Below is an interview I did with Franklin Sanders, editor of The Moneychanger newsletter, on 13th October 2003. The Moneychanger focuses primarily on the gold and silver markets, but looks also at other events and markets as they affect gold and silver.  The stated purpose of The Moneychanger is "to help Christian people prosper with their principles intact in an age of monetary and moral chaos." A yearly subscription to the Moneychanger costs US$149. 

MONEYCHANGER: How did you come to market technical analysis? Weren't you educated as an engineer?

STEVE SAVILLE: I obtained an engineering degree and spent the first 14 years of my working life with an engineering company, initially as an engineer and then as a project manager and then as a branch manager. This experience was generally enjoyable and gave me a good grounding in real-world business management. 

For as long as I can remember I've been interested in the financial markets. Starting in my early 20s I began reading books on finance, investment, and monetary history, and at around the same time became actively involved in the stock market. This involvement gradually increased over the years such that by the time I reached my mid 30s I almost had two full-time jobs -- a day job as a manager of an engineering company and a night job studying the markets and figuring out my own investment/trading strategies. Although I continued to enjoy my day job, my night job was what I was really passionate about so in 1995 I decided to become a full-time speculator. 

Life took an unexpected turn at that time, however. Soon after I made my decision to leave the engineering world an opportunity arose to come to Hong Kong and manage some projects associated with the new Hong Kong Airport. This opportunity was too good to pass up and caused me to put my plans to become a full-time speculator on hold for three more years. I'm still in this part of the world (currently in China) and have been 100% focused on the financial markets (trading them and writing about them) since 1998.

I am primarily a fundamental analyst. All of my longer-term views stem from fundamental considerations, but I analyse price charts and market sentiment in an effort to ascertain good entry/exit points. 

Reading your work, I notice that you often look at related spreads to get a fix on a market. For instance, to judge the strength of the stock market, you look not only at stock indexes themselves, but also at spreads like the Nasdaq 100 divided by the Dow (NDX/Dow ratio). Why do you do that? Which spreads do you find particularly useful?

Every price is a ratio with one part of the ratio usually being the dollar or some other currency. For example, if we say that the Nasdaq100 Index gained 5% in a week what we are really saying is that it gained 5% relative to the US$. However, sometimes more information can be gleaned by removing the US$, or any other currency for that matter, from the equation.

You mentioned the NDX/Dow ratio. The performance of the NDX/Dow ratio has, over the past 2 years, provided more information about what has been happening in the stock market than has the absolute performance of either the NDX or the Dow. This is because the NDX tends to out-perform the Dow when people are becoming less risk averse and under-perform the Dow when people are becoming more risk averse. 

It is, in turn, useful to understand the trend in the general level of risk aversion because this trend will often reverse course before the price action of the stock indices reverse. For instance, even though the Dow made a new recovery high in March of 2002 the NDX/Dow ratio had, by that time, been trending lower for about three months. This warned anyone paying attention that the February-March 2002 surge in the stock market was a head fake. Similarly, while the stock market appeared to be very weak over the first 10 weeks or so of this year the NDX/Dow ratio remained in an upward trend during this period. This, in turn, was a clear sign that the October-2002 lows were going to hold.

At the present time the NDX/Dow ratio is trending higher so there is no evidence yet that a major stock market peak is in place.

Another ratio I follow closely is the ratio of the 30-year interest rate and the 13-week interest rate. I've found that the performance of long-term interest rates relative to short-term interest rates provides information that cannot be seen by looking at the performance of any one interest rate alone. For example, regardless of what is happening to the absolute levels of various interest rates, the environment tends to be bullish for gold when long-term interest rates are rising relative to short-term rates (as they have been since the final quarter of 2000).

Two more examples of ratios I monitor closely are the gold-stock/gold-bullion ratio and the S&P 500/gold ratio. The gold-stock/gold-bullion ratio is useful because when gold stocks are trending higher relative to the gold price the outlook is almost always bullish for both gold and gold stocks. The S&P 500/gold ratio is interesting because it gives us information regarding the extent to which market participants perceive earnings improvements to be inflation-related. For example, if the S&P500/gold ratio is rising slower than the nominal S&P 500 Index then this, in my opinion, suggests that people are wise to the fact that inflation is responsible for at least some of the gains in the market. Right now the S&P 500/gold ratio is technically much weaker than the nominal S&P 500 Index, so it seems as though a significant number of people are aware of the role inflation is playing in boosting stock prices.

