Gold stocks are in a bull market: How to make it work for you

Hedge funds turn commodity bears at record pace

Traders work the floor at Bovespa Commodities Exchange in Brazil in 2004. Image: Alf Ribeiro

Gold is in a bull market.We believe that gold has been in a secular uptrend for most of the 21st century, although it is clear that gold experienced a cyclical decline that began in 2011. Depending on the currency you use to buy gold this cyclical decline ended some time over the past couple of years, and given recent strength in the U.S. Dollar Index this bull market is least established in U.S. Dollars. But those of you who follow the gold market in terms of other currencies will recognize that gold has reversed its negative price action quite aggressively.As the U.S. Dollar hangs on as the world’s reserve currency a gold bull market in U.S. Dollar terms is arguably the most important, despite its practical insignificance for many gold buyers. As a result the recent strength in gold priced in Dollars has established a new (or more accurately a “resumed”) gold bull market.We tend to agree with this sentiment, and note that despite our long-term bullishness that until recently we were on the other side of the equation calling for lower prices in the face of skepticism. Despite the fact that we don’t like to make short or intermediate term calls on markets publicly we called for lower gold prices in 2014, citing:

Dollar Index strength as psychologically bearish for gold.
Stock market strength as psychologically bearish for gold.
Falling/low interest rates as generative of a preference for interest-bearing assets vs. gold.
The fact that gold had not tested its 2008 peak/2009 break-out point of $1,000-$1,035/oz.

We might have also added silver’s underperformance, along with that of mining shares.

These indicators have largely shifted in gold’s favor:

The Dollar Index isn’t weakening but the Euro, Canadian Dollar, and Australian Dollar seem to have found floors while the Yen appears to be in a new uptrend. The Pound is weak but for reasons that are generally favorable for gold.
U.S. stock indexes are at/near all-time highs but many bellwether stocks such as Apple, JP Morgan and Ford appear to be in downtrends. Foreign stocks have been significantly weaker with only a handful of U.S. names holding those markets up. Much of the strength in these U. S. stocks is counterintuitive considering declining revenues and earnings, and rumor has it that central banks are pushing up stock prices with newly manufactured fiat currency.
This last point can be extended to many bond markets, especially corporate bonds which are being issued at a record rate in order to fuel stock repurchases. Even long-term U.S. Treasuries have been rising in value, although we note that short-term Treasury rates are flirting with multi-year highs
Gold managed to trade down to the $1,035/oz. level late last year, wiping out all of the gains made in the 2009-11 bull run.
Silver is now decidedly outperforming gold, having risen ~50% from its lows, while gold has risen at best ~30% from its lows. This shows risk appetite among monetary metal speculators. From hereon when we refer to the gold bull market a silver bull market is implied.
Mining shares are now outperforming, and you’d be hard-pressed to find a name in this sector that hasn’t shown triple-digit returns off of its lows except in the most heavily distressed cases such as Dynasty Metals and Mining or Primero Mining, both of which have company-specific issues. Many stocks have risen 4X off their lows or better, while investors trip over themselves to participate in financings.

So while the stars have not aligned themselves perfectly many things that concerned us in 2014 have shifted in gold’s favor, and with the market trading more than 25% off of its 2015 low and with sentiment having dramatically shifted it is evident to us that gold has entered a new up cycle.

Some Investment Strategies

Navigating a bull market is surprisingly difficult, especially when it is as volatile as the gold market, particularly the mining stocks. As an investor you want to ensure that you maximize the profits that you can reasonably stand to earn given the level of risk you’re willing to assume. We’ve come up with a few rules of thumb to help guide investors.

1: Don’t Trade

The up cycle should last a few years and we’re just at the beginning–maybe the bottom of the first inning or the top of the second. While it can be very tempting to take profits when you have them keep in mind that the market has a lot more to move. We know it is a common practice to to “sell half and let the rest run” but we believe this pushes investors to violate our second rule, namely to limit the number of positions you have. We only believe it makes sense to trade/take profits if the fundamentals have changed. So if a catalyst you were looking for has come and passed, or if something goes wrong, then it makes sense to take money off the table. But if a stock you like runs, especially on good news, it doesn’t make sense to sell.

2: Limit The Number of Positions

In a bull market everything looks great and everything is moving up, so that it feels like if you aren’t in everything that you’re missing out, especially if something you don’t own moves while something you do own remains stagnant for a while. The main risk here is that it is difficult to know a lot about a lot of companies, and the fewer positions you have the more you can know about each one. If you feel the need to diversify beyond a handful of positions–say 6 or 7 (although this is admittedly arbitrary)–think about having somebody else manage some money for you (there are plenty of gold funds out there), or invest in a diversified company such as a major or a diversified royalty/streaming company. Note that at MiningWEALTH our top conviction list consists of just 4 or 5 gold stocks.

