Transcription of Interview

September 3, 2001

JIM:  It's time to introduce our expert of the day. Joining me on the program is Dave Morgan. Dave has been a private economist and precious metals analyst for over twenty years. He also adheres to the Austrian School of Economics. Dave has written numerous articles, some of which may be viewed at Gold-Eagle and has been interviewed recently on the Don McAlvany program. He's no stranger to Financial Sense listeners. Dave, welcome back to the program.

DAVID:  Thank you, Jim.

JIM:  In the last few months, we've seen gold showing some strength lately and yet silver is still quite weak. Would you comment on why we've seen a movement in gold, but not in silver?

DAVID: Both gold and silver exhibit a seasonal history. Normally they are weak during the summer. Most analysts attribute this to the "European Holiday" season. There isn't much buying activity during the summer vacation months. Gold has been acting strong. Silver has been acting weak, and to be honest, I don't have a very good reason. My best analysis is that obviously, demand seems weak and there is much talk about silver doing poorly in a recessionary environment. To put it simply, Jim, the market sentiment for silver is rotten.

JIM:  What about the silver market in a recession? I have seen some posts on the web stating that the silver deficit might actually turn into a surplus this year because the demand will be down so much with the economy weakening. Do you buy that?

DAVID:  I've seen the same thing. It is basically another case of good spin doctors. Yes, demand is usually down in a recession. I won't argue that. But that is where the truth ends, because the total truth is that the amount silver mined is also less. Since zinc and copper prices have suffered lately. In fact, zinc prices are down about 18% year to date. The amount of byproduct silver is going down -- perhaps more rapidly than silver demand. CPM believes the fundamentals for silver remain attractive and it has raised its 2001 deficit target from 97 million ounces in February to 115 million ounces in the second quarter 2001 report. So what that means is that the deficit predicted for 2001 has just been increased by nearly 20%. So, Jim, this talk about the structural deficit going away this year is just talk.

JIM:  There's a lot of talk about an economic recovery. Dave, for the first time in memory, this is the first time in about three decades, that monetary policy isn't working. Normally when the Fed begins to counteract a downturn, they start cutting interest rates. The first thing you see recover is the stock market. As the stock market recovers, it signals that the economy is turning around. But as we look at this time around, we've had five interest rate cuts of a half a point or more. We've had two interest rate cuts of a quarter point or more. So the Fed has now cut interest rates seven times. There was a Bloomberg story out today that they are expecting the Fed could cut interest rates another quarter of a point next month. So it looks like, monetary policy isn't working. Is this a little different this time? And I guess leading up to that, what does this mean for the financial markets and ultimately, silver and gold?

DAVID: Very good question. And here's where I probably separate from the pack. I listen to some analysts saying that the cuts are working, or we have just turned the corner or are about to turn the corner. What people are saying is, "Why doesn't the government just inflate their way out of the problem?" And to some degree, these seven rate cuts show they have already tried to do that. Why isn't it working? In essence, the problem is that in advanced economies, the damage done by destroying the bond market is greater than the stimulative effect of eliminating all debt. Only in countries without advanced capital markets such as say, Latin America in the 1970's, can the government induce runaway inflation. In deflation, powerful feedback mechanisms prevent re-inflation from becoming a quick fix. While a central bank can create liquidity by creating debt, this is not the same thing as creating capital. Any time a central bank monetizes an asset by buying it with printing press money, it also creates a liability. Only the market can create capital by valuing assets above liabilities. Turning on the printing press at higher and higher levels destroys more wealth than it creates. For example, when a government buys corporate bonds in an attempt to prevent liquidation, the corporate bond rallies, but then as a byproduct, the government bond declines, as the quality spread narrows. Thus in trying to solve one problem, re-inflation efforts can create an even larger problem and the bond traders, through appraisal of quality spreads will make certain that bad debts are liquidated and not monetized. This is my stand on the situation and I am sticking with it!

JIM:  Well, the long-term bond market would support that. Because if we take a look at the last recession back in 1991, as the Fed was cutting short-term interest rates, we also had long-term rates coming down. This time, we haven't seen the downward movement in long-term rates as we saw in the last recession, when the Fed cut aggressively. So that would seem to support your thesis.

