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For several years now, gold has played an increasingly important role in the international financial system. To better understand this dynamic and its implications, we turned to macro strategist Otavio (Tavi) Costa. As a key figure at the asset management firm Crescat Capital from 2013, Tavi has developed in-depth expertise in currency cycles and precious metals. His research has been featured in some of the world's most respected financial publications, including Bloomberg, CNN, The Wall Street Journal, and others. Our conversation therefore focused on the main forces driving the gold and silver markets today. We also discussed the risks of a future market correction, the evolution of the US economy and the declining dominance of the world's leading power. At a time when the global financial landscape is changing, his thoughts offer a valuable perspective on the major changes to come...

Julien Chevalier (JC): In your view, what are the main factors driving the outflow of gold capital from Europe to the U.S.?

Otavio Costa (OC): I believe we are approaching what could potentially be a monetary alignment across countries. When examining the current U.S. gold reserves, particularly as a percentage of government debt, they stand at approximately 2%. In contrast, prior to World War II, this measure was around 40%. Clearly, there is a pressing need for the United States to consider becoming a significant buyer of gold, a market in which it has not actively participated despite the international gold acquisition trend observed over the last few decades, and especially in the past decade.

I believe a policy shift toward gold accumulation is imminent. Various indicators support this notion, particularly the surge in Swiss gold exports to the United States. This trend may signal the initial stages of increased interest from retail investors, high-net-worth individuals, and potentially even institutions, who are positioning themselves in anticipation of such changes.

Discussions regarding U.S. gold reserves have persisted for a considerable period and are not new. However, history demonstrates that financial systems undergo significant transformations roughly every fifty years, often marked by sudden and profound shifts. I suspect we are approaching another such inflection point. This underscores the importance of research into the current state of U.S. gold reserves, which are at their lowest levels in ninety years, while international reserves have reached their highest levels in fifty years. Historically, U.S. gold reserves accounted for 53% of global gold holdings; today, that figure has declined to just 20%. The United States has, in effect, opted out of the global gold acquisition trend. However, I believe we may soon witness a reversal of this stance.

JC: Is the gold market experiencing a liquidity crunch? If so, how long do you expect it to last?

TC: Certainly. I believe that gold has always been a subject of strong opinions, particularly regarding its price movements and broader role in the market. However, in recent years, younger investors and those who have entered the market more recently have largely dismissed the significance of gold. The primary driver behind the recent rise in gold prices is the well-documented supply constraints. We are aware that production is tightening, and global gold production has been in decline. Historically, every time production falls, we tend to observe the emergence of a secular bull market for gold - an occurrence that many have also overlooked.

Those who have ignored gold and its importance are now experiencing an accelerated lesson in both market dynamics and financial history. Furthermore, I believe the next significant historical lesson will center around silver, and we may be approaching that moment as well.

Recently, there has been a substantial increase in gold prices. Under such circumstances, it would be entirely natural to see some degree of price retracement. Nevertheless, the long-term thesis remains exceptionally strong. It would be quite surprising if we do not witness a sustained upward trend in the gold market over the next decade, potentially extending to 2035. For now, this remains my opinion. However, as always, market conditions and returns in the coming periods could influence future expectations.

JC: Are mining stocks currently undervalued? With gold prices rising and production costs remaining relatively stable, should we anticipate stronger returns?

TC: Gold miners tend to follow fundamentals, much like any other industry. However, cash flow per share for gold miners has significantly lagged behind the price of gold, which largely explains the underperformance of miners relative to gold itself. More recently, however, a notable shift has occurred. With the price of gold essentially doubling over the past two years, while the cost structure of mining has remained largely stagnant, there is now a significant disconnect in the estimated cash flow per share.

From my analysis, cash flow per share - one of the most reliable metrics for evaluating miners' performance - now indicates a compelling opportunity. Free cash flow, including cash flow per share, is approaching all-time highs. If we examine estimates for this year and the following year, we are on the cusp of reaching record levels. Furthermore, I believe these figures will not remain mere estimates but will be realized, and potentially even exceeded.

However, despite these fundamentals, the prices of gold mining stocks remain approximately 50% below their prior highs. In my opinion, we are on the verge of a significant catch-up in share prices, aligning with fundamental performance. This trend can also be observed in the private market, which has become considerably more active in acquiring mining assets. There has been a noticeable increase in the number of firms expressing interest in purchasing private mining companies. In recent years, the major beneficiaries of this trend have been private mine owners, while public markets have lagged. However, such disparities are typically temporary. Success in the private sector ultimately tends to reflect in public markets as well. The current strength and competitiveness within the private mining sector suggest that a corresponding movement in public markets is inevitable.

JC: When do you expect silver to begin narrowing the gap with gold?

TC: I believe we are very close to witnessing a significant move in silver prices. While I do not possess a crystal ball, we are approaching the end of a quarter, and it would not be surprising to see silver prices rise substantially over the next thirty days or so. Such a movement could result in an all-time high on its quarterly candle, reaching approximately $40 or more. This scenario is entirely plausible. It is important to recall that silver previously reached $50, though its highest quarterly candle was around $40. Given this historical context, it is reasonable to anticipate silver retesting that prior high.

