Precious Metals Supply Pipeline “Getting Harder And Harder To Fill”

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Mike Gleason: It is my privilege now to welcome back David Smith, senior analyst at The Morgan Report and regular contributor to MoneyMetals.com. David, thanks for joining us again and, how are you?

David Smith: I'm just fine, Mike. It's great to be back.

Mike Gleason: Well, David, not too long ago you wrote an article for our site about how gold and silver were getting ready for an historic run you called it. So, before we start discussing some of the market action here recently, fill our listeners in on why you believe things were set up and are set up for us to see a good run in the metals here.

David Smith: Well, we've had a very trying period since 2011 when a lot of people have been really worn out and torn out and left the market because the prices have declined substantially and what is really a normal reaction in a very large bull market, what we call a cyclical reaction within a secular bull market. The prices, if you look at other times in history where this has happened, the prices did not decline more than what you would expect but it's pretty hard when you see prices drop by 40 or 50% over five years.

Last year kind of started to turn things around and then we had a correction from that. And now we're building this very large sideways space, which all sorts of indicators are indicating that we're now ready to launch into the next part of the bull market, which will be as David Morgan has always taught it will be the most profitable part of the whole thing and we're looking at probably three to five years of advancing prices and maybe more in gold and silver as this thing gets under way. So, we're building this base. It's moved about $1,300, gold as you know last week and held there. So, things are going to be going a very positive way for the bulls going forward here.

Mike Gleason: So, the metals have been showing some good signs of life here. We've got gold at its high for the year. Silver is still lagging a bit and hasn't reached its high for the year yet. Now, I'm not sure if you're thinking the same thing, but things are feeling a little bit different this time in terms of the advance that we're seeing and the set up that you just alluded to. Do you think silver will finally start outperforming? And how much of a run do you see in silver prices in the next say six to 12 months?

David Smith: Silver will at some point start outperforming. It's a metal that surprises people. They're looking at it now, and they say well why isn't it stronger in relationship to gold? Over time there's about an 85% correlation. In other words, if gold is moving up, silver will too, but it doesn't do that on a daily basis or even a weekly basis. And what it likes to do is to make people think it's going to stay weak for a long time and then all of a sudden there's a price explosion. So, one of these days, we'll wake up and silver will be up 75 cents on the day and people will go “where did that come from?” When the reality is what's going on under the hood all along and it was taking its time. Then all of a sudden, they go into the upside.

These different things that are going on with big money moving in some hedge funds into the metals space and the mining stocks being more strongly supported and the incredible demand, which just keeps on growing and going from China and India and now Turkey. Turkey's become the third largest importer of gold now in the world. All of these things augur very positively for the precious metals. That doesn't even discuss the supply concerns that are starting to accrue.

Mike Gleason: I know it's been maybe a little bit difficult for a lot of the silver bulls out there to see it just kind of go sideways for all this time these last four or five years now. But what is the saying? The bigger the base...

David Smith: The larger the base, the bigger the upside case. It's kind of an old trading truism. You know, the supply issue, the person on the street will say well wait a minute I can still buy gold and silver at Money Metals at a pretty reasonable price and that's true. But what's happening is the supply pipeline is going to be getting thinner and thinner because these projects are not coming online like they used to. The big discoveries aren't being made. The grades are the ones that are being produced in gold, silver, and copper are declining.

There are more issues with country risk. Last week in Indonesia, one of the largest gold, copper projects in the world was almost taken over by the government. The Grasberg Project had been producing for many years. They had about an 85 or 90% ownership. Now, the government has told them you get 49%. So, the government has become the majority owner. These things don't augur very well for increased production.

So, when the next up surge happens, which is in the way of building now, as people come in and they buy more gold and silver physically, then that pipeline is going to be harder and harder to fill. The price will rise and the premiums will rise as well, too.

Mike Gleason: Speaking of supply, that kind of leads me right into my next question. I wanted to get your thoughts on a very interesting tidbit that I read in one or your other recent articles for MoneyMetals.com where you made the point that even with higher gold prices this year, the scrap or recycling of gold is actually down a pretty good percentage, which is very interesting because you would think that people would be more apt to sell their gold jewelry or whatever gold items they may have when the price is rising. But the data shows the opposite. So, to me, that either means that the gold has already been recycled and there is less of it out there for scrap or because people realize that maybe I don't want to get rid of this stuff or perhaps it's a combination of both. So, what do you make of all that, David?

David Smith: I think you're right on the mark with that. I don't have a solid statistical figure to prove our view or my view, but I really believe I think first of all I think a big factor is that the supply pipeline from the standpoint of precious metals from jewelry and whatnot and recycling is becoming thinner and thinner. And there's just been so much of it sold into the market, there's not that much left anymore. Then as you say, I think, the sharper people that do have some of these things are saying “wait a minute, maybe I should hang on to this.” So those things are kind of coming together. I really don't expect that recycling will be a huge element going forward in trying to deal with the supply pipeline. I think it'll be less and less of a factor as we go forward.

