The Evolving Role and Value of Gold in Modern Portfolios (w/ Grant Williams and Simon Mikhailovich)

The Evolving Role and Value of Gold in Modern Portfolios (w/ Grant Williams and Simon Mikhailovich)


Grant Williams: Simon welcome back to Real
Vision. It’s been a while since you and I have had a chance to sit down and talk. I
mean, privately we do it all the time. But I figured it was time to let some other people
in on the conversation. So I really want to do today– we’re going to talk about golf
because that’s what you and I spend so much time talking about. But as we do when we talk
about it, the price– we’re going to put that to one side. Because I think you and I both
agree that that’s, perhaps, one of the least important components of this. And what I want
to do to begin with, if I can, is something that the early viewers of Real Vision gave
heard but, perhaps, some of the later viewers haven’t. And that’s I want to tell your story
of how you came to be in the gold markets, because I think it’s really important the
route you took to get there. So perhaps you could just start off by telling us that story.
Simon Mikhailovich: Sure, thank you. I was born in the Soviet Union. I grew up there.
I lived there until I was 19. At some point, myself and my family came to the conclusion
that system wasn’t going to survive for, unfortunately, many of the reasons that I’m observing here
these days. But when I say the system wasn’t going to survive, I’m not talking about Armageddon.
I’m talking about financial, political, economic system. And so we left, and when we decided
to leave, we got expropriated because– in other words, I came to the West, not with
the proverbial $100 in the suitcase but with the actual $100 in a suitcase. Because it
just so happened that the Soviet government had capital controls in place, and you were
allowed to exchange $100 worth of rubles, precisely that amount. So that’s what it was.
So we came with $100 and a suitcase each and started fresh. Now, for me, it wasn’t as hard
as it was from my parents, but it was sufficiently hard. I went to college. I had to work my
way through college. And then I got a job in an insurance company where I worked for
13 years in the investment side. Grant Williams: I’m I hate to interrupt you, but there’s something
that– amazing it’s never occurred to me to ask you this. It’s just to occured for me,
I want to dig into this. At the time, you were 19 when all this happened. and I remember
my understanding of the broader world as a 19-year-old was basically girls and soccer.
That was basically it. So did your dad ever talk to you about the decision he’d taken?
Had you seen it coming or were you just following you father or did you kind of get a sense
of–? Simon Mikhailovich: Oh no, I came to that decision the same— Grant Williams:
I’m You did? Simon Mikhailovich: Absolutely, because it was all fake news. And so very
early on from the early teens, my parents, my father was always listening to the Voice
of America and the BBC– the Russian service of the BBC and Voice of American, so we got
the alternative news. And then when I was about 13 and we started going to Latvia, a
little town where my grandfather was from. And they were very much removed– very much
more removed from the whole Soviet thing because Latvia was independent until 1940. And so,
this was ’70, so it was only 25, 30 years later. So it is still very much of a different
mindset and there were relatives there that had moved to Israel before. So I started getting
an alternative version of reality pretty early on. And yes, by the time I was 19, I was actually
politically formed and had my own views. So no, I wasn’t just following my family. Grant
Williams: I’m OK, fine. So back to the story. Simon Mikhailovich: Yes, back of this story.
So anyway, so I spent 13 years in the insurance company, and that’s where I learned about
credit, default swaps, and collateralized debt obligations. And in ’98, I got an opportunity
with a gentleman who was a fellow portfolio manager there– credit portfolio manager,
and so was I– started our own business in the CDO space. And so, that’s how we learned
about the technology and what happened to the credit system of the United States or
the west. And how the credit was being provisioned not through the banking system but through
off balance sheet. And the whole scam with the ratings when you essentially recharacterized–
well, I don’t want to use a bad word here but low quality cash flows. –into triple-a
securities, right? And so when that space blew up in 2000– when the credit cycle, the
high yield bonds– we thought that this was over, which of course was already started.
And that’s when, actually, we made our first real money by learning how to invest in distressed
CDOs and understanding how these complicated structures obscured the economic substance
of what was going on. So if you could pierce through that, if you could if you had the
tools to look through that and understand what was going on, I mean, you could really
buy cash flows at cents of the dollar, which is what we did. And of course, we thought
it was all over, but, of course, it wasn’t. Because it came back bigger than ever. And
by the 2006, we started realizing that this was going to be a really bad crisis next one.
Grant Williams:: I’m But it did it come back– between 2000 and 2006, 2007, did it come back
because it had to or did it come back organically? When you was sitting there, was it— Simon
Mikhailovich No, it came back because the rates got dropped— Grant Williams: I’m right,
basically you got the sense that they had to get this thing back on its feet. It wasn’t
organic? Simon Mikhailovich: It was a bailout. It was another bailout. It was a bailout in
the form of– Greenspan dropped rates to 1% and kept them there. That ignited the housing
bubble. And we were looking at these subprime mortgages, and we’re looking at the CDO issuance
hit all time highs again. And yes, high yields didn’t come back into favor but so there were
bank loans CDO. But the same kind of excesses were happening again. And so, by 2006 I personally
started being concerned that the financial system was in trouble. And that if the same
thing like in 2000 happens, I mean, now it’s much bigger– more debt, more leverage, more
everything. It’s really going to be bad. So I started buying gold just as a reserve, just
as a way to hold value outside the financial system. But my first foray into that was–
like with everybody– was guilty GLD. It is a gateway drug. I mean, that’s how i– you
try it, and then you start figuring out what works and what doesn’t. And we started also
raising money to prepare for the crisis to short the buy protection, credit default swap
protection, and so forth. But also at that time, I personally started getting even more
concerned by ’06, ’07. And I used to go frequently to Switzerland and I have clients there. And
so I opened the bank account just like everybody does– perfectly legal and declared, filed
my forms. I started buying physical gold and putting it aside there. And then a crisis
happened of course, and it was very fortunate for us, because we were correctly position.
