-- Posted 8 August, 2011 | | Discuss This Article - Comments:

The new normal could be $75/oz. silver. In this exclusive interview with The Gold Report, David Morgan, editor of The Morgan Report, maps out a path for silver that could sink as low as $5/ounce (oz.) during the summer pullback and then bounce up to $75/oz. to establish a new base level. A consistent Silver Institute Production Cost Standard could help investors make smarter decisions during the coming upswing.

The Gold Report: In your Morgan Report, you have written extensively about the impact of global financial issues on gold and silver prices. At least temporary solutions have been found for the euro-Greek tragedy and the U.S. debt limit debacle. Will this give the U.S. dollar a boost at the expense of precious metals?

David Morgan: It is getting more difficult to predict what the market reaction will be to specific events. As people figure out that there really is no solution to the global financial system without a great deal of pain and some defaults along the road, more will seek the safety of precious metals. So, even when things calm down for the moment, it does not mean the precious metals will not get pushed down. You could see gold and silver react to the downside, perhaps dramatically—$5/ounce (oz.) silver is not entirely out of the realm of possibility. My best guess is we will see some pullback going into mid-August.

TGR: Today, gold hit $1,700/oz. during what is normally a summer slow season. Can this climb continue? What are the drivers?

DM: Yes, it can continue and the driver is uncertainty. Look at all the problems in the currency markets. It seems interbank lending is starting to freeze up in Europe. This was one of the main factors contributing to the financial crisis of 2008. So there is much to consider and it boils down to the fact we are in the final stages of a currency depreciation on a global basis.

TGR: A lot of the economic indicators—GDP and consumer confidence, in particular—are coming in weaker than expected, not to mention the Standard and Poor's downgrade of U.S. debt. Could we see another 2008-style sell-off, and how would that impact precious metals?

DM: Fundamentally, nothing of substance has changed since 2007 except that the banks have lots of money on hand. You have to understand that the silver market has a mind of its own. What happened in 2008 was a silver sell-off that caused a shortage, pushing the physical price of silver at the retail level to around $13/oz. while paper silver traded under $9/oz. on the futures exchanges. Excessive short selling then ran the price from about the $20/oz. level to the brink of $50/oz. The next leg up could take out the $50/oz. level after a few tries and then not look back until establishing a new nominal level of $65/oz.–$75/oz.

TGR: Where is the demand for silver coming from? Is it industrial or investment-driven? Is the developed or developing world pushing the market?

DM: Look East. In July, the Hong Kong Mercantile Exchange launched a U.S. dollar-denominated silver futures contract. It cited "surging international demand for silver" as the cause for the launch, pointing out that silver demand rose 67% domestically between 2008 and 2010. China accounted for almost 23% of the world's silver usage last year. It is now using four times as much silver per-person as it did 12 years ago, but this is still one-fifth the amount used on a per-person basis in the U.S. and Canada. Silver demand is growing for both industry and as an investment.

The game has changed, however. The physical market is gaining control day-to-day and the bankers are finding it more difficult to persuade the market in their favor. This will only add to the volatility.

TGR: How will the new Silver Institute standard help investors assess production cost accounting and make smarter investment decisions?

DM: The silver version of the Gold Institute Revised Production Cost Standard is an attempt to create an apples-to-apples yardstick for silver production across the sector. In the past, companies used different metrics to arrive at cost/oz. estimates. Some excluded royalties, while others ignored shipping refining costs. A significant benefit of the new cost standard is that it helps clarify the use of silver equivalent/gold equivalent ounces jargon. About 70% of silver extraction comes as a result of base metals production. But what happens when a company with very little silver on its property decides to report its silver equivalent ounces? Theoretically, the property could be devoid of silver and still use this term by assigning a "silver value" to its base metals. The silver standard should eliminate that practice.

The standard is a general accounting system. So, by definition, it will not fully address all circumstances that producers in the sector might face. For example, a "pure" silver producer with relatively low base metals production in relation to silver ounces will not be able to post a significant base metals figure under the "byproduct credits" entry. And given that the refinement cost of base metals can be substantially higher (up to 40%) than for silver ore, this disparity could work against a given producer when "Total Production Costs" are tallied. Other disparities that might arise can happen when looking at "payable versus produced" ounces, taxation/shipping costs on the export of doré versus silver concentrate, etc.

The standards are also voluntary. Time will only tell how consistently this reporting process will be followed. It was widely embraced on the gold side. Early indications should be evident this fall, when silver producers begin filing their third-quarter financial statements. However, if investors feel it helps them clarify how much profit a silver producer actually makes from its operations, then it is likely to become a de facto yardstick in such matters.

One word of caution. This, or any measurement tool, should never be thought of as a yardstick that will lead to an investment go/no-go decision. Even assuming that this metric gave a totally accurate picture of a company's silver production costs, it would be unwise to "pull the trigger" just because Company A showed a lower production cost than Company B. What if your lowest cost-of-production company gets nationalized? How about the effects of a major mineshaft collapse on production? I'm just saying that the path to high-probability investment decisions depends on a multiplicity of factors, assigning subjective weighting to each, and then accepting a certain level of risk to compensate for unknowns, no matter how the numbers stack up. Therefore, the more factors that jibe, the more likely one is to have arrived at a "profitable" trading consideration.

TGR: Any final thoughts you would like to leave our readers?

DM: Yes, as economic times continue on a path of increasing stress it is a great time for people to reflect upon true wealth. The old adage that the best things in life are free is a bit naïve in my book. Nonetheless, people can reflect upon family, character, health, contribution and all the things that make us human. Perhaps you could do a thought experiment and ask, “What are the 10 things I value the most that do NOT involve money?”

TGR: Thank you for taking the time to share your ideas with our readers.

DM: Thank you.

David Morgan (Silver-Investor.com) is a widely recognized analyst in the precious metals industry and 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, author of "Get the Skinny on Silver Investing" (Morgan James Publishing, 2009), and featured speaker at investment conferences in North America, Europe and Asia.

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