I want to move on to a topic that you hear talked about in terms of economic downturns. How did silver do in the last serious downturn in our economy, which would have been the Depression? We had an economic downturn in 1973 and 1974. But, what about a more serious time - back in the 1930's - how did silver do during that period?

7:11 DAVID:  That is a tough one, Jim. To answer, I must first build some background. Silver was $1.33 at the beginning of 1920. After WWI, the post war depression brought the price down to 56 cents. Silver slipped throughout the twenties, and by 1932, reached its all-time low of 25 cents per ounce. During the Depression, Congress abdicated all of its monetary responsibilities to the Executive Branch in clear violation of the Constitution. On December 21, 1933 Roosevelt directed the Treasury to purchase silver at 65 cents per ounce, better than 40% above the then 45 cent market price. This was followed by another Act on June 19, 1934 called The Silver Purchase Act of 1934. This was a two-part law. The Treasury was to purchase silver until it reached its statutory price of $1.29 per ounce, or until the Treasury held enough silver to constitute 25% by value of the total reserve of the Treasury. Pursuant to this act, the US government basically was the silver market. They were buying silver from all over the world.

So, the short answer on a personal level is when did you buy silver? Of course this question is rhetorical because silver was money at the time. However, if you were able to buy at the bottom at 25 cents in 1932 and sell at $1.29 in 1934, then you would have made five times on your investment. Again, I must state due to government involvement in both the gold and silver market during the Great Depression, it is very difficult to draw any real conclusions for today. This is due to the fact that all accepted the fact that gold and silver were money back then. Today, most think that silver and gold are mere commodities.

The government was actually very very involved and accumulated as much silver as possible.

JIM:  And so, really in the thirties or the last serious downturn, we had government controlling the price of gold. And we also had government controlling the price of silver.
DAVID:  That's correct. I think it's important to point out again that this vast amount of silver that was collected during this time frame is now basically gone. I called the Silver Institute last week and verified that the mint is down to perhaps 10M ounces of silver. So, you might say we are in a similar situation as 1932. Silver is at an extreme low, adjusted for inflation, and the government is soon to become a buyer! Personally, I think the silver eagle program that Congress instituted in 1986 will continue for a few more years, but Congress will discontinue it within 4 to 5 years.

JIM:  If we were to have a serious downturn, how would you see silver performing?

DAVID:  Jim, I look at monetary history. I still see it performing better than gold on a percentage basis. I know many analysts disagree with me. But the facts speak for themselves. Because silver is imperative for our way of life, there is a structural demand that even the most severe recession or depression will not stop. Because silver is recognized as money -- in fact its name is synonymous with the word for money in the romance languages -- the monetary demand will return. It really sets me on fire when almost everyone is looking at silver from a myopic United States viewpoint only. How arrogant to think that because the US does not look at silver as money, no one else does or should. In fact, silver is still in an up-trend in Australian dollars and up to neutral in Euros. It strikes me as interesting that many people speak of the global economy, but their analysis is through United States lenses, if you know what I mean.

Commodities often return to the mean or their average. So, if we use the work of Franklin Sanders, he states:

If you had a chart 45 feet long where each foot equaled 100 years, only in the last 15 inches would the gold/silver ratio ever rise above 16:1. In1941 the ratio shot up briefly to 100 to 1. It occurred again in 1991. It is also important to remember that the last time people sought monetary refuge, that the ratio again returned to 16:1 ($800 gold/$50 silver). What this suggests to me is this time, silver will shine brightly during any economic condition.

JIM:   Dave, we were talking about how well gold and silver, and specifically silver, does in a downturn. I wonder if we can talk about the last great downturn which was in the thirties. You couldn't own gold because the government confiscated it in 1933. They were also controlling silver as you mentioned. But what about mining companies? How well did they do in the Great Depression?

