologists. It's hard to find folks that know how to drill in order to explore commodities as a whole. And so there's clearly a lack not only of investments, but also skilled labor to pursue a lot of the usual patterns that we see in the commodity space. And we saw commodities do nothing but go lower and lower from the global financial crisis until really the last quarters where we saw commodities starting to turn higher. And I think that sure, that has a lot to do with the monetary disorder and fiscal disorder that is creating a need for.

Starting point is 00:10:39 for investors to buy those tangible assets, but there is also a supply side of the argument that I think is very compelling. When we look at the amount of labor in general, number of folks working in those industries, we are basically at all time lows right now of availability of skilled labor in the space. When you look at CAPACs, so capital investments in mining and developments of those natural resource projects, we are also seeing very severe declines in depending on the industries. And so it's almost like we've seen a depression in the whole space meeting these issues with the pandemic now, with the demand shock of the fiscal policies creating a demand that we've never seen before. And we also have the savings rate at extremely elevated levels

Starting point is 00:11:26 creating large demand for goods and services. So there's a lot of things playing into this. And some folks believe this is going to be transitory. I'm definitely on the other side of this because I've seen this many times in other places, not only in the U.S., and usually when inflation as a psychological development and behavior among the population, it starts to unfold. It's very difficult to move things around. You're not going to see folks McDonald's now charging, paying $18 an hour, up to $18 an hour, for someone to work for them.

Starting point is 00:12:00 Now, that's going to be a difficult pattern to see that reversing anytime soon. And so those patterns tend to reinforce themselves over time. And that is what really creates the long-lasting inflationary forces in the economy as a whole. I think that's happening globally. Larger extent, I would say, the developed economies that haven't really seen that in a long time are starting to experience that in a large way. And worries me is on the fiscal side and policymaker's side is that when you read about the 70s, the 40s, the 1910s, there was a sense of worry about, inflation. And I don't see the same fear for those policies to translate into higher prices of goods and services. And that's for me where this all ties up together into the supply issue side,

Starting point is 00:12:48 the demand side, the fourth pillars of inflation, but also from a policymaking perspective where there's a lack of fear towards what could really all this money printing, call it money printing or expansion of the monetary base and fiscal policies will translate into. So I'm quite worry about the next few years when it comes to what I think inflation is going to look like. Let me ask you this. Do you think there's a lack of fear because they just keep changing the CPI numbers that can control the definition of inflation more or less? You have this great example of Lyft and Uber in the CPI. Why don't you talk to us about that? That's a good question. Well, Lyft and Uber, there's something called the Intercity Transportation

Starting point is 00:13:29 component of the CPI where if you looked at back from January 20, 2018 to now, the growth in that component is about 5%. I don't know what state you were in right now, but myself here in Colorado, I can tell you that the growth in services for Uber and Lyft have certainly gone up, you know, at least I would say, no, 50 to 90% or so, which in that research and referred to was this research from Yahoo Finance, where they said that Uber and Lyft rights have increasing price by about 90%. And that is completely. out of line with what is being calculated on the CPI, which number one, they don't explicitly say if Uber and Lyft is part of the CPI. And if it's not, you know, who is, I don't see a lot of people really taking cabs rather than Uber and Lyft, that that would be an insane form of calculating intercity transportation, which is exactly where it should be the calculation or the inclusion of Uber and Lyft as part of that. But that's just one example. You know, you can look at the the price of agricultural commodities. That is another great example of that. Even the price of or cost

Starting point is 00:14:38 of use car prices, we've seen that rise significantly. And very few people talk about this. But if you look at the inventories picture, well, what most people will say about the use car prices is that, well, that really happened after the pandemic and that really was what magnified that trend. But you go back to the 2019 or so way before the pandemic, inventories are already at all time lows for use cars. Kind of interesting idea that we were already seeing those patterns happening prior to the pandemic. Obviously, the pandemic really intensified those supply issues, but there were a lot of those problems already starting to develop an economy for whatever the reason is. Perhaps some of the issues with natural resource spaces referred to, which it was kind of clear

Starting point is 00:15:23 that the demand for electrification in the world, there was a miscalculation. If there is a miscalculation of the idea of innovating the global economy through electrification and so forth with the amount of commodities that we have to allow that to occur. All those are playing into this inflationary trends that we're seeing in the long term. But going back to your question, yes, there's a lot of components part of the CPI that are not in line with what we're seeing in regards to the real inflation in the system. I think inflation, you know, from internal calculations, we see at least, you know, double digits, low double digits of growth year over year. And we can use a lot of examples in the past of times when we had those levels of inflationary forces. Usually they stick

Starting point is 00:16:09 around for longer. Even if we use a transitory example, the 1940s, is a great example where we saw inflation going above 5% in a CPI calculation twice during that decade. During the two times, inflation stayed above 5% for over two years. So do we have an equity market? that would justify the current valuations if we have inflation staying at those levels for over two years. I think it's a tough justification of the current multiples. And so I'm quite worried about the implications of inflation in the rest of financial markets as well. Let's take a quick break and hear from today's sponsors. All right.

