The following is an excerpt from famous contrarian speculator and libertarian freethinker Doug Casey’s latest book, Right on the Money. The interview with Casey Research Chief Metals & Mining Analyst Louis James took place on September 30, 2009, when gold stocks were clearly rebounding from their post-crash lows. Doug’s thoughts are just as timely and true today as they were then, presenting a perfect picture of this most volatile and most rewarding of sectors…
Louis: Doug, we were talking about gold last week, so we should follow up with a look at gold stocks. If one of the reasons to own gold is that it’s real—it’s not paper, it’s not simultaneously someone else’s liability—why own gold stocks?
Doug: Leverage. Gold stocks are problematical as investments. That’s true of all resource stocks, especially stocks in exploration companies, as opposed to producers. If you want to make a proper investment, the way to do that is to follow the dictates of Graham and Dodd, using the method Warren Buffett has proven to be so successful over many years.
Unfortunately, resource stocks in general and metals exploration stocks in particular just don’t lend themselves to such methodologies. They are another class of security entirely.
Louis: “Security” may not be the right word. As I was reading the latest edition of Graham and Dodd’s classic book on securities analysis, I realized that their minimum criteria for investment wouldn’t even apply to the gold majors. The business is just too volatile. You can’t apply standard metrics.
Doug: It’s just impossible. For one thing, they cannot grow consistently, because their assets are always depleting. Nor can they predict what their rate of exploration success is going to be.
Louis: Right. As an asset, a mine is something that gets used up, as you dig it up and sell it off.
Doug: Exactly. And the underlying commodity prices can fluctuate wildly for all sorts of reasons. Mining stocks, and resource stocks in general, have to be viewed as speculations, as opposed to investments.
But that can be a good thing. For example, many of the best speculations have a political element to them. Governments are constantly creating distortions in the market, causing misallocations of capital. Whenever possible, the speculator tries to find out what these distortions are, because their consequences are predictable. They result in trends you can bet on. It’s like the government is guaranteeing your success, because you can almost always count on the government to do the wrong thing.
The classic example, not just coincidentally, concerns gold. The U.S. government suppressed its price for decades while creating huge numbers of dollars before it exploded upward in 1971. Speculators that understood some basic economics positioned themselves accordingly.
As applied to metals stocks, governments are constantly distorting the monetary situation, and gold in particular, being the market’s alternative to government money, is always affected by that. So gold stocks are really a way to short government—or go long on government stupidity, as it were.
The bad news is that governments act chaotically, spastically. The beast jerks to the tugs on its strings held by its various puppeteers. So it’s hard to predict price movements in the short term. You can only bet on the end results of chronic government monetary stupidity.
The good news is that, for that very same reason, these stocks are extremely volatile. That makes it possible, from time to time, to get not just doubles or triples but 10-baggers, 20-baggers, and even 100-to-1 shots in these mining stocks.
That kind of upside makes up for the fact that these stocks are lousy investments and that you will lose money on most of them, if you hold them long enough. Most are best described as burning matches.
Louis: One of our mantras: Volatility can be your best friend.
Doug: Yes, volatility can be your best friend, as long as your timing is reasonable. I don’t mean timing tops and bottoms—no one can do that. I mean spotting the trend and betting on it when others are not, so you can buy low to later sell high. If you chase momentum and excitement, if you run with the crowd, buying when others are buying, you’re guaranteed to lose. You have to be a contrarian. In this business, you’re either a contrarian or road kill. When everyone is talking about these stocks on TV, you know the masses are interested, and that means they’ve gone to a level at which you should be a seller and not a buyer.
That makes it more a game of playing the psychology of the market, rather than doing securities analysis.
I’m not sure how many thousands of gold mining stocks there are in the world today—I’ll guess about 3,000—but most of them are junk. If they have any gold, it’s mainly in the words written on the stock certificates. So, in addition to knowing when to buy and when to sell, your choice of individual stocks has to be intelligent too.
Remember, most mining companies are burning matches.
Louis: All they do is spend money.
Doug: Exactly. That’s because most mining companies are really exploration companies. They are looking for viable deposits, which is quite literally like looking for a needle in a haystack. Finding gold is one thing. Finding an economical deposit of gold is something else entirely.
And even if you do find an economical deposit of gold, it’s exceptionally difficult to make money mining it. Most of your capital costs are up front. The regulatory environment today is onerous in the extreme. Labor costs are far above what they used to be. It ’s a really tough business.
Louis: If someone describes a new business venture to you, saying, “Oh, it’ll be a gold mine!” Do you run away?
Doug: Almost. And it’s odd because, historically, gold mining used to be an excellent business. For example, take the Homestake Mine in Deadwood, South Dakota, which was discovered in 1876, at just about the time of Custer’s last stand, actually. When they first raised capital for that, their dividend structure was something like 100 percent of the initial share price, paid per month. That was driven by the extraordinary discovery. Even though the technology was very primitive and inefficient in those days, labor costs were low, you didn’t have to worry about environmental problems, there were no taxes on whatever you earned, you didn’t have to pay mountains of money to lawyers. Today, you probably pay your lawyers more than you pay your geologists and engineers.
So, the business has changed immensely over time. It’s perverse because with the improvements in technology, gold mining should have become more economical, not less. The farther back you go in history, the higher the grade you’d have to mine in order to make it worthwhile. If we go back to ancient history, a mineable deposit probably had to be at least an ounce of gold per ton to be viable.
Today, you can mine deposits that run as low as a hundredth of an ounce (0.3 g/t). It’s possible to go even lower, but you need very cooperative ore. And that trend toward lower grades becoming economical is going to continue.
For thousands of years, people have been looking for gold in the most obscure and bizarre places all over the world. That’s because of the 92 naturally occurring elements in the periodic table, gold was probably the first metal that man discovered and made use of. The reason for that is simple: Gold is the most inert of the metals.
Louis: Because it doesn’t react easily and form compounds, you can find the pure metal in nature.
