Bulls Behaving Badly
Source: David Morgan, The Gold Report (4/18/08)
Riding the sudden ups and downs of the precious metals market without getting thrown can be tricky. David Morgan offers a steady outlook fortified by 30 years of studying market behavior. In this exclusive interview with The Gold Report, Morgan, founder of the Silver-Investor.com and publisher of the Morgan Report, explains when to hang on for the big gains and when to let go.
TGR: Silver just had a nice little pullback. Where do you expect the price of silver to go next?
DM: I expect the price to go higher, but I do look for some backing and filling for some period of time. There are a couple of ways to confirm this. Obviously, the price of gold and silver is up, but more importantly, gold and silver are moving up in all currencies. And it’s been that way for a while.
The main point is that most markets get overbought and oversold during the major trend. The major trend is up and up. Silver especially gets in these mini-parabolic modes—and gold too—where large moves higher happen fast. Then they have to correct or consolidate. No market is straight up or straight down but back and forth. To make a lot of money you need to know the main trend and base investing or trading on that knowledge.
We got in the market early. Actually, I called the bottom—not to the date, but extremely close—back in September 2003. Gold had already been in a bull market for a couple of years –what I call the stealth phase—where you don’t even know that it’s happening unless you're a gold or silver bug. The market is slowly moving up and there’s no news whatsoever about it. The average guy on the street has heard nothing. Once you get past that phase, there is a consolidation phase. Then you get another leg up, and on it goes until the very top.
But the most important thing to point out is how these markets can move both up and down very rapidly which is a normal phenomenon in the commodity sector. Now here's the crux of that statement. Ninety percent of the move usually takes place within the last ten percent of the time. Go back and look at the last bull market in gold and silver and see how gold moved above $300 per ounce and silver once it got over ten. You will find both metals moved much higher very rapidly! That is key. This is not true of just the metals markets, take a look at the way the Dow Jones Industrial Average moved from the bottom around 1980 until it peaked around 2000. Look at a chart and see where the largest percentage of the move occurred. It happened at the very end of the market. This is the mania or blow-off phase!
The same thing happened in the tech sector, and I believe strongly it will also happen in the metals market. The easy money has already been made. My readers were able to buy Silver Standard (TSX: SSO; Nasdaq: SSRI) at C$.65, and today that stock closed at $31. They were able to buy Pan American Silver (NasdaqGS: PAAS) at about a dollar, and today that stock closed at $37. So, if you’re making 3,000%, you’d be pretty happy, but that didn’t happen overnight. It took eight years. So the easy money has been made but, big money will come later if you are prepared for how markets operate. If we get this acceleration move that I’m predicting, then we will see days like we saw these past few weeks where silver went from $17 to $21. Then in about four trading days, it dropped right back to $17. Markets go down faster than they go up. At the end of the cycle we're going to see a move on steroids, meaning we may see silver go from the old NOMINAL high of $50 (I'm picking a number— don't hold me to the number just hold me to the idea) to $120 in a matter of weeks!
TGR: So, where are we now?
DM: Temporarily we may have peaked. Short-term moves are extremely difficult to call. On an intermediate basis, I believe we may move down to hit the 200 day moving average or close to it in both the metals. We'll probably have to get down to where the sentiment in the precious metals markets is dull or negative which could be at the end of this summer. If that happens a lot of the mainstream financial press will be saying that the gold market is dull, the cycle is over, and that if you haven’t gotten out at $1,000 mark in gold and the $21 mark in silver, you’ve missed the boat. That will be a perfect indicator to get back into the market if you’re on the sidelines; to re-deploy your trading account or add to your positions, which is what I do. We use 75% of our money as a core position and never touch it.
Look at history and ask a simple question: What currency has lasted for a very long time? Not one. Then ask how well gold and silver have fared over time. They have endured for more than 5,000 years. Does the price vary? Yes, the paper price of the metal does vary. Are there times not to be invested? Yes. But no matter when you were in precious metals, they never fail. They never drop to zero. They never suffer a credit crisis.
Now ask whether we going into a new deflationary depression where cash is king? Probably not. We may get into a very harsh recession in six to nine months that'll stun those who have never experienced one. But I don’t believe credit markets will fail. I don’t think it’s going to go so far that the paper dollar is the best asset to hold. I think the dollar will strengthen over the next few months relative to the international dollar index. But over the long term, I don’t see how any fiat currency can survive.
TGR: Can we talk about the 200-day moving averages on gold and silver?
DM: The 200-day average for gold is near the $785 level. During these large bull markets—consecutive markets lasting a decade or more—it’s quite normal to touch the 200-day moving average more than once during the entire course of a bull market.
