Tavi Costa (02:32):
Number two, we have some of the supply constraints. We’ve done a lot of research going back to the 1990s 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 happens until now, but what is next after using that as a roadmap?

Tavi Costa (02:56):
What we see there is that the next step would be a large increase in wages and salaries. As the cost of living begins to rise, you start to see the demand from workers to also want to be paid 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.

Tavi Costa (03:19):
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. So it’s a matter of time. 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 spiral growth similar to what we saw in the ’70s.

Tavi Costa (03:48):
So that’s the second pillar, which is also linked to some other issues in regards to natural resources, in terms of the supply side were a lot of folks are seeing this as the likelihood of things especially in the logistics side improving quickly when I actually am on the other side of that camp given the fact that we’ve had a large or a long period of time of other investments in mining and exploration of natural resources in the West and globally.

Tavi Costa (04:14):
So the third pillar of inflation has to do with the monetary and fiscal policy. The monetary delusion that we’re seeing from central banks in order to allow governments to spend money in terms of fiscal spending, 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.

Tavi Costa (04:44):
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 average ratios from the government, corporations, and other parts of the economy.

Tavi Costa (04:57):
So I think that really feeds into the monetary delusion side of the basement of 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 imbalances and macro imbalances have not changed at all since the pandemic or since the global financial crisis have really unfolded back in ’08.

Tavi Costa (05:19):
The fourth pillar, which I think it’s long-term implications that we’ll see develop in the following years and perhaps a decade or so from now has to do with the China situation and the US and that in my opinion is the deglobalization 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. That shifted now with the idea of it seems like a fiscal arms race between China and the US.

Tavi Costa (05:52):
The idea of a lot of countries not only the US 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. 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.

Tavi Costa (06:18):
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 deglobalization trend, but I do think that the first reaction of this in the markets would be very inflationary.

Tavi Costa (06:35):
So this need to move capital away from China from a fiduciary standpoint to a company standpoint of the behavior of what we see in terms of the executives in general of trying to avoid building up manufacturing plants in general in China, I think we’ll have inflationary implications in the long-term.

Tavi Costa (06:54):
So those four pillars are all acting in my opinion in a very strong way today, and it’s very different from what’s being priced 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 that yield more than inflationary expectations will force investors to buy tangible assets in my opinion. That also feeds into this inflation thesis. So it’s a lot to unpack, but in a nutshell, that’s what the four pillars of inflation would look like in my opinion.

Trey Lockerbie (07:30):
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 create more of itself. What I’m 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 costs 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 a, I don’t know if you’d call it negative or positive feedback loop happening here, but is that something that you watch unfold using some kind of metric?

Tavi Costa (08:11):
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 referred to which is the large focus on margins. We’ve seen so far in the last decade or so is this focus on top-line growth where sales have been the priority to a lot of executives that were on companies to really pursue.

Tavi Costa (08:35):
With the increase of inflationary forces and the cost of capital, as a result, becoming more expensive, I think we’ll create a need for bottom-line improvements. So the security selection process of investments will have to in my opinion shift towards prioritizing margins and improvements in profitability, which is something very different. That’s the old-school fundamental analysis that has been out of favor for so many years. I think that’s about to come back.

Tavi Costa (09:03):
Going back to your point, it’s certainly psychological shift inflation, and when the genie is out of the bottle, it’s difficult to deal with it for a few years and decades. Some countries have not have had these issues for decades. The US 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 those who lived through the ’70s know that it was a very difficult time to reconcile the issues with the cost of capital as a whole.

Tavi Costa (09:34):
I don’t think a lot of the companies that exist today in the West 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.

Tavi Costa (09:45):
Now, the issue with the cost of goods and services, number one, I think it has to do a lot with the problems of skilled labor has been a problem for so many years. 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.

Tavi Costa (10:11):
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. We saw commodities do nothing but go lower and lower from the global financial crisis until really the last quarter where we saw commodities starting to turn higher.

Tavi Costa (10:33):
I think that, sure, that has a lot to do with the monetary disorder and fiscal disorder that is creating a need for investors to buy those stable assets, but there’s also the supply side of the argument that I think is very compelling. When we look at not of the 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.

Tavi Costa (10:59):
When you look at CAPEX, capital investments in mining, and developments of those natural resource projects, we are also seeing a very severe declines depending on the industries. So it’s almost like we’ve seen 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.