Doug: Right. You can find it in its pure form, and it doesn’t degrade and it doesn’t rust. In fact, of all the elements, gold is not only the most inert, it’s also the most ductile and the most malleable. And, after silver, it’s the best conductor of both heat and electricity, and the most reflective. In today’s world, that makes it a high-tech metal. New uses are found for it weekly. It has many uses besides its primary one as money and its secondary use as jewelry. But it was probably also man’s first metal.
But for that same reason, all the high-grade, easy-to-find gold deposits have already been found. There’s got to be a few left to be discovered, but by and large, we’re going to larger-volume, lower-grade, “no-see-um”-type deposits at this point. Gold mining is no longer a business in which, like in the movie The Treasure of the Sierra Madre, you can get a couple of guys, some picks and mules, and go out and find the mother lode. Unfortunately. Now, it’s usually a large-scale, industrial earth-moving operation next to a chemical plant.
Louis: They operate on very slender margins, and they can be rendered unprofitable by a slight shift in government regulations or taxes. So, we want to own these companies… why?
Doug: You want them strictly as speculative vehicles that offer the potential for 10, 100, or even 1,000 times returns on your money. Getting 1,000 times on your money is extraordinary, of course—you have to buy at the bottom and sell at the top—but people have done it. It’s happened not just once or twice, but quite a number of times that individual stocks have moved by that much.
That’s the good news. The bad news is that these things fluctuate down even more dramatically than they fluctuate up. They are burning matches that can actually go to zero. And when they go down, they usually drop at least twice as fast as they went up.
Louis: That’s true, but as bad as a total loss is, you can only lose 100 percent—but there’s no such limit to the upside. A 100 percent gain is only a double, and we do much better than that for subscribers numerous times per year.
Doug: And as shareholders in everything from Enron to AIG, to Lehman Brothers, and many more have found out, even the biggest, most solid companies can go to zero.
Louis: So, what you’re telling me is that the answer to “Why gold?” is really quite different to the answer to “Why gold stocks?” These are in completely different classes, bought for completely different reasons.
Doug: Yes. You buy gold, the metal, because you’re prudent. It’s for safety, liquidity, insurance. The gold stocks, even though they explore for or mine gold, are at the polar opposite of the investment spectrum; you buy those for extreme volatility and the chance it creates for spectacular gains. It’s rather paradoxical, actually.
(to be continued)
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Louis: You buy gold for safety and gold stocks specifically to profit from their “un-safety.”
Doug: Exactly. They really are total opposites, even though it’s the same commodity in question. It’s odd, but then, life is often stranger than fiction.
Louis: And it’s being a contrarian—”timing” in the sense of making a rational decision about a trend in evident motion—that helps stack the odds in your favor. It allows you to guess when market volatility will, on average, head upward, making it possible for you to buy low and sell high.
Doug: You know, I first started looking at gold stocks back in the early 1970s. In those days, South African stocks were the “blue chips” of the mining industry. As a country, South Africa mined about 60 percent of all the gold mined in the world, and costs were very low.
Gold was controlled at $35 per ounce until Nixon closed the gold window in 1971, but some of the South Africans were able to mine it for $20 an ounce or less. They were paying huge dividends.
Gold had run up from $35 to $200 in early 1974, then corrected down to $100 by 1976. It had come off 50 percent, but at the same time that gold was bottoming around $100, they had some serious riots in Soweto. So the gold stocks got a double hit: falling gold prices and fear of revolution in South Africa. That made it possible, in those days, to buy into short-lived, high-cost mining companies very cheaply; the stocks of the marginal companies were yielding current dividends of 50 to 75 percent. They were penny stocks in those days. They no longer exist; they’ve all been merged into mining finance houses long since then. Three names that I remember from those days were Leslie, Bracken, Grootvlei; I owned a lot of shares in them. If you bought Leslie for 80 cents a share, you’d expect, based on previous dividends, to get about 60 cents a share in that year.
But then gold started flying upward, the psychology regarding South Africa changed, and by 1980, the next real peak, you were getting several times what you paid for the stock, in dividends alone, per year.
Louis: Wow. I can think of some leveraged companies that might be able to deliver that sort of performance, if gold goes where we think it will. So, where do you think we are in the current trend or metals cycle? You’ve spoken of the Stealth, Wall of Worry, and Mania Phases of a bull market for metals—do you still think of our market in those terms?
Doug: That’s the big question, isn’t it? Well, the last major bottom in this sector was from 1998 to 2002. Many of these junior mining stocks—mostly traded in Canada, where about 75 percent of all the gold stocks in the world trade—were trading for less than cash in the bank. Literally. You’d get all their properties, their technology, the expertise of their management, totally for free. Or less.
Louis: I remember seeing past issues in which you said, “If I could call your broker and order these stocks for you, I would.”
Doug: Yes. But nobody wanted to hear about it at that time. Gold was low, and there was a bubble in Internet stocks. Why would anyone want to get involved in a dead-duck, nineteenth century, “choo-choo train” industry like gold mining? It had been completely discredited by the long bear market, but that made it the ideal time to buy them, of course. That was deep in the Stealth Phase.
Over the next six to eight years, these stocks took off, moving us into the Wall of Worry Phase. But the stocks didn’t fly the way they did in past bull markets. I think that’s mostly because they were so depleted of capital, they were selling lots of shares. So their market capitalizations—the aggregate value given them by the market—were increasing, but their share prices weren’t. Not as much.
Remember, these companies very rarely have any earnings, but they always need capital, and the only way they can get it is by selling new shares, which dilutes the value of the individual shares, including those held by existing shareholders.
Then last fall hit, and nobody, but nobody, wanted anything speculative. These most volatile of stocks showed their nature and plunged through the floor in the general flight to safety. That made last fall the second best time to buy mining shares this cycle, and I know you recommended some pretty aggressive buying last fall, near the bottom.
Now, many of these shares—the better ones at least—have recovered substantially, and some have even surpassed pre-crash highs. Again, the Wall of Worry Phase is characterized by large fluctuations that separate the wolves from the sheep (and the sheep from their cash).
Where does that leave us? Well, as you know, I think gold is going to go much, much higher. And that is going to direct a lot of attention toward these gold stocks. When people get gold fever, they are not just driven by greed, they’re usually driven by fear as well, so you get both of the most powerful market motivators working for you at once. It’s a rare class of securities that can benefit from fear and greed at once.