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Starting point is 00:20:54 Another quick question on wages. I'm not sure if you're familiar with this chart. It's basically going back to what you said earlier about the secular decline of wages since the 1970s, but you juxtapose that secular decline with the productivity growth line, right? And the productivity growth of our country has been going up linearly. And I'm curious if you have a theory around potentially the reversion to the mean, so to speak, with wages.

Starting point is 00:21:16 Are we seeing wages kind of going to come back in line with that productivity line? Well, there is certainly a possibility that that could happen. I think wages and salaries are very long-term trends that, at least from my understanding of smoothing out the volatility and looking at the data on a two-year horizon in terms of the Delta. And if you go back throughout the 40s and 50s and 60s, those are usual trends to develop themselves and build on themselves over time. I think we're kind of seeing one of those now in regards to wages and salaries. We haven't seen minimal wages didn't go up, don't go up since 2009, I believe. And so there has been a sense of the initial reaction really comes from the cost of living rising that really makes folks to

Starting point is 00:22:03 start demanding higher wages, salaries. And we haven't really seen that in a long time. Usually inflation, at least in the last few decades, have been very cyclical. We saw inflation rising. And we've been in this vicious cycle of policies in general, which is inflationary forces begin to rise and the Federal Reserve immediately starts to change their policies that creates a financial shock that is immediately accompanied by a large increase of fiscal and monetary stimulus that feeds into this long-term inflationary problem. We've seen this since the 90s, basically, with Allen Greenspan starting to really intervene in a larger way and perhaps trying to avoid the cyclicality of financial markets. And it certainly seemed like for a while

Starting point is 00:22:45 the Federal Reserve was succeeding at that. But I'm strong believe that. of business cycles still exist. And I think we're still going to see the reckoning of high valuations at some point. It's really a liquidity issue that is created at some point in regards to cost of capital or some exogenous shock or anything like that. So wages and salary is something that we have not seen, especially coming from executives, if you look at the surveys coming out from manufacturing surveys and non-manufacturing surveys in regards to paying up higher wages and salaries and employment plans of those folks, clearly we're seeing upper trends of those indices as well. And all those feed into this idea of we may see a larger increase of remuneration of workers as a

Starting point is 00:23:31 whole. I am very focused and also looking for what are the companies that will be squeezed from those margins, the ones that have less buying power and selling power as a whole, will be the ones that are really going to get hurt. And there are quite a lot. And there are some companies will really benefit from this environment. And I think the natural resources would be one of them. Productivity is an interesting topic because when it goes back to the idea of owning tangible assets, you don't want to own that if we're seeing organic growth in the economy that is really being happening through without the need for fiscal and monetary stimulus. If you were a believer of that, we're starting to see a new era of productivity, which we've seen that before, by the way,

Starting point is 00:24:11 we've seen that during industrial revolution and some other periods of history, If you think we're going through one of those, an important trend that may actually cause this wages and salaries growth to become actually cyclical, go back to a downward secular trend. That is not my belief. I think that inflation is a problem here that is here to stay. I don't think that any of the technological advancements we have in place today will be capable of preventing those issues from happening. And I think that in regards to fiscal and monetary stimulus, I think we may see more rather than less. in the next few years. And so this dependency of policies in order to create growth in a way, I think will likely continue. We sort of seen disciplinary C-belt come off back in the 70s with

Starting point is 00:24:58 the break of the gold standard. So government debt, you know, growing at those times in a significant way all the way to we see now. And there's almost like this new awakening of a root awakening that I call among folks asking for this discipline to come back. And so that's why we're seeing so many developments with the crypto markets and some other markets with the idea of really moving away from fee currencies that are backed by corrupted governments and a lot of indiscipline as a whole when it comes to the monetary and fiscal disorder. So quite interesting what's happening. And I think tangible assets and this need for buying tangible assets, regardless of what investors find as the way to expose themselves towards from housing to crypto,

Starting point is 00:25:41 to commodities, to gold and silver, all those. look attractive, in my opinion, in the next, for the next few years. So what I heard from that was, you know, going back to your McDonald's example of wages going to $18 an hour, there's obviously an incentive there where maybe the executives choose to then start putting kiosks at the front or displacing workers if they start to become too expensive. But from your point there, it sounds like maybe the Tesla robots of sorts are still a few years off. I think it's still a few years off. And I would say maybe perhaps even a few decades off. I'm happy to change my opinion if I see a large trend towards automation

Starting point is 00:26:18 that really drives a deflationary environment. I think that that would be important to look at. However, in order to develop those tools as a whole, the need for copper and iron ore and other common base metals that will be used silver itself to develop everything that will be needed to replace human labor, I think will be significant and will create a large demand for tangible assets. So initial reaction in the markets, I think, would be perhaps in a way inflationary to, you know, I believe that automation will take place at some point and official intelligence will be a lot of those changes in terms of the technological trends will perhaps reinforce another deflationary shock at some point.

