Gold, Debasement, and Henry VIII

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First of all, what part of 0% chance of precipitation on Tuesday does Mother Nature not understand? Is what I would like to know, because I had that driveway of mine cleared black. It's a blacktop driveway. It was dry. Everything was nice. And then we got just like a sneeze of snow, like a, like a half inch of powder, just, just enough to turn the driveway white and, uh, potentially icy as it gets cold. Now, now there's more stuff to be done. So thanks, Mother Nature. I'm sorry, when do we turn the microphones on? There was actually a note out from B of A on the potential economic impact of the storm. This is from their US economist. This was, by the way, called Fern, this storm that we just had. And to assess the impact of Fern, he looked at Viola. Viola? One of those is an instrument and the other one's a person and a storm. But I'm going to say Viola. And that was in February 2021. And consumer spending fell by 0.9 of a point that month. That's after a 1.3% increase in January. So there was an effect. Both that storm and this one put roughly half the country under a winter weather advisory. BofA also has their own credit card spending data that they can look at. They said that slid during Viola, Viola, which one did I decide on?

Viola.

They said that slid during Viola. You know, maybe it's voilà. Now that I think about it, I think you need like a hat on one of the letters for it to turn a Viola into a voilà, right? How do you spell voilà? V-O-I-L-A.

V-O-I-L-A.

Okay.

That's a different spelling. Folks, don't mind me. I'm just figuring out some life things here on the fly. B of A points out that Fern probably wasn't as disruptive as Viola, which cause big, uh, disruptions to the power grid in Texas, but it did dump a lot of snow in the Northeast, which has higher income households. Bottom line, they write, our initial estimate is that the drag on first quarter 2026 growth will be in the range of 0.5 to 1.5 percentage points. But they say the effect won't be long lasting. Of course, some of that lost spending is just really postponed spending. They write, this means there is as much upside to second quarter GDP growth as there is downside to first quarter. I don't know if they factored in all that salt that people hoarded from Home Depot when they cleared out the shelves before the rest of us got there. I'm assuming they counted that. By the way, if you have an icy path and, uh, they run outta rock salt at the store and you're wondering, what about that salt that I have by the bath, that Epsom salt? I looked it up and it says it's not very good for that job. It doesn't de-ice when it's really cold. That's the problem with Epsom salt. Anyhow, so that's the potential economic impact of Fern. Sounds like not too much to worry about as it stands. We're going to do a listener question special. Cozy up over there, put another log on the fire, have a seat next to your 75 bags of hoarded rock salt.

If you're one of those people, you know who you are.

Alexis, reach into the listener mailbag over there and tell me, uh, tell me what you have.

Oh yes, we have some good ones. I mean, they're always good ones, but today we have—

are they better or worse than the last batch that we did? I don't mean that to sound accusatory. It was a lovely batch of questions the last time. I'm just saying, I like a— I like a competition. I like a scoreboard.

I think this is like gymnastics level better, like 0.01%.

Okay.

Better.

All right.

So don't feel too bad. But we have a question about Fannie and Freddie. We have questions about asset allocation and buybacks and dividends, your favorite.

Yep.

So I think we should jump in.

Let's do it. Who do we have?

First up, we have Chase from Florida.

Chase from sunshiny, funshiny Florida. Let's hear it.

Hey, Jack. This is Chase from Florida. I've been hearing about two companies, Fannie Mae and Freddie Mac, in my news feed, and increasingly about how they may be released from conservatorship under this current administration. From what I can tell, as a business, they seem to play a major role in stabilizing the mortgage market. They seem to be profitable, but unfortunately, from a shareholder perspective, they don't seem to pay dividends, and they look like they're listed on an over-the-counter exchange, and their historic chart It looks like a nightmare. Could you please shine some light on what a government-sponsored enterprise is, any similar historic precedent there may be, and what an individual shareholder could interpret from all this? Thank you. Love the podcast.

