Some folks may think we have returned to a pre-crash environment all over again, where the market moved on multi-year highs. Year to date, the major indexes are up roughly 15% depending on when you’re reading this article; and that’s on top of 7% returns from the year before and 5.5% the year before that. To the uninitiated, this almost looks like acceleration. To the more pessimistic, it looks like a trap: we’re in for a nasty correction that will pull down the entire market. You can’t turn on the television or read through a financial news website without being overwhelmed by stories telling us the market will crash in the next “X” number of weeks or months.
I’m not even going to try to predict what I think will happen because we’re long term investors, not traders. But every one of us should be concerned about this and take appropriate actions to profit from the upside and protect ourselves from the downside. After all, many folks have to make up for lost time while others need to make their money last far longer than they dreamed.
During my peak earning years, I imagined what retirement would be like based on the generation ahead of me. When those folks stopped working full time, they slowed down a bit, spent weekends watching their grandchildren’s activities, and had plenty of time for a little fun of their own. They had few financial worries; perhaps their biggest concern was their health, and even that wasn’t an issue until they got really old.
How do you know when you are really old? I don’t know; you would have to ask someone much older than I am.
For the generation ahead of me, “retiring comfortably” meant you had accumulated enough wealth and/or had a pension large enough to not worry about money. Retirement meant your money was working for you. These folks had no debt and enough money coming in to pay the bills. For the first six years of my retirement, life was exactly like that for me too, and it was fun.
Of course, not everyone in my parents’ generation had it quite this good. Folks who were a little less fortunate might still retire, but their retirement was more about basic survival. They had enough money for food, clothing, and shelter, but not enough to take a cruise or foot the entire cost of taking the children and grandchildren to Disneyland.
These folks lived within their means, much like my grandparents did on the farm. Grandma and Grandpa grew their own food and had a huge cellar with enough canned food to feed an army. Instead of looking after their finances – of which they had little – they looked after their garden and managed what little money that had wisely. While their golden years were simple, they were happy and managed to survive independently.
The Wisdom of Retired Old Men Eating Out
During a recent breakfast with my ROMEO (Retired Old Men Eating Out) buddies in Illinois, a friend shared his concerns about the shaky stock market. Is it experiencing a real boom, or is it just a house of cards? Apparently he was not alone in his concerns, because Chuck Butler mentioned the same issue in a recent Daily Pfennig:
“I talked to a stock analyst the other day, and the first thing she mentioned to me was that she didn’t understand why investors didn’t see that the stock market rally was nothing more than an asset bubble created by stimulus. I told her to get ready to deal with this for a long time. The Fed is in a rut and so is the economy, unable to get out unless the stimulus is applied. This should keep the economy going with a pulse, and interest rates low, so housing continues to improve and stocks reach price levels that are not supported by earnings.”
I could have easily answered that question for her. Sure, investors know it’s an asset bubble, and when it bursts, it will be terrible. Retirees just hope to be out of the market when that happens. In the meantime, we need income to survive, and there’s nowhere else to find it.
A decade ago we could have invested the vast majority of our life savings in safe, fixed-income investments. Today, fixed-income investments that pay anything near what we need no longer exist. For our money to really work for us, we have to live off the income and never touch the principal. The consensus among my ROMEO buddies was: What other choice do we have today but to invest in dividend-paying stocks? (Here’s a plan using some of my favorites for monthly income.)
Retired folks now have two choices:
Invest in the stock market with full knowledge that it is risky and propped up by the Federal Reserve.
Invest in fixed-income investments that do not even beat inflation, which means we eat away at our principal and worry about outliving our money.
Investing a large portion of our portfolio in the market is just the lesser of two evils. And of course, it still comes with plenty of caveats about investing wisely and diversifying across sectors and risk levels. On top of that, you still have to find yields that keep up with inflation and provide income.
If we can’t meet this huge challenge, our dreams will suffer, and we may even find ourselves in survival mode. The last thing we want is to be dependent on the government or our children for our next meal.
There are a variety of approaches for getting the job done. One of my wealthier ROMEO buddies has an independent, professional money manager with whom he’s worked for years. While he is pleased with the results, he still oversees the process and is constantly on top of it.
Another member has fired five financial advisors over the years. His primary complaint was that they didn’t listen and invested in ways too risky for his personal comfort, no matter how hard he tried to explain his concerns.
He shared an example from late 2008 when the financial crisis got into full swing. While our CDs got called in, he had several good-quality, high interest-rate bonds that were non-callable. One prospective money manager wanted to sell them off immediately. Many of those bonds, however, have now matured after paying a nice yield up to maturity, and the others have appreciated handsomely. He would be kicking himself now if he had listened to that money manager.
Nevertheless, now that interest rates are so low, he is afraid the gains from his immature bonds will quickly disappear if they begin to rise. Does he sell his high-yielding bonds now at a profit, or ride them out to maturity? In the meantime, now he must invest his recently redeemed cash in a shaky stock market along with the rest of us.
Regardless of the size of our portfolios, we are all experiencing some market anxiety and need to actively monitor our money. The consequences of ignoring our nest eggs are too great to bury our heads in the sand.
