MONEY, METALS AND MINING

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MONEY, METALS AND MINING Published by: David Morgan Excerpt from May 2009 Morgan Report Gold Fields Mineral Service (GFMS Ltd) published a document on the Silver Investment Market in late April 2009.

1 MONEY, METALS AND MINING Published by: David Morgan Excerpt from May 2009 Morgan Report Gold Fields Mineral Service (GFMS Ltd) published a document on the Silver Investment Market in late April I carefully went over this report and will offer some comments, but my main analysis this month centers around the fundamental case for silver. Both GFMS and CPM Group will be issuing their respective reports on the silver market shortly. Being a proponent of true free markets, not the version that is spun by way of the mainstream financial press, we only need to go to Ayn Rand of fame to check our premises and verify that we have not overlooked something or assumed something that is not valid. First, we must define what we are trying to prove or at least examine, and this is simple (not easy): just how tight is the current silver supply? Before delving deeper it is absolutely essential to define our givens. Givens: the bases for this analysis The silver bullion market will be examined Allowing for the amount of commercial grade silver per CPM Group Coin market will be mentioned but not pertinent to this analysis As mentioned to our readership, we examine the bullion market more carefully, because this is the market that sets the price for silver. Yes the coin market is an important aspect of the silver market, making up roughly fifty percent of the total, but this silver is not deliverable against a COMEX contract or London Bullion Market Association (LBMA) position. There are two main studies on the silver market. I have both and have read them for years. One is produced by CPM Group of New York, and this year s CPM Silver Yearbook 2009 is due the 28 th of April. The other is sponsored by the Silver Institute and is produced by GFMS of the United Kingdom. Your editor has met and spoken with the principals of both of these organizations at a face-to-face level. Although no one in this industry knows the true amount of physical silver bullion existing in commercial form (1000-oz. bars), we need to begin our analysis at some point. Therefore rather than give you my opinion of how much exists, let me cite the two best-known studies on the silver market. According to last year s study by CPM in their Silver Yearbook 2008, page 17, the Estimated Silver Bullion Inventories, Year-End, were less than 400 million ounces. However, this year s study, just released, put the figure at nearly 600 million ounces. This is primarily due to increased silver production and increased recycling. As we can see (chart on next page), according to CPM there is approximately 600 million ounces of fine bullion available. Now before moving onward, we must examine what GFMS has to state about total silver bullion inventory, and here we find a much larger number, primarily about 200 million ounces more in fact. While reviewing all the data for this segment over the weekend, it suddenly dawned on me that we can arbitrarily add 200 million ounces at any point in time because this is the float of recycled silver each and every year. Specifically, the amount of silver recycled in 2008 was closer to 250 million ounces per the new CPM report. You can thrive in down markets, if you know where to look and when to move. It's what David Morgan does every day, loves to do, and why he shares his insights through the Morgan Report. Click link below to sign up...

So, it does not make either of the studies right or wrong; it just helps to explain a wide fudge factor in the data. Let me be very clear: this is my take on the matter and is NOT that of GFMS.

2 So, it does not make either of the studies right or wrong; it just helps to explain a wide fudge factor in the data. Let me be very clear: this is my take on the matter and is NOT that of GFMS. I only wish to keep this discussion as fair and open as possible without resorting to bookkeeping entries of silver. In other words, a great deal of silver over 200 million ounces is always in the recycling pipeline as film, scrap, or as many may not know liquids. Going a bit further, people who are very studied on the silver market may recall that in March 2006 an article was penned about the debate between Jeffrey Christian of CPM Group and Philip Klapwijk of GFMS concerning silver inventories. Without going into all the details, the GFMS survey has maintained that more silver is available than the CPM Group but cannot point to it, and my bias is to that which can be proven. For the purposes of my analysis I will take the best case scenario and use the 600-million-ounce case of commercial grade silver. Again, you can use any number you wish. The purpose is not to determine exactly how much silver exists in commercial form, and the main purpose is to give a strong indication of just how tight the silver market is at present. Known: Barclays ETF, 270 Million Ounces Zurich Cantonal Bank, 44.6 Million Ounces ETF Securities, 17 Million Central Fund of Canada, 58 Million Bullion Management Group, 5 Million COMEX, 116 Million Total: 500 Million + Basically we have very little silver that is not accounted for as investment silver. This gives us a very clear message that the market must be very tight presently. COMEX is only about 20% of the total market yet it has a huge influence, as does the LBMA, because of the massive amount of paper contracts bought and sold on a daily basis. If we look forward we must consider that if new purchases of silver are going to continue, and that is a very 2 THE MORGAN REPORT May 2009 Copyright 2009