Thank you, Chase. The answer to this question could be as complicated as you want to make it, but let me make it simple if I can. First, what does Fannie Mae do for people who don't know? It does not lend money. It buys mortgages from the companies who do lend money, and then it bundles those mortgages into investments, and it guarantees payments on those investments, and it charges a fee to the lender in exchange. And the purpose of doing all this is to replenish the availability of capital. Lenders get loans off their books. They're sold to investors. Lenders get more money to make more mortgages., and it also kind of sets the standard for what mortgages ought to look like. Fannie is the reason why most of our mortgages look kind of the same, except for maybe the rate. You ask, what's a government-sponsored enterprise? It's a murky thing. It's usually something that serves a public purpose, but it's not explicitly guaranteed by the government, but there's an assumption that the government is kind of behind the thing. You also ask, is there any similar historic precedent? Definitely. 1968, Fannie Mae went from a government agency to a shareholder-owned company. And how did it go? It went quite well until it didn't. Investors liked it. There were dividends that grew. Again, it wasn't guaranteed by the government, but there was an assumption that the government would never let it fail. And it all worked fine for about 40 years until the global financial crisis in 2008. And then Fannie had to be taken into conservatorship by the government. And now there were growing calls to take Fannie private again. And about a year ago, my colleague Andrew Barry at Barron's wrote a story titled, Taking Fannie Mae Private Could Be Ugly. Here's Why It May Not Happen. And so far he's been right. It hasn't happened. There are expectations that it could happen in the first half of this year. There's just one thing that makes it complicated, and that thing is pretty much everything, like the whole fundamental principle behind how Fannie works. If you're a publicly traded company, you have shareholders to answer to, and your goal is to make money for those shareholders. You have kind of a fiduciary responsibility to seek out profits as best you can. But that's not really what Fannie's thing is supposed to be. Its thing is supposed to be freeing up more capital for the mortgage market. That keeps mortgage rates lower than they might otherwise be. You could say it's a public service. A company can't really serve the public and its shareholders with the same level of dedication at the same time. I mean, it can for a while, but eventually there will be problems. For example, if you have shareholders who want you to seek profits, but if you also have this implied government backstop, you're going to know that you can take lots of risk. There'll be help down the road if you need it. And that puts you in a weird place where the right thing to do for your shareholders is to take on lots of risk to go after extra profits because you know that risk for you isn't the same as it would be for another company that doesn't have those ties to the government. You see what I mean? That's what got Fannie in trouble in the first place. That's why it was taken under government conservatorship. So if you want to bring it public again, you have to solve for that. And it's beyond me, honestly, how you do solve for that in a permanent way. I'm not sure that you can. But not only do you have to solve for that, but the job has to be done by Congress. Think of the Congress we have. Think of the narrow majority in Congress. Think of the simple, basic things that Congress has struggled with up until now. And now picture that same Congress trying to prepare for a Fannie IPO by figuring out new rules for how Fannie will serve both the interest of the public and the interest of its shareholders at the same time without letting conflicts of interest get in the way. I think that's why the IPO is taking time. I can't tell you that it won't happen. There are people who have strong financial interest in this happening. Bill Ackman, he's a hedge fund manager. He has a position in this and he could cash in on an IPO. If you do see an IPO in the next couple of years and you're wondering how it will go, I can only guess. I usually look for past patterns and guess based on that. In this case, it's not so much a pattern as an instance of this thing happening once before. But my guess, let me see, do I want to be hopeful or cynical here? I'll be cynical. My guess is, let's say there's an IPO in, I'll call it 2028. That puts us at a nice round 60 years since the last time we did it. That's enough time to do the same dumb thing again. I'm going to guess Congress makes the most minimal of efforts to get this thing figured out. And I think the thing will do very well initially. Will we get another 40-year run out of it? I feel like we'll get less this time. Call it 20. That puts us at, let's see, 2048, and then the thing blows up again.

And hopefully by then you'll all be rich enough to buy a stake for pennies on the dollar and then let the thing lay low under its next future government conservatorship and then start arguing that it's time to take Fannie public again.

That's too cynical, right, Alexis? I think all this snow made me grumpy.

I think a dose of realism is helpful here.

All right, Chase, I hope that answers your question and good luck.