Although, not everything worked and that taught me a lot of lessons as to using financial
products to hedge financial debacles. Because the relationships in real time between correlations
that you expect would happen don’t necessarily happen. And it also taught me the value of
having things that are not connected. And by 2009, all of a sudden, I get a call from
my banker and just telling me, we’re really sorry, but we can’t have you as a customer
because you’re an American. And the bank has taken a dec– it was one of the largest banks–
has taken a decision to discontinue private banking services to American customers. Grant
Williams: I’m And this was ’09? Simon Mikhailovich: This is the summer— Grant Williams: I’m
So this is pre-FATCA really? Simon Mikhailovich: This is pre-FATCA, but this was when UBS already
got in trouble, as you recall, with yet with hiding American accounts. Now, I’m not hiding
anything. I have a perfectly legal account, filing W-9 forms, whatever. And so, they ask
me to leave. And they ask me to leave and, of course, physical gold, you can’t wire it
back to wherever, so you have to do something with it. And so I showed up in Zurich, it
was the Summer of ’09. And I had a lot of clients who were family offices, and one of
them recommended this relationship to me in the first place. So I went back to him and
the others and I said could you please– I’m in this situation. I don’t need the way out.
I need a solution. And so everybody said it’s not a problem. We’ll call the general partner
of this and the managing partner of that bank. And they all came back and they said they
couldn’t do anything for it because they didn’t realize there was a real problem for an American
to open an account. Grant Williams: I’m And what was driving that problem at the time?
Was it simply fear of another whistleblower type thing that UBS suffered? Or were there
moves being made behind the scenes? Simon Mikhailovich: Well, remember, it was already–
by 2009, the United States has had made– I mean this is started before that. The United
States had made significant inroads into breaking the Swiss Bank Secrecy laws. UBS had been
indicted. My account was at Credit Suisse, which is a global bank. And they have huge
facilities right here in New York City. And they saw what happened across the street,
and they just didn’t want any of it. And, of course, as the other banks saw that, they
just got scared and didn’t want any trouble. It got worse later, but this was early on.
And so, long story short, but for the fact that I had a lot of relationships, and one
of them at the very last minute worked. I pretty much found myself on the street with
a suitcase that I had to move personally to some other place. You know 22-inch rolling
bag– [? bet ?] many people know exactly what that is. The wheels are cracking, and that
really put me in a frame of mind where I said well, A– what is going on with me? I’m a
completely legitimate person. I’m the Sushil money manager. I’ve been in this for 25 years,
completely complying with all laws and regulations have done nothing wrong. Why am I standing
on the street? And I’m standing on the street– you know, my experience leaving the Soviet
Union and understanding what a contingency planning is all about and what it’s like to
show up somewhere with not a penny to your na– $100 to your name and have to start from
scratch. Not that we were wealthy in the Soviet Union, but we had an apartment, a car, a little
country cottage. I mean, we had a little middle class life by those standards which was perfectly
comfortable, and then we had nothing. And so in that frame of mind, I’m thinking so
here I am. I didn’t do anything wrong. I didn’t hurt anybody. I didn’t break any laws. And
here I am put out in the street essentially with no place to go but for the fact that
I knew all these people. And even that, only one of them ended up helping me. So what was
going to happen to me then? Like I said, you can’t wire this gold, you have to do something
with it. And so that’s what put me on the path of thinking, what’s the right way of
doing it? So for a normal, legitimate person who is sophisticated enough, who understands
what’s going on– I mean, where is a framework for doing this? And as I started looking into
the infrastructure that exists in the United States, I realized that because gold has not
been a part of financial investing in operations, there was really no– there’s no infra– there
still isn’t, really, any infrastructure. You go from pawn shop and gold– I mean a coin
shop, a guy with the gun, essentially, in the bulletproof glass, dirty nails. Nothing
wrong, I mean, I’m sure they’re nice people but different type of professional standards
than I’m used to or most professional people are used to. And you go straight into financial
products that are just– that are just that, they’re financial products. But the reason
I wanted to own gold is because I wanted reserves. I wanted something that– and we’ll talk about
it, but I wanted something that was not connected to the financial system. Something that was
something different than everything else of what I owned. And I realized there was no
solution. And the other thing I realized is that it just brought back flooding memories
from the Soviet Union, from my childhood– the issues of trust. And the difference between
institutional trust and personal trust, institutional relationships and personal relationships.
So I had a relationship, I thought, with a premier global bluechip institution. And I
trusted them to take care of my money, in the manner in which I would expect or my clients
have always expected me to take care of their money. But what’s happened in the financial
world over the past 30, 40 years is relationship type of banking or relationship type of transacting
turned into transactional relationship, where “what have you done for me lately”? So yes,
we had a wonderful relationship, until they decided they didn’t want to have a relationship.
And that was that, and that was the end of that. And so I wasn’t transacting. So they
offered me actually an opportunity to transfer into their asset management business where
they didn’t want to keep my gold or money, they wanted me to invest in stocks. They wanted
me to trade those stocks. They wanted to give them a mandate. And they wanted to charge
private banking fees for doing basically Vanguard does in the United States. Grant Williams:
I’m So that was the solution? It was that you can sell your gold– we’ll keep your account
if you sell your gold and invest in the traditional way? Simon Mikhailovich: –into our money
management. We’ll manage your money for you. Grant Williams: I’m So this wasn’t a problem
with having an American as a client? It was having an American holding physical gold in
a vault as a client? Simon Mikhailovich: It was an American having it as a private client
as opposed an American as a money management client with a regular 40% bonds, 60% stocks.
They have in New York, they have a [INAUDIBLE] business. So they wanted me to transfer from
a banking relationship into, basically, being— Grant Williams: I’m Transactional? Simon Mikhailovich:
Yes, transactional stock brokerage relationship. Grant Williams: I’m So we should clarify because
there will be the odd conspiracy theorist out there that’s going to say this is just
a means to push gold out of the system? It’s not that at all. It’s just a case of we don’t
owe any fees if you just have lumps of metal sitting in a safety deposit box. We are minimal
income for— Simon Mikhailovich: Yeah, right, it’s not a valuable relationship. Exactly,
we want to make money. We want to turn the account. And we would be happy to do that,
and it would be SEC regulated and all that. It would be basically New York. And so, well,
what do I need that for? I mean I already have that. I don’t need that. So what I need
is a safe haven or I need a sort of reserve. And so, it wasn’t– and I’ve told you that
before. It’s not like I’m a goldbug or anything. To me— Grant Williams: I’m No, that’s why
these conversations are always fascinating to me because you’re the antithesis of a goldbug.