Remember that the Fed ’s pumping up of the money supply ignited a huge bubble in tech stocks, and then an even more massive global bubble in real estate—which is over for a long time, incidentally—but they’re still creating tons of dollars. That will inevitably ignite other asset bubbles. Where? I can’t say for certain, but I say the odds are extremely high that as gold goes up, for all the reasons we spoke about last week and more, that a lot of this funny money is going to be directed into these gold stocks, which are not just a microcap area of the market but a nanocap area of the market.
I’ve said it before, and I’ll say it again: When the public gets the bit in its teeth and wants to buy gold stocks, it’s going to be like trying to siphon the contents of the Hoover Dam through a garden hose.
Gold stocks, as a class, are going to be explosive. Now, you’ve got to remember that most of them are junk. Most will never, ever find an economical deposit. But it’s hopes and dreams that drive them, not reality, and even without merit, they can still go 10, 20, or 30 times your entry price. And the companies that actually have the goods can go much higher than that.
At the moment, gold stock prices are not as cheap, in either relative or absolute terms, as they were at the turn of the century, nor last fall. But given that the Mania Phase is still ahead, they are good speculations right now—especially the ones that have actually discovered gold deposits that look economical.
Louis: So, if you buy good companies now, with good projects, good management, working in stable jurisdictions, with a couple years of operating cash to see them through the Wall of Worry fluctuations—if you buy these and hold for the Mania Phase, you should come out very well. But you can’t blink and get stampeded out of your positions when the market fluctuates sharply.
Doug: That’s exactly right. At the particular stage where we are right now in this market for these extraordinarily volatile securities, if you buy a quality exploration company, or a quality development company (which is to say, a company that has found something and is advancing it toward production), those shares could still go down 10, 20, 30, or even 50 percent, but ultimately there’s an excellent chance that that same stock will go up by 10, 50, or even 100 times. I hate to use such hard-to-believe numbers, but that is the way this market works.
When the coming resource bubble is ignited, there are excellent odds you’ll be laughing all the way to the bank in a few years.
I should stress that I’m not saying that this is the perfect time to buy. We’re not at a market bottom as we were in 2001, nor an interim bottom like last November, and I can’t say I know the Mania Phase is just around the corner. But I think this is a very reasonable time to be buying these stocks. And it’s absolutely a good time to start educating yourself about them. There’s just such a good chance a massive bubble is going to be ignited in this area.
Louis: These are obviously the kinds of things we research, make recommendations on, and educate about in our metals newsletters, but one thing we should stress for nonsubscribers reading this interview is that this strategy applies only to the speculative portion of your portfolio. No one should gamble with their rent money nor the money they’ve saved for college tuition, etcetera.
Doug: Right. The ideal speculator’s portfolio would be divided into 10 areas, each totally different and not correlated with each other. Each of these areas should have, in your subjective opinion, the ability to move 1,000 percent in price.
Why is that? Because most of the time, we’re wrong when we pick areas to speculate in, certainly in areas where you can’t apply Graham-Dodd-type logic. But if you’re wrong on 9 out of 10 of them, and it would be hard to do that badly, then you at least break even on the one 10-bagger (1,000 percent winner). What’s more likely is that a couple will blow up and go to zero, a couple will go down 30, 40, 50 percent, but you’ll also have a couple doubles or triples, and maybe, on one or two of them, you’ll get a 10-to-1 or better win.
So, it looks very risky (and falling in love with any single stock is very risky), but it’s actually an intelligent way to diversify your risk and stack the odds of profiting on volatility in your favor.
Note that I don’t mean that these “areas” should be 10 different stocks in the junior mining sector—that wouldn’t be diversification. As I say, ideally, I’d have 10 such areas with potential for 1,000 percent gains, but it’s usually impossible to find that many at once. If you can find only two or three, what do you do with the rest of your money? Well, at this point, I would put a lot of it into gold, in one form or another, while keeping your powder dry as you look for the next idea opportunity.
And ideally, I’d look at every market in every country in the world. People who look only in the United States, or only in stocks, or only in real estate—they just don’t get to see enough balls to swing at.
Louis: Okay, got it. Thank you very much.
In 2009, at the time of this interview, Doug said it was not the perfect time to buy because “we’re not at a market bottom.” That, however, has changed dramatically. In the last two years, gold mining stocks have gotten slaughtered, and even the best companies with proven, high-grade gold deposits are now trading 50-75% below their actual value.
The time where contrarian investors can literally make a fortune may be close: Right now, Doug and many other seasoned resource investors are seeing unmistakable signs of an imminent turnaround in the gold market.
Find out how to play the turning tides of the precious metals market by watching “Upturn Millionaires,” a free online video event hosted by Casey Research—featuring Doug Casey, Porter Stansberry, Rick Rule, John Mauldin, Frank Giustra, Ross Beaty, Louis James, and Marin Katusa. Click here to save your seat.
Gold has been in a downturn for more than two years now, resulting in the lowest investor sentiment in many years. Hardcore goldbugs find no explanation in the big picture financial numbers of government deficits and money creation, which should be supportive to gold. I have an explanation for why gold has been down—and why that is about to reverse itself. I’m convinced that now is the best time to invest in gold again.
Gold Is the Alternative to Non-Convertible Paper Money
If you’ve been a Casey reader for any length of time, you know why gold is a good long-term investment: central banks are expanding paper money to accommodate the deficits of profligate governments—but they can’t print gold. Since the beginning of the credit crisis, the world’s central banks have “invented” $10 trillion worth of new currencies. They are buying up government debt to drive interest rates down, to keep countries afloat. The best they can do is buy time, however, because creating even more debt does not solve a credit crisis.
Asia Is Accumulating Gold for Good Reason
Since 2010, China has been buying gold and not buying US Treasuries. China’s plan seems to be to acquire a total of 6,000 tonnes of gold to put its holdings on a par with developed countries and to elevate the international appeal of the renminbi.
