first majestic silver

Consolidated Overview

July 23, 2005

The views expressed in this column over the past couple of years have been wide ranging and, at times, disconnected. It seems appropriate at this point to set out a consolidated overview. It will also be constructive to highlight past errors and examine possible reasons for these errors.

For openers, it will probably be helpful to summarise one thought paradigm regarding the global financial infrastructure.

I am of the general view that the world is too deeply enmeshed in - and dependent on - fiat currency for that medium of exchange to be modified in any meaningful manner within the foreseeable future. It seems to me that precious metals may (and probably will) have an emotional role to play; and will always be (emotionally) viewed as a "currency of last resort". For this reason, whenever there is a crisis, it is reasonable to expect a rush into precious metals until the crisis blows over. It also seems reasonable that at some point in the foreseeable future, gold may once again play a role as a "backing" for fiat currencies but - as a starting point - this backing is likely to be more cosmetic than real.

From an investment perspective It seems to me that silver is preferable to gold, for two reasons:

  1. Silver has broader practical applications. It has unique properties in areas of light reflectiveness and electrical conductivity; as well as (incidentally) an ability to be used as a bactericide. Because of these unique properties, industrial applications which require silver as a raw material are likely to grow rather than shrink. In this context, the shift from photographic imaging to digital imaging is probably more appropriately viewed as a "speed wobble"
  2. Silver is relatively inelastic from a supply perspective because, at present, it is produced largely as a by-product of the mining of other metals.

In context of rising demand for silver pursuant to an increasing variety of applications, and relative inelasticity of supply, and historically low world inventories, I expect silver to outperform gold over the next 5-10 years.

Using the horizontal count technique (which I have found to be more reliable) the following Point & Figure chart (courtesy is telling me that the gold price is likely to see a price target of around $495 per ounce, but it does not give any clues regarding timing. For the sake of completeness, it must be acknowledged that the vertical count technique is anticipating a target price of gold of $599 per ounce but, for reasons highlighted below, I do not (yet) take this possibility seriously.

It should also be noted that I originally saved this chart on my system on June 10th 2005, and on revisiting the same chart today (five weeks later), I found an identical picture.

The following monthly bar chart (courtesy shows that a conceptual target gold price of between $400/ounce on the downside and $525/ounce on the upside is also within the bounds of possibility within the next twelve months without it entering into a dramatic new phase of valuation perceptions; and this higher target number is consistent with other technical (relative strength) methods of forecasting. There is an outside chance of a target of $800 per ounce being reached, but there is as yet no compelling technical reason to focus on this number. Indeed, given the various trendlines that have been drawn in - the level of $500 - $525/ounce looks like it could represent a "cap" on the gold price for the time being.

A combination of the thought paradigm articulated above, and the 22 year chart monthly chart of the gold price above does not allow me to see - within the foreseeable future - gold reaching a ratio of 1:1 with the Dow Industrial Index as is being forecast by some commentators. In any event, this kind of reasoning is circular - it assumes that which it is trying to prove - and, given its circularity, there is a logical disconnect. There are only two bases for this ratio to ever be reached again:

  1. If the economic/financial system is perceived to be in danger of breaking down. Unfortunately, if the system breaks down, any price for an ounce of gold is a conceptual nonsense. Under such circumstances there will not be a need for any medium of exchange. Ergo the question devolves to whether or not the system will actually break down. My view is that the system will not break down, but it will likely undergo structural changes.
  2. At the point where the system starts to undergo a structural change, gold well may be introduced as an element of the newly restructured system. Thereafter, gold may evolve once again to become a major component of Central Bank Foreign Exchange Reserves, but that seems likely to be so far into the future that it does not bear applying one's mind to it at the present time.