In the last bull market—from the early 1970s to 1980—gold went from the government- fixed price of $35 ounce (it was really $42.22 but I don’t want to get into that) to roughly $200 an ounce. Then it had a major correction to almost $100 an ounce. Any gold bug that bought it at $100 and saw it go up to $200, doubled his money.
However, it pulled back all the way to $100. If you had held it the whole time, you would have felt that maybe you should have sold at $200; maybe there isn’t a bull market, and on and on. The sentiment was very negative. But if you had added to your position or just held on, that market went from the $100 low (it was a bit above that) to the $850 high.
The point is that in major bull markets, buy-and-hold is not a bad philosophy if you can keep the big picture in mind. For those who are not in the market yet, consider this simple question. Given the current economic climate, what investment is better than gold and silver? If you have an answer for that, do it. I don’t think there are any better investments right now. However, I am not advocating to put all your money in the money metals, only a portion.
TGR: Okay. Let's talk about the 200-day moving average for silver.
DM: The 200-day moving average for silver is $14.66 but this varies over time and is moving up over time because we are in a bull market. Silver has a history of being much more volatile than gold. Therefore, it would not surprise me for silver to actually get below the 200-day moving average and then come back up.
Remember that a moving average is just that, a moving average. So, every day that goes by, from today forward, the moving average price will continue to increase. So, we might hit a low of $15.25, and that actually happens to be the 200-day moving average when it is touched. The $14.66 is a snapshot. That’s the moving average as of March 20, 2008. But since we have this big move to $21, we’re going to see the moving average continuing up for quite some time
TGR: That's a good explanation. Now, have the silver stocks lagged behind silver as we've seen in the gold markets where the junior gold stocks have lagged the price of the metal?
DM: Yes. That's a two-part answer. We have always advocated having big money in big stocks, not necessarily the biggest, but mid-tier companies with good growth. Goldcorp Inc. (TSX: G) (NYSE: GG) has been very favorable so has Agnico-Eagle Mines (AEM.TO). Both of those stocks are actually making new highs and have done so for quite some time. But generally speaking, the silver equities have performed very sluggishly in the top-tier sector and extremely poorly in the junior sector.
One reason for that is that there is a great deal of fear in the financial markets right now. Physical gold and physical silver investments are unique because they’re the only money totally outside of the financial system.
TGR: So, you think we have a bit of a choppy correction that could last through the summer?
DM: Yes. There’s so much chaos in the markets behind the scenes that we’re not really privy to, that this four-day correction to $17 could be it. I'm forecasting that yet. What I am saying is that the markets are so volatile and that the metals markets move counter to the general equity market. If another crisis occurs in the next few weeks, for example, you could see gold and silver move right back up, and perhaps the gold and silver equities right along with them.
TGR: Let’s say our readers were going to put a million dollars into silver. Would you have them buy a third of that position today? And wait to buy another third at a lower price, and another third at a price that may be higher?
DM: Absolutely. I think that is the way a professional does it and for the record, we bought silver yesterday. We bought about one third to one fourth of what we want. I don’t know any better than anyone else who's being honest, where the market’s going to go in three days. What I do know is that this is a major bull market until proven otherwise. If we average in over the next six months or so, regardless of the prices, we are likely to have a very good position relative to where it’s going to be in three to five years.
TGR: Typically there are three legs, to a bull market. Correct?
DM: Good question. There are really four different attitudes for the market and three cycles. I will try to explain them in general terms. Looking at the big picture, you’ve got pessimism, skepticism, optimism, and euphoria. Those are the four major attitudes toward the market. I divide them into three cycles: stealth, major participation, and the mania. In the stealth phase you go from the very bottom up to the end of the first leg. Until it’s over, you don’t know how high that is. During that time you can make a great deal of money, but no one is paying attention.
Then, just about the time that some of the public finally wakes up to the sector, it corrects, and you get a long consolidation. To describe this, I have kind of coined the expression, “The market will wear you out or it will scare you out.” So, if you got into gold at $550 near the top of the stealth phase when it was starting to consolidate and it took several months before the next leg up began, it wore out a lot of people. It was like it was going nowhere, back and forth, back and forth. People thought, "David Morgan and these guys don’t know what the heck they’re talking about, and I am getting back into tech stocks or whatever.” They gave up, in other words!
