The following, written by David Galland of our Casey Research, helps put today’s markets in perspective and provides an important word of caution about overvalued resource stocks.
While the positive trend for resource stocks is very much intact and our friend, it is a friend that will grow increasingly volatile as the bull market progresses.
Doug Casey
The gold and silver markets continue to stun and delight, blowing decisively last month through $700 and $14 respectively and, by doing so, beginning to attract the attention of small and large investors. While the precious metals have come off their rapidly attained highs, there’s little doubt that this correction will be short-lived, bringing ever more investors to the opinion that “this time the gold rally is for real.”
Reflecting that growing interest, we increasingly find references to the metals in the world’s mainstream media. And noticeably, the references are beginning to discuss the precious metals in terms of their historic role as crisis and inflation hedges, and less as the playthings of speculators.
“… investors bought the metal as a hedge against inflation after the U.S. Federal Reserve signaled concern about rising prices,” says Bloomberg.
“Gold has risen more than 37 percent this year, and 63 percent since the start of 2005, as investors diversify into precious metals as a hedge against global tensions, including those over U.S.-Iran relations, high energy prices and uncertainty about the dollar,” weighs in Reuters.
Things are indeed starting to get interesting.
Trading opportunity ahead?
But what about the resource stocks?
How can it be that gold pops $15 or so on any given day or even takes out a psychologically important price point like $700, but the stocks, on the whole, remain flat? Or, the other side of the same coin, any retreat in the commodity price of the metals, even a small one, sends the junior resource companies all red.
As explained in the lead article of the April International Speculator, “Seasons of Gold,” the reason may be related to the traditional summer pattern best expressed with the adage “sell in May and go away.”
Per that article, we have been watching closely for signs of which way the junior resource stock market will break this summer. Namely, will the market stick with the norm and retreat, or break with tradition by heading higher in a more or less consistent fashion right through the summer?
The chart just below offers a useful benchmark for where we are today. It shows a three-month average volume and price of the Toronto Capped Gold Stock Index, a proxy for the gold stocks we favor around here.
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As you look at it, you will see a couple of things.
First, the bull market is clearly evident. Confirming the big picture is that the trends in both volume and price are for higher highs and higher lows.
You will also see that while price is clearly at a recent high, volume is just barely so, and neither are we at the point of a breakout yet.
If the historical pattern does hold true – and for reasons I’ll touch on just below we believe it will – the correction in the gold and silver stocks on March 15 in conjunction with the steep sell off in the bullion prices will be just one of a number we’ll experience in the months just ahead. That’s the bad news.
The good news is that, given the secular nature of this bull market, any corrections should be relatively short-lived and, again, the lows should be well above previous lows. I’m speaking, of course, in generalities … because some of the more thinly traded issues, especially those with more smoke than substance, could go “no bid” in the face of a panicked seller and fall further than the averages.
The very good news, however, is that should these corrections occur, they will offer us what may turn out to be the last best buying opportunities before things go stratospheric. If you look back at the history of the dot.com mania, you will find a very similar pattern – gut wrenching corrections, followed by higher highs. Be prepared to buy with both hands.
Why might the shares sell off a bit here?
The primary reason has to do with the fact that many of the longer-term players in this sector are, habitually, selling in anticipation of summer doldrums. That their stocks have appreciated so strongly over the last year only adds fuel to the selling fire.
They do so because most investors in these stocks aren’t true believers. After a 20-year bear market, they still see any strength as a selling opportunity. Especially as we head into the traditionally slow summer season.
It is for this reason that, despite a noticeable pick-up in trading volume, the effect of that volume on the prices of many of the more widely followed stocks has been noticeably muted by the offsetting selling.
But the real risk in here is the rapid increase in metals prices. While we are all for higher prices and think we are still very early on in this bull market, there is likewise no denying the possibility that the metals have gotten ahead of themselves.
Should we, therefore, see additional entirely-to-be-expected correction in the metals prices in the near term – no market goes straight to its ultimate peak – the buying from the uninitiated and uncommitted will dry up just as the traditionally slow season approaches, sending waves of panic through the old timers who have been trained to the level of a Pavlovian expectation to anticipate short-lived cyclical versus long-term secular rallies.
Viewing their eroding brokerage statements and visualizing being left on the dock while their boat sails away, and sinks, the early buyers will redouble their efforts to sell off their biggest and most appreciated positions … then begin to sell pretty much anything with a bid, creating a self-fulfilling prophecy and exacerbating the sell-off.