But you’re not– you and I have talked long into the night about the stuff so many times
I’ve lost count. And it’s never about gold. It’s about— Simon Mikhailovich: It’s a a
tool. It’s like stocks. It’s like bonds. It’s like you own different things, you buy a hedge.
Well, why did you do it? Well, because you’re trying to solve some risk in your portfolio.
You’re trying to insure against some type of event. And so then you go on an exploration
and say, well, how would I do that? And so that’s how I came to gold. I just looked at
the risks, and I said, well, if the risk of financial– if the financial system is exposed
to systemic risk, risk of disruption, how do you deal with that? And so that was my
that was my solution, and it remains the case. I don’t have any ideological views about it.
I just think it’s the tool, and I think the tool is more valuable today than it was six
or seven years ago. But so anyway, so just continuing the story. I looked at all that,
and I said, well, so what is there? So there’s no solution. But I realized with the trust–
the theme of trust that I started– institutional trust is something that—How best to say
it? I guess because in the past 30 or so years, the policies of the central banks has been
to bail out financial institutions. I mean, they’ve only been in the past crisis when
financial system essentially collapsed, only three broker dealers been bankrupt without
being bailed out. And two of them in the context of a crisis and one later– MF Global happened
later. Lehman Brothers and Refco went down in the context of the financial crisis. Even
though they were precipitant and they were important events in terms of psychology and
otherwise, they were not that important in terms of confidence in the system because
there were only so many limited amount of people who got directly impacted. Grant Williams:
I’m – But people would argue that Lehman was so important to the system that it had to
be saved. I mean, that was the argument put forward the time, right? That the whole system
needed saving because Lehman was allowed to go. Simon Mikhailovich: Yes– no, well, that’s
what people say. No, the system collapsed– all of it collapsed. And the reason all of
it collapsed is because all of them– and by “all of them,” I mean all major investment
banks in the United States– had sold these CDOs, these subprime CDOs. And as most– but
they were not completely out to lunch, by the way, in terms of understanding the risks.
They didn’t fully understand the risks, but they didn’t completely not understand the
risks. And they did what insurance companies do when they take on more risk than they think
is prudent– they reinsured. And what did they do? They reinsured it with AIG. They
realized that they could make a lot of money by selling insurance against something that
would never happen. That’s called 0-risk underwriting, 0-loss underwriting. So they were selling,
for fractional pennies, insurance against triple-a tranches which had zero chance of
default. And when those zero chance of default trenches defaulted, of course, AIG did not
have the money to pay the claims, because they did not set up the reserve. They thought
they were just getting free fees for providing this coverage so that the accountants of the
investment banks felt better about the risk that they laid off. Now, the capitalization
of the banking industry at the time– I mean, net capital– was I think in the $400 billion
range, $450 billion range. So if AIG bailout was close to $200 billion, the banks lost
half of the capital. That’s just from that one loss from that one place, never mind all
the other things that they had on their balance sheets that went bad. So I would say the financial
system collapsed in its entirety. And simply, it became clear when Lehman Brothers failed
what the real consequences were about to be of what just happened, and that’s when the
bailouts started. But the point I was trying to make before we got into this is that because
of the bailout starting with Continental Illinois and the SNLs and so forth in the 90s, it’s
become cheap to misplace trust. I mean, it used to be if you misplaced trust financially,
you lost money. You know people misplaced trust with Bernie Madoff, and they lost money.
People misplaced trust with banks and they keep not losing money. And so if you keep
if you can keep making mistakes or making bad decisions, and it costs you nothing, you
keep making bad decisions. And then one day, it cost you everything but that day hasn’t
come yet. And so more broadly, as I started thinking about how does one deal with this
situation, I realized that institutional trust– and this was a perfect example for me as to
what happened to me. I placed trust in the global institution, and when it became inconvenient
for them to have me and to provide me with protection or service that I contracted with
them to provide, they said, “That’s it. Excuse me, goodbye.” And they left me completely
in the lurch. And so that led me down the path of understanding that when you deal with
contingency plans, when you deal with trying to address situations that may come up in
a context of either distress or disruption or some sort of stress in the system, you
have to really think as to who your counterparty is. Not in terms of just failing and stealing
your money or something like that, but the willingness to provide services because if
they’re not committed really to provide services. You’re dealing with employees– and is my
banker was very lovely about it. I mean, she felt very bad. She was a nice, trustworthy
person— Grant Williams: I’m but you’re still out on the street with a suitcase. Simon Mikhailovich:
But there I am on the street with a suitcase regardless, because it wasn’t her place to
provide the service. She was just there. So would you like somebody, your branch manager
in a bank, you have to understand that their ability to help you stops at where their institutional
decision. Because if the institution decides that this is not where they want to do or
they are prohibited from doing it or whatever reason, that’s it. They can’t help you. So
what I realized is whatever it is I would do to solve this problem had to be based on
some kind of relationship with some kind of people as opposed to purely organizations
that were a rational actor and competent actors in their own right. And, of course, there’s
always an element where you can ensure– trust is trust, and it can be broken. But I didn’t
want to be in a situation where it was pre-determined that it would be broken in a certain situation.
As with institutions, it normally is. And so as I started looking around, I realized
that there was no solution. And so I created one, and I don’t want to get into discussing
that because I’m not here to promote it. But conceptually, the issue of trust I think people
need to think very carefully as to who they deal with, and whether they’re dealing with
people of character or they’re dealing with a small private organizations of high standards
of integrity or some history of performing and of doing things correctly as opposed to
some sort of nameless organization or an app on the phone or something like that where
there is no relationship of any kind. Grant Williams: So let’s– I mean, that brings us
nicely back to gold. And so let’s just talk a little bit about what you see the role of
gold in a portfolio, but perhaps more broadly, within the context of someone’s life circumstances.
