David Morgan, whose interest in silver dates to the tender age of 11, returns to The Gold Report today to discuss the latest buzz about his favorite subject. One of the world's leading authorities on silver as a commodity, an investment, a safe haven and an increasingly important manufacturing metal, he expects this year's stronger-than-anticipated late spring climb to lose momentum before the end of the month. Longer term, though, the founder of the respected monthly, The Morgan Report, sees silver appreciating at a faster pace than gold. And while he also likes the idea of monetizing silver—rather than gold, because silver is far more liquid—that's one wish he does not expect to see granted.
The Gold Report: Last month saw the biggest single gain in silver since the 1980s. Why did this happen when it did? And what should we expect in the months to come?
David Morgan: I don't know if anyone can really answer why it happened in May. This sounds trite, but it's true: Any market, commodity or stock, is based on buying or selling pressure. A lot of buying pressure in silver from all angles—the exchange traded funds, the mining equities, and the physical market itself—combined to really push the market higher.
Normally you see good seasonality in precious metals, with peaks sometime in the first quarter every year. We've seen the May peak a couple of times before, the big peak in 2008 also came in May. Here we are again actually in early June and we're still near a peak. I do believe, unfortunately, that we will see the top of this on an intermediate-term basis.
TGR: And what will happen then?
DM: Loss of momentum. I've been following this market for more than 30 years and I'm good at making calls. It has a very historic parabolic pattern, silver especially. Basically, like anything, it loses momentum. If you throw a baseball up into the air, it reaches its apex. As it's getting to its peak, it's starting to run out of energy. It's the same in the stock market. You starting to run out of energy and that energy is new buyers. So I think we're getting to that point. Also, it's very obvious if you look at the charts. As far as everything I know so far, it appears as if we're going to hit a peak fairly soon.
There could always be surprises, especially on the silver side. Silver is such a small market that anything can happen. It wouldn't take much buying to continue to accelerate silver to the upside. As an example, when Warren Buffett bought silver, the silver market went from under $5 to $8 very, very rapidly. Everybody wondered what was going on. It was only after the fact, once Buffett announced that he'd bought 129.7 million ounces of silver, that we learned the reason for that rapid rise.
So, certainly, some large buyer could be waiting in the wings to come into the silver market. That kind of new buying could take silver to $20 or $25, who knows? It depends on how much buying is available; how much is done would determine where the price rests. Barring an event of that nature, I think we're near a top—temporarily.
Longer term, I believe we're going to see silver again outpace gold as it has done this year. And I don't see the top of this market coming until probably 2011 to 2012, and perhaps longer than that.
TGR: When you say 'this market,' are you referring to precious metals as a kind of hedge against inflation? Or do you mean silver specifically?
DM: The precious metals move together, generally. When they peaked in January of 1980, they basically peaked nearly the same day. Whether that'll happen the next time around, I don't know, but I think they'll peak probably within the same month or so.
There are arguments on both sides. People such as Jim Sinclair state that gold is going to make a huge rally and it's really not going to pull back but will stay at a very high level. Certainly that could be the case if gold were remonetized (at a high price) at some point.
I don't think silver will ever be remonetized, though I would like to see that happen. My friend in Mexico, Hugo Salinas Price, proposed putting silver into circulation alongside the Mexican peso. It was an extremely favorable idea to not only the governors of all the states of Mexico, but additionally to almost all the legislature and something like 90% of the people. However, the banking establishment has a lot of clout in Mexico, and right now the proposal has been shot down.
TGR: Assuming that precious metals investors should use different strategies for silver versus gold, could you highlight the difference?
DM: There's a widely held perception that gold is much, much different than silver. Gold-centric people have the philosophy that gold is the only monetary asset available and it's the only safe-haven asset. But the actual objective truth is that silver has about an 85% correlation with the price of gold. It doesn't move exactly as gold moves, but it does most of the time. So regardless of what guru or what gold expert you listen to, you have to stay grounded and realize that silver and gold pretty much march to the same drummer.
