David Morgan: In the Grips of a Currency Crisis
Source: Interviewed by Karen Roche, Publisher, The Gold Report 2/26/10
However the evolving global currency crisis ultimately manifests itself, either total deflation and a debt-liquidating depression or a hyperinflationary blow-off, David Morgan of The Morgan Report says "There's none better than gold—and silver is probably just as good—if you're worried about a crisis hedge." In the interim, David tells us in this exclusive Gold Report interview, the time might be right to build cash and watch the markets. He likes the old adage: when in doubt, stay out. But he also likes finding opportunities in undervalued and overlooked resource equities for speculative investments.
The Gold Report: Your investment strategy has long involved finding undervalued or overlooked opportunities. What metals does that umbrella cover these days?
David Morgan: The byline of The Morgan Report is "Money, Metals and Mining" and I approach the market in that fashion and in that order. Mining—that's where you get the greatest leverage. And metals—are the best asset class, particularly the precious metals, during these uncertain times. From the metals-only perspective, I'm a top-down analyst. We determine supply-demand fundamentals, what would cause a price to be higher or lower or stagnant. With the precious metals, we look at some timing cues as well. And then we look for resource opportunities, not just in the precious metals or base metals, but throughout the sector, and we do a fair amount of work in the REE, the rare earth elements side. But overall we look for undervalued situations.
TGR: What looks undervalued these days?
DM: Nickel is probably one that's pretty undervalued, although it looks to be breaking out now. If you study the London Metals Exchange (LME), you'll find pretty good inventory buildup in some of the base metals at this time—high enough to cause some concern on a short- or intermediate-term basis. Unlike wheat, corn, oats, cocoa or sugar, metals don't deteriorate. From an economic point of view, if you can buy any of the metals under or near the cost of production and store them, you'll make money in the long run. You might have to wait longer than you think because markets "can be irrational longer than you can stay solvent." But all that aside, I do see opportunities. If you want me to pick one, I'll pick nickel.
TGR: All the metals or nickel?
DM: All the metals should go higher relative to the U.S. dollar, but I think 2010 will be very back-and-forth. Stress levels are high on both sides—the inflationary pressures for governments trying to print their way out of this mess and the deflationary side of the equation because so many countries are on the edge of default.
TGR: What key economic factors are you watching to decide which side of the fence you'll go to?
DM: The velocity of money. Enough money has been printed to have a hyperinflation in milliseconds, so obviously it's not a function of the size of the money supply. It's a function of the velocity of money or how quickly some of it—we don't know how much—starts moving out of a currency. We've already seen it, with India moving into 200 tons of gold, for example. That's very small relative to the amount of debt out there, but still it's a very strong signal to the markets about the fact that India values gold over U.S. dollars at this time, and believe me, they are not the only nation that thinks this way.
We could come to a situation of the straw that breaks the camel's back, some subtle tipping point that the market may not recognize initially. When the Creditanstalt bank went bankrupt, nobody said, "Oh, my goodness, that's going to take us down and cause a global depression—yet most of us who study such things can point to that as a contributing factor to the Great Depression in the '30s.
You have to think of it in broader terms than inflation or deflation: are we in the grips of a currency crisis? That's when you don't trust the underlying currency. Judging from what we see in the mainstream press, it's pretty evident that other nations are questioning their trust of the U.S. dollar.
In economic situations such as this, history shows that there's a price to be paid by everyone. It's an issue of productive capacity. True wealth isn't money. Real money is a store of value component. To produce wealth, you have to produce something of value to the marketplace. The productive capacity of the United States has been in decline since 1974. The productive capacity of China has increased substantially from that timeframe to the present day. Today the problem is that the means of exchange is not trusted (longer term) on part of the producer—China in this example. That portends some very serious issues ahead.
TGR: Going back to the undervalued or overlooked resources, in this environment where we don't know whether to expect inflation or deflation, what sorts of investment opportunities are presenting themselves?
