It is widely believed that silver leads gold during bull markets for these metals. I wonder how this belief first arose and persists to this day given that it is contrary to the historical record.

It is partially true that silver outperforms gold during precious-metals bull markets. In particular, it’s true that silver tends to achieve a greater percentage gain than gold from bull-market start to bull-market end. It’s also the case that silver tends to do better during the final year of a cyclical bull market and during the late stages of the intermediate-term rallies that happen within cyclical bull markets. However, the early stages of gold-silver bull markets are characterised by relative strength in gold.

Gold’s leadership in the early stages of bull markets is evidenced by the following long-term chart of the gold/silver ratio. The boxes labeled A, B and C on this chart indicate the first two years of the cyclical precious-metals bull markets of 1971-1974, 1976-1980 and 2001-2011, respectively. Clearly, gold handily outperformed silver during the first two years of each of the last three cyclical precious-metals bull markets that occurred within secular bull markets.

Now, in the same way that all poodles are dogs but not all dogs are poodles, the fact that gold tends to strengthen relative to silver in the early years of a precious-metals bull market doesn’t mean that substantial strength in gold relative to silver is indicative of a precious-metals bull market in its early years. For example, there was relentless strength in gold relative to silver from mid-1983 until early-1991 that took the gold/silver ratio as high as 100, but there was no precious-metals bull market during this period.

Between mid-1983 and early-1991 there was, however, a multi-year period when gold, silver, most other metals and mining stocks offered very profitable trading opportunities on the long side. I’m referring to 1985-1987. We are probably in a similar period today, with the next buying opportunity likely to arrive before the end of this quarter.

The amount of gold mined in a year is only about 1.5% of the total existing stock of gold, which is why changes in gold production have almost no effect on the gold price. It is also why changes in the cost of mining gold do not affect the gold price. In fact, cause and effect works the other way around — the change in the market price of gold determines, with a lag, the average cost of mining gold. To put it another way, the cost of mining gold follows the price of gold.

What happens is that as the gold price rises, mineral deposits or parts of deposits that were previously uneconomic become economic and start being mined. The mining of this lower-grade/higher-cost gold pushes up the average cost of production. And as the gold price falls, lower-grade/higher-cost gold is left in the ground and the average cost of production moves downward. Of course, there are substantial time-lags involved, because it takes years to bring a new mine into production and because mine plans won’t be changed in response to a price trend until the trend has been in progress for long enough to appear sustainable.

Adding to the tendency for the mining cost to follow the price is that after the price has been trending upward for a long period there will be less focus on cost control and more focus on growth, with the opposite being the case after the price has been trending downward for a long period.

Perhaps not surprisingly given that the Bitcoin system was designed to mimic gold in some respects, the relationship between the bitcoin mining cost and the bitcoin price is the same as the relationship between the cost of mining gold and the gold price. That is, the average cost of mining a bitcoin moves up and down with the price. That’s why, several years ago, it was profitable to mine bitcoins when the price was less than $1 and why the average cost of mining a bitcoin has since risen to around US$5,000.

One difference between gold and bitcoin is that the bitcoin mining industry can respond very quickly to changes in price. Whereas it probably will take at least a strong 3-year trend in the gold price to bring about a substantial change in the average cost of mining an ounce of gold, it takes almost no time to put a new bitcoin mining rig into operation and even less time to turn it off.

The way the Bitcoin distributed ledger system is designed, the computational gymnastics that have to be performed to add new blocks to the ‘chain’ and create new bitcoins scale up and down based on the total amount of computing power dedicated to the task. And the amount of computing power dedicated to the task will be dictated by the price. That is, the lower the price the smaller will be the total amount of resource (computing power and electricity) channeled into obtaining the reward of a new bitcoin, thus reducing the difficulty of performing the computations that verify transactions and the associated mining cost.

Therefore, if the price of a bitcoin falls from its current level of around $8,500 to only $100, mining bitcoins will remain a profitable business. It’s just that the quantity of resources being consumed/wasted by the mining process will be a small fraction of what it is today. Alternatively, if the price of a bitcoin skyrockets to $100,000 then the cost of mining bitcoin will also skyrocket, meaning that the quantity of resources being consumed by a process that adds nothing to the general standard of living will be vastly greater than it is today.

Returning to gold, a popular argument is that gold is an inefficient form of money due to the high cost of adding a new ounce to the existing stockpile. However, the relatively high cost of mining an ounce of gold is incurred regardless of whether or not gold is money; it is incurred because humans want to own gold and value it highly.

To further explain, well before gold was used as money, people liked to have it in their possession because of its physical characteristics: its look, feel, weight, malleability and extraordinary resistance to deterioration. In fact, it was the widespread desire to own gold that led to gold becoming money. And now that gold is no longer money (due to government command, not market preference), billions of people still desire it enough to cause the price and the mining cost to be relatively high. Allowing gold to be money again would therefore impose no additional cost.

Bitcoin is obviously different, in that its high price and associated high production cost are due solely to the possibility that it will, at some future time, be widely used as a medium of exchange. I think that the probability of this possibility is close to zero and therefore that the price of a bitcoin will eventually drop to near zero, but at the same time I think that the blockchain idea is brilliant.

The changes to US taxes that were approved late last year have drawn acclaim and criticism, but in most cases both those who view the tax changes positively and those who view the tax changes negatively are missing two important points.

