The impact of Mexico’s new tax on miners

‘The silver bottom is in. Time to hold, add and ride it out’

David Morgan
David Morgan

When the bulls are running for the doors, that is a sign that we have hit bottom and wise investors should hold on to their portfolios for the ride up, says Editor David Morgan in this interview with The Gold Report. It may take a couple of resource war-addled years for gold and silver prices to move back to profitable levels, but the right companies — and he points to five from the members-only Morgan Report files — could make money all the way up.

Morgan ( is a widely recognized analyst in the precious metals industry; he consults for hedge funds, high net-worth investors, mining companies, depositories and bullion dealers. He is the publisher of The Morgan Report on precious metals, the author of “Get the Skinny on Silver Investing” and a featured speaker at investment conferences in North America, Europe and Asia.

Interview by J.T. Long of The Gold Report

The Gold Report: When we interviewed you last, you mentioned the possibility of “resource wars” in 2014 as referenced in Michael Klare’s book of the same title. What will that look like to the average investor?

David Morgan: The resource wars have already started. Look at Mexico. It has a resource that it covets very much, and that’s energy. That is why the government levied a new tax designed primarily at energy but subsequently adds a 7.5% royalty on mining profits. Is it a war? Not per se, but it is detrimental to companies that operate in Mexico today and in the future. I think we will see even more of this kind of thing in 2014.

Gold Report: Last year was a volatile year for precious metals prices with silver going below $20/ounce ($20/oz) and gold bobbing around $1,200/oz at the end of the year. Are we still three or four years from $100/oz silver as you said in your last interview? What’s going to push it to that level?

Morgan: What’s going to push it to that level are fundamentals. There is no change fundamentally in why investors would buy gold in 2001 compared to why they would buy gold in 2013 or 2014. The fundamental fact is that there isn’t a nation state on earth that has a handle on the debt problem. Because of that, we’re going to see more people wake up to the need for precious metals, because precious metals are true money outside the framework of the current system.

Trevali Mining Corp. is one of the few positive stories out there right now.

The correction we had in silver and gold isn’t that abnormal in a major bull market. I’ve been through one bull market already in my lifetime. I watched gold go from the fixed price of $42.22/oz up to $200/oz, then to sell off to around the $100/oz level. It later advanced all the way back to the peak of $850/oz in January 1980. I have seen the damage a big shakeout in a major bull market can have. That experience makes me a little bit more hardened to weather the storm we just experienced.

However, I think that the worst is over. I think silver has bottomed. Gold probably has as well. This year, 2014, will be a rebuilding year. Depending on what happens in the global economic system, it’s possible that we could even see a very good year for the metals, but I don’t anticipate that. I’m anticipating a rebuild year where silver climbs back over $30/oz and gold travels up well over $1,600/oz, probably to the $1,700/oz level or higher depending on how the economy unfolds.

Gold Report: Precious metals experienced a nice little bump at the beginning of the year. Of the companies now in the resources market, what percentage will live to see an upturn in the metals prices? How many are just on the edge right now?

Morgan: That’s a good question, but I’m probably not the best to ask because we focus mostly on top-tier and mid-tier companies, companies that are producers or near producers. We do study a great deal of the junior exploration sector, but suggest very few. If I would venture a guess, of the micro-cap companies — $0.5–3 million — probably half will survive, maybe fewer than that.

It has been very difficult in the precious metals sector over the last couple of years. Even some of the best companies — I am thinking of one recently that has one of the richest gold mines in the world — can be mismanaged. That is why with some of these companies I tell people to only risk money they can lose because the payoff can be great, but they can lose it all, too. And some of my readers thank me for it later. That happened just this morning.

Gold Report: You mentioned Mexico’s new tax. What impact is that going to have on producers large and small there? Are there some companies that could do well even with the new royalty burdens?

Morgan: Yes, there are. We’re still working on our white paper on the topic, but I can outline it in general terms. If you’re a major producer, like First Majestic Silver Corp. (FR:TSX; AG:NYSE; FMV:FSE) as an example, the new Mexican tax is going to cut into the bottom line, but major producers will be able to adjust to still make a profit. For a mid-tier company, it could have more of an effect because the margins are less. But in the junior sector, after this tax is paid, it’s going to be touch and go in many cases. The smaller companies that have very little margin or would need to be producing for a few years to become profitable are not going to be able to start as easily because their breakeven analysis is pushed out farther. So, basically, if a company is currently producing with wide margins, it will be OK. But companies just getting started or very small producers are going to have a tougher time.

Gold Report: Do you see this mining tax as a permanent thing or will the government see the error of its ways and rescind it?

“I have seen the damage a big shakeout in a major bull market can have. That experience makes me a little more hardened to weather the storm we just experienced.”

Morgan: I really don’t know. There may be too much political pressure to take it back in the short term. It might be altered somewhat, but I don’t think it will come off entirely.

Gold Report: You mentioned First Majestic. The company just started production at the Del Toro silver mine in Mexico. Is that significant?

Morgan: Yes, it will help the bottom line, but I’m sure First Majestic would prefer that things were the way they were before this tax took place.

Gold Report: Your December Morgan Report included Silver Standard Resources Inc. (SSO:TSX; SSRI:NASDAQ). You said the company is selling assets. Will that help profitability?