Turning now to silver:

Based on horizontal count techniques as applied to Point & Figure charts, a price of silver of around $10.50 per ounce seems probable (again without reference to time), and a maximum (short lived) price of $55 per ounce seems conceptually possible within the foreseeable future for two reasons:

  1. It seems to me that at some point in the future there will be a "squeeze" on the Commercial short position. In context of shrinking world inventories and an inelastic supply, it is ill advised, bordering on irresponsible to sell silver short. As an aside, this raises questions regarding whether the regulatory authorities themselves are acting responsibly by allowing a situation to arise where it is currently physically impossible for the Commercials to honour their contractual commitments
  2. The 600 year chart below has a downward pointing trendline that shows resistance at around $40 an ounce in 1998 dollars. I cannot see any logically acceptable reason for a 600 year trend to be broken on the upside.

Assuming the gold price stabilises up at between $450 and $500 per ounce, a "stable" silver price of around $22 - $27 per ounce seems to be a reasonable target, given that the ratio of gold:silver of around 18-20 was constant for nearly 400 years prior to the commencement of the collapse in real silver prices in the late 1800s.

The US Dollar:

From my perspective, the generally held view that the US Dollar Index will fall below 80 cents in the foreseeable future does pass the "common sense" test.

My paradigm reasoning is that there is no logical alternative to the US Dollar.

In simple terms, if the world is to pass a vote of no confidence on the US Dollar, this will be tantamount to a vote of no confidence in fiat currency across the board. Yes, the Euro chart below (courtesy has a "gap" in it that seems likely to be covered, but that gap is at around 125, and there is no technical evidence to support a conclusion that the Euro will replace the US Dollar as the world's reserve currency.

For reasons outlined above, I cannot foresee gold replacing the US Dollar as the world's medium of exchange within the foreseeable future.

This leaves …. What? There is no alternative. Therefore, in the absence of a financial collapse, the US Dollar will remain the core international fiat currency.

From a technical perspective, the evidence that is apparent from the monthly chart below is pointing to a US Dollar that has bottomed.

The PMO oscillator is showing a "buy" signal - flowing from the fact that the deeply oversold blue line has crossed upwards above the green line. Further, the steeply falling red trend line has been penetrated on the upside.

It now seems to me that the US Dollar Index may have entered a trading range that could see it batting around for years to come between 80 on the downside, and (say) 95-100 on the upside.

This begs the question regarding whether a US Dollar Index that does not fall below 80 will it have a "capping" impact on the Gold Price?

From one perspective, the following monthly chart of gold contains a cautionary note.

By the same argument as applied to the US Dollar chart, the monthly PMO is giving a "sell" signal, but in this particular case there is a subtle difference: There are still two rising trendlines that remain intact. Given that an overbought or oversold oscillator can remain overbought or oversold for longer periods of time than one would intuitively expect, the primary difference between the monthly charts of the US Dollar and the Gold Price lies in the trendlines.

In my view, there is still room for the gold price to rise in line with its more gently inclining trendline/s. The effect of this on the oscillator may be that it will remain in overbought territory.

This view is validated further by the Goldollar Index chart below, which shows that the inverse nexus between gold and the US Dollar may have been severed.

What this chart shows is that the gold price multiplied by the US Dollar Index has broken to new highs within the context of a rising trend. It follows that the US Dollar can remain strong without the gold price weakening significantly; and vice versa.

On balance, therefore, a target price of $495/ounce seems more likely in the medium term than a target price of $400/ounce.

Industrial Equities:

An area where I have indeed been mistaken, is that I was previously of the view that the US Equity Markets were at risk of collapsing. This view was based on a combination of technical "evidence" (which turned out to be wrongly interpreted) and lack of underlying value.

Another of my thought paradigms is: If there is a clash of wills between an individual investor and 'the market', the market will most likely win. Therefore, if the facts do not fit your thought paradigm, change your paradigm. There is no room for ego in this field of endeavour.

The fact is that Dow Theory gave an intermediate term buy signal over the past week - when both the Industrials and the Transports rose to new intermediate term highs. This provides technical evidence that the equity market is stronger than I had originally believed it to be.

