When The Market Turns Bearish, It Is Time For Investors To Get Bullish

|
 |  Includes: ANV, GLD, PGLC, TGD
by: Patrick MontesDeOca

It has not been a pretty sight the past few weeks for anyone following the gold market with a rooting interest. This chart of gold going back to the beginning of the year illustrates the downward spiral that every gold investor has been experiencing recently:

Not a pretty sight. "Gold Hit by Panic Selling, Margin Calls" was a headline on CNBC yesterday as what had been a turbulent situation got even worse with the metal dropping 9.3% and settling at $1,365 on Monday, its lowest level in two years. Gold bullion recovered slightly yesterday after recording its biggest ever daily fall in dollar terms on Monday, being down $142 an ounce.

With increasing bullion demand, why are prices falling?

"Prices are falling because the Comex market, which is a paper market, determines the price. People are shorting the paper market and driving the physical price down. Big banks are scaring hedge funds into thinking gold and silver are going to go down. They all start shorting it. All the while the big bankers have been short the whole time and covering their shorts, and now we've got all the hedge funds going short," explained Eric Sprott CEO, (Sprott Asset Management), in a recent interview with Equity Management Equity. "The commitment of traders report showed that the specs increased their short position to a massive 22,382 contracts from about 2,900 as of February 5. I believe that such numbers are a key indication of the way the market is being held down."

Over the past 90 days and without any announcement, stocks of gold held at Comex warehouses plunged by the largest figure ever on record during a single quarter since record keeping began in 2001 (roughly the beginning of the bull market).

Short Selling Hurts Gold Mining Companies

The market for gold mining stocks has been even worse, as evidenced in this chart:

Why? In a recently published article on Seeking Alpha I wrote, "The short selling in the paper market also hurts mining companies, which have to sell into an artificially devalued futures market. When this short selling ends, it should greatly aid mining company stock prices. Our analysts at the Equity Management Academy, supported by precious metals insiders such as Rick Rule, agree that mining company stocks could be set for a major rebound. The question is when?"

"As you get closer to the cash cost production for gold, which is around $1,200 an ounce, people get nervous," Jonathan Barratt, founder of Barratt's Bulletin told CNBC.

But Barratt added that he believes this is a "significant overreaction" and offers a good entry point for investors. He said, "For the amount of money that's going into the system, you have to take a longer-term view that stimulus will support gold prices."

In a previous report, I pointed out that the U.S. debt continues to increase. In the first two months of the current fiscal year that began October 1, the U.S. national debt grew $320 billion. That is $21 billion more than the same two-month period last year, which illustrates that the growth of the national debt continues to accelerate. The reason is the federal government's huge operating deficit, which is not getting any smaller.

High Cost Producers Feel the Pinch

At the current price of gold, one thing is certain: only low-cost producers will survive. The timing for entry into several of the low-cost producers is more attractive than it has ever been. If the price of gold were to settle in at these lower levels, it would have polarizing effects on the high-cost compared to the low-cost producers. The high-cost producers, simply put, have tremendous inherent business risk that is being highlighted even further with gold's decline.

The low-cost producers will still be able to survive and even thrive at the new price level of gold. Here are some examples of low-cost producers that I think are presenting great buying opportunities based on their low costs of production and their attractiveness as takeover targets: Allied Nevada (NYSEMKT:ANV); Pershing Gold (NASDAQ:PGLC); and Timmins Gold (NYSEMKT:TGD).

Allied Nevada Gold Corp

Allied Nevada is a prime example of a well positioned producer. The stock is down 71% from its 52-week high. That compares to the 25% fall of SPDR Gold Shares (NYSEARCA:GLD). Yet investors need look no further than the company's latest corporate presentation to see that Allied has a bright future.

Allied is on track to triple production by 2016 and the company has 47.3 million gold equivalent ounces of reserves and resources at its Hycroft mine alone. Upon achieving a run-rate of about 1 million gold equivalent ounces, Allied's costs will be comfortably in the bottom quarter with its investor presentation projecting a cash cost of $565 to $585 per ounce for 2013 (with silver as a byproduct credit). It is important to note that Allied Nevada has projected cap ex needs of $1.24 billion to fund its Hycroft mine, although the company believes it can fund the project through its current cash balance, operating cash flow, available capital leases and its undrawn revolving credit facility of ~$120 million.

Allied Nevada is trading at a 1x multiple of its expected run-rate revenues in 2015. The majors are trading at an average of approximately 3.5x revenues. Either Allied Nevada will see a substantial improvement in its valuation or it will get acquired.

TECHNICAL LANDSCAPE

Daily

Allied Nevada closed at 11.47. The price closing below the 9 day MA (13.09) is confirmation that the trend momentum is bearish. A close above the 9 day MA would negate the weekly bearish short-term trend to neutral. With the market closing below the VC Weekly Price Momentum Indicator of 13.24, it confirms that the price momentum is bearish. Look to take some profits, if long, as we reach the 15.01 and 18.42 levels during the week.

Weekly

With this week's lows (11.61) not violated by closing below this level on a weekly basis, we can build a strong argument that the lows are in and the foundation is in place to support a larger move to the upside.