In 2013, China imported over 1,000 tonnes of gold through Hong Kong alone, and it’s likely that as much gold came through other sources. For example, last year the UK shipped 1,400 tonnes of gold to Swiss refiners to recast London bars into forms appropriate for the Asian market.
China mines around 430 tonnes of gold per year, so the combination could be 2,430 tonnes of gold snatched up by China in 2013, or 85% of world output.
India was expected to import 900 tonnes of gold in 2013, but it may have fallen short because the Indian government has been taxing and restricting imports in a foolish attempt to support its weakening currency. Smugglers are having a field day with the hundred-dollar-per-ounce premiums.
Other central banks around the world are estimated to have bought at least 300 tonnes last year, and investors are buying bullion, coins, and jewelry in record numbers. Where is all that gold coming from?
COMEX and GLD ETF Inventories Are Down from the Demand
The COMEX futures market warehouses dropped 4 million ounces (over 100 tonnes) in 2013. The COMEX uses two classes of inventories: the narrower is called “registered” and is available for delivery on the exchange. There are other inventories that are not available for trading but are called “eligible.” I don’t think it’s as easy to get holders of eligible gold to allow for its conversion to registered to meet delivery as the name implies. Yes, that might occur, but only with a big jump in the price.
The chart below shows the record-low supply of registered COMEX gold.
Meanwhile, SPDR Gold Shares (GLD), the largest gold ETF, lost over 800 tonnes of gold to redemptions. At the same time, central banks have provided gold through leasing programs (but figures are not made public).
Why Has Gold Fallen $700 Since 2011?
In our distorted world of debt-ridden governments and demand from Asia, gold should continue rising. What’s going on?
The gold price quoted all day long comes from the futures exchanges. These exchanges provide leverage, so modest amounts can be used to make big profits. Big players can move markets—and the biggest player by far is JPMorgan (JPM).
For the first 11 months of 2013, JPM and its customers delivered 60% of all gold to the COMEX futures market exchange; that, surely, is a dominant position that could affect the market. By supplying so much gold, they are able to keep the price lower than it would otherwise be.
A key question is why a big bank would take positions that could drive gold lower. Answer: Banks gain by borrowing at zero rates. But the Federal Reserve can only continue its large quantitative easing programs that bring rates to zero if gold is not soaring, which would indicate weakness in the dollar and the need to tighten monetary policy. Voilà—we have a motive. Also, suppressing the price of gold supports the dollar as a reserve currency.
The chart below shows the month-by-month number of contracts that were either provided to the exchange or taken from the exchange by JPM. For a single firm, the numbers are large, but the effect across all gold markets is greater because so many gold transactions follow the price set in the paper futures market.
What jumps out from the chart above is the fact that while JPM had been selling gold into the futures market for most of the year, it made a major shift in December, absorbing 96% of all gold delivered.
That is a radical shift and, I believe, an indicator that JPM‘s policy has shifted. In my opinion, their deliveries of gold were suppressing the price during 2013, but now their policy has shifted in a way that will support gold going forward.
This leaves a vital question unanswered: Why? Has the motivation to suppress the price of gold gone away? Not likely, and we may never know the full truth of what is happening, but I suspect the main reason for the shift is that they have done their damage. The $740 drop from top to bottom, a 39% decline, has shaken confidence in gold as a financial “safe haven” among many investors, especially those new to precious metals. At the same time, continuing to lean on gold at this point could become very costly. JPM delivered $3 billion (about 2 million ounces of gold) into the market up to December in 2013, and may not have ready sources of gold to keep that up. It is dangerous to put on big short positions unless you have gold or some future gold deliveries as a hedge.
By now, everyone knows of the shortages in the gold market; JPM has to be as aware of that as the rest of us. It just isn’t safe for them to continue to lean on the market. Being aware, it looks like they are taking the bet that gold will rebound, so they could do well on the other side of the trade.
Another confirmation of the shift by big banks comes from data provided by the US Commodity Futures Trading Commission (CFTC) that shows the net positions of the four biggest US banks in the futures market. There has been a dramatic change from being short the market to now being long.
Crisis Brewing in the Gold Market
Germany claims to hold 3,390.6 tonnes of gold, about half of which is held by foreign central banks. Over a year ago, they announced a plan to repatriate 674 tonnes of gold from France and the United States. The US said it would comply, but told the German government that it would have to wait seven years for all the gold to be delivered. The news out last week was that after a year, Germany had only obtained 37 tonnes of its gold—and only five of them were from the US. That is a trivial amount (only 160,000 ounces).
So why can’t Germany get its gold? Explanations of having to melt down existing gold and recast it just don’t make sense. The most logical conclusion, and the one I’ve come to, is that the United States simply doesn’t have the gold it says it has—neither Germany’s nor its own.
Of course, the US government isn’t going to admit that there’s a problem, but I say there is.
More evidence: JPMorgan’s COMEX warehouse contained 3.0 million ounces of gold in 2012, but that had dropped to 0.5 million ounces by mid-2013. Its registered inventories are a razor-thin 87,000 ounces. These kinds of swings are indicative of shortages and instability.
Further, JPMorgan sold its gold vault in New York City—located next to the Federal Reserve’s vault—to the Chinese. The banking giant also just announced the sale of its commodities trading business (although it may not have sold the precious metals part of that business). Perhaps they were concerned about new regulations of banks with deposit insurance from the government.
In another relevant development, Deutsche Bank recently surprised the gold community by quitting its position on the committee that sets the London a.m. and p.m. fixings. This came a few weeks after a German regulatory body called BaFin started investigating how these prices were set. BaFin also gave an indication that the process appeared worse than the LIBOR fixing scandal, which resulted in billions in fines.
Putting Inventories and Traders Together
The futures market looks fragile to me. The basic problem is that there are many more transactions that could put a claim on gold than there is gold registered for delivery in the COMEX warehouses.
The chart below gives a dramatic picture by simply dividing the open interest of all futures contracts by the registered inventories. The black line at the bottom shows the big jump in the ratio as the registered inventories declined. There are 107 times more open-interest positions than there is registered gold.