Who's next on the sheet here?

Next up, we have a question from Anthony who actually commented on Spotify. Yes, we read the comments and yes, we're going to answer this question.

There's comments on Spotify? Yes. Are any of them nice?

We get a lot. A lot of them are nice. Some of them are correct. Correcting your pronunciation.

There's a lot of that.

Yeah, I know.

Again, I've said this before, I don't rule out the possibility that I'm mispronouncing my own name. How?

H-O-U-G-H. Some people say Huff, and they might be right.

So I'll read it. He says, Jack and Alexis, thank you for the work that you do. Thank you, Anthony. For someone like myself who is fairly early in my investing journey, this podcast has been invaluable. I have so far invested only in indexes, target retirement funds, and ETFs focused on dividends. However, over the holidays, every party I went to, people were talking about Ripple, XRP, or the potential of Ripple Bank. In your view, are these completely speculative or is there some truth to the potential of these assets?

Thank you, Anthony. You've been hearing a lot about XRP and Ripple Bank. Ripple isn't quite a bank. It's a financial technology company, and its focus is on moving money across borders, kind of like the SWIFT system for banks. And XRP is a cryptocurrency. Ripple Labs is the creator of XRP. Ripple does have some contracts with major financial institutions. You can think of it as a provider of financial plumbing. It's not publicly traded.

There's been talk of an IPO, but I don't see any immediate plans for one.

You can buy XRP, the cryptocurrency. It hasn't done particularly well over the past year. Looks like it's down by a little over a third. You ask, are these completely speculative or is there some truth to the potential?

And my answer is yes and yes.

There's definitely potential to use crypto technology to change the way money is zipped around the world. But that doesn't necessarily mean that XRP is going up. Maybe it is, maybe it isn't. So if you're buying XRP based on that, it sounds pretty speculative.

There, of course, have been long stretches in the past where cryptocurrencies did wonderfully well. And I think you have to look at the current administration and say it's very supportive of crypto.

The president's family has made kind of a lot of money on crypto ventures. There was even an ETF proposed from the president's media company. It hasn't launched. I don't know whether or when it'll happen. It was to be called the Truth Social Crypto Blue Chip ETF, and it was going to hold some Bitcoin, some Ethereum, some others, and a little bit of XRP.

So you can hardly do better than that for policymaker support.

On the other hand, Just recently, we have seen a stark separation between precious metals and cryptocurrencies. Precious metals are going nuts. We talked about that, I think, just a few episodes back. You can call that a debasement trade.

Investors are looking at current circumstances and saying there's no end in sight to these federal deficits, and there has been some unusual pressure on the Federal Reserve's independence which could one day down the road lead to more inflation, and we're not quite comfortable with that. Whatever the reason, gold, silver, copper, right on down and across the periodic table, they're all running higher.

That hasn't been the case with crypto. How's, uh, let me see how our friend Bitcoin is doing. Past 6 months, it's down 25%.

I mentioned that just because in the past, people making the case for crypto have said, Maybe this is digital gold. Maybe this is the thing you buy to protect against inflation. But if I'm judging by recent trading, I would say crypto looks more like something you buy for speculative fervor, and metals are looking like the thing that people want to pile into when they're worried about inflation.

That's about all I can tell you, Anthony.

I don't want to give you a specific recommendation because we both know that if I say stay away from it, the thing will quadruple in price tomorrow. I don't know which way XRP is headed, but I like what you said earlier about the indexes and the retirement funds. And he even mentioned a focus on dividends.

That was my favorite. I give that 3 rocket ship emojis. Alexis, that's 2 down. I'm already, I'm already thinking break. Uh, but that, I guess, depends on how many we're doing. Um, how many are we thinking total here?

Cause I want to.

I think 3 or 4. So I think now is a good time for a break.

Oh, I'm past break time if we're only doing 3. Are you kidding me? I'm overdue. We better do 4. That's true.

We'll take a quick break here. We'll be right back with another 2, if my math is correct. Check me on that.

Data is everywhere, but is it ready for consumption? Morningstar developed the language of global investment data so you have the right ingredients to help you shine. Morningstar, where data speaks.

