The Gold Report: Your investment strategy has long involved finding undervalued or overlooked opportunities. What metals does that umbrella cover these days?

David Morgan: The byline of The Morgan Report is “Money, Metals and Mining” and I approach the market in that fashion and in that order. Mining—that’s where you get the greatest leverage. And metals—are the best asset class, particularly the precious metals, during these uncertain times. From the metals-only perspective, I’m a top-down analyst. We determine supply-demand fundamentals, what would cause a price to be higher or lower or stagnant. With the precious metals, we look at some timing cues as well. And then we look for resource opportunities, not just in the precious metals or base metals, but throughout the sector, and we do a fair amount of work in the REE, the rare earth elements side. But overall we look for undervalued situations.

TGR: What looks undervalued these days?

DM: Nickel is probably one that’s pretty undervalued, although it looks to be breaking out now. If you study the London Metals Exchange (LME), you’ll find pretty good inventory buildup in some of the base metals at this time—high enough to cause some concern on a short- or intermediate-term basis. Unlike wheat, corn, oats, cocoa or sugar, metals don’t deteriorate. From an economic point of view, if you can buy any of the metals under or near the cost of production and store them, you’ll make money in the long run. You might have to wait longer than you think because markets “can be irrational longer than you can stay solvent.” But all that aside, I do see opportunities. If you want me to pick one, I’ll pick nickel.

TGR: All the metals or nickel?

DM: All the metals should go higher relative to the U.S. dollar, but I think 2010 will be very back-and-forth. Stress levels are high on both sides—the inflationary pressures for governments trying to print their way out of this mess and the deflationary side of the equation because so many countries are on the edge of default.

TGR: What key economic factors are you watching to decide which side of the fence you’ll go to?

DM: The velocity of money. Enough money has been printed to have a hyperinflation in milliseconds, so obviously it’s not a function of the size of the money supply. It’s a function of the velocity of money or how quickly some of it—we don’t know how much—starts moving out of a currency. We’ve already seen it, with India moving into 200 tons of gold, for example. That’s very small relative to the amount of debt out there, but still it’s a very strong signal to the markets about the fact that India values gold over U.S. dollars at this time, and believe me, they are not the only nation that thinks this way.

We could come to a situation of the straw that breaks the camel’s back, some subtle tipping point that the market may not recognize initially. When the Creditanstalt bank went bankrupt, nobody said, “Oh, my goodness, that’s going to take us down and cause a global depression—yet most of us who study such things can point to that as a contributing factor to the Great Depression in the ’30s.

You have to think of it in broader terms than inflation or deflation: are we in the grips of a currency crisis? That’s when you don’t trust the underlying currency. Judging from what we see in the mainstream press, it’s pretty evident that other nations are questioning their trust of the U.S. dollar.

In economic situations such as this, history shows that there’s a price to be paid by everyone. It’s an issue of productive capacity. True wealth isn’t money. Real money is a store of value component. To produce wealth, you have to produce something of value to the marketplace. The productive capacity of the United States has been in decline since 1974. The productive capacity of China has increased substantially from that timeframe to the present day. Today the problem is that the means of exchange is not trusted (longer term) on part of the producer—China in this example. That portends some very serious issues ahead.

TGR: Going back to the undervalued or overlooked resources, in this environment where we don’t know whether to expect inflation or deflation, what sorts of investment opportunities are presenting themselves?

DM: As far as I’m concerned, there’s none better than gold if you’re worried about a crisis hedge however it unravels eventually, either total deflation—a debt-liquidating depression or a hyperinflationary blow-off. Silver has done best in periods of high inflation.

People really get hung up on the inflation-deflation debate, but let’s face it, in both cases there are so many similarities. High unemployment, declining productive capacity, distrust of government, more government interference, general malaise throughout the economy—a great deal of uncertainty.

I would ask anyone who’s worried about this debate to put a silver coin or a gold coin in their right hand and their currency of choice in the left hand and ask themselves, which one has retained purchasing power over time? If you’re going to have savings, do you want the kind that has stood the test of time for thousands of years? Or the type of savings that has always failed throughout recorded history? If you’re not sure, divide it in half. Keep 50% of your savings in your currency of choice and the other 50% in the precious metals.

TGR: If people have cash ready to invest in equities or precious metals, would you say put all of your cash into precious metals now, and then liquidate as you want to invest in various equities? Or keep cash on hand just for equity opportunities?

DM: You can buy the precious metals themselves at almost any time. That’s a different asset class than the mining equities. The mining equities generally follow the stock market to a certain point. Then comes a point—which we haven’t reached yet—when the mining equities start to take on a life of their own. In other words, you’ll see gold and silver mining equities generally going opposite the general stock market. At this time I think mining equities will follow the stock market down. A week or so ago I posted an article on my website about Harry Dent seeing the stock market debacle starting at the end of February. I would not be real quick to jump into the mining equities right now. But if you’re not invested in the physical metal itself, I would definitely buy some. I prefer a dollar-cost-averaging approach to accumulating the precious metals.

