Patience On Precious Metals Sector Will Be Rewarded: Context For Trading

by: Emmet Kodesh

In addition to strong fundamentals, CFTC data showing net long positions near 3 million oz. of gold suggest that patience with PMs (precious metals), bullion and miners will be rewarded. If you have the grit and income to wait out the volatility attending value-buying by leveraged participants, there should be substantial gains. As this spiky path plays out, periodic selling to bank gains can help you stick with a sector that will shine when current market enthusiasm confronts fundamentals.

Fundamentals ultimately impress themselves on market sentiment. They express reason, purposeful activity and facts that endure even when eclipsed by spin. It also must be understood that in all aspects of the markets, especially the PM sector policy and strategy by major players set short-term price parameters. Volatility that would otherwise be irrational simply reflects the self-interest and strategic positioning of those who move markets and dominate sectors. Below I review comments by Dr. Philippa Malmgren, a prominent financial advisor and strategist on this situation.

A historical precedent is the affect that the abrogation of Bretton Woods had on gold prices in 1971 when gold rose from $35 - $200/oz. In 1974 the IMF sold gold and the price fell nearly to $100 only to climb to $800 by 1980. Today another new monetary order is advancing in the context of market volatility, enormous debt creation, recessions in Europe and Japan and economic contraction (at least in industrials) in China and America. Those who initiate or add to positions in the PM sector will reap a good harvest starting by 4Q 2013.

Markets YTD present an intriguing pattern of inverse relations and relative value: the major indices have surged despite alarming economic fundamentals summarized by the recent regional Fed reports and PMI. The national manufacturing index as I discussed here is now in contraction territory at 49.7 and has been trending down since July 2009. Unemployment is high, yields on savings are minimal and demographic trends are bad. Even USA non-manufacturing PMI has declined nearly 6% since February. The economy is not recovering but for the markets it is happy hour. Von Mises described the "orgy of speculation" that attends a persistent policy of debt creation and the market collapse that inevitably follows.

Precisely the opposite pattern pertains in the PM metals and mining sector. There fundamentals are strong and growing stronger by the quarter: CBs (Central Banks) are purchasing record amounts of bullion while retail buying of bullion and jewelry sets records despite rising premiums and shortages of physical metal leading to protracted delivery times. Major currencies continue to be devalued in an "easing" rather like a last quietus, and bilateral trading agreements and open policy discussion in major world capitals indicate that anticipation of a new world reserve system by 2018 is plausible. But the price action in the PM sector is the antithesis of the main indices: silver, -28% YTD and gold -17.4% have been by far the worst performing commodities and sub-sector. Copper, -11% YTD completes the grim picture for the precious metals and their mineralogical and sometime monetary kin Cu (Copper).

Many people including myself would argue that this makes the sector today's prime value play. Technological and industrial uses for Ag (silver) are extensive and growing. The central role of Cu (NYSEARCA:JJC) in industry and global growth is so well known that it often is watched as a barometer of global commerce and economic health. Swelling purchases of gold and by Sovereigns to support a re-ordered world reserve system and protect their currencies from geopolitical fiscal jousting make the case for gold as does the recent price plunges. The beautiful fundamental view is obscured by disastrous price action YTD and especially 2Q. It is a prime example of the divergence of value from a managed, artificial and tenuous virtual reality with which we have become familiar in many areas of life.

The result is volatility and extreme uncertainty. I suggest that the latter condition, uncertainty affects major equity indices from NY to London, Berlin and Tokyo as markets live and die by interpretations of the latest hints or expectations about Fed QE policy. This unhealthy condition also makes the case for precious metals and the miners that produce them. Slowing production and increasing cuts in capex will bring future shortages when Sovereigns deploy their enhanced holdings of the metals. So it is important to participate as one's means permit. Speaking to this point, Caesar Bryan, in financial management for 34 years and Director of the Gabelli Gold Fund (MUTF:GOLDX) since 1994 urges that "investors not be shaken out of their gold holdings by machinations taking place in the gold futures market."

Because PM volatility often does not reflect fundamentals, purchase should be done by puts and calls or limit orders with which you should be patient: significant dips will come. This is among the primary lessons of the past two months. Frequently tested support levels of Au $1550/oz and Ag $26.50/oz quickly broke and prices now are groping for bedrock. Given the fundamentals it ought to be near: there were major price corrections for PMs in 2006 and 2008. Now, however the stakes are higher as CBs and major banks, "globally active, systemically important institutions" are busier than ever in equity markets and debt and leveraged derivatives are at record levels. Managing the major indices and steering investors into equities requires that CBs also manage the PM sector. So if you dislike volatility or have a nest egg you feel is too small or time-limited for roller coasters your main exposure to PMs should be through a diversified equity fund or ETF.