Of course, silver is a smaller market, so its moves are greater percentage-wise than gold's. It's like a NASDAQ stock versus a Dow stock. I think that's a good analogy. Gold is like the Dow stock; more of a sure thing. It trudges along as long as you're in a bull market and you're pretty safe buying it. Silver is more like a NASDAQ stock. It has bigger moves up and down, but chances for extreme gains are much greater than with the Dow stock.
In my opinion, metals portfolios should have both gold and silver. The advantage of silver is actually liquidity. Although more gold than silver is available in investment form, silver has a much lower price, which makes it far more liquid. Gold is not nearly as liquid. It's pretty hard to buy groceries or gasoline with a gold coin in circulation when it has a value of $1,000.
TGR: In January the ratio of silver to gold was on the wider end than usual, so many people who follow silver were expecting a good run up to return to a more traditional ratio. What is that ratio and where are we today?
DM: This ratio question is very controversial. I've probably become more of an adherent to the ratio than many others. If we go back in history and look at the background, and for 4,500 years we charted this out and every century measured one foot long, the chart for 4,500 years would be about 45 feet. And for every foot of that chart, you'd have a gold/silver ratio below 16:1 except for the last 19 inches of that chart. So, let that sink in for a moment please!
If you can picture that in your mind, the chart measures 45 feet from left to right and the ratio is 16:1 or less for every foot except for the last 19 inches, you're visualizing monetary history. (This information courtesy of Franklin Sanders of The Money Changer.)
For many, many hundreds of years, the ratio was 12:1, which is what I call the natural ratio. The natural ratio is how it came out of the ground relative to gold for all of those centuries. No one had a mandate for a 'correct' ratio. The marketplace determined the ratio based on what came out of the ground. Today the ratio favors silver from the aspect now that the natural ratio is now 8:1, which means that in the earth's surface, there's roughly eight ounces of silver available for every ounce of gold that's available.
Silver usually disperses itself nearer the surface and a lot of that easy-to-get-to silver has already been mined out of the earth's surface. During one of the periods that the metals were "officially" monetized, Sir Isaac Newton established the ratio of silver to gold at 15.5:1. That's what I call the monetary or the classic ratio, which held up until about 1873. The Crime of 1873 (the Coinage Act of 1873) basically demonetized silver. At that time, the ratio started to take off and it's been as high as 100:1 a couple of times in recent history.
Because silver is becoming scarcer and its uses continue to increase and investment awareness grows, I believe that the ratio will favor silver over the longer term. When I said that the silver market bottomed in September of 2003, I was very accurate with that call. The ratio was roughly 80:1 then. Today it stands at about 60:1. It's been as low as about 50:1 during this bull market. At the top of the market, we may see the classic ratio reestablished.
The classic or monetary ratio, as I call it, was reestablished very briefly in 1980, when silver peaked. The ratio got to around the16:1 level at that time. I think we could reasonably see 30:1, which would mean that silver would outperform gold 2:1 from here on out. However, to be consistent I have stated that in a buying panic we might even see a 10:1 ratio. I want to keep my creditability, before we get that type of ratio we need to see 50:1, then 40:1 and so on; in other words, let us watch the market before we make too wild a forecast.
TGR: How does paying attention to the ratio benefit the investor?
DM: There are lots of ways to look at the ratio. It's just numbers. Everything I've said to this point is pretty much history, so does it mean anything? I think it does. Whether you put a lot of faith in the ratio is an individual choice. What does a ratio do to your advantage?
From my perspective, it's a huge advantage. These metals trade within a wide channel, and I do physical trading between gold and silver. When silver is dear, we sell it; when it isn't, we buy it back. So you can actually trade this ratio back and forth and make money by just driving down to your coin dealer or mailing your metal in to your favorite coin dealer.
In summary, there are advantages to this ratio if you pay attention and know what you're doing. I like it. And I like the wide swings because, as I said, you can take advantage of them. You can end up with a much bigger position in the metals just by swapping silver and gold back and forth.
TGR: How do you know when silver becomes more dear or less dear if it trades in a much wider band?