And as far as selling the metal to buy equities goes, I would never do that. I’d do the opposite. If I have a big gain on a mining equity—say I made a three, four, five, 10-bagger—I usually turn that in precious metals. I’d rather turn paper into gold than gold into paper.

TGR: You were talking about currency of choice and in this case, gold. A lot of gold investors expect that at some point silver will stop trading as an industrial metal and start trading as a precious metal. A lot of people use the gold-silver ratio as an indicator of how rapidly silver can move up. Do you believe in that ratio and what it portends for silver?

DM: There is a lot made of the silver-gold ratio. Silver probably will reach what I call the classic, or the monetary ratio, which is 16:1. It could even get down to the natural ratio, which at this time is about 10:1, but I don’t see it getting to any better ratio than that. Of course, this implies that silver is undervalued relative to gold.

When will silver take on this monetary aspect alone? That’s part of what I’m writing for the March issue of The Morgan Report. It’s basically looking at the silver market over the next 10 years. We have a 10-year bull market behind us and in my view we have several more years to go.

What happens is at the end of these great bull markets is you get into the euphoric or manic stage and this happens in almost all markets. You’ve seen it in the technology sector, when people were buying dot-com stocks that had no business plan and no equity, just an idea.

TGR: It was the new economy.

DM: Yes. So that will take place. I think we’ll see the biggest run up of all time in gold and silver, especially the equities, a euphoric state of panic buying driven by fear and greed. I’ll probably face a lynch mob me when I say “sell,” because no one will want to trade physical metal for paper currency and I don’t blame them. Anticipating this, I’ve already planned some techniques to use to preserve our physical metal and still allow us to sell to a strong market, but those are days ahead.

When the panic hits, gold probably will go up to $2,000 and beyond—the average person will wake up thinking, “Oh, I’ve got to get gold equities; I listened to my friends and I thought they were idiots and now I see the light.” Many will turn to silver because it’ll still affordable relative to gold.

Significant money will move in to the metals. And because silver is cheaper than gold, a lot of it will go silver, which will cause the ratio to spike relative to gold. You’ll see the ratio drop from 60:1 to 50:1 to 40:1 to 35:1 to 20:1, maybe to 16:1 or 10:1 because there’ll be more money, relatively speaking, moving into silver than in the past. And since silver is such a small market, any small increase in buying power will send the price far higher.

TGR: The way you explain this, these ratios are really only short term.

DM: It depends on where you start the line. One of my earliest lectures, which I still do from time to time, is about the gold-silver ratio. If you go from the 12th century, it’s a 12:1 ratio, which was exactly the natural ratio at that time. In other words, 12 ounces of silver in the ground for every ounce of gold, and that’s basically how it was mined up to about the 17th century.

So the market figured out that 12:1 ratio, and it held up for centuries. We got to the monetary ratio when England was having a problem similar to what the world economy is having today, and during the turmoil of a currency crisis Sir Isaac Newton told the Bank of England to go on a gold standard and they did. He said the correct silver to gold ratio in the new monetary regime was 15.5:1—where the market was at that point. This ratio, roughly 16:1, remained static for hundreds of years.

So does it matter? Yes and no. Once silver was demonetized and deemed an industrial metal, there was no longer a tie to silver as money per se and so it was revalued. The important point is if silver is undervalued or not and if you think it is then obviously it represents opportunity.

TGR: The interesting thing when you bring up the histories of ratios is that silver gets consumed and gold doesn’t. It’s back to the silver as an industrial metal. Silver is also the by-product of mining for other base metals. You’re projecting the economies are not growing over the short term. If silver is a by-product of base metals, should silver production decrease and would that have an impact on silver prices?

DM: Yes, it should decrease and it could affect prices short term. The industrial demand on silver was roughly 35% of the total market in 2000. In 2010, industrial demand now is 54% of the market. The industrial demand for silver is not only the largest demand, but it’s the fastest-growing. But that’s really not totally true because since 2006 you’ve had a huge increase of commercial buying of silver because its investment demand has increased extremely quickly. Since the advent of the SLV, the silver ETF, and other silver ETFs, there’s been a huge amount of money, relatively speaking, moving into the silver market as investment!

So you’ve got the industrial side. Regardless of mining activity being up or down, industrial demand is always off-taking silver and a lot of that off-take never comes back into the market. Recycling is significant, but it’s not total. In some cases, it gets used and it’s gone.

So that is an underlying eating away at the above-ground stockpile. When you throw an increased investment demand on top of that, especially in a small market, you can see an explosive situation approaching. Everybody wants to know when it will take place. I’ve said that the earliest it would take off in that manner is probably 2012 and I may be wrong. Markets do what markets do, but such explosive moves go in phases and we’re still somewhat in the skeptical phase.

For example, some of the people who bought gold above $1,000 are skeptical right now. They’re not sure it’s going to go to $1,200 ever again. I believe it will go far higher, but the longer it wallows between $1,200 and $1,000, the more likely these people are to listen to their friends, neighbors and brokers and say, “Gee, you know, gold isn’t a good investment. I’ve held it for a year and it’s gone nowhere. Put me back in the Dow or something.” Even worse, if we do break the $1,000 level, which I doubt but it could happen, they’ll be very unsure and probably will sell back into the market, causing it to depress in price further for a short time.