DM: As far as I'm concerned, there's none better than gold if you're worried about a crisis hedge however it unravels eventually, either total deflation—a debt-liquidating depression or a hyperinflationary blow-off. Silver has done best in periods of high inflation.
People really get hung up on the inflation-deflation debate, but let's face it, in both cases there are so many similarities. High unemployment, declining productive capacity, distrust of government, more government interference, general malaise throughout the economy—a great deal of uncertainty.
I would ask anyone who's worried about this debate to put a silver coin or a gold coin in their right hand and their currency of choice in the left hand and ask themselves, which one has retained purchasing power over time? If you're going to have savings, do you want the kind that has stood the test of time for thousands of years? Or the type of savings that has always failed throughout recorded history? If you're not sure, divide it in half. Keep 50% of your savings in your currency of choice and the other 50% in the precious metals.
TGR: If people have cash ready to invest in equities or precious metals, would you say put all of your cash into precious metals now, and then liquidate as you want to invest in various equities? Or keep cash on hand just for equity opportunities?
DM: You can buy the precious metals themselves at almost any time. That's a different asset class than the mining equities. The mining equities generally follow the stock market to a certain point. Then comes a point—which we haven't reached yet—when the mining equities start to take on a life of their own. In other words, you'll see gold and silver mining equities generally going opposite the general stock market. At this time I think mining equities will follow the stock market down. A week or so ago I posted an article on my website about Harry Dent seeing the stock market debacle starting at the end of February. I would not be real quick to jump into the mining equities right now. But if you're not invested in the physical metal itself, I would definitely buy some. I prefer a dollar-cost-averaging approach to accumulating the precious metals.
And as far as selling the metal to buy equities goes, I would never do that. I'd do the opposite. If I have a big gain on a mining equity—say I made a three, four, five, 10-bagger—I usually turn that in precious metals. I'd rather turn paper into gold than gold into paper.
TGR: You were talking about currency of choice and in this case, gold. A lot of gold investors expect that at some point silver will stop trading as an industrial metal and start trading as a precious metal. A lot of people use the gold-silver ratio as an indicator of how rapidly silver can move up. Do you believe in that ratio and what it portends for silver?
DM: There is a lot made of the silver-gold ratio. Silver probably will reach what I call the classic, or the monetary ratio, which is 16:1. It could even get down to the natural ratio, which at this time is about 10:1, but I don't see it getting to any better ratio than that. Of course, this implies that silver is undervalued relative to gold.
When will silver take on this monetary aspect alone? That's part of what I'm writing for the March issue of The Morgan Report. It's basically looking at the silver market over the next 10 years. We have a 10-year bull market behind us and in my view we have several more years to go.
What happens is at the end of these great bull markets is you get into the euphoric or manic stage and this happens in almost all markets. You've seen it in the technology sector, when people were buying dot-com stocks that had no business plan and no equity, just an idea.
TGR: It was the new economy.
DM: Yes. So that will take place. I think we'll see the biggest run up of all time in gold and silver, especially the equities, a euphoric state of panic buying driven by fear and greed. I'll probably face a lynch mob me when I say "sell," because no one will want to trade physical metal for paper currency and I don't blame them. Anticipating this, I've already planned some techniques to use to preserve our physical metal and still allow us to sell to a strong market, but those are days ahead.
When the panic hits, gold probably will go up to $2,000 and beyond—the average person will wake up thinking, "Oh, I've got to get gold equities; I listened to my friends and I thought they were idiots and now I see the light." Many will turn to silver because it'll still affordable relative to gold.
Significant money will move in to the metals. And because silver is cheaper than gold, a lot of it will go silver, which will cause the ratio to spike relative to gold. You'll see the ratio drop from 60:1 to 50:1 to 40:1 to 35:1 to 20:1, maybe to 16:1 or 10:1 because there'll be more money, relatively speaking, moving into silver than in the past. And since silver is such a small market, any small increase in buying power will send the price far higher.
TGR: The way you explain this, these ratios are really only short term.
