 Gold Mining
Stocks - Blood, Sweat and Tears
Kenneth J.
Gerbino
Archives
Kenneth J.
Gerbino & Company
Aug 10, 2006
Metal markets have been
in a strong bull market for four years. Currently a correction
and sideways consolidation is in progress. Normally, pullbacks
and consolidations are part of all long term up-trends in any
market. Not withstanding all the bullish fundamentals in a world
floating on printed money and debt there are always corrections
and sharp pullbacks in the gold sector. This goes with the territory.
With the Fed still terrorizing
all markets with their interest rate policies, actions and statements
(all totally anti-free market) expect plenty of volatility for
a long time. The Fed cannot stop inflation with rate hikes. This
is a huge misconception by the Harvard - Yale - London School
of Economics - NY Times - WSJ - Stanford - Goldman-Sachs - Morgan
Stanley - Washington Post - Georgetown - dinner party axis. Please
see The
Fed Can't Stop Inflation article posted on our website.
Unfortunately some money managers and hedge fund managers with
huge multi-billion dollar portfolios who are new to the mining
sector and certainly the gold market can create havoc if they
line up on one side or the other of the inflation-gold-interest
rate equation. This will create opportunities and plenty of danger
in the years to come.
Gold's $200 advance during
April and May might have implied the possibility that an unraveling
of one of the many very extraordinary economic time bombs that
are part of the investment landscape could be suddenly evolving.
One can never be sure if a derivative meltdown is about to start
or a global housing bubble causing defaults by the hundreds of
billions (on risky adjustable and the new gimmick mortgages)
or some major banking or insurance group in trouble could create
some sort of monetary panic. The fact that global stock markets
were also pounded in May and June makes one a believer in the
value of gold assets despite the moves up and down. Gold has
since recovered and is now around $640.
This recent volatility was
unfortunately just a warm up to what is most likely in store
for precious metal investors. If you were uneasy with this correction,
are you prepared for gold going to $1,000 and then back down
to $600 sometime in the future and then perhaps back up to $1,500.
One needs to be able hedge with in the money puts, go short overvalued
stocks or have a policy of taking some off the table on substantial
run ups. Xerox back in its heyday went from $1 to $170 and then
back to $45. A decade later it was at $4,000 (split adjusted).
You would have had a hard time riding it down from $170 to $45
but you would have missed the great move up if you had bailed
out. So an investing policy and basic strategy is vital to do
well in the mining sector. I always tell people keep at least
50% invested always in case gold explodes one morning but
don't be afraid to take some profits on run ups and find new
and better values to invest in with that cash... and buy on the
pullbacks.
Money and Power Lining Up at The Gold
and Base Metal Window
This pullback in the precious
metals has allowed the more conventional global money managers,
who so far have not embraced the metals, to start looking at
gold related assets. Swiss giant UBS is the largest gold bullion
trader in the world. In a recent report they noted that up to
20% of commodity portfolios tracked by their trading desk are
being allocated to precious metals. AIG, one of the largest financial
institutions in the world announced that their Japan unit alone
may invest $4.4 billion (3% of assets) into commodity related
assets to diversify away from stocks and bonds. Governments are
also being heard from; Russian President Putin announced that
the Russian central bank will raise their gold holdings from
5% to 10%. With $237 billion in reserves (expected to rise another
$100 billion this year from oil sales) this allocation alone
would require about half the global mine output this year. Yu
Yongding, Chinese monetary committee member recently called for
China to diversify a portion of their $875 billion reserves into
gold. World powers live by, but also are beginning to lose confidence
in, paper money.
China is now the 2nd largest
consumer of oil in the world versus only 10 years ago when it
was 20th. Oil consumption is a solid measure of economic activity
and this stat is telling the world that base metals and precious
metals will be in high demand next - as hundreds of millions
of new middle class consumers buy jewelry, air conditioners,
televisions and cars. Massive infrastructure projects will also
require large quantities of base metals - and a U.S. or Chinese
recession will not stop bridges and roads and power lines being
built in China. Huge state projects (in any country) are financed
by paper money or government debt and are recession proof.
Volatility and Value
So far, this spring and summer
has been volatile for stock markets globally. Hong Kong was down
10%, Germany down 9% and Singapore down 18% in May and June.
The Indian stock market lost 10% in one single day.