Most criticism of the tax changes boils down to one of three issues. The first is that the tax cuts favour the rich. This is true, but any meaningful tax cut will have to favour the people who pay most of the tax. Furthermore, contrary to the Keynesian belief system a tax cut will bring about the greatest long-term benefit to the overall economy if it favours people who are more likely to save/invest the additional income over people who are more likely to immediately spend the additional income on consumer items.

The second criticism is that corporations, the main beneficiaries of the tax changes, will invest only a minor portion of their additional corporate profit in employment-generating business growth. This criticism is valid as far as it goes, because most large, listed corporations will use the additional income for stock re-purchases and dividend payments, while most small businesses will not be presented with new expansion potential by virtue of receiving a boost to their after-tax profits.

The third area of criticism is that the tax cuts will result in a large increase in the government’s debt, in effect meaning that the government is swapping a promise to steal less money from the private sector in the near future for a promise to steal more money from the private sector in the distant future. Again, this is true.

Those who view the tax changes in a positive light assert that corporate America will respond to the lowered taxes by making large additional investments in growth. Also, some supporters of the tax cuts either invoke the fictitious “Laffer Curve” to argue that the tax cuts will lead to higher government tax revenue and thus pay for themselves or argue that government debt is never repaid and therefore that an increase in government debt doesn’t matter.

While it is certainly true that the US government’s debt will never be repaid it doesn’t follow that an increase in government debt doesn’t matter.

The reason that an increase in government debt always matters, regardless of whether the debt ever gets repaid in full or even in part, is that unless the debt investors have access to a virtual printing press then every additional dollar invested in government debt implies a dollar less invested in the private sector. It must be this way because the dollars that are invested in government debt have to come from somewhere. If they aren’t being created out of nothing by the central bank or a commercial bank* then they must be drawn away from alternative investments. For example, if the recently-implemented US tax cuts resulted in $1T being added to the total US government debt burden over the next 5 years then an effect of the tax cuts over this period would be a $1T reduction in investment in the private sector. This $1T reduction in investment would be offset by whatever additional investment was stimulated by the increased incomes of corporations and high-net-worth individuals, but it would be only a partial offset because the beneficiaries of the tax cuts would invest much less than 100% of their additional income.

In other words, deficit-funded tax cuts result in a net reduction in productive investment. This, not the increase in the government debt per se, is an important point that is being missed by almost everyone.

The other important point that is generally being missed is that the US federal government’s tax revenue is likely to be greater in the 2018 than it was in 2017, leading to a reduced government deficit. There are two reasons for this. First, regardless of whether or not retained corporate profits held outside the US are repatriated, corporate America will have to foot a large repatriation tax bill in 2018. This should either fully or mostly offset any tax benefit collectively received by corporations in 2018. Second, the monetary-inflation-fueled economic boom should continue for another two quarters at least, giving a hefty boost to capital-gains tax payments.

The increase in the government’s tax revenue during the first year of the new tax regime will undoubtedly prompt the fans of the Laffer Curve to give themselves public pats on the back, but it’s likely that 2018’s reduced government deficit will be followed by an explosive rise in the deficit during 2019-2020 as revenues collapse in response to the combination of lower tax rates and an economic recession.

*The outcome would be different if the dollars invested in government debt were created out of nothing. Instead of the increased investment in government debt being ‘funded’ by reduced investment in the private sector (corporate bonds, etc.), the new money would cause price distortions and promote bubble activities. The short-term consequences would be superficially positive, but the long-term consequences would be dire.

A press release from Apple last week generated a lot of excitement about the new investments in the US that will be stimulated by Trump’s tax cuts, but it seems to me that apart from paying $38B of extra tax Apple is not planning to do anything that it wouldn’t have done in the absence of the tax cuts. This is what I gleaned from dissecting the above-linked press release:

1) Apple estimates that the new investment it plans to make over the next 5 years will ‘create’ an additional 20,000 US jobs, but what Apple counts as job creation is hugely different from Apple’s direct employment. Specifically, the company employs 84,000 people in the US but estimates that it is responsible for creating 2 million US jobs. The non-Apple employees involved in developing new iOS apps account for about 80% of this 2 million jobs number.

2) Additional job ‘creation’ of 20K amounts to only a 1% increase, but how much of this 1% increase is related to the tax cuts? As discussed below, possibly none of it.

3) Apple and other US companies with profits held outside the US are required to pay a one-off repatriation tax regardless of whether or not the profits are repatriated. Apple has stated that it will be making a repatriation tax payment of $38B, but has not stated that it will be bringing any of its overseas money back to the US.

4) Regardless of whether or not Apple shifts some of its foreign-held money to the US it is unlikely that this shift will result in additional capital investment in the US. The reason is that at no time over the past several years were Apple’s US investment plans constrained in any way by inadequate access to cheap financing. In other words, there is unlikely to be a significant change in Apple’s US capital investment plans due to the tax changes.

5) The concluding sentence in the above point is supported by the figures contained in last week’s press release from the company. The press release trumpets “350B contribution to the US economy over the next 5 years”, but goes on to mention that in addition to new investments this $350B includes Apple’s current rate of spending. The current rate of spending is $55B/year, which amounts to $275B over 5 years assuming no “inflation”. Allowing for a small amount of “inflation” would bring the amount up to around $300B. The $350B also includes the $38B repatriation tax, so we can quickly account for about $338B of the planned $350B without allowing anything for ‘new’ investments.

Apple is a great company and it will almost certainly invest heavily in the US economy over the next 5 years, but no more heavily than it would have invested in the absence of the “tax reform”.

Kudos to Apple management for creating the false impression, via a cleverly worded press release, that massive new investment would result from the tax changes. Politically, this was a smart move.