DM: There are several ways and, of course, it's an art—not a science. One is by using technical analysis. A second one is looking at sentiment. Not very many articles were favorable to silver a couple of months ago; now tons of articles are talking about silver. I'm reading articles by people I've never heard of, and that's fine. I always encourage new people to come into the market. I'm a big free-market guy. In fact, I've said many times and will state it again—the "free-est" market of all is the free market of ideas. Everybody who wants to should have a voice on whatever subject they want.
TGR: You've been kind enough to write a series of articles on basic silver investing, which we're going to feature in The Gold Report in our Guide to Silver Investing every week. Would you like to share any thoughts about this series for our readers to whet their appetites?
DM: I would. We're on the verge of the next big move up in the metals. Whether that happens this summer or next spring, I don't know, but I know it's going to take place. A lot of people will be entering this market for the first time.
As you know, gold gets a lot of free publicity. It's become almost mainstream. You hear it on Wall Street, you hear it on CNN, CNBC, some of the financial channels. But silver is hardly ever mentioned. So I thought it was a good public service to write kind of the primer on the silver market, on how you establish an investment position in silver, why it's an important part of a precious metals portfolio.
I was happy to do it, I'm glad you asked me to—I think it's going to be beneficial to some people out there who are at least curious enough to investigate the silver investment realm.
TGR: With all of the publicity focused on gold, the metal itself, a lot of the gold mining companies, particularly the seniors, also have enjoyed a lot of media attention and have seen a really great run up in stock prices. What's been happening with the silver producers?
DM: Silver mining companies have gone up equal to the gold mining companies, better in most cases. You don't see a lot of that in the news, but I study as much as I can on both sides—gold and silver—but I devote more time to silver. There's been quite a bit of coverage lately—not in the mainstream but on the Internet—regarding silver and silver stocks. A lot of these stocks have done quite well, as you would expect. Silver's had its best month (May 2009) in 22 years, so, obviously, somebody's going to notice that. A lot of latecomers, so to speak, are jumping on the silver bandwagon right now.
If silver does its usual, which is to disappoint right at the top, you probably won't hear from some of these people again for a while. The markets get overbought on the way up and they get oversold on the way down. But generally speaking, you've got to look at the major trend and the major trend is still up for both of these metals.
Because of that fact, if you align yourself with a major trend, you're going to come out quite well in the long run. The problem with today's investors is that most of them are failed speculators. They want everything to go their way for a week or a month or two and then trade out. Certainly, you can make more money trading than you can in any other way, but it's extremely difficult. That's why I advocate keeping a core position on about 75% and trade with 25%. That way, if anybody mis-times the market and you know you're in a major bull market, you're still going to come out way, way, way ahead.
TGR: In that core position of 75%, do you have a certain percentage in seniors versus juniors?
DM: I do, but not really in percentages. Very much of the big money goes into the major companies that have huge potential. A lot of times I actually write options against my position, as I'm doing now. I think that we are at an intermediate top. These stocks have gone up substantially. I can rent my stock for about a 17% yield for maybe an eight-month write. And if the market comes back, as I expect it will, somebody has rented my stock from me and the premium comes out of that. I keep the option premium, and I also keep my stock.
I use that option premium as my fun money. I take that money and put it into some of my favorite juniors. But I advocate small money for smaller companies that are highly speculative. You really want to bet money you can afford to lose. In other words, if you put a lot of money in a junior and it's going to ruin your life if it fails, you're doing the wrong thing.
If you want big money, serious money goes into serious companies. Fun money goes into fun companies. That's the way I approach it.
TGR: Mines Management Inc. (TSX:MGT) (NYSE.A:MGN) probably would be characterized as being in the advanced exploration stage. What's the story there? Is that a place for some fun money?
DM: Full disclosure, I own Mines Management. I was the first one to write it up back in the early 2000s. It's a company that I've gone back and forth on. It has a project called the Montanore in northwestern Montana. Historically Montana was notoriously unfavorable to mining, but that's the past. Montana has become much more favorable to mining. I believe that with about 150-plus million ounces of silver and well over a billion pounds of copper that Montanore will become a mine.