If the lows of this week hold, it will support a rally into the following Fibonacci target areas over the short term:

1. 22.64

2. 26.20

3. 29.78

A close above 29.78 puts into perspective the upper end of the target zone. A weekly close above this level would set the stage to challenge the 41.29 highs made in November 2012.

Pershing Gold

Pershing Gold will be in production next year. It will have a low-cost operation at its Relief Canyon Mine in Nevada. A simple heap leach, open-pit mine, processing 1g/ton gold, the mine will generate robust economics. As the mine grows from an initial 50k ounces of gold per year to 100k ounces, costs per ounce should trend even lower. Pershing's remaining cap ex is minimal as it already has a completed and permitted mine requiring just minor upgrades. This differentiates Pershing from most emerging producers that require substantially more capital in a horrific market for raising funds.

Pershing can get into production cheaply because it already owns a permitted, built and paid for processing facility. Relief Canyon is a past-producing mine. Therefore, significant infrastructure such as roads and the open pit itself are readily available. Importantly, the initial mine operating plan only includes 3% of Pershing's total of 25k contiguous acres. Operating cash flow from Relief Canyon will be used to expand the pit and extend the mine life, as well as find additional deposits nearby.

Assuming a 10-year mine life, a $1,400 gold price and 50k ounces per year (growing to 100k ounces), the Relief Canyon project alone could be worth well above Pershing's current Enterprise Value. With near-term production, excellent exploration potential in known mineralization zones, low-operating risk, high margins and 100% owned processing facilities, I believe that Pershing is a compelling takeover target for any company looking to acquire near-term production with minor cap ex needs and low geo-political risk. A few examples of companies that may meet these criteria and for whom I believe this acquisition would be received very favorably in the market include: Midway Gold (NYSEMKT:MDW), New Gold (NYSEMKT:NGD), Coueur d'Alene (NYSE:CDE), and even Allied Nevada, which I mentioned above as a takeout target itself.

TECHNICAL LANDSCAPE

Daily

Pershing Gold closed at .40. The price closing below the 9 day MA (.43) is confirmation that the trend momentum is bearish. A close above the 9 day MA would negate the weekly bearish short-term trend to neutral. With the market closing below the VC Weekly Price Momentum Indicator of .41, it confirms that the price momentum is bearish. Look to take some profits, if long, as we reach the .46 to .53 levels during the week. Buy corrections at the .34 to .38 levels to go long on a weekly reversal stop.

Weekly

With this week's lows (.35) not violated by closing below this level on a weekly basis, we can build a strong argument that the lows are in and the foundation is in place to support a larger move to the upside.

If the lows of this week hold, it will support a rally into the following Fibonacci target areas over the short term:

1. .79

2. .96

3. 1.13

A close above 1.13 puts into perspective the upper end of the target zone. A weekly close above this level would set the stage to challenge the 1.67 highs made in February of 2011.

Timmins Gold Corp

With gold and silver production in North America increasingly sought after, Timmins Gold Corp is in the right place at the right time. The company's San Francisco Gold Mine in Sonora, Mexico is a low-risk, open pit, heap leach operation expected to produce 125k-130k ounces in 2013. In addition, Timmins has vast exploration upside from a remarkable 200k hectares of contiguous claims in the prolific Northern Sonora Gold District.

Timmins has what every small-to-mid sized gold producer wants; free cash flow to fund robust exploration. Self-funding of exploration will enable production growth well beyond 125k ounces in coming years with minimal equity dilution. As production grows, Timmins costs will decline, making it one of the lower cost gold mines in Mexico. Given the company's bite-sized $300 million market cap, many mid-to-large cap gold producers have the financial wherewithal to take the company over.

TECHNICAL LANDSCAPE

Daily

Timmins Gold closed at 2.27. The price closing below the 9 day MA (2.70) is confirmation that the trend momentum is bearish. A close above the 9 day MA would negate the weekly bullish short-term trend to neutral. With the market closing below the VC Weekly Price Momentum Indicator of 2.47, it confirms that the price momentum is bearish. Look to take some profits, if long, as we reach the 2.79 to 3.30 levels during the week. Buy corrections at the 1.94 levels to cover shorts and go long on a weekly reversal stop.

Weekly

With this week's lows (2.16) not violated by closing below this level on a weekly basis, we can build a strong argument that the lows are in and the foundation is in place to support a larger move to the upside.

If the lows of this week hold, it will support a rally into the following Fibonacci target areas over the short term:

1. 2.48

2. 2.59

3. 2.69

A close above 2.69 puts into perspective the upper end of the target zone. A weekly close above this level would set the stage to challenge the 1.67 highs made in November of 2012.

TRADING DERIVATIVES, FINANCIAL INSTRUMENTS AND PRECIOUS METALS INVOLVES SIGNIFICANT RISK OF LOSS AND IS NOT SUITABLE FOR EVERYONE. PAST PERFORMANCE IS NOT NECESSARILY INDICATIVE OF FUTURE RESULTS.

Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in AGOL, DGL, DGLD, DGP, DGZ, DZZ, GLD, GLL, IAU, PHYS, SGOL, UBG, UGL, UGLD 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.

Additional disclosure: The information in the Market Commentaries was obtained from sources believed to be reliable, but we do not guarantee its accuracy. Neither the information nor any opinion expressed therein constitutes a solicitation of the purchase or sale of any futures or options contracts.