And again, we’re not here to promote anything this is— Simon Mikhailovich: Sure. Grant
Williams: I’m Because I just find your perspective on this fascinating. Because I talk about
gold a lot. I travel around the world. And wherever I go, the subject kind of comes with
me, and I end up conversations about it. And I’m always surprised how price is the first
thing that people want to talk about. Because to me that’s kind of the last thing you talk
about. The price is going to reflect the conditions at the time, and we won’t get into manipulation
stories and all this kind of stuff. And people think the price is false. The price is always
right, but it can be wrong for short periods within the cycle. So what does gold mean to
you as a tool and as a component of a life or a portfolio. Simon Mikhailovich: Gold is
a couple of things. Again, there’s no magic about it. People imbue it with some sort of
mystique. It’s not a mystique, it’s a lump of metal that is a currency whatever arguments
about it are. In fact, it’s a reserve currency. It is a global officially recognized reserve
currency. It is held in the balance sheet of all major central banks. On average, the
top 50 central banks in the world hold 10% of their reserves in gold. IMF the third or
fourth largest holder of gold reserves. One of the websites– I’m sorry, I don’t remember,
and I should give proper credit to these people because they did good research. They polled–
it was in the last few weeks, they polled central banks and asked them why they held
gold. Some banks said they didn’t want to answer the question. It’s a matter of policy,
but a few did. And those that did, I mean, it was clear. If you reduce everything they
said to a few words, the words that I use now regularly but originate with Tony Deaton
who you’ve interviewed before. And those are three reasons why they hold it, it’s because
of its scarcity, because of its permanence, and because of its independence. And to unpack
that, that means scarcity basically to the extent money can be printed and financial
assets can be replicated, gold is in limited supply. It is difficult to extract. It is
actually getting more difficult to extract and more expensive to extract. All the gold
in the world still exists, but there’s only so much of it. In the context the financial
world, all the gold in the world is worth about $7 trillion dollars or something like
that of which 50% is in jewelry around people’s wrists and about 20 some percent is in the
vaults of central banks, and only 20 some percent is really is available in the investment
world. So its a fair– it’s scarce. And scarcity imbues it with intrinsic value. It’s completely
time tested for 2,500 years. It’s not an accident. There are chemical properties– you’ve done
it in the new documentary, where you went very clearly for the chemical properties of
gold which makes which made it suitable. How it emerged out of all the elements to become
a store of value and a reserve currency if you will. So in the first place its the reserve
currency, there’s no argument about that. Its true. In the second place, it is the only
financial asset. It is the only financial asset that can be effectively stored and transacted
without involving financial intermediaries and capital markets. Grant Williams: Right,
which is a lot more important than people think it is. Simon Mikhailovich: Correct,
its independent. It is no one’s liability. And you can go through an examination, it
is the only– I will say that again. It is the only financial asset that is universally
liquid at presentation on its face and does not require financial intermediaries to store,
transact, move, and deal with. And that’s what makes it– that’s why its a reserve.
Because in the military sense, if you think of your reserves– I mean, what countries
military doesn’t have reserves? They all have reserves, so why do they have reserves? They
have reserves because if they are engaged in a war or in some sort of altercation and
the main forces are found insufficient to prevail, then you need to call on some other
resources. Now, in your normal life, I mean, don’t you have like whatever the milk that
people have in the cupboard— Grant Williams: Yeah, the long life. Simon Mikhailovich: When
they run out of fresh milk. I mean, don’t you have some– I mean, reserves is a concept
Boy Scouts. I mean, that’s what they teach you. You have to have a little matches, your
dry matches, your whatever in case of emergency. So it’s simply that, when you look at the
portfolio, you look at the financial affairs of yours, where is it all? And if anything
happens to the system, financial system, or to the markets or there is a big bear market–
if there are real risks, what are you going to do it? Most people don’t even carry cash.
Grant Williams: But I find this truly fascinating because we’ve ended up in a position where
when you talk to people about this, they will say, well, gold doesn’t earn anything. It’s
just sitting there. I could have it invested in the stock market. I could make a return
on it. But when you talk about reserves, those a reserves are, by definition, not supposed
to be in the stock market and not supposed to make a return on them but that has become
important to people. Now is that because we haven’t seen the kind of conditions under
which gold does its job? Is that why people now think of it in terms of opportunity cost
rather than the reserve value it provides? Simon Mikhailovich: It’s exactly the same
thing with as with trust. It’s cheap to misplace trust. I mean, when a long period of time
precedes, when people are excused from doing stupid things or imprudent things, and it
cost them nothing. They start thinking that maybe that’s the way to do it. And then maybe
there is no punishment for having unprotected relations with other people or whatever. I
mean, you can take this analogy into any scenario. So just because you’re lucky for a while doesn’t
mean you’re going to be lucky forever if you keep doing imprudent things. Grant Williams:
Right, but it takes a certain kind of mindset, which I think goes against the typical way
that human beings think about things. The recency bias that we all suffer from is there.
And so it takes a certain kind of person to think, well, everything has been great for
25 years, but— Simon Mikhailovich: Absolutely, well, this goes into a somewhat different
direction. I mean, here you have to start thinking as to whether what’s going on around
us and whether the economy that we have today and whether the political system that we have
today and whether the banking system that we have today are sustainable in the way that
they are. And we’ve recorded a number of interviews about this issue, and I’ve spoken about it
and I tweet about it, and I believe no. The answer to all of that is no for a completely
objective factual reasons. The interest rates are at 5,000 year lows. OK, they’ve ticked
up a little bit, but they’re still near 5,000 year lows. The asset prices, even though the
markets have wobbled earlier in 2018, are still near 5,000 year highs. And so to assume
that this is the way things will continue forever is pure hubris. I mean, it just is.