Often you project timing by past behaviour. For example, if it took a market so many months to go from peak to trough, you might project it will take about that long again. A recent example is your expectation that the Amex Gold Bugs Index (HUI) will top 2 - 3 weeks later than the broad stock market. Does the threat of discontinuities make you nervous? Basically your projection assumes that things will pretty much continue on as they always have. I know that GENERALLY things actually do continue on pretty much as always, but a discontinuity -- an unexpected surge or collapse -- can clobber you.

Discontinuities will never cause you a major problem if you do a good job of managing risk. The people who get clobbered as a result of discontinuities are typically the ones who've bet very heavily on one particular outcome and have left themselves no escape route.

In any case, I never just assume that things will continue the way they always have. However, if the markets have shown a strong tendency to behave in a particular way over a very long period of time then I would need a good reason to assume that they are going to behave differently in the future. Let's take, for example, my current forecast that gold stocks will peak a few weeks after the broad stock market and drop sharply once the stock market enters the accelerated phase of its decline. 

I won't go into why I think the HUI will top after the overall stock market, but I don't see any reason to expect that gold stocks won't get hit hard if the overall stock-market plunges. This is not just because they've invariably been hit hard during previous stock market panics, but also because there's no reason to expect anything different to happen during a future stock market panic. The point is that when people panic they panic to cash, or to gold bullion, or perhaps to treasury bonds. They never panic to equities, even gold equities. Gold equities will do extremely well over the coming years if there is a steady rise in inflation fears, but anyone who expects that a discontinuity (some sort of financial crisis where markets suddenly move way beyond normal extremes) is going to occur in the near future should buy gold bullion and steer clear of gold stocks until after the dust has settled.

How do you pick stocks?

I base the decision firstly on fundamental value and secondly on price action. I won't buy any stock unless I think the current price offers genuine value (taking into account growth prospects), but I will use technical factors such as the position of the stock relative to support and resistance levels in an effort to optimise the timing of the purchase.

Also, I learnt a hard lesson a long time ago that it is very important to make sure that most of your trading/investing is in synch with the investment tide. In other words, you can be the best stock picker in the world but you probably aren't going to achieve good returns if you are buying stocks during a bear market or buying stocks within a sector that happens to be in a bear market. Correspondingly, a mediocre stock picker can achieve good returns if he/she is focused on a sector that happens to be in a bull market. I therefore developed a 'top down' approach whereby I first identify the major underlying trends in the markets and the stock-market sectors that stand to benefit from these trends. Having identified the right sector of the market most of my effort is then directed towards selecting stocks within that sector.

What is your long term outlook for (a) stocks, (b) bonds, (c) currencies, (d) gold, and (e) silver? Ultimate targets for those markets?

I'm very bullish on gold and silver and bearish on stocks, bonds, and all fiat currencies. 

It is impossible to calculate a target for the gold price because the general level of fear and distrust in the markets will determine the price of gold. However, I'll be surprised if the gold price doesn't trade above $1,000 within the next 5 years. I expect silver to move roughly in line with gold, but with greater volatility.

Compared to some gold bulls I'm not overly bearish on the stock market, but I do expect the Dow to trade down to around 6,000 within the next 2 years (most likely next year). If this happens it will probably turn out to be the bottom. Another probable outcome would be that the Dow trades in a wide range bounded by last year's low and this year's high for a few years, in a similar fashion to what happened with the Japanese market during the 1990s, before collapsing late this decade or early next decade.

My view is that interest rates made a long-term bottom earlier this year and will trend higher over the remainder of this decade.

You implied in an article a couple of years ago that you thought gold and silver had decoupled in the 1990s, and there was some talk of that. Do you still think that way? How do you expect the gold silver ratio to behave as a bull market in precious metals unfolds? (Assuming of course you believe we have a bull market in metals.)