They have continued to work on the project, but it's going to take some time. The Environmental Impact Statement public review period just ended. Whether it gets approved on the first round or not doesn't necessarily mean it won't be approved ultimately. The price of silver and capital requirements for development are other factors that may affect the timeline. Although the company has fairly strong cash and line-of-credit balances, they may opt to curtail development activities to conserve cash until conditions improve.
In any event, Mines Management is a rather conservative speculation. It doesn't trade a lot of volume. We basically recommended the stock around the $1 level and recommended taking profits around $8. As the stock came down, I continued to watch it and we reentered around the $2.60 level.
TGR: What do you expect for the final phase or leg of the precious metals market?
DM: I think what we just saw into early June is a pretty good precursor to it, meaning that these metals keep going up in price; they can't go any higher and yet they do continue to move up. In the final leg some of your gurus like me might be saying they've peaked and they continue to go up. At that point, people start getting greedy and think it can continue forever. This is known as a blow-off top but sooner or later the bubble does burst.
It's just like what happens in all markets. It happened in the housing market, it happened during the technology boom. People were buying stocks there that were cheap at the top because they were cheap and these companies had absolutely no merit whatsoever. You'll see the same thing happen in the gold and silver sector, especially with the mining stocks in my view. The problem this time is selling gold or silver (the actual metal) might not be wise this time and I will address my readers at the time on strategies I have already developed to keep them profitable and safe at the same time.
TGR: When silver is frothy and there's some summer slump, many times you'll see a pullback in exploration. Minefinders Corporation (NYSE.A:MFN) (TSX:MFL) and Kootenay Gold Inc. (TSX.V:KTN), for instance, seem to be relying a lot on exploration. Could they weather a longer-term slump in the silver price?
DM: Well I consider Minefinders well past the exploration phase; in fact, if you understand the "discovery" cycle, Minefinders has a chart pattern that is almost textbook perfect. This is one we got in and out of when the "overvaluation" hit during the initial discovery. Regardless, you have to ask yourself two simple but fundamental questions: 1) How much money do they have in the treasury?; and 2) What is their burn rate? You really have to look at that and find out whether your favorite exploration company can weather another year or so of downtrend. I doubt it's going to take that long, but it may be two years. In any case, at the end of that time, you still want to have a fair amount of cash to proceed onward, because without cash you can't continue a drill program. So you have to ask the right questions.
There are, undoubtedly, some very good exploration companies out there that are out of cash and basically unable to raise any more. The really, really good ones will be cherry-picked by companies that maybe don't have as good a project but do have the cash to buy them up and thus make a better combined company for their shareholders. If I were on the board on any mining company, that would be my recommendation—use cash wisely to strengthen shareholder value.
You have to be very careful, I think. The heyday of easy money in the mining sector is over. You can't just blindly buy any company that has gold or silver in its name and expect to make 500% anymore. You have to be much more careful about where you place your money from here on out.
I do need to give a caveat, though.
TGR: What's that?
DM: When the public rushes into the market, you will see any company that has gold or silver in its name start to move. But it's a very, very short period of time before it peaks—similar to what happened to the technology boom. At the end, the public was buying some really ridiculous companies because they were technology stocks, but not for any other reason.
DISCLOSURE: David Morgan
I personally and/or my family own the following companies mentioned in this interview: Mines Management.
I personally and/or my family am paid by the following companies mentioned in this interview: None.
A precious metals aficionado armed with degrees in finance and economics, as well as engineering, David Morgan founded the silver-investor.com website and The Morgan Report, a monthly that covers economic news, overall financial health of the global economy, currency problems ahead and reasons for investing in precious metals. In addition to The Morgan Report, David writes Kitco's weekly Money, Metals and Mining Review. His articles have appeared in The Herald Tribune, Futures Magazine, The Gold Newsletter, Resource Consultants, Resource World, Investment Rarities, The Idaho Observer, Barron's, The Wall Street Journal and (of course) The Gold Report.
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