Mike Gleason: Yeah. Maybe the weak hands, so-to-speak, have already gotten rid of what they have and now it's left in mostly the hands of more convicted folks. We've talked a lot about the PGMs, the platinum group metals, with you before. We had palladium hit nearly a $1,000 earlier this week. It's now almost caught up with the platinum price, something which is extremely unusual. You've been really bullish on palladium for the last three to five years now and you've really nailed it. Does palladium have more room to run? Is it time to play the platinum/palladium ratio and favor platinum here?

David Smith: Historically that would be the case when palladium get “overvalued” compared to platinum. I think things may be a little different this time. I'm not saying that there won't be a realignment in the relationship, but I think palladium will continue to be strong on its own merits because so much of it is produced in Zimbabwe and Russia. And there isn't any indication that that supply pipeline is going to be refilled anytime soon. And it is much rarer than platinum. I still like palladium a lot better. Platinum certainly has some room to move up, but how and when or if it'll go back to its premium over gold is really difficult to say. I think the relationship is really undergoing a fundamental change, and we'll find out all the reasons for that later. But it is something to kind of keep an eye on.

Mike Gleason: Kind of revisiting that palladium conversation that we had, gosh I guess it was two or three years ago, where you favored that as your number one precious metal of the time and, like I said, you've totally nailed it. And the advantage of having palladium or any of these PGMs is really as a portfolio diversifier. They're obviously driven by different fundamentals. Is that fair to say?

David Smith: Both platinum and palladium are primarily used in catalytic converters and then there are other industrial applications, there's a fair amount of jewelry, especially in the Far-East, that is made from platinum. So, they both go on those merits. We hear a lot about the electrical cars and things like that, and those are coming along. How that will affect the PGMs down the line, probably pretty substantially. But I think palladium has got a pretty good run left in it before we have to start worrying too much about that situation.

Mike Gleason: The U.S. Mint is just now announcing that they're going to be introducing a Palladium Eagle, which will be interesting. The first time that they're doing that. We'll see what kind of demand there is for that item here later this year.

How about the miners, David? They finally started to perk up in the last two weeks as gold finally broke above $1,300 again, but they've been in the doldrums for the last year after starting out 2016 with a huge move. Is it time to get into the mining stocks again? And if so, what kind of stocks would you suggest people look at?

David Smith: Well, the very fascinating, to me, change that's taken place and this it's like one of those things it's not 100% confirmed yet, but I'd say it's about 90% confirmed, for up to 20 years the relationship between gold and the mining stocks has been tilted in favor of gold. So, in other words, for the last two decades people that bought physical metals did better on a percentage basis with less risk than buying the mining stocks. That is now starting to change. It looks like the mining stocks are going to outperform the metal. They're both going to do very well. They should outperform because there's much more risk.

If somebody comes to you and they buy 10 ounces of gold or 1,000 ounces of silver, the only risk they have from buying it to you after they hold it is the price of gold and silver. Is it going to go up or down? But if you buy a mining stock, you've got about dozens of risks. You've got nationalization. You've got the cost of production. Are they going to run out of the ore that they thought they had? All sorts of things like this. A mine collapse. So those things necessitate that anyone buying a mining stock has to accept greater risk. The only reason that they'll accept more risk is if there's more rewards. So that has not been in their favor on a consistent basis over the last 20 years. Although as you mentioned, last year they did outperform.

But now, that's starting to change. So, there's a lot to be said for a person holding a physical metal as the insurance part and as a profit part, and also holding some very carefully selected mining stocks. I think both are going to do very well going forward over the next few years.

Mike Gleason: Yeah. That's very well put and you illustrate that very well. Obviously, we've said for a long time that mining stocks are not a substitute for owning the physical metal, but it's more of a supplement to a physical holding that you already have.

Let's change gears here and talk for a minute about Bitcoin. You see lots of promise in Bitcoin. It has at least the potential to serve as another form of honest money, but it will need to clear some hurdles. One of the big ones we can see coming is regulation. Governments are increasingly aware of the threat posed by Bitcoin both to the fiat currency monopolies they have been running and to their friends in the banking sector. What is your take on whether or not regulators will be able to succeed in controlling cryptocurrencies, David?

David Smith: Regulators are going to have a direct impact on that currency space, there's no doubt about it. But the blockchain is something that is kind of the genie that's out of the bottle. It's not going away. It's going to fundamentally transform a big chunk of financial exchanges as we know of because it's peer to peer exchange. In other words, there's no middle man. So, point A to point B goes straight through on the blockchain. It's a public pronouncement of a transaction and this type of thing.

So, the blockchain itself is a fundamental change that will be with us. Which of the cryptocurrencies will be around is anyone’s guess. Of course, right now Bitcoin and Ethereum are a couple of the biggest ones and Ethereum is more of a tool than a currency itself. It was very interesting when China cracked down last week. They outlawed most of the ICOs that have been out there, the initial coin offerings. Some of them are just junk. That's true in the United States as well, too. But when they kind of stopped that market dead in its tracks, Bitcoin dropped $1,000. Well, now it's back up. It's gained 600 of that.