TGR: How do you see nickel, which you brought up early on, play out in scenarios you’ve been talking about?

DM: I believe all commodities are in longer-term trend upward. If you dig into the archives, I made a good call in the early 2000s on the Financial Sense Newshour with Jim Puplava. I said the new era is here. We’re going from an era of having things we want to an era of having things that we need. Of course, we need food and shelter and raw materials. Those needs will continue. So do we need nickel in the future? You bet. It’s used primarily in stainless steel. If you’re going to build any food processing plant—and there are always more mouths to feed—you’ll use a great deal of stainless steel. And that’s not the only application.

You can play nickel, other metals or any commodity or stock short term if you wish, but I like to take the major trend and stick with it because that’s where you could make substantial money. Certainly some traders can do extremely well. But really successful traders are very rare and most people don’t have nearly enough discipline, because you have to be willing to take loss after loss after loss after loss. Even if they are small losses, psychologically that’s very difficult. Most people are not suited for it. They can’t handle the stress that comes with a trading strategy.

TGR: Some people suggest the equities because there’s substantially more leverage, thus more upside than with the metals themselves. What’s your feeling about equities at this time and are there any equities you’re looking at that represent good opportunity?

DM: We put out something in the rare earth elements (REE) area recently and it’s a speculation, so it falls in the class of fun money or money you can afford to lose. It’s a very hot sector right now. I believe it’s fairly safe to invest in, as safe as you can be in a speculation. But overall, right now I think it’s a good time to build cash. The next couple of months bear watching. I like the old adage: when in doubt, stay out. There’s nothing wrong with staying out of this market right now and if the market tells us something we have techniques for getting in quickly.

TGR: But when you buy, you like the undervalued stocks.

DM: We always like to buy bargains. I like to invest for value. If I find something worth $10 and can buy it on sale for $5, that’s when I’m more interested in making the purchase. I have people who bought Silver Standard Resources Inc. (NASDAQ:SSRI) at under $1 and now it’s at $17. They’re probably not happy if they didn’t sell some at $40, although some have. But how can you be unhappy about a 17-bagger over 10 years? On the other hand, if you just came into this sector and bought it at $20 or so a few weeks ago, you’re going to be unhappy now that it’s sitting at $17.

My timing is more of an intermediate-term basis. I cannot day trade; it just doesn’t interest me. But longer term, yes, timing can definitely help you, but you have to really know what you’re doing and no one can get it right all the time. So for the average investor a dollar-cost-averaging approach makes the most sense. Technical analysis is a very useful tool, but you can’t rely on it 100% and I’ll give you a quick example. There is no charting service or no human being that can make a 100% accurate case because you can’t chart, for example, where a 9/11 event is going to take place.

My approach is to hold about 75% of the total precious metals stocks through thick and thin. And the other 25% can be traded in and out of the market.

TGR: You suggested that you like to find $10 stocks that are on sale for $5. Do you have any companies that fit those criteria now that you’re watching?

DM: Not at this time, at least not at that big a discount, but I just returned from Phoenix where I gave a lecture on the mining cycle. If you look at Minefinders Corporation (MFN) and you look at the mining cycle, we bought that stock at around $1 and sold it at $13 right at the top. That’s a classic. It’s a good value at this point in time and I believe as things progress, it’s undervalued now. Based on my lecture people will have a pretty good idea where this company could go over the next several years. Buying MAG Silver Corp. (MVG) is discounted by the market right now, but that one could be discounted more.

TGR: What makes these two companies undervalued at this time?

DM: It’s their internal rate of return. It’s the growth rate of their assets, which are precious metals. People get hung up on the dollar price of the metals. As an example, if you started off in 2000 with 10 ounces of gold and you ended up in 2010 with 50 ounces of gold, by definition you’re wealthier because you own more gold. The price variation is very significant to most people, but in the big scheme of things, it is not that important because gold is wealth and you have more of it. In other words your real wealth has increased regardless on a temporary paper price.

It’s the same with a mining company. If it has more wealth in the ground or is producing more wealth above ground, that’s what you need to focus on. Markets are very psychological and emotional, so what you want to focus upon is the increase of book value per share and you want to see how the company’s growing internally. If the market price doesn’t reflect the increase in book value on an annual basis—that would be an undervalued situation.

Let me say that I don’t want anyone to jump in to either of these companies just because I think they’re undervalued. I believe they are, but it doesn’t mean that they can’t be more undervalued. Still, if you like those, you can take a beginning position. If you want to own a lot of one of those companies (as an example) and don’t do technical work or subscribe to a newsletter or whatever, just take a long-term view and dollar-cost-average your purchases. If you have a disciplined rational approach and know it’s undervalued now and you buy it, you want it to go lower because you know you’re buying value. Instead of being upset about your loss when it goes lower, you say, “Fantastic! I’m not buying that $10 stock for $5. Now I’m able to buy it for $4.” And then next month comes along and you can get it for $3. You are ecstatic because you know what you’re doing. The problem is some people use this technique in stocks that have no real value, that is a huge mistake and too common by the way.

