You Need the TRUTH to Make Informed Decisions — Part Five

In May 2018, the Gowdie Family Wealth newsletter included a copy of a personal note I penned to my three daughters.

Here’s an excerpt:

‘Hello girls,

‘Not sure if you’ve been following the Theranos saga in the US.

‘For a bit of background, Theranos was the biotech start up founded in 2004, by 19-year-old entrepreneur, Elizabeth Holmes.

‘Theranos was founded on good intentions. Holmes wanted to “democratise healthcare” by making it possible to diagnose a variety of illnesses from a simple, low-cost blood test.

‘Early detection could save lives…a noble concept.

‘There was one small problem…her professors at Stanford University said “it was not possible”.

‘Perhaps they were wrong. Perhaps there was a way for science and technology to evolve to the stage when a few drops of blood could replace more extensive (and expensive) testing regimes.

‘Holmes certainly didn’t lack self-belief.

‘In 2011, she convinced former US Secretary of State, George Schulz, to join the company’s board…which also included Henry Kissinger.

‘In 2013, the pharmaceutical giant Walgreens entered into a partnership to place Theranos blood sampling centres in its stores. A major coup.

‘In 2015, Forbes magazine named Elizabeth Holmes as the world’s youngest self-made billionaire…at the time Theranos was valued at US$9 billion.

‘Elizabeth Holmes was being hailed as the next Steve Jobs.

‘But it was all a fraud.

‘In 2016, serious questions were being asked about the accuracy of the results from the blood tests.

‘There’s your first lesson.

‘Never promise something you cannot deliver…eventually you’ll be found out.’

Elizabeth Holmes was found out in a very spectacular and public fashion. US District Judge Edward Davila has determined the penalty for her lies is…11 years behind bars.

The parallels between Holmes and the now disgraced Sam Bankman-Fried (SBF) are very similar. He, too, appeared on magazine covers.

Fortune magazine’s August/September 2022 cover had the nerve to even ask…

SBF also basked in the glow of the rich and famous…Tony Blair, Bill Clinton, Tom Brady, Gisele Bundchen…

SBF’s supposed empire was built on a web of deceit.

The glossy veneers created by Holmes, SBF, Bernie Madoff, and a host of others hide the ugliest of ugly truths…these are scams.

But it should be noted not all investments are scams. Some just get caught up in the hype. Momentum, fuelled by greed, pushes prices well above fair value.

Knowing the truth about scams is easy…they all have that ‘it’s-too-easy slickness’ about them.

However…

Even bona fide investments can get caught in a lie

Knowing the truth on valuations of bona fide investments — quality shares, property, bonds, precious metals — is a lot more difficult to uncover.

For example, investors who bought the Dow Jones (top 30 US stocks) in 1929 had 25 years to ponder their error of judgement…

Also, investors caught up in the late 1970s gold hype, waited a painfully long 27 years to be made whole again:

And neither example of valuation excess accounts for inflation…which extends the recovery time of real buying by another few decades.

We have lived through THE greatest period of excess in HISTORY!

Never has there been so much cheaply available printed money pumped into markets.

Distortions occur.

Assets are valued on a ‘relative to’ basis…relative to X, then Y is worth (pick a figure).

But, if X is overpriced, it stands to reason Y will be too.

This is how the valuation process can spin out of control.

What’s real and what’s fake?

Knowing a solid version of the truth on valuation can, hopefully, minimise the risk of suffering decades of buyer’s remorse.

Gold and silver

In the post-GFC period, gold and (to a greater degree) silver took off on the expectations of ‘rampant money printing’ heralding in an era of hyperinflation.

From 2009–13, precious metals (black and red lines) outperformed the S&P 500 Index.

After 2013, with hyperinflation fears dispelled, the value of paper assets (as represented by the S&P 500 Index) increased substantially, while the performance of gold and silver went, more or less, sideways.

Precious metals is an asset class that DID NOT get swept up in the hype surrounding the everything bubble.

For me, yesterday’s underperformer provides a good starting point for identifying tomorrow’s potential outperformer.

In our search for truth on the value of precious metals, we looked at the Gold-to-Silver ratio.

Traditionally, the ratio is 50oz silver to 1oz gold.

When silver peaked in April 2011, the ratio had shortened to:

In September 2022, when The Gowdie Letter recommended readers begin investing in gold and silver, the ratio had blown out to:

The current ratio (as at 21 November 2022 pricing) is:

In 2013, when the ratio was UNDER the long-term 50 to 1 valuation marker, correcting the imbalance required silver to depreciate in price.

Now, it appears that the ‘reverse swing’ is on…silver is appreciating more in value than gold.

Our search for the truth on the valuation proposition of precious metals was the subject matter of the 12 September 2022 issue of The Gowdie Letter.

Here’s an edited extract:

‘After much consideration, I’ve decided to increase the precious metals weighting in the Model Portfolio…

‘The next decision is how much of this weighting is divided between gold and silver.

‘In broad terms…

‘100% Gold & 0% Silver

‘OR

‘50% Gold & 50% Silver

‘OR

‘0% Gold & 100% Silver

‘Even though the analysis appears to be heavily in favour [of investing all in silver], the more cautious investor in me, leans towards a balanced approach.

‘50/50 or 60% gold/40% silver or 40% gold/60% silver.

‘Do you buy physical gold and silver, or ETFs backed by physical gold and silver or a mixture of both?

‘When do we start buying and in what quantities?

‘The reason for including silver in our precious metals’ exposure, is due to the apparent undervaluation of silver to gold.

‘The current ratio is…

‘If we look at the Gold to Silver ratio AFTER the two previous bubbles busted, the ratio returned to the 50oz level and below.

‘Therefore, if this same scenario plays out when the everything bubble collapses or simply deflates, then here are some variables to ponder on how the ratio of 50 oz to 1 oz might occur…

‘If the ratio was to return — ever so briefly — to the [post] GFC low of 30…then the percentage increase in silver prices would be even greater

‘If you’ve formed the view that gold is likely to either hold its value while the Dow falls OR increase in value (due to central bankers losing their nerve and start printing again) AND the Gold-to-Silver ratio is likely to undergo Reversion to the Mean, then silver is the clear winner in the precious metals’ stakes.

‘Allocation to silver and gold

‘Historical evidence and the principle of Mean Reversion provide a compelling case for silver outperforming gold in the coming years.

‘Some readers are committed gold bugs…it’s gold and nothing else. That’s fine.

‘I’ve long believed the most appropriate asset allocation is the one that enables you to sleep soundly at night.

‘Lying awake at night, wondering and worrying about what’s happening on Wall Street is not how I want to make it to old bones.

‘Even though I’m confident in the analysis of silver’s likely outperformance, for me to sleep at night, I just need to strike the [right] balance.

‘In my view, our investment in precious metals is for the longer term — the remainder of this decade.

‘Therefore, the strategy is to gradually (through dollar-cost averaging) move towards our targeted…allocation.’

How is our strategy working out?

Since 12 September 2022, our staged entry into precious metals has posted a gain of…4.3%.

The stronger performance of silver explains why the gap in the Gold-to-Silver ratio is narrowing.

Early indications are positive…but there is still a long way to go.

The real test will come when Wall Street is confronted with a far more conservative (and brutal) ‘relative to’ valuation model.

Regards,

Vern Gowdie,
Editor, The Daily Reckoning Australia