Nevertheless, the fact that I have modified my view on the possibility of a "collapse" in the equity markets does not therefore imply that I believe listed equities represent a sensible investment at this point in time.

In my view, listed equities remain overvalued and it is for this reason that I believe unlisted equities represents a sensible area to target. Unfortunately, investment in this latter area is fraught with risk, requires talent in a range of technical skills which few have mastered, and is therefore not generally available to the investing public.

Why was I mistaken here? Why did the markets not collapse?

There are two possible reasons:

  1. The "weight of money" theory still seems to hold water. The US Federal Reserve has injected so much cash into the system that money is going into the markets for reasons primarily related to lack of alternative options.
  2. The chart below (courtesy shows that Price:Earnings ratios have been improving as a result (partly) of improving underlying corporate profitability. Currently, whilst the market is still overvalued, extreme overvaluation is no longer present. Conceptually, if earnings remain constant, the market could pull back by 28%, but the latest bout of earnings reports seem to be showing increases that are continuing.

All of the above is limited to a five to ten year view, and within that ten years, I anticipate that a structural change within the world economy will start to manifest.

One reason for this anticipation lies in the flattening yield curve. The difference between short dated yields and long dated yields is contracting, indicating that the "time value" of money is decreasing.

In brief, in a world awash with money (oversupply), there is no logical reason for the "price" of money (interest rates) to be high. In a world awash with money, that money no longer has a significant time value.

In terms of conventional Economic theory, the word "Inflation" does not refer to price inflation but rather to inflation of the money supply. Historically, price inflation followed monetary inflation because the demand for "products and services" rose relative to their supply when the availability of money became abundant.

In today's environment of supply overcapacity in virtually all secondary and tertiary areas of the world's economy, an increase in the supply of money will not necessarily translate into an increase in demand for goods and services - in excess of supply - and so it does not therefore follow that monetary inflation will lead to price inflation. In this regard something structural has already changed.

Furthermore, it does not follow that because there appears to be a "cap" on price inflation, therefore we are facing the opposite scenario, viz price deflation.

Again, deflation is defined as a contraction in the availability of money, and there is no sign of this. Indeed, as long as there is not an implosion of the debt mountain, there appears to be no possibility of deflation in the money supply given that Central Banks can actively control this.

This begs the question as to whether there is likely to be a debt implosion?

The chart below - that of the yield on the 30 year bond - seems to contain technical evidence that the yields will no longer fall from here. But, again, it does not necessarily follow that, therefore, they must rise from here. A stable interest rate environment within the USA might be consistent with a stable US Dollar, and we could also see long dated yields entering a "trading range" of 4.0% to 5.5% for the foreseeable future.

If yields remain stable (and relatively low); and the economy keeps ticking over - albeit at a slower rate of growth - debt can continue to be serviced and, over the long term (several years) be slowly paid down. What will give over time is that standards of living will go into holding mode, and possibly decline; and relatively less money will be spent on discretionary purchases if (for example) the price of oil remains high.

But it should be born in mind that if less money is spent on discretionary purchases to compensate for rising non discretionary costs, the total amount of money spent will remain constant as between non-discretionary and discretionary spending. There may be no "net" reduction in spending. More likely, there will merely be a reallocation of resources, and a decline in living standards.

A stable interest rate environment would also allow the currently overvalued property market to remain overvalued without the necessity for it to collapse.

In turn, as with an equity market whose underlying profits are growing to cause P/E ratios to come back in line with historical averages (around 15 X) so property P/E ratios can also begin to contract as rentals rise along with (slowly) rising personal incomes. Again, this has implications for discretionary spending and standards of living.

What does the long-term future hold?

It is in this area that the views expressed in these columns over the months may have been met with a mixture of bemusement/confusion/amusement/derision.

In truth, no one can peer into the future, and whatever opinions are expressed in this regard by anyone are nothing more than entertaining speculation.