In 2007, our ROMEO breakfast talks were all about sports. But today, even though baseball is in full swing, fans are still on a high from the Blackhawks winning the Stanley Cup, and the NFL will soon start pre-season games, the only sentence I’ve heard about sports is: “At least when we want some relief from trying to figure this stuff out, we’ll be able to watch the Bears.” We all have bigger fish to fry.
Not Our Fathers’ Game
The investment lessons we learned from our fathers were nice, but most just don’t apply today. Folks point to technology as a marker of how quickly things change. The same holds true for retirement.
“Set it and forget it” investments don’t exist anymore, and we sure can’t abdicate responsibility for our life savings to a financial advisor. But managing our own money means educating ourselves on topics we may have ignored before. What is a balanced portfolio, and how can it help mitigate risk? How can we earn income while keeping our nest egg relatively safe?
For those of us who don’t want to go it completely alone, we also need to know how to work with a broker or financial advisor. Having to fire your advisor is difficult and often costly, particularly if he lost some of your money. Learning to manage your advisor or broker should be on the top of your list, if you’re going to work with one. It’s not only a matter of trust, it’s simply the prudent thing to do if you want your money to last.
Entertainment vs. Education
Many older baby boomers and retirees like to read the financial section of the newspaper and watch market pundits on television. That’s fine as long as we see it for what it is – pure entertainment. We have all heard horror stories about folks who mistook a blurb on a hot stock for true, in-depth research. Some of those so-called money shows should come with a disclaimer on the bottom of the screen: “Don’t try this at home.” Following the risky advice they spew can be downright dangerous.
The good news is there are trustworthy sources of real financial information that can help us manage our life savings, but they are not found in a 30-second sound bite, nor a column limited to 300 words. Every retiree needs his own information arsenal: newsletters, periodicals, websites, and trusted advisors. Combined with our life experiences, this arsenal can keep our nest egg safe and our golden years, well… golden.
Retirees who understand they have a job to do – looking after their life savings – and approach it with diligence and a commitment to learn generally fare pretty well. Those who don’t, however, risk spending much of their lives on the dole. That doesn’t sound like much of a choice to me.
One of the reasons we started Money Forever was to provide retirees and those planning their retirement with solid advice free of any conflicts of interest sometimes found with many financial advisors. When my retirement finances were put at risk by the financial crash, I put every bit of my time into working with the leading investment minds in the country – experts who had no other agenda than to help me.
With the help of these experts, we developed an entirely new strategy, one that actually has me better off today than I was before the crash: and one that’s being used by thousands of Money Forever readers right now. Part of our strategy is to create a monthly income stream from conservative investments. We’ve recently put together a short presentation explaining how the plan works – how you can receive income every month, and even when you should expect that income. Click here for more.
Even if you decide not to give Money Forever a try, I urge you to find reputable investment newsletters with editors you feel you can trust. Most have full refund periods and you’ll generally know within the first couple of issues whether the editor, his strategy, and his newsletter are right for you. Bottom line is, don’t go it alone.
Earlier in July, Jeff Clark showed in his article A Rare Anomaly in the Gold Market that the gold sector is dramatically undervalued based on its price-to-book ratio. In this article, I would like to expand on his analysis and provide some additional context.
In that article, we found only 31 primary gold producers with a market cap over $1 billion. This seemed rather small when one considers just how many stocks trade around the world, so we wanted to compare this to other industries.
The charts below are built from a database of 6,830 companies. They’re grouped by industry, and all have a market capitalization of US$1 billion or more. They trade on various stock exchanges.
Here’s how the number of gold producers compares to other sectors.
Primary gold producers are clearly a tiny group when compared to the number of companies in other industries at this MCap.
Gold producers with a $1 billion MCap or more are a small subset of the Metals and Mining group, a sector that comprises 229 companies, which in turn is a part of the Materials category that consists of 600 stocks, including companies producing chemicals, construction materials, containers, forest products, etc.
What’s staggering is that there are three times as many companies in the Financials group as there are stocks in the whole Materials category. Further, there are 470 real estate companies with +$1 billion MCap within the Financials group. Primary gold producers would be just 6.5% of that subset.
What about the market value of the different sectors? They also vary widely, though the Financials group dwarfs them all.
By market capitalization, billion-dollar gold stocks represent only 12.5% of the total MCap of the Metals and Mining subcategory, which in turn is about 43% of the total Materials group. Billion-dollar gold stocks have a market cap just 0.9% the size of those in the Financials group.
The conclusion we can draw from these two charts is rather obvious: gold stocks are a tiny constellation in a big universe. That’s important, because it shows just how very crowded his little area could get when the larger universe of investors turns to the gold sector. If they invest in the bigger companies, there won’t be that many to choose from, which could swell stock prices.
In the meantime, gold stocks remain deeply undervalued. Let me build on Jeff’s argument that gold stocks are cheap on an historical basis and compare them to other industries’ price-to-book values as of July 17.
The gold industry remains the most undervalued sector available to stock investors today. Its latest price-to-book value is 1, the only industry at that level. It is slightly higher than what we reported in the beginning of July because gold has risen slightly since then, and so did many gold miners’ share prices. But they remain very cheap, as further evidenced by the Metals and Mining group having a higher P/BV, implying that non-precious metals producers are valued more than precious metals producers, a rare anomaly.