Starting point is 00:27:01 But I think we're years ahead of that. And I really think, you know, when it comes to the problems of the lack of labor, meaning in not only almost anything, almost any business today in terms of business models in the U.S., are really in seeking not only high-scale labor, but any type of labor. And I'm not sure, you know, maybe we're going to see some sort of UBI when universal-based income sort of trends once the time being for those robots and some sort of automations that are able to replace human labor. But I think we're so far from that right now.

Starting point is 00:27:32 I really think inflation is a trend that is here to stay and it will build on itself for a few years. And what concerns me is back in the four and in the 70s, certainly there was. a sense of acknowledgement from especially fiscal policies would perhaps create inflation. And today, given the fact that we've seen monetary stimulus become a much bigger part of the pie than fiscal, and now we're seeing the shift, there is kind of a lack of acknowledgement from policymakers that will create inflation. The issue with fiscal stimulus is so direct. That's not an issue. It's just the way things work. It's so direct in regards to the bottom 50% from changes such as the cancellation

Starting point is 00:28:12 of student debt. Those are all forms of transfer of wealth. You know, for a person in the bottom 50% to cancel their student debt, that is a big accomplishment for them in regards to not, I wouldn't say accomplishment is not the right word. It's a big shift in regards to what they would be spending in terms of their monthly budget and so forth. And so those are all forms of transfers of wealth that we may see in the future. We saw food stamps going up 27%. That's not transitory. That's going to stay. And obviously that doesn't create the large demand, but those are all examples of large changes in the government with the focus in the bottom 50%. The fiscal agenda is pretty clear to me that there's a lot of fronts here.

Starting point is 00:28:50 The Green Revolution is one of them. The peak inequality issue is a large one. The fiscal arms race with China that I was alluded to earlier. And this infrastructure revamp that we're seeing as well. Policymakers are saying all the time that the issue with inflation is the lack of infrastructure. I don't think that that's the issue. I think the issue has to do with the policies that are so misguided to have. been creating inflation. Not to say that we don't need infrastructure developments. We do need

Starting point is 00:29:17 infrastructure developments in the U.S., but that's not the root cause of inflation. So, Tavi, you have a pinned tweet thread, I should say, about the Federal Reserve and how they are trapped. And it's a great synopsis of the macro environment. There's a lot of points in there that we've touched on on the show. I think we share a similar thesis here. But I wanted to highlight a few of the facts you listed there that really stood out to me that I didn't know. for one, foreign investors only bought 5.2% of treasuries issued in 2020. 5.2%. I found that to be surprising. The second point was that U.S. banks now lend more to the government than households and businesses. Maybe that's not as surprising, but just seeing it

Starting point is 00:29:56 laid out is something I hadn't thought of. What does your analysis say about the magnitude qualitative easing that is yet to come? It's a good question because it goes back to this dependency of fiscal stimulus or, say, monetary stimulus to fund fiscal. And in regards to the foreign investors when it comes to participating in the treasury market, it's an issue that we've seen, it's sort of also a secular shift we're seeing in the markets where we used to be able to fund most of our debt here in the U.S. through foreign investments. And unfortunately, that is changing quite a lot. And it's making more and more the Federal Reserve as the buyer of less resort for those treasuries. And what

Starting point is 00:30:37 called my attention on this was the amount of issuances of treasuries in the last months, especially, and where I don't think that that's going to change at all, as I alluded to those four kind of main fronts of the fiscal agenda, I think fiscal stimulus, or I would say policymakers are always looking for a reason to spend money. And certainly we have plenty of reasons to spend money in the next few years, like it or not like it. And this issue of running fiscal or, I should say, twin deficits of fiscal and current account deficits, double digits, which I think will stay here for a long time. First, we saw fiscal stimulus being very large relative to GDP. Now we're seeing the current account side being very large, meaning the net imports are increasing

Starting point is 00:31:21 significantly relative to GDP. So when you add those two together, you have a twin deficit. And a twin deficit relative to GDP is at levels that are highly unsustainable. But at the same time, if they're going to keep doing what they're doing, who is going to be funding all those net issuances of treasuries. And that goes back to the U.S. bank side. I mean, U.S. banks have been back in the 40s used to be a large buyer of treasuries. And certainly that is a trend that is now going back to a situation that we haven't seen in the past where when it comes to commercial loans in general, I would say from banking, from the banks in the U.S.,

Starting point is 00:31:54 we've never seen such a high level relative to what they've been doing in regards to buying treasuries. So the spread, I think, is very telling for on the idea of how the Federal Reserve is so trapped into continuing to buy treasuries and being the buyer of less resort, but unfortunately, feeding into an inflationary problem. So you almost have a situation where what are they going to pick? Would they allow interest rates to rise and create a reckoning moment for the equity market where we have valuations reaching all-time highs almost every day relative to fundamentals, the only reason we are able to justify that is because of cost of capital. One main reason for that is interest rates being so low. So by allowing the government to continue