The futures markets operate on the expectation that only a few big traders will demand delivery. JPMorgan has shown that it is in a position to demand almost all (96%) of the gold for delivery. They are big enough that they could cause a collapse of the market, if they were to force delivery of more than is available. They know better than to do so, though, and I would guess that they will just manage to try to gain back what gold they have been delivering over the last several years. That should support the price of gold.
Gold Will Rise, and It’s on Sale Now
Now is the time to stake your claim in gold. In the long term, we know that paper money will become worthless; in the short term, the biggest seller has just shifted its actions to becoming a buyer. That makes this a good time to accumulate gold and gold mining stocks before a major shift upward in price.
Speaking of gold mining stocks: My Casey Report co-editor Doug Casey, as well as other famous gold speculators, are also convinced that a turnaround in the gold market may be upon us. If you haven’t yet, do yourself a favor and watch “Upturn Millionaires,” Casey’s online video event with eight well-known resource speculators and investment experts that premieres Tuesday at 2:00 p.m. EST. It’s free, so you just have to sign up to register.
Recent price action in the stock market has many traders on edge. With the market closing below our key support trend line last week, the market has now technically starting a down trend.
While trend lines are a great tool for identifying a weakening trend and reversals in the market, I do not put a lot of my analysis weighting on them.
Most of my timing and trading is based around what I call INNER-Market Analysis (Market Stages, Cycles, Momentum and Sentiment). Using these data we can diagnose the overall health of the market. Knowing the strength of the market we can then forecast short term trend reversals before they happen with a high degree of accuracy.
In this report I keep things clean and simple using just trend lines. During the last three weeks we have seen the price of stocks pullback. And because 2013 was such a strong year for stocks most participants are expecting a sharp market correction to take place anytime now.
So with the recent price correction fear is starting to enter the market and money is rotating out of stocks and into the Risk-Off assets like gold and bonds.
Stocks tend to fall in times of economic uncertainty or fear. These same factors push investors towards the safety trades (Risk-Off) high quality bonds and precious metals. As more money goes from risk-on to risk-off, stocks will continue to fall and the safety trades will rise. The move by investors to select the safety of gold and bonds compared to the volatility of stocks will result in these risk plays to moving in opposite directions.
Let’s take a look at the chart below for a visual of what looks to be unfolding…
How to Trade These Markets:
While these markets look to be starting to reverse trends, it is critical that we understand how the market moves during reversals and understand position/money management.
Getting short stocks and long precious metals in the long run could work out very well, but if you understand the price action that typically happens during reversals you know that the stock market will become choppy and we could see the recent highs tested or possibly even a new high made before price actually starts a down trend. And the opposite situation for gold and bonds. Drawdowns can be huge when investing and why I don’t just change position directions when the first sign of a trend change shows up on the chart.
Price reversals are a process, not an event. So it is important to follow along using a short term time frame like the daily chart and play the intermediate trends that last 4-12 weeks in length. By doing this, you are trading in the direction of the most active cycle in the stock market and positioned properly as new a trend starts.
What I am looking for in the next week or two:
1. Stocks to trade sideways or drift higher for 3-6 days, then I will be looking to get short. Again, cycle, sentiment, and momentum analysis must remain down for me to short the market. If they turn back up I will remain in cash until a setup for another short or long entry forms.
2. Gold remains in a down trend but is starting to breakout to the upside. I do have concerns with the daily chart patterns for both gold and silver, so next week will be critical for them. We will be using some ETF Trading Strategies to take advantage of these moves.
3. Bond prices (not yields) look to be forming a bottom “W” pattern. They have had a big run in the last few weeks and are now testing resistance. I think a long bond position is slowly starting to unfold but if we look at the futures price charts for both bonds and gold, they have not yet broken to the upside and have more work to do. As mentioned before ETFs are not really the best tool for charting but I show them because they what the masses follow and trade.
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It’s not exactly news that gold mining stocks have been in a slump for more than two years. Many investors who owned them have thrown in the towel by now, or are holding simply because a paper loss isn’t a realized loss until you sell.
For contrarian speculators like Doug Casey and Rick Rule, though, it’s the best of all scenarios. “Buy when blood is in the streets,” investor Nathan Rothschild allegedly said. And buy they do, with both hands—because, they assert, there are definitive signs that things may be turning around.
So what’s the deal with junior mining stocks, and who should invest in them? I’ll give you several good reasons not to touch them with a 10-foot pole… and one why you maybe should.
First, you need to understand that junior gold miners are not buy-and-forget stocks. They are the most volatile securities in the world—”burning matches,” as Doug calls them. To speculate in those stocks requires nerves of steel.
Let’s take a look at the performance of the juniors since 2011. The ETF that tracks a basket of such stocks—Market Vectors Junior Gold Miners (GDXJ)—took a savage beating. In early April of 2011, a share would have cost you $170. Today, you can pick one up for about $36… that’s a decline of nearly 80%.
There are something like 3,000 small mining companies in the world today, and the vast majority of them are worthless, sitting on a few hundred acres of moose pasture and a pipe dream.
It’s a very tough business. Small-cap exploration companies (the “juniors”) are working year round looking for viable deposits. The question is not just if the gold is there, but if it can be extracted economically—and the probability is low. Even the ones that manage to find the goods and build a mine aren’t in the clear yet: before they can pour the first bar, there are regulatory hurdles, rising costs of labor and machinery, and often vehement opposition from natives to deal with.
As the performance of junior mining stocks is closely correlated to that of gold, when the physical metal goes into a tailspin, gold mining shares follow suit. Only they tend to drop off faster and more deeply than physical gold.
Then why invest in them at all?
Because, as Casey Chief Metals & Mining Strategist Louis James likes to say, the downside is limited—all you can lose is 100% of your investment. The upside, on the other hand, is infinite.
In the rebound periods after downturns such as the one we’re in, literal fortunes can be made; gains of 400-1,000% (and sometimes more) are not a rarity. It’s a speculator’s dream.
When speculating in junior miners, timing is crucial. Bear runs in the gold sector can last a long time—some of them will go on until the last faint-hearted investor has been flushed away and there’s no one left to sell.
At that point they come roaring back. It happened in the late ’70s, it happened several times in the ’80s when gold itself pretty much went to sleep, and again in 2002 after a four-year retreat.
