Wealth is merely transferred in crisis, not destroyed


If you want to make money in the next 6-12 months or if you’re an institutional investor .. you may want to stop reading now. The chances are .. you’ll lose some money and maybe your job. However, if you’re a retail investor (less sensitive to market volatility) and you want to position yourself for the next 20-30 years and come out on the winning side .. keep reading:

Intro:

We often have a hard time understanding where does all the money go to in crisis. Does it simply disappear or does it change hands? Is it a zero-sum game? In order to answer that we must understand the monetary system in its entirety and how money (debt) is created. I don’t think many people in the world have a full grasp on this. I could give it a try but I don’t know enough to lecture you on that. The point I’ll try to make here is a different one: That wealth (not money) is merely transferred in a crisis, not destroyed.

So let’s first clarify what wealth is:

Most people consider wealth as the money in their bank accounts. That is the case in today’s paradigm. You sell your time by going to work and store your labor in a bank account, for future use. But things change (as they’ve always done in the past). Do you take a shower with money? Do you eat dollar bills? Money in your bank account is only wealth to the extent that people trust it to be worth something. The moment this trust evaporates (as it has many times throughout history) so does your wealth.

So wealth must be something else more tangible: A barrel of oil (which can heat up your house or take you from A to B), a house (provides you shelter) , a farm (feeds you), car (means of transport), ownership of a company (you partially own its output), gold (real money for 5000+ years), education (a skill you can convert into something tangible), freedom (the ability to spend your life doing the things you want), a patent / royalty, water, etc. That is wealth!

2007-2008 Global Financial Crisis

In the last global financial crisis in 2008, a lot of paper and electronic currency disappeared, but the wealth remained. There were still the same barrels of oil, the same gold, the same commodities, the same housing, the same water, the same food at the end of the crisis as there was at the beginning. Prices were simply re-set lower, but the underlying wealth remained. But because we price everything in dollars, we tend to think we lost something when in reality you may have won purchase power. Everything else equal, if your house price dropped 30% but stocks crashed 60%, then you doubled your wealth. If your gold drops 50% but silver drops only 25%, then you halved your wealth.

We’re all too accustomed to look at prices in $ terms. A house costs $200,000, a car $20,000, an ounce of gold $1070, a barrel of oil $35. If you invest for the long-term though … you should think of prices differently: How many barrels of oil can I buy with an ounce of gold? How much bread can I buy if I sell my silver coins? So let’s look at a few ratios and try to gain some insights:

 

Gold / Dow Jones ratio: 

This graph shows the ratio fluctuating very wildly. Just before the 1930’s Great Depression the ratio was 17 and dropped to 2. In the 1960’s was close to 30 and came down to 1 (as gold peaked at $850). At the peak of the tech bubble, the ratio hit 43!! (but surprisingly didn’t drop that much when the tech bubble burst) and now stands at 16. Where’s the next move likely to take us? The honest answer is “I have no idea”. However in the long term (next 10-20 years) you know history is likely to repeat itself, meaning dropping <5, or maybe even parity, meaning either the Dow drops to $1100 as gold stays at $1100 .. or Gold increases to match the Dow’s value (at whatever value it may be). That means that at the end of the cycle, those holding gold will increase their wealth 16x versus those sitting on stocks. Can this ratio reach 20 or 30 in the next 6-12 months? Sure it can, in which case you’ll be bleeding big time. But again, think long term. In order to get long term gains you must endure short term pain.

 

Gold / Oil ratio:

With the ratio currently around 30 and historical heights, you can infer where its heading next.. DOWN! Gold today is too expensive today relative to oil. And I’m a gold bug so I don’t say this lightly. So either buy oil (or oil related assets such as Shell/BP, ETF on oil, NOK, Saudi Arabia stock index – Tadawul, etc) or short gold or both.

 

Gold / Silver ratio: 

This graph doesn’t fluctuate as wildly as others (as expected since gold and silver are related commodities), but you still see 10x difference between highest and lowest ratio (hit close to 100 in the 40s and 90’s and ~10 in the late 70s). With the ratio now close to 80, you know where the next big move will take us .. and that is DOWN, probably to around 20 area. Meaning either gold drops to $280 (at today’s $14 silver price) or silver increases to $53,5 (at today’s $1070 gold price).

 

Gold / Housing ratio: 

In 1980, when gold hit $850 peak, this ration hit the lowest point, meaning you’d need only 100 ounces of gold to buy an average US house. So either housing was cheap and gold was too expensive. I think the latter. In 2000 the ratio hit 565, meaning house was too expensive or gold too cheap (or both). With the benefit of hindsight, I think housing was cheap but gold was much cheaper. In 2011 gold hit $1900 and housing corrected significantly, hence we reached the bottom ratio of 100. The ideal would have been to sell gold and buy houses in 2011, but I think you’re not too late to take that train. With the ratio now around 200 (average single family home  around $220,000 for gold price around $1100), my take is that you should still sell gold to buy housing as the ratio is likely to go up from here.

 

There are many more ratios you can do to understand the massive wealth transfer that will take place in the years to come. Oil to stocks, housing to oil, oil to silver, among others.. shed some light on how to benefit from the times ahead.  Leave your contact on the comment section or “like” the post and I’ll send the full detailed analysis with exactly what you should buy / sell now so that you can prosper and become wealthier even when the hurricane hits. The hard part is being able to go against the flow and withstand the possible short-term pain. But if you invest for financial freedom, for retirement, for the very long term .. it shouldn’t matter if you’re down 5-10%. It’s actually more likely you’ll lose money in the short-term than winning. These long term trends don’t change overnight, there’s strong fundamental reasons why they are where they are and likely to continue. But I actually prefer when these distortions get more acute because it allows me to double down on my positions and make a disproportionally larger gains in the future. And even if it goes down .. its in $ terms anyway, not in real wealth terms.

You should also think that if a Great Depression 2.0 hits us, then would your $$ be safe in a bank? Probably not, so it may be good idea to start looking at paper fiat currency differently.

 

Conclusion:

If you’re concerned about the upcoming crisis … you should, it’s going to be ugly. 99,9% of us will be worse off (in $ terms). But what matters is not how much you’ll lose in dollar terms, but how your wealth performs against other forms of wealth. That’s why looking at historical graphs comes in handy. History does not always follow the same patterns, but it rhymes very strongly, specially when you look at a 20-50 year time horizons. Life is made of cycles, there’s day and night, summer and winter, recoveries and recessions, high and low prices…

A final note to recognise that this post adds nothing to the world. We’re simply thinking of ways of stealing existing claims on wealth from other people, not creating new wealth. A far more ambitious goal in life should be how to create new wealth to make this world a better place and a life worth living. I will address this in a future post.

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