Despite their recent underperformance, David H. Smith, Senior Analyst with The Morgan Report, remains bullish on precious metals, especially silver and palladium, as the “love trade” heats up and the global economy adds more debt to the system. Smith believes that the secular bull run in precious metals will be reignited later this year and that investors should take advantage of the regular volatility native to silver prices. In this interview with The Gold Report, Smith provides some of the silver and platinum group metals equity names he owns and that could offer significant upside, even from current prices.
The Gold Report: David Morgan, principal of the eponymous The Morgan Report, and Equity and Economic Analyst Chris Marchese recently co-wrote “The Silver Manifesto.” A major theme in the book is the “debt bomb.” Please briefly explain what that is and why investors should be concerned.
David H. Smith: “The Silver Manifesto” was written to inform and appeal to precious metals investors with all levels of experience. A lot of our new subscribers are getting connected with the silver story, but there are others who have been in the trenches for quite a while. David and Chris wanted to make the fundamental case for silver a compelling one. The debt bomb is technically the piling on of derivatives and central-bank-induced debt from ultra-low interest rates and quantitative easing.
We almost had a global economic collapse in 2008, yet the overhang is still there. We also have other information benefitting silver and that’s the “love trade,” which we will talk about later. Your readers are likely well versed in the idea that they have to be prepared for the coming debt bomb by owning some physical precious metals and a few mining stocks. It’s folly for anyone to think that they can wait until the bomb explodes to take action.
TGR: The Federal Reserve and other central banks around the world have done an exceptional job of kicking the can down the road. Why can’t they continue?
DS: At some point the piper has to be paid. In mid-March, some top European officials said that 95% of the euros loaned to Greece would never be repaid. Growing global debt is causing a lot of repercussions in the market. In March, the German central bank issued five-year negative interest rate bonds. People who bought those bonds are going to pay the bank to own them. Who would have thought that was possible? I like “Currency Wars” author James Rickards’ snowflake analogy, where one small event could set off an avalanche and bring down the whole mess before the central banks can react.
TGR: What event could set it off?
DS: It could be Greece leaving the Eurozone and creating a mini-panic, a shooting war in the Ukraine between the U.S. and Russia, or a run caused by a major European or U.S. bank going under. It could come in a lot of forms. We could literally go to bed one night and wake up the next morning looking at a potential global collapse. The question I have is: How many of us would have the courage to buy silver $10 an ounce ($10/oz) higher and gold $200/oz higher on that day, assuming we could find any?
Central banks think they can control bank runs or a credit contraction by pumping money into the system, or through capital controls, but they are playing with fire. As evidence, I would point to an excellent study done by Dr. Antal Fekete a few years ago—not long before the 2008 crisis—where he demonstrated that it was entirely possible to have hyperinflation, with the price of derivatives spinning out of control, and deflation—where money/credit drained from the system so fast that it overwhelms central banking’s ability to cope.
TGR: Do you risk marginalizing yourselves with this apocalyptic narrative?
DS: I don’t think so, because we’re simply saying that the debt that has been created is not going to be paid off. I could see something of a slow-motion implosion where we have degradation over time by inflation, which is basically a tax on savers. We could have a series of devaluations and debt write-offs that would cause people to lose a large percentage of their financial security. It wouldn’t happen over a few days but rather over years.
But even if by some miracle we don’t witness that type of collapse, there is still what Frank Holmes calls the “love trade,” which is happening in a massive way with the purchase of physical gold and silver by people in China, India and other countries. That’s really become a much more potent force than it was even a few years ago and looks set to continue.
TGR: What are some things that every silver investor needs to know about the market?
DS: First, silver is called the restless metal for a reason—it has a much greater volatility than gold. People have to plan for and expect that. Second, it has a stronger correlation to the price of gold than most people realize, as much as 90%, according to work done by Adam Hamilton of Zeal Intelligence. If we see gold moving up while silver is quiet, silver is probably getting ready. Third, whereas gold movement into China and India gets most of the headlines, silver is also being accumulated in massive amounts by these countries. Last year it’s estimated that India bought around 28% of the world’s newly mined silver. And fourth, as David Morgan likes to say, about 80–90% of the potential of the entire bull run can be available to investors during the last 10% of the time it takes to complete the cycle. David has studied this topic in depth. There will be some outsized gains available if people are willing to step up and take calculated risks. I hope to be one of those people.
TGR: You have talked about what you call the Tsunami Return Wave. Would you please explain?
DS: I use the analogy of a tsunami wave to describe what gold and silver did leading up to their 2011 cyclical tops. The initial wave came in, concomitant with the financial destruction in 2008–2009, crested and then withdrew—a process that’s been going on for almost four years. That wave is going to return, only this time it will be due to massive dislocations in the financial system. It’s going to bring back all the unfinished business, causing huge demand for physical gold and silver in both the Fear Trade and the Love Trade, as Frank Holmes calls them.