DAVID:  During the 1930's, Homestake Mining soared from $65 to over $540 in only six years from about 1930 to 1936, for an amazing gain of 730%. Now, here's the important thing. In addition, Homestake paid out dividends of $2.00 (special) per share, per month between 1934 and 1937. An additional one time payment of $20 per share was made in 1935, all of which was on top of it's regular quarterly dividend of $7 per share. I had someone ask me what I expected for one of these companies, I stated that if you had bought a premier mining company in the early seventies. Your dividends were equal to your initial principal investment in 1979. In other words, if you had invested $10,000 in the early part of the cycle, your dividends were $10,000 by the end of the cycle. This is fantastic performance.

JIM:  So, you could not own gold. But owning a gold mining company was a great investment. I would have to say, if you look at how well mining stocks have performed this year so far, we've seen the same thing. You have the stock market down again this year. The S & P is down over 10%, the NASDAQ is down 24%. Yet you have companies such as Homestake which is up because they've been bought out by Barrick. But if you take a company such as Agnico-Eagle, it is up year to date 58%.

DAVID:  That's right. That is one of the theories that I adhere to. In secular precious metals bull market cycles, the mining companies lead the actual metal. I know this sounds absurd with silver at 4.19 today, but I think the corner has been turned. What we have now is defined up-trends in both the XAU and the HUI. The metals have not performed yet, but they will catch up later. Unless these up-trends are breached to the downside, I truly believe the bottom is here.

JIM:  Well, getting back to the present, a lot of readers that come to my web site or listeners to this show have sent me e-mails that say silver is ready to crash. I'm sure you've seen this as well. Some analysts are saying silver could go below $4 an ounce. Some say even as low as $2 an ounce. What do you make of that?

DAVID:  There are many out there writing and predicting in the financial community. Since the real fact is no one knows for certain, what we are really dealing with is investor sentiment or emotion. For example, one of the most respected analysts is Robert Prechter. He has predicted that silver may go as low as $3 and gold could go down to $200. However, he also states he is not against buying now in both metals although he might miss the exact bottom. In fact, I recently read an  interview with Mr. Prechter. When asked about buying silver now, Prechter states "Compared to where it [silver and he means gold too] is going, I don't care if it does go down to $3. You should own physical. Begin to accumulate every time the central banks and the scared people, and the people in debt sell gold and silver, buy some." This is what most of the professionals do. To pick the exact bottom is a fantasy. Have your capital available and average in over time. Once you are invested, stick to your plan. To pick the bottom is an amateur's approach to the market.

JIM:  What about the short position? We've talked about this in previous interviews. What about the current shorting of silver which has suppressed the price of silver?

DAVID:  That's a very good question and it comes up frequently. There is a very complete piece written recently by Ted Butler that I have linked from my site. He makes some very interesting points. The most important to me are, first, the overall short position is huge -- still over one half billion ounces of silver. The second, and I think far more fascinating point, is that the commercials are holding the smallest short position, probably ever.

JIM:  Dave, let me just stop you there. Explain for our listeners who are the commercials?

DAVID:  The commercials are generally known as the insiders. These are the folks that know the most about any given commodity market. These are mining companies, dealers with inventory in storage, big players! They are not always correct, but they are right more often than not. So this implies that the people with the

most knowledge are not willing to short the silver market aggressively. The shorts are being held by technical trading funds. These are usually firms that trade on computer generated signals. These funds have been getting whipsawed in the silver market and I am not sure if they are making much money at all. These people are short half a billion ounces, what happens if contract holders demand settlement in silver?

According to this bar graph,
approximately 800 million ounces of silver
have been borrowed for fabrication and refining
since 1997.

Is there enough silver available to satisfy the loans?

JIM:  Now, awhile back, during an earlier interview, you made the point that the commodity market, although it's a major factor in determining the price, had very little to do with the physical silver market because so little activity is actually settled in physical metal. In other words, a lot of these contracts on the exchange are just paper contracts. It's like a debit or credit to somebody's account. In going back to something you mentioned earlier, that the short position is close to 500 million ounces of silver. I don't know where that stands in relation to total production per year. But if these people are short half a billion ounces, what happens if contract holders demand settlement in silver?