Starting point is 00:32:37 to pile on more and more debt and issue more treasuries, would the Federal Reserve let those issuances find a buyer and perhaps would allow interest rates to rise? Or would they be the buyer of less resort and feeding to, by doing that, feeding to this inflationary problem we've seen so far. I kind of think the inflation is the path of lease resistance. And that's why when it comes to building a portfolio of assets, I really think about what are the best hedges of inflation because I think that's ultimately what the Federal Reserve is going to choose to pursue in the next few years. So when it comes to tapering, comes to tightening, normalizing policies, what's the capability

Starting point is 00:33:18 of the Federal Reserve doing that in an environment where we are with record valuations across almost any risky asset on top of the leverage issue, especially in the government side. And so you're referring to that tweet. I was really trying to not only look at the data and see the level of issuances, how much were the foreigners or foreign investors really buying. There's also another thing happening here, which is with the need for, and a lot of investors are starting to buy into the Stangible Assets idea, we're seeing the issue with international reserves by almost every central bank across the globe, where there is a need.

Starting point is 00:33:53 for improving the quality of those reserves. And certainly the quality of those reserves would not be linked to owning a lot of U.S. Treasuries would be linked to owning some sort of tangible asset of high quality. Am I a few, one of those would be gold. And so I think there is also perhaps a beginning of a trend where you're going to see some countries beginning to buy tangible assets to try to fix some of the issues of fiscal and monetary disorder in their own places. And that improvement of international reserves worldwide, I think would also create demand for things like gold relative to U.S. treasuries. And so I'm always trying to think on the liquidity side of how this is going to play out. But it's quite concerning to see this conundrum for the Federal Reserve of having

Starting point is 00:34:40 to pick between two destructive outcomes in my view. One would be a deflationary shock. And the other one would be an inflationary problem that would be really developed over the years. And I think that the Federal Reserve has, or I would say policymakers have finally figured out to be more effective when it comes to their policies. A mix of fiscal with monetary is probably the most effective way. I think that trend is going to continue and will continue to see the Federal Reserve being the buyer of less resort for treasuries with the need of suppression of interest rates. And that for me is what creates this whole thesis behind buying tangible assets at the end of the day. Well, let's talk about some of those assets because you cover them quite extensively and I'm

Starting point is 00:35:22 really eager to dig in. They're not, I would say, assets we often talk about on the show, primarily because a lot of our listeners, myself included, we come from that Warren Buffett camp of buying real businesses that actually have cash flow producing assets. But I want to talk about them because you're right. There's definitely a case being made for them. Let's start with gold. My biggest question with gold is mainly around, as you kind of put it, it was underperforming since 2008 or so. It had this run-up in 2020, right? It had this hockey stick effect happening. I think when all of the announcements came out about the amount of stimulation that was coming to the market, that fear of inflation, people seem to flock to it. But ever since then,

Starting point is 00:35:58 it's kind of lagged. And I'm kind of curious, the base case or that thesis hasn't changed. You know, perhaps there's more of an understanding of how much credit is going to be needed. But what is your base case for why gold is sort of lagged after that first runoff? Well, it's a question I ask myself all the time because it is a major investment for myself as well and especially silver defaults into that category too. My best way to answer that question is, number one, we did see a very interesting improvement of gold prices starting really in 2018. 2018 was in August of 2018 was when we started uprising prices here, but really started back then and lasted all the way to August 2020. Gold was up about 75%.

Starting point is 00:36:40 that is knowing how the gold market works, that is not usual to see such a large move in gold prices. That is certainly significant. So was, in my opinion, what was happening was that gold was really signaling the issues that we saw in regards to the fiscal and monetary stimulus being much larger than anybody I ever expected. And so I think that's one part of it. The second part of it had to do with nominal rates increasing, even though we saw the break-evens or inflation expectation continue to rise since nominal rates were also rising. We did see a large moving rates that I think perhaps took away a little bit of the shine from gold. The second thing has to do with the crypto market. Crypto markets have certainly attracted a lot of the capital that would probably

Starting point is 00:37:26 flow into precious metals, end up stealing a lot of the show. So we've seen that as well. There's a lot of reasons behind this. And the other thing is the tapering, you know, if you were trapped, wouldn't you look for any opportunity you had to exit from that position? I mean, I would. And so I think the Federal Reserve is really seeing this position right now as a potential form of exit when it comes to tapering and seeing how the market is going to react when it comes to perhaps an increase in interest rates from the lack of purchases of treasuries and the lack of demand from investors. Would that create upward move in interest rates? And so clearly the Federal Reserve is sort of committed to making sure that they are able of tapering,

Starting point is 00:38:06 or at least trying to taper. Do I believe that will be sustainable? No, I don't think so. I think there's a high probability that we'll see the Federal Reserve actually returning back to their policies if there is any source of financial shock created by the lack of liquidity in the system, which is kind of crazy to think, given the factor there has been so much liquidity. And it's so quick to shift that in regards to removing liquidity from, especially from

