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Weekly Market Wrap

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Alternative Money Mania Coming with New Inflationary Cycle

David Smith: Cryptos Bringing Broad Attention to All Dollar Alternatives

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Welcome to this week’s Market Wrap Podcast, I’m Mike Gleason.

Coming up we’ll hear another terrific interview with David Smith of The Morgan Report and MoneyMetals.com columnist. David weighs in whether crypto-currencies and precious metals can coexist and talks about what we can glean from the current mania in the cyrptos as it relates to the upcoming mania in precious metals. Be sure to stick around for my conversation with David Smith, coming up after this weeks’ market update.

Now that Republicans have passed their tax cut package, investors are trying to position themselves in what they think will be the big winners as the new law takes effect next year.

Broadly speaking, the new law is a big win for U.S. corporations. Their tax rate will drop from 35% down to 21%. President Trump believes lower taxes on businesses will lead to more factories being built, more jobs being created, and stronger economic growth. He’s probably right – at least to some extent.

On Thursday, the Commerce Department announced GDP growth for the third quarter coming in at a robust 3.2%. Economists are now projecting close to 4% growth next year as the tax cut stimulus kicks in. Of course, with our government’s serial under-reporting of true inflation rates, these economic growth numbers are overstated in real terms.

But the conventional wisdom is that U.S. stocks will continue to charge ahead. This week saw some notable divergences develop in markets, however, and that could be foretelling major trend changes. Bonds, along with interest-rate-sensitive sectors such as real estate and utilities, sold off. Meanwhile, oil and natural resource stocks rallied strongly.

Investors appear to be reacting to the potential inflationary side effects of stronger economic growth that’s fueled by deficit-financed tax cuts. Yes, the tax cut package is expected to grow the deficits by as much as $1.5 trillion over the next decade.

Metals markets responded this week by moving higher. Copper prices rose 3% to near a 3-year high. Palladium ticked up to a 16-year high, while its sister metal platinum gained over 3% this week to pull out of its recent slump.

As for gold and silver, they are posting modest advances. Gold prices are up by 1.4% this week to trade at $1,273 and spot silver trades higher by 1.6% to come in at $16.36 an ounce as of this Friday morning recording.

If metals markets continue to show strength into 2018, they may well be signaling a larger inflationary trend set to take hold. Any significant increase in consumer price levels would be disastrous for the bond market – and spell trouble for some or even most sectors of the stock market.

Higher rates of inflation are bad news for most financial assets… but good news for most hard assets. Precious metals markets tend to thrive when the inflation rate is rising faster than interest rates – in other words, when interest rates are trending negative in real terms.

There is the potential threat of Federal Reserve rate hikes pushing rates positive in real terms. But you can bet President Trump’s incoming handpicked Fed chairman will back off at the first sign of serious trouble for the stock market. Trump is on record favoring higher asset values and a weaker dollar – which effectively means he favors higher rates of inflation.

The government itself has powerful incentives to promote price inflation. The IRS gets to tax the nominal gains on assets artificially boosted by inflation. And the Treasury Department gets to see the real value of its massive debt obligations steadily eroded.

But the biggest inflation trick the government employs is understating it. Using manipulated inflation gauges such as the Consumer Price Index enables the government to artificially hold down cost of living adjustments for Social Security. Understated inflation also generates stealth tax increases.

One “inflation tax” hazard for investors is winding up in higher tax brackets due to nominal increases in income. Wages or investment income that rise merely at pace with inflation can push taxpayers into higher rates of taxation.

The problem of “bracket creep” is supposed to be offset by annual increases in the bracket cut-off levels based on the Consumer Price Index. But a provision buried in the GOP tax bill passed by Congress this week changes the inflation gauge to “chained CPI.”

The difference between chained and unchained CPI is small in any given year. But according to the Joint Committee on Taxation, the obscure little change to “chained” will generate $30 billion in additional tax revenue through 2026. That’s because chained CPI usually comes in lower than regular CPI.

Inflation is an insidious threat to investors in more ways than one. And while gold and silver markets aren’t guaranteed to keep pace with inflation every single calendar year, the precious metals often massively outperform official inflation rates during periods when they flare up.

Well now, without further delay, let’s get right to this week’s exclusive interview.

David Smith

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, Merry Christmas, and thanks for joining us again. How are you?

David Smith: Very good Mike, and thank you and the very same to you and yours.

Mike Gleason: Well, as we start out here, David, let's talk first about the setup as we finish up 2017 and move into the new year. There are a lot of similarities to last year, maybe the year before. We've had the Fed just announce a rate hike. The move was well telegraphed and all the selling in the metals happened prior to last week's FOMC meeting. Open interest in the futures got pretty extended about a month ago, and as often happens in that scenario, the speculative long buyers were taken out to the wood shed and punished as the bullion banks cashed in on their shorts. Now we're seeing a bit of a rally in the metals, so the situation in these regards is very similar to a year ago. What are you expecting from the metals markets in the weeks and months ahead? Are you looking for a rally to match last year's?

