Who Should Invest In Precious Metals In These Times?

by: Emmet Kodesh

(Editors' Note: This article covers a micro-cap stock. Please be aware of the risks associated with these stocks.)

On April 10, a new stage in fiscal, monetary and market dynamics began with the Goldman Sachs call to short-sell gold (NYSEARCA:GLD). Usually this suppression occurs via COMEX or the twice-daily price-set in London, now under investigation, during which those involved may trade metals or derivatives. These forms of steering a sector match the era. After all, official fiscal/monetary policy is to manage the housing, bond and, thus, equity markets by massive Fed purchases of Treasury debt brokered by major banks that profit from these transactions, earning interest on new money deposited with the Fed.

The point for all investors and for investors in the PM (precious metals) sector especially is that this new phase of market and monetary intervention reduces choices for buffering one's holdings from radical currency devaluation and growing ex-USD trade facilities. It is essential to acknowledge and adjust to emerging tendencies and dominant trends. I have written on this critical fact here and the huge crushing of PM prices December 2, sparking a sell-off that continued 12/03 emphasizes some points I have made. There is large, perhaps enormous opportunity for some investors in the PM sector where deflated pricing contrasts with inflation in other major asset classes. However, dangers are equally salient and this article will identify and discuss some of them.

For thirteen months and especially YTD, PMs have forced questions on whether one should average down in the hope of recovery or, rather, cut or at least trim losses. Those are the questions. The context is that PMs are an alternate asset class obnoxious to the fiat system. It will not cease to be a target for short selling and hostile narratives that build negative sell-side sentiment.

Despite the compelling value buys and contrarian plays that fill the PM sector, most investors should limit their allocation: artificial action and governance issues will bear as or more heavily on price performance as company merits and the glowing fundamentals for gold as a monetary metal and silver as a monetary and industrial commodity. Those who are invested and enduring great pain, deeply red despite having bought at depressed levels must steel themselves to hold most of their PM positions at least for a while. Depending on their net worth and income stream, they can add or trim gains (or cut losses) at the next period of rising share prices such as occurred in August.

First, I will review the latest price plunge as it affects key companies and then consider the reality made by the confluence of fiscal policy, market maneuvers, the approach of new monetary arrangements and fundamentals. Lastly I will suggest the degree to which investors in various life circumstances should prepare to reduce or add to the sector in this volatile situation, which has high stakes for the future of the West's entire socio-economic profile.

December 2-3 the Gold Miners ETF (NYSEARCA:GDX) sank to a 5-year low of $20.57, down 7.47%. Among major producers, Barrick (NYSE:ABX) fell 5.78% to $15.51, still 15% above its secular low. It has regained its position as market cap leader over Goldcorp (NYSE:GG) which for several months had surpassed it. GG was down 7.15% December 2-3 to $20.88, a new secular low as did Newmont (NYSE:NEM), second to ABX in reserves and revenues, which dropped 6% to $23.37. Few would have thought that among such carnage debt-encumbered ABX would stand best among its peers, but that has been my thesis for seven months because of its low-cost, mammoth reserves, cost control and John Thornton's accession as CEO. (For my ABX archive, see here). Tuesday, ABX held up best among all large and mid-tier PM miners: green most of the day before closing down 3 cents. Only exploration project Reservoir Minerals (OTCPK:RVRLF), +2.36%, partnering with Freeport-McMoRan (NYSE:FCX) on rich sites in Serbia and battered Silver Standard Resources (NASDAQ:SSRI), +3.52% were positive after the latest 2-day wipe out.

Among mid-tier gold miners, Yamana (NYSE:AUY) with the lowest production costs, low debt / equity, good profitability and safer (Western Hemisphere) sites lost -5.72% and made new secular lows Monday and again Tuesday. Profitable and diversified Eldorado (NYSE:EGO), with established, productive mines, stellar E&D properties and sound metrics fell -9.99% in two days. Its action is an epitome of gamed bullion and bad sentiment trumping fundamentals. Agnico Eagle (NYSE:AEM), profiled here, with its six sites in good to great mining jurisdictions, growing production and glowing recent upgrade by Morgan Stanley fell 7.08%, Monday, yielding its recent gains. It was green most of Tuesday, which may portend strength. Mid-tier New Gold (NYSEMKT:NGD), made a secular low, down 10.13% to $4.79 and fell another 2.08% Tuesday to $4.71. Three of its four producing sites are just getting up to speed and their 7.6% growth is hobbled by bullion prices despite its great ratio of net income to revenues and strong quick ratio.