How long will gold stocks continue to be so undervalued? As Louis James wrote last week, we don’t try to time or predict the bottom. Those who’ve made fantastic amounts of money speculating in this sector didn’t even try. They made money buying when valuations were ridiculously low… and simply waiting to be right.
That’s exactly what we recommend, too—because when investors do return to the gold sector, it won’t take much capital for this small minnow to become a much bigger fish.
Not all companies will be equally attractive when investors return, but there are a number of precious metals producers that we’re convinced will outperform in a big way, based on important factors—especially their price to tangible book value. They’re revealed in the latest issue of BIG GOLD.
Last week I shared with you a couple videos from my pal, Tom Dyson.
Tom, if you remember, was a very successful trader at Citi and Salomon Bros who’s overseen billions of dollars in trades.
And in the last video Tom shared with you, step-by-step, how to put into action the best-kept trading secret in his 20 years in the biz.
Well today, Tom has an important update to announce… he’s looking to take an elite group of people, “under his wings,” so to speak, to train them on how to take advantage on coming changes in the markets… Changes that could net you up to 2-3 times more income.
Contrarian thinking is easy but successful contrarian investing is difficult. Most amateur contrarians neglect that the crowd is right most of the time. It’s only at market turning points where the crowd is wrong and contrarians are right. In recent weeks the voices against precious metals have not only appeared but grown. Weeks ago we debunked a rant of a widely followed mainstream blogger and commentator. He was ranting against the gold stocks and his rant was devoid of any analysis or actionable information. Meanwhile, more mainstream calls to sell gold stocks have popped up and during what likely will be exactly the most inopportune time to sell.
On Yahoo Finance TV, host Jeff Macke and Mike Santoli, a respectable commentator formerly of Barrons tried to analyze the gold stocks on a segment called “The Trade.” While they make a few good points their ignorance is overwhelming. They mention Newmont Mining as the blue-chip stock of the sector. There is no mention of Franco-Nevada which most would consider the blue-chip of the sector and the company that makes the most sense given their discussion of the difficulties of mining. They are telling people to sell the sector after its already declined over 60% and the cyclical bear is long in the tooth. Clearly these gentlemen have not done the historical analysis like we have (the chart below) which shows that this decline is typical during a secular bull market in gold stocks. On a show called “The Trade” these guys couldn’t come up with what is quite obvious from the chart below.
Another key argument that gold has hit support is the idea that miners are at breakeven on production costs and will not be willing to extract more metal from the ground — thus limiting supply and boosting prices. However, it’s willfully naïve to think that major miners like Barrick Gold or Newmont Mining will simply shut down and bleed cash. They have payrolls to make, operations that require maintenance and — most importantly — debt to service. Consider that Barrick had $14.7 billion in total debt as of its first-quarter earnings report, which isn’t going to pay for itself. Like it or not, these companies will continue to mine simply to keep the lights on, even if it’s not in their long-term interest – which is one of many reasons that gold miners are a bad investment right now.
This is an epic fail. Mine to keep the lights on? At breakeven? Ever heard of turning the lights off? Companies shut down mines because they can’t make money (or enough money) and they can layoff employees as Barrick is doing. Clearly this author spent no time supporting his bizarre assertion with any facts. When the price goes too low, future supply shrinks. This isn’t rocket science. The key word is future. It doesn’t impact the short-term market trend but does so later on.
The root of the problem here is the majority of the mainstream fails to understand not only Gold but the mining industry and the proper way to invest in mining companies.
The mining industry is unlike most industries. It is a venture type industry where performance is skewed and not uniform across the sector. In secular bull markets you can make money buying the mining sector but it does underperform the metals. This is true now and it was from 1960 to 1980. Yet, everyone acts as if today’s underperformance is some revelation. It’s not. It happened in the last secular bull market and will continue in the coming years. Therefore there is little reason to buy and hold the sector. Rick Rule has said if you buy the sector you’ll get killed.
The huge returns and strong outperformance are a result of picking the right companies and buying at the right time. This requires proper due diligence of the industry as well as due diligence on the companies. The mainstream doesn’t have the time for this. These guys are too busy staring at a computer screen, tweeting, hosting shows, and being interviewed to conduct proper due diligence and historical analysis.
Speaking of historical analysis, many are quick to compare Gold’s decline (36% in nearly two years) to 1980 (40% in two months) without even mentioning 1976 (45% in eighteen months) which is the better comparison. Below is an index of Gold and Silver comprised of half of each. The recent decline bottomed at multi-year trendline support and is closely in-line with the 2008 decline. In 1980 this index declined 54% in two months! After two and a half years it was down 75%.
The bottom line here is twofold. First, the growing mainstream negativity toward the gold stocks (after a 65% decline) is a textbook contrarian buy signal. It comes at a time when historical analysis suggests this is the best time to buy and when valuations are at multi-year lows. Second, one should consider the gold stocks a venture capital type of investment. Don’t buy the entire sector but look to buy specific stocks. That is how wealth is attained. While GDX and GDXJ are starting to rebound there are a fair number of stocks which have spent several months bottoming and look ready to lead the the sector in the coming months. If you’d be interested in our analysis on the companies poised to recover now and lead the next bull market, we invite you to learn more about our service.
