first majestic silver

Don't Shoot the Messenger

March 24, 2008

I have been reading the independent views of Ian McAvity, as expressed in his letter “Deliberations” for more than 30 years and like me, he too is not afraid to tell it like it is. His unconventional perspectives provide the thinking investor with many contrary and controversial ideas. Along with his periodic jabs at the foolishness found on Wall Street, our politicians and the irrationality within the markets themselves, he uncovers profitable opportunities for those who can anticipate and accept a non-conformist point of view. I recently read an interview in The Gold Register in which Ian expresses his and my views better than I could express them myself; so instead of writing a complete letter all alone, I thought you would be better served if I incorporate some of his thoughts about the hidden cockroaches that are now being exposed to the light of day and make them part of UNCOMMON COMMON SENSE.

The first cockroach exposed to the sunlight was the sub-prime problem. In the past month or so, we have learned about another brand new layer of credit cockroaches (Credit Default Swaps) that resulted in UBS taking a $14 billion write-off and nobody had ever even heard of that kind of credit risk until then. Then later that same day, they indicated that $120 billion more of that stuff was still outstanding. But that’s not the end of them by a long shot as we find more new cockroaches, like the Monolines, keep creeping out into the sunshine.

Probably the best call that I made was last March 2007 in my letter titled “DENIAL is not just a river in Africa”. When the first inkling of the sub-prime cockroach came to light, I warned you then that it would be just the tip of the iceberg. When the Fed finally responded to it, all the talking heads on television immediately said, “Okay, the Fed’s dealing with the problem, let’s now consider it solved”. But as you all know, “Killing the First Cockroach Never Solves the Problem.” There is NEVER just one roach. That’s why Ian has been referring to them as cockroaches surfacing every time we pullback back another veil of deception. Neither I nor anyone else knows just how deep the infestation really is or will eventually become. The Ministers of Finance seem to think its $400 billion. A number of self proclaimed experts think it’s more like $600 or $800 billion, personally I think it’s in the trillions. The perennial optimistic, bullish, talking heads think since the problem is now out there for all to see, that the market’s discounted it all, especially since the banks have written off $150 billion so far. When how much is the rest of it going to get written off? And yet no one is even talking about, yet alone, speculating on how large the credit card, car loan and student loan cockroaches will be. Rest assured they too like the rest of the roaches are yet to come to light but like all roaches, the infestations are long and deep!


What about Japan, the world’s second largest economy? We haven’t even heard a peep out of the Japanese banks. It was and is Japan that has been the biggest and lowest-cost provider of money and credit for the last 17 years or more. That’s where all the Yen Carry Trade stems from; where people borrow at very cheap interest rates from Japan to make external investments. I have been warning you for years to be on the lookout for the eventual unwinding that must come and the tremendous damage that will reverberate around the world when it does. It is already showing up in the tremendous weakness of the US dollar. What will that do to the American, Australian and other high interest rate countries’ currencies and Bond Markets once the unwinding really begins in earnest? To date no one seems to have noticed it yet. What’s critical here is that Japan’s fiscal year ends March 31st, so between now and then, my guess is that a number of auditing firms and Japanese bankers are engaged in some sort of death dance. What are the write-offs going to be? They’ve been living in denial for the last decade. And denial is not just an oversight, it’s a policy. A nasty series of surprises from Japan could quite suddenly wreck havoc with the Yen, and Dollar exchange rates and what about its effect on the price of GOLD? What we have been witnessing thus far is just the beginning.


Cockroaches still hiding in the dark are Inflation, Commercial Real Estate, the Treasury Bond Markets and the Hedge Funds and Private Equity Take-over Markets, just to name a few. “There is never just one.” And yet after all of that, we have not even broached the Real Problem; the huge over supply of homes and buildings caused by five plus years of massive speculation made possible by 25% + per year price increases and exacerbated by the 1% teaser loan rates in conjunction with liar loans. That is the real problem. Further easing of interest rates and supplying more liquidity will do absolutely nothing to facilitate the buying of homes since most of all foreclosures are deeply under water and as the supply of homes and buildings coming on to the market continues to increase, PRICES will continue to be driven lower and will shortly begin to crash. Nobody but nobody is even talking about this, let alone thinking about how to solve this problem. Bernanke, Paulson and Company are only focusing on savings the financial-institutions.