Starting point is 00:38:30 the valuations that we are today. So it's a very tough answer. But I think that those are the best ways of tax. this. I think it became sort of a conventional trade in 2020. Usually conventional trades never end well. And then gold, we saw a sort of a correction since August of 2020. But still, if you look at gold in 2020, it was up about 25%, which is quite impressive. And it did serve as a capital protection form of asset during that period. This year, we have not seen as much. And I think that has to do also with the growth in the economy. Some investors,

Starting point is 00:39:06 thinking that perhaps we would be able to leave this issues without the need for monetary and fiscal stimulus, which I think it's a crazy idea. And so it gave, in my opinion, a very good opportunity to be adding to a position. And that's what we've been doing. We've been buying a lot of properties with gold and silver in the ground. That's where you get the most leverage, not from a debt perspective, but from a price leverage perspective by investing in this market. So we've been doing a lot of that looking for the best and high quality, highest quality projects worldwide that are economically viable to develop mines and look for places where we can find gold and silver in different parts of the world. You can do that across the whole commodity space. You can do that in the base metal space as well, which I think looks quite attractive given the lack of exploration, spending and so forth.

Starting point is 00:39:55 But gold is now really cheap not only relative to equity markets, not only relative to the expansion of monetary base. but also cheaper relative to even commodities. So something that really calls my attention when it comes to capital allocation and how we should be exposing yourselves for the next few years when it comes to what I think is the need for monetary metals, not only given the issues that we see in regards to policymaking as a whole, but also has to do with the macroimbalances that really feed into this demand side of owning an asset that perhaps could capitalize on those issues. is in a large way. And I think gold and silver are indeed some of those assets.

Starting point is 00:40:37 Well, gold obviously gets its value from being scarce. And you mentioned this lack of spending on exploration. And it kind of raises the question for me. And maybe this is an unfair question to pose to you, but I'm curious, if you had to hold gold itself or gold miners, say maybe a basket of gold miners over the next five years, which one would you choose and why? So that's a good question. So there's quite a lot of ways to invest as you become constructive in the metals. You can buy silver, you can buy the royalty companies, you can buy the larger producing businesses, and then you can buy the developers or the explores. So let's break it down into what are some of, and I'll tell you my opinion about which ones I think are going to perform

Starting point is 00:41:17 the best. Usually in a secular bull market for gold, where, and I think we started really in 2018 or so, usually if you identify, and obviously there's no way to factually identify you are in a secular bull market, but our framework of looking at the macro data makes us believe that we are in a secular bull market for precious metals. And therefore, if you have that view, you want to be buying the things that I usually have a higher leverage to gold prices. They're also riskier. So those are the exploration side of our exploration businesses, the ones that only perhaps have a property. They believe they have gold or silver. Some of them already have, they've been drilling that property to look for those underlying commodities or metals such as gold and silver. And so that's

Starting point is 00:41:59 one form of investing. Then you have the royalty businesses are the safest forms of exposing yourself to this whole industry. The larger producers, which are the Newmonts and Barracks and Kirklands of the world, those are also quite interesting. They have a stream of free cash flow over the years, been producing consistently for over a decade. A lot of those companies are being able to create a very large balance of cash net of debt for the last few years, given the fact The gold prices are so high, but their costs remain very low. And so you're seeing a very large improvements, fundamentally speaking, for a lot of the producers. They don't have the developers.

Starting point is 00:42:38 The developers are the ones that already know that they have a deposit. They know they have a system, a gold and silver or any other metals underneath the ground. And what they do is they're trying to develop those mines. They are usually, you're going to see a lot of financially savvy folks navigating those markets. They know very well how much would cost for them to develop those mines. And so as they become, they get into production, they're going to have some issues back and forth to until they get more consistent. So you're paying for that risk. There's no way around that.

Starting point is 00:43:07 There's some great deposits out there with incredible development stories. But you're definitely paying for the risk of actually being able to produce those ounces over time in a very consistent way with very high levels of recoveries and so forth. And then I would say that what attracts me the most is the fact that we're seeing this creation of balance in terms of cash. by the major producers, but they have not been buying a lot of exploration assets in order to increase the amount of reserves that they have to produce. So what's happening is when we look at the reserves among the producers, is that those reserves have been in a downward trend, depleting those reserves and not replenishing them. And so from my perspective, when I see this, I wanted to own the highest quality projects

Starting point is 00:43:53 in the exploration side that can perhaps become not only a high leverage to gold, and silver prices on a macro environment that is very favorable for those metals, but also in a place where they can benefit from this buildup of cash in the need for those majors to buy exploration assets. And they're going to be looking for the most economically viable deposits you can find on Earth. And so we build a portfolio of 90 companies in the exploration space. Now, those 90 companies, why do we have so many? Because there's an incredible amount of risk in those businesses and statistically made sense to us to own a large percentage of those companies that we like. And you would be surprised. The majority of the companies in the gold and silver