Futures speculators have responded to this year’s extreme bearishness plaguing gold by amassing wildly-outlying record short positions in it. These huge and highly-leveraged bets can only be unwound by buying gold futures to cover the shorts. As gold continues rebounding out of its recent hyper-oversold lows, the futures traders on the short side will have to buy. This will likely fuel a massive short squeeze.
Major short squeezes are the stuff of market legends, rare and extreme events. Whenever a price falls particularly far and fast, traders wax exceptionally bearish on it. They extrapolate the downside action continuing indefinitely, and some want to play that momentum. So they reverse the usual trade of buying low then selling high. They effectively borrow the asset from someone else to sell it in the open market.
Naturally whatever is borrowed must be repaid. If the short sellers are right, if the downtrend continues, they can buy back the underlying asset later at a lower price. They strive to sell high then buy low, the difference pocketed as gains. This buying to return the underlying asset to its original lender is called covering. It’s in this covering that short squeezes are born, when prices turn against the traders shorting.
Unlike normal long trades, short ones have unlimited risk. The biggest loss possible when buying an asset outright is 100%, at worst it goes to zero. But there is no limit to how high prices can be bid up, so the worst-case loss on a short is theoretically unbound. This attribute puts tremendous psychological pressure on shorts when trades move against them. They have to cut their losses as soon as possible.
When the prices of heavily-shorted assets start rallying rapidly, this covering dynamic quickly feeds on itself. Initially a small fraction of short traders buy to exit their bets. But their very buying accelerates the rally, spooking progressively larger fractions of their peers. So they rush to buy too, forming a vicious circle. The covering shorts are squeezed out of their positions by their own buying, fueling big rallies.
These short squeezes can cascade into full-blown buying panics. These are the opposite of the usual selling panics, igniting some of the biggest and fastest rallies ever witnessed. Several factors greatly increase the odds for spawning a buying panic. They are exceptionally-large short positions for the underlying asset, excessive leverage among the short traders, and hyper-oversold price conditions.
All exist in spades today in the US gold-futures market, which implies high odds for an enormous and imminent short squeeze. Speculators’ short positions in gold futures are at a wildly-outlying secular-bull record high. And these futures traders are running extreme leverage of up to 16 to 1, radically ramping the speed and magnitude of their losses during a gold rally. And boy is gold sure overdue to surge higher!
The yellow metal was hammered to its most-oversold levels by far of its entire dozen-year secular bull near the end of last month. In just 9 months, gold plunged far enough to surrender a third of its value! This pummeled it down to an unprecedented three-quarters of its 200-day moving average. Such an extreme selloff would herald a giant mean-reversion recovery for any asset, and gold is certainly no exception.
This first chart looks at the total long and short contracts held by large and small gold-futures speculators as defined by the Commodity Futures Trading Commission in its famous weekly Commitments of Traders reports. Total spec longs and shorts are rendered in green and red respectively, with the gold price superimposed on top in blue. Speculator gold shorts have just surged to a stupendous outlying record!
The CFTC releases its CoT late every Friday afternoon, current to the preceding Tuesday. So the latest available data when this essay was published was Tuesday July 9th’s. And it is truly stunning. Gold-futures speculators held the short side of an astounding 178.9k contracts that day! This was at least a 12.3-year high, the most-extreme gold-futures spec short position by far in gold’s entire secular bull.
The sheer size of this bearish bet is breathtaking. Each COMEX gold contract controls 100 troy ounces of the yellow metal. So American futures speculators have borrowed and sold 17.9m ounces, or 556.4 metric tons! That even dwarfs the also-outlying record selloff in the holdings of the flagship GLD gold ETF over the past 7 months, which now weighs in at 417.3t. This epic gold short is wildly unprecedented.
The risks of such a big downside bet on gold are mind-boggling. By definition, futures speculators don’t produce or consume the commodities they trade. They aren’t gold miners, so the only way they can repay the 556.4t of gold they’ve borrowed is by buying it in the futures market. But even that won’t be easy. 556.4t is the equivalent of a fifth of total global production from all the world’s gold mines last year!
In order to amass such an enormous collective bet on further gold downside, futures speculators have to be both exceptionally bearish and highly convicted about that worldview. This is especially true given the very high leverage inherent in futures trading. High leverage makes already-unforgiving short selling an extraordinarily risky game, greatly multiplying both the speed and magnitude of losses when gold rallies.
At $1250 gold, a single 100-ounce futures contract controls $125,000 worth of the metal. But traders don’t have to put up the full $125k to play. The minimum maintenance margin on COMEX gold futures contracts these days is just $8k. This means the maximum leverage available to aggressive gold shorts is 15.6 to 1! Stock traders can scarcely comprehend that, as stock margin has been legally limited to 2 to 1 since 1974.