Welcome back. A minute ago I mentioned the debasement trade. That's the subject of my column this week in Barron's Magazine. Let me say a couple of words about it here before we get back to listener questions. There was a King of England called Henry VIII. He was tall and fat, moderately tyrannical by 1500 standards. And prone to excess in palaces and clothes and wives and prestige wars.

Henry inherited great wealth from his father, and he seized more from monasteries after breaking with the Catholic Church, yet he still ended up short on cash.

So he issued more of England's silver coins at their familiar face values, but he gradually changed the metal from nearly all silver to mostly copper with silver coating. The tell was Henry's nose. The nose stuck out the most on coin faces, and so it lost its silver first. And that earned the king the nickname Old Copper Nose.

Merchants balked at the new money. Prices soared.

Wages didn't keep up. The poor and England's trade reputation suffered. More than a decade after Henry's death, a daughter of his, Elizabeth I, became queen, and restored confidence with a nationwide recoinage. That's an example of physical monetary debasement. Debasement used to be easier to spot. Today, Wall Street uses the term debasement trade to describe this startling run-up we've seen in gold's price. Just this past week, it blew past $5,000 per troy ounce to as much as $5,600. It raises the question: if this is a debasement trade, Are we debased yet? How will we know when we get there? What does it mean for stocks and other assets?

Is it too late to buy gold?

Let me just tell you this. There's a big difference between inflation, which is a rise in prices, and debasement, which is a decline in the value of money. Even though they're two sides of the same coin, the difference is in the method and the degree. Central banks like to run a little bit of inflation, maybe around 2% a year.

It keeps people spending rather than hoarding cash, and that's good for growth.

So, when we say that bread used to cost a nickel, that's not evidence of debasement. Cash is not designed to hold its value over decades. Debasement happens when a monetary regime loses its credibility. Think about Zimbabwe in the early 2000s or Argentina over much of the past half century. It can start with emergency government spending..

It can turn into big chronic baseline deficits, bloating debt.

Leaders often demand low interest rates and they exert control over the central bank.

Inflation runs consistently above interest rates.

Investors sour on government bonds. The government creates money to cover its expenses.

Citizens convert their pay into anything but the local currency. There might be capital flight restrictions or dual interest rates. Businesses begin to prefer to be paid in outside currencies.

Today in the U.S., only some of these things apply.

Deficits have been large and chronic, and they've juiced growth, and closing them would probably trigger a deep recession.

And that's not really a vote-getter.

So politicians lack the will for it.

But the 12-month inflation rate looks only a touch high. And yes, I know there's still the lingering pinch of fast price growth during COVID and some continuing run-ups for individual items like electricity. President Trump has called for lower rates and badgered or threatened to fire the Federal Reserve Chair Jerome Powell. Recently, his Justice Department issued Powell a criminal subpoena. I will call that debasement footsie. That's on the path to debasement.

We're not there yet.

Powell's term is up in May. On Friday, Trump nominated as his successor Kevin Warsh, who has spoken out in favor of lower interest rates. Gold, in response, dropped 5%. If the bond market expects runaway inflation, it is not yet reflected in Treasury demand or yields or futures. And the dollar has fallen relative to other currencies, but from multi-decade highs. It remains dominant in trade. I can't tell you where gold is headed next. Over time, it tends to go up, not as fast as you think. Deutsche Bank looked at the past 235 years and found that Even with the recent run-up, gold has outpaced inflation by 279%. It sounds like a lot, but it works out to barely half a point a year compounded. JP Morgan said before the latest run-up that gold could hit $6,000 per troy ounce by 2029. If foreign central banks continue to convert incremental amounts of their US assets into gold, the price of gold could continue to rise. But some of the recent price action to me looks like momentum trading. UBS says that 68% of the price movement in gold over the past year is explained by US policy shifts. How do you tell a thing like that? There's a statistical technique called event-targeted vector autoregressions. And as I hear myself say that out loud, I feel like I've already said too much.

