Junior mining stocks have taken a big hit.
As more uncertainty brews, investors don’t want to speculate – they want certainty in an uncertain world. The junior resource sector is meant for speculators. As such, the first thing investors do in a volatile market is sell first and ask questions later.
I suggested in a May letter, Right Under Your Nose, to take profits off the table. If you did, you should have been able to weather some of the volatility and much of the downside the market has shown us since May. You should also be well cashed up to take advantage of a potential run in the junior precious metals sector.
Let’s face it, we invest in the juniors for one reason: to make lots of money. We don’t invest in juniors to preserve wealth, or to make small returns to pay for our next vacation – we invest in juniors to change the way we live. That’s because juniors offer us a leverage that no other vehicle can offer. In this letter, it’s a leverage on precious metals prices – in particular, gold.
When you are buying a junior miner, you are getting physical gold at significantly deep discounts. Many of the gold juniors have production costs of less than $600/oz. That means with gold prices at $1600, they’re making $1000 for every ounce they pull out – which is a phenomenal profit margin for any sector (see How to Double Your Wealth in One Year). Furthermore, many of these junior miners are still exploring and drilling out new resources, as well as making discoveries that could significantly influence their share prices.
However, not all junior gold stocks are production stories. Many of the junior gold stocks are explorers. While these companies are even more volatile when risk aversion is in the picture, it also means they are the ones with the highest potential reward – high risk, high reward.
If you are going to speculate in a crazy market like this, you have to speculate in companies that have money in the bank to weather the most immediate risks.
Back in 2008, companies without cash were left in the dust. Those with cash and compelling projects trading at less than cash valuations reaped serious rewards for shareholders that were willing to take the risk and hold on – shareholders who understood that fundamentals would eventually triumph over market volatility.
In today’s volatile market, you are fighting against traders – not investors or speculators. These traders will do anything and everything to get their fix. They are willing to buy anything if the media tells them it’s good, and they are willing to sell when the media tells them it’s bad. They are willing to take losses, as long as everyone else is. They get their information from the market – from what the media tells them. They are the mob. That is their destruction. But that is also our time to take advantage of their downfalls.
The greatest time to be an investor is when everyone is so disgusted in the market that they are willing to sell anything for less than what it’s really worth. I am beginning to see a lot of companies trading at far less than they are worth with insanely low valuations. While this is still nowhere near as bad as the lows of March 2009, there are many sound companies that are getting close.
The key is to take advantage of the arbitrage that today’s volatility has presented. While companies with a drill shot potential can reap rewards, you don’t need to take that type of risk in this environment. There are so many battered companies – as I just presented – with great fundamentals and the cash to back it up. Some of these miners have strong positive cash flow, while others have strong resources and amazing drill results to back up their assets. The majority of the big, safe, and consistent money comes from finding great value during times of uncertainty.
Remember that dramatic volatile swings will lead the market to lower lows, but also higher highs. While it’s hard to see the bottom in this environment, I would be taking advantage of the dips but also keeping enough cash aside for if the worst happens.
If you can be patient while having an iron stomach, then you may be able to change your lifestyle with the juniors.
Don’t Forget History
Remember what happened to the TSX Venture – an exchange dominated by mining and resource plays – when things began their rebound? It was the strongest performing exchange (see Where the Billionaires Invest.) They were also hit the hardest when 2008 happened.
While I invest a lot in the gold juniors, I also invest a lot in the majors – and gold itself. Remember, gold equities have other risks such as political, management, and liquidity risks, that gold itself does not. Don’t make the mistake of thinking you don’t need gold just because you own gold stocks.
As far as gold, I still maintain my stance that gold still has a long way to go. You would know this if you have been a reader of the Equedia Letter for some time. As I mentioned before, there are new things happening everyday that compounds the fundamentals of gold’s rise.