DM: It depends on where you start the line. One of my earliest lectures, which I still do from time to time, is about the gold-silver ratio. If you go from the 12th century, it's a 12:1 ratio, which was exactly the natural ratio at that time. In other words, 12 ounces of silver in the ground for every ounce of gold, and that's basically how it was mined up to about the 17th century.
So the market figured out that 12:1 ratio, and it held up for centuries. We got to the monetary ratio when England was having a problem similar to what the world economy is having today, and during the turmoil of a currency crisis Sir Isaac Newton told the Bank of England to go on a gold standard and they did. He said the correct silver to gold ratio in the new monetary regime was 15.5:1—where the market was at that point. This ratio, roughly 16:1, remained static for hundreds of years.
So does it matter? Yes and no. Once silver was demonetized and deemed an industrial metal, there was no longer a tie to silver as money per se and so it was revalued. The important point is if silver is undervalued or not and if you think it is then obviously it represents opportunity.
TGR: The interesting thing when you bring up the histories of ratios is that silver gets consumed and gold doesn't. It's back to the silver as an industrial metal. Silver is also the by-product of mining for other base metals. You're projecting the economies are not growing over the short term. If silver is a by-product of base metals, should silver production decrease and would that have an impact on silver prices?
DM: Yes, it should decrease and it could affect prices short term. The industrial demand on silver was roughly 35% of the total market in 2000. In 2010, industrial demand now is 54% of the market. The industrial demand for silver is not only the largest demand, but it's the fastest-growing. But that's really not totally true because since 2006 you've had a huge increase of commercial buying of silver because its investment demand has increased extremely quickly. Since the advent of the SLV, the silver ETF, and other silver ETFs, there's been a huge amount of money, relatively speaking, moving into the silver market as investment!
So you've got the industrial side. Regardless of mining activity being up or down, industrial demand is always off-taking silver and a lot of that off-take never comes back into the market. Recycling is significant, but it's not total. In some cases, it gets used and it's gone.
So that is an underlying eating away at the above-ground stockpile. When you throw an increased investment demand on top of that, especially in a small market, you can see an explosive situation approaching. Everybody wants to know when it will take place. I've said that the earliest it would take off in that manner is probably 2012 and I may be wrong. Markets do what markets do, but such explosive moves go in phases and we're still somewhat in the skeptical phase.
For example, some of the people who bought gold above $1,000 are skeptical right now. They're not sure it's going to go to $1,200 ever again. I believe it will go far higher, but the longer it wallows between $1,200 and $1,000, the more likely these people are to listen to their friends, neighbors and brokers and say, "Gee, you know, gold isn't a good investment. I've held it for a year and it's gone nowhere. Put me back in the Dow or something." Even worse, if we do break the $1,000 level, which I doubt but it could happen, they'll be very unsure and probably will sell back into the market, causing it to depress in price further for a short time.
TGR: How do you see nickel, which you brought up early on, play out in scenarios you've been talking about?
DM: I believe all commodities are in longer-term trend upward. If you dig into the archives, I made a good call in the early 2000s on the Financial Sense Newshour with Jim Puplava. I said the new era is here. We're going from an era of having things we want to an era of having things that we need. Of course, we need food and shelter and raw materials. Those needs will continue. So do we need nickel in the future? You bet. It's used primarily in stainless steel. If you're going to build any food processing plant—and there are always more mouths to feed—you'll use a great deal of stainless steel. And that's not the only application.
You can play nickel, other metals or any commodity or stock short term if you wish, but I like to take the major trend and stick with it because that's where you could make substantial money. Certainly some traders can do extremely well. But really successful traders are very rare and most people don't have nearly enough discipline, because you have to be willing to take loss after loss after loss after loss. Even if they are small losses, psychologically that's very difficult. Most people are not suited for it. They can't handle the stress that comes with a trading strategy.
TGR: Some people suggest the equities because there's substantially more leverage, thus more upside than with the metals themselves. What's your feeling about equities at this time and are there any equities you're looking at that represent good opportunity?