Commodities, precious metals and mining stocks had large sell
offs and swings. The US stock market had four days with over
200 point swings in the Dow (compared to only five such days
the previous five months). The major cause of this global volatility
was that the Bank of Japan had lent out hundreds of billions
of dollars to domestic banks and this money was lent to large
international hedge funds over a two year period. The Bank of
Japan then abruptly called in these loans. Don
Coxe, the extraordinary and brilliant strategist at the Bank
of Montreal, called this "unprecedented in the history of
modern central banking." A global liquidation took place
as these funds were forced to sell everything in sight to raise
cash. The few hundred billion was significantly leveraged so
somewhere between $750 billion and $1.5 trillion of global financial
assets had to be liquidated in a very short time period... gold
and gold shares were part of this liquidation.
It appears that many good mining
companies have temporarily sold off more than fundamentals dictate.
All markets experience sell offs that sometimes push asset values
to very undervalued levels. This is what happened to the precious
metal stocks, this conclusion is bolstered by the fact that over
the last five years there have only been four instances where
the Net Asset Values of the major and intermediate mining stocks
have been trading at such a low valuation to their discounted
cash flows. All four of these instances saw a significant
rally occur from those levels. Also the senior precious
metal mining sector is currently trading at only 9 times 2007
expected cash flow - historically very undervalued territory.
In relatively mild to good metal markets these stocks usually
trade between 15-25 times cash flow.
Own Good Merchandise
One owns mining stocks for
various reasons: portfolio insurance, long term capital preservation,
some alternative money versus printed paper, inflation hedge,
and financial diversification. One also has to make sure the
mining stocks owned have the minerals in the ground and have
a good shot at economically recovering those minerals. The price
we sometimes have to pay for these attributes, as well as above
average performance, is above average volatility.
We are both a value investor
and a production growth investor. We want the stuff in the ground
and we want to see a 2-3 year growth profile for a company. In
my opinion, the sweet spot in the mining industry are companies
that are expanding and building mines that will produce gold
on average for under $250 per ounce, allowing for significant
cash flow, profits and upward share price valuations. The long
term prospects are also excellent for base metal companies with
multi-billion dollar deposits of valuable metals that a new global
economy will demand in greater and greater quantities in the
years to come.
Your portfolio should be diversified
in various metals but concentrated in the precious metals. We
are expecting strong capital gains in this sector. The best companies
are the ones with quality mining projects coming on stream and
are well funded and have substantial investment banks behind
them to fund these and future projects. The worst companies are
the risky exploration stocks. For those who want some leverage
and would like to trade warrants (long term options) you could
check out www.preciousmetalswarrants.com
They cover the Canadian and U.S. companies. Warrants are more
risky, so be careful if you allocate some portion of your risk
capital and go that route, and stick with established companies
or those with plenty of resources.
In the long term the political-economic
landscape for almost all governments is a policy of printing
money and increasing debt levels to meet the overwhelming medical
and retirement demands of their electorates. Gold assets are
historically the most reliable and therefore the preferred asset
class when a period of fiscal and monetary problems are coming
on stream. This will surely happen in the future. Gold assets
insure some wealth protection in an uncertain future plagued
by paper money and debt.
The graph below shows if gold
stocks are over or under valued versus the underlying price of
gold. The higher the ratio the more undervalued gold stocks are.
At current ratios one should own the shares.
The summer is usually a slow
time for the developmental mining companies. Most of the Canadian
and European financial people are on extended vacations and taking
constant three-four day weekends. The mining people are all out
in the field drilling and expanding deposits. The summer work
programs are usually extensive and the results are usually published
at the end of August through November. This is usually a strong
period for mining companies and it also coincides with strong
gold bullion demand from wedding seasons in Asia and buying by
jewelry fabricators for the holiday season.
The long term prospects for
gold and mining stocks appear to be very strong and should prove
to be the best asset class in the coming years to invest in.
For more articles on gold and mining stocks visit our website
at www.kengerbino.com.
Kenneth J.
Gerbino
Archives Kenneth J. Gerbino & Company
Investment Management
9595 Wilshire Boulevard, Suite 303
Beverly Hills, California 90212
Telephone (310) 550-6304
Fax (310) 550-0814
E-Mail: kjgco@att.net
Website: www.kengerbino.com Copyright ©2004-2016 Kenneth J. Gerbino & Company. All Rights Reserved.
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