It will be financially devastating for those who hold only paper assets, but if you have a “gold and silver lifeboat” and can ride the wave, you will have afforded yourself some important protection. Another corollary is that due to the devastation visited upon the mining sector during the past few years, many exploration companies—the new supply generators needed by the majors to replace their production—have simply blown away. As if this was not enough, a number of big projects have been cancelled, a lot of producers have been high-grading just to keep the lights on, thereby rendering much of the low-grade properties unprofitable at anywhere near today’s prices, and new exploration budgets have been sliced to the bone.
At some point, we are going to see an epic collision between the precious metals’ tectonic plates of supply versus demand. This interplay should lead to stellar profits for investors who have positioned themselves ahead of time.
TGR: The silver spot price has hovered around $16/oz for a couple of months. It dipped well below that in December. What are some ways investors can play the volatility in silver?
DS: You could play the silver-gold spread when it’s between 65 and 75 to 1, where one ounce of gold buys 65 or 70 ounces of silver. But I personally prefer adding to positions in mid-cap producers that seem to be underappreciated by the market.
Another tactic could be for high-risk investors to do swing trades, trading leveraged exchange-traded funds (ETFs), like ProShares Ultra Silver ETF (AGQ:NYSE.ARCA) and Credit Suisse AG VolicityShares 3x Long Silver ETN (USLV:NASDAQ). Those vehicles are leveraged to the price of silver so if you’re right they’ll go two to three times as fast as silver on the upside. If you’re wrong, it will go two to three times faster against you. They’re not for the faint-hearted.
TGR: What are some mid-cap silver producers that can generate cash at $16/oz silver?
DS: The more successful mid-cap junior producers have been able to cut back their all-in costs substantially. First Majestic Silver Corp. (FR:TSX; AG:NYSE; FMV:FSE) has reduced its costs to that range. Alexco Resource Corp. (AXU:NYSE.MKT; AXR:TSX), which closed its Bellekeno mine until silver rises above $20/oz, has moved its cost structure way down and could develop its low-cost Flame & Moth asset.
Another one I like is IMPACT Silver Corp. (IPT:TSX.V). I have visited the property and the company is very well run. Just getting back to where it was last year would make it a five-bagger. IMPACT was a $2/share stock, and in 2011 it traded at over $3/share. It’s now around $0.22/share.
Another case that’s underestimated by the market is Endeavour Silver Corp. (EDR:TSX; EXK:NYSE; EJD:FSE). Bradford Cooke and Godfrey Walton are solid managers. I’ve visited the El Cubo mine. It’s a complicated story, but the company has worked out a lot of the operational kinks, and is now planning a big increase in production. If Endeavour continues to find new silver, which is highly probable, things will turn out just fine. Endeavour Silver was one of the leaders during the silver price run up into 2011. It’s a good one to keep an eye on.
TGR: How is First Majestic handling the volatility in silver prices?
DS: It has five mines in Mexico and on a couple of occasions First Majestic management has held back production to sell at higher prices. Endeavour Silver has done this also. The company is flexible on its feet. I believe that First Majestic will be one of the leaders when silver re-establishes its secular uptrend.
TGR: Alexco renegotiated its streaming deal with Silver Wheaton Corp. (SLW:TSX; SLW:NYSE). Your thoughts?
DS: I’ve seen a couple of fairly negative articles about that stream. However, I was in the audience at a recent conference when the Alexco CEO, Clynton Nauman, gave a presentation about Silver Wheaton and the agreement. I spoke with him at length afterward and came away impressed with what the company has done. It has an option on whether to take that renegotiation or not. If it does, it will be protected on the downside but give up some silver price upside. If it doesn’t, it will enable Alexco to handle more risk by doing it alone. It is bringing in several million dollars annually from Alexco Environmental Group, a subsidiary that conducts reclamation work on mining properties. I’m comfortable not only holding my position in Alexco, but adding to it on any price weakness.
TGR: Did Nauman talk about the potential sale of its environmental remediation business?
DS: I would be surprised if Alexco has it for sale. It’s been very profitable and has a long-term contract with the Yukon government to continue cleaning up the zinc residue at Keno Hill, which was left in quite a mess after decades of silver mining by previous operators.
TGR: Silver Wheaton recently raised $800 million ($800M) in a bought-deal financing, which it used to buy 25% of the byproduct gold from Vale S.A.’s (VALE:NYSE) Salobo copper-gold mine in Brazil. What are your thoughts on that deal?
DS: Silver Wheaton added this 25% gold stream with Vale to an initial 25% stream it bought in 2013. Salobo is Brazil’s largest copper mine and is expected to run for 40 years. Chris Marchese recently did an updated and comprehensive fundamental review on Silver Wheaton for subscribers to The Morgan Report. In his view, the Salobo gold stream attributable to Silver Wheaton could double and even triple by early in the next decade. The fundamental analysis for Silver Wheaton is really compelling. It’s an interesting company to watch.
TGR: CIBC World Markets has a target price of $31 for Silver Wheaton. Is that reasonable?