TGR: Good words to the wise. Are there any other undervalued situations that you can share with us?

DM: Again, I want to keep my integrity and value to my members but longer term, Great Panther Silver Limited is a very strong company with a good return rate. First Majestic Silver Corp. (FRMSF.PK) is a big growth story. SilverCrest Mines Inc. is very near production. Fortuna Silver Mines Inc. (FVITF.PK) is another company with good assets in the ground and probably not a very well-known story because they’re not very promotional.

So Fortuna, Great Panther, First Majestic, SilverCrest, MAG, Minefinders, and then one that I’ve come back to. I was first on the Silvermex Resources Ltd. story. Silvermex is good. We got in probably at the initiation of the company and then the credit crisis hit and we basically were stopped out of the stock. They’re moving toward production. It’s probably a higher risk than, say, some of these other companies that are producing metal or will be shortly. I wouldn’t consider it particularly undervalued at this point, because we haven’t had a long enough history on the company as an up-and-coming producer. And again, all these are speculations in my view, although almost all of them actually mine metal.

TGR: Very good. David, I really appreciate your time. Once again, you’ve been a wealth of knowledge and insight.

DISCLOSURE:
1) Karen Roche of The Gold Report conducted this interview. She personally and/or her family own none of the companies mentioned in this interview.
2) The following companies mentioned in the interview are sponsors of The Energy Report or The Gold Report: Minefinders Corp., MAG Silver Corp., Great Panther Silver Limited, First Majestic Silver Corp., SilverCrest Mines Inc., Fortuna Silver Mines Inc. and Silvermex Resources Ltd.
3) David Morgan—I personally and/or my family own shares of the following companies mentioned in this interview: MAG Silver, First Majestic, SilverCrest and Silver Standard. I personally and/or my family am paid by the following companies mentioned in this interview: None.

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Introduction – Development Transitioning Into Production

Great Basin Gold (GBG) is a development stage gold junior bringing two Gold mines in disparate parts of the world into significant production this year. The first mine, Hollister, is a high grade epithermal vein type deposit in the Carlin Trend in Nevada. The second mine, Burnstone, is a new development mining a shallow uplifted segment of the Gold-laden conglomerates of the Kimberly Reef structure in Balfour, South Africa. Great Basin has overcome economic and technical challenges to bring these mining developments close to production. As the company turns the corner to profitability, the investment world may pay attention and support the share price higher.

Situation Analysis – Two Mines Coming Into Production

Pre-production Investing

Great Basin Gold has endured and survived the difficult path of bringing a mining prospect into production. In the mining world, out of hundreds of prospective properties, only a select few overcome the myriad obstacles to become a producing mine. This difficult task of successful mine development is multiplied by two, as GBG is bringing two different complex mining projects into fruition. For a detailed look by the author at GBG’s two mining properties see “Great Basin Gold – Jump to Mid-Tier Producer”.

Low Risk/Highest Reward Investing Prior to Production

As detailed in the classic mine development article, “The Second Best Time to Buy a Mining Stock”, investing in a mining stock as “it is being readied to go into production provides some of the lowest risk/highest reward mining industry investment opportunities.” See the Classic Model of Production Startup chart following. GBG is between Step #6 of Development/Construction and Step #7 of Production Startup.

Figure 1 – Classic Model of Production Startup – Note the ramping up to production brings share price appreciation. Source

For investing in Great Basin Gold, this strategy of pre-production investing is leveraged, as there are two actual mines coming into official production. Each mine is in separate regions of the world and may complement each other to enhance results and back each other up to reduce the total risk for the investor.

Risks and Challenges of Mine Development

Great Basin Gold warns that “GBG is currently developing two mines, with all the risks, challenges and caveats associated with the delivery of new capital projects” (.pdf), in their February 25, 2010 Interim Report. This declaration is standard for mining development, as there are huge risks with unknowns and roadblocks along the project path. However, an examination of GBG’s February 25, 2010 Interim Report detailing their capital expenditures along with their progress reports indicates that the majority of the risks and unknowns may now be behind them.

The Burnstone project in South Africa has estimated capital requirements of $235 million USD with $147 million spent as of December 31, 2009 and $88 million to be spent by June 2010. The remaining expenditures are for mainly for the construction of the surface process plant and further mine development. Burnstone is now developing access to the ore blocks, with over 1000 meters of the reef bearing ore exposed. See the photograph following of the exposed “Kimberly Reef” in Block B.

Figure 2: Kimberly Reef Ore Exposed for Mining Development. Note the distinct appearance of the ore bearing reef layer that will be mined.

Assays of the ore exposed in the on- reef development match GBG’s expectations.

The Hollister project in Nevada has estimated capital requirements of $110 million USD with $95 million spent as of December 31, 2009. Hollister is essentially completely developed, only waiting for the permit to switch from test mining to production mining. Hollister is concentrating on maximizing the high grade ore and minimizing dilution with waste rock.