David Smith: I really think that we could be looking at a very similar set up to 2016 where the metals actually bottomed in December, and the mining stocks tried to put a lower low in in mid-January. And I'll never forget it, January 19th, and on an inter-day basis, they turned around, and then it was up and away for the metals and the miners for the next six months.

Then between then and now they gave back about 50% of it, which is what you'd expect on a retracement, and nobody can predict the future exactly, but I really feel pretty strongly that we're going to see a very strong, right out of the box, in January, on the metals and miners, and it may even turn before the new year, but there's so many technical indicators themselves, that when you add them all up, they become something larger, and so I think if a person is waiting to purchase their metal, they shouldn't be waiting too much longer if they had the same view I do.

And not only that, as you know, when the demand starts ramping up pretty quickly, the premiums go up too, so you would have a double whammy against you, buying at a higher price and paying a higher premium if you wait until a lot of other people kind of get the same idea.

Mike Gleason: Yeah, certainly a buyers’ market right now, both in terms of low spot prices, and also the premiums, as you mentioned. And the last couple years, we have had pretty strong, right of the gate, moves there in the metals and the miners, and maybe 2018 is going to have the same thing.

Now in your most recent article that we published this week in MoneyMetals.com, you make the case for physical metals and cryptocurrencies to coexist. Now we think that is a vitally important idea right now as people are working through questions about what the advent of Bitcoin and other cryptocurrencies will mean for gold and silver. It would be pretty easy for people to look at price charts and leap to the conclusion that metals are quickly becoming irrelevant. The reality is that the times we live in are desperately calling for honest money and that both cryptocurrency and metals both have important roles to play. They have very different strengths and weaknesses, however, so talk for a minute, David, about how these two asset classes are likely to coexist.

David Smith: Well, the majority of the buying right now worldwide in gold and silver is in the Far East, and it's been that way for a while… probably 65-70% of the volume. Things have tailed off a little bit in the United States, but elsewhere in the world, that's not the case. In fact, Germany came out of nowhere to be, I think one of the, if not the largest country buyer of the last few months of gold. And a year ago, their volume was almost nothing, so Turkey is I think number 3 in the world now.

So these areas are all becoming more and more important demand pieces for gold, even as gold and silver look to be tailing off in terms of production. It's getting more expensive to do it… the grades continue to drop in both gold and silver in many of these mines. So, we're going to be seeing more demand and relatively less supply and that's going to put upward pressure on the prices. And as you've mentioned before, we're talking about gold and silver having been money for thousands of years.

They're going to continue to occupy that stage, and not only that, a lot of the people that are in Bitcoin are actually buying metals with the Bitcoin, so the price has gone up and they get to buy more gold, and they get to buy more silver, before it drops again. And we've been seeing these huge, huge swings. It's nothing to see bitcoin drop $5,000 in a couple days, and so far it's been able to recoup most of those, but I mean, that's a tremendous amount of volatility. It makes mining stocks look like they're designed for widows and orphans compared to the cryptocurrencies right now.

Mike Gleason: Yeah, you are one of many gold bugs who has become interested in Bitcoin and cryptocurrencies, and it isn't just about the price appreciation, though the action in those markets is definitely a spectacle, as you mentioned. You, like many of us, can see the potential for crypto to change the world. People are starting to imagine something like Bitcoin becoming a major world currency, and a very real threat to banks, including central banks. There are even some who think the current price explosion is signaling that this sea change is already upon us.

Now we happen to think that is a bit premature, Bitcoin for example, is not ready yet for prime time. The network is horrendously backlogged with transactions, taking hours to confirm. Fees have risen dramatically. It is nowhere near being able to serve as a major world currency. The network would need to handle tens of thousands of transactions a second, not the current limit of less than 20.

Now, there are solutions being proposed to these scaling problems, but it will be some time before anyone can say with confidence they will work. So, in the light of that, we're wondering if price hasn't already moved ahead of capability for Bitcoin. What are your thoughts there?

David Smith: It's really possible, and the thing is, as you mentioned, the issues that Bitcoin has about the state of execution and scalability, but there are a number of other altcoins, you might say, that are trying to do something similar, and even Bitcoin Cash, which is a spinoff fork – since August of this year it has really been trading because it moves transactions much more quickly. And then of course, there is Monero and Litecoin and Dash, and so, there are a number of other similar coins that are doing similar things and there's no way to know which one will end up becoming top dog. It might be something other than Bitcoin, but right now it has the first mover advantage.