If you didn’t like the first 20% down leg that the S&P took between October and January, too bad, because I think we’ve got another two legs just like it coming. In essence, the first leg was really just the putting in of the top that marked the initial breakdown into a full-fledged Bear Market. The first phase of a Bear Market typically is greeted by denial. The second phase will be when they try to price in RISK, that heretofore has been completely ignored, looking backwards into the Bull Market for the numbers instead of looking into the future. The third and terminal phase is the capitulation phase, where people say, “I’m never going to buy stocks again in my life, all brokers are crooks.” Both McAvity and me, believe that we are just in the transition phase from denial to reality. The stage is basically set for what could be consider a crash-like environment, particularly since they no longer have the up-tick rule. We could get a waterfall decline one of these days and it would not surprise me to see some hotshot hedge fund manager(s) throw in an extra $10 or $20 billion worth of naked shorts to try and compound the fall. They sure did it on the way up and with all the ETF”s floating around, it would be just as easy to exacerbate the move on the way down; especially now that everything that was put in place (the Securities Acts of 1933-34 and all the collars) to make sure that another 1929 - 32 or 1987 didn’t happen again have been removed. Watch out below!.

There has been some talk that the Bear Market may have started in July 2007 and since it’s had a 20% correction it should be over in 12-to-18 months. Maybe so, but I doubt it, I think this time it will only mark the end of the first phase of the Bear Market which, in my opinion, is more likely to last 5 to 15 years. The damage is going to be brutal, regardless of the time frame. What’s brutal you ask? Maybe as much as a 50% drop from top to bottom, which would match the Bear Markets we had in 2002, 1987 & 1973-74. It can be argued that the real estate and credit mess that’s behind all of this is a hell of a lot bigger than anything we’ve ever seen before including the 30’s and so it’s possible the sell off could match 1929-32. Will we ever learn? That it is Bi-partisan Government Socialist policies that got us into the problems in the first place and is not doing more of the same to get us out nothing more than the definition of insanity?

The main problem is one of perception. If you think about it, the economy is roughly $14 trillion; the total market cap of the stock market is about $16 trillion. The credit market is $50 trillion. These are all trillions, not billions. That makes the credit market about three times the size of the stock market BUT on top of that, we have about five or more times that amount ($200-$500 trillion) in interest rate and currency derivatives outstanding; that nobody knows how to measure and on which there is absolutely no control, supervision or even oversight. Just watching the twosome of Paulson and Bernanke makes it increasingly clear that they haven’t got a clue. They’re basically reacting to whatever the daily scare is and professing they’re going to fix it. I am a firm believer in the old adage that government isn’t the solution to problems; it’s always been the cause of them and their attempts at repair, in most cases, have made the problems worse. We couldn’t get much more bearish, in case you hadn’t noticed.

So what do we do with our money?

For the typical non-sophisticated investor, you go directly to Treasury Bills. The Bond Market is close to an all time high and paying virtually nothing, especially after taxes and inflation. The dollar’s losing value; making it a negative cost to carry, but the value of a Treasury Bill is in that it’s the final form of paper that the government cannot tinker with. It’s the 91-day T-Bill auction that keeps the wheels of the system turning. If you had a one or two year note, you might suddenly discover some sort of emergency forced your notes to suddenly become a five or ten-year note. They couldn’t possibly do that with a 91-day T-Bill or the whole system comes to a complete halt. A T-Bill is Cash, which has now become king. “THAT THERE IS A TIME AND A PLACE FOR EVERYTHING”.