Best of breed mid-tier silver miners First Majestic (NYSE:AG) and Endeavour (NYSE:EXK) with multiple sites in good venues and outstanding direction, have been crushed this week, AG - 7.38% and EXK -9.56%. AG's greater number (5) of producing sites, steady 9.4% growth and outstanding profitability, revenues 8.7 / debts, where EXK is solid at its 3 mines and growing output rapidly, did not exempt them from a drop worsened by tax-loss selling. December 3 left AG a few pennies above its secular low at $8.81. In late August it was near $16.50. Compare these companies' metrics to price action since August to see how punitive and irrational the PM sector is at this time.

Among the best juniors, debt-free companies with great management, McEwen (NYSE:MUX), primarily a gold producer was down 12.71% and Fortuna Silver (NYSE:FSM) plunged 15.28% in 2 days. Among top streaming companies, world-leader Silver Wheaton (NYSE:SLW) was -8.60% and gold and energy royalty company Franco Nevada (NYSE:FNV) -6.58% Dec. 2-3. Junior streamer Sandstorm (NYSEMKT:SAND) has fallen 7.65% and made a new secular low. Among the issues noted above, FNV and MUX remain highest above their secular lows, 19% and 15% respectively.

What then is one to do? The answer depends on your net worth, income stream (the higher these are, the longer one's time horizon) and temperament. As the markets are driven more by sentiment, extremely negative for the under-owned PM sector, one must have a great tolerance for volatility and irrational price action to be more than 5% in this sector. My view is that at current valuations, someone considering an allocation should not have less than 5% and of that half should be in physical metal ETPs like Sprott Physical Silver (NYSEARCA:PSLV) or bullion allocated through a dealer like this or this. PMs demand patience but the upside is great and the downside small. One cannot say the same for equity, bond or real estate prices. However, PMs may suffer their own form of extended depression (indeed, they are in one) despite fundamentals: one must take note of this.

Some herald the November national PMI, 57.3 as proof the economy is recovering. Then the PMI is used to renew taper talk. This too is a way to moderate rising indices. But the markets were unimpressed December 2-3 by the PMI or surge in holiday cyber-shopping. Retail sales fell 2.7% Y/o/Y though holiday online purchases rose. Also, the Fed postponed, because of a glitch some reports said, a bond sale so the loss of that new liquidity did not help assets that depend on QE and low interest rates: the 10-year was up 8 basis points Monday before subsiding to 2.76% Tuesday. In May it was 1.62%. A troubling note came from Irish Finance Minister Noonan who said the EU will use "bail-ins," taking depositor accounts to re-capitalize failing banks.

If your net worth and income stream are adequate and your temperament can endure an extended period of continuing sell-offs, this is a good time to increase allocation to the PM sector. Among miners there may be company failures and consolidation in which only the fittest will survive so stick to the best even if you look at the sector mainly as a trading vehicle. The best include AG, AUY, EXK, FNV, MUX and SLW. If you want super value plays for trading, try the Global X Gold Explorers (NYSEARCA:GLDX), -7.19% in 2 days with new secular lows and Kinross Gold (NYSE:KGC), -4.03% and another secular low. KGC is so depressed in price it closed even Tuesday. Its reserves are substantial but its negative 7.1% growth and alarming -$5 billion cash flow, 25% greater than revenues make it a risky play. I would rather trade with a first rate company and periodically trim gains.

The macro takeaway is that the world's major banks all have been and are engaged in massive debt creation and devaluation: China's debt / GDP ratio is as high as that of Japan. The jostling in the China Sea is, for now, mainly a distraction from internal issues in China, Japan and the USA. The feckless bumbling on Iran is a distraction with potential to spark a series of expensive and bloody crises that, like all such nightmares, have a way of growing in duration, expense and scale.

Like Barry Bannister of Stifel Nicolaus, I see government policies from finance to social "welfare" to geopolitics as more problematic than economic basics. This argues for holding some bullion privately and in ETPs like PSLV, Central Fund of Canada (NYSEMKT:CEF) or Swiss Gold Trust (NYSEARCA:SGOL).

The PM sector brims with value buys. However, just as markets can remain irrational longer than most people can remain solvent, so too PM prices may be driven lower for longer than positive fundamentals suggest. Equities are ripe for correction. It is between this Scylla and Charybdis that one makes choices in these markets. Overweighting cash is reasonable for those unsettled by stocks, bonds and PMs as well.

Disclosure: I am long ABX, SLW. 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.