History is mean reverting. The biggest lesson of history is that people don’t learn lessons
of history. Most people of our generation will think that Santayana said that. No, it’s
in the Bible. It’s in the Ecclesiastes actually. So it’s five thou– people should think about
this. The last 100 years have essentially seen the entire event– or 90% of the advances
in technology and hard sciences that have happened in the last 5,000 years have happened
in the last say 150 years. But if you want to go and see in terms of the human sciences,
philosophy, when were the breakthroughs made in that? I mean, you go thousands of years
ago. And frankly, and since then, there’s only been incremental advances made in human
knowledge and self-knowledge. So self-knowledge of humans goes back 2,000 some years. So maybe
this software and the hardware that we’re operating right here are not totally in alignment
because humans are the same, nothing has changed. I mean, it’s an Ecclesiastes that says there’s
nothing new under the sun. It’s then they said it. But how did they explain it? It says
in the early in the early chapters of it Ecclesiastes, it says that we don’t remember what happened
to those who have come before us. And those who come after us won’t remember what happened
to us, which is exactly the same thing as people don’t learn from history. So 3,000
years ago, we didn’t learn from history and we’re still not learning from history. So
simply, if you look at history and you realize that history is cyclical, which is why it’s
cyclical because humans repeat the same mistakes over and over and over again. They forget
the same lessons over and over and over again. Then you have to say there is wisdom to be
drawn from the ancients and from the history and even from recent history. Now, I personally
happen to have had that history. I know Americans haven’t had a personal debacle on the scale
like getting expropriated down to your last $100 through no fault of your own, but I went
through that. And I’ve also spent 13 years in the insurance industry, I understand what
insurance is all about. Grant Williams: Now, which was worse, Soviet Union or the insurance
industry? I’m kidding. Simon Mikhailovich: Soviet Union. Grant Williams: This discussion
of history is important because, to your point, a lot of this stuff happened so long ago that
it’s really only the people that go looking for that kind of wisdom are those who will
find it. If you just get your wisdom from what you read the newspapers, what you observe
around you, the people you talk to, you’re going to miss all this. And so, you do get
caught up in that, well, things have been great. I mean, the things we’re talking about
here, the end of a regime let’s call it. In this case, communism in the Soviet Union.
The end of the financial system. These are huge concepts for people to get their heads
around, and they seem so big that the law of large numbers applies. It’s so big I either
don’t want to think about it or it couldn’t possibly happen because they will stop it
happening– whoever “they” are. It’s such a big thing, they’ll never let the financial
system go down. But financial systems go down, not just because of but in spite of the people
that are there to safeguard them. I mean, that’s how it’s always happen throughout history.
Simon Mikhailovich: Everybody knew that the US dollar was exchangeable for $35– $35 was
exchangeable one ounce of gold. Everybody knew that until one Sunday, 1971, Richard
Nixon said, no, that’s not going to happen anymore. Everybody knew that the Soviet Union
was an immutable empire that stood– the empire of darkness that stood opposite the American
empire, right? And for 70 years, everybody knew that until one day it stopped. I mean,
everybody knew the financial system could never collapse. And then in 2008, it sort
of did. So everybody knew the Donald Trump could never be elected president. They knew
it. They knew it on the eve of the election. I mean, do you remember the faces of the commentators.
I mean, they couldn’t believe it. They couldn’t believe it, a lot of people still don’t believe
it. So what do we know today? Well, we know for sure that the banks will always be bailed
out, right? We know that the banking system after 2008 has been strengthened. We know
these things, right? You know what Mark Twain said about it? It ain’t what you don’t know
that gets you it trouble. It’s what you know for sure that just ain’t so. Grant Williams:
Exactly right. Simon Mikhailovich: Right? So all I’m saying is so why do people insure
their houses? Why do people insure their cars? I mean, do you realize that 75– let me just
finish that. Do you realize that 75% of the balance sheet of the American public of net
worth is in financial assets and 25% is in real assets. 75% percent is in financial assets.
There’s no concept of insuring your savings. I mean, there isn’t a concept. So a particularly
people of means, so they have they whatever– a $60,000 a car, and they insure it, and they
pay thousands of dollars for insurance. They could replace the car. They could selfinsure.
I mean, I know by law you have to have some liability insurance. But you don’t need to
insure the car itself, you can take that risk. When was the last time your car was totaled?
I mean, it’s not a big risk. But people just they just write these tickets. And by the
way, at the end of the year, does anybody sit down and say, sweetheart, we just wasted
all this money. Why don’t we cancel insurance? So look at life insurance. I mean, life insurance
I would describe as unpredictable inevitability. That’s what it is. It’s inevitable that it’s
going to happen, we just don’t know when or how, right? So when I look at the financial
system– when I look at the underpinnings of the financial system, of the monetary system
today, I mean, to me, it presents itself is unpredictable inevitability. It’s inevitable
that this has to get reorganized. It’s inevitable that these balance sheets have to be restructured.
But it’s unpredictable as to how and when that’s going to happen. So what do you do?
You have to have insurance. And when you have insurance there are two ways to go about this.
There’s a retail way to go about it which is you get quotes, and then you see the ad
on the TV that says if you called Geico, we’ll save 15% or more. So now, you don’t know what
insurance Geico is selling you. You just know there’s going to be 15% cheaper than something
else. And so you buy the insurance, and then when you have a claim, then you go through
the thick thing. And you try to figure out whether it’s covered. Then you find out it’s
not covered. Now, another way to buy insurance, which is what we’re discussing here with gold,
is the way, let’s say, General Electric buys insurance. They probably have a Department
of hundreds of people. It’s called insurance department because they have industrial plants.