Then, just about at the end of the consolidation period, or correction, it starts up on the next leg. That’s where I think we are. I don’t want to be too specific here, because until we look backwards, we won’t know if this move up to $21 silver and $1000 gold is really part of the second leg or a part of the first leg. We really don’t know yet. I believe it’s probably a part of the second leg up. It is definitely not the euphoria phase, since the general sentiment is skeptical. There are people who were watching silver at $17 who probably wanted to get in but were scared. They didn’t get in, and watched it go to $21, and now it’s back to $17, and they’re saying, “I’m so glad I didn’t get in.” And if it goes down to $15, they will probably never get in this market.
A bull market gets its name for a reason. It will shake as many people off its back as possible all the way up. We’re witnessing one of those shakeouts right now. Those who follow me closely and listen to my radio shows are well aware of that fact. If you’re mentally prepared for it, it's not a big deal.
TGR: It happens in all the markets.
DM: True, but the commodity markets are so volatile because they're so leveraged. I mean the price fixing mechanism is based on the paper contract that’s leveraged, so therefore you’re going to see amplification of the moves up and down.
TGR: Let’s talk about equities now. What would you be buying and would you be doing it in thirds or would you be backing up the truck here?
DM: I'm watching the equities closer than ever because I think we may have seen the worst in the junior mining sector. We could see this correction continue in the metals themselves and yet the junior miners refuse to go down much more. Just to be on the cautious side, I am going to watch for further developments.
TGR: What about for the majors?
DM: The same thing could be true of the majors, but I doubt it because they are held by hedge funds, and they will sell anything. They don’t have a philosophical attachment to the metals that I would have. So, they’re not going to hold them through thick and thin. They’re going to sell them regardless. What I expect through the summer and maybe into early fall is that we might be buying more on the junior side than on the mid-tier to senior side only because they offer the best value.
TGR: Why do you think the worst may be over for the juniors? Some of the money managers I’ve talked to have said, “We’re not buying drills in the ground; we’re not buying moose pasture. We’re buying producers.” Whether it’s silver or gold, if they’re producing now, their year-to-year comparison earnings have got to be great. So, that’s where the money has been going. If you’re a really tiny junior it’s pretty hard to raise money right now. So, with all this going on, why are the juniors going to be up?
DM: I'm not saying they’re going up. I’m saying they may have bottomed and not go further down for the reasons you outlined. There’s pessimism—and this occurs at the start of the market, right? Pessimism, skepticism, optimism, and euphoria—there’s tons of pessimism in the junior market. That’s phase 1. Phase 2 is what happened during the August debacle when everything got clobbered, especially the metals stocks. I said at that time that we’ve probably seen the lows for some of these stocks. It’s actually a healthy correction. As this downturn continues or flattens out, some junior companies are going to fall by the wayside, and the ones that remain are those that the market has determined are the best.
TGR: Let’s go to some stock ideas. What would you buy in this market?
DM: I like to put big money on safe bets. I don’t like to put a lot of money on a long shot. So, what I’ve taught our readership is big money and big solid companies, not necessarily the biggest. Put what you can afford to lose on the juniors. Everyone likes to make a lot of money in the markets. The way to do it in the junior sector is to bet a little to win a lot. You don’t want to bet a lot to win a little. You have to be extremely careful in the junior sector. That's not to say you won't find the best values there; it’s just saying that determining those values is very tough.
My favorite model is a junior silver producer because you have a couple of things going for you. Even if it’s only producing a million ounces a year, it can usually increase production fairly easily. So if it goes to 2 million ounces, you just doubled your production. Effectively you have the price of silver working for you and, in most of my recommendations, you have exploration potential for further upside. Downside risk is limited since they’re producing metal at a profit and they may increase production. The long-term trend is in your favor. They're may be drilling out there in other parts of the property or other properties that you own looking for more or a bigger resource. That model has been very good to us. We have about four companies that fit that model.
For bigger money, I look for opportunities that are solid, safe, and where management has a philosophy similar to mine. Like Franco Nevada Corp. (FNV.TO) that just became available recently. When I started my reports, we had a huge percentage of our portfolio in that stock. Then Newmont Mining Corp. (NEM) took it out and did quite well in the early days. So, our readership made a very tidy profit. Now, it's available again and was offered in the Initial Public Offering at $15.20. The IPO was oversubscribed and has traded up as high as $22 or so. It’s fallen off pretty strongly to about the $19.50.
I believe that anything under $20-$22 a share is a safe buy long term. Franco Nevada is a royalty company. It's gold and oil and has some of the smartest mining brains in the industry. That's one at the senior level that I like a lot.
TGR: So, it’s got the black gold and the yellow gold.
DM: On the silver side, I will discuss three. There's Pan American Silver,whose mission is to become the largest primary silver producer in the world. They have become one of the stalwarts in the industry, and they are mining. That stock in terms of net present value is about $42 a share. Today, it’s around $37 a share. Would I buy it here? Maybe. It could certainly go either way but it’s undervalued and longer term will become a $100 stock.