The most recent rally of 2009-’10 was breathtaking: Louis’ International Speculator stocks, which had gotten hammered with the rest of the market, handed subscribers average gains of 401.8%—a level of return Joe the Investor never gets to see in his lifetime.
So where are we now in the cycle?
The present downturn, as noted, kicked off in the spring of 2011, and despite several mini-rallies, the overall trend has been down. Recently, though, the natural resource experts here at Casey Research and elsewhere have seen clear signs of an imminent turnaround.
For one thing, the price of gold itself has stabilized. After hitting its peak of $1,921.50 in September of 2011, it fell back below $1,190 twice last December. Since then, it hasn’t tested those lows again and is trading about 6.5% higher today.
The demand for physical gold, especially from China, has been insatiable. The Austrian mint had to hire more employees and add a third eight-hour shift to the day in an attempt to keep up in its production of Philharmonic coins. “The market is very busy,” a mint spokesperson said. “We can’t meet the demand, even if we work overtime.” Sales jumped 36% in 2013, compared to the year before.
Finally, the junior mining stocks have perked up again. In fact, for the first month of 2014, they turned in the best performance of any asset, as you can see here:
(Source: Zero Hedge)
The writing’s on the wall, say the pros, that the downturn won’t last much longer—and when the junior miners start taking off again, there’s no telling how high they could go.
To present the evidence and to discuss how to play the turning tides in the precious metals market, Casey Research is hosting a timely online video event titled Upturn Millionaires next Wednesday, February 5, at 2:00 p.m. Eastern.
The non-static, changing correlation between precious metals and equities is something we’ve written about several times in the past few years. We last wrote about this in June in Epic Opportunity in the Gold Stocks. The mainstream is entirely oblivious to the fact that gold stocks (and precious metals) can have rip-roaring bull markets when equities are in a bear market. The precursor to this is two-fold: precious metals are in a secular bull and the correlation between the two has been negative for more than a year. The current negative correlation has been in place for more than two years and now gold stocks have bottomed (in our view) and equities are looking toppy.
There are several examples of this negative correlation. Gold stocks soared from 1973-1974 when the S&P 500 was cut in half. The same thing happened from 2000 to 2002. Also, gold stocks for over 18 months in 1977-1978 began a new cyclical bull market while the S&P 500 declined 19%. This scenario has happened three times: twice in the last bull market and once in the current bull market.
Recent market action suggests that this negative correlation will continue but in favor of precious metals and also hard assets. In the chart below we plot the S&P 500, GDX and CCI (commodities). Since the end of summer in 2011 there has been a clear negative correlation between equities and gold stocks as well as equities and commodities. The tide appears to be shifting as today GDX closed at a two-month high while the S&P 500 closed at a two-month low. A few days ago, CCI closed at a two and a half month high.
This price action shouldn’t come as a surprise as global markets and asset classes are ripe for a shift. The bull market in the S&P is already quite mature while hard assets have been in a cyclical bear for nearly three years. Sentiment on equities (according to the Merrill Lynch fund manager survey, Investors Intelligence or NAAIM data) has been extremely bullish and in some cases even more so than in 2007. Meanwhile, sentiment on bonds (which are also rallying), commodities and precious metals has been extremely bearish since last summer making these markets ripe for a strong reversal.
Keep an eye on the gold stocks as they’ve been leading the metals and have a tendency to rebound substantially from important bottoms. The chart below shows that GDX is facing a confluence of trendline resistance here at $24. If GDX breaks to the upside then there is no major resistance until $30. That is another potential 25% upside. Your stop-out point could be support at $22.
Conventional thinking could lead you to believe that equity weakness would be a negative for precious metals. While that was the case in 2008, the negative correlation from 2011-2013 and recent price action suggest precious metals (and gold stocks in particular) will benefit from a bear market in equities. Gold stocks have already endured a multi-year bear market. Large-caps shed 65% while juniors lost 80%. Everyone has already sold out of precious metals and piled into US and developed market equities. However, we are seeing signs that the trend is shifting. Over the past month GDX is up 18% and GDXJ is up 27%. As long as the 50-day moving averages hold, we expect continued gains in the coming weeks and months. If you’d be interested in learning about the companies poised to rocket out of this bottom then we invite you to learn more about our service.
The US Fed released its January statement earlier today. The decisions appear to be almost identical to the ones taken in December. Stocks and the dollar suffered on the news release, gold and US Treasuries closed (slightly) higher on the day. Mind that both stocks and gold are at critical junctures, as we show on the charts below.
The FOMC voted unanimously, and we don’t recall off hand the last time that happened, to reduce purchases by $10 billion to $65 billion per month and promises to maintain the same pace of reduction assuming progress is being made to its dual labor-inflation mandate. In December Eric Rosengren voted against, claiming that the rate of unemployment was too high and that to taper at the time would prove counter-productive.
As usual, Zerohedge was extremely fast to release the highlights of the FOMC meeting:
US FED tapers bond buying to $65 billion monthly pace from $75 billion
US FED says labor market “mixed,” “showed further improvement”
US FED reiterates low rates until jobless rate well past 6.5%
US FED repeats risks to outlook have become “more nearly balanced”
US FED says unemployment has declined “but remains elevated”
There are a couple of important things to note.
First, the reaction of the markets on today’s tapering decision is different than the previous one a month ago. Back then, stocks catapulted higher. Today, they closed significantly lower on the day, a sign of weakness. It appears that tapering is not that fruitful for the stock market, contrary to what the market thought a month ago.
The key point is that nobody knows what will happen with Taper III, IV and V. Will the effects manifest themselves in a linear fashion (additional but similar weakness on each Taper)? Or will it evolve in an logarithmic way? Nobody has the answer to this question, as we are in uncharted territory, no matter if policy makers want you to believe that they are in full control. The truth of the matter is that they are not. The recent emerging markets crisis, being the result of the developed world’s central bank policies, is evidence that the markets can take over control from central planners.
From a chart point of view, the S&P 500 is trading at an important support level (horizontal blue line on the chart), a bit lower than its 50 day moving average. This is a critical juncture. Should this support level give up, then the area between 1705 and 1720 becomes a major price point (breaking through that area would signal the start of a bear market).