DS: Yes. You’re going to need to see higher silver prices, but given its silver and gold streams I don’t see where that would be unreasonable at all. As recently as early 2013, Silver Wheaton traded around $34/share. Looking at the chart, it’s got a triple top between $27 and $28/share. Once you get above $28/share, I’d say it’s all clear technically for a challenge at the $30 range or better.
TGR: Are there other silver companies you would like to discuss?
DS: Over the past few years I’ve whittled down the companies that didn’t look as if they would bounce back strongly. It’s an art as much as a science. I will say this: Investors should strongly consider overweighting in quality gold and silver streaming and royalty companies. It removes much of the risk. Those companies have binding agreements to stream mined gold and silver at a specified price, regardless of whether there is a mine collapse, geopolitical risk or whatever else with the operators.
TGR: What are some royalty and streaming companies you own?
DS: I am a long-term shareholder of Sandstorm Gold Ltd. (SSL:TSX; SAND:NYSE.MKT). Sandstorm Gold is relatively unknown compared to well-known streamers, like Franco-Nevada Corp. (FNV:TSX; FNV:NYSE). The Sandstorm management team includes people who gave birth to Silver Wheaton, so they are not one-trick ponies.
A relatively new one is Osisko Gold Royalties Ltd. (OR:TSX), which bears watching. It has some compelling streams and royalties. During the near panic in early March, Osisko fell to $12/share and I bought a tranche. It is almost $14.50/share now.
TGR: When we talked with you for your July 2014 interview, you discussed the Precious Metals Four, which included gold, silver, platinum and palladium. At that time you believed platinum group metals (PGMs) would be the frontrunners in a rebound in precious metals prices. Is that still the case?
DS: My premise was that PGMs would lead the rebound whenever we witnessed a secular bull run in gold and silver. Platinum has been a laggard, but I’m happy with how palladium has performed. I felt palladium had the most upside potential in percentage terms. I also stated early on in my writings that at some point the PGM bull, especially platinum, would be compromised by the development of relatively shallow, high-grade PGM deposits in South Africa. That could be anywhere from three to six years out, but once those reach production, that’s going to add a lot of supply to the market. But assuming that Norilsk Nickel (GMKN:RTS; NILSY:NASDAQ; MNOD:LSE) takes as long as 10 years to reinvent itself and develop more palladium deposits in Russia, palladium has the potential to continue being the stronger PGM mover.
TGR: What are some platinum and palladium equities that you’re following?
DS: I have a lot of respect for Ivanhoe Mines Ltd. (IVN:TSX), of which Robert Friedland is the chairman. Ivanhoe is developing the Platreef PGM project in South Africa and that’s the only PGM project there that interests me. I hold shares in Ivanhoe.
I like Wellgreen Platinum Ltd. (WG:TSX; WGPLF:OTCPK), formerly known as Prophecy Platinum, in the Yukon, which I have visited twice. It’s a robust PGM project worthy of attention.
TGR: Wellgreen has released a preliminary economic assessment (PEA) on the Wellgreen project. The initial capital spending requirement for an open-pit operation would be just under $600M. Is that reasonable?
DS: I think so. It depends on how much the majors want to get hold of the deposit. Something that few investors pay attention to and I wish more companies did, is starting production with a smaller operation to get cash flowing and prove to the market that it can be done. There are 175,000 tons of tailings at the Wellgreen project that were left from an earlier operation. Just working these tailings could prove interesting. There’s a lot to be said if you can get underway with a smaller operation and then expand. Pretium Resources Inc. (PVG:TSX; PVG:NYSE), for example, is looking at starting with a smaller operation, a good tactical move for any company that requires a big-dollar capital expenditure check to get started.
TGR: Please give our readers one foolproof prediction for precious metals in 2015.
DS: Foolproof predictions are hard to come by, but here’s what I believe: This year will mark the absolute end of the precious metals’ cyclical bear market that began in May 2011, enabling the re-ignition of the long-term secular bull market in gold and silver. It’s highly probable that the lows in mining stocks as a whole are now in. Even if they’re not, I believe that by September it will be apparent that we’re ready to start the moving-up phase of a multiple-year bull run.
The Plan B scenario would be a new primary low to be established by late June, with a higher low in late August. I base this analysis on what Reg Ogden wrote in “The Ultimate Gold Stock Trader.” He said that on an annual basis, mining stocks tend to put in a secondary, higher bottom right around Aug. 23. If we hit new lows, it’s going to flush out the last of the diehards and then turn around. Times like this remind me of what Goldcorp Inc. (G:TSX; GG:NYSE) Chairman Ian Telfer once said: “I’m more of an opportunist than a prognosticator.” If you can “Shut out the doubt”—a famous Clint Eastwood saying—and take calculated risks, even if you have a position that is underwater, over time I believe that you’re going to be glad you did.
TGR: Thank you for your insights today, David.
Courtesy: Brian Sylvester of The Gold Report
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