Mainstream economists and mainstream media remain convinced that the economy and markets are in full recovery mode. Along the same lines, gold is unanimously expected to decline in the year(s) head.

One of the most recent appearances of that kind was the 2014 outlook of IMF economic counselor, Olivier Blanchard, who explained last week that global growth would average 3.7% in 2014.

Ironically, the recovery story, based on the central bank premise that they can create wealth by simply exploding their balance sheets, seems as solid as a “house of cards.” Past week Thursday and Friday, several emerging markets suffered from an economic earthquake, especially in their currency markets, which resulted in losses in most developed world markets not seen since 6 months. The Yen and the Swiss Franc were considered a safe haven, just like gold and US Treasury bonds.

Bloomberg says this is the worst selloff in emerging-market currencies in five years, revealing the impact from the Federal Reserve’s tapering of monetary stimulus. “Investors are losing confidence in some of the biggest developing nations, extending the currency-market rout triggered last year when the Fed first signaled it would scale back stimulus. While Brazil, Russia, India, China and South Africa were the engines of global growth following the financial crisis in 2008, emerging markets now pose a threat to world financial stability.”

Argentina, Venezuela and Turkey have been hit hard. Argentine’s Peso and Turkish Lira lost significant value against other major currencies in the past week. They recovered slightly today.

In Argentina, the central bank pared dollar sales aimed at propping up the peso to preserve international reserves that have fallen to a seven-year low. “The central bank said it would lift two-year-old currency controls and allow the purchase of dollars for savings starting next week. […] The government told today it isn’t intervening in the peso’s decline, allowing the market, which is mostly closed to buyers of dollars, to adjust prices. It wasn’t a devaluation induced by the state. For the lovers of free markets, supply and demand was expressed in the capital markets yesterday.”

The Turkish central bank tried an unscheduled intervention in the market to stop the lira from falling to record lows, something they haven’t done since two years. “Investors are speculating the central bank’s efforts to prop up the lira by burning through foreign-exchange reserves will prove futile without raising interest rates.”

The loss in purchasing power for people holding Argentine’s Peso is astonishing:

• The Peso closed on Friday January 24th at USD 8.0.
• Week on week, the Peso lost 17.6% of its value against the USD.
• Three months ago, the Peso stood at USD 5.9, a decline of 35.5%.
• Since September 2012, the Peso lost 69% against the USD.

The loss in value of the Turkish Lira is not as dramatic as the Peso, but it is still very bad:

• The Lira closed on Friday January 24th at USD 2.24.
• Week on week, the Lira lost 4.4% of its value against the USD.
• Three months ago, the Lira stood at USD 1.97, a decline of 19.2%.
• Since September 2012, the Lira lost 27% against the USD.

The interesting part for us, gold enthusiasts, is the price of gold in the slaughtered currencies (prices on the close of January 24^th):

• Gold in Argentine’s Peso is up 30% in the last 30 days; it is trading at all time highs.
• Gold in Turkish Lira’s is up 17% in the last 30 days; it is trading just 10% below its all time highs of September 2011.

This chart shows the price of gold in USD (yellow line) and in Peso (blue line). The black line is the currency exchange rate Peso against the USD. Chart courtesy: Sharelynx.

Interestingly, the explosion of the gold price in Peso and Lira has pushed the gold price higher in the Western currencies. That is an important evolution, as it indicates what gold really stands for: a monetary asset. One should note that gold has gone higher even without inflation fears. This could be one of those catalysts that could break the downtrend in gold in major currencies.

The underlying reason for the emerging market turmoil is said to be attributed to capital flight out of  those markets. Directly linked to that is the tapering fear from the US Federal Reserve.

What is the importance of this for Western investors? There could be a counter intuitive answer to that question.

Basically, up until today, there was a narrative surrounding the Federal Reserve who got credit for the positive economic results after having stopped the implosion of the financial system in 2009. However, there is still no empirical evidence that the plan has worked, because the world is still on the monetary infusion. We should note that the present type of situation, characterized by tapering in a global fiat based monetary system with huge amounts of debt, is unique in human history.

As John Mauldin pointed out this week, if the narrative about central planning changes, indicating that the present monetary experiment was the wrong answer to the problem, there could be very nasty effects, especially out of the emerging markets. This is why (courtesy of Ben Hunt):

For 20+ years there has been a coherent growth story around Emerging Markets, where the label “Emerging Market” had real meaning within a common knowledge perspective. Today … not so much. Today the story is that it was easy money from the Fed that drove global growth, Emerging Market or otherwise. Today the story is that Emerging Markets are just the levered beneficiaries or victims of Fed monetary policy, no different than anyone else….

I’m not asking whether the growth rate in this Emerging Market country or that Emerging Market country will meet expectations, or whether the currency in this Emerging Market country will come under more or less pressure. I’m asking if the WHY of Emerging Market growth and currency valuation has changed. The WHY is the dominant Narrative of a market, the set of tectonic plates on which investment terra firma rests. When any WHY is questioned and challenged you get a tremor. But if the WHY changes you get an earthquake.

What are the investments that such an earthquake would challenge? You don’t want to be short the yen if this earthquake hits. You don’t want to be long growth or anything that’s geared to global growth, like energy or commodities. You don’t want to be overweight equities and underweight bonds. You don’t want to be overweight Europe. You can run from Emerging Markets with US equities, but with S&P 500 earnings driven by non-US revenues, you cannot hide. If you think that your dividend-paying large-cap US equities are immune to what happens in China and Brazil and Turkey … well, good luck with that. My point is not to sell everything and run for the hills. My point is that your risk antennae should be quivering, too.

Nodoby knows how exactly a change in the narrative will play out, but given this week’s evolution, it seems likely that a flight out of risk assets into gold as a safe haven is very likely. Once the narrative changes, the product of the most powerful central bank, i.e. the US dollar, could be hit by a serious trust crisis. That is the point where the Western world could rediscover the monetary value of gold. That is the point where the correlation between the commodity index and precious metals prices (as evidenced since 2011) will break. Gold is more than a commodity. It is the ultimate protection against the central banking illusion.

There really is a reason why we advocate holding physical gold outside the banking system.

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 Silver-Investor.com 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 could make money all the way up.

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.

TGR: 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?

DM: 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.

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.

TGR: 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?

DM: 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.

TGR: 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?

DM: 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, 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.

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

DM: 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.

TGR: 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?

DM: I have studied this issue as much as anyone other than The Moneychangerauthor 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.

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

DM: 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.

TGR: Thanks, David, for your insights and time.

David Morgan (www.Silver-Investor.com) 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.

DISCLOSURE: 
1) JT Long conducted this interview as an employee of The Gold Report. 
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