Dr. Philippa Malmgren is former head of investment strategy at UBS and head of Global Asset Management for Bankers Trust in Asia and its Currency Strategist. She is President of the Canonbury Group, has a PhD from the London School of Economics, is a Senior Consultant for Deutschebank (NYSE:DB) and a member of the most influential and prestigious policy groups. She states that major investors know that manipulation of the gold market is a fact of life. One result is that many funds and high-end retail investors are pursuing diamonds. Those interested should review Dominion Diamond Corp (NYSE:DDC) with its EPS of $6.27. It has risen nearly 45% in the past 52 weeks while the PM sector has suffered. Dr. Malmgren also notes that unprecedented Sovereign devaluation of currencies intensifies government interest in managing the PM markets. One should be cognizant of this.

Dr. Malmgren states that the magnitude of sovereign debt is so great that it cannot be paid down and "will have to be defaulted on." This will cause chaos on bond and then equity markets, another reason why in the mid-term gold will resume its role as preserver of wealth as a turbulent de-leveraging attempt unfolds.

In another cautionary note that affects investment strategy, she describes "a change in the fundamental relationship of the citizen to the State" in which the State aggrandizes itself by finding socio-economic rationales for taking the money of individuals. This is the "wealth consolidation event" I often discuss and is a primary feature of what Dr. Andrew Lobaczewski terms pathocratic government.

If your financial and emotional posture allows you to participate in the PM sector, select a few major, mid-tier and small miners for investment. Their progress, market dynamics and your needs will shape the time you hold them before taking profit or limiting downside. Note too that YTD Sprott Physical Asset Gold (NYSEARCA:PHYS) and Physical Silver (NYSEARCA:PSLV) have done slightly less badly than bullion. They are at depressed levels and new entrants or those able to add to positions should do so.

Here are some suggestions: Goldcorp (NYSE:GG), Newmont (NYSE:NEM) and Barrick Gold (NYSE:ABX) in the large-cap space. Analyst Research at rates ABX at $29, down in recent weeks with guidance ranging from Strong Buy to Hold. Still the estimate is 42% above the last close. In my view, this estimate is low and reflects more caution than merited regarding Barrick's Pascua Lama project in Chile which ABX has positioned to proceed. Its enormous reserves sustain its 4.2% dividend. Most estimates for GG are Buy-Strong Buy and the 12-month target of $38.25 is 36% above Friday's close. In the June 7 PM plunge, NEM held up best. Its 12-month target is $41.80, 24% above its last close. In the mid-tier space, Kinross Gold (NYSE:KGC) has a $8.95 target, 43% above its current level and yields 2.55%. Eldorado Gold (NYSE:EGO) like its older peer KGC is geographically diversified: I wrote about it here. It has mostly Buy-Strong Buy ratings and its 12-month target of $12.50 is nearly double its Friday close. It yields 1.81% annually. Small cap, McEwen Mining (NYSE:MUX) maintains its consensus estimate of $5.11, 54% above its June 7 close. Having followed the price performance as well as explored the fundamentals of these companies I feel that GG, EGO, KGC and MUX have the most growth potential while ABX and GG are the best value plays.

In the silver space, perhaps in the entire PM sector, streaming company Silver Wheaton (NYSE:SLW) may be the safest investment. It maintains a preponderance of Strong Buy ratings which it has held through volatility and steep decline. Its 12-month consensus at $36.70 is 61% above its Friday close and it yields 2.04%. The average target estimate at Marketwatch is even higher, $38.62.

Equity indices are rising amidst an unprecedented fiscal context and deteriorating socio-economic metrics. As Seth Klarman of Baupost said last month, markets surging amid "challenging fundamentals" are "the riskiest environment of all." Unless those who increasingly sway the indices by fiscal policy and nuanced comments have superhuman powers, turbulence and a major correction will occur but the degree of distortion in the system makes its timing as hard to predict as it is inevitable. Being in the PM sector can buffer a re-set: the readiness is all.

Disclosure: I am long SLW, EGO. 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. I own shares of PM miners in two diversified funds and an ETF.

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