The key words for this author in examining GBG’s Indaba Presentation of February 3, 2010 (.pdf) are that GBG is “Trial Mining” at Hollister and that GBG has “ 60,000 ore tons on stockpile” at Burnstone. This indicates that the long and strenuous development cycle is nearing fruition and demonstrates that the mine development is now transitioning into production tuning, in order to manage the costs and profitability of each production process.

Further Challenges Impacting GBG’s Stock Price

South African Nationalism

The militant African National Congress (ANC) youth wing have persistently called for nationalization of major South African businesses, starting with mines. On February 1st, 2010, the ANC youth again made headlines with their demand for nationalization of South African mines. On February 2nd, 2010 the Mineral Resources Minister Susan Shabangu rejected calls from the ANC’s youth wing saying “Nationalization will not happen in her lifetime.” Later, South African President Jacob Zuma stated that Nationalization is not government policy, in an effort to calm the business world.

The threat of nationalization does cast a pall over GBG’s share price, whether real or perceived. The investor needs to make their own decision as to the investment risks here.

Possible Upsides Impacting GBG’s Stock Price

Esmeralda Mining Development

Great Basin Gold acquired the Esmeralda Mine property in 2008 mainly for the production milling equipment on site. The property also contains an existing mine that may be restarted.

Great Basin Gold gave a hint of possible re-development of the existing Esmeralda Mine in their February 3, 2010 Indaba Presentation:

• there is an opportunity to access areas where development is complete, rehabilitation is minimal, and the ore is high grade, providing a low cost mining start up.

• revenue generated from bulk sampling will be utilized to offset the cost of the initial underground drilling, mapping and sampling programs

A low cost entry into another production property for GBG would be a bonus.

Monetizing of 40 k oz. Gold in Hollister Stockpile

Great Basin Gold has an existing stockpile of high grade ore from Hollister, as described in their February 25th, 2010 Investor Presentation. See the chart following detailing the ore stockpile at Hollister.

Figure 3: Hollister Ore Inventory Stockpile. Note the 44 k oz. of Gold contained as of January 31, 2010.

As this stockpile is processed and monetized, this will provide additional cash flow for Great Basin Gold.

Status – February 25, 2010 Conference Call

Great Basin Gold gave an interim report for investors on February 25, 2010 in a conference call. The bulk of the call gave details of progress in the Burnstone mine development.

The new item of GBG production guidance is detailed in the chart in Figure 4, following.

Figure 4 – GBG 2010 Guidance. Note the estimated 195K Au oz. recovered at a cash cost of $480 USD per oz.

Barring an unforeseen catastrophe and given the existing production profile and the depth of management expertise at Great Basin Gold, the forecasted production appears achievable.

Summary

Great Basin Gold is uniquely positioned to bring their two mining projects of Hollister, Nevada and Burnstone, South Africa into production in 2010. Hollister is projected to deliver 135 k oz. of Gold this year. Burnstone is expected to deliver 60 k oz. of Gold this year. GBG’s guidance calls for 195 k oz. of Gold production in 2010. As Burnstone ramps up, GBG is expected to double this production to approximately 380 k oz. annually.

The bulk of the risks and uncertainties with mining development have now been largely mitigated and overcome by GBG to bring their two mines on-line. At Hollister, GBG has essentially been mining for over one year in all but name as trial mining. The mining processes are focused on costs management by minimizing rock waste and preserving the high grade gold ore content. GBG reports an average grade of 1.23 Oz/ton (42 g/ton) Gold extracted in Quarter 4, 2009. GBG is now reporting the pouring of Dore bars for sale at Hollister.

At Burnstone, the pre-mining development is focusing on developing access to the ore stopes of the Kimberly reef. They have developed a 60 k ton stockpile of lower grade ore (est. 5 g/ton). The strategy that they are pursuing is to provide multiple accesses to the different ore blocks for future mining when the mill is operational. At Burnstone, GBG is also focusing on minimizing the waste rock handling to reduce their operating costs.

The major capital expenditures are now nearing the end for GBG. GBG is fully financed for completion of their two mine developments. Revenue has started at Hollister and will start in the second half of 2010 for Burnstone. GBG is planning to produce about 200 k oz. of Gold for 2010 and is focused on delivering this by managing and tuning their production processes.

Recommendation

Great Basin Gold’s share price has dipped recently in response to a pull back in Gold prices and also due to the perceived political risks of a mine in South Africa. This creates an opportunity for investors that may be interested in a mine developer that is transitioning to mine producer. The startup of revenue for GBG with the ensuing profitability may create new interest in the investment world. The author believes existing news and perceptions are already priced in to GBG’s stock price and the forthcoming good news with production increases will move the share price upwards. A method of leveraged investment by warrants in Great Basin Gold is detailed in a previous article “Great Basin Gold – Follow the Flood for Fortune”.

Disclosure: Long position in Great Basin Gold

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INTRODUCTION

S&P 500 01 FEB 27

The Prior Week

Little changed as markets groped for direction from the forces discussed below.

The EU debt crisis remains the overwhelmingly big story–Greek bond fiasco may signal that the PIIGS are already beyond help.

Still no concrete plan from the EU, as Northern European leaders are reluctant to commit political suicide, with their voters in no mood to pay for Greek mismanagement, lying, corruption, and tax dodging. Greece is virtually certain to default within a month without help.