At maximum leverage, a mere 6.4% gold rally would wipe out 100% of the capital risked by gold shorts! While not all futures traders run with minimum margin, plenty do. The faster that gold rallies, the more pressure it puts on these guys to buy offsetting futures longs to cover. Short squeezes are born when just a small fraction of traders are forced to cover, unleashing buying pressure that sucks in many more.
The power of this futures leverage to violently move prices shouldn’t be underestimated. It is actually the dominant factor responsible for most of gold’s extraordinary losses this year. Year-to-date as of its recent late-June low, gold had lost $474. Incredibly $285 of this, or 60%, happened on just 3 trading days. First in mid-April and then in late June, the very high leverage inherent in gold futures fueled selling panics.
Every futures contract is a deal between two traders, the buyer on the long side and seller on the short side. And this is a zero-sum game, every dollar won by one trader is a direct dollar loss for the opposing counterparty. Back in April and to a lesser extent in June, gold plunged so fast that the max-leveraged speculator longs were forced to sell. Their selling greatly exacerbated gold’s selloff, sparking that vicious circle.
This cascading dynamic amplified gold’s down days to 4.7%, 9.6%, and 5.1%, enormous selloffs. The leveraged futures traders didn’t even have a choice. With gold moving so fast, brokerage margin computers stepped in to unilaterally sell longs at any price to protect their firms from having to make good on their customer traders’ losses. High leverage amplifies big moves as trapped futures traders are forced out.
This is true both ways, on exceptional down days and exceptional up days. Just as plunging prices drive forced liquidations of longs, surging prices drive forced buying by shorts. The brokerages unilaterally close these risky positions by buying at any price, and that buying pressure amplifies the rally which forces out more shorts. Today’s bull-record gold-short position among speculators is like short-squeeze rocket fuel.
After plummeting so rapidly in 2013, largely driven by the high gold-futures leverage biting the longs, gold is hyper-oversold and due for a massive rebound rally. If that happens fast enough, the shorts will be forced to buy to cover rapidly and trigger a short squeeze. The US futures markets have a long history of every contract being honored, there are no defaults. So the vast gold shorts can only be closed by offsetting buying.
Obviously speculators willing to run 10-to-1-plus leverage are much more sophisticated than your average long-only stock trader. High leverage is very unforgiving, quickly weeding out the traders who don’t know what they are doing. Nevertheless, as a herd gold-futures speculators have a long track record of making the wrong bets at price extremes. They miss major reversals as they get too fixated chasing momentum.
When gold-futures speculators are the most bearish, as evidenced by relatively high total shorts and relatively low total longs, gold is nearly always in the process of carving a major bottom. I highlighted instances of this in light blue above. These are major gold lows leading into major new uplegs where the futures speculators were utterly convinced gold would continue heading lower. Their track record is dismal.
A great example is the last secular-bull-record short position held by gold-futures speculators in early 2005. With gold near a major low, longs plunged to 145.1k contracts while shorts surged to 108.3k. This extremely bearish bet by the futures traders was dead wrong though. Over the next 15 months or so, gold would blast about 65% higher in its biggest upleg of its secular bull at the time. High spec shorts are a bullish indicator.
And with gold merely near $425 at this bull’s last record high in spec shorts, they were risking far less capital than they are today with gold near $1250. Those 108.3k contracts then controlled $4.6b worth of gold, but the recent outlying-record 178.9k contracts controlled a staggering $22.4b worth of gold! The more extreme the futures speculators’ shorts, the more guaranteed buying exists to catapult gold higher.
This next chart looks at a second episode of extreme futures speculator bearishness during 2008’s once-in-a-lifetime stock panic. That was the last time the spec longs in gold futures were lower than today’s, revealing extreme bearishness. Spec shorts were way above average too. Yet it was a terrible time to bet against gold, as this metal would dramatically power 167% higher over the next several years or so.
At peak bearishness during the stock panic, futures speculators’ long and short gold positions fell and rose to 144.7k and 84.5k contracts. These guys, with nearly everyone else, were utterly convinced gold was dead. If it couldn’t rally during an ultra-rare stock panic with the greatest market fear anyone will see in our lifetimes, then when would gold ever rally? The bearishness in it then was absolutely universal.
Yet nearly all traders, even the sophisticated leveraged futures guys, bet wrong at price extremes. They are the most bearish after long exceptional selloffs when they should be the most bullish. That happened in late 2008, it happened at this secular bull’s other major gold lows, and it is happening again today. These big short positions are actually what fuels the early rallies out of lows, when they’re often the only demand.
Shorts have to cover, they have effectively borrowed gold from other traders that has to be repaid. And the smart ones want to buy after extreme selloffs, to close their successful downside bets and realize their profits. But buying isn’t always easy. Every futures contract requires a willing buyer and willing seller. And as a price starts surging out of major lows, there aren’t many traders looking to sell gold futures.
So as shorts bid on gold futures to cover, in a short-squeeze situation there’s insufficient supply. The shorts dominate the market and a large fraction of them want to buy. But the longs who bought low are not interested in selling to the shorts in a nascent rally likely to run much higher. So in order to buy to cover, the shorts have to keep raising their bids to attract sufficient supply which accelerates the rally higher.