Lastly, what does the soaring price of gold mean for the US stock market? The investment bank Stifel argues that after 3 mighty years for stock gains, the gold price might cap the S&P 500 7,000 this year.

That's not far from where it is now.

It points out that the ratio of the S&P level to the gold price has broken down recently like only 4 other times in history, and that each of those times left stocks, quote, range-bound for years. I'm not sure that's the kind of thing to base an investment move on, but stocks do look pricey.

I wouldn't be surprised if they took a pause for a while. Anyhow, that's enough on gold debasement and English kings. Let's get back to listener questions.

Who do we have, Alexis?

Next up, we have Victor from Texas.

Hello, Victor from the great state of Texas. You know, I'm just back from Texas. Am I gonna drop a hint, Alexis, about what I'm up to for a future episode coming up in maybe a couple of weeks?

I think you should go ahead.

I don't wanna give too much away. I will tell you that I wore my boots. Okay. Not cowboy boots. I can't pull off that look. I wish I could. Not yet anyhow. We'll see what happens in retirement. But I wore my work boots and I got plenty of mud on them. That's all I'm going to say. Is that enough of a hint, Alexis?

What do you think? I think you can give them a little bit more.

All right.

How about this? Moo. Now I've said too much, right?

A little too much.

I went too far. All right, look, let's get on with the question before I really give it away.

Hi, Jack. This is Victor from Texas. A big fan of your show and your humor. The S&P 500 index is a core holding in a 60/40 portfolio, but the index is currently very expensive by historical measures. I'm thinking about paring down my exposure to it by 5 to 10 percentage points, but on the other hand, I think I should stick to my asset allocations because it's difficult to predict or time the market. What's your take on these two strategies? Or maybe suggest a different strategy?

Thanks. Victor, I really like your question because it shows— what's the word here? Restraint. You say the stock market is expensive. You're right. I show the S&P 500 at 26 times last year's projected earnings. We don't have all those fourth quarter results in yet, so it's still projected earnings for 2025, and it's about close to 23 times this year's projected earnings.

That's high.

The historical average is maybe around 15, 16 times earnings. Kind of depends how far back you look. And so you're saying, should I sell some and do something else? But you're not saying, should I sell everything and put it all in Scooby-Doo coins?

And that's probably trademarked.

I don't think you can do Scooby-Doo coins. You know, you're not saying, should I do something rash? You're saying, Should I make a shift in my percentages? Should I do something with 5 or 10%? Yeah, probably at least a strong maybe. Now there has been a huge stretch of what we called American exceptionalism because the US was outperforming all these other markets overseas. And that was on the backs of these very impressive big tech companies that we have in the US. And that trend stopped last year. Or at least it paused. Last year we saw developed markets ex-US actually outperform the US. Lately we've seen small caps start to percolate a little bit. That's another asset class where people for years said small caps are due. Didn't happen. Is it happening now?

Maybe.

We heard from B of A's strategist Jill Carey Hall, who said that this year's gonna be a very good year for small-cap earnings growth.

And then we did an episode on this phrase I've heard again and again, sell America.

Is it time to sell America? And that's kind of people who are saying, hey, the US has done so well for so long and now I'm worried about this or that trend. Should I do something else?

I don't think it's time to sell America, but maybe it's time to rebalance a little bit.

Again, not something rash. So if your question is, should I take 5 or 10% out of my S&P 500 fund and do something different with it? I would just ask you, do you have developed markets overseas? If you don't, maybe shift some money there. Do you have any small caps? If you don't, maybe put a smidgen there. That's by no means fleeing the US. It's just diversifying, and it's diversifying into some places where valuations are lower. So, it's going to bring down the average valuation of your portfolio. You mentioned, Victor, that it's difficult to predict or time the market. I'm with you. I think it's pretty much impossible. So I don't know whether this shift will pay off over the next year.

I think it'll leave you well positioned for, let's say, the next 10 years on average.

And I don't think it'll fundamentally change what you've been doing, which is cheap, broad exposure to stocks with some cheap, broad exposure to bonds on the side. Good luck.

Okay, Alexis, I see that we have a question coming up.