Tavi Costa (11:22):
We also have the savings rate at extremely elevated levels creating a large demand for goods and services. So there’s a lot of things playing into this. 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 US. Usually, when inflation as a psychological development and behavior among the population starts to unfold, it’s very difficult to move things around.

Tavi Costa (11:51):
You’re not going to see folks, McDonald’s now charging, paying $18 an hour, up to $18 an hour for someone who works for them. Now, that’s going to be a difficult pattern to see that reversing anytime soon. 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.

Tavi Costa (12:14):
I think that’s happening globally. Larger extent I would say the developed economies, they haven’t really seen that in a long time are starting to experience that in a large way. It worries me is on the fiscal side and policymaker 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. That’s for me where this all ties up together into the supply issue side, the demand side, the four pillars of inflation, but also from a policymaking perspective where there’s a lack of fear towards what could really be all this money printing, call it money printing or expansion of the monetary base and fiscal policies will translate into. So I’m quite worried about the next few years when it comes to what I think inflation is going to look like.

Trey Lockerbie (13:09):
Let me ask you this. Do you think there’s a lack of fear because they just keep changing the CPI numbers? They 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?

Tavi Costa (13:23):
That’s a good question. Well, Lyft and Uber, there’s something called the intracity transportation component of the CPI, where if you look it back from January 2018 to now, the growth in that component is about 5%. I don’t know what state you’re 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 at least I would say 50% to 90% or so, which in that research you’re referring to was this research from Yahoo Finance, where they said that Uber and Lyft rides have increased in price by about 90%.

Tavi Costa (14:03):
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 are part of the CPI, and if it’s not, 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 intracity 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.

Tavi Costa (14:31):
You can look at the price of agricultural commodities. That is another great example of that, even the price of or cost of used car prices. We’ve seen that rise significantly, and very few people talk about this, but if you look at the inventories picture, well, most people will say about the used car prices is that, well, that really happened after the pandemic and that really was what magnified that trend.

Tavi Costa (14:54):
You go back to the 2019 or so, way before the pandemic, inventories were already at all-time lows for used cars. Kind of an 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 in the economy for whatever the reason is. Perhaps some of the issues with natural resource space as I referred to, which it was clear that the demand for electrification in the world, those with a miscalculation if there is a miscalculation of the idea of innovating the global economy through electrification and so forth if the number of commodities that we have to allow that to occur.

Tavi Costa (15:41):
All those are playing into these 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 from internal calculations we see at least double digits, low double digits of growth year over year. We can use a lot of examples in the past times when we had those levels of inflationary forces. Usually, they stick around for longer.

Tavi Costa (16:10):
Even if we use a transitory example, the 1940s is a great example where we saw inflation going above 5% on a CPI calculation twice during the 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. So I’m quite worried about the implications of inflation and the rest of the financial markets as well.

Trey Lockerbie (16:44):
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 early about the secular decline of wages since the 1970s, but you juxtaposed that secular decline with the productivity growth line, right? 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. Are we seeing wages going to come back in line with that productivity line?

Tavi Costa (17:10):
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 are moving out of volatility and looking at the data on a two-year horizon in terms of the delta. If you go back throughout the ’40s and ’50s and ’60s, those are usual trends to develop themselves and build on themselves over time.

Tavi Costa (17:34):
I think we’re seeing one of those now in regards to wages and salaries. We haven’t seen minimal wages don’t go up since 2009, I believe. So there has been a sense of, the initial reaction really comes from the cost of living rising that really makes folks start demanding higher wages and salaries. We haven’t really seen that in a long time. Usually, inflation, at least in the last few decades, has 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 the financial shock that is immediately accompanies a large increase of fiscal and monetary stimulus. That feeds into this long-term inflationary problem.

Tavi Costa (18:22):
We’ve seen this since the ’90s basically with Alan 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 the federal reserve was succeeding at that, but I’m a strong believer of business cycles it would exist. 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 the cost of capital or some exogenous shock or anything like that.

Tavi Costa (18:53):
So wages and salaries are 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 upward trends in those indices as well. All of those feed into this idea of we may see a larger increase in the ratio of workers as a whole.