But one of the things that I think that is very positive for gold and silver and people who believe in it, is that, Doug Casey made this argument, and I think it's a very powerful one. He said, "The interest in Bitcoin is stimulating people to ask, 'what is money?'" They hadn't really been talking about that so much anymore, I mean, the hardcore gold bugs and silver bugs have always felt that way, but the average person on the street never asks themselves, "what is money, and what does it mean to have it deteriorate in value?" And so, the money in their pocket buys about 3 cents from what it did, say, as far back as 1960. So, this is going to, when people really ask that question, and they say, "what has been considered money for centuries and millennia?" They're going to go "Oh, you know, it's been gold and silver." And so, I think it's going to introduce a lot of new people to the precious metals that maybe hadn't ever held it, so that is a salutary advantage of what's going on with all the chaos that's going on in Crypto Space, in my view.

Mike Gleason: We’ve had a huge influx of folks buying metals with Bitcoin this year, and especially over the last 2 or 3 months. And aside from being an outlet for people to spend their crypto profits, we are one of the only national dealers out there who also has the ability to pay people in crypto, whether it be Bitcoin, Litecoin, Etherium, etc, when customers are selling to us. So, we’re seeing a lot of coexistence between these two asset classes for sure, at least from our perspective as somewhat of a leader in terms of doing metals for crypto transactions both ways.

Now, another aspect that I wanted to touch on between the amazing developments that have taken place, and are currently taking place in the Crypto Space, and comparing it the potential for precious metals, is this incredible volatility that can accompany a mania phase for an asset class. Now that mania is in full force for the crypto world right now, but perhaps that day will be coming soon for metals as well. Talk about that for a minute because we could see a foreshadowing here of what might happen in gold and silver markets once people start to pile into physical ownership of the metals. Talk about what we might be able to glean from this crazy situation in Bitcoin that we're in the midst of. How might a mania in the metals look similar and how might it look different?

David Smith: I think that we will see in a few years a mania in the metals, and it'll be similar in terms of the velocity of money moving around and the spikes up and down, and the price of the metals. And the reason for that is because communication is so quick nowadays, it's instantaneous, and that's the reason people all over the world ... This is the first time in world history where people all over the world are invested in an asset class at the same time, for many different reasons actually, but that's why I think the people that were calling for a Bitcoin mania in January, when it was $900 and then all the way through the year, then when it was $2,000 or $3,000, $4,000, and they've been spectacularly wrong, and nobody knows. Maybe the top was registered a couple days ago, but it wouldn't surprise me to see it go much higher, with big swings up and down at the same time.

But when people move into the metals in a big way, which they inevitably will, you're going to see the same type of a thing when the supply/demand ratio gets out of kilter. And people are going to be striving to find metal at any price, at some point. And they're going to be able to have that same level of communication around the globe and trying to do that, that people are doing now with their cryptocurrency. So, it does share that one element in common, plus human nature never really changes, does it?

Mike Gleason: No, certainly not, and obviously one of the issues that we're dealing with right now is that with these low prices, the producers, especially the primary silver producers are not terribly profitable at these types of prices, so there's not a lot of new exploration. Thus, supply is going to continue to dwindle. If we go with the data that tells us that maybe 1-2% of Americans actually own an ounce of precious metal.

If, all of a sudden, that doubles during a mania phase. It takes a while for that supply to come online, as you well know, studying these miners. It's not a switch that you can just flip, and automatically have a bunch of new ounces being pulled out of the ground. It takes years in many situations to get a mine up and running... go after those exploration projects and so forth. So that really could potentially drive that mania and make it go even quicker than we were expecting if you truly can't get your hands on the metals. Speak to that.

David Smith: That's really true because they're not making any really large discoveries anymore. The article I wrote last month, quoting Pierre Lassonde. He just said, "We're not finding anymore 15 million ounce gold discoveries and we're finding just a few 3 million ouncers." And so all the companies that are producing today, regardless of the metal they're producing, they are wasting assets. Unless they find ways to bring in more ore on stream, they are producing ounces that aren't going to be replaced and then that means the value of their company goes down, and what they can produce. And so, this is going to be something that's going to weigh on the whole industry big time going forward. It's just not very likely that you're going to see any more mega-discoveries, like were fairly common 30 years ago.

Mike Gleason: Sticking with the mining industry here for a moment, what is your intel showing in terms of the state of the industry? How are they doing? Are you expecting more consolidation as the prices remain suppressed here? What's the situation with the mining industry?

David Smith: A number of the better run companies are doing reasonably well. They're producing at a reasonably good profit. There's going to be more consolidation in the industry because the medium-sized ones are going to get swallowed up by the larger ones. It's a lot cheaper for a big company to go out and buy a project that's already been permitted and maybe even having production going on, than to go through the permitting process. I visited a company in BC this year that took almost 20 years to get through all the environmental permits and the agreements with First Nations, and, not to mention, to keep delineated enough of a resource to turn it into reserves.