Trends in the gold/silver ratio have tended to last for about 10 years. The ratio was flat throughout the 1970s (with a downward spike during the final 6 months due to the Hunts' attempt to corner the silver market), trended higher during the 1980s (gold out-performed silver during the 1980s), trended lower during the 1990s (silver out-performed gold during the 1990s), and has been trending higher since 1999. My view is that the upward trend in the gold/silver ratio that began in 1999 will continue through to the end of this decade, that is, that gold will continue to out-perform silver, or that we'll look back at the current decade and see a volatile trading range for the ratio with gold initially leading. 

Do you find some reason in the fundamentals to expect gold to outperform silver until the end of the decade?

A traditional commodity-style analysis (comparing manufacturing demand with new mine supply) is irrelevant as far as the gold market is concerned. Gold needs to be analysed in the same way that the US$ is analysed. In fact, it probably helps to think of gold as an anti-dollar - something that responds to the same forces as the dollar but in the opposite direction. As such, gold has a tendency to be counter-cyclical. 

A traditional commodity-style analysis does, however, have some relevance to silver. The silver price is controlled by both industrial demand and investment demand and if we make the assumption that these sources of demand are roughly equal then silver can be thought of as non-cyclical. In any case, silver is clearly less 'counter-cyclical' than gold. 

Further to the above, if the world's monetary authorities manage to hold things together for several more years then I would expect non-cyclical silver to out-perform counter-cyclical gold, but if we are about to embark on a prolonged period of economic weakness then counter-cyclical gold should out- perform. 

Note, by the way, that I'm not forecasting substantial out-performance by gold over the remainder of this decade. I've been suggesting that investors give gold a much heavier weighting than silver in their portfolios for at least two years now, but a lot of the upside in gold relative to silver might already be behind us. My expectation is simply that we'll look back at the current decade and either see an upward-trending gold/silver ratio or a volatile trading range with gold initially leading. However, unless my current long-term views on economic growth turn out to be overly pessimistic I don't see much chance that the gold/silver ratio will drop below its 1999 low [at 40:1].

Three times in the 20th century the gold/silver ratio returned to 16:1, twice after hitting highs at 100:1. Do you expect to see 16:1 again at the bottom of the ratio this time? Do you have a target for the ratio?

I don't have a specific target for the ratio, but as mentioned above I don't expect the 1999 low to be breached this decade.

Does it really make any sense at all to apply fundamental commodity analysis to gold and silver, except as very slow causes of change at the margin. All commodity uses of gold and silver are low order uses, since the highest order use of those metals is monetary.  Commodity analysis leaves out the single most important component of demand, namely, monetary demand. Neither gold nor silver will rise (or fall) significantly without monetary demand. When monetary demand hits, then their prices go wild, and commodity demand is wholly overshadowed. In a world system of fiat currencies, doesn't it make the most sense to view both metals as "alternative currencies competing with the dollar"? 

To some extent both could be considered to be forms of money that compete with the dollar, but over the past 30 years gold has tended to out-perform silver during those periods when confidence in the dollar has been falling. This is why I say that silver is less counter-cyclical than gold.

Wouldn't fundamental commodity analysis of silver alone suggest some rather large price adjustment lies in the not too distant future? According to Gold Fields Mineral Services statistics, for the past 12 years silver has run a supply shortfall equal to about 15% of yearly demand. That shortfall has now consumed about 1.25 Billion ounces of silver. Given silver's quirky supply demand profile (inelastic demand & 80% of new supply from by-product of other metals), doesn't that whisper at a supply train-wreck somewhere in the future? Wouldn't that alone carry silver's price higher, even in the face of reduced world economic activity?

I agree that silver's supply/demand fundamentals appear to be extremely bullish, but while a supply shock is possible at some stage price action suggests that such an outcome is not probable over the next several months.

You focus on trading rather than "buy & hold." Given human nature (which works against successful trading) and the expenses and risks involved, how do you justify that?