They go they inspect the plants. They determine what risks they’re exposed to. What exactly
can happen. Then they invite insurance companies and they negotiate contracts that specifically
cover what needs to be covered. And, of course, they contract not with the company that tells
them I’ll save you 15%, but they select the company that they have the highest level of
confidence will actually pay when this claim occurs, is good for the money. So there are
different ways to go about this. And so when we’re talking about gold and reserves, I think
that the second way the professional way makes a lot more sense than just saying, well, there’s
this thing. I can just do this. Yeah, everything works when there’s no problem. It’s when there
is a problem, you need these plans to work when something happens not today. Grant Williams:
So why is it you think that so many people think that buying gold is such a difficult
thing to do? It seems to be held up as an extraordinary length to go to. People will
say, well, just buy the GLD and then you’ll get exposure, and there are some very important
differences that people understand between owning GLD for example and owning a bar of
gold in a safety deposit box outside the banking system. So talk about the once you decide
the “OK, I need a gold reserve,” whatever it may be. What’s your thought process and
how you structure that holding? Because that’s everything, right? It’s everything. Simon
Mikhailovich: Oh, we started about this– insurance. I mean, this is what it is– it’s
insurance. So the first question is what are you trying to insure? Before you can determine
what sort of policy you need and what this policy needs to cover, you need to understand
what are the risks you’re trying to ameliorate. So if the risk you’re trying to ameliorate
is– if you’re just trying to hedge your portfolio, meaning if it goes down by 10%, I want something
else that goes up by 20% to offset the decline in 10%. That’s one line of thinking. If you’re
thinking about insurance, the proper insurance, then there are principles. There are certain
principles that have nothing to do with gold or anything else that apply across the board.
Like, for example, systemic risk cannot be insured within the system. So if you go to
your insurance policy– anybody who’s listening to this, go to any insurance policy you have–
any one. Read the fine print. It’s going to say war, riots, insurrection, nuclear threat,
and terrorism are excluded. These are called uninsurable perils. OK, so they’re insurable
perils, they’re uninsurable perils. They are systemic risks because the concept of insurance
is based on collecting a small amount of money from everybody and then paying large sums
of money to few to whom something bad happens. Insurance does not work– that type of insurance
does not work when everybody has a loss. It’s like with lottery, everybody cannot win the
lottery. Because if everybody won the lottery, the only thing they could get back is the
cost of the ticket minus expenses because there’s no money in the fund rate. So the
first principle is you can’t insure systemic risk inside the system. You don’t plug your
backup generator back into the wall socket because it will work perfectly up until the
moment the grid goes down and then so will your generator. So when you talk about GLD
and other instruments, it doesn’t matter how good– we can go into the fine points, but
that really doesn’t matter. As a matter of core principles, it is not an appropriate
vehicle to hedge systemic risk because it is in the system and is exposed to the very
same risks you’re trying to insure. So that’s how you get to physical gold outside the system.
That’s why central banks– I mean, we’re having this discussion. It’s almost like funny because
there is a body of– I mean, look, the United States government– I mean, you don’t need
to go far– do they keep their gold in the banking system? Do they own GLD? No, they
keep it with the military. Now, the New York Fed, for example, holds gold for other countries,
but not to the US. There’s very little US gold in there. Simon Mikhailovich: All the
US gold is at the West Point and— Grant Williams: Fort Knox Simon Mikhailovich: Fort
Knox– that’s right– in a vault, in a private vault— Grant Williams: Guarded by soldiers.
Simon Mikhailovich: That’s right, guarded by soldiers. So it’s not like we’re talking
about it like this is some sort of revelation, but it’s all around. You don’t need to you
don’t need to figure out that. Grant Williams: But is it– see, I think it– this strikes
me because it is a revelation to a lot of people because we’ve become so used to everything
being done within the system because there’s been no need to escape the system for 30,
40, 50 years. And so people have been educated or educate themselves to do everything within
the system, and that means you put your hedges where you shouldn’t put them. You take all
the risks that complacency and a lack of any material disconnection creates. This is self-fulfilling.
Simon Mikhailovich: There is no field of human endeavor– I’ll say that one time. There is
no field of human endeavor in which backup systems are constructed to rely on the primary
system, except in finance. Grant Williams: Except in finance, precisely. Simon Mikhailovich:
Nowhere– I mean, would you want to get on the Boeing aircraft to learn that the backup
steering system will fail if the primary steering system fails? If the left engine goes, the
right shuts off automatically? I mean, does that make any sense? Grant Williams: No, it
doesn’t but why is it then that finance and people’s wealth, their wellbeing has which
is, arguably the most important thing to have. Let’s take health aside, it’s the most important
component of their lives. Why is it that that is the one backup system that people have
a complete blind spot for? Is it because finance is complicated, and it’s been– over the years,
it’s been turned into more of a video game. And nobody does research anymore, the move
to passive investing is become something that it was never intended to be, which is let’s
make this most complicated, most important part of people’s lives as easy as we possibly
can for them. And so there’s nothing to worry about. You just click a mouse, your trade
cost you $5. It’s all easy, don’t worry about it. Everything’s fine. Is that what’s happening?
Simon Mikhailovich: It’s the same thing as with trust. There’s impunity for doing stupid
things because of the policies of central banks because of the bubbles that they’re
inflating. I mean, people have been excused from thinking and from learning because markets
go up. So buy the dip, right? I mean, markets go up. Now, this has been going on for 35
years. So 35 years in a lifetime is a very– well, it’s the bulk of most people’s careers.
I mean, think about this, the high yield bonds. Do you know the high yield bonds have never
existed in a rising interest rate environment? Never. Grant Williams: Yes, of course, they
haven’t. Simon Mikhailovich: Right? The high yield as an asset class emerged in the 1980s,
Michael Milken. It’s had it’s sort of blow ups along the way. But in the end, it paid
to buy the bottom every time because it always recovered and that always kept going up because
the interest rates kept always going down. And the asset prices, you know the financial
math– when rates go up, prices go down. And when rates go down, prices go up. So how would
a financial– how would a high yield manager with 25 years experience, what personal experiences
does he have with a rising interest rate environment and what does that does to the balance sheet
of companies and what that does to the recoveries on defaulted bonds? I mean, there’s no experience.
Jeff Gundlach made a great analogy to that. We were at a conference a few years ago. He
said it’s like ice to summer insects. Rising interest rates with high yield investors,
he said, is like ice the summer insects. They can’t relate. They have no concept of what
it is because how would you know anything about ice if you only live in the summer,
right? So what we’re talking about here goes back to Ecclesiastes. We don’t remember what
happened to people before us, and people that come after us won’t remember what happened
to us. Just because in this narrow window of time that we have– the past 35 years,
which is not narrow for us personally. Grant Williams: No, it’s everything for us, exactly
right. Life. Simon Mikhailovich: Of course, it’s our life, but for history, it’s nothing.