DAVID:  Well, the market WILL explode. We have already had an example of this. Let me digress for a minute back to the silver squeeze under the Hunt’s. Some have the idea the Hunts were only playing the paper market. Although they did have huge contract positions, it was because they were taking physical silver off the exchange that the real problems began. Some of the silver longs, as their contracts approached maturity, were refusing to sell offsetting contracts. Instead, they were giving notice that they intended to take delivery of the metal. The growing practice of demanding delivery was what put real pressure on the shorts. Hunt and his partners took delivery at one time of 23 million ounces. Hunt had also taken delivery in 1974, but I forget the amount. During this period when one of the major shorts was getting into trouble, they devised a plan to sell 5000 to 10,000 contracts of silver “at the market” five minutes before the close. This did put pressure on the market for some time. This means, "Whatever the price is, I'm selling!" This is similar to what is currently happening in the gold market presently, with Goldman Sachs and others selling vast amounts of contracts. What is sad from my point of view is that since well over 90% of all the commodities only trade in paper, these financial powerhouses cannot get into trouble, unless the physical commodity is demanded to be delivered off the exchange.

JIM:  Well, that sets up a very precarious situation, because right now, the investment public, although they have experienced two years of losses in the financial markets, they are still holding onto hope. I mean, if you watch the financial shows and the cable programs, investors are still saying that they are in the markets for the long term. Everybody expects a recovery shortly. Eventually, the Fed will lower interest rates enough and turn the stock market around. My gut feeling is that those "good old days" are gone. The double-digit annual returns for technology stocks are over.

There was an article in Friday's Wall Street Journal about the P/E ratio for the S&P 500. There was a difference between the analysts at First Call in what they were including as earnings and the analysts at S&P. According to the S&P analysts, the S&P was selling at close to 36 times earnings. They're saying if you keep writing off stuff every quarter, you can't say we're not going to count these write offs. So S&P analysts began to count those write offs. They began to count those losses, which meant that actual earnings were much lower. So in actual reality, the S&P is selling at 36 to 37 times earnings. This compares to other analysts who value the S&P at a much lower multiple of 24 times earnings. So, a lot of people who are looking at the markets to rally from these high multiples are going to be greatly disappointed.

The point I want to make is you've had a year that the XAU has risen. Gold and silver are up. You have stocks like Agnico-Eagle up 58%. You have silver mining stocks on the rise. You have the S&P Gold Index up this year. No one is paying attention to this. I've always found it fascinating that you have one market down and another market like gold and silver stocks up. It is hard for people to consider that gold and silver would come back. Most people aren't looking right now at gold and silver as an investment. Do you have any comments on this?

DAVID:  Certainly, it's a great study of human nature. It is also a stealth bull market. This is how bull markets start. In 1982 when the Dow was around 897 and selling at ten times earnings, you could not give stocks away. But the market started up. For those that follow my work or the work of other precious metals analysts, this is the bottom. Even with the mining companies up this year, we still have a long way to go. I feel the metals themselves have a very long way to go. When capitulation takes place, people who have held a technology stock that is still at a loss finally decide to sell in order to purchase what is popular at the time. This is when the people who got in early will begin to sell. This has a great deal to do with psychology. These types of cycles repeat over and over again.

JIM:  Well, Dave, I'm afraid we're out of time. Tell us about your newsletter. It focuses on silver, correct?

DAVID: Yes, I do write a substantial amount about silver. However, I also take in the macro economic picture. For example, earlier in the program, I spoke about how well Homestake Mines performed during the Great Depression. My letter outlines a company that has the same parameters and I think will do as well as Homestake  -- perhaps even better during the turbulent times I see just ahead. I am not partial to junior mining companies at this time. I am still with the majors for the present. My subscribers know I have a plan for the second and third tier companies as things unfold. But, for right now, better safety and liquidity is my focus.

JIM:  Finally, how does one get a subscription and give out your web site address.

DAVID:  The easiest way is to go to my web site and send me an email or simply, call toll free at 877-610-9962.

JIM:  Dave, thanks again for updating us on the silver market. Once again, that web site is to get more information and to keep up-to-date on the silver market.


Jim Puplava and David Morgan continued their discussion after Jim went off the air.

Here is the text of Jim's further questions and Mr. Morgan's answers on "Prospecting For Silver."

JIM:  I want to get back to the economy and our financial markets. I want to discuss the Kondratieff Wave Cycle. Explain for our listeners what it is and how it fits in with our markets today.