The alternative to a bailout may be worse. However, it may also be unavoidable anyway. Even if Greece could be bailed out for now, could Italy and Spain, with their much larger debt loads? Once one of the PIIGS block defaults, the others are likely to be shut out of bond markets, which will seek compensation for risk at rates too high for the PIIGS to afford.

Is the real plan to arrange for ‘orderly’ default, simply because it is likely inevitable?

In Europe, the sovereign debt crisis is steadily metastasizing as long as it is going untreated, and although the spotlight remains on Greece, contagion fears are lingering as both Spain and Italy owe far more and are not getting their deficits as percentages of GDP down.

Up to €5B in 10-year Greek bonds were expected to be priced this week in a key test of investor appetite, but the 10-year Greek spread versus Bunds deteriorated back towards the 350bps area, forcing Greece to postpone the sale. Is Greece, and the PIIGS block, already beyond saving?

Time is running out, as the Greek PM himself confirmed that the country’s borrowing needs are only covered until March.

Meanwhile, neither debtors nor potential rescuers have shown the will to bear the pain associated with any realistic solution.

If any EU member defaults on its bonds, the resulting rise in risk aversion could send EU sovereign bond prices plunging and demand yields soaring to rates these countries can’t afford, effectively shutting them out of the bond markets and setting off a wave of defaults. Greece’s de facto failure to sell bonds may mean PIIGS are past the point of saving.

If Lehman Brothers’ collapse was enough to ignite the market crash in the fall of 2008, imagine how markets will react to an entire chunk of the EU rolling over?

EU’s Pain is America’s Gain

The US continues to benefit from the EU debt mess, which continues to keep fear levels high, and demand for safe haven US Treasuries brisk, questions aside about who is actually buying. Yields moved markedly lower despite $118 in coupon supply this past week.

Bond prices were also buoyed by a swath of generally softer than expected economic data.

This may be fine for now, though the consequences of a wave of Southern European defaults could spark increased borrowing rates for all governments and easily crash asset markets once again. We question whether the rest of the world will be able to stand aside. See Here’s Why Southern Europe Will Not Be Allowed to Default for details

STOCKS

Markets whipsawed lower then higher this week in an atmosphere of uncertainty as conflicting headlines out of Europe on Greece and mixed US data kept trading unsettled.

For the week, the DJIA dropped 0.7%, the Nasdaq declined 0.3%, and the S&P500 fell 0.4%.

COMMODITIES

Oil

Crude oil recorded the first weekly decline following rises over the past 2 weeks. We expect oil to remain between $60-$80 for the foreseeable future, though extreme bouts of fear or concerns about supply from geopolitical tensions could send it beyond these ranges.

Gold

On a weekly basis, gold price slipped -0.265 to 1118.9.

Although we remain long-term bullish in gold, the precious metal is expected to be range-bound in the near-term.

Moreover, global inflation remains benign, undermining demand for gold and oil, as both are used as US dollar hedges.

FOREX

Despite an optimistic start, by mid-week risk aversion came back due to the various developments cited above benefitting the USD and JPY. Slumping US consumer confidence, the Fitch downgrade of Greece’s four largest banks, warnings of more EU credit ratings downgrades, the FDIC’s troubled bank list and more dovish comments from the BoE were all factors.

US Dollar Weekly Outlook: Supports For Longer Term Upside Remain, Short Term Overbought Drop Possible

US Dollar Bias: Bullish

• Events: Mon-Personal Income, Spending, ISM Mfg PMI, Wed-ISM Non Mfg PMI, ADP Non-Farms Payrolls Thurs-Pending Home Sales, Fri- Non-farms Payrolls Change, Unemployment Rate.
• US Dollar range trades with S&P 500 reflecting market seeking direction from EU debt resolution, China growth. EUR/USD ends week almost unchanged near 9 month lows above 1.3600. If there is an oversold bounce, attempt to resell around the 1.3850–3950 area.
• EUR/USD long term average is 1.18, so easily could drop to that or lower as long as EU debt crisis remains unresolved.
• Packed news week ahead, but USD could benefit from both good and bad news as both safe haven and also rise if jobs data raises expectations for tightening, rate increases.
• EU debt mess still the primary USD driver barring major surprises in US economy.

Euro Weekly Outlook: Greece Unable To Attempt Bond Sale – PIIGS Condition Already Terminal?

Euro Bias: Bearish

• Events: Mon- EZ Unemployment Rate, Tues- EZ CPI, PPI, Wed- EZ PMI Services, German Retail Sales, Thurs- EZ GDP, ECB Rate Announcement, Press Confr. Fri- German Factory Orders.
• Rating agencies Moody’s, Standard & Poor’s warn of another Greek downgrade.
• German business confidence contracts for the first time in 11 months through February.
• EUR/USD maintains its steady down trend, as Greece faces default w/in a month, yet EU lacks both plan and will for a real solution to Greece and other debt woes.
• One default should be enough to shut rest of PIIGS block out of bond market (if they aren’t already) as fear sends borrowing costs too high, sending all to default. Greece unable to sell bonds this past week due to high rates – are PIIGS already terminally ill?
• Even if the Greek rescue is successful, what about the much larger debts of Italy, Spain?