Starting point is 00:44:37 space are basically sub 200 million market cap. And so we like to own those businesses at very early stages, sub 20 million market cap. We buy 20%, 10% stake on those companies and help them to develop those deposits going forward with the help of a geologist. His name is Quentin Haney. Now, I think the entire industry is going to be very attractive for the next few years. I think we're going to see the royalties and the major producers do very well. I think we're going to see some new producers coming into play, some companies that have very profitable deposits that will become projects that become company makers for new producers. So basically, my answer would be that if you own the top five companies in the market today,

Starting point is 00:45:21 I still think you're going to do very well. It doesn't happen to be that that's what I've been investing. I've been investing, as I said, on the other side of the industry, which is much riskier. But we have a whole team in place in order to tackle that as an opportunity. I think there's very few investors with the long-term mentality and the capital really going after those exploration and assets. And for me, it's not only the macro imbalances that created demand, but also this need for supply of new ground to be produced. And I think that companies that provide those high-quality projects will be in high demand for the following years. So it's tough for me to say names, specific names.

Starting point is 00:46:02 There are a few names that I really like that I will be, in my opinion, company-making types of projects. S-K mining would be a great one, great example of a company that is in its process of discovering its ground. There's some other companies that have already done very well recently in regards to discovery that will look like, producers or perhaps will be bought out by larger producers, new found gold would be a great example. That's in Newfoundland. King Fisher is another very early stage company that we have a large belief that would be a company that will look like a large discovery. Goliath resources is another one that we think would be a company that will show a lot of strength when it comes to developing a discovery and moving towards becoming, you know, over the years and those processes

Starting point is 00:46:49 take a long time. That's why when you ask those questions about transitory, building a mine, it's hard enough to find a discovery. When you have a discovery, then it takes you another five years at least to develop that mine. So this idea that the supply of metals will catch up with the demand so quickly, it's just not correct at all. And so there is, you know, a timing constraint here, part of the variable as part of this equation that I think is understated when it comes to the transitory argument. So I hope it provided some names, but I would say that the whole industry looks very attractive, but I like to own the highly leveraged ones, which makes sense in regards to also what they offer when it comes to the quality of those projects. Let's take a quick

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Starting point is 00:51:22 that is. I think in this world where we're going from the old to the new economy and commodities is the highway to go from this, make this transition happen, I think there's going to be the need for commodities that play into the base metals side. And when you look at silver, it's right in between having the features to allow this transition to happen, but also is a huge part of the monetary system as it played into being an alternative for FIA currencies over the years. And I like that the optionality of silver in a large way. It kind of, it perplexes me, actually, the fact that silver is still trades below $30 an ounce, given all the issues that we've seen so far in the macro side of things in the last few years. I think silver not only looks

Starting point is 00:52:10 cheap relative to money supply, the monetary base itself, broad equity markets to gold itself as well. And when you go back to times in history where we have this inflationary decades, you can use the 70s, you can use the 40s or the 10s, 1910s, all of those actually, we saw commodities outperforming equity markets in a large way. Some of those situations, we actually saw equity markets suffering during that period. It wouldn't surprise me, given the fact the valuations are so high today. So when I look at the commodities to equity ratio, which is basically at a 50-year low or so, I start to think, well, what are the best ways of positioning myself on the long side of this trade, which would be long commodities? Should I be

Starting point is 00:52:53 buying oil? Should I be buying natural gas and agricultural commodities, base metals, gold? And then I looked at silver. And silver is the one that looks cheap relative to almost any asset in the world today. And I know that the difficulty of finding silver in the world, given the fact that I'm so involved with the mining exploration side and development of mines as a whole, as a capital allocator, not as a geologist, I know the challenges of finding gold and silver. And I think that as we push towards more innovations on the technological side of things, we're going to see a large demand fitting into the silver market. And I know the silver market is a very thin market in terms of volatility in terms of liquidity as a whole. And so when we start seeing large capital allocators

Starting point is 00:53:38 buying to the silver thesis, it's going to look like a large squeeze in prices, a long-term squeeze type of movement in the price situation. I think we've seen parts of that move in August of 2020, and that was when sort of it peaked recently and we've been kind of going sideways since then. I think the silver is consolidating in a large way. When you look at the long-term chart, it looks like a massive cup and handle. I'm not so a great technician, but I look at technicals. And when I look at quarterly candles going back, you know, five decades or so, and I see the silver price forming this massive cup and handle.

Starting point is 00:54:16 It's one of the most bullish charts I've ever seen. It's almost like I can't stop looking at that chart. I really think when silver breaks out, it's going to be an explosive move to the upside. And I can't stop thinking about what would that do to any company that owns silver in the ground, which provides even higher leverage to silver prices. So I don't know when it's going to happen and if it's going to happen, but I believe that we will. I believe if we are in a secular bull market for gold, silver is going to follow and it's going to lead the way to the upside. And we're going to see the gold to silver ratio fall into a large way, probably go back

Starting point is 00:54:51 to its average at about 30. And once that happens, it's going to lead to a lot of capital allocation towards this whole industry. It's a total lack of liquidity in exploration, development. The whole industry lacks liquidity as a whole. And I think we're going to see that coming back in the following years. Those businesses are looking more and more lucrative, just where prices of battles are today. They don't have to move at all. And so it's attracting more and more capital, and I will continue to attract more and more capital over time. And so I think the next few years, we're going to see an explosive move for silver. And I'm trying to look for the most compelling stories within the silver market that I could own in order to be positioned for that move.