Tavi Costa (19:21):
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 ones that are really going to get hurt, and there are quite a lot. There are some companies that will really benefit from this environment. I think natural resources would be one of them.

Tavi Costa (19:38):
Productivity is an interesting topic because, I mean, 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 has really been happening through without the need for fiscal and monetary stimulus.

Tavi Costa (19:54):
If you are a believer in that, we’re starting to see a new era of productivity, which we’ve seen that before, by the way. We’ve seen that during the 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 back to a dollar 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.

Tavi Costa (20:29):
I think that in regards to fiscal and monetary stimulus, I think we may see more rather than less in the next few years. So this dependency of policies in order to create growth in a way I think will likely continue. We’ve seen disciplinary seatbelts come off back in the ’70s with the break of the gold standard. So government debt growing at those times in a significant way all the way to what we see now. There’s almost like this new awakening, a rude awakening that I call among folks asking for this discipline to come back.

Tavi Costa (21:04):
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 fiat 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. I think tangible assets and this need for buying tangible assets regardless of what investors find as a way to expose themselves towards from housing to crypto, to commodities, to now gold and silver, all those look attractive in my opinion for the next few years.

Trey Lockerbie (21:39):
So what I heard from that was 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.

Tavi Costa (21:59):
I think it’s still a few years off. 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 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 and other 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.

Tavi Costa (22:32):
So any show reaction in the markets I think would be perhaps in a way inflationary, too. I believe that automation will take place at some point. Artificial intelligence will be a lot of those changes in terms of technological trends. We’ll perhaps reinforce another deflationary shock at some point, but I think we’re years ahead of that, and I really think when it comes to the problems of lack of labor, meaning not only almost anything, almost any business today and in terms of business models in the US are really seeking not only high skilled labor but any type of labor.

Tavi Costa (23:07):
I’m not sure. Maybe we’re going to see some UBI, universal base income trends once the time being for those robots and some automation is able to replace human labor, but I think we’re so far from that right now. I really think inflation is a trend that is here to stay and it will build on itself for a few years.

Tavi Costa (23:28):
What concerns me is back in the ’40s and ’70s, certainly, there was a sense of acknowledgment from especially fiscal policies that would perhaps create inflation. 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 that shift, there’s a lack of acknowledgment from policymakers that that will create inflation.

Tavi Costa (23:51):
The issue with fiscal stimulus is so direct. It’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 of student debt. Those are all forms of transfer of wealth. 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, it’s 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.

Tavi Costa (24:20):
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. Obviously, that doesn’t create a large demand, but those are all examples of large changes in the government with the focus on the bottom 50%.

Tavi Costa (24:36):
The fiscal agenda is pretty clear to me that there’s a lot of fronts here. The green revolution is one of them. The peak inequality issue is a large one. The fiscal arms race with China that I was alluding 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 that have been creating inflation. Not to say that we don’t need infrastructure developments. We do need infrastructure developments in the US, but that’s not the root cause of inflation.

Trey Lockerbie (25:11):
Tavi, you have a pinned tweet thread I should say about the federal reserve and how they are trapped. 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 set 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.

Trey Lockerbie (25:36):
The second point was that US banks now lend more to the government than households and businesses. Maybe that’s not as surprising, but just seeing it laid out is something I hadn’t thought of. What does your analysis say about the magnitude, qualitative easing that is yet to come?

Tavi Costa (25:54):
It’s a good question because it goes back to this dependency of fiscal stimulus or says monetary stimulus to fund fiscal. 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 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 US through foreign investments. Unfortunately, that is changing quite a lot, and it’s making more and more the federal reserve the buyer of last resort for those treasuries.

Tavi Costa (26:26):
What called my attention to this was the number of issuances of treasuries in the last months especially, where I don’t think that that’s going to change at all. As I alluded to those four main fronts of the fiscal agenda, I think fiscal stimulus or I would say policymakers are always looking for a reason to spend money. Certainly, we have plenty of reasons to spend money in the next few years like it or not like it.

Tavi Costa (26:52):
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. Now, 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 significantly relative to GDP.

Tavi Costa (27:12):
So when you add those two together, you have a twin deficit. The 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. That goes back to the US bank side. I mean, US banks have been back in the ’40s used to be a large buyers of treasuries. 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 with say from the banks in the US, we’ve never seen such a high level relative to what they’ve been doing in regards to buying treasuries.