That classic dynamic was very apparent in late 2008’s stock panic, when gold started surging dramatically out of the depths of despair on gold-futures short covering. And compared to today, both the peak speculator shorts and gold price were much lower then. So the shorts then only had $6.6b of forced buying they were legally and institutionally bound to do, compared to the utterly staggering $22.4b today!
If that last episode of extreme bearishness among gold-futures speculators led to gold nearly tripling, how much more bullish is today’s far-greater extreme? In the post-panic years between 2009 and 2012, total spec long and short positions in gold averaged 288.5k contracts and 65.4k contracts. Merely to mean revert to these levels, not even overshoot, will require incredible gold-futures buying in the coming year.
On the long side, speculators would need to buy 91.6k contracts (9.2m ozs or 284.9 metric tons) to just return to post-panic-average long levels. Unlike the shorts who have to buy to repay the gold they’ve borrowed, this buying is optional for the longs. But as we saw after the stock panic, nothing brings back futures longs like rapidly rising prices. In under only a year after late 2008, longs were once again high.
The average futures-speculator short position in gold in the 4 full years after 2008 and before 2013 was 65.4k contracts. That is a long way down from today’s outlying-record 178.9k short position, we are talking 113.5k contracts! This is a mind-boggling 11.4m ozs of gold, or 353.1t. And unlike the longs, this buying is not optional. All this futures gold borrowed and sold short has to be repurchased, full stop.
Add these mean reversions from extreme lows in speculator gold longs and extreme highs in speculator gold shorts, and you get highly-probable buying in the coming year of 20.5m ounces or 638.0t! This is the equivalent of nearly a quarter of total world mine production in 2012! And all this is atypical exceptional demand on top of all the normal gold demand throughout any given year. So much buying is wildly bullish.
And I just can’t see how an exit from such outlying-record gold shorts when gold is at hyper-oversold lows and due to surge can be orderly. At some point, gold is almost certain to rally as fast as it plunged on the down days when the long futures traders were trapped in forced liquidations. And with such massive and highly-leveraged short positions, a short squeeze cascading into a buying panic is highly likely.
The total buying pressure on gold as it rebounds is going to be unprecedented. On top of the futures mean-reversion buying, there is the 417.3t of GLD holdings that had to be liquidated since December as money managers dumped gold. When gold starts rallying decisively again, they will realize they’ve made a mistake in portfolio allocation and migrate back in. GLD holdings should recover to new record highs in a year or two.
On top of all this exceptional buying, with wildly unprecedented 1055.3t potential between gold futures and GLD, is gold’s strong season. Much of gold’s enormous secular-bull run has been driven by huge buying out of Asia. The strong season over there begins with harvest in August, and runs for months on end. And unlike dumb American investors who foolishly like to buy high, Asian investors love bargains.
They are going to buy like never before with gold so extremely oversold and at such incredibly low levels compared to the past couple years. This is going to put even more pressure on the gold-futures speculators to exit their short positions. We are truly set up for a perfect storm of gold buying after 2013’s perfect storm of gold selling. The futures-short-driven component of that selling has to and will reverse.
And while a short squeeze in gold will work wonders for it and silver, the price impact on the viscerally-loathed and apocalyptically-oversold miners will be awe-inspiring. In late June as gold hit its most oversold levels of its secular bull, the miners were literally left for dead. Their flagship index was trading at exactly where it first traded 9.8 years earlier when gold and silver were merely priced near $390 and $5.25!
This absurd fundamental anomaly will unwind fast as gold surges, catapulting the precious-metals stocks far higher. We continue to research all the publicly-traded ones to uncover our fundamental favorites. Every few months we publish a fascinating new report profiling a dozen of these elite gold and silver stocks in various categories. Buy some reports today, learn about the best miners, and buy them cheap before they soar!
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The bottom line is the record short position futures speculators have amassed in gold is wildly bullish for the yellow metal. These guys have a long track record of betting completely wrong at major gold lows, extrapolating major downtrends continuing indefinitely even when they’ve begun reversing. This grave error leads to forced buying as the rallying gold price forces the shorts to cover their hyper-bearish bets.
And given such extreme spec gold shorts, widespread despair, and gold recently hitting the most oversold levels by far of its secular bull, it is due for a monster upleg. As this accelerates, the leveraged shorts will be forced to buy back the gold they owe at increasing rates. This will feed on itself and likely ignite a buying panic. It will very likely lead to the biggest and fastest upleg of gold’s entire secular bull.
That’s how long the sneaky trading technique my friend Tom wants to show you today was banned for.
Today it’s 100% legal… and almost works 100% of the time, too (94.6%, to be exact).
This isn’t a “one-shot” deal, either, and Tom’s no crackpot. He’s worked for Salomon Bros. and Citi as a trading specialist and has overseen billions of dollars in trades. But none come close to this method.
During the recent weeks we have seen commodities especially precious metals continue to drop in value. Market participant sentiment has become more bearish on commodities and couple that with a rising dollar it’s no wonder why we continue to see commodities as a whole fall in value.