It’s a moment. Grant Williams: But that– I mean, that’s what I want to get into next
because it feels everywhere you look, whether it’s in the markets, whether it’s in the news
cycle, whether it’s societal, whether it’s politics, it feels as though we’re at a point–
I’m not going to say where everything is going to change. But it feels like we’re at a point
where systems be they financial, social, political whatever, this feels like what they looked
like when they begin to change. And I’ve read enough history to recognize certain things.
It doesn’t guarantee that what happened before will play out the same way, but it feels as
though we’re at a point where the entire system could conceivably change. What does that do
to the preconceived ideas about how you earn gold and how should people think about it
if they attach any kind of quantifiable percentage chance of a system change? Simon Mikhailovich:
Well, let’s be specific because we can talk in generalities a lot. But people who are
listening probably want– like, OK, fine. This is all great. What do I do? How to do
this? Well, you have to think very practically. I mean, first of all, this goes back to Boy
Scouts, be prepared. Let me just say this, cyber risk is a huge risk. World War III to
the extent– and I know, this a very loaded term. We’re potentially in the middle of it
already just because we don’t recognize it because the buildings aren’t being blown up
doesn’t mean a war is not underway. A German strategist, von Clausewitz, from 18th century
defined war is continuation of state policy by other means. OK, so in his time it meant
cavalry and burning the crops and whatever. Today, it’s a trade war. We’re in the middle
of a trade war. We’re in the middle of a currency war. We’re in the middle of a cyber war. Whatever
happened with the elections, we’re doing the same thing to a lot of other people. The fact
that the city of Atlanta recently was attacked and all of its data is being held at ransom.
I mean, you cannot as a reasonable person 100% rely on cyber networks being completely
operational and up to snuff at all times. Grant Williams: And now, everybody is ground
zero Facebook is out– that’s the one system people have totally relied on because they’ve
given their information to that. So when that– it sounds asinine, but I’m making a very serious
point that when Facebook turns out to be a danger to people’s privacy ends, that should
be a wake up call that these things are real. Simon Mikhailovich: It is. I don’t know if
it will be a wake up call to the millennials, because they have grown up with this. They
don’t value, necessarily, privacy. But in financial affairs, and I mean, if you– I
mean, think about if you don’t have cash in the pocket. Well, this happened here the hurricane
in what is it? Grant Williams: Sandy. Simon Mikhailovich: 2012, right? Yeah, we were together
in that. I remember, you got kicked out of your hotel. Anyway, so everybody who lived
below– whatever– 34th Street essentially lost– they couldn’t go up the buildings.
They couldn’t get back to their apartment because the elevator didn’t work. If you’re
on the 34th, you can’t get back. Of course, you can’t get money out of the machine. You
couldn’t get gasoline the pumps are below the stations didn’t work. So you have to think–
I’m not talking about Armageddon. You just have to think about how would you operate
in a degraded cyber environment. How would you operate in a degraded financial environment?
How would you operate in a degraded communications environment? Not Armageddon, but infrastructure
sometimes fails. So you have to think about this. So, for example, people think I need
to have gold coins. OK, a gold coin right now is $1,300 some an ounce. So each one ounce
coin is a $1,300 bill today. Where are you going with $1,300 bills to buy your milk and
cookies? Right? Doesn’t make any sense. So right there, for people who think– or for
people who want to have some reserve to pay for expenses, God forbid– and this is a very
extreme situation, not as likely as a financial debacle of which we’ll get to next. How am
I going to– how can I operate? Silver dollars because today silver dollar is what $17, $18,
whatever dollars. OK, it’s a $20 bill. So maybe it will be a $50 bill. It’s manageable.
$1,300 bill which is– the coin could be $5,000 bill. It’s not feasible. So right there, instead
of hoarding gold coins, or you can hoard some gold coins for like bigger purchases, but
for every day, you should have silver. It’s common sense right there. Now, in terms of
wealth preservation and larger amounts of money so say over $100,000 for people who
have that kind of money, you have to think what are the risks and how am I going to use
this if and when the time comes. So for example, one of the answers to those questions that
I referred to earlier– German Central Bank, they actually made some very good points.
They said, well, obviously, it’s for emergency. It could be used as collateral. Gold could
be used as collateral in case of emergency to borrow against, right? And it can also
be sold for different currencies for which purpose it should be stored in different locations.
So they explained why they store gold in different places because it could be mobilized and not
just converted back into their own currency. But if it’s held in other countries, it could
be converted in other currencies. So for an American, for example, if you store gold in
the United States, aside from logistics issues as to how you’re going to be handling it if
you want to store it personally, the only exit through that is through US dollar. Well,
it so happens that the dollar may be problematic. I mean, we may have a currency change and
you may not want to get back into US dollars. You may want to get into a different currency.
Well, you can’t do this inside the United States. So that’s why, for example, the Bundesbank
prepositions, if you will, some of its reserves in different locations. Now, another common
sense, think what intelligence agencies do. I mean, they have safe houses in different
places. Why? Well because when they need to operate in a different terrain, they need
to have resources locally. That’s not the time to be wiring the money from here to there
because you may not be able to do that. It’s also not the time to move gold across borders,
because you may not be able to do that. There are storage facilities in locations that I
think don’t make a lot of sense, because they’re either isolated– their islands or they’re
small. Let’s say Utah. There’s nothing wrong with the state of Utah. But there’s not exactly
a vibrant market for gold bullion in Utah. And so, if you need to monetize that or exchange
it or move it, I mean, it’s very far from everything. So that doesn’t make a lot of
sense. But at the same time, places, let’s say, Switzerland or Singapore or the world
hubs of bullion commerce where there’s a tremendous amount– there’s smelters. There are traders
who are not banks, who are commercial traders. They’re jewel– I mean, there are major jewelry
supply chains. There are places where you can monetize and easily exchange your gold
in the case of emergency. So I’m just giving you the framework of how you think about it.