Tavi Costa (27:48):
So the spread I think is very telling on the idea of how the federal reserve is still trapped into continuing to buy treasuries and being the buyer of last resort, but unfortunately feeding into an inflationary problem.

Tavi Costa (28:01):
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 that are in all-time highs almost every day relative to fundamentals?

Tavi Costa (28:18):
The only reason we are able to justify that is because of the cost of capital. One main reason for that is interest rates being so low. So by allowing the government to continue to pile 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 last resort and by doing that feed into this inflationary problem we’ve seen so far.

Tavi Costa (28:46):
I think the inflation is the path of least resistance. 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.

Tavi Costa (29:02):
So when it comes to tapering, it comes to tightening, normalizing policies, what’s the capability 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 issues especially on the government side.

Tavi Costa (29:18):
So what you’re referring to in that tweet, I was really trying to not only look at the data and see the level of issuances, how much were the foreign investors really buying, there’s also another thing happening here, which is with the need for a lot of investors are starting to buy into the idea of this tangible asset, we’re seeing the issue with international reserves by almost every central bank across the globe, where there is a need for improving the quality of those reserves, and certainly, the quality of those reserves would not be linked to owning a lot of US treasuries. It would be linked to owning some sort of tangible asset of high quality.

Tavi Costa (29:55):
In my view, one of those would be gold. So I think there is also perhaps a beginning of the 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. That improvement of international reserves worldwide I think would also create a demand for things like gold relative to US treasuries.

Tavi Costa (30:20):
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 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 really develop over the years.

Tavi Costa (30:41):
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 we’ll continue to see the federal reserve being the buyer of last resort for treasuries with the need of suppression of interest rates. That for me is what creates this whole thesis behind buying tangible assets at the end of the day.

Trey Lockerbie (31:08):
Let’s talk about some of those assets because you covered them quite extensively, and I’m 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, 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 put it, it was underperforming since 2008 or so. It had this run-up in 2020, right? It had this hockey stick effect happening.

Trey Lockerbie (31:38):
I think when all of the announcements came out about the amount of stimulation that was coming to the market that feared inflation. People seem to flock to it, but ever since then, it’s lagged and I’m curious. The base case or that thesis hasn’t changed. 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 lagged after that first run-up?

Tavi Costa (32:00):
It’s a question I ask myself all the time because it is a major investment for myself as well and especially silver that falls into the 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, August of 2018 was when we started uprising prices here, really started back then and lasted all the way to August 2020. Gold was up about 75%. 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.

Tavi Costa (32:38):
So in my opinion, what was happening was that gold was really signaling the issues that we saw with regards to the fiscal and monetary stimulus being much larger than anybody ever expected. So I think that’s one part of it.

Tavi Costa (32:52):
The second part of it had to do with nominal rates increasing even though we saw the breakevens or inflation expectation continue to rise since nominal rates were also rising. We did see a large move in rates that I think perhaps took away a little bit of the shine from gold.

Tavi Costa (33:09):
The second thing has to do with the crypto market. Crypto markets have certainly attracted a lot of the capital that would probably 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.

Tavi Costa (33:23):
The other thing is tapering. Now, if you’re trapped, wouldn’t you look for any opportunity you had to exit from that position? I mean, I would. 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 an upward move in the interest rates?

Tavi Costa (33:50):
So clearly, the federal reserve is committed to making sure that they are able of tapering 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’s any source of the financial shock created by the lack of liquidity in the system, which is crazy to think given the fact that there has been so much liquidity and it’s so quick to shift that in regards to removing liquidity especially from the valuations that we are today.

Tavi Costa (34:21):
So it’s a very tough answer, but I think those are the best ways of tackling this. I think it became a conventional trait in 2020. Usually, conventional traits never end well, and then gold we saw a correction since August of 2020, but still, I mean if you look at gold in 2020 was at about 25%, which is quite impressive. It did serve as a capital protection form of an asset during that period.

Tavi Costa (34:49):
This year, we have not seen as much and I think that has to do also with the growth in the economy. Some investors thinking that perhaps we would be able to leave these issues without the need for monetary and fiscal stimulus, which I think it’s a crazy idea. 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 the debt perspective, but from a price leverage perspective by investing in this market.