As Good as Cash
Last year, I mentioned that gold had become as good as cash (see The First Time in History):
As of November 22, 2010, clearing house ICE Europe will begin accepting gold bullion as initial margin for crude oil and natural gas futures trading. This marks the first day in modern financial history that gold will be eligible collateral for energy futures. And this is a big deal. A really big deal. The only form of collateral allowed by ICE before this was cash, and government securities. But with this announcement, ICE has effectively made gold equivalent to cash and government bonds. And this trend is expected to continue. Although no time frame has been set, Rival clearer LCH Clearnet has also been considering accepting gold as collateral for some time.
Last week, LCH Clearnet Group Ltd. announced that it will accept gold as collateral by the end this October amid growing demand from banks eager to depart from their traditional reliance on cash and government bonds to cover margin requirements:
David Farrar, Director, LCH Clearnet said “Market participants want greater choice when it comes to assets that can be used as collateral. Gold is ideal; as an asset it typically performs well in times of financial stress, remains liquid and has a well established pricing mechanism.”
While the use of bullion as collateral with the clearinghouse will be capped at $200 million per member, the CME Group just increased the amount of physical gold its U.S. clearing members can post as collateral for margin requirements, from an existing $200 million to $500 million.
Both developments are extremely bullish for the gold market and I see more to come, as I did last year. Since writing the letter last year on this topic, clearing houses were not the only ones beginning to accept gold as cash. State governments and large banks around the US have been pushing to do the same thing.
In the letter The Banks Are In from February:
JP Morgan Chase (NYSE: JPM), one of the largest banks in the US, said it will accept physical gold as collateral for certain transactions. That means a hedge fund wanting to borrow money for a short period can put up gold as collateral and use the borrowings to invest elsewhere. That means gold is as good as cash.
In the Letter The Greatest War in History, I talked about how many US states were already looking at gold to be recognized as legal tender.
I went on to discuss how it’s not just individual states that are moving in that direction, but Central banks around the world have been doing the same thing.
The central bank of Russia, a regular buyer from its own domestic market, continued its long-term program of gold accumulation in August by adding 118,000 troy ounces to its reserves, which now stand at 27.161 million ounces, according to figures from the International Monetary Fund.
Russia’s holdings were up more than 7% since the start of 2011.
Thailand continued to boost its reserves, lifting them 300,000 ounces to 4.4 million ounces, a step up from its January holdings of 3.2 million ounces.
The Bolivian central bank lifted reserves by 225,000 ounces to 1.361 million ounces. Tajikistan and Greece also reported minor additions to their bullion holdings, the IMF data show.
According to GFMS, a leading precious metals research consultant, net central bank gold purchases are expected to total at least 336 metric tons this year, equal to around $20 billion based on recent prices.
The annual expected total estimated by GFMS is more than four times the 77 tons recorded last year.
There is a reason why central banks and countries around the world are hoarding their gold. I suggest anyone who missed the Letter The Hoarding Has Begun to go back and take a look. I am sure you’ll continue to find more compounding reasons for gold’s rise.
With counterparty and sovereign risk at such high levels, gold is no longer being viewed as just a commodity. It is being view by the smartest market participants as an important asset and a currency with no counterparty risk.
We are gradually seeing the power of gold as a financial asset comparable to currency and government bonds, as gold is gradually being reincorporated into the modern financial and monetary system.
All of these developments in the gold market have been ignored by reporters and journalists who have no clue as to what is really going on in the financial markets. Eventually, they will get the point. When they do, they will help push gold and related investments to highs that we have never seen.
Remember, most pension funds and individuals have not been investing in gold-mining stocks or the metal itself, even though gold has been the trade of the millennium. But with short rates at near zero, and “real rates” in the negative, gold’s lack of a dividend (a major consideration for fund managers) becomes less of an issue.
Given the fact that gold-stocks represent well below the 1% of all global pension fund assets, imagine what will happen when these funds begin to shift even a small portion of their assets into gold stocks…
Until next week,
Ivan Lo
Equedia Weekly
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