Human nature also works against 'buy and hold' because most of the people who are committed to a 'buy and hold' strategy end up capitulating at the worst possible times. In fact, major bottoms in markets usually only occur after devotees to the 'buy and hold' approach decide that they can't take the pain any longer and finally sell their shares.

After figuring out where the bull market is, my approach involves scaling into positions on severe weakness and scaling out of positions during periods of extreme strength. Even if you are very confident that a long-term up-trend is in place, it's amazing how much more relaxed you can be during the periodic corrections if you've harvested some profits during the preceding run-ups.

What is your outlook for the US dollar long term? Short term?

I expect the US$ bear market to continue until the US's quarterly current account deficit has been reduced to almost zero. This will probably take at least another five years to come about and entail a further decline in the Dollar Index of at least 40%.

In the short-term there's a good chance we'll see a 3-6 month rally in the Dollar following a low within the next several weeks.

Would you clarify "a further decline in the dollar index of at least 40%"? With the dollar index currently around 92, does that mean you expect the dollar index to decline to 55? 

My expectation is that at the next major bear market low for the US$ one Swiss Franc will buy 1.00-1.10 dollars, which constitutes a 40% decline in the US$ relative to the SF. A reasonable long-term target for the Dollar Index is 60.

Stock cheerleaders (not coincidentally a group largely identical with people who sell stocks) are now filled with glee over the last few days' action. Do you think a bull market in stocks has begun again?

I did a good job of identifying the October-2002 and March-2003 lows in the stock market, but confess to being surprised at the longevity of the ensuing rally. It didn't seem like a realistic prospect six months ago, but the US financial establishment (the Fed, the Government Sponsored Enterprises [GSEs, Freddie Mac & Fannie Mae], the commercial banks, Wall Street financial firms, etc.) have managed to promote sufficient credit growth to inflate a whole new stock market bubble centred, once again, on tech and Internet stocks. This bubble is going to end badly as they all do, but as mentioned above in the discussion of the NDX/Dow ratio there is not yet any evidence of a trend reversal. It is possible that we will get an October-November peak, but it's also possible that the new bubble could continue to build into early 2004. Either way, it will end over the next several months and when it does it will probably unravel at a faster pace than the bubble that burst in 2000 because there aren't as many true believers (people who think stock prices can be justified based on real earnings growth) now as there were back then. It is worth mentioning, too, that the money-supply growth trend reversed lower about six weeks ago. This is likely to become a big problem for both the US stock market and the US economy within the next few months. 

Would you explain briefly the connection between money supply growth and stocks & the economy?

The CPI-adjusted M2 growth rate has been one of the best leading indicators of US economic growth over the past 40 years with a typical lead time of 2-3 quarters, so the recent downturn in money-supply growth implies a downturn in economic growth around the second quarter of next year. The stock market tends to move in advance of the economy (and should therefore reverse course ahead of next year's economic downturn) and also tends to benefit directly from strong money-supply growth. 

The flood of information from the Internet and other sources are like drinking out of a fire hose. What sources of information do you find most useful in your own analysis? Do you read other analysts, or do you find that skews your thinking too much? If you do read them, then whom?

I go out of my way not to read other analysts because I don't want to be influenced by others' opinions on the markets. In particular, I steer clear of the popular gold web sites because these sites generally contain very strong opinions. The only other market analysts I read on a regular basis are Kevin Klombies (www.krk-imra.com) and Ed Bugos (www.goldenbar.com) because I've found that they prompt me to look at things in ways that might otherwise not have occurred to me. 

I tend not to read many articles in the mainstream financial press because most of the explanations put forward in the press with regard to why the markets did what they did on a particular day bear little relationship to reality. I do, however, scan the headlines in popular financial publications such as the WSJ in order keep up with the latest news.

In general I'm much more interested in finding out the details of what happened and relating the happenings in different markets than I am in reading others' opinions and explanations. I therefore spend quite a lot of time reviewing charts. I'm also interested in reading good analysis of economic fundamentals wherever and whenever I can find it. In this regard I've found that Prudent Bear's Doug Noland and Northern Trust's Paul Kasriel are worth reading. [end of interview]

© 2003, The Moneychanger
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