Gold Stocks – Are You Kidding Me?


Given the unbelievable negativity in the gold equities space, I felt compelled to put together a short blurb on gold stocks, and where we might be in the cycle.

First, let’s be clear… I agree with our friend Harris Kupperman when he says that “mining is a terrrible business.” It’s a God-awful business, for many, many reasons. BUT, it can also be a business where fabulous wealth is created.

I often mention the story of Diamond Fields Resources. I have very fond memories of this one – ah, if I only bought more (hindsight is better than 20/20!)

These guys were digging for diamonds and found nickel. Not as sexy, but it was a BIG nickel deposit. In short, I bought the stock at something like .50, watched it fall to .25 and then rode it to $40 and sold. I should have held a bit longer, as it got bought at $100 by Inco. Hey, I’ll take .50 – $40 any day! For that ride I’d like to thank our friend Doug Casey!

It happens that way sometimes. For most however, their typical investment in gold stocks looks something like this:

Rusoro 5 year stock performance

Don't feel bad if this is you, we've been there too!

There are a lot of theories as to why the gold stocks have underperformed gold bullion recently. I’m not going to cover those here, because frankly, I don’t care about the “why.” All I care about is our reaction to the market as it stands TODAY.

By the way, that’s all you should EVER care about when you are investing. Forget the past, forget predicting the future… worry about the here-and-now!

Today, the here-and-now reality is that gold equities are about as bombed-out a sector as you will find, and I’m including US real estate! Gold newsletter writers are bordering on suicidal, some are suggesting to sell everything, and others are just floating away, never to be heard from again… A Canadian warrants site I used to follow closely has not been updated since February!

Even the popular MSM commentator, money manager and newsletter writer Dennis Gartman is bagging on gold stocks. He’s just in time! With the GDXJ (junior gold stock index) down ~45% from its 2011 highs, he is advising his clients to give up on them because even when gold goes up, they can’t stage a rally. He said that the juniors are “a mugs game if ever there was one,” in this past Monday’s The Gartman Letter.

I love the smell of capitulation in the morning…

Guess what all this means? We should (probably) be buying with both hands!

But, as another guy I respect a lot, Stewart Thomson, editor of Graceland Updates likes to say, don’t be an (Elmer) Fudd and make the typical rookie retail investor mistake of “price plopping” all your capital into a market you think is bottomed out. Guess what, a ten cent stock can still go to one cent, or zero!

Buy a little at a time, and buy selectively. Scale your purchases in at lower levels, buying more of your favourites as they decline. If they rise a bit, let them go and maybe sell a bit as that’s occurring. Never, ever, ever chase a market higher.

I’m going to quote Rick Rule a couple times here, because quite frankly, Rick knows his %$@t. If you aren’t as smart as Rick (I’m not) you should heed his sage advice:

“What is the appropriate response to a strong market? Sell! What is the appropriate response to a weak market? Buy! Be a contrarian or be a victim.”

So, armed with that advice, how do we play this?

I recommended Sandstorm Resources in a post I wrote a while ago entitled “A Golden Opportunity.” Sandstorm is a great company in my opinion, and my enthusiasm has been supported by the fact that when compared to the rest of the gold juniors space, Sandstorm is a rock star. Stocks that can hold up in a market like this need to be bought.

You could also buy the GDXJ (Market Vectors Junior Gold Miner’s Index ETF) or the GDX (Market Vectors Gold Miner’s Index ETF) if you prefer not to buy the more speculative issues.

GDX Chart - 2 year

Bombed out?

My partner Chris has suggested buying long-dated calls on some of the better miners (you could do the same on the GDX and GDXJ). They’re cheap as chips here, but they are an all-or-nothing bet, with the disadvantage of time decay.

For those who hold the lofty designation of “accredited” investors, something Rick said in a recent article struck me as having relevance to what we talk about in these pages - private placements.

“If you have the courage and the means, this could be an epic year for private placements. Issuers were reluctant to raise capital last year as a consequence of declining equity prices, but they continued to spend. They have, as an industry, pursued an illogical circular exercise: spending money to generate news… to increase share prices… to raise money. This year many will have to raise equity irrespective of market conditions, and the small institutions and mutual funds that funded them so generously in the past will probably be unable to do so in the future. Back only the best teams and good projects. And go for a warrant!”

Music to our ears. We always think private placements in good companies are better investments than buying retail, but there are cycles in the private placement market too, as the quote above suggests.

We prefer private placements for many reasons, including, as Rick pointed out, warrants! Private placements often entice the investor by including a warrant to buy additional shares at some point in the future, at a pre-determined price. We like having multiple swings at the ball.

We’ve alerted our readers to a few private placement opportunities we’ve found in previous posts, and we’ll continue to do so in the future. In fact, we are in the process of putting together a subscriber-supported service catering to accredited investors interested in private placements. We are also working on something in the crowdfunding space that may allow for our non-accredited readers to participate in some of the things that we find as well.

If a service like that would be of interest to you, drop us a note and tell us.

- Mark

“The cure for low prices is low prices; the cure for high prices is high prices. In order to sell high, you must buy low.” – Rick Rule

Comments

  1. I agree – not that they can’t go lower, but these things are so out of favor it is ridiculous. Over the past couple of weeks I added longer dated calls as well as some that expire late in this year.This seems like the best setup that we’ve had since 2008. Again, it may fail miserably but unless the gold bull is over(highly unlikely) I think looking out a year or two these prices will appear very attractive, even if the valuations get cheaper before they begin to run.