DAVID:  The principle is based on the idea that there is a strong interaction between political and social developments, wars, and the long-term economic cycle, all of which come to peak at 50 to 60 year intervals. This cycle is not a new idea. In fact, the ancient Israelites refer to it as the Jubilee cycle, and a similar idea is also mentioned in the Mayan civilization.

I can give a brief outline of the idealized Kondratieff Wave. The up wave is usually 25 to 30 years, and prices start to rise slowly with economic activity. Prosperity increases until prices rise rapidly and it's boom time. At the peak, inflation peaks, and a recession starts. This usually lasts 8 to 10 years. After say ten years, an economic recovery begins and things are just like they were at the peak. In fact, people get the feeling that the good times are going to last forever! However, things begin to unwind. Something is happening and people do not expect the decline, nor how quickly it develops and how rapidly the economy falls. What takes place is high unemployment, bankruptcy, and depression.

JIM:  Where are we today?

DAVID:  1980 was the peak, recession to say 1992. Good times until maybe a year to a year and a half ago, and now we are in the down cycle.

Jim, I'll send you a graph Sharefin sent to me. It makes a compelling point.

From Nick Laird, Sharefin,

"This chart clearly shows the transfer of stocks to the investment public. And I think it is possible over the last few years as derivatives have exposed hidden stocks to the market place. If you look at this chart on Cumulative World Gold Production, consider that the difference between total stocks and government stocks is public demand (industrial and jewelry). You get some idea of the ever increasing, insatiable demand for gold. They've bled the cupboards dry with paper right in the face of ever increasing demand. It's the same with silver. Time will tell us how correct we are. But everything I research, points to huge stocks 50 years ago and now they are basically all gone. Demand has consumed most all. Interesting times ahead."

JIM:  Now, to change gears, let's look at investing in silver. What is it that you look for in evaluating a silver mining company?

DAVID:  First of all, I look at three things: profit, production, and political environment. I check the hedging and the amount of debt and debt service requirements. I also look at any legal tangles, such as pending environmental lawsuits. There is much more I examine, but these are the main factors

JIM:  What about the risk of hedging?

DAVID:  I am not totally against hedging, but it can be overdone. It is difficult to find any mining companies without any hedging. But my top pick is totally unhedged. I try to avoid those that hedge if possible.

JIM:  What kind of leverage do you expect in a silver company? Most gold miners are about a three to one factor?

DAVID: I expect a greater leverage factor than for gold companies. Most primary silver miners are unhedged. The market capitalization for silver miners is so tiny that any real money invested in them will make them fly. Back in the late seventies, Hecla Mining (HL on the NYSE) was the top performing company on the entire exchange. I expect similar results during the next precious metals bull market.

JIM:  How do you build a metals portfolio?

DAVID:  I still maintain that the core position is the actual physical metal itself on an unleveraged basis. After that, solid top tier mining companies. And lastly, for those that can afford it, some speculation in options.

JIM:  What percentage do you recommend for a portfolio's total asset allocation to precious metals?

DAVID:  Most of the major financial analysts on Wall Street recommend between 5% and 7%. Personally, I go as high as 10%. This is not a strict amount, but a good rule of thumb.

JIM:  Once you have chosen a company, what do you do to follow up?

DAVID:  I check for new mine openings, drill results, cash flow, management changes, and the political landscape.

JIM:  What would cause you to sell a mining stock?

DAVID:  That is a two-part question really. I would sell a stock if it had performed well and I felt it was overvalued. I would also sell a stock if it was under-performing. For example, I would sell it if the country the main mining activity took place in was experiencing political problems, or a huge local tax was placed on the mine, or any of a host of other problems that can arise in the mining business.

© 2001 James J. Puplava
(858) 486-3939 Tel (858) 486-8934 Fax
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David Morgan ( is a widely recognized analyst in the precious metals industry; he consults for hedge funds, high net-worth investors, mining companies, depositories and bullion dealers. He is the publisher of The Morgan Report on precious metals, the author of Get the Skinny on Silver Investing, and a featured speaker at investment conferences in North America, Europe and Asia. You can receive a free 30 day trial subscription here

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