Of course, I could be mistaken, and this development might unfold in the next quarter instead. That would be entirely acceptable. However, my suspicion is that we are on the verge of such a shift, particularly given the recent performance of silver mining stocks. Their recent strength has been, in my view, quite remarkable. Additionally, I believe we are approaching a period where gold derivatives may start performing exceptionally well. Even if gold prices were to decline by $500 per ounce, many mining companies would still be generating significant profits at current levels. Given prevailing valuations, there exists a substantial asymmetry favoring mining companies across the board.

Furthermore, with the gold-to-silver ratio exceeding 90, I find this level not only unsustainable but also indicative of a major investment opportunity. This is particularly relevant as we are not witnessing production increases across key silver-producing countries such as Mexico and Peru. Such constraints could signal an increasingly tight market. Considering current dynamics in the gold market, it is reasonable to expect silver to be the next asset to move significantly, potentially offering investors a renewed understanding of its monetary importance.

JC: In your view, what will be the key drivers of gold and silver over the next year and the following five years? Will central bank purchases continue to be the dominant force, or could other factors play a larger role?

TC: There has been a fundamental shift in the demand drivers for gold in recent years. Previously, demand was largely driven by international central banks and large institutions. However, it is now increasingly influenced by retail investors, particularly in the United States and Western societies, where more capital is entering the space. This trend is evident in the rising inflows into various investment vehicles available in the U.S. and other Western markets.

I see the first phase of this shift as being driven by a loss of confidence in the U.S. Treasury market over the past few years. This has led to a divergence between real interest rates and gold - something that was initially considered unlikely or even impossible. However, investors are beginning to recognize that such correlations can break down in inflationary periods, which I believe is the current environment. Looking ahead, I anticipate that one of the primary drivers for gold over the next few years will be weakness in the U.S. dollar, a trend that has not yet materialized. Instead, we have witnessed an exceptionally strong U.S. dollar, which I do not believe is sustainable for several reasons. One key factor is that the U.S. is currently facing one of the highest interest payment-to-GDP ratios in history, with approximately 5% of the economy's growth required merely to service its debt. As a result, policymakers will likely prioritize reducing yields and interest rates across the entire curve, not just the two-year, ten-year, or thirty-year yields, but all rates.

If one understands currency markets, it becomes clear that relative changes in interest rates play a significant role. Unlike the U.S., other economies do not face the same pressure to adjust their interest rates. For instance, Japan has a higher debt-to-GDP ratio than the U.S., yet it pays less than 1% of GDP in interest payments, primarily due to significantly lower interest rates. In contrast, the U.S. is in a position where policymakers- including both the Federal Reserve and the Treasury Department - must find ways to cap yields and limit the strength of the dollar.

In my view, this policy shift will serve as a catalyst for increased investment in emerging markets and other regions of the global economy that have been overlooked for an extended period. Historically, such an environment has been highly supportive of gold prices, and I believe it will become a key driver of gold’s performance in the years ahead.

JC: What is your outlook on equity markets? Do you believe we are approaching a financial bubble burst?

TC: I believe that the primary driver of growth in the U.S. economy has largely been monetary and fiscal policy aggressiveness. However, we are now approaching the limits of fiscal expansion. The monetary side of this equation ended some time ago, and I believe that this shift in liquidity will have a broad impact on the market. The key question is whether policymakers can sustain current conditions by cutting spending or implementing austerity measures. However, sustaining austerity becomes highly challenging once economic growth begins to contract. At some point, I anticipate a return to fiscal stimulus, along with some degree of yield curve control. While I do not believe this shift is imminent, I do consider it to be a likely scenario in the future.

For now, the prevailing strategy appears to be an attempt to cut spending and observe the consequences. The rationale behind this approach is clear - if spending is not controlled, the U.S. risks experiencing what I would describe as an "emerging market moment," characterized by a severe loss of confidence in both U.S. Treasury securities and the dollar itself. In my view, the U.S. had been on the verge of such a situation for some time, necessitating a shift in policy direction.

Efforts to reduce wasteful spending - excluding defense budget cuts and other politically sensitive expenditures - are being actively discussed. However, it is important to recognize that even inefficient government spending contributes to overall economic liquidity. Therefore, shifting away from such expenditures will inevitably have an impact on markets. Currently, financial markets are not adequately pricing in this risk. Given these factors, I believe we are approaching a significant correction in the broader equity market.

JC: Do you expect U.S. economic growth to significantly outpace that of other economies?

TC: I believe we are now closer to the end of American exceptionalism - at least from a market standpoint - rather than the beginning. However, I distinguish this from political leadership, as these aspects are separate. The United States is finally beginning to acknowledge some of the economic imbalances that have fueled extraordinary returns over the years. These imbalances are now reaching their peak, necessitating corrective measures.

Addressing these challenges requires a shift toward a more populist agenda - not necessarily in the negative sense of the term, but rather in the form of significant structural changes in policy going forward. Therefore, we (the United States) are witnessing discussions about gold revaluation and proposals for the creation of a sovereign wealth fund. The idea of monetizing national assets is now being considered, along with other policy shifts that have not been seriously discussed for decades. In my opinion, these changes are likely to coincide with a shift in the strength of the U.S. dollar. As the dollar declines, we will likely see a corresponding adjustment in the assets that have benefited from past inflows of U.S. capital.

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