But, again one needs to understand that what one person views as potentially reasonable, another will regard as potentially "flaky" or "off-the-wall" if the disparate views that apply to the long term flow from differing paradigms of logic. To understand this argument better, perhaps the reader will consider this:

There is likely to be one or a combination of the following two dominant thought paradigms that apply to reasoning processes of the millions of people who visit the gold-eagle web site:

  1. People who believe in "gold" are often also religious - given that gold as a medium of exchange and/or a store of value dates back to biblical times. For this reason, subscribers to a religious thought paradigm will be predisposed to reject (with varying degrees of intensity) any proposal that falls outside this paradigm
  2. Some people who believe in gold are not necessarily religious, but do subscribe to an "order within Nature". These people could (and often do) embrace technical analysis of a more esoteric nature, including Fibonnacci numbers associated with Elliott Wave theory, Gann Line Analysis, Cyclical analysis, and whatever other mathematical model/s seem capable of explaining the "repetitive" nature of human behaviour.

The problem with these two paradigms is that they are rigid in their view that "history is preordained and/or destined to repeat itself". People who are comfortable within this paradigm will be uncomfortable with any conceptual argument that "this time it is different". Such statements will typically be received with wise and knowing smiles, and an unexpressed view which runs something along the lines of "poor schmuck".

In all honesty, history is certainly on the side of this viewpoint against a "this time its different" argument, but it needs also to be recognised that this negative attitude is based on prejudice which, ultimately, gives rise to a phenomenon known as a "limiting belief".

The problem that I have with such a limiting belief in today's environment is that we are certainly experiencing issues which have never before been experienced in recorded history of civilization. Examples of this are:

  • Global Warming (yes the Earth has experienced this before, but not - as far as we are aware - in context of organized society)
  •                                     Depletion of fossil fuels excluding coal. Given that fossil fuels have been the primary source of non-human/animal energy to date, and given global warming, to contemplate the continued use of coal as a primary source of energy does not seem sensible.
  • Depletion of the Earth's capacity (yield per hectare multiplied by number of available hectares) to feed its inhabitants. Yes, Genetically Modified foods might change this, but the very act of contemplating GM foods is in itself a departure from historical behaviour.
  • The world has not reached a point where there is merely a temporary excess of supply capacity over demand. If one assumes that Third World economies will remain un-developed or under developed, then there appears to be no compelling and/or immediate need to continue adding any further capacity in legacy industries for the foreseeable future (except, possibly, within the economies of China and India). Of course, if there is a structural change in technological emphasis, then this observation will not hold true because, by definition, new technologies will supersede "legacy" technologies. However, a structural change in technological emphasis will, of itself, represent a structural change in behaviour. Yes, one could argue that "we have seen this change in technological emphasis before". However, it has never before occurred within the context of effectively saturated global markets for legacy products/services. Henry Ford's motor car brought about a changed paradigm. It brought independence to people who previously relied on horses and trains. But now, most people already have this independence. What any future change will bring will be a replacement within an existing paradigm (maintenance of existing economic momentum) rather than an addition ( growth in underlying economic momentum). In this context, the paradox is that we may be locked into a paradigm which calls for homeostasis as opposed to growth.
  • Human fertility rates are falling as a result of trihalomethanes in the environment (which have caused a significant fall in male sperm counts over the past 70 years or so); and further - in developed/developing countries - human predisposition to have large families for social reasons is waning. Women in the Western World are giving birth later than at any time in history, and this is likely to have a significant impact on social behaviour. This is another mitigating factor against "growth" of markets.
  • There has been a depletion of water tables (the water in underground storage caverns) flowing from population growth and excessive strain on water resources. Again, there is a potential technological solution to this (sea water desalination) but, again, this will represent a structural departure from previous behavioural patterns - for example the need to think in terms of water conservation within urban areas.