Second, gold is holding up very well in this environment. The price of gold closed slightly higher today, although there was significant volatility in both directions during the day. After the previous FOMC meeting in December, gold closed neutral.
From a chart perspective, gold is right above a major resistance line and it is holding well for the time being. It broke resistance a week ago and it should go higher from this price point (ideally with increasing volume) in order to confirm a break out.
Gold’s current relative strength is not only confirmed by weakness in US equities, but also by a weakening US dollar and the gold mining complex. The gold miners recently broke through important resistance (see blue line on the following chart) and are holding up quite well. For us, the most surprising evolution of today was that gold miners went significantly higher after the FOMC news, although they were neutral before, amid a weakening stock market.
For now, these are all encouraging signals for the precious metals complex. If both the metal(s) and the miners can hold above resistance and move higher in the days and weeks ahead, it would confirm a break out and a trend reversal. Readers know which price levels to monitor.
Evidence is mounting that the bottom for gold may be in. While there’s still risk, there’s a new air of bullishness in the industry, something we haven’t seen in over two years.
An ever-growing number of industry insiders and investment analysts believe the downturn has come to a close. If that’s true, it has immediate and critical implications for investors.
Doug Casey told me last week: “In my lifetime, the best time to have bought gold was 1971, at $35; it ran to over $800 by 1980. In 2001, gold was $250: in real terms even cheaper than in 1971. It ran to over $1,900 in 2011.
“It’s now at $1,250. Not as cheap, in real terms, as in 1971 or 2001, but the world’s financial and economic state is far more shaky.
“Gold is, once again, not just a prudent holding, but an excellent, high-potential, low-risk speculation. And gold stocks are about to create a whole new class of millionaires.”
Just a couple of months ago, you would have had a hard time finding even one analyst saying something positive about gold and gold stocks—even some of the most bullish investment pros had gone silent.
But that’s changing. Case in point: When Chief Metals & Mining Strategist Louis James and I attended last week’s Resource Investment Conference in Vancouver, we witnessed quite a few very optimistic speakers.
Take Frank Giustra, for example, a self-made billionaire and philanthropist who made his fortune both in the mining sector and the entertainment industry. He’s the founder of Lionsgate Entertainment, which is responsible for blockbuster movies like The Hunger Games, but he was just as heavily involved with mining blockbusters such as Iamgold, Wheaton River Minerals, Silver Wheaton, and others.
More Upturn Advocates
Here’s a quick scan of the growing number of voices that think the decline is over, some of which are outright bullish:
“The worst is over with gold. It’s time to call your broker.” —Frank Holmes, US Global Investors
“Sentiment is as black as night on gold, so I’m actually long on some gold miners.” —Jeffrey Gundlach, bond guru and DoubleLine Capital founder
“We’ll see a gradual recovering throughout the year, because all the negative factors are already in the price.” —Eugen Weinberg,head of commodities research at Commerzbank
“Looking ahead, the downside risks seem to be diminishing, and overall we feel that the big shocks we’ve seen over the last two or three years are done…” —Marc Elliott, Investec
“The mainstream narrative on gold is changing, indicating a possible bottom.” —Bron Suchecki, Perth Mint
“Orthodox investments are working on a cyclical peak, as precious metals are working on a cyclical bottom. The big pattern could be fully reversed by February-March, with gold becoming one of the best-performing sectors through the rest of 2014. The advice is to seriously reduce exposure in stocks and bonds and get fully invested in the precious metals sector. This should be completed in the first quarter.” —Bob Hoye, Institutional Advisors
“I’m telling you, you’ve seen the bottom of the gold market,” he told the rapt audience at the conference, offering a bet to the Goldman Sachs analyst who claimed gold is going to $1,000.
The stakes: Whoever loses has to stand on a popular street in downtown Vancouver dressed in women’s underwear.
Tom McClellan, editor of the McClellan Market Report, stated in a recent interview on CNBC: “The commercial traders are at their most bullish stance since the 2001 low, and they usually get proven right. It’s a hugely bullish condition for gold, and I’m expecting a really large rebound.
“The moment we see a major gold producer announce that it’s curtailing production or it’s going out of business,” McClellan continued, “that’ll be the moment we mark the low in gold. I expect to have one of those announcements any minute. We’re getting down to the production price of gold right now, and they won’t continue producing gold at that level for very long.”
Are they just guessing? To answer that, first consider the historical context of this bear market—it’s getting very long in the tooth:
The current correction in gold stocks is the fourth longest since 1879. The decline of 66% ranks in the top 10 of recorded history.
In silver, only two corrections have lasted longer—the ones that ended in 1936 and 1983.
Some technical analysts have pointed to positive chart formations, most notably the powerful “double bottom” that can portend a strong upward move. Based on intraday prices…
Gold formed a double bottom last year, hitting $1,180.64 on June 28 and $1,182.60 on December 31, a convincing six-month span.
Silver formed a higher low: $18.20 on June 28 vs. $18.72 on December 31, a bullish development.
Gold stocks (XAU) formed a slightly lower low: $82.29 on June 26 vs. $79.73 December 19, 2103, a difference of 3.2%. However, as our friend Dominick Graziano, who successfully helped us earn doubles on three GLD puts last year, recently pointed out…
The TSX Venture Index, where most junior mining stocks trade, has stayed above its June low. In fact, it recently soared above both the 50-day and 40-week moving averages for the first time since 2011.
Meanwhile, Goldcorp (GG) sent a huge bullish signal to the market earlier this month. It decided to pounce on the opportunities available right now, launching a takeover bid of Osisko Mining for $2.6 billion. The company wouldn’t be buying now if it thought gold was headed to $1,000.
As Dennis Gartman, editor and publisher of The Gartman Letter, says, “It’s time to be quietly bullish.”
The smart money, like resource billionaire Rick Rule, is not just quietly bullish, though—they are actively buying top-quality junior mining stocks at bargain-basement prices to make a killing when prices rise.