Money has been flowing out of bonds at record levels this summer telling us most of market participants are feeling bullish on the stock market. This shift in sentiment of the masses are typical as they move their money from the risk on safer assets (bonds & commodities) and rotate into risk-on assets like stocks. While this is a bearish (contrarian sign) stocks could easily continue to rally for an extended period of time and possibly several more months before they actually top out.
Let’s take a look at the financial market business cycle diagram:
Bond prices have been falling for months and they typically lead the stock market lower. I feel we are starting to enter the phase where stocks will soon top and head lower also. Once this starts money will naturally flow into safer assets that are more tangible like commodities.
Keep in mind this cycle is very slow moving and rotation from one phase to another takes months. This is a process not an event but it is still very tradable.
Now let’s fast forward to precious metals both gold and silver are likely to do in the next couple months. If you review the charts below you will see gold and silver bullion prices are looking primed for a bounce/rally from these deep oversold levels.
Gold Weekly Price
Silver Weekly Price
Take a look at a basket of commodities through the GCC ETF.
GreenHaven Continuous Commodity Index Fund (GCC) is an Exchange-Traded Fund (ETF) that provides an innovative and efficient way to deliver broad based, diversified commodity exposure. It aims to achieve this by using futures contracts to track the Thomson Reuters Equal Weight Continuous Commodity Total Return Index (CCI)†. The CCI-TR is an equal weighted index of 17 commodities plus an additional Treasury Bill yield. Because of the equal weighting, GCC offers significant exposure to grains, livestock, and soft commodities and a lower energy weighting than many of its peers. In addition, GCC is rebalanced every day in order to maintain each commodity’s weight as close to 1/17th of the total as possible.
So, knowing metals are 24% of the index it bodes well for a bounce in the overall commodity index. Keep in mind this report is only focusing on precious metals, but many other commodities look ready to rally also like natural gas.
GCC – Continuous Commodity Index Fund Weekly Trading Chart
The chart below shows a very bullish 4 year chart pattern. At the very minimum a bounce to the $29 is highly.
Commodity Basket Trading Conclusion:
In short, commodities as a whole remain in a down trend. Until they show signs of real strength I will not be trying to pick a bottom. Several commodities are starting to look oversold and ready for a bounce like sugar, coffee, copper and natural gas.
Last month I talked about how a major market top is likely to unfold during the second half of this year. I still believe this to be true. But keep in mind these major market tops which only happen every few years are a MAJOR PROCESS. They take time to form and often we will see a series of new highs followed by quick sell offs as the market gets more people long as they big money distributes their shares/contracts into the new money rotating into the market.
As of last Friday, gold has now fallen as much 35.4% (based on London PM fix prices) over 96 weeks. But if you’re like us, you still recognize that the core reasons for investing in gold haven’t changed. People who sold their gold recently made a shortsighted decision. Before too long precious metals will rebound—and probably in a big way.
But when? Does history have any clues about how long we’ll have to wait for that rebound?
Perhaps the most constructive way to forecast a turnaround in gold is to look at how its price behaved in prior big corrections.
Here’s an updated view of gold’s three largest corrections since 2001, along with the time it took the price to return to the old high and stay above that level.
It has taken a significant amount time for gold to return to old highs after each big selloff this cycle. And the bigger the correction, the longer it has taken—with each correction lasting longer than the last.
However, I think our current correction more closely resembles what occurred in 1974-1976 than any of the dips so far this cycle. Here’s an updated overlay of the gold price then and now.
As you can see, during the big correction of the 1970s, gold declined 47% and took 187 weeks to recapture old highs. This fits in with the pattern discussed above: the bigger the correction, the lengthier the recovery. Another interesting pattern: the time to reach new highs always equals or exceeds the duration of the decline.
While the current correction hasn’t been as deep as that of the mid-’70s, the decline is already longer, and it’s the most prolonged of the current cycle. It is thus reasonable to expect gold to take two years or more to regain the $1,900 level and continue beyond. Barring a black swan event, gold will likely log its first annual loss since 2000 this year. These are not predictions, just possibilities, and a reminder that if gold is slow to recover, it’s simply adhering to past patterns.
However, it’s not all bad news, as the chart shows: gold nearly doubled in the two years from its ’76 low to its ’78 return to former highs. The message here is obvious: add to your inventory at depressed levels. And don’t worry about missing the bottom; investors who waited to buy until gold had retraced 30% of its decline still netted about a 70% gain once it returned to prior highs.
The same patterns hold true with stocks. You can see the high-to-low-to-prior-high time frame was longer, but the gains were bigger once the dust settled.
Investors who bucked the conventional wisdom of the day and bought a basket of gold and silver producers in the autumn of 1976—after they had dropped by almost 70%—more than tripled their investment. We’re now approaching the degree of selloff that was seen then, setting up a similar opportunity to profit.
Don’t let the long recovery times shown in the charts deter you. Stay focused on the pattern; once the declines reversed, the general trend was up. Contrarians and forward-thinking investors need to prepare for that reality, rather than take umbrage with how long it might take to beat old highs. By the time mainstream analysts—who know little about gold in the first place—declare it has entered a “new” bull market, the lows will be long behind us, along with the best buying opportunities.