It is also worth noting that while most stories sound great and will move up that some will move up a lot more than the rest, and it follows that you have to be very discerning. There are maybe 2,000 mining stocks out there, and even if you own 20 of them that makes you more selective than Harvard admissions. Look for reasons to exclude rather than for reasons to include names in your portfolio.

If you have 5 or 6 stringent criteria you can be sure that the vast majority of names won’t make the first cut; and no matter how enthusiastic the CEO or IR representative may be just keep in mind that it is his job to sell you stock. With the MiningWEALTH subscription service having just launched we received innumerable inquiries from companies, and it always seems as if we’ve focused on companies we find on our own, or which are recommended by friends. There aren’t any gold companies on our top conviction list as a result of a call/email from the CEO or IR rep. This is by accident, but it does indicate that the most interesting names out there are run by people focused on developing assets rather than developing an investor base (although you can’t have one without the other).

3: Find Companies With Many Attributes

A well-balanced portfolio will have companies with many different attributes, but the best portfolios will be filled with companies that incorporate many of these. So, for silver investors you may want to buy First Majestic (AG) as a quality producer and Golden Arrow (TSX.v: GRG) (GARWF) for its leverage and in-ground ounces relative to its market capitalization. But we discovered Santacruz Silver (TSX.v: SCZ) (SZSMF), which has the unique combination of both. Finding both attributes in one company enables us to deal with just one management team, make half as many trades, and focus our energies on analyzing just the one company’s assets. The great thing about a situation like Santacruz is that it can finance its own exploration and development through internally generated cashflow, which in turn limits the downside while creating immediate upside should metal prices rise. It is this kind of scenario that creates 10-20 baggers or better.

4: Management is Key

Mining is a very difficult business, and even smart, accomplished individuals will get it wrong a lot of the time. This is why you want a seasoned management team that can consider as many contingencies as possible. You also want them to own a lot of stock and to participate in financings. This last point not only indicates that management believes in the company, but it means that it consists of individuals who have money, and in many cases it will have come from previous success in the mining sector. Note also that “success” goes beyond bringing a project forward, but includes creating shareholder value. We were recently introduced to a company with a new CEO, and this company bragged about the CEO’s success at her last company, without mentioning that this success came at the expense of tremendous dilution–only those who got in at the very end or who traded wisely made any money.

As a final note we are not paying up for superstar management teams. If you dig deep enough you can find highly accomplished individuals in the space that don’t promote as much as they could (or possibly should), and as a result their companies’ shares are undervalued. We note the incredible past success of Sarama Resources’ (TSX.v: SWA) team at Moto Gold. Now they are quietly amassing a highly prospective land package in the Birimian Greenstone Belt in West Africa. Even if this is not another Kibali (22 million ounces sold to Randgold (GOLD) and AngloGold Ashanti (AU)) we have an unusually accomplished team with a multi-million ounce district and tremendous exploration potential trading at a substantial discount to its peers. These are the kinds of stories that can make you fortunes if you are disciplined and recognize their talents and tactical approach to gold exploration.

4: Don’t Worry About The Past

It is psychologically very difficult to buy into a story if the shares have risen dramatically. There are stocks that are up 5-10 fold already, and there’s a good chance that if you buy into one of these that your counterpart will be taking a nice profit. This is a purely psychological barrier, and we wouldn’t be surprised if some of the best stories in a few years have already risen several hundred percent from their lows. So the short answer is to ignore the past price and to focus on quality, management, and value going forward.

5: Seek Outside Advice

Putting aside the shameless self-promotion of this kind of advice the fact is that even the smartest of us can benefit from bouncing our ideas off of others or from looking at other people’s ideas: remember that there are other smart people too and that they are acting on a different fact set than you are. Even if you don’t like another investor’s ideas you can at least benefit from understanding the logic behind his or her investment decisions.

The Bottom Line

There are lots of ways to make money in the upcoming upward move in gold. Right now it seems as if everything is going up. If you are looking for great opportunities in the mining space you have to remain tactical, disciplined, and patient. Furthermore you have to accept that you will be wrong frequently: if you own, say, 5 speculative junior gold/silver stocks then expect two to be duds. There is no certainty. There are just strategies for shifting the odds slightly in our favor. In baseball the difference between a .250 hitter and a .300 hitter is that the latter gets one more hit in 20 at-bats; yet this is also the difference between a mediocre hitter and a great hitter. To be great in junior mining investing means to be slightly better than the mediocre investors: the difference may take some time to show, but it will! Those who recognize this will not become emotional when their investments don’t turn out the way they had hoped–both on the downside and to the upside.

Read more at: MiningWealth