Gold Stocks: Insiders Unfazed

Includes: GDX, GLD
by: Acting Man

A recent article published in Canadian newspaper 'The Globe and the Mail' summarizes the latest insider trading data collated by our friends over at INK Research in Canada.

In short, insiders in the 'junior' gold sector were completely unfazed by the recent price drop in gold - on the contrary, they have stepped up their buying to a new record high (as will be seen further below, INK's 'short-term activity' indicator reached a new record high for the entire 'venture' sector). This confirms what we said on occasion of a previous article on insider buying in gold stocks: the buying does not reflect a particular view about the future price of gold. Rather, it is telling us that insiders believe that their stocks represent good value even at lower gold prices. As we have argued at the time, it would be erroneous to believe that the insiders at listed gold mining and exploration companies possess any special insight regarding the direction of the gold price. However, they do have a pretty good idea what their companies should be worth at various gold price levels.

According to the article:

Those looking for even more evidence that corporate executives are smelling bargains in the junior mining sector should consider this: Insider buying on the TMX Venture exchange is near a record high.

INK Research's Venture indicator is at 715% today, just 20 percentage points below its record peak of 735% set on October 27, 2008. That means there are more than seven stocks listed on the exchange with insider buying for every one seeing selling. It also marks a steep increase since early March, when the indicator was near 400%. Such a high level of buying interest among officers and directors within their own businesses in the resource sector has correctly foreshadowed a recovery in share prices in the past: That high point of nearly five years ago came about six weeks before the Venture market bottomed on December 5, 2008, points out Ted Dixon, INK Research CEO.

The Venture indicator is based on insider transactions over the past 60 days. But INK also has a Venture indicator that covers just the past 30 days of transactions. It's more volatile, but gives a better sense of the more recent insider activity.

And right now, that shorter-term indicator is painting a picture of corporate insiders scooping up beaten-down shares with little hesitation. The 30-day Venture indicator is at 1,229% today, after reaching a record high on Monday of 1,305%.

The gold sector is clearly driving a lot of the buying enthusiasm. The INK Gold Stock Indicator - which tracks insider buying on all Canadian-listed gold stocks and is heavily influenced by junior miners - has now surpassed its March high and is over 1,000%, according to Mr. Dixon. That's more than 10 stocks with key insider buying for every one with selling.

The indicator hit an all-time peak of 1,046% last Thursday.

(emphasis added)

INK's basic materials gold insider buying indicator versus Canada's TSX S&P Gold Composite Index

A file that contains the above chart as well as details on the companies with the highest level of insider buying can be downloaded here (pdf).

Insider Buying and Successful Speculation

A few things need to be kept in mind about corporate insiders. For one thing, they are not really 'market timers'. Often they begin buying (or selling) long before the ultimate low (or peak) in their shares is reached. This is because they base their decisions mainly on their interpretation of company fundamentals.

The stock market by contrast is also reflecting the psychological state of market participants, predominantly in the form of herding effects. It is also affected by technical factors, such as the number of participants using margin who either become forced sellers in downturns, or add to their margin buying during upturns. Moreover, the central bank's suppression of interest rates below the natural rate not only falsifies economic calculation, it also distorts the assessment of stock market valuations by investors.

Lastly, the stock market is decidedly not obeying the tenets of the 'efficient market hypothesis', which posits that all fundamental data are perfectly known to a perfectly rational bunch of market participants, and that it is therefore impossible to determine market inefficiencies such as prices that are too low or too high.

This idea completely rejects the existence of entrepreneurial foresight, this is to say, the fact that astute entrepreneurs or investors can display an ability to correctly forecast future prices. If that were indeed the case, there would be no successful entrepreneurial activity whatsoever. However, the market process is driven precisely by what the EMH and the 'rational expectations' theory from which it was derived denies to exist: namely the actions of individual entrepreneurs who discern profit opportunities that others overlook. Such opportunities consist of a mispricing of factors of production relative to the prices that can be obtained for the future products they yield.

A speculator or investor in the stock market who decides which stocks to buy or sell is involved in an analogous appraisement process. The fundamental and technical data of the past are available to everyone - but not everyone interprets them in the same manner or interprets them correctly with regard to the future. If market prices in the stock market were to correctly reflect everything that can be discerned from the data at all times, then there would be no reason to trade - and yet, there are always buyers and sellers. Obviously, both groups cannot be right, and their opinions are diametrically opposed in spite of the availability of all relevant information.

With regard to insider buying, it should also be pointed out that there are countless reasons for insiders to sell (most insiders receive part of their compensation in the form of stocks). These may range from a sudden urge to paint a garage to the need to diversify one's investment holdings; insider selling as such is therefore not necessarily an indication that insiders regard their stocks as overvalued (unless their selling becomes especially pronounced).

However, there is only one reason for insiders to buy stocks of their companies: they regard them as undervalued and expect them to rise. Again, in the case of gold stocks, insiders have no particular edge in forecasting future gold prices, so they could turn out to be wrong about that aspect. They do however know more about the companies they run than outsiders. As the chart below shows, gold stocks continue to be shunned by most investors though.

The HUI-gold ratio versus gold (the green line). The ratio remains stuck near recent lows, reflecting the market's lack of enthusiasm for gold stocks.

In the next article we discuss why we believe the sector has remained under pressure and has so far failed to reflect the recent rebound in gold.

Charts by: INK Research, StockCharts