Silver Standard Resources (SSRI) was one of the first we recommended in the sector; at the time it was under $1.00. I love the company. I love the outlook but the story of collecting silver in the ground that was uneconomic or would be economic has panned out. They are going to start producing. I think they need to—I think the story’s a bit stale. I like the management; I like the philosophy; I like everything about Silver Standard, but I think Pan American represents a more solid value at this point. The last one is Silver Wheaton (SLW.TO), which has a unique model. They contract with base metal miners, and some silver producers, and buy silver at a set price with a set upside and then sell it on the marketplace for whatever the market will bear at the time. All these stocks move, but Silver Wheaton moves up and down a lot, so you want to be a little bit careful with it. That's one I would trade rather than buy and hold. Obviously, if you bought it very early you could hold it and not be in any trouble, but if you’re getting into Silver Wheaton now, you should consider it more as a trading vehicle.
TGR: What about some junior companies, smaller companies that are about to produce? Or do you not look at those?
DM: I do. We write up more than 10 juniors in the report; but give formal recommendations to no more than 10, although we cover many more than that. It is all explained in the document “How to Use the Morgan Report” — which is available to members only! So at times myself or one of our research staff will write up a company that is not on the speculative list. Let me explain that. There may be a company that we love. But if it’s only trading a volume of say 30,000 shares a day, and we recommend it in The Morgan Report, all of a sudden the volume goes to 300,000 shares a day for three or four days in a row, and the stock comes back down, I have basically done my readership a disservice. My own readers have pushed the price of the stock up. Unless someone else recommends it, or they get good drill results or production increases, they may be stuck with a stock that they paid up on and have to hold for quite some time. So it’s almost dangerous to get into some of these stocks that I might like a great deal without having a volume commensurate with what our readership might put into the company.
Another one we recommended one year ago was Samex Mining Corp. (TSX.V:SXG; SMXMF). It went up 85% from our recommended price, and then back below the original recommended price, and now I think it's up 15% or so. That's how these juniors can move. There's a good possibility for Samex to make a major copper discovery, but no one knows. We’ve got to watch the drill results carefully. Samex has good management and a fair amount of cash. I believe they have a much better than average chance of becoming a real situation. But be careful with the juniors.
DM: Here's a uranium stock— Pitchstone Exploration Ltd. (TSX.V: PXP; PEXPF). It's in the Cigar Lake District and has some of the best uranium guys in the business. I love this company and still own it. In fact, I own all of these stocks I've mentioned. Two years ago I recommended it at C$1.28. It's been as high as almost C$4.00. We thought it had gotten overvalued, and advised our readers to lighten up on it. Pitchstone recently hit our stop loss (-15%) and it is a shame, but I teach discipline in investing regardless of all of the hard fought research we conduct.
Fifteen is a pretty tight stop on these juniors, but the reason I do it is because the market knows better than any of us, and to teach self-control while investing. These juniors can move wildly up and down. If you’re speculating—and that's what I believe juniors are for—you should always maintain your capital as much as possible. If something goes awry and a stock falls off 15%, we put a sell on it, even though our primary reason for buying the company may not have changed. In fact Pitchstone is better than ever; the balance sheet is better; the drill results are better; and the assays look good.
TGR: It does work that way sometimes.
DM: I gave you three juniors, and that’s enough because I have no more than 10 on the formal list. Again, we do write up many more than those 10 for the eager beavers or for people willing to dig deeper.
TGR: How about one more question? In your March newsletter, you discuss the ramifications of the mining law changes. Could you comment on that?
DM: The commodities bull cycle is far from over, and it’s the one sector that's going to be very lucrative. For that reason, governments are going to say, “Wow, we need to grab some of this money that's coming out of the ground.” That is the main driver for the mining law changes—and not just for the U.S. It will spill over into other jurisdictions.
TGR: I think we’re seeing that already with governments around the world.
DM: We are and I expect it will continue and probably get worse. So, they’re going to kill the golden goose—maybe not kill it—but certainly stifle it.
TGR: Any final comments?
DM: I would like to suggest that all your readers get on our free email list . We do two letters — a free newsletter and our formal reports (paid service) for serious investors. The Free list allows you to receive news and updates concerning the silver market, the economy, precious metals, and the mining markets. We have even sent company investment information we usually reserve for our paid subscribers!
Also I will be speaking in Las Vegas at the Money Show in May and explaining how U.S. investors can purchase physical gold and silver using their IRA Accounts. Thank you for the opportunity to be of service.