Tavi Costa (35:21):
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, but gold is now really cheap not only relative to equity markets, not only relative to the expansion of the monetary base but also cheaper relative to even commodities.

Tavi Costa (35:55):
So something that really calls my attention when it comes to capital allocation and how we should be exposing ourselves 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 it also has to do with the macro imbalances that really feed into this demand side of owning an asset that perhaps could capitalize on those issues in a large way. I think gold and silver are indeed some of those assets.

Trey Lockerbie (36:27):
Well, gold obviously gets its value from being scarce. You mentioned this lack of spending on exploration. It 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, it may be a basket of gold miners over the next five years, which one would you choose and why?

Tavi Costa (36:49):
So that’s a good question. So there’s quite a lot of ways to invest as you become constructive into 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 explorers. 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 the best.

Tavi Costa (37:07):
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. Therefore, if you have that view, you want to be buying the things that usually have higher leverage to gold prices. They’re also riskier.

Tavi Costa (37:33):
So those are the exploration side or 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. So that’s one form of investing.

Tavi Costa (37:50):
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 Barricks, and Kirkland’s of the world, are also quite interesting. They have a stream of recashflow over the years, then 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 that gold prices are so high but their costs remained very low. So you’re seeing very large improvements fundamentally speaking for a lot of the producers.

Tavi Costa (38:26):
Then you have the developers. The developers are the ones that already know that they have a deposit. They know they have a system of gold and silver or any other metals underneath the ground. What they do is they’re trying to develop those mines. Usually, you’re going to see a lot of financially savvy folks navigating those markets. They know very well how much it would cost for them to develop those mines.

Tavi Costa (38:47):
So as they become, they get into production, they’re going to have some issues back and forth until they get more consistent. So you’re paying for that risk. There’s no way around that. There are 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.

Tavi Costa (39:10):
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.

Tavi Costa (39:37):
So from my perspective when I see this I wanted to own the highest quality projects in the exploration side that can perhaps become not only 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.

Tavi Costa (40:06):
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 it statistically made sense to us to own a large percentage of those companies that we like. You would be surprised. The majority of the companies in the gold and silver space are basically sub 200 million market cap. So we like to own businesses in very early stages, sub 20 million market cap. We buy a 20%, 10% stake on those companies and help them to develop those deposits going forward with the help of a geologist. His name is Quinton Hennigh.

Tavi Costa (40:44):
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.

Tavi Costa (41:05):
So, basically, my answer with that if you own the top five companies in the market today, 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 that tackles that as an opportunity. I think there are very few investors with the long-term mentality in the capital really going after those exploration assets.

Tavi Costa (41:32):
For me, it’s not only the macro imbalances that create the demand, but also this need for supply of new ground to be produced. I think that companies that provide those types of other projects will be in high demand for the following years. So it’s tough for me to say names, specific names. There are a few names that I really like that will be in my opinion company-making types of projects. SK mining would be a great one, a great example of a company that is in the process of discovering its ground. There are some other companies that have already done very well recently in regards to the discovery that will look like new producers or perhaps will be bought out by larger producers. Newfound Gold will be a great example. That’s in Newfoundland.

Tavi Costa (42:17):
King Fisher is another very early-stage company that we have a large belief that would be a company that would look like a large discovery. Goliath Resources is another one that we think would be another company that will show a lot of strength when it comes to developing discovery and moving towards becoming over the years. Those processes take a long time.

Tavi Costa (42:40):
That’s why when you ask those questions about transitory, building a mine is hard enough to find a discovery. When you have a discovery, then it takes another five years at least to develop that mine. So this idea is that the supply of metals will catch up with the demand so quickly. It’s just not correct at all. So there is a time in constraint here part of the variable as part of this equation that I think is understated when it comes to the transitory argument.

Tavi Costa (43:09):
So I hope I’ve provided some names, but I would say that the whole industry looks very attractive. 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.

Trey Lockerbie (43:23):
You recently posted, and by the way, for those who haven’t checked out your Twitter feed and all the charts that you guys post, they’re incredible, they’re very simplified, easy to digest. One stood out to me which was around silver, and I think it was a 30-year chart and monthly candles and there was basically a wedge that silver was starting to break out of if I’m not mistaken. What’s your base case on silver? I’ve heard you call it the most asymmetric bet of the bunch. So walk us through why you think that is.