Selloffs Can Be Profitable Setups
Once gold bottomed at $103.50 on August 25, 1976, the trend reversed and the metal rose a whopping 721% to peak at $850 on January 21, 1980.
Silver’s climb was even more dramatic. From its 1976 low of $4.08, it soared 1,101%. This is the 10-bagger grail of investing, where investors had the chance to add a zero to their initial investments.
But remember: the process was multiyear and began after a dismal two-year decline that was punctuated with sharp selloffs, similar to gold’s behavior since its 2011 high. While that’s a stupendous return within a short time frame, the biggest gains were seen in the final five months. The patience of some investors would certainly have been tested in those first three years.
Here’s a look at the gains for the metals from their respective lows.
Both gold and silver logged double-digit returns every year after the bottom (except silver the first year). Once the momentum had shifted, buying and holding while the fundamental forces played out led to huge profits. No “trading” was necessary; just buy after a big correction and hold on for the ride.
No need to attempt to time the bottom, either; those who bought a year after the lows still reaped gains of 490% for gold and 996% for silver. The largest chunk of profits came in the second year and beyond.
Also of note is that the second leg up in precious metals was bigger than the first. There’s no reason to think we won’t experience the same thing this time around.
The messages from history are self-evident:
Be patient. Odds favor gold emerging from a period of price consolidation and volatility. This process will take time.
Be prepared. Big gains follow big selloffs. We can’t be certain if the final bottom is in yet, but buying at these levels will ultimately net big profits if you’re buying the most solid of the major producers and potentially life-changing gains if you’re buying the best juniors.
Gold stock investors have been pummeled, including myself. Worse, we’ve had to hear “I told you so” from all the gold haters in the media.
There are a few commentators expressing mild interest in gold at these levels, but one thing I haven’t heard any of them talk about is a metric that gold analysts are rarely able to use, because gold stocks just don’t get this undervalued.
Mainstream analysts sometimes talk about book value, especially when a stock appears cheap. Book value (BV) is a metric that, in essence, sets the floor for a stock price in a worst-case scenario. BV is equal to stockholders’ equity on the balance sheet, and is the theoretical value of a company’s assets minus liabilities – sometimes you’ll hear this called “net asset value” (NAV). So when a stock price yields a market capitalization (share price x number of shares outstanding) equal to BV, the investor has a degree of safety, because if it dropped lower, a buyer could theoretically come in, buy up all shares, liquidate the company’s assets, and pocket the difference.
Price to book value (P/BV) shows the stock price in relation to the company’s book value. A stock can be considered “cheap” when it is trading at a historically low P/BV. Or, even better, it can be considered objectively ” undervalued” when it is trading below book value.
Given the renewed selloff in the gold market, I wanted to see if gold equities were getting close to book values, not just because it would point to opportunity but also the margin of safety it would imply.
We analyzed the book value of all publicly traded gold producers with a market cap of $1 billion or more. The final list comprised 31 companies. We then charted book values from January 1, 2007 through last Thursday, June 27 (index equally weighted). Here’s what we found.
This chart makes clear the current dramatic undervaluation of gold stocks.
As a group, gold producers are now selling below their book value.
Based on this metric, gold stocks are now cheaper than they were at the depths of the 2008 waterfall selloff.
The chart doesn’t show it, but gold stocks were trading above book value (about 1.1x) when gold bottomed at $255.95 on April 2, 2001, which was the beginning of the bull market.
Here’s an even more dramatic fact:
We went back as far as 1997 and could not find one episode where gold producers as a group traded below book value – and the late ’90s was known as the “nuclear winter” for the gold mining industry!
Needless to say, we’re in rare territory.
So does this mean we should buy now? To be sure, book values fall when precious metals prices decline, and costs have risen substantially since 2001 as well. So it’s possible values could fall further. But in that scenario the relationship between stock prices and book value would remain in rarified territory, making the anomaly even more appealing to a contrarian investor.
While the waterfall decline in gold stocks is painful for those of us already invested, the reality is that this is a setup we get a shot at only a few times in our investing life. It’s a cruel irony that those who are fully invested are now faced with the buying opportunity of a lifetime; however, it would be a shame for anyone to miss this blood-in-the-streets opportunity. Our future profits should be higher by an order of magnitude, when the market does turn around.
It’s times like these when I remember what Doug Casey told me the first time I interviewed him:
“You don’t make money buying when you’re optimistic. You have to actually run completely counter to your own emotional psychology.”
The extent to which each of us is able to take advantage of the opportunity shaping up is of course dependent upon our personal set of circumstances. For some, this might mean doing nothing; for others, it might mean being bold for the first time in their life. I suspect most readers fall somewhere in between.
Either way, the opportunity is clear: book values for gold producers are at rarely seen levels. Gold stocks may not reverse tomorrow or could get even cheaper when producers start reporting this quarters financial results, but history shows this opportunity will not last forever. It will probably never occur again in this cycle, once gold turns – and it should be fantastically profitable.
If you’ve been on the fence about whether or not to give BIG GOLD or International Speculator a try, the July issues for both come out this week. We can tell you exactly which companies to buy and also which have the most upside potential. Your timing, in retrospect, could turn out to be one of the great investing decisions of your life.