The ability to learn from experience and change one's habits is often praised but difficult to do. It is vital in all aspects of life, certainly in investing. This article considers PMs (precious metals), one of the smallest, intriguing, contested and even traumatic sectors in global markets. The last six months surely have taught everyone involved to re-consider their assumptions and goals.
The context for PMs in the era of CB (Central Bank) debt creation and yield suppression, QE and ZIRP (zero interest rate policy) is the devaluation of currencies, disorder in other asset classes and the approach of a new global monetary order. Another key factor is massive buying of gold by Asian CBs, mainly but not only in China and by retail investors worldwide. The same is true for retail investment in silver bars and coins. An additional floor for silver prices should be provided by its tech-industrial uses which are pervasive and increasing rapidly for twenty years.
Despite these factors that should sustain rising PM bullion and mining prices, at least in the best companies of which there are many, silver and gold for two years have fallen more than all other basic material commodities save uranium. Adjusted for inflation they remain far below their 1980 levels. With the USD declining nearly 75% since then, gold should be near $3200 oz. not even taking massive CB buying into account. Clearly things are awry in the sector.
To explain the current two-year decline, observers have cited over-ambitious expansion during the 2001-11 bull run, inattention to country risks, e.g. Pakistan, an emphasis on growing production rather than profitability and a consequent accumulation of debt. However, while this story line applies to the major producers, Barrick Gold (NYSE:ABX), Goldcorp (NYSE:GG) and Newmont (NYSE:NEM) in various degrees and to some mid-tier companies like Kinross Gold (NYSE:KGC) and IamGold (NYSE:IAG), it does not fit many mid and small cap companies that are cost conscious and have strong revenue / debt ratios, sturdy cash flow plus growing E & D of rich sites. Stand outs in this area include First Majestic Silver (NYSE:AG), Endeavour Silver (NYSE:EXK), McEwen Mining (NYSE:MUX), Fortuna Silver (NYSE:FSM) and Yamana Gold (NYSE:AUY). Yet none of these, not even MUX carefully managed by Rob McEwen, founder of GG and recently added to NY ARCA and the Market Vectors Gold Miners ETF (NYSEARCA:GDX), has escaped the mad volatility and apparent irrelevance of fundamentals that typify the sector.
Here is one example of typically irrational action: Friday Sept. 20, Goldman Sachs (NYSE:GS) issued numerous ratings on PM companies. Despite having revenues 2.2 x debts and a positive if modest EPS, IAG was listed as "sell" and led the sector down the rabbit hole, plunging 11.9% on quadruple volume as investors stampeded to the exits. GS listed GG as "buy" although its negative growth, -22.5% is nearly as bad as IAG and has but half IAG's cash flow on twice the revenues and a negative EPS. Note just one more of many examples of analyst-assisted irrationality: EXK whose revenues are 6.5 x debts, boasts 57% revenue growth, has cash flow nearly double its debts, 8.2% ROE, a huge 37 coverage ratio and a board each of whose members has decades of experience in the field and degrees in geology, metallurgy and mining, in short an outstanding and highly profitable company with great prospects and three producing sites fell 8.4%. FSM, a junior with no debt, 9.9% ROE, good cash flow and a savvy and experienced board fell 8.9% and on it goes.
Factors that cause this wild, time and energy-consuming volatility and lack of true price discovery are widely discussed (outside the mainstream media) and easily identified. However, they are not easily rectified and may be hard-wired in our systems of governance, finance and law. More important therefore is the issue of how to respond to the keen and disruptive interest and involvement of strong hands in the PM sector. Considering price action in the five+ months since the GS short sell guidance pushed PM prices through a frequently tested support level, and continuing volatility indifferent to basic metrics, those with more than 10% of their portfolios in PMs should consider gradually shifting to the 7-10% range and, at suitable times, replacing some mining holdings with hard assets, privately held bullion or other equities with low debt and strong growth. See this article for options.
This should not be done by abruptly closing out positions. Those familiar with price history and recurrent volatility know that big rises (or declines) of 2-3 days or weeks are common. Holders of the best companies should consider their cost basis, identify a period of topping out and trim their positions. Holders of challenged companies should look for surges and exit their positions. In this way, gradually eliminate all but the best companies (I have identified and discussed them many times, including above) and even among these, trim holdings when gains are significant. If one follows the company's properties, revenues, management and debt, then one can buy back at troughs and thus steadily lower cost basis. It also is possible that the sector will begin to out-perform consistently at some point but, despite good fundamentals, do not bank on this.