Tavi Costa (43:49):
I think in this world where we’re going from the old to the new economy and commodities is the highway to go to make this transition happen, I think there’s going to be the need for commodities that play into the base metals side. 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 fiat currencies over the years. I like that the optionality of silver in a large way perplexes, actually, the fact that silver 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.

Tavi Costa (44:35):
I think silver not only looks cheap relative to the money supply, the monetary base itself, broad equity markets to gold itself as well. When you go back to times in history where we have these 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.

Tavi Costa (45:00):
In some of those situations, we actually saw equity markets suffering during that period. It wouldn’t surprise me given the fact that valuations are so high today. So when you 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 belong to commodities? Should I be buying oil? Should I be buying natural gas and agricultural commodities, base metals, gold?”

Tavi Costa (45:25):
Then I look to silver and silver is the one that looks cheap relative to almost any asset in the world today. 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. I think that as we push towards these more innovations on the technological side of things, we’re going to see a large demand feeding 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.

Tavi Costa (46:02):
So when we start seeing large capital allocators 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 it peaked recently and we’ve been going sideways since then. I think the silver is consolidating in a large way.

Tavi Costa (46:27):
When you look at the long-term chart, it looks like a massive cup and handles. I’m not so a great technician, but I look at technicals. When I look at quarterly candles going back five decades or so and I see the silver price forming this massive cup and handle, 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.

Tavi Costa (47:02):
So I don’t know when it’s happening 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. We’re going to see the gold to silver ratio fall into a large way probably go back to its average at about 30. Once that happens, it’s going to lead to a lot of capital allocation towards this whole industry.

Tavi Costa (47:25):
A total lack of liquidity in the exploration, development, the whole industry lacks liquidity as a whole. 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 metals are today. They don’t have to move at all.

Tavi Costa (47:40):
So it’s attracting more and more capital, and will continue to attract more and more capital over time. So I think in the next few years we’re going to see an explosive move for silver. 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. So I’m very bullish on silver. I think it’s the cheapest metal on earth. I’ve said this a few times, and it’s the most asymmetric opportunity in the markets today in my opinion.

Trey Lockerbie (48:06):
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 stand with gold and silver?

Tavi Costa (48:20):
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 and palladium for the next few years. We’ve been exposed to those through exploration assets. We like to own those metals as well and have exposure to it. They are just like silver, and I think of silver in steroids in terms of volatility, they’re very volatile. Platinum, for instance, has a much higher, believe it or not, a much higher correlation to the oil market than gold and silver, which is interesting when you look at the two charts and overlay those lines over the history of the two assets.

Tavi Costa (49:03):
We like to own those as part of this transition from the old to the new economy. We think that supply and demand for almost any commodity worldwide look very attractive and the precious metals side and base metals are the ones that call our attention most.

Tavi Costa (49:17):
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.

Tavi Costa (49:32):
Precious metals are the one that looks not only the cheapest, but it also looks like there’s significant growth for cashflow. Margins are improving. You’re seeing balance sheets improving quite a lot. The actual balance sheet looks very attractive relative to the others. So when you think about precious metals relative to other commodities today, it looks really attractive.

Tavi Costa (49:51):
Energy looks very profitable as a business right now. However, you paid up for the leverage. So there’s quite a lot of leverage. Your balance sheets don’t look as attractive. So they have more heavy or heavier balance sheets relative to the other commodities.

Tavi Costa (50:05):
Then you come into the base metals. Base metals 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 growth and fundamentals. Also, I would say we’re saying unfortunately an increase in cost that is being linked to the base metals stories as well.

Tavi Costa (50:24):
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, I think you want to own the whole spectrum of the commodity.

Tavi Costa (50:36):
Agricultural commodities 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 and oil 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. So that looks quite attractive, too.

Tavi Costa (51:06):
Coal had an actually good run. Some coal-related businesses had a good run recently, but when I look at the fundamental metrics, nothing looks attractive to me in that space. 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 has been precious metals because I think it fits into these two lines of thinking of monetary metal and the shift from the old to the new economy. I think precious metals serve that purpose very well.

Tavi Costa (51:34):
So it’s quite a lot of ideas that you can explore when it comes to exposing yourself towards tangible assets, but that’s the way I view it as capital allocation. Now, we think that precious metals look the most attractive.

