Excerpt on Gold from John MauldinCan't get charts to work here but have bolded, near the bottom, a couple intersting remarks that we should all take particular note of.
Back into the Time Machine for a Return to the Present
As you have just read, in December of 2006 we were convinced a credit crisis would unfold and gold would do particularly well, both of which have now come to pass. Back then, gold was $648 per ounce. Today, it sells for about $730. Given our view that the budding credit crisis will soon morph into a genuine currency crisis -- thanks to the unprecedented six trillion U.S. dollars held by foreigners showing increasing displeasure with the easy-money policy of the Fed -- we think gold is going much higher.
But what about the performance of the junior resource stocks? After all, that is the sector that got our nod as the most profitable way to play this crisis. Those stocks have largely underperformed. Could we have missed something?
Or has the opportunity somehow been frozen in time, allowing you to jump in today at yesterday's prices for spectacular profits as the current crisis regains momentum? While we are not afraid of admitting mistakes, in this case we remain convinced the big move is still ahead.
Here's why...
The junior resource sector is dominated by Canadian stocks, specifically those that trade on Toronto's Venture Exchange. These stocks have several attributes that give them explosive upside. In no particular order...
A. They are thinly traded. A lot of buying can quickly send prices to the moon, with daily moves of 10% or even 100% not that unusual. Great when a lot of people are trying to get in (and you are in ahead of them), the opposite of great when a lot of people are trying to get out. The rush for liquidity this past July and August, therefore, triggered an especially sharp correction in the illiquid juniors. Which makes sense, given that gold was still flying under the radar of most investors... and the next leg up in bullion prices had not yet begun.
B. The industry is full of perma-skeptics. Ninety-nine percent of the Vancouver resource community, including brokers and exploration company executives, if pumped full of truth serum and asked four years ago – in the early days of gold's run-up -- how long they thought the bull market in gold would last, would have confessed the end is nigh.
Why? Because experience shows resource cycles are short-lived. That has created a near DNA-level pessimism about the prospects for metals prices in general, and stocks in particular, over any period longer than it takes for the morning cup of coffee to cool.
The consequences of this widely held attitude is an industry that speaks out of both sides of its mouth, cheering on investors with one side as gold prices rise, while calling their brokers to dump highly appreciated shares with the other. It is not possible to overstate the impact of this "psychological overhang" on the junior resource market.
(By contrast, the stocks of larger producers that trade on the big exchanges operate mostly on fundamentals – for example, an actual P/E ratio – something totally lacking in most juniors... for the simple reason that until they actually discover something and go into production, the juniors have no P, or E.)
C. The old adage "sell in May and go away" rings especially true up north. During the summer months in the Northern Hemisphere comes the melting of snow, and access to remote exploration targets returns (and these days, most of the remaining good ones are remote). Exploration companies grab their gear, load up the helicopters, and get back to work searching for the glory hole that will secure a steady supply of champagne well into old age. Canadian brokers, knowing that the mine finders are absent and that news will slow as a result, take full advantage of the short summer months with long vacations.
Completing this vicious cycle, the exploration companies tend to hold their news, figuring why send a report to an empty desk. In the midst of this self-reinforcing news vacuum, investors grow bored and then impatient, leading to widespread weakness.
I mention all of that, because as we headed out of July and into August, the junior resource sector was at its most illiquid and therefore most vulnerable. And as the red line in the chart below shows, while there was evidence of the normal summer doldrums in the junior sector, it was not excessive and, in fact, by early July the shares as a whole were turning up (that usually doesn't happen until the fall).
But then, as you can also see, in late July/early August, financial Armageddon peaked its horned head over the horizon. In the scramble for liquidity in all things, the seasonally illiquid junior resource stocks were elbowed off a high cliff. (Or, looking to the Thesaurus for further guidance, we learn the junior resource sector was "devastated, killed, collapsed, destroyed, slaughtered, ceased, withered and ruined.")
Important point #1: The devastation to the junior resource stocks was quick and punishing, a loss of 27% nearly overnight. The S&P 500 would have needed to fall from 1,553 to 1,133 to equal such a loss, far more than the frantically discussed fall to 1,406 that the index actually suffered over the same period.
Historically, of course, the faster and steeper the excesses in any market are corrected, the sooner said correction ends. This is especially the case when the underlying sector, in this case gold – shown with the blue line -- is in a solid uptrend.
Canaries in the Gold Mine
Further evidence of that contention comes from a glimpse at the recent performance of the large-cap producing and near-production stocks. These are the "canary in the gold mine" stocks that institutional investors look to first after deciding to move into gold.
The chart below shows the Gold Bug Index (the blue line) against the S&P 500 over the one-year period ending September 25. As you can see, after a somewhat sloppier dive than the one so crisply executed by the junior team, the large-cap gold stocks clearly caught the attention of the Wall Street herd and popped back up like a blue whale with wings and on steroids. That, no doubt, after a collective slapping of foreheads as realization dawned that the only hope of economic salvation remaining in the Fed's mostly empty tool chest was to reach for a wrench to turn on the money spigots – creating inflation – while also recalling the six trillion dollars in foreign hands and positing that they might be none-too-happy about the "fix."
Important Point #2: Looking over these present-day charts, one is drawn to an Aristotelian line of reasoning that goes something like this: If (A) gold is going up, as it has been pretty much throughout the period, and (B) stocks of gold producers are beginning to run ahead of the pack, then isn't it logical that (C) the recent momentum in the juniors will soon accelerate, providing the triple- and even quadruple-digit returns that are the hallmark of the junior resource sector in a gold bull market.
And, make no mistake, we are in a gold bull market.
Returning to the chart of the junior resource stocks, you can see they are starting to also track gold, clawing slowly back. They still have a long way to go to get back to the step-off point in July/August... the seeds of an opportunity, if you ask us.
In fact, not only do we remain unconcerned about whether prior recent highs for the juniors will be revisited, we remain, per our discussion from December 2006, convinced those highs will be greatly exceeded as the credit crisis turns into currency crisis that is now all but inevitable. (Especially as we are expecting to hear news any day of the next big discovery... that is all but inevitable given the amount of exploration money that has gone into the ground over the past few years.)
At the beginning of this modest treatise, I offered up the notion that the opportunity in the junior resource sector has been frozen in time. As you can see, a thaw is beginning. The time to take your positions is here and now. Waiting even a few months from today, while still not too late to profit, will be viewed with perfect hindsight as money lost.
The trend remains our friend.
You still a big gold bull analyst,
John F. Mauldin
johnmauldin@investorsinsight.com