3 reasonable assumption, at what point do we start to see delivery delays and/or price increases? The first Silver ETF was introduced in April 2006, so in three short years we have gone from 130 million ounces (what SLV began with as their projected allotment ) to 331 million ounces. This yields a total increase of 200 million ounces in three years time. If the silver demand continues unabated for three more years at a similar pace, where will the silver come from? (Note: 331 is the total of Barclays, Zurich, and ETF Securities combined.) Central Fund of Canada recently added another $210 million in mid April to purchase more gold and silver bullion. Additionally, all the others mentioned above Barclay s, Zurich Cantonal, and ETF Securities added to their holdings the past two months. Increased investment demand is expected to continue for several years into the future as more people seek silver to diversify their holdings into precious metals including silver. According to Gene Arensberg of the report, as of Friday, April 24, Barclay s Silver ETF (SLV) still had not filed an amendment with the SEC either naming an additional custodian or increasing the amount of silver storage available under the current custodian agreement with JP Morgan Chase London. The current custodian agreement was for up to 264,550,265 ounces. We, as everyone else who tracks the silver market closely, are interested to see when a new custodian is named and how much silver storage they will be able to provide. Some of us think that the 270 million ounces held by Barclay s represents nearly the entire amount of silver available for investment purposes in London. Thus it may become difficult for SLV to find more sources of silver with enough room to store a larger expansion of the fund s holdings. In the meantime COMEX inventories fell mostly from the registered category (dealer s inventory). HSBC, one of the main COMEX-approved warehouses, saw about 8 million ounces leave their facility within a week s timeframe in early April. The explanation is due to the strike at Peñoles s refinery in Torreon, Mexico. The strike ended near the end of April and it will be interesting to watch if COMEX inventories build back up to the previous level of 135 million ounces held near the end of last year. The key driver will be investment demand and we have now taken a look at the bullion or commercial bar investment demand, but coins are a very important component of silver demand. Silver and gold coin demand has never been greater. All of the main retail and wholesale dealers that we speak with have told us basically the same story product is hard to come by, and the premiums remain high. However, as we go to press, it seems that things have started to loosen up and some sellers are coming into the market and premiums are starting to soften. The overall coin market for silver is approximately five percent of the total demand, but it is additive. This means that over the past several years, people have been buying and saving their silver coins. The Silver Eagle program is basically on fire; last year in March (2008) Silver Eagle sales were 1.8 million, this March (2009) Silver Eagle sales were 3.1 million. Year-to-date sales of Silver Eagles through March is over 7 million ounces. The U.S. Mint basically cannot keep up with demand and has put some restrictions on dealers as to the time and amount of product they can obtain. The total coin market represents about 500 million ounces, which is roughly half of the entire amount of current investment based silver counting both coins and bars. In our exercise, we just examined that nearly all the commercial bars are accounted for, and the coin market is an even tighter market currently. Most coin buyers today buy silver coins, hold them, or buy more. This was not always the case, however! During the last larger run-up in silver through the 1970s to the final top in January 1980, many investors bought silver bags, coins, and bars. As many of these investors either died or gave up, much of this silver returned to the market either by widows, family members, or stale investors looking for another opportunity. It took quite some time for this silver inventory to work through the market. However, it did, and both the silver studies conclude basically the same idea that the silver market went from net retail sellers to net retail buyers a few years ago. Nothing proved this fact better than the extremely difficult time getting 100-oz. bars, coins, or silver rounds of silver last summer. This was proof beyond a shadow of a doubt that the silver market had become a market where there were far more buyers than sellers, and new product had to be obtained to meet demand. This caused a large move up in premium in all silver investment products, including junk bags, which normally have a very low premium and once in a while can sell at a discount. Copyright 2009 May 2009 THE MORGAN REPORT 3