DM: We put out something in the rare earth elements (REE) area recently and it's a speculation, so it falls in the class of fun money or money you can afford to lose. It's a very hot sector right now. I believe it's fairly safe to invest in, as safe as you can be in a speculation. But overall, right now I think it's a good time to build cash. The next couple of months bear watching. I like the old adage: when in doubt, stay out. There's nothing wrong with staying out of this market right now and if the market tells us something we have techniques for getting in quickly.
TGR: But when you buy, you like the undervalued stocks.
DM: We always like to buy bargains. I like to invest for value. If I find something worth $10 and can buy it on sale for $5, that's when I'm more interested in making the purchase. I have people who bought Silver Standard Resources Inc. (NASDAQ:SSRI) at under $1 and now it's at $17. They're probably not happy if they didn't sell some at $40, although some have. But how can you be unhappy about a 17-bagger over 10 years? On the other hand, if you just came into this sector and bought it at $20 or so a few weeks ago, you're going to be unhappy now that it's sitting at $17.
My timing is more of an intermediate-term basis. I cannot day trade; it just doesn't interest me. But longer term, yes, timing can definitely help you, but you have to really know what you're doing and no one can get it right all the time. So for the average investor a dollar-cost-averaging approach makes the most sense. Technical analysis is a very useful tool, but you can't rely on it 100% and I'll give you a quick example. There is no charting service or no human being that can make a 100% accurate case because you can't chart, for example, where a 9/11 event is going to take place.
My approach is to hold about 75% of the total precious metals stocks through thick and thin. And the other 25% can be traded in and out of the market.
TGR: You suggested that you like to find $10 stocks that are on sale for $5. Do you have any companies that fit those criteria now that you're watching?
DM: Not at this time, at least not at that big a discount, but I just returned from Phoenix where I gave a lecture on the mining cycle. If you look at Minefinders Corporation (TSX:MFL, NYSE.A:MFN) and you look at the mining cycle, we bought that stock at around $1 and sold it at $13 right at the top. That's a classic. It's a good value at this point in time and I believe as things progress, it's undervalued now. Based on my lecture people will have a pretty good idea where this company could go over the next several years. Buying MAG Silver Corp. (TSX:MAG; NYSE:MVG) is discounted by the market right now, but that one could be discounted more.
TGR: What makes these two companies undervalued at this time?
DM: It's their internal rate of return. It's the growth rate of their assets, which are precious metals. People get hung up on the dollar price of the metals. As an example, if you started off in 2000 with 10 ounces of gold and you ended up in 2010 with 50 ounces of gold, by definition you're wealthier because you own more gold. The price variation is very significant to most people, but in the big scheme of things, it is not that important because gold is wealth and you have more of it. In other words your real wealth has increased regardless on a temporary paper price.
It's the same with a mining company. If it has more wealth in the ground or is producing more wealth above ground, that's what you need to focus on. Markets are very psychological and emotional, so what you want to focus upon is the increase of book value per share and you want to see how the company's growing internally. If the market price doesn't reflect the increase in book value on an annual basis—that would be an undervalued situation.
Let me say that I don't want anyone to jump in to either of these companies just because I think they're undervalued. I believe they are, but it doesn't mean that they can't be more undervalued. Still, if you like those, you can take a beginning position. If you want to own a lot of one of those companies (as an example) and don't do technical work or subscribe to a newsletter or whatever, just take a long-term view and dollar-cost-average your purchases. If you have a disciplined rational approach and know it's undervalued now and you buy it, you want it to go lower because you know you're buying value. Instead of being upset about your loss when it goes lower, you say, "Fantastic! I'm not buying that $10 stock for $5. Now I'm able to buy it for $4." And then next month comes along and you can get it for $3. You are ecstatic because you know what you're doing. The problem is some people use this technique in stocks that have no real value, that is a huge mistake and too common by the way.