Trey Lockerbie (51:46):
One question I’ve been asking a lot of our guests is around what they think the biggest risk to the market currently is. You touched on or you alluded to it earlier and this risk of coming from the trade balance issues and deglobalization. Is this where you see the biggest risk in the market today?

Tavi Costa (52:05):
I do. I think it’s difficult to think about the liquidity of crash where obviously what we’re seeing if the equity markets drop at about 25% to 30% on any event, you would probably see the federal reserve coming in for rescue with a very large package stimulus and probably trying to really suppress the issues in a large way. I think it would have to come from an exogenous shock.

Tavi Costa (52:30):
The biggest risk I see to the global economy today is in regard to China. I remember back in the days in 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.

Tavi Costa (52:47):
So what we found today is that the banking assets of China are closer to $50 trillion. It’s about 300% of GDP. At what point do you see some real implications in terms of what that could cost in regards to a credit bust and any sort of issue. I think that the biggest risk for China is deflation. The economic model of China with exports and entry buying a lot of raw materials meaning commodities in a large way has worked because commodities were really cheap over the years. Now that’s shifting. I think that that will create a problem in the Chinese economic model.

Tavi Costa (53:23):
So I’ve been very focused on that. I think that the crackdown in the CCP on the massive 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 shoot themselves in 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.

Tavi Costa (53:47):
Even though we’ve seen some degree of that happen in 2015-2016, today we’re seeing a much worse setup when it comes to that. I think China, you study the history of credit bubbles, it’s difficult to pinpoint what exactly causes those to burst, but it seems to me like China could be … It has all the recipes for a credit bust. I don’t know what the federal reserve would be capable of doing if that would actually occur.

Tavi Costa (54:13):
So I am very concerned about that. I think that you want to build an inflationary edit score when it comes to a portfolio. You’re looking for deflationary hedges when it comes to those exogenous risks. One of them I think in China. 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 would feed into also a devaluation or a major devaluation of the Chinese yuan.

Tavi Costa (54:45):
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 Asian markets and South American markets, and other developed economies as well is that gold in local currency terms tends to do really well in subsequent years of those issues.

Tavi Costa (55:12):
So we own tangible assets, mostly gold, silver, precious metals, base metals, and then we have some short positions in the Chinese currency. So mathematically, that is the long precious metals or tangible assets in Chinese yuan 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, we’ll lose 1%-2% of the portfolio. 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.

Tavi Costa (55:46):
So I think that’s it’s a significant risk to the market. It is a deflationary risk. I think that devaluation of the yuan would mean deflation to the rest of the global economy. We’ve seen so far is the Chinese ADRs started to falter with issues with the US and 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 starting to have some issues.

Tavi Costa (56:16):
That usually, when you look at those changes, the delta of those price movements in Chinese assets tends to lead to the deceleration of macro data in the US and other developed economies. So I happen to believe that if that’s going to unfold, that is going to be negative for the West. 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 at Chinese currency and being long US dollars. Again, if I’m wrong, it’s not the end of the world, but I view it as a very important insurance policy for the rest of the portfolio.

Trey Lockerbie (56:52):
So Tavi, before we let you go, I want to make sure I give you a handoff to Crescat Capital, to your Twitter feed. Any other resources you want to share with our audience?

Tavi Costa (57:00):
Well, thank you for allowing us to share that, Trey. I would say our website, crescat.net, is where you can find our letters and information about 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, @TaviCosta, where I share a lot of macro data and charts and ideas and thoughts about what we are positioned in our portfolio. 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. I really enjoy doing that and sharing some of the concerns and opportunities that I think are today in the markets.

Trey Lockerbie (57:38):
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. I would love to have you back and do this again. I’m watching silver myself closely as well as gold. This China issue is an interesting topic that I think we should explore a little bit more. So thank you so much again for coming on. Love to do it again soon.

Tavi Costa (57:59):
Thank you, Trey. It was a pleasure.

Trey Lockerbie (58:01):
All right, everybody. That’s all we have 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, @TreyLockerbie. 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 will pop right up. With that, we’ll see you again next time.

Outro (58:28):
Thank you for listening to TIP. Make sure to subscribe to Millennial Investing by The Investor’s 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 Investor’s Podcast Network. Written permission must be granted before syndication or rebroadcasting.