So, I think the cryptocurrencies are going to continue to be a significant factor because they deal with money transfer and preservation in a different way than the metals. But for anyone to go all in on the cryptocurrencies, I think, at this point is a very, very risky move. Now, I trade these myself as well. But I do what I call an asymmetric trade where I put a relatively small amount of money into a particular currency idea and if I lose it all, I've lost a little bit of money. At the same time, I might be up three or four or five times. So, this way no one position knocks me out.

There has been, I think, a competition in the last year between buying gold and silver and cryptocurrencies. I think these big swings that we're seeing is causing people that are thinking about what they're doing to be more cautious and say well now would I put my next X amount of money automatically into the cryptocurrencies or would I buy some more gold and silver. And I think from the standpoint of our discussion today, the value proposition in relation to risk and potential improvement in which you buy really rests with the gold and silver and PGMs today for the majority of the new money that you want to put in to either investment or insurance.

Sure, put some money into the cryptocurrencies if you understand them properly and understand that the swings in them. If you think the swings in the mining stocks are profound, it's nothing compared to the cryptocurrencies. They can literally go from 0 overnight to an 800% the next day and then down 600% the day after that. So, they're the wild west on steroids. So, I just would caution people to be conservative. You should learn how these things operate and understand the blockchain, but don't think that you're going to just come up with your child's education here in the next six months and be able to hang onto it. Just be careful.

Mike Gleason: Yeah. Very good point. It can be a little bit of a speculators game, but obviously there's a lot of value in there. Just the fact that we do have some currency that's not controlled by governments, I guess, is a good thing at the end of the day. We've definitely upped our game when it comes to Bitcoin. We've accepted Bitcoin for a long time now for purchases of metal and soon we're going to be able to pay people in Bitcoin who want to sell their gold and silver back to us.

Well, finally, David, as we begin to wrap up here, talk about some of the key support and resistance levels you're watching here in the metals as we progress towards the end of the year and into next year. Are we poised to take out some of the overhead resistance levels we've seen, especially when it comes to silver or do we still have some work to do before we get too excited about a sustained-up move? What are your thoughts there on the technicals as we begin to close?

David Smith: Well, the progressive levels of resistance, in other words the levels of prior selling that kept prices from going higher for quite a while, they're being attacked pretty vigorously. But I think right now we've seen a pretty good run in both metals especially gold and they'll be back and filling going on. Probably stand above $1,300 in gold or if it drops below that, it won't stay there very long. But these levels are going to be increasingly attacked as we go forward. $1,375 is another good-sized level in gold… $1,400, $1,450. Once you get above that round number of $1,400 and moving up toward $1,500, that's going to tell people more and more that hey this gold market is for real. It's not a flash in the pan. It's going to go up.

In terms of silver, $20 is a psychological point that needs to be bested at some point. Then $22 and $26. And once those levels are over, then people are really going to be piling in. So, we talked about this topic before, but I think it's important that people remember there's two types of risk when you have an investment or when you buy for any reason. One is the information risk and the other is price risk. So, if you buy something that is "low" in price or perceived to be low in price, what you have there is low price risk in relationship to what's going on because we don't have a lot of information as to why the price is at that level.

So, when you wait for prices to rise substantially, then more is known about why those prices are going up. And at some point, you have lower information risk and you have higher price risk. So, there's no getting around it. You're going to pay for it one way or the other. Either accept the information risk or accept the price risk or ideally accept something in the middle. So, if people want to wait until silver is $26 an ounce and that'll prove that our thesis is correct, that's fine. But they'll pay $26… actually they'll pay what $27 or $27.50 an ounce or maybe $28 for that metal, whereas now they can pick it up because the price risk is lower and the information risk is higher, they'll pick it up for what $18. So just decide what you're going to do, but be aware of why you're making that decision so that you understand intellectually what you've done and why you're doing it.

Mike Gleason: Yeah. At the end of the day, none of the reasons that made gold and silver worth owning five, six years ago – out of control government debt, fiat currencies being printed all over the world – none of those things have changed at all. The fundamentals are still there and the rationale for why you want to have some financial insurance is very much alive today.

Well, David, thanks so much for your time today and for enlightening us with your wonderful insights once again. Continued success with the book, Second Chance: How to Make and Keep Big Money During the Coming Gold and Silver Shockwave. We definitely urge everyone to check that out if you haven't already. David Smith and David Morgan do a great job there. Look forward to catching up with you again before long. I hope you have a great weekend. Thanks, David.

David Smith: You too, Mike. People when they look at this book, they're going to find out how to hang on to most of what they make as well, too, which nobody really deals with that very effectively. So, it's one thing to make it and it's another to keep it and I think that's the philosophy that you guys have at Money Metals because you do provide a two-way market where you don't just sell you actually buy back as well, too. So, when the time comes that people want to sell some of their metals for a good profit, you'll be there for them unlike some other entities that maybe won't be still standing because of their business practices.

Mike Gleason: Well that will do it for this week. Thanks for again to David Smith, Senior Analyst at The Morgan Report and regular columnist for MoneyMetals.com and co-author, along with David Morgan, of the book Second Chance: How to Make and Keep Big Money During the Coming Gold and Silver Shockwave, a book which is available at MoneyMetals.com and Amazon, pick up a copy today.