Other FX

GBP: In the UK, the BoE discussed the merits of increasing the scale of its asset purchases program and kept talking down the pound ahead of a policy meeting next week. Sterling slumped of off highs around 1.575 as dealers absorbed the dovish comments from BoE testimony in parliament on Tuesday. Each of the BoE members seemed to mention the benefits of weak sterling over and over again and dealers took the point.

The BoE rate decision and comments this week could move pound, especially if more hawkish than expected, as the pound is due for some kind of bounce.

JPY: Japan reported consistently strong economic data this week. The yen also benefited from risk aversion and the unwinding of historical carry trades, as well as chatter that the pending Dai-ichi Life IPO (set to be largest in Japan since 1997/98) was receiving overseas interest, which could generate short term yen demand. Rumors that China may revalue the yuan also helped hopes for Japanese exports, which would then become more competitive. JPY hit 11-month highs against the euro and pound pairs.

CHF: Moving opposite the USD, with the EUR, as the SNB tries to keep the Swiss Franc from rising vs. the euro in order to preserve Swiss exports to their prime market, the EU. PIIGS default may mean risk aversion overwhelms the SNB as cash seeks safe haven currencies.

Commodity Dollars- CAD, AUD, NZD: These do not lack their share of data, but are likely to move with the below market drivers for the coming week. The RBA rate decision and comments could be influential, but more likely to the downside unless it is bullish enough to suggest more rate increases coming.

Otherwise, the below listed market movers are likely to overwhelm local news from these economies.

The Week Ahead Key Market Drivers To Watch – Bias To Continued Risk Aversion

The Big Two: EU Debt and US Jobs Data

EU debt related events remain a primary market driver, perhaps the only events risk that can seriously challenge Friday’s US jobs reports and related news leading up to it throughout the week. Be particularly alert for any attempts by the PIIGS to sell bonds, CDS rates on these, and news of rescue plans. No reason to expect any serious improvement, though something to buy time for Greece and the EU through the coming months is possible and relatively cheap, especially compared to the alternative.

As we’ve noted in The Week Ahead: The Key Idea For Profiting, the US Dollar could well benefit no matter what the outcome of US jobs reports and data leading up to it.

Other Potential Market Moving Events

• Rate Decisions: The two central banks that have the greatest potential for altering monetary policy will convene this week in the RBA and BoE which could initiate new trends in their crosses and should garner the focus of markets.

• Data on Chinese growth: Including official and HSBC Manufacturing PMI

• Confirmation of a new general election in the UK could add uncertainty to the already fading British Pound.

Disclosure: No Positions

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Avoid Surprises. Expect the “Unexpected.”

If it weren’t so sad, it would be amusing to see the financial headline writers’ competition to feign the most astonishment when the most obvious news is reported.

Thursday it is the “surprising weakness of jobs data” (Marketwatch). A couple of days ago it was the “unexpected plunge” in the Consumer Confidence Index from 56.5 in January to 46 in February.

Why should any of this be “stunning”, “shocking”, or some other hyperbolic bolt from the blue? Here’s a news flash for those headline writers and the commentary that inevitably fills page after page beyond the headline:

• No market goes straight up forever.
• No market goes straight down forever.
• No market goes in either direction in a straight line.

“Surprising news,” good or bad, often acts merely as the catalyst that may add a bit more amplitude to what the market was going to do that day anyway, but it gives the talking heads on TV something more concrete to say than, “Ummm…I don’t know why the market moved. I guess there were more sellers than buyers today?”

The market always ratchets its way up and down just enough to confound those who think there is some simple way to make money in the stock market, like “I just find some technician who knows when it’s going to go down and I short. Then when my guru tells me to go long, I buy and make money on the upside!”

Many investors read financial articles in print or the Internet because the author validates their opinions. If one has a “bullish bias” it makes us feel good to read some expert who tells us we are correct, that, say, the market is bound to rise. Or vice versa. If they write well or are entertaining we give them even more credibility.

But I’d like to suggest an alternative. Whether the author agrees with your bullish or bearish bias or not, whether they write well or not, whether they are entertaining or not, just doesn’t matter. In fact, I look for writers who disagree with me. They are the ones from whom I might learn the most! Instead of seeking writers who agree with you, especially at a site like SA, where the contributors’ track record is there for all to see by following the chain of their previous articles, find writers, advisors, brokers, et al, who make you money.

Yet, I’ll wager that many folks who read an article they like or see a stock recommendation they agree with, buy it based on the strength of the author’s writing and/or convictions without ever even looking at their last dozen or hundred articles to see if a single one of those previous recommendations worked out!

Isn’t that why we invest? Isn’t that why we read Seeking Alpha, consult other websites, read the Wall Street Journal or Barron’s, or other financial publications? We figure that’s why the subscribers to our financial letter subscribe to our publication and not someone else’s.

