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.