At first I thought it was Patrick Naudio. But I'm looking more closely and I see it's Patrick No Audio. His name is not Naudio.

Not as far as we know, correct?

Although I like the name Naudio for something.

Maybe another kid?

Well, I'm like 100, so no. I was thinking like a superhero arch villain type of thing, but let's meet in the middle and say maybe a pet someday.

Okay.

Anyhow, back to Patrick and his question.

Yes, he wants to know, why don't more companies buy back and then dividend repurchase shares? It seems like the most advantageous combination. The buyback would still drive upward price pressure, and distributing those bought back shares as a scrip dividend would give investors an automatically reinvested form of cash flow they could either hold or sell for liquidity. It feels like that approach could offer the best of both worlds. What's your take on this?

I love the creativity here, Patrick, but it's a little bit like trying to fly by pulling up the backside of your own pants. You just, you're not gonna get very far, and there might be some discomfort, I guess you could say, on the way. When companies buy back stock from the public, they spend their cash.

They say, we think shares look attractive here, so we wanna buy these back.

They reduce the number of outstanding shares and that raises earnings per share. It theoretically makes remaining shares more valuable. And when I say theoretically, I mean, it's highly theoretical.

There have been many, many cases in the past where companies bought back shares and they ended up buying too high.

In fact, if you think about it, when's a company going to want to buy back shares? When it has plenty of cash. When's it going to have plenty of cash? When times are great and it's making loads of money. Well, during those times, its shares are probably riding high. What's going to happen when hard times come? It's not going to be making as much money.

It's not going to have as much cash.

It might not want to buy back stock. It's one of the reasons why when people say, why don't you like stock buybacks more than dividends? They're more tax efficient and so on. Well, yeah, but a dividend is like a company saying, we're going to try to pay this steady amount no matter what. Doesn't always happen that way, but at least the company's trying. With buybacks, there's a little too much temptation to buy during good times and stop buying during bad times.

I kind of prefer the dividends because it gives you that steady stream of incoming cash to hold on to.

If you look at your account statement, you see, hey, my portfolio value is riding high, great, you're happy. But if you look at it and say, hey, my portfolio value is down in the dumps, well, Start looking at your stream of cash coming in. Maybe that'll make you feel better. But that wasn't your question, Patrick. It was, why don't companies buy back stock and then issue that stock right away as scrip dividends? If a company wants to issue a scrip dividend, it can create new shares, or it could issue shares from its treasury.

What does that mean? Well, if a company buys back stock, those shares are no longer outstanding.

They're still issued. They're not outstanding. They become what's called treasury stock. If you take treasury stock and then you issue it to shareholders as a scrip dividend, it goes back to being outstanding shares. You haven't issued new stock, but in a way you have changed your share count. In fact, you could say you've come full circle. You bought back stock and then sent it out again.

The other thing, Patrick, is that scrip dividends kind of send a different signal to investors than either cash dividends or stock buybacks. Cash dividends or buybacks say, we have a lot of cash.

We've been doing well. We want to return some money to our shareholders. A scrip dividend says, we want to do something for our shareholders. In principle, we think that's a good idea, but we need to hang on to our cash. In other words, it's not nearly the sign of confidence or prosperity that a cash dividend or a stock buyback is. In a way, it risks getting investors asking, why won't you just give me cash? So the answer to your question, why don't more companies do this? It won't really mathematically create shareholder value. It will probably create some fees.

And more important, it might create some confusion. And hopefully I haven't confused people.

I want to thank you all for listening.

Thanks for sending in your questions.

Keep them coming. They could be played and answered on the podcast.

You can record your question using the voice memo app on your phone and send it to jack.hou. That's H-O-U-G. G.h. at barons.com.

Alexis Moore is our producer. You can subscribe to the podcast on Apple Podcasts, Spotify, or wherever you listen. If you listen on Apple, you can write us a review.

Apparently you can write one on Spotify too. See you next week.

Data is everywhere. When orchestrated properly, it sings. At Morningstar, we analyze and enrich data, making it actionable and powerful for you. Morningstar, where data speaks.