Gijsbert Groenewegen
Silver Arrow Partners
View from the Top

Metals Equal Discipline: The Bull Case for Au, Ag

By MBN Staff | Tue, 10/20/2020 - 10:21

Q: What are the fundamental factors behind the current gold and silver bull market?

A: Fiat money, also known as paper money, is one of the main factors influencing gold today. This type of money is government-issued currency that in general is not backed by a physical commodity such as gold or silver, but rather by the credibility of the government (US dollar: “This note is legal tender for all debts, public and private”) that issues it. A fiat currency does not have intrinsic value. Paper does not have value: there is plenty of it. On the other hand, gold has intrinsic value, as there only is a limited amount of gold available. Though it should be noted that until 1971 the US Treasury redeemed dollars for gold at US$35/oz. Also, since 1974, it created the Petro dollar to create more demand for US dollars in replacement of the gold link. Fiat money is considered to have counter-party risk because it does not have value on its own and the issuing government has the duty to ensure that fiat (decreed) money keeps its purchasing power over time. The risk lies in that governments are not always able to guarantee purchasing power. There is a dependency on the counter-party that needs to deliver on the promise that the money will keep its value. If the obligation cannot be met, then the money loses its purchasing power. When the economy is doing well, counter-party risk is, in general, not a problem. Nevertheless, in times of high debt levels, large budget deficits and monetary financing the purchasing power of a currency can become a major issue.

Q: Has fiat money always been unstable?

A: It has not always been the case that government-issued money is not backed by an intrinsically valuable or tangible asset. We just have to go back to the period 1944 (Bretton Woods) till 1971 (Nixon Shock) when the US Treasury redeemed US dollars for gold at US$35/oz. The “Nixon Shock” refers to when US dollar was detached from gold. But the US diplomat Henry Kissinger insisted that another backup for the US dollar was needed to keep the dollar valuable and wanted. The chosen asset was oil, and the Petrodollar was born. The agreement with Saudi Arabia was that the US would provide military assistance as long as the Saudis priced their oil in US dollars and reinvest the received US dollars in the US economy, particularly in bonds. This enabled the US to issue bonds “ad infinitum.”  Recently, China and Russia have strived to decouple oil from US dollars. Quoting oil in Chinese currency, Euros or other currencies is a way to achieve that. This would eventually strip the US dollar from having any backing by a real commodity. This is all happening in a context where China and Russia are challenging US military hegemony. Also, the US has a huge budget deficit. Lastly, COVID-19 is deeply destabilizing the world economy. Hence, it might not be excluded that the US dollar seeks a gold backing, especially in light of the fact that President Trump is known to be a proponent of the gold standard.

Q: What is the relationship between fiat money and precious metals?

A: Gold and silver are expressed in US dollars: there is an inverse correlation between them.  If the value of the US dollar goes down, gold and silver go up in price and vice versa. In real terms, measured in gold and purchasing power, ever since the Fed took over in 1913, the US dollar has lost over 96 percent of its value, and continues to lose value. This is because the economy needs to be kept alive using debt even as the amount of debt in the US and the world is increasing to unsustainable levels. The world’s total debt is between US$250-300 trillion or US$250,000-300,000 billion. If interest rates go up 1 percent, that would mean an interest payment increase of US$2.5 to 3 trillion. That kind of money is simply not available. Hardly any country in the world has a surplus, and because taxpayers are already heavily taxed governments only have the option to square their budgets by debt issuance.

US federal debt at the end of the 2018-2019 fiscal year was US$22.7 trillion. Nonetheless, governments can issue money only to a certain point. If money is issued with nothing to back it up, currency in circulation gets devalued. If a company issues 100 percent of its shares to the existing shareholders without any payment for them their value halves. This is the same when governments print money or resort to monetary financing without receiving payments. The government’s ability and credibility to manage purchasing power will be put in doubt. That is what we are witnessing now. And as a result of the weakening of the US dollar, we are now experiencing increasing gold prices: remember inverse correlation.

Investors start to realize that fiat money represents manipulation because governments can hit the money print button whenever it suits them, which ultimately results in the devaluation of their currencies. On the other hand, precious metals stand for discipline in the sense that a specific quantity of money can be created, corresponding to the ounces of gold in the vaults of the Central Bank or Treasury. Gold or silver has to be physically mined out of the ground and cannot be printed at random.