Starting point is 00:55:30 So I'm very bullish on silver. I think it's the cheapest metal on earth. I've set this a few times. And it's the most asymmetric opportunity in the markets today, in my opinion. One metal we never discuss on the show, to my knowledge, is palladium. So walk us through, maybe there's some overlap as far as the bullish case for palladium. But I'm curious, how does that kind of stand with gold and silver? Look, I think all of those metals look quite interesting. I think, to be frank, the supply reasons to own gold and silver seem a lot more compelling than any other base metal or other precious metal. However, there is certainly a need for platinum in palladium for the next few years. And we've been exposed to those through exploration

Starting point is 00:56:11 assets. We like to own those metals as well and have exposure to it. They are just like silver. And I'll think of silver in steroids in terms of volatility. They're very volatile. Platten, for instance, It has a much higher, believe it or not, a much higher correlation to the oil market than gold and silver, which is kind of interesting when you look at the two charts and overlay those lines over the history of the two assets. But we'd like to own those as part of this transition from the oil to the new economy. We think that supply and demand for almost any commodity worldwide looks very attractive. And the precious metal side is in base metals are the ones that call our attention the most.

Starting point is 00:56:50 We did a whole breakdown into precious metals, base metals, energy, and also agricultural or soft commodities, and even coal. And what you find there is quite a lot of interesting things going on in regards to fundamental analysis of those companies that are linked to those commodities. Precious metals is the one that looks not only the cheapest. It looks like there's a significant growth in free cash flow. Margins are improving. You're seeing balance sheets improving quite a lot.

Starting point is 00:57:15 The actual balance sheet looks very attractive relative to the dollars. So when you think about precious metals, relative to other commodities today, it looks really attractive. Energy looks very profitable as a business right now. However, you paid up for the leverage. So there's quite a lot of leverage. The balance sheets don't look as attractive. So they have more heavy or heavier balance sheets relative to other commodities.

Starting point is 00:57:38 Then you come into the base metals. Base metals kind of had a run recently. So in regards to valuations, they don't look as attractive as the other parts. But they still look very profitable when it comes to the growth in fundraising. fundamentals. And also I would say we're seeing, unfortunately, an increasing cost that is being linked to the base metal stores as well. So that is something to be aware of, but they don't look as attractive as precious metals. But obviously, if the whole market is going to go significantly higher, you know, I think you want to own the whole spectrum of commodity. Agricultural commodities

Starting point is 00:58:10 look quite interesting as well. I don't have an edge on them. I don't understand exactly the business model as well as I understand precious metals and base metals. In order, you know, all the as well. But I think there are some opportunities in that as well. When you look at the fundamentals and the free cash flow yield for those businesses, you look at the balance sheets, look attractive, they look healthy. They have a very significant amount of cash balances. I've seen costs not increasing as dramatically as other companies. And so that looks quite attractive too. Coal had actually a good run. Some coal-related businesses had a good run recently. But when I look at the fundamental matrix, nothing looks attractive to me in that space.

Starting point is 00:58:50 So we have zero allocation towards that. So I think that that gives you a big sense of what I think about commodities as a whole. The focus as being precious metals because I think it fits into the two lines of thinking of monetary metal and the shift from the old to the new economy. And I think precious metals serve that purpose very well. So it's quite a lot of ideas that you can explore when it comes to exposing herself towards tangible assets. But that's the way I view it as capital allocation.

Starting point is 00:59:15 Now we think that precious metals look the most attractive. One question I've been asking a lot of our guests is around what they think the biggest risk to the market currently is. And you touched on China. You alluded to it earlier and this risk of coming from the trade balance issues and de-globalization. Is this where you see the biggest risk in the market today? I do. I think it's difficult to think about a liquidity sort of crash where obviously what we're seeing, if the equity markets drop by about 25 to 30% on any event, you would probably see the Federal

Starting point is 00:59:52 Reserve coming in for the rescue with a very large package of stimulus and probably trying to really suppress the issues in a large way. I think it would have to come from an exogenous shock. And the biggest risk I see to the global economy today is in regards to China. I remember back in the days in 20, even 2014, 2015, when I used to look at China a little more in depth. and we were very concerned about the size of the banking system, given the fact that it's also a close capital account economy. So what we found today is that the banking assets of China are closer to $50 trillion.

