Precious Metal Investors Amid Equity Bull: Darkest Before Dawn

by: Emmet Kodesh

"In today's world few markets provide true price discovery and few economic indicators are without serious reservations." (Robert Fitzwilson, Director, the Portola Group 5-28-13)

Many investors and, perhaps more importantly, fund managers won't touch miners now, especially PM (precious metal) miners. This year they have made a series of new 52-week lows, multi-year lows or as with the Junior Gold Miners ETF (NYSEARCA:GDXJ) a series of lows-since-inception (44 months). Why buy PM sector assets now when the economy has been declared "in recovery" despite contradictory remarks by Fed spokesmen last week that prompted instability in markets worldwide. Down action in the indices May 29 is a sign of things to come (including more QE) and fundamentals for PMs are intact.

The abundant macro-economic, fiscal and commercial reasons for buying precious metals are detailed in my previous pieces here, here and here. A more scholarly piece citing quotes from von Mises on the relation of debt-based monetary policy to "an orgy of speculation" and depression may be read here. The fundamentals for PMs are stronger than they were 6 months or a year ago. The refurbished narrative about economic strength is dubious though no one can deny that sentiment is bullish: indeed it is euphoric which is a warning sign. Moreover, today's happy hour rides on debt creation and someone will pay the piper when digital credit is withdrawn and the derivatives they support evaporate. Let us hope that never happens and taxpayers never are called upon to bail in big banks: legislation for "resolving systemically important institutions" already is on the books on Canada, America, England and New Zealand. Either a disaster will occur or the current equity stampede will make history as for the first time markets sustain themselves on debt, excitement and gawking at the emperor's new clothes.

Perhaps the outcome will more resemble the result for a streaker at a ball game: security personnel descend and then comes a sobering trip to the pokey and an expensive fine and bail.

Before suggesting ways that someone new to the PM sector or those with investable cash can get in at very depressed prices and thrive when the ski-jump markets plunge, let's glance at a view of the indices by a senior investment analyst with 43+ years of professional experience. Remember: Sir John Templeton said that "bull markets die of euphoria."

Jeffrey Saut: Tuesday (20th consecutive green Tuesday) was the 102nd day of what Saut terms a "buying stampede," a string of plus days uninterrupted by 3-consecutive down days on the DOW. Saut, Chief Investment Strategist for Raymond James mentions that he has notes going back fifty years showing that such stampedes (his term) rarely exceed thirty days. The stampede that preceded the crash of the DOW October 19, 1987 was 38 days in length. In 2010 there was a 53-day period without a 3-day correction. Saut believes that fund managers have been under-invested in the current bull and are pushing it further in an attempt to show good performance. This is another reason, like QE debt creation that these markets are unsound. Saut believes that this urge to make hay will persist into 3Q 2013 and that we then will see a double-digit correction in the indices. Perhaps May 29 will prove to be the first of three such days: we will see.

Investors should note that Saut believes that after the substantial correction and period of malaise the mid - long-term basis for America's economy will be supported by massive energy reserves tapped by new technologies. That however will take a few years to kick in and in the meantime the economic and demographic bases for the economy are strained. "Durable goods orders show a weaker recovery" writes John Williams (May 24, #526, left column, home page) while the U-6 has just eased to its 3Q 2008 level.

A tiny "minority is creating the future" by building markets based on debt creation states Robert Fitzwilson, quoted above. He specializes in software systems and cycles in major industries and invests in many sectors and asset classes. Fitzwilson, headquartered in Silicon Valley is not a gold bug as may be seen by checking the Portola Group site (linked at the head note, above) but he believes the "invented" bull market is creating a situation in which wealth preservation may largely be sustained by PM holdings. The Fed's attempt to achieve monetary "velocity and [slowly] graduated inflation instead is creating economic stagnation," he states. His reasoning is sound and similar to the thesis of von Mises.

"True value always wins in the long run" Fitzwilson concludes his recent remarks and that leads us to the despised PM sector.

Silver long positions have dropped YTD from about 40k to 23k while hedge shorts have soared from 4k to 23k: the short and long positions are crossing to create a bear outlook on silver at odds with steady buying pressure and increasing demand from economies said to be healing (though China's manufacturing PMI, 49.6 shows contraction). Since October 2012, gold long positions at hedge funds have sunk from 200k to about 100k while YTD short positions like those for silver show a spike from about 4k to 75k. The contrarian play for PMs continues to strengthen.

Art Cashin is director of NYSE floor operations for UBS. He has 45 years experience and does an update daily with CNBC, "90 seconds with Art Cashin." He also mentioned the 20-consecutive Tuesday trend I noted recently. Cashin believes that May 28's market rise largely resulted when the chaotic market and fiscal situation in Japan calmed a bit. That is, rather than being intrinsic to our economy Tuesday's rise reflected foreign reactions to and assumptions about the extent of future QE. Similarly, the drop of the indices May 29 reflected transient stability in the devaluing yen (amid "unprecedented stimulus") and a USD slip. World markets have become a species of divination about Fed policy. It is like Homer's Greeks doing augury from the flight patterns of birds. This does not bode well.