Additionally, physical gold and silver in your physical possession eliminate counter-party risk. You are not dependent on the ability of the counter-party to fulfill his or her obligation. The value of physical gold (not paper gold, like ETFs) is in the gold itself. It has intrinsic value. A physical gold bar represents value, whilst a piece of paper that promises to deliver a gold bar only has value when the gold bar can and is delivered. Again, paper by itself without an obligation that can be fulfilled does not have value: there is plenty of paper in the world: it is not scarce.

Q: How does all this influence the price of gold and silver?

A: In the past, when the gold price started going up, it was depressed artificially. A gold price above US$2,000/oz could make investors doubt the real value of US dollars: remember, inverse correlation. That is why in 2011, after reaching a price of US$1,923/oz the US Government started to suppress the gold price. Naked futures were issued at the Comex by the cabal, a term used for the bullion banks and central banks that engage in suppressing the gold and silver price. These naked futures are uncovered futures that are not backed by the physical gold in the category of registered inventories. Bullion banks who act for the Fed and BIS can therefore issue as many futures as they want. They just dilute the incoming funds by issuing futures and thereby dilute the price rises.

Pricing can also be manipulated because the bullion banks who help suppress the gold and silver prices know where their customers’ stop losses are, at which price they want to get out of their position; they use that knowledge to push prices down through different price levels.

However, market fundamentals are changing, and people are interested in buying physical gold and silver. Bullion banks are thus losing the game of suppressing the price of these metals because investors are no longer interested in nominal settlement but demand physical settlement: they want the real thing. This trend will result in the price of these commodities to increase steeply in the future because physical demand is exceeding supply. Current prices are considered cheap and gold may reach US$2,500/oz in the next couple of months, especially in light of the uncertainty around the US Presidential election and the increasing need for rescue packages following the devastating economic effects of COVID-19. As for silver, when it breaks the US$30/oz level, US$50/oz will be the next target for investors, followed by US$100/oz. There is definitely a shift going on in the economies from intangible assets (paper) to tangible (hard) assets backed up by the fact that Bloomberg Commodity Index is breaking upwards from its 2011 downtrend.

Q: What should investors look at when deciding whether to invest in a gold or silver mining company in Mexico?

A: Management’s track record is crucial. Investors should ask themselves the following questions: Have they successfully brought a mine from inception to production? Has the team produced a good margin? Have they managed to keep AISC as low as possible? Investors should look for a team that delivers on its promises. It is always better to over-deliver, than to under-deliver, as the latter makes markets nervous.

The current precious metals bull market should be very good for Mexico, the largest silver producer in the world. Mexico just needs to maintain a friendly climate for mining and ensure that the rules remain clear for the next five to 10 years. Investors want stability. A major advantage of Mexico, next to expedited permitting, is that weather permits you to mine all year round: projects can be brought from exploration to production in relatively short time. Mining provides jobs and infrastructure for the local communities. Governments receive taxes from the activity. Everyone — the government, the ejidos and investors — benefit when mining picks up in Mexico.

I have co-founded Regency Silver Corp, which owns two projects in Mexico. The other founder is Bruce Bragagnolo who successfully incorporated and developed Timmins Gold and Silvermex. The first project is called Dios Padre, located in Sonora, where Regency has found high-grade silver intercepts (up to more than 3kg over 1.9m) with wide intervals (up to 30m). After Regency goes public — expected before 2020 is over — the company will be drilling a very promising target with 6 holes. Dios Padre is not far from Agnico Eagle’s La India mine (2018 production of 101,357 oz gold and 180,000 oz silver) and Alamos Gold’s Mulatos, a 4.6moz open-pit and underground gold mine (40km away). Regency Silver’s second project in Mexico is called El Tule in northern Nayarit. A 5km corridor of near surface gold open pit workings indicate the possibility for a large open pit gold project.

Q: Why is Regency Silver the best option for investors that want to take advantage of the current bull gold and silver market?

A: Regency Silver is a mining company focused on high-grade, large-size exploration gold and silver projects in Mexico. Its strategy is to develop and sell 43-101 qualified deposits to mid/large tier mining companies to fill their pipeline. With the focus of selling projects in the first part of the Lassonde Life of Mine Cycle, the company reduces permitting, financing, construction and production risks. It increases ROI for its investors with only a 1-2 year instead of the usual 5-7 year time horizon. Regency Silver has the experienced management with extensive knowledge and network to operate successfully in Mexico as proven with the successes of Timmins Gold and Silvermex.

Silver Arrow Partners is a private consultancy firm that focuses on global gold and silver mining projects supported by a leading global advisory and operations team.

MBN Staff MBN Staff MBN staff