So far, it looks like my Monday morning call to cover all your shorts was a stroke of genius, but in reality I was probably just lucky. OR was I just following the cardinal rule (TOIOW).

I don’t know how many of you were watching and listening to the news and the machinations about what was happening on Wall Street on Friday, but if you were and did not succumb to panic and dump everything, I commend you, because I sure felt like doing that. However, instead of panicking I decided to examine the situation and lo and behold I discovered that the cardinal rule might have worked again. By 11:00 am, with the market down 300 points and approaching the January low, I noticed that there were only 100 new lows as compared to 1100. As I wrote this paragraph, it was 3:00 pm and the DJII was down 280 points, I noticed that there were still only 195 new lows on NASDAQ and 155 new lows on the NYSE. Instead of selling, it looked more like a time to buy at least for a short term move, which could be substantial. So I decided to speculate against my gut feelings and took a chance and BOUGHT 100 QQQCP at .90 with a stop of .75, 100 DAWCP at 1.00 with a stop at .80 and 250 CSCO at .24 with a stop at .19, for a total investment of $27,000 and a risk assuming all my stops are ticked off of $4,500.

NOTE: I have taken these three positions to hopefully make a very important point. The stock market and economy do NOT follow each other in lock step! As an example Even though the market made its all time low in 1932 at about 40 it then rallied to 200 in less than 3 years, right into the depths of the depression, which did not end until 1946. If you want to be a truly successful investor, you must learn to not let your emotions rule your reason.


We talked about the unwinding of the Carry Trade, so let’s try and make some money. In my opinion, next to the Chinese Yuan the Yen is the most undervalued currency. Since we cannot easily invest in the Yuan that leaves the YEN whose rise against the Dollar will be reinforced by the unwinding of the carry trade: BUY the Yen ETF the FXY which will go up as the Dollar falls and the Yen rises.


With Gold at $950, as much as I want to, I’m not rushing in to buy more here; BUT I am still holding more than two-thirds of my total exposure in GOLD. I am now looking for what could be as much as a $150 consolidation. However, we can just as easily, after some backing and filling, rocket straight through the $1000 natural resistance point and be well on the way to my $1225-$1425 Wave I target. Then, after some more consolidation, it’s up, up and away to Gold’s eventual $2,500 to $5,000+ Target. The same holds true for Silver. I am now talking short term, which should not affect your medium to long term holdings. I try very hard to never contradict myself. You may think I do, but ONLY if you take my words out of context. You must always keep your eye on the BIG PICTURE if you really want to understand what is happening. You shouldn’t ever try to trade your core positions in Gold or Silver. DO NOT GET BUCKED OFF THE GOLDEN BULL!

DO NOT SELL YOUR CORE POSITIONS for the simple reason that NO ONE can tell in advance when we will get hit with a BLACK SWAN event that would trigger a 1929 or 1987 type crash for which we must always be prepared for; even though we are all praying that it won’t happen.

As for gold itself, we just had a $350 run in a little over five months. It’s been a tremendous run and it has huge implications for the long-term future. But if somebody is looking at Gold now for the first time, will their blood pressure sky-rocket should Gold go down $100? If Gold goes back down to $850 or something like that, are they likely to panic? Or will they have the courage to buy more into the correction? Unfortunately, newer players will panic and sell instead of buy.

In a stock market crash, initially everything goes down because people have to meet margin calls and they are forced to sell their winners because their losers often have NO BIDS. So it’s quite possible we could see Gold come back down to $800. Yeah, I’d be a big buyer then, but I would not be chasing it over $950 as I expect some consolidation until it builds up a big enough head of steam to break through the $1,000 mark. It may not pull back much but instead, consolidate sideways. So hold of, at least until it breaks out decisively above the $1,000 mark before buying Gold for the first time or adding to your positions.

Gold and Silver shares

We already have a technical divergence for most stocks as they have been lagging badly relative to the metal. Historically, when the general market takes a real hit, initially the Gold shares take a hit too. But this time around, most of the damage has already been done, so hold on to your PM shares.