4 In my view the silver market really did not start this bull market until September of These major bull markets normally go for ten years minimum, with a great shaking out somewhere along the path, as we are now witnessing. The biggest encouragement is the fact that investment demand for physical silver continues. Remember that every Silver Eagle, Maple Leaf, or any government-minted coin starts its life as a 1000-oz. commercial grade bar that is melted down and fabricated into a coin. In other words, coin buying actually cuts into the overall bullion supply, over time. Consider that the total amount of Silver Eagles since beginning in 1986 now totals over 130 million ounces. Looking at the Commitments of Traders Report for silver as of April 28, 2009, we find total open positions of about 96,000, which represents 480 million ounces. This is a rather low, open-interest level and just slightly higher than the point where we are most comfortable entering from the long side. The total net short position of the commercial interests stands at 125 million net short, which by historic standards is on the low side, but again we might like to see even more favorable conditions. We have not addressed the COT report in our report for several months, primarily for two reasons. First and most importantly, the signals given by the COT have become much less reliable since the advent of so many Silver Exchange Traded Funds. Secondly, Ted Butler does an open, public discussion on the Commitments of Traders quite often and we do not wish to be redundant. When I gave my first workshop on using the COT for executing entry and exit points, silver was able to be traded almost to the penny believe it or not! However, so much has changed over the last several years that again, although useful, the COT is not nearly the help in making trading decisions that it once was. Looking at the GFMS Silver Investment Market book prepared in April 2009, it was noted in their Executive Summary that the credit and banking crisis have given a fresh impetus to investment demand in the last two years. I must comment on this, because having read this study for years and sharing the same speaking venue at times, it is somewhat satisfying to me to see GFMS put into print something I had stated years earlier and was considered a kook by them and others. One of my main complaints about this report is one mentioned almost every year and that is the continual reference to high prices for silver, currently. This really annoys me, because, using the GFMS number of $12.60 per ounce in the first quarter of this year, we need to adjust for inflation. What cost $5.00 in 1980 is now $12.90 in Yet GFMS and almost all other commodity-based publications seem to act as if $5 then is the same as $5 now! The average price for silver in 1984, for example, was $8.15, which equates to $16.70 today. And please note this is using the official government inflation numbers and in my view understates the case. Anyway, at a $16.70 price, most primary silver miners would be able to make a suitable profit and pay back debt and perhaps eventually pay out dividends to their shareholders. But at current prices, the margin is very thin to non-existent and therefore many primary silver producers may show scattered earnings. This means they may show a profit in one quarter, to be followed by losses the next. This goes to further the point that primary silver mining was marginal in 1980 at five-dollar silver and is marginal again today at about the $12.50 level. We do not wish to imply that all silver miners are not profitable at today s silver price. Some are, but many of them are not, when total costs and not just cash costs are considered. Another interesting point is, how can we have a silver price averaging over $8.00 in the early 1980s when there was so much less demand and an inventory of more than 1.6 billion ounces of silver bullion with a surplus building since 1978? In common sense terms, this just does not add up when you consider how much less silver is available today, the amount of value that has left the U.S. dollar, and the huge increase in industrial demand for silver during the past twenty-five years. One of the main problems with the silver market is the fact that approximately seventy percent of the silver comes to market due to base metal mining. For practical purposes ALL of these miners could care less about the price of silver. As long as the copper, lead, zinc, or even gold mining operations are profitable, these companies turn over their silver book (physical silver production) to a banking facility to manage this unwanted material, not caring about price or what is done with the silver. This of course is where the commercial interests get to have their fun with the silver markets in all aspects, physical silver, options, futures, over-the-counter derivates, and on and on. If the primary silver producers were mining over seventy percent, we would have a much different silver dynamic taking place. Regardless, the silver investor is the wild card and will have the greatest influence overall, and this is just now really taking hold. We have already seen silver prices near the $21 level in March of 2008 and it is still our view 4 THE MORGAN REPORT May 2009 Copyright 2009

