A view on tight supply in platinum group metals, plus the 3-year bear in gold...
DAVID H.SMITH is senior analyst for The Morgan Report, as well as a professional writer and communications consultant through his business, The Write Doctor Inc.
A regular on HoweStreet.com, Smith has visited and written about properties in Argentina, Chile, Mexico, China, Canada and the US. Also presenting investment conferences and workshops, he writes for subscribers on www.silver-investor.com and for the general public at Silverguru.
Now, after just 3 years of bear market, precious metals are already forming another secular bull market, says Smith. Here he tells The Gold Report how platinum group metals will lead the resurgence, plus his outlook for gold prices...
The Gold Report: South African platinum group metals (PGM) miners have been plagued by a 21-week strike, which has cost those companies an estimated $2 billion in lost revenue. Is there an end in sight?
David H.Smith : It's the end of the beginning rather than the beginning of the end, because this is a systemic issue between the miners and companies. The companies are trying to recoup their costs because they are producing PGMs below the cost of production, whereas the miners are still not getting much money for doing a dangerous job. During that five-month strike the mining companies were losing 5,000-10,000 ounces per day of production. It certainly didn't help the supply side of the equation for PGMs.
TGR: Spot platinum prices have witnessed steady support above $1400 per ounce since January and roughly $1450 per ounce more recently. Would an end to the strike bring with it price weakness?
David H.Smith: Yes, because it's a buy-the-rumor, sell-the-fact situation. On the day that the strike was said to have concluded, PGM prices dropped $40-50 per ounce because that was the expectation. I look at it as a buying opportunity for people who believe the PGM story has upside. Both platinum and palladium are in a deficit situation but platinum is still more than $400 per ounce from its five-year high, whereas palladium penetrated its five-year high a few weeks ago. Of the two, palladium has a higher percentage profit potential, in my view, given that it can be substituted for so many of platinum's uses and yet sells for $500-600 per ounce less.
TGR: You have written on what you call "The Precious Metals Four". As part of that you see platinum and palladium being the frontrunners in the eventual price rebound in precious metals. Tell us more.
David H.Smith: The precious metals four are gold, silver, platinum and palladium. Investors interested in precious metals should focus on all four even if they don't hold all of them because of how they relate to each other and how their chart patterns correlate.
My premise is that platinum and palladium – and this has been documented by Sprott Asset Management, Rick Rule and several others – are going to be in a long-term supply deficit because the primary producers in South Africa and Russia are not going to be able to ramp up production any time soon, whereas catalytic converters, exchange-traded funds and individual PGM purchases (physical metal, jewelry) continue to sharply move demand. Meanwhile, gold and silver have been in a three-year cyclical bear market until just a few weeks ago when they made a large reversal on high volume in what looks to be the start of the next leg of the secular bull market in precious metals.
TGR: But the PGM market is relatively small, so one new producer can instantly change the market.
David H.Smith: Yes, the PGM market is about 7 million ounces annually for both platinum and palladium, whereas the gold market is about 80 Moz annually. The PGM market is infinitesimal, yet those metals have a lot of critical uses. It may take a little longer than I would like to reach a certain target, but the bull run in precious metals is underway and I think it's going to last a long time.
TGR: How do investors get in on the run? Is it about being in bullion or equities or both?
David H.Smith: I have worked for more than a decade with David Morgan at The Morgan Report and he suggests buying the physical metal first. Once you're comfortable with your allotment of physical precious metals, then start looking at equities. Shares can offer two or three times the upside potential on a percentage basis to the metal, but some go bankrupt and others underperform. Look at producers and royalty companies first, and if you have some money left over, buy a couple of exploration stocks with the hope of 10 or 20 times gains, knowing that they also represent a potential 100% risk to the funds you commit to a given position.
TGR: What are your near- and medium-term forecasts for platinum and palladium?
David H.Smith: It's really difficult to put a time and price on any commodity. It's more important to look at the risk/reward ratio. Over the next two or three years, in my opinion, the risk for having a platinum/palladium position is probably about one and the reward is four or five. I like those metrics.
If people are looking for a certain price target in a given timeframe and it doesn't happen, they lose faith and believe that the premise is wrong. The premise might still be accurate; it just may take more time to get there. For example, for some time I believed we would see a breakout in PGM prices. It took longer than I expected, but the premise was valid. The same thing is going to happen with uranium. It's taking longer than most people expect, but when it happens I think it's going to be a very powerful breakout.