The government is now printing money like crazy. I don’t even try to keep track any more as the money supply numbers they publish get revised so frequently and are so misleading that I really don’t know what they mean. So instead, I watch the credit spreads – the spread between Treasury Bonds and Junk, which has already increased by 700 basis points since I first pointed it out to you as the best risk free trade, almost a year ago. In theory, one buys Gold mining stocks for leverage on the commodity price, but in point of fact, the shares of Gold and Silver today are trading at lower multiples of the Gold price than when it was $250. The Gold price has almost quadrupled. The majors have kept up with it, but they haven’t outperformed it like they should. However, when we get into that third and then the final fifth Wave of this Gold Bull Market, everything is going to fly. I lived and traded through the last one. But I remember that once it got really going, the whole thing was over in about four or five months. This time around, I don’t plan to wait another 20 years for the next one. Besides, I’m too damn old to make it through to the next one. I am not a Gold BUG, I just love making money.


It’s looking increasingly prescient that Wayne Murdy, Pierre Lassonde and Seymour Schulich all left Newmont to restart Franco Nevada, and Newmont is not acting well at all. I’ve seen some analysis that basically think they won’t really be turning around for a minimum of 18 months, maybe longer. And because of their size and diversification, they have some geopolitical risk problems around the world. They’re getting beaten up a little bit in Indonesia right now. They were battered badly in Uzbekistan. If the Gold price rises to $1,500 or so and they have a couple of elections in South America, they may have problems there too. So, whereas I once really liked the world’s biggest Gold producer, I’m more inclined to follow Lassonde and Schulich (who I knew personally back in my Montreal days) into Franco Nevada.

I have always been partial to both FRANCO NEVADA (FNV.TO) and ROYAL GOLD (RGLD) - I just love the concept. In return for financing Juniors, instead of getting shares or debt, they end up with a NET SMELTER ROYALITY INTERST. What that means is that they get a fixed percentage (usually 3%) of the total Gold mined regardless of the profitability of the mine. They can’t lose. If Gold is rising, their royalty payments (payable in Gold) are worth more. When Gold is falling and money becomes tight, like it is now, the Juniors have great difficulty raising money and therefore they are forced to make sweeter deals with FNV and RGLD in order to get money. In the long run, a no lose proposition.

Goldcorp (GG) was once my favorite Gold stock when it was just the Red Lake deposit. I was never partial to the Wheaton takeover. It expanded the company tremendously and then the deal with Glamis completely changed the landscape. I’m not a big fan of companies growing by taking over other companies and issuing more stock. The recent sale of Silver Wheaton probably makes sense. Goldcorp is going to be one of the leading stocks. The industry has consolidated to such an extent that you haven’t got much selection. I am still concerned by the fact that it hasn’t managed to get above its 2006 high. It has made higher highs lately, so relative to the South Africans, it looks great, but their chart isn’t anywhere near as good as Kinross, Agnico-Eagle or Barrick. Barrick is the #1 Gold stock. The sad part is that Barrick isn’t included in the S&P 500. None of the Gold stocks except for Newmont are. So all the index money flows to support Newmont and nobody else. But basically Barrick, Kinross, Agnico and Goldcorp are the healthiest. The other one that is getting a lot of attention is Yamana, but it makes me a little bit nervous because the President of Yamana keeps talking about using the shares to acquire other projects. It seems like he wants to be a “deal junkie.” So I don’t share the general enthusiasm for Yamana. I would rather buy the companies that he is about to takeover.


Power problems, tax problems, and royalty problems: But more importantly, I was surprised to see Anglo American sell off AngloGold Ashanti and that says more to me about South Africa than any research I can do. If they want out, then so do I. Watch the charts, but basically I would just stay clear of South Africa and other parts of the world that present too much political risk.

March 15, 2008


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Aubie Baltin CFA, CTA, CFP, PhD.
2078 Bonisle Circle
Palm Beach Gardens FL. 33418
[email protected]

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