Forget all the hyperbole and fluidity of writing style and just ask, “Which gurus, experts, CNBC talking heads, CEOs, companies, financial advisors, and writers make me money?”

At the advisory firm I am Chief Investment Officer for, we were not “surprised” by the consumer confidence numbers or the employment report. Not because we have a crystal ball that is any less cloudy than anyone else’s but because we expect surprises. We expect our national government leaders to massage the numbers to get themselves re-elected. We expect those numbers to be revised weeks or months later when they are buried on column 6, page 6 and lost in other, more recent news. We expect the market to fluctuate day-to-day rather than for today to be a mere continuation of the trend from yesterday. And we invest accordingly.

Regular readers of our articles know that we ratchet our investments just as the market ratchets its movements. We don’t go “all in” because some magic – and arbitrary – number is reached or panic out because of some piece of news. And lately we’ve been ratcheting down because we’ve become uncomfortable with the current market.

A market that can’t go up – will go down. So on January 8, we sounded the warning on bonds and began selling out our long bond positions and began buying inverse ETFs on long Treasury bonds (here).

On January 11, we sounded the caution signal for muni bonds in particular (here).

On January 17, in “Something Wicked This Way Comes” we continued to “ratchet” down our market exposure and buy some positions that would better prepare us for any decline (here).

And so on and so on until our most recent article stating that index investing may be dangerous to your wealth! (here)

Do we have a crystal ball? No. But we believe that preserving capital comes before risking capital in order to maximize one’s reward. So we invest as if the following were true:

• No market goes straight up forever.
• No market goes straight down forever.
• No market goes in either direction in a straight line.

“Surprising news,” good or bad, often acts merely as the catalyst that may add a bit more amplitude to what the market was going to do that day anyway.

So we ratchet in and we ratchet out. We are seldom “surprised” by a “sudden turn of events” this way, and we and our clients sleep better at night. Right now we are positioned out of bonds, but in income-producing securities; for anticipated volatility; for the unexpected crisis or two that will send investors fleeing to gold and other safe havens; and for the likelihood that there will be some terrific bargains down the road. Here are some thoughts for your further research….

For income, we have been buying coal “royalty” firms like Natural Resource Partners (NRP) and Penn Virginia Resources (PVR), holding on to 50% of our pipeline MLPs like Magellan Midstream (MMP), Boardwalk (BWP), Enbridge Energy (EEP), Kinder Morgan (KMR), and Buckeye (BPL) and a couple Canadian Royalty firms Enerplus Resources (ERF) and Pengrowth (PGH), as well as some Canadian banks like Canadian Imperial Bank of Commerce (CM) and Royal Bank of Canada (RY) and utilities like Atlantic Power (ATLIF.PK), as well as selected foreign telecoms like New Zealand Telecom (NZT), France Telecom (FTE) and Deutsche Telecom (DT). [To which I must add, thanks to an astute reader who asked about the absence of a previous recommendation in this list, also Bell Canada (BCE).]

Against the probability that yields will rise and bonds will fall we’ve bought the iShares TIPS Bond ETF (TIP), the ProShares UltraShort 20+ Year Treasury ETF (TBT) and the Direxion Daily 30 YR Treasury Bear 3X (TMV) – recognizing the inherent volatility of leveraged ETFs in these latter two.

The way we’ve chosen to play the possibility of extreme volatility is via the iPath S&P 500 VIX ETF (VXX). Since most people will wait to sell until all others are selling, we’re betting, via VXX, that volatility will rise.

In the precious metals / crisis protection arena, I provide for your further research Goldcorp (GG), Kinross (KGC), Agnico Mines (AEM), and Yamana Gold (AUY), as well as the royalty firms Franco-Nevada (FNNVF.PK), Royal Gold (RGLD) and Silver Wheaton (SLW). (For more on what makes these last three unique, see here.)

Finally, for those bargains I expect down the road, we have a solid cash position. This will harm us if the market roars ahead as it did in 2009 and we are on the sidelines with up to half our funds – but it will keep us in good stead in any other scenario.

Author’s Disclosure: We and / or clients for whom these investments are appropriate, are long BCE, NRP, PVR, MMP, BWP, EEP, KMR, BPL, PGH, ERF, CM, ATLIF.PK, CM, NZT, FTE, TBT, TMV, TIP, VXX, GG, KGC, FNNVF.PK, RGLD and SLW – while maintaining a very large cash cushion.

The Fine Print: As Registered Investment Advisors, we see it as our responsibility to advise the following: We do not know your personal financial situation, so the information contained in this communiqué represents the opinions of the staff of Stanford Wealth Management, and should not be construed as personalized investment advice.

Also, past performance is no guarantee of future results, rather an obvious statement if you review the records of many alleged gurus, but important nonetheless – for example, our Investors Edge ® Growth and Value Portfolio beat the S&P 500 for 10 years running but did not do so for 2009. We plan to be back on track on 2010 but then, “past performance is no guarantee of future results”!

It should not be assumed that investing in any securities we are investing in will always be profitable. We take our research seriously, we do our best to get it right, and we “eat our own cooking,” but we could be wrong, hence our full disclosure as to whether we own or are buying the investments we write about.

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