5 that we will see a wide trading range the rest of this year. However, at this point we are all aware of just how tight the physical market is, and thus silver could explode at any time. Another area that many silver investors seem misled about is just how different silver is than gold. Well, we have some interesting news for everyone: there is an 84% correlation to the gold price. So, not 100%; there is no one hundred percent correlation. When comparing two things, rest assured that no matter who you read or what authority speaks, most of the time silver does what gold does. If gold moves up, silver moves up, and if gold moves down, silver moves down. It goes without stating but perhaps we should: silver s moves are much greater, percentage-wise, both up and down. Looking at the favorable aspects of the GFMS report, we find silver s industrial fabrication continues to grow and this is outweighing further attrition in photography, mine production is failing to increase adequately to match the increased industrial demand, and aboveground stocks continue to deplete. They also mention that many funds trade the gold/silver ratio despite it having little fundamental basis. That may be true, although we have used our channel analysis favorably so far, and Mr. Franklin Sanders presented an even better method of trading the gold/silver ratio in his newsletter recently. We must note that the CPM Yearbook makes it clear that they expect a great deal more silver to be produced over the next few years, more than 100 million ounces starting in a couple of years, and also have stated in the past that the silver market went from a deficit to a surplus situation a few years ago. This means of course that the amount of silver mined on an annual basis does meet total silver demand without the need to draw into the silver stockpile. Currently, silver demand is down, across the board for industrial use, photography, jewelry, and silverware. But the lone and most positive exception is investment demand both at a retail and institutional level. Remember, no matter how you slice it gold s price is almost all investment demand and there are decades worth of gold above ground. Whereas silver has a much smaller component of investment demand, it is just as vital to determining the overall price of silver as it is for gold. In the end, silver will shine brightly! The Ten Rules of Silver Investing was available to paid subscribers only it is now available to you -FREE! This information will keep you from making costly errors when investing in this volatile market. There is a reason Mr. Morgan was chosen to write these rules over all the other silver analysts in the world. Each rule is explained in detail and you will receive one rule each day for the next ten days. Many people paid over $50 to buy the book that lists these rules. These rules have actually been expanded and updated from the time the Investing Rules Book was published. Subscribing to the Silver Investor Free mail list: You also receive news and updates concerning the silver market, the economy, precious metals, and the mining markets. We have even sent company investment information we usually reserve for our paid subscribers. But that is not all, you will receive another bonus for joining our free mailing list, you will receive "Riding The Silver Bull". This e-booklet will give you more knowledge about the silver market than most Wall Street analysts. That is correct this very pertinent report spells out in detail why silver is one of if not the absolute best investment for the foreseeable future. All we ask for is your address and name. Click the link below to join now... Unlike other mailing lists, you won't receive a bombardment of from us, just periodic news concerning updates, alerts and additions to the site. Every contains a link to remove yourself from our free list. Copyright 2009 May 2009 THE MORGAN REPORT 5

6 This section is for serious money where an investor can place up to ten percent of their Precious Metals Equity money in each company. Please spread out in this sector. We list 2-3 Top Gold/Resource companies these are usually good for long term 3-5 year horizons for serious investors. serious investors We list 2-3 Top Silver companies these are usually good for long term 3-5 year horizons for In this section (Table Below) only place money you can afford to lose. We will use a trailing stop of 15 percent from the time we feature a speculation in the list below. If a featured company falls to a level of 15 percent below the date the company was featured, we will issue a sell. Investing is NOT for everyone, if this would be your only newsletter subscription or your first subscription to a newsletter ever, we recommend you DO NOT begin with us. We rather be of service to those that are "seasoned" with a mature attitude toward the financial markets and their own decisions and responsibilities. Information contained herein has been obtained from sources believed to be reliable, but there is no guarantee as to completeness or accuracy. Because individual investment objectives vary, this Summary should not be construed as advice to meet the particular needs of the reader. Any opinions expressed herein are statements of our judgment as of this date and are subject to change without notice. Any action taken as a result of reading this independent market research is solely the responsibility of the reader. Stone Investment Group is not and does not profess to be a professional investment advisor, and strongly encourages all readers to consult with their own personal financial advisors, attorneys, and accountants before making any investment decision. Stone Investment Group and/or independent consultants or members of their families may have a position in the securities mentioned. Mr. Morgan does consult on a paid basis both with private investors and various companies. Investing and speculation are inherently risky and should not be undertaken without professional advice. By your act of reading this independent market research letter, you fully and explicitly agree that Stone Investment Group will not be held liable or responsible for any decisions you make regarding any information discussed herein. 6 THE MORGAN REPORT May 2009 Copyright 2009

THE MORGAN REPORT ASSET ALLOCATION

THE MORGAN REPORT ASSET ALLOCATION This section is for serious money. Our suggestion is for retirees or fund managers to focus on this section; it could contain up to 90% of the money allocated to precious