The above non exhaustive list is pointing to a conclusion that this time around it is unarguably different. Going forward, the world's economy (and the commercial activity within it) cannot continue to be managed in the same manner as heretofore - ie focussed on quantitative growth within legacy markets that are effectively saturated; and dismissive of the environment.

Where it will end up is anyone's guess, and my "armchair speculations" in this regard should not be taken too seriously - except insofar as they contain a single common thread; and that is that we are either going to see an evolutionary change - which will be a departure from "more of the same" - or we are going to face destruction of the fabric of society.

References to the Mayan Calendar ending in 2012, and Indigo Children evidencing the possibility of genetic mutation, and the need to turn banking into a not for profit endeavour have the same probability of being "garbage" as they have of being "valid". Who can see into the future? It's anyone's guess.

Author's note:

Much of my thought processes are influenced by a "limiting belief" of my own - that markets for legacy products and services have effectively saturated in the developed world, and can be effectively self satisfied within the developing world.

Clearly, this is a "broad brush" observation that cannot be objectively validated by any comprehensive tests. However, in an attempt to convince the reader that this observation is not too far off the mark, I offer the following anecdote.

Some years ago, I was Lead Managing a fairly complex financial transaction in Atlanta in the USA, and this required me to effectively live in a hotel room for months on end, away from my family in Australia. To mitigate against boredom I bought a book of ten Delta Airline coupons at $50 each which allowed me to fly anywhere in the USA and Canada for $100 return. I am also predisposed to want to understand society at the coal face, and am therefore predisposed to walk the streets of the suburbs/city in which I am visiting, and to use public transport instead of cabs. Sometimes - as in Rio De Janeiro or in Beverly Hills, L.A. - this can be potentially dangerous. But most folks - even the roughies - will accept a stranger who is non threatening to them.

One evening at rush hour, I happened to be on a $2 ride on the MATA - which is a brilliantly conceived public transport system in Atlanta. The train was filled to capacity.

One lady - who appeared to me to be a woman of fine character, and who was clearly on her way home after a hard days work - started a conversation with me:

Lady: "Excuse me sir. Don't mind my asking. Where did y'all get those sneakers you are wearing?"

BB: "I was in Toronto last week, and a friend took me to a sports shop to help me choose them. Why do you ask?"

Lady: "I notice that they are New Balance (a brand) and my son owns every design of New Balance shoes on the market. I have never seen that design"

BB: "How many pairs does he own?"

Lady: "I've lost count. Maybe five or seven"

So, here we have a working class lady, living and working in Atlanta to support her family by means of honest toil, whose son owns maybe 5-7 pairs of sneakers which cost around $100 a pair. The reason my friend in Toronto took me to the sports store is that my one pair of four year old sneakers was incapable of providing instep support while I walked on the treadmill for exercise, and this lady - who probably earned a fraction of what I was then earning - had a son who owned enough branded sneakers to use a different pair every day of the week.

Are the markets for legacy products saturated? You betcha!

And that, ultimately, is why Mr Greenspan's penchant for printing money has not given rise to rampant price inflation, but has given rise to asset price bubbles. Andthat, ultimately, is why the price of long term money has stayed stubbornly low, giving rise to a flattening of the yield curve. And that, ultimately, is why it suits the countries which are in current account surplus to recycle the dollars back into Treasury instruments in the US, which has a current account deficit. And that, ultimately, is why this time around, it really is different.

And, finally, this preparedness to recycle dollars into US Government debt instruments is ultimately why we will not have a debt implosion.

Except if the velocity of money slows down, giving rise to negative GDP growth.

Clearly, the key challenge is to keep the velocity of money from falling.

And that, ultimately, is why the politicians are behaving with no integrity, and are lying through their teeth.

Which brings us to the final realisation: When the facts don't fit the political paradigm. It's time to change the political paradigm.

So, which is it to be fellas: Retention of personal power through "contrived conflict" and the resulting terrorism backlash, or evolution of the species?

It is estimated that the total amount of gold mined up to the end of 2011 is approximately 166,000 tonnes.
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