And so, it’s just a whole lot cheaper to buy a company that's already figured it rather than to go out and find it on your own. And as that happens of course, that's not adding anything new to the total amount of gold and silver that's available to be produced. It's just shuffling the card deck, so to speak. So, it isn't like they're buying a new project that's never been put into production before. Some of that's going on, but a lot of it's already buying companies that are already in the pipeline and then they just add that mill or that mine to what they're already doing.

Mike Gleason: Getting back to your article, you lay out all the reasons why it's important to stay the course and not let the noise get in the way of your investment plan. Recap that a bit here for our listeners and talk about the dangers that the average investor faces these days given the over saturation of information that's constantly bombarding us with the 24/7 news cycles and all the talking heads constantly giving their opinions on anything and everything in the investment world.

I mean, in terms of precious metals, the fundamentals that made it a wise investment a few years ago, and the very things that probably peaked our interest about owning it as a hedge and as insurance against financial turmoil, is still just as relevant today as ever despite the price kind of languishing, so you have to just phase out all of that noise and resist getting tempted by alternatives or swayed by this opinion or that opinion, don't you David?

David Smith: You really do because it's hard for all of us to maintain our bearings when all this information's coming in, and we have to look at each piece of it and try to determine if that is valid or if that changes our thesis. And the thing is, as you said, all the reasons for holding the metals are as valid as they ever were, in fact if not more so. And the fact that the metals haven't gone up sharply as we're talking doesn't mean that they're invalid, it just means that it's taken a little longer than we expected.

I look at the uranium market as a classic example. This thing went on, people said, a year and a half ago, "Well, we've never seen a market that's been in the bear markets for six years, the odds that it's going to turn around very quickly." Well, it took another 18 months, and even now it's still just getting started. But the thing is, once it makes that turn, and once the smart money is starting to position itself, and once a certain amount of the public get on to the idea, you can have a very, very fast move upward, just like we had in 2016. And it's very difficult to get on, and on that move, it caught so many people by surprise, both in the physical space and also the mining shares space, that the vast majority not only didn't get on – because they were waiting for a retracement that never really came – but they also sometimes got out too quickly. They thought "Oh, well, this'll be a couple months and it'll be over, just like it has been the last four years." Well, it didn't turn out that way. It went for seven months with hardly any kind of a correction.

And these prices today, the better companies and, of course, the metals themselves, are still above where they were when that turn was made, so if you wait a little longer, you're going to find yourself buying at prices higher than they were when they were in 2016. So, if a person believes in it, they should start accumulating in tranches, or buying into weakness, or buying on a dollar-cost averaging, or whenever they have the extra money to budget for, rather than trying to pick the exact low. Try to buy 30 cents lower and then end up paying a 40 cent premium, that you wouldn't have had to pay then, plus maybe 40 cents higher… the old "penny wise, pound foolish" theorem.

Mike Gleason: Yeah, certainly letting the emotions get the best of us in the investment world has taken down many people over time. Well finally, David, as we begin to wrap up here, maybe talk about some of the key support or resistance levels you're watching here in the metals, in terms of the charts and so forth. And then anything else that you're focused on in the metals or financial world that we maybe haven't hit on yet as we wrap up the year and look forward to 2018.

David Smith: Well, I think in silver, we want to see silver get above $17 and of course, it would be very, very positive psychologically and chart-wise to get above $20. And then you have a real solid base start to be built there. That would be very important.

In terms of gold, getting well above $1,300 and staying there, $1,325, $1,350. There are a lot of respected economists and analysts that feel that we'll see $1,450 to $1,500 gold this (next) year, even without some major issues.

So, I think that the risk/reward is really turning in the favor of a cautious investor who decides on how much to put in, and then does it, rather than trying to wait for even more ducks to line up because Mr. Market seldom waits until everybody understands the story before it moves. And by the time you feel comfortable about it, it's going to probably be moved quite a bit a ways away from where we are talking about it today.

Mike Gleason: Yeah, very well put, obviously we're seeing a lot of this type of situation play out in the crypto world. A lot of people I'm sure are kicking themselves for not having gotten into Bitcoin $10,000-$15,000 ago on the price charts, but we could be looking at something very similar in metals. If you've got a conviction and you know that precious metals are the place that you need to be long-term to protect yourself, by all means, go by that conviction and make your moves.

Well, David, thanks so much for your time today and for enlightening us with your wonderful insights once again. I've certainly enjoyed having you on this past year, and wish you and your family a very Merry Christmas, and I look forward to catching up with you in the new year. Take care, my friend.

David Smith: Okay, take care, Mike, and I've enjoyed speaking with you too.

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

And check back next Friday for our next Market Wrap Podcast. Until then, this has been Mike Gleason, with Money Metals Exchange. Thanks for listening and Merry Christmas everyone.

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