Starting point is 01:00:26 It's about 300% of GDP. At what point do you see some real implications in terms of what that could cause in regards to a credit bus and any sort of issue? I think that the biggest risk for China is inflation. The economic model of China with exports and to be buying a lot of raw. materials, meaning commodities in a large way, it has worked because commodities were really cheap over the years. And now that's shifting. And I think that that will create a problem in the Chinese economic model. So I've been very focused on that. I think that the crackdown on the CCP on

Starting point is 01:01:00 domestic companies has a lot to do with the crackdown and actual inflation that they would never admit to it. But clearly to me, no one would shift themselves to the foot by doing what they have been doing in regards to the changes when the crackdown comes in from the CCP and really damaging a lot of domestic companies in China. Even though we've seen some degree of that happened in 2015, 2016, today we're seeing a much worse setup when it comes to that. And I think China, you study history of credit bubbles, it's difficult to pinpoint what exactly causes those to burst, but it seems to me that China could be, it has all the recipes for a credit bust. And I don't know what the Federal Reserve would be capable of doing if that would actually occur. And so I am

Starting point is 01:01:47 very concerned about that. I think that you want to build an inflationary at its core when it comes to a portfolio, but looking for deflationary hedges when it comes to those exogenous risks. And one of them, I think is China. And so what I think about this is I really believe that if that happens in terms of an unfolding of the currency and credit crisis in China, I believe that we believe that would fit into also a devaluation or a major devaluation of the Chinese you want. And usually what we see is that sometimes those credit busts happen with the equity markets falling apart in local currency terms. Sometimes we see the actual currency having issues. But one pattern that we found throughout, you know, Asian markets and South American markets and other developed

Starting point is 01:02:37 economies as well is that gold in local currency terms tends to do really well in a sub-average. subsequent years of those issues. And so we own tangible assets, mostly gold, silver, precious metals-based metals. And then we have some short positions in the Chinese currency. And so, mathematically, that is, being long precious metals or tangible assets in Chinese you-won terms. So we like to have that as just adding to the asymmetry. It's an insurance policy. That's the way I see it. If we're wrong about this, you know, we lose one and two percent of the portfolio. You know, We could certainly make up a whole year of performance if that happens to be the case where the currency in China happens to devalue significantly as we foresee. So I think that is a significant risk to the market.

Starting point is 01:03:23 It is a deflationary risk. I think that the valuation of the one would mean deflation to the rest of the global economy. And we've seen so far is that Chinese ADRs started to falter with issues with the U.S. in China. then we saw domestic shares in China also falling apart. We look at the year-over-year change of that. It tends to lead to issues in emerging markets. So we've had emerging markets, it's starting to have some issues. And that usually, when you look at those changes, the delta of those price movements in Chinese

Starting point is 01:03:55 assets tends to lead to deceleration of macro data in the U.S. and other developed economies. So I happen to believe that if that's going to unfold, that is going to be net negative for the U.S. And so I am very focused on how do I hedge that from my overall position. I think that the best way is really by being short the Chinese currency and being long U.S. dollars. Again, if I'm wrong, no, it's not the end of the world.

Starting point is 01:04:20 But I view it as a very important insurance policy for the rest of the portfolio. So, Davy, before we let you go, I want to make sure I give you a handoff to Crescott Capital, to your Twitter feed, any other resources you want to share with our audience. Well, thank you for allowing us to share that trade. I would say our Crescott, our website, Crescott.net, is where you can find our letters and information of our company, but also a lot of content in regards to interviews and presentations that we do almost weekly and daily. You can also find my Twitter at Tavi Costa, where I share a lot of macro data and charts

Starting point is 01:04:53 and ideas and thoughts about what we are positioned in our portfolio. And you can also find me on YouTube, if you just type my name. There's quite a lot of interviews where I share my. views just like this one. And I really enjoy doing that and sharing some of the concerns and opportunities that I think that are today in the markets. Tavi, this has been a lot of fun. I learned a ton. I know our audience is going to love it. You've been very generous with your knowledge and insights. And I would love to have you back and do this again. I'm watching silver myself closely as well as gold. And this China issue is an interesting topic that I think

Starting point is 01:05:27 we should explore a little bit more. So thank you so much again for coming on and love to do it again soon. Thank you. Trey, it was a pleasure. All right, everybody, that's all we had for you this week. If you're loving the show, please don't forget to follow us on your favorite podcast app so you get the episodes automatically because you do not want to miss the guests that we have coming up. Tavi and I connected on Twitter, so if you'd like to get in touch, you can always find me there at Trey Lockerbie. And if you're looking to do your own research, especially on stocks, definitely check out the resources we have built for you at TIP. Just Google TIP finance and it'll pop right up. And with that, we'll see you again next time.

Starting point is 01:06:01 Thank you for listening to TIP. Make sure to subscribe to millennial investing by the Investors Podcast Network and learn how to achieve financial independence. To access our show notes, transcripts or courses, go to theinvestorspodcast.com. This show is for entertainment purposes only. Before making any decision consult a professional. This show is copyrighted by the Investors Podcast Network. Written permission must be granted before syndication or rebroadcasting.

Starting point is 01:06:31 Thank you.

We Study Billionaires - The Investor’s Podcast Network - TIP387: Precious Metals Masterclass w/ Tavi Costa

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