Morgan: It’s a decision by Silver Standard to cut costs and I will withhold judgment for now. Basically, this is a time when metals prices are pretty much near the cost of production for gold and silver miners across the board. Companies with low margins look at every possible way that they can increase the margins. One way is to cut costs. And one way to cut costs is to sell assets that someone else would want. Prices in the metals industry are notoriously volatile, and it’s always good to increase margins. But companies start looking a little harder in tough times than they would in a more robust environment for precious metals. Silver Standard initiated a cost reduction initiative in the first half of 2013 and costs could continue to decline for the next three quarters.

Gold Report: Outside of Mexico, what silver producers do you like?

Morgan: I’m fond of the royalty companies. It’s pretty hard on the silver side to go wrong with Silver Wheaton Corp. (SLW:TSX; SLW:NYSE). The company has such a geographic diversification that it’s very difficult to beat that business model. Silver Wheaton is probably one of the safer ways to invest in silver because the margins are so high. Even when a streaming contractor has a problem, Silver Wheaton is much safer than a one-stock bet. That is why I like the royalty companies and it’s hard to beat Silver Wheaton.

Gold Report: What is the next catalyst for Silver Wheaton? Are you watching the ramp-up at Vale S.A.’s (VALE:NYSE) Salobo mine in Brazil?

Morgan: Yes. Silver Wheaton has a lot of streaming deals that will continue to grow for the company. The deals are attractive to Silver Wheaton’s shareholders and, in most cases, to the underlying company because many wouldn’t be able to get the funding to move forward without it. So it’s a win-win situation.

Gold Report: What about gold companies? Are there any you like right now out there?

“Now is the time, for those not in the sector, to get in. Those already in should either hold what they have, add to their positions or ride it out.”

Morgan: We have done a great deal of research on many gold companies and one that we have discussed with members for the last five years is Goldcorp Inc. (G:TSX; GG:NYSE), one of the most sought-after names at one time. That company looks so good going forward that if investors are patient, meaning willing to wait three years or so, it could pay off nicely.

Gold Report: What about non-gold and silver companies?

Morgan: Trevali Mining Corp. (TV:TSX; TREVF:OTCQX; TV:BVL) is a zinc play. It’s one of the few positive stories out there right now. It’s up from where we recommended it and has the capital to keep moving the Caribou and Santander mines into production. Some of the major bank analysts are now talking zinc; we were pretty early.

Gold Report: We’ve had a lot of debate among some of our experts about the ideal ratio between gold and silver. If gold goes to $2,000/oz in 2014, do you believe silver will follow based on a specific ratio or do you see them working independently?

Morgan: I have studied this issue as much as anyone other than The Moneychanger author Franklin Sanders. A 45-foot long historic silver chart covering the last 4,500 years, where each foot would be 100 years, shows that only in the last 19 inches the silver-gold ratio would be above 16:1. The 4,400 years before that, it would be less than 16:1! So, from a long-term perspective it means silver is undervalued to gold. Yet, let us agree that for the current time frame it has much less meaning.

My point is that the ratio tells you which metal is doing better relative to each other. The ratio was 80:1 when the silver bull market started, and it’s basically 60:1 now. That means as volatile as silver has been, from the start of the bull market, if investors put the same amount of dollars into gold or silver, they would be better off putting it into silver. I’m not advocating that. I think investors should own both gold and silver. But, overall, I believe silver’s outperforming trend will continue.

Now Eric Sprott believes in the monetary classic ratio of 16:1 ratio and thinks the metal will eventually return to that level. I think the ratio will at least test where we’ve already been in this bull market, and that’s about a 35:1 ratio. We’ve already been there very, very briefly when silver did its big magic jump from $19/oz to $48/oz in 2011. In the meantime, we’re looking at more volatility.

Gold Report: What message did you give people at the Cambridge House Investment conference in Vancouver?

Morgan: The bull market is not over and it’s normal in these secular bull markets to shake off some bulls and reach the status that we are currently at where the sentiment is very low. There is a lot of distrust and a lot of people are questioning whether they should be in the sector. Those are signs that the bottom is in. Now is the time, for those not in the sector, to get in. For those already in, either hold what they have, add to their position or ride it out. A couple of years from now we’re going to see much higher prices in the precious metals. Three or four years out, it may be overvalued in real terms, but that remains to be determined.

Gold Report: Thanks, David, for your insights and time.


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1) J.T. Long conducted this interview as an employee of The Gold Report. She personally and/or his family own shares of the following companies mentioned in this interview: None.
2) The following companies mentioned in the interview are sponsors of The Gold Report: Trevali Mining Corp. Goldcorp Inc. is not affiliated with Streetwise Reports. Streetwise Reports does not accept stock in exchange for services. Interviews are edited for clarity.
3) David Morgan: I or my family own shares of the following companies mentioned in this interview: All companies named in this interview. I personally am or my family is paid by the following companies mentioned in this interview: None. My company has a financial relationship with the following companies mentioned in this interview: None. I was not paid by Streetwise Reports for participating in this interview. Comments and opinions expressed are my own comments and opinions. I had the opportunity to review the interview for accuracy as of the date of the interview and am responsible for the content of the interview.
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