Don't Panic On Precious Metals, Seek Rounded Bottoms

by: Emmet Kodesh

Precious metals prices have been significantly correcting for four months. This reversal has several accelerators: consolidation from an extended secular bull and risk-off trading as investors lose patience and hasten to the lure of hard-charging stock indices. Computer-driven trading adds its amplifier effect and massive short positions magnify the amount of low-hanging fruit. Don't sell on panic. Don't panic on the metals or the miners which have sold off even more in response to sagging commodity prices tied to mining.

I hope readers heeded my advice that most people should limit precious metals and mining exposure to 10-20% depending on time horizon. "Few can afford less than 10%" I wrote, "few can afford more than 20%" because of sector volatility amped by trading technologies and fiscal manipulation. If you bought prior to May 2012 and have retained your holdings, it hurts. But past is past: let's consider buying scenarios going forward.

Despite soothing remarks after the G20 meet, devaluation of currencies continues and will not abate. Rising debt levels in all developed economies, inflationary fiscal methods and government giantism will continue destroying real net worth. "Fasten your seat belts for dramatic swings in the currency markets from here on" says John Hardy of Saxo Capital Management. "The new paradigm is driven by global currency wars as nation after nation moves aggressively to get the upper hand in the mud wrestling match of competitive devaluation. All currency values are likely to lose out in the long run, save for the one true currency - gold."

Longtime member of Barron's Roundtable, Felix Zulauf has forty years experience evaluating and trading currencies. He confirms Hardy's view. Zulauf notes that thirty eight nations are engaged in massive digital currency expansion and wealth destruction. He points out that nations in Asia, the Middle East and Russia, States outside the international currency-gaming matrix increasingly invest and encourage investment in gold rather than the inflated digital cloud of pounds, Euros, dollars and yen. Because of the double blow of devaluation and sagging economies, Zulauf urges a 25% allocation to precious metals.

On February 20 it took only a hint from the Fed that the economy might be weaned from $85 billion/month bond purchases to tank the markets. This indicates that in this era of State intervention, regulation, manipulated metrics and falling net worth the markets depend on artificial stimulus. Similarly, in his February 20 podcast, Michael Pento noted that the bull market of 1933-37 ended when the Fed raised interest rates. We just had confirmation of that link and its relevance to today's dicey economic reality. My last piece cited recent comments from top Wal-Mart (NYSE:WMT) executives on the shrinking economic pie. As John Williams observed in a February 08 interview,

Retail sales and housing growth are based on the condition of the consumer. The consumer increasingly is illiquid. Reports of median household income, adjusted for inflation, show that household income plummeted well into 2011 and has been stagnant at the lowest levels of the current cycle ever since. The average guy is not staying even with inflation. That is important, because income drives consumption, and consumption accounts for more than 70% of GDP. If, net of inflation, you don't have sustained growth in income you're not going to have sustained growth in consumption.

What happened after the Fed's hint, perhaps a trial balloon supports Williams' assessment that "eventually the underlying economic reality will become undeniable, and even official reporting will be revised to a pattern of contraction, an official double-dip recession. That likely will not be good news for stocks." Do not count on government honesty but the point is valid.

Panic selling has hit the precious metals and the slingshot effect has ravaged mining shares. Major producers like Barrick Gold Corp (NYSE:ABX), Goldcorp (NYSE:GG) and established silver and gold streamer Silver Wheaton (NYSE:SLW) again crumbled. So did mid-sized gold-streamer Sandstorm (SAND), which set a 52-week low on 5x average volume. It was similar with geologist-recommended juniors like Fortuna Silver Mines (NYSE:FSM), McEwen mining (NYSE:MUX) and Vista Gold (NYSEMKT:VGZ) selling down 2.5% to 8% on very heavy volume. The Junior Gold Miners ETF (NYSEARCA:GDXJ), the Silver Miners ETF (NYSEARCA:SIL), and the Gold (NYSEARCA:GLD) and Silver (NYSEARCA:SLV) bullion ETF's dropped like lead on triple their usual volume. Similar results occurred with base metal and rare earth miners like Freeport McMoran (NYSE:FCX). Copper, gold and rare earth prodigy Turquoise Hill Resources (NYSE:TRQ) made a secular low at $6.89. Given its geopolitical situation, its 4.83% decline seemed almost moderate in the current frenzy.

The Junior Gold Miners have been making new lows-since-inception for several days, continuing the secular decline that began May 2011. They have since lost about 60%. With the major indices as overheated and detached from economic fundamentals as the metals are depressed, how does one find entry points to precious metals and the markets?

One waits and looks for emergence of support and for several bounces off the new support line. Wait for charts to show a rounded bottom: then and only then is it safe to initiate or add to positions in bullion or mining shares. As to miners, remember that resource nationalism and regulation will increase going forward. Also note that gold closed at its May-July 2012 support near $1555/oz and that silver at $28.49/oz is $2 above its frequently made secular support at $26.50.

In selecting silver or gold or a mining company, remember two things: silver has many industrial uses, consumer uses and is also a currency substitute. As to miners, look for proven reserves, life of mine and production costs. On the plus side, credit is cheap. Barrick has a large advantage in proven reserves (about 65 million ounces). Gold Corp, Kinross Gold Corp (NYSE:KGC), Rand Gold (NASDAQ:GOLD) and Gold Fields (NYSE:GFI) have significant reserves and life of mine from 23 to 26 years. Mine-life will increase if stagnant prices slow production and from technological advances. AuRico Gold (NYSE:AUQ) has a forty year estimate mine life but far less reserves (about 7.5 million oz) and a median production cost. Yamana Gold (NYSE:AUY) has low costs/oz but shorter mine life and issues with Argentina given its currency problems, a harbinger of global trends.

Current volatility and price trends make a case for numismatic coins, antique collectibles. Many experienced people discourage these but like fine works of art, they do retain value and are buffered from market swings. If you have funds and inclination for this option, comparative shopping is a must as is researching the field. If you buy, be sure the coins are graded by NGC (Numismatic Guaranty Corporation) or PCGS (Professional Coin Grading Society) and keep them in their clear hard plastic cases to retain full value. It is a legacy.

As to allocation, it is a blend of your time horizon (a shorter horizon --how soon you need to draw on savings and how much -- means a lower exposure to precious metals and other commodities) with macro-economic and market fundamentals. The markets formed a secular triple top in mid-January and are hovering around it, playing between DOW 13,850 and 14,040. Growing liquidity makes the markets giddy but the base is uncertain at best. I reiterate previous suggestions that buying now means nibbling and having stop positions in place.

The unofficial test of February 20 showed that the Fed will not stop monetizing the debt and easing credit (for big borrowers) until there is a change to new currency standards. Cautious participation in the markets is dictated by stimulus tempered by underlying economic distress from burgeoning student loan debt to unmanageable health insurance burdens to declining real income and jobs. Also re-affirmed is the ultimate benefit of acquiring farm land for multi-use purposes including habitation if that is within your abilities. Near a small town is best or overseas if one has the energy and flexibility. The times are out of joint and one must find flexible responses to bumps disgorged by the dominant culture.

Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in VGZ over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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