TGR: Good words to the wise. Are there any other undervalued situations that you can share with us?
DM: Again, I want to keep my integrity and value to my members but longer term, Great Panther Silver Limited (TSX:GPR) is a very strong company with a good return rate. First Majestic Silver Corp. (TSX:FR; OTCQX:FRMSF) is a big growth story. SilverCrest Mines Inc. (TSX.V:SVL) is very near production. Fortuna Silver Mines Inc. (TSX.V:FVI) is another company with good assets in the ground and probably not a very well-known story because they're not very promotional.
So Fortuna, Great Panther, First Majestic, SilverCrest, MAG, Minefinders, and then one that I've come back to. I was first on the Silvermex Resources Ltd. (TSX.V:SMR) story. Silvermex is good. We got in probably at the initiation of the company and then the credit crisis hit and we basically were stopped out of the stock. They're moving toward production. It's probably a higher risk than, say, some of these other companies that are producing metal or will be shortly. I wouldn't consider it particularly undervalued at this point, because we haven't had a long enough history on the company as an up-and-coming producer. And again, all these are speculations in my view, although almost all of them actually mine metal.
TGR: Very good. David, I really appreciate your time. Once again, you've been a wealth of knowledge and insight.
When people ask David Morgan, "What do you do for a living?" he has the good fortune of being able to respond, "I do what I love." A precious metals aficionado armed with degrees in finance and economics as well as engineering, David created (and recently revamped) the silver-investor.com website and originated The Morgan Report, a monthly newsletter that covers—very broadly speaking—money, mining and metals. A dynamic, much-in-demand speaker all over the globe, he considers himself a big-picture macroeconomist whose main job is education—including helping people understand money, the benefits of a sound financial system, and the importance of research and patience in investments. In addition to The Morgan Report, David has written for Kitco's Money, Metals and Mining Review, 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. In addition, he has been on CNBC, Fox Business, and BNN in Canada. Searching "David Morgan Silver" on YouTube yields pages worth of links to some of these (and other) programs he's appeared in.
Want to read more exclusive Gold Report interviews like this? Sign up for our free e-newsletter, and you'll learn when new articles have been published. To see a list of recent interviews with industry analysts and commentators, visit our Expert Insights page.
1) Karen Roche of The Gold Report conducted this interview. She personally and/or her family own none of the companies mentioned in this interview.
2) The following companies mentioned in the interview are sponsors of The Energy Report or The Gold Report: Minefinders Corp., MAG Silver Corp., Great Panther Silver Limited, First Majestic Silver Corp., SilverCrest Mines Inc., Fortuna Silver Mines Inc. and Silvermex Resources Ltd.
3) David Morgan—I personally and/or my family own shares of the following companies mentioned in this interview: MAG Silver, First Majestic, SilverCrest and Silver Standard. I personally and/or my family am paid by the following companies mentioned in this interview: None.
Streetwise – The Gold Report is Copyright © 2010 by Streetwise Inc. All rights are reserved. Streetwise Inc. hereby grants an unrestricted license to use or disseminate this copyrighted material (i) only in whole (and always including this disclaimer), but (ii) never in part.
The GOLD Report does not render general or specific investment advice and does not endorse or recommend the business, products, services or securities of any industry or company mentioned in this report.
From time to time, Streetwise Inc. and its directors, officers, employees or members of their families, as well as persons interviewed for articles on the site, may have a long or short position in securities mentioned and may make purchases and/or sales of those securities in the open market or otherwise.
Streetwise Inc. does not guarantee the accuracy or thoroughness of the information reported.
Streetwise Inc. receives a fee from companies that are listed on the home page in the In This Issue section. Their sponsor pages may be considered advertising for the purposes of 18 U.S.C. 1734.
Participating companies provide the logos used in The Gold Report. These logos are trademarks and are the property of the individual companies.
P.O. Box 1099
Kenwood, CA 95452
Tel.: (707) 282-5593
Fax: (707) 282-5592
Email: [email protected]