Of course, that entire scenario might never come to pass. We present it here simply as a possibility that very well could happen. Even though the secular trend will be one for the record books, within that trend it’s wise to be fearful when others are bold, and bold when others are fearful. Right now, they’re becoming a bit bold.
And from what we’ve seen so far, there is no denying that the old timers are selling into the rising volume.
On the other hand, given that the stocks, historically, lag the bullion prices, should bullion prices rebound quickly and strongly from the May 15 sell-off, we could see the momentum in trading volume resume, potentially blowing through the selling by the early adopters.
At this point, there is really no telling – so a little caution seems advisable, even if that means simply holding back on new purchases for a bit … or maybe trimming some off the top of your best positions, looking to trade back into them at lower prices in a month or two.
The really important thing to remember
Stepping back from conjecture, I would like to point out that so far, things are unfolding for the resource stocks almost exactly according to the script laid out by Casey Research and in the pages of our various publications over the past several years.
Does that make us prescient? Not hardly (though Doug’s well-documented March 22 call, with gold at $550, for it to make an imminent and surprisingly big move might qualify). Rather, it’s simply a matter of inevitability.
By that I mean this is one of those very rare instances when you can look at a complex system – the very definition of most any investment market – and see what’s coming with any clarity.
Crossing the line of being repetitious, the U.S. – and by extension, the world – is firmly between a rock and a hard place. A box canyon. A dead end.
Rates must continue to rise to keep the wounded dollar afloat, but they cannot do so without killing the economy. Massive inflation, which is already going on behind the scenes, will increasingly show up in the prices of things.
And that credits none of the full deck of wild cards currently on the table. Flip one over and you have an expanded war in the Middle East. Flip another and reveal another 9-11 attack. Flip another and you have a revolution in Saudi Arabia, another and you find an assassin’s bomb killing Musharraf of nuclear-armed Pakistan. Flip another and you have Chavez cutting Venezuela’s trade links to the U.S. Another and you see the Chinese formally announcing they are diversifying out of the dollar. And those are just a sampling of dozens.
Impressions aside, I’d like to think that I’m not gloomy by nature. And Doug is definitely one of the most positive people I know.
But there’s no denying that when the curtain opens for the next scene to be revealed on the world’s stage, it is far more likely that it will open on a tragedy, rather than a light-hearted comedy.
Almost regardless of what happens with the resource stocks over the short term – and by that we mean 2 to 3 months – you can be confident that the stage is set for almost unimaginable profits ahead for those with the steady hands to stay involved in this market.
And, finally …
A prejudicial attitude pervades the hearts of many Americans about certain other cultures. Arabs are lesser beings. South Americans are inept, corrupt and lazy.
Naturally, those prejudices make their way into political doctrine. After all, politicians are nothing if not human, with all the failings of humanity (actually, they evidence such failings in aces).
But any prejudice can blind its holder to the reality on the ground.
Take the current diplomatic dust-ups with Iran, Venezuela and now Russia. It may not be accidental that all three of those countries are deeply dependent on the revenue that oil and gas provide.
Reflexively, the administration in Washington and its minions and allies are rushing about in a frenzy of arm waving and backroom arm twisting, crediting the despots that run these countries with all manner of evil intentions and using their own strong anti-American statements as proof that they intend to act on those intentions.
But what if the reality is that Ahmadinejad and Chavez and certain Russian officials are deliberately saying just what they need to say and doing just what they need to do to keep their most precious resources selling at premium prices?
If you ran one of these countries and simply by making a particularly bellicose statement you could assure the price of a barrel of oil would remain over $70 for another month – or maybe run up to $100, sending waves of money your way – wouldn’t you at least entertain the notion?
Of course, the trick will be for the oil producers to keep the pot boiling, without boiling over. And they may be making a poor bet indeed if they bet too heavily that some politico in the West won’t do something really stupid.
Interesting times, indeed.
The emerging bull market in precious metals and in the precious metals stocks is just beginning to gather speed, with 100 percent, 300 percent, even 2,000 percent profits ahead for early investors.
But the really big profits require being selective in your chosen stocks, avoiding the “paper tigers” and focusing on those with excellent management teams, working on big targets in highly prospective geology. For over 20 years, Doug Casey’s International Speculator has been providing investors with clear, unbiased recommendations on the world’s best resource stocks. Learn more about this uniquely valuable service.
David Galland is managing director of Casey Research, LLC.