TGR: Are there other PGM development plays or are there some producers that are producing PGMs as a byproduct?
David H.Smith: There are some, most notably in South Africa but, frankly, due to country risk I don't follow them. (Interestingly, in looking at Russia's massive Norlisk project, the primary metals harvested there are nickel and copper – with palladium as a byproduct!) My primary interest is the gold and silver market, but I'm also interested in PGMs in the sense that their chart patterns will inform us as to how gold and silver will look when they move into a public mania phase.
Some years ago palladium went to $1090 per ounce after Ford Motor Co. bought a lot of supply. At one point, as David Morgan has stated publicly – at the time he was involved in that futures market – the exchange demanded two times the total value of a palladium contract as margin money, a 200% margin call. That's eventually what we could see in all four of the precious metals.
TGR: Does the current precious metals rally have legs?
David H.Smith: Over the last few weeks we have seen, in some cases, a record volume turnaround in the physical metals and the buying of mining shares, which started about a week or two before metals prices turned. We have touched this area twice before over the last year or so and each time it's held. Anything is possible. We could see weakness and surprise announcements that could cause new lows in gold and silver, but I think they'll be short-lived. I think the risk/reward ratio is very favorable. If you're trying to find zero risk, you're not going to be involved. With great reward there's always great risk. It's how you manage that risk that determines how well you do.
TGR: Another big theme is China's growing influence on the gold market. Tell us about that.
David H.Smith: China always has a long-term strategy. China's gold strategy involves several aspects, one of which is thought to be a gold-backed yuan. Another is to diversify out of US Dollars in its trade account balances, if for no other reason than currency diversification. If there's a rift between China and the US, China doesn't want to have its money hostage in US Treasuries. And China is going to keep acquiring gold and silver, most of it under the radar. State-owned enterprises have bought some major gold companies, and last week China established a trading office in Vancouver to expand its reach into the mining sector.
There's a Chinese game – the Japanese call it Go – that's played with black and white stones on a table. The object is to surround your opponent and keep him or her from moving. That's what the Chinese are doing – but for them it's not a game.
TGR: Some recent news reports suggest China plans to introduce vending machines so that Chinese people have better access to gold.
David H.Smith: That shows how widespread the idea of gold ownership is. Last year China was the world's largest gold consumer but India will probably retake the top spot this year. People buy gold in Asia for different reasons than you or I. They're not trying to sell it when it goes up $50 per ounce. They look at it for the accumulation of wealth and for security.
TGR: You also see it as an extension of central bank gold buying.
David H.Smith: Yes. China is still an authoritarian society and if the government said tomorrow that it's illegal to hold gold and that Chinese citizens must turn it in, most Chinese people would. I think this is a kind of Plan B for the central bank, if it is indeed trying to accumulate as much gold as possible – and all indications point to that.
TGR: At about this time last year you told investors to set aside some money for what you called "stupid cheap" prices.
David H.Smith: It's time to look at prices in relation to where you think they'll be in a few years. A few weeks ago, the prices were stupid cheap.
The idea of setting aside extra money is not only for stupid cheap prices, but also for something that comes out of the blue that is undervalued in relation to everything else. Having the money and courage to take advantage of those opportunities is what I call psychological capital. If you lose that, you can actually lose your ability to trade effectively.
TGR: What's your view on Colombia?
David H.Smith: I don't think you can eliminate country risk. Colombia is a much better place to do business than it was a few years ago. Investors have to continually look at where they are investing and ask: Am I willing to accept the risk in relation to the reward that I hope to get from holding stocks in that country?
TGR: Do you have any parting thoughts for precious metals investors?
David H.Smith: The last three years have been incredibly difficult. No one, myself included, thought it would take three years to spin out of this. I still believe the potential is so large over the next few years that a modest position in the better precious metals stocks and holding some of the physical metal will result in outsized gains for people who really understand what's driving this market. This is a global bull market. The one in 1979-1980 was largely confined to North America. Asia wasn't even a component. Asia is driving this market and at some point everybody is going to be on that bandwagon, as David Morgan and Doug Casey and a few others have said. Investors willing to accept the volatility with what's going on are going to be very happy they did.
TGR: Thank you for talking with us, David.