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Bad Economics

Steve Saville
written Tue Jan 22, 2008
posted Wed Jan 23, 2008

When a market becomes extremely oversold and sentiment becomes overtly pessimistic the market will usually bounce. The low-probability alternative is that the pessimism and fear evolve into outright panic, leading to a 'wash out'. For example, as at the end of last week the Australian stock market had fallen for 10 days in succession. This was a highly unusual losing streak that would normally be followed by some sort of bounce, but, instead, the market accelerated to the downside as panic set in. Australia's stock market has now fallen for an incredible 12 days in a row, topped off by a 7.3% 'wash out' in today's session. The Hong Kong stock market has also just experienced a 'wash out', having dropped by almost 14% from last Friday's close to today's low. In fact, the Hong Kong market's decline now falls into the "crash" category.

Financial panics are always painful for those caught on the wrong side of them, which would be most people right now since few investments have been left unscathed over the past week. But they are also always brief. Panic conditions can only ever persist for a very short while because panic is an emotional peak.

The plunges that have occurred in non-US stock markets since the beginning of this week and the likelihood that the US market will follow suit may well prompt the Fed to cut interest rates today (Tuesday), but it would be better if the Fed just let the US stock market 'wash out' and find a natural low. A natural low will occur within the next day or two simply because any 'longs' who are susceptible to panic will soon be out of the market. On the other hand, if the Fed were to cut rates prior to the start of US trading today it would engender considerable hope and prompt many of the remaining weak hands to hold on, without actually changing anything.

Our junior resource stocks were hammered in Canadian trading on Monday and in Australian trading earlier today. Such occurrences will make most shareholders feel some degree of consternation, although it's easier to keep your head when all about you are losing theirs if you are not financially over-extended and if you have a clear understanding of the underlying value of each stock you own. Keep in mind that the underlying values aren't changing. All we are seeing is a financial market event whereby people whose minds are clouded by fear are selling indiscriminately in a mad rush to 'get liquid'.

Figuring out how much an ounce of in-ground gold or a pound of in-ground uranium is worth is not an exact science, but most people would agree that the non-extracted commodity does have significant value, especially during a long-term commodity bull market. At the moment, however, the market capitalisations of some exploration-stage uranium stocks are roughly the same as the amount of cash these companies have in the bank. The stock market is therefore saying that in-ground uranium is almost worthless, even though utilities are prepared to pay $90/pound for the aboveground stuff.

We did a small amount of buying in Canada on Monday due to the filling of a below-the-market buy order for Sabina Silver (TSXV: SBB). We placed the order to buy the stock in the C$1.50s a few weeks ago and had almost given up any hope of it getting filled, but someone on Monday obviously decided it was a good idea to sell us in-ground silver at only C$0.30/ounce and to throw in a huge pile of zinc for free. We have no idea whether this latest purchase will look smart or dumb a week from now, but we are very confident that it will look smart a year from now.

We have a below-the-market buy order in place for another junior resource stock that may get hit during North American trading today, but we aren't buying aggressively at this time. One reason is that we already have substantial exposure to our favourite stock-market sectors and wish to maintain our cash reserve at its present healthy level. Another reason is that regardless of how low this week's low turns out to be, it will probably be tested within the next 3 months.

Steve Saville
email: sas888_hk@yahoo.com
Hong Kong

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