Back then, we made a strong case for this once-in-a-generation opportunity—but it was still undetermined when the bottom would be in. It looks like that time is now very near, and we believe it’s time to act.
On Wednesday, February 5, at 2 p.m. EST, resource legends Frank Giustra, Doug Casey, Rick Rule, and Ross Beaty, investment gurus John Mauldin and Porter Stansberry, and Casey Research resource experts Louis James and Marin Katusa will present the evidence and discuss the possibilities for life-changing gains for investors with the cash and courage to grab this bull by the horns.
How do we know the absolute bottom is in? I’ll answer that with a quote from a recent Mineweb interview with mining giant Rob McEwen, former chairman and CEO of Goldcorp:
“I’d say we’re either at or extremely close to the bottom, and as an investor I’m not prepared to wait to see if the bottom’s there because it’s very hard to pick it. Because … if you’re not taking advantage of it right now, you’re going to miss a big part of the move. And when you look at the distance these stocks have to travel to get to their old highs, there’s some wonderful numbers in terms of performance that I think we’re going to see.”
Granted, these voices are still in the minority—but that’s what makes this opportunity wonderfully contrarian. After all, once “Buy gold stocks” is investor consensus, we’ll be approaching the time to sell.
Our Upturn Millionaires experts believe that our patience is about to be rewarded. And when that happens, gold stocks will be easy doubles—and the best juniors potential ten-baggers.
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Last month I warned about the bubble in the stock market, and what was going to happen when it popped. Make no mistake the chart of the S&P is the most dangerous chart in the world. When this parabolic structure collapses, it is going to bring down the global economy.
My initial target for this rally was a test of the reaction high on the NASDAQ in 2000. As you can see we came within just a whisker of hitting that target.
After what happened on Friday I think we can safely assume that the current daily cycle has now entered its declining phase. As I have noted before, the average duration trough to trough for the daily cycle in the stock market is 35-40 days. Friday was day 24. We should expect a bottom probably on the next employment report on February 7.
Now here’s the thing, I expect the Fed, and the plunge protection team to go into full panic mode this weekend, come out Monday morning with guns blazing, and try to stop the sell off. Unfortunately this behavior is what has allowed this parabolic structure to develop. Every time the market has tried to correct over the last year the Fed has prematurely aborted the sell off. I’m pretty sure they are going to try again next week. If they succeed then we will probably have a final panic melt up phase with the NASDAQ testing the all-time highs above 5000 over the next 2-3 months.
If on the other hand the selling pressure overwhelms the plunge protection team and starts to spiral out of control next week then we are witnessing the breaking of the parabola and the end of this bull market.
Here’s what we need to watch next week. If the Fed can turn this market around and prevent the S&P from breaking through this intermediate trend line over the next two weeks, then this will turn into just a normal daily cycle correction and will be followed by a fifth daily cycle that should include the melt up phase of this bull market.
If on the other hand the selling pressure overwhelms the plunge protection team’s efforts to hold it back and breaks through that intermediate trend line early in the week then we are witnessing the collapse of the parabolic structure and I wouldn’t expect it to stop until we reach the 2000 and 2007 previous bull market high support zone.
Back on January 3 I instructed my subscribers to buy long-term puts on the market to take advantage of the collapse as I knew it was eventually coming. We should know by early next week whether or not those puts are going to pay off huge in the next two weeks or whether we will take a modest profit and reenter them at NASDAQ 5000.
Whether the parabolic structure collapses next week or in two months we all know what the Feds response is going to be. They are going to reverse their taper decision and double or triple down on QE. The problem is that when a parabolic structure collapses it can’t be put back together. My theory all along has been that when the stock market bubble pops the Fed would then completely destroy the dollar trying to pump it back up and that liquidity would then flow into the commodity markets instead of the broken parabola of the stock market and create another inflationary event similar to 2008.
Those people that say we have to have wage and employment growth in order to generate inflation are ignoring recent history. We had a severe inflationary event in 2008 while the economy was already in recession and unemployment was surging.
You don’t need wage growth to have inflation. You just need a central bank to destroy your currency. The Fed has already destroyed our currency. At the moment the inflation is being stored in the stock market, bond market, and echo bubble in the real estate market. When those bubbles pop the inflation is going to flow back into the commodity markets.
At the start of the year we asserted that the mining equities could lead the metals higher. Since then, the shares have roared higher while the metals have remained subdued. Gold has gained a bit but Silver has really struggled. Why are the stocks performing so well if the metals are not confirming?
The main reason is the stocks led the metals down (specifically Gold) during the bear market. The chart below plots CDNX (Canadian juniors), GDXJ (US juniors), GDX (large caps) and Gold. Note that both junior markets peaked months before Gold. GDX technically peaked at the same time but began its topping process in December 2010, well before Gold peaked.
The stocks essentially began to underperform in December 2010 and then peaked a few months later. Most companies peaked even before Gold went parabolic! As a result, most mining stocks have been in a bear market longer than Gold and may have already discounted the worst. It makes sense that they would bottom first and there is a precedent for that scenario.
The chart below shows the action in the HUI and Gold during the 2000-2001 bottom. The HUI bottomed in November while Gold formed a double bottom in February and April. The HUI barely corrected when Gold declined to its first bottom. The HUI did decline nearly 20% before the April bottom in Gold but that was after it rebounded 70% in only four months. Moreover, the HUI exploded after Gold’s final bottom in April.
Moving along, another reason for stock outperformance is because the relationship to Gold recently reached a historic extreme. I am usually not a fan of comparing gold stocks to Gold. Over time the gold stock sector as a whole struggles to outperform Gold. It badly underperformed in the 1970s and has badly underperformed over the past five years. However, this relationship (gold stocks vs. Gold) recently hit a 70-year low! When something reaches that type of extreme, we have to take note. (Source: NowandFutures.com)
It turns out that there have been two great buying opportunities in the stocks (June 2013 and December 2013) with a possible third to come. During Gold’s final decline in 2001 the HUI shed about 20%. Yet Gold rebounded strongly and the HUI did too, exploding 65% in less than two months. If Gold hasn’t bottomed then its final bottom (presumably in the coming months) could offer another major opportunity for the mining stocks.