Because of the tech-industrial and monetary merits of the metals, one should always own some: 5% of holdings are a minimum level and 10% reasonable. Those with larger net worth can afford to allocate more to the sector, to hold longer and trim less. Everyone also should own some coins: some people prefer to hold the sector only in coins. That is understandable. However, one must be mindful of governance issues. Those who believe that a significant level of cultural stability will endure through our ongoing period of great socio-economic changes and stress also should own some numismatic coins graded by the NGC (Numismatic Guaranty Corporation) or the PCGS (Professional Coin Grading Society). Colorado Gold and Gold and Silver Online in America and Sprott Money in Toronto provide reliable and timely service. The latter two companies, like local coin shops allow one to purchase limited quantities for reasonable cost above spot bullion price.
With taper talk having resumed a day after the Fed announced that QE would continue, the hollow markets may be talked down (and pulled down by a struggling economy and bad demographics in all major economies) to the 1630 level at which we had several touches August 27. That day marked a 4.76% decline from the YTD highs of August 2. In the euphoria that began 2pm on Sept. 18 and at the open the next morning, the S&P hit 1730. Re-tracing to 1630 would mean a 5.52% decline. If the conflict over the "Affordable Care" mandates which includes a struggle over two-party (as opposed to one party, i.e. authoritarian) politics in this nation becomes intense or if a few geopolitical issues heat up, we might revisit the June 24 low at 1573. That would be a 9.07% correction from 9:34am Sept. 19. Moreover, the economy continues to struggle and labor force participation and real wage levels to drop as costs of life basics rise. Even with the Fed buying T-bills it is possible that yields could start rising which would cramp housing and all that depends on it. Significant market declines remain possible and a solid cash position is prudent.
I mention these plausible scenarios because classical thinking is that PMs become safe havens in such markets. There is something to that for privately held hard assets but "thought leaders" in the media have created a climate such that PM issues, whether bullion ETPs or miners are early risk-off assets in a sell-down like we had Friday. Moreover, it cannot be stressed too often that action in the sector often defies fundamentals.
The commodity chief for Goldman Sachs, Jeffrey Currie recently issued a short-term gold estimate of $1050, saying "it surely could trade below $1000." Shortly afterward, GS rated Yamana , Silver Wheaton (NYSE:SLW) and MUX as "buys" and dropped IAG, Eldorado (NYSE:EGO), a great company by all metrics, and New Gold (NYSEMKT:NGD) to "sell." Those who are cynical might suggest that this means GS wants its clients to buy EGO at discounted levels and get people into great companies like MUX and AUY only to pull the rug out with a drumbeat of negativity and then buy on panic selling. Those who think this far-fetched can search "lawsuits" for GS and JP Morgan (NYSE:JPM) and find many cases from credit card privacy abuse, to fiddling with commodity warehouses (e.g. aluminum), MBS-peddling, driving down prices on takeover targets, silver price "influence" and more.
The paradigm on gaming the markets and not only in PMs, seems like a degraded rehash of famous and honored verses:
There is a time to juice the goose, a time to shake the tree, A time to gather fruit, and a time to rinse and repeat.
Bart Chilton may rail against questionable high volume trading by "the shark tank" of major banks and refer to "hundreds of pending CFTC cases" against illegal trading, but while his title, "Commissioner" sounds grand his head is Chairman Gary Gensler, an 18-year GS alumnus, a former Under Secretary and Asst. Secretary of the Treasury and a major force in Democratic politics. So sparks may fly but the system is likely to remain intact despite, as in LIBOR, occasional fines.
Therefore, investors with less than $2 million net worth ($3 million for couples) should consider trimming their PM exposure as noted above. There are many great companies in most market sectors (see this piece) and the sad truth is that PM companies, even the best are playing against a different set of rules.
Perhaps suggesting lessened allocation is a form of capitulation but at this point it simply examines a hard reality and adjusts accordingly. Those able and inclined to keep PMs, including bullion in the 10-20% range or more are free to do so. Time may validate their approach: in a sane world it would be borne out. But a premise of cultural and market analysis is that gaming of the system by strong hands will not cease until there is massive socio-economic change including generalized systemic crashes. This likely will be for the worse before it is for the better. It seems less prudent in this scenario to be over-weighted in PMs than invested heavily in Health Care and bio-tech, certain consumer issues, energy and media companies, cash and some hard assets. Be strong and take care.
Additional disclosure: I own precious metal companies in diversified funds and individually.