So you have to think what can happen. And then you have to think when that happens,
what actually am I going to be doing? So what if I have it on an app. Well, OK, I mean,
these people have millions of customers on an app. I mean, are they going to be to help
me in my situation or not? So, yes, today no problem, but what happens when 10%, 100,000
pick up the phone to say my app doesn’t work and I want my gold. Then what happens? Who
is answering 100,000 phone calls? Those are the types of simple things. So what I would
say– and then we’ve talked about this before, you know, your property rights. I mean, of
course, trust is the most important thing. As my lawyer has always told me, I can write
a good contract, but if you deal with the wrong people, all it’s going to give you a
good lawsuit. You don’t want that, because by that time you’ve lost already. So the first
thing to do is you have to invest in due diligence. You have to understand with whom you’re dealing
and are these trustworthy people. Are these people of high integrity? Are these people
of character? And will they be there for you? Or at least, you don’t know whether they physically
can be there for you, but will they do everything that they can to be there for you when the
time comes or are they fair weather friends like the institutions are? You know, they’re
there for you as long as it’s convenient for them and as long as they’re making money.
I mean, look at the business models of people who deal in gold. Most of the business models
are based on transactions. If you don’t transact, you’re not a valuable customer. I mean, think
about that. Grant Williams: This goes back to your story with the bank in Switzerland,
which is the same principles. Simon Mikhailovich: Of course. Look at Facebook– if you’re not
paying for the service, for the product, you are the product. So if, for example, there
are all these cyber platforms that are now rising up with the gold blockchain and gold
connect, and somehow it’s all free. It’s not free. I happen to know that storing gold cost
money, that insuring gold costs money. So if you’re being offered a free service, how
is that working? Who’s paying for it? Well, they’re trying to defray the cost of all that
through the transaction volume. Is that going to work or not? I don’t know. Grant Williams:
Well, this is it. We don’t know, and the technology is changing so fast. And all the changes are
optically at least designed to make things easier and cheaper and better for all of us.
And we’ve kind of got used to that, that every technological innovation makes things better
and easier and cheaper and more seamless. But this is different, right? This is different.
This is not buying fake farm animals. This is not shuffling things. This is that reserve
at the base of your wealth pyramid that you really shouldn’t want it to be easier and
cheaper and more seamless. You want it to be secure and if there’s a cost to that–
it’s almost the– what’s the– I think it’s that Stella Artois beer– “reassuringly expensive.”
Simon Mikhailovich: Yes, reassuringly expensive, that’s right. Grant Williams: There needs
to be a cost for preserving the one thing you can’t afford to lose. Simon Mikhailovich:
Free insurance is worthless. It’s as simple as that. Free insurance is worthless. You
have to pay for the service, you don’t have to pay through the nose. It doesn’t mean that
people need to steal from you or take your money and promise you things. No, but there
are actual real life costs of services. And if you are not paying those costs, then somehow
they’re being hidden into what you’re not getting. I mean, it’s as simple as that. And
again, going back to the Facebook example, if you’re not paying for a product, you’re
the product. You’re the fool. There’s no there’s no other way around it. So in looking for
the solutions I think people need to look for relationships, they need to look for legal
structures that keep them compliant. That’s very important. The US regula– this is for
US listeners. US regulations about FATCA regulations and about reporting precious metals are ambiguous.
They’re purposefully, I think, ambiguous. It says, for example, that you do not have
to report gold held off shore if it’s held directly. It is purposefully not explained
what that means. So it can be interpreted and is interpreted by the people who provide
services that if the gold is in your name, and it’s in the warehouse somewhere that it
is held directly. But reasonable people can have a different interpretation. They can
say directly means if you’re an American who happens to live abroad and you happen to have
gold in your sock drawer, while that’s directly. But if you’ve given it to somebody else to
hold on your behalf, well that’s not directly. That’s through somebody else. And so these
rules will be interpreted sometimes later, and it will be your burden just like with
all the tax– when people use some kind of tax deduction that’s a little ambiguous. In
the accounting world, they say we’re going to take a position. We’re going to take a
position that this is how we interpret the regulations. Well, guess what? If you get
audited, it’s incumbent upon you to prove that your position is correct to the IRS.
The burden is on you. So you have to think about that. So compliance is very important.
Trust is very important. Location is very important. And thinking through who will be
there to provide you the service when the phones at these mega services behemoths are
not ringing. I mean, I’m sorry are ringing off the hook. Is there a physical ability
to service the clients and to be there for the clients. Those are the types of things
that you need to think about. And yes, it’s a reserve that not just can protect you in
terms of your wealth, but it can create multigenerational wealth. Because you know my background is
in distressed investing, and if one thing I learned is that access to liquidity in the
moment when people have no liquidity is priceless. I mean, this is when you buy things for pennies
of their intrinsic worth, precisely because 99% of the people haven’t thought of what
you and I were talking about. 99% of the people never thought of what you and I are talking
about in every situation. So that’s what creates an opportunity. So I see gold not only as
a panic type thing, where the Armageddon. I see it as a strategic liquidity reserve
that can, a– help you survive. But it can also make you much wealthier than you are
by giving options and opportunities when other people have no options and no opportunities
and are forced down the path of selling off what they have just to meet their obligations.
Grant Williams: It’s the perfect way to wrap it up. Simon, you and I’ve talked so much
about this. And it’s never not interesting to me to do it, so I’m glad we gave other
people a chance to sitin and listen. I hope they find it is as insane as I always do.
Thanks, so much. Simon Mikhailovich: Thank you, take care.

7 Comments

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  2. Gold is old school. Yes, it’s a real asset but not where the majority will flow. To many countries buying gold! Silver will be our best exchange and hedge in America during the transition.The new monitory system is going digital and our new currency will be backed with better commodities in clean energy. Bitcoin is a recognized commodity by bakkt where young money will flood. Cash is going away. Wake up!!!

  3. I've watched many of these videos and by far this was my absolute favorite!! Thank you for this fantastic interview!

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