    Also – Stewart Thomson is great – gotta love his disciplined approach. Scaling into positions is probably why my clients have a lot more patience than I would expect normally. It seems as though they are less patient with me holding so much cash.

    • Selling puts on these things is also great. You get to collect payment and if you have the stock put to you you’re buying at what are very attractive prices.

      Hard not to like!

  2. mark S. says:

    Hi Guys,

    After reading your article on how inexpensive gold miners are along with similar write-ups by other investors I respect, indicating that the miners may be a smart way to leverage gold prices without much downside while the dividends are a nice sweetener, I have to say this is all good contrarian logic and extremely alluring to value investors, but I’ve been thinking about this idea for a while and am not convinced it’s the best trade at this time.

    I have a hard time pulling the trigger on GDX (not because it is out of favor, I LOVE that) mostly because of the way the miners worked vs. gold during the previous gold bull market. Back then the only time miners outperformed gold was after gold prices started correcting from their final peak. [Owning miners during the bull-market simply sucked vs. owning gold.] That outperformance lasted about 3 quarters, then with gold continuing its Southward journey, the miners abruptly reversed course and crashed too.

    I suspect the reasons behind that relationship to be purely psychological. On gold’s way up doubt about the sustainability of the ever higher gold prices prevailed and therefore were not yet baked into forecasts for mining EPS and CF; thus the miners lagged. By the time the bull-market crested and was correcting, investors finally accepted that a high level of gold prices was the new norm and built that into their EPS/CF projections, viewing the correction to be temporary just as all the others had been over the previous decade; thus the miners rose a lot while gold fell.

    If I am right that psychology, rather than unique conditions, primarily determined how mining stocks and gold prices interrelated, then why won’t similar behavior occur this time? To date, gold has way outperformed miners as the bull-market builds – just like last time. This is not an anomaly to gold as studies show that during past commodity bull markets (all lasted 18–22 years), all commodities, on average, outperformed commodity stocks by 300%.

    There may be something else we can learn from the last gold bull market. We may know which gold correction marks the end of the bull market… the one in which mining stocks rise strongly. That’s when market participants have become raving bulls. When the bullish forecasts for gold mining EPS/CF gets fully reflected in mining share prices via a spike while gold is falling, we’ll know the crown has capitulated to permanently high gold prices and there is no room left on that side of the trade. Unfortunately, gold mining stocks are a lagging indicator for gold prices but they still have utility – rather than holding or buying during the dip where miners advance, we’ll know to exit GLD.

    With all that in mind, I would like to submit what I am doing for consideration as an alternative trade. Own DGP now to gain 2x exposure to gold prices at this stage of the bull market because I do not think the prior run to $1,900 was the final peak and this is being confirmed by mining stocks not advancing during this correction (in fact they are correcting even harder). After gold makes its next big advance past the prior high, switch from DGP to GLD to maintain 1x exposure to gold while reducing your losses in the next inevitable dip. Stay with GLD right into the next correction. I don’t want to be a trader during a secular bull market.

    During the next correction, watch the miners and 1) if the miners rally hard while gold slips (highly unlikely IMO), that may signal the end of this gold bull market so sell GLD and either (a) buy GDX with a 3–6 month time-horizon or (b) move on to a different asset class, or 2) if the miners do NOT rally while gold slips, hold onto your GLD until you feel a bottom is in then switch half to DGP and sit tight because the bull-market is still intact.

    In short, it is too soon to own GDX. Wait until AFTER gold goes on another tear, in which GDX will lag badly if history/psychology have any utility, before even thinking about buying gold miners. If you think the gold bull market has at least another strong rally and new highs in it, then the opportunity cost of owning GDX today instead of DGP or GLD is much too high.

    Mark S.

  3. Mark Wallace says:

    Thanks Mark! Excellent analysis and I think very insightful. I hope other readers review this comment.

    • Naresh says:

      Mark S. – I got into Gold Equities in March 2009 right after my father died. I purchased AEM, GG, SSRI, MFN. It’s 2012, and we are below the levels I purchased in 2009. No one bothered to tell me to book profits. I was naively under the assumption that the gold bull run will expand earnings of the mining shares. Wrong answer. Although I was happy that I was long gold since 2004, I made a stupid mistake buying “blue chip” gold miners. Unfortunately Casey’s BIG GOLD also recommends a perpetual ‘Buy’ on all the big gold mining stocks. I never see, ‘T’ (Take profits), or ‘S’ (Sell). But as you said correctly the mining shares have in the past taken to the races giving an average return of 22 times on capital AFTER gold started falling from its peak. This is a no brainer, and I wonder how the guys at Casey got it wrong. Then I purchased some crapshoots (mining juniors) and lost money. Now it is just buying selectively like Denison Mines, Fission Energy, and Lydian International. But I just wished I knew what you wrote in 2009 itself! Thanks for the share. – Naresh

      • Mark Wallace says:

        Naresh,

        It’s now 4th October, 2012… The senior golds you bought are definitely marching higher now!

        If I owned the seniors (I don’t) I would hold them here. With QE to infinity these will likely be some of the best equities to be owning.

        Cheers,

        Mark

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