One hundred and fifty gram gold bars are sold out in Singapore and people are bringing wheeled suitcases to carry away their purchases. This indicates the disjunction between paper markets that greatly impact miners in the short term and buying of physical metals, which will lift PM miners mid-long term. Tom Iacono recently discussed this as did several of my columns. This effect will be intensified by current cutbacks in PM miner capex for E & D and production, too. For example, First Majestic Silver recently cut its 2013 capex 16% though its 2013 production guidance remains c. 11.5 million oz Ag. I discussed the company here. Its revenues and profitability continue to rise.

For those who are new (last two months) to the PM sector, this is an excellent time to establish a position while still leaning carefully into the exuberant markets (it is hard to quibble with those who are banking gains at this point, or ready to do so soon, on a portion of equities). May 29 action in utilities (NYSEARCA:VPU), consumer staples (NYSEARCA:VDC) and high dividend ETFs (NYSEARCA:VYM) among others indicate future trends. Seeking to ride the apparently invincible indices, investors have been leaving utilities for several weeks. Soon the sector may be at levels that make its defensive and dividend-rich status appealing again.

I noted AG above: analyst updates include a "Buy" rating BofA-Merrill Lynch which comments "First Majestic is our Top Pick small cap producer for 2013." Cormark Securities maintains its "Buy" with a target price of $27.50 (AG was up 3.81% May 29 at $10.63). On February 27, Casimir Capital maintained its "Strong Buy" call. Raymond James on the same date rated AG as "outperform" and cited its "growth profile and low geopolitical risk." For perspective on the latter, consult the jurisdiction overview by the Fraser Institute. After the recent drops, analysts at still rate AG "Buy-Strong Buy" with a 12-month target of $20.60.

The mid-February drop of gold (NYSEARCA:IAU) below its long-term trend line to its oft-tested lows between $1550-1565/oz elicited my piece, "Don't Panic on Precious Metals." The bounce back to $1600, fall back to $1575 and slow rise to $1600 prompted me to write "Paint it Black: Buy Precious Metals." Like many others who follow the sector, I thought the bottom was in with the repeated testing and hold at the support area. Then the Goldman Sachs guidance April 10 and 16 brought a sudden plunge to $1350 and, after a sharp recovery (some would say dead-cat bounce) to $1475, the second plunge, this time to $1365 on May 16-17 amid capitulation selling of shares while buying of physical metal remains heavy. May 29 has seen a strong recovery in the PM sector, particularly among senior producers like ABX and Goldcorp (NYSE:GG) up 2.79% and 3.77% respectively at 3:16 EDT.

Those who have substantial funds in long-term bonds might take the recent drops in fixed income NAV to shift to short-term investment grade like Vanguard's ETF (NASDAQ:VCSH), cash and PM hard asset holdings like Sprott Physical Gold (NYSEARCA:PHYS), Silver (NYSEARCA:PSLV), or Sprott Physical Platinum & Palladium Trust. The Asian Gold Trust (NYSEARCA:AGOL), Swiss Gold Trust (NYSEARCA:SGOL) and Central Fund of Canada (NYSEMKT:CEF) are other choices. Ex-USD trading deals and CB acquisition of gold have become key features of global finance and economies.

The most profitable and still highest rated among the miners are streaming company Silver Wheaton (SLW) which is about 85% below its consensus price target (May 29 up 3.07%). In recent weeks, royalty company Franco Nevada (FNC) has performed best in the PM sector. There are many deep value plays. Among the majors, the best may be Barrick Gold (NYSE:ABX) which has a mountain of negativity priced into it, now yields a 4.2%, has consensus estimates 135% its current price and is likely to go ahead with its giant Pascua Lama project given Chilean additions to its management team as I discussed here. Raja Sekhar writing today on SA shares my view on the upside for ABX. In the mid-tier space there are many value choices: Kinross (NYSE:KGC), IAMGOLD (NYSE:IAG) and Eldorado Gold (NYSE:EGO) which I wrote about here. McEwen Mining continues to perform best among juniors and in Rob McEwen has skilled management personally invested in the company. He draws no salary, a notable point for those annoyed by levels of corporate compensation generally. IAG also has less than half the average level of executive compensation per their April 15 shareholder notice (pages 31-43).

By all means participate in the equities though the degree to which you do this depends on the amplitude of your nest egg and the sureness of your income. In any case, bank some gains in the current euphoria. Shorten the duration of your bond holdings and, for now underweight fixed income. The current bubble is leaking and you don't want to be there when it pops. One can buy back into fixed income after inflated prices have dropped and yields have risen. As I have written, you can get a hefty 8.3% yield from Vanguard Natural Resources, an oil and gas LLP and 10.5% from Sprott Resources (OTCPK:SCPZF) with its investments in agriculture (One Earth Farms, Stonegate Agricom), nutrients (Union Agriculture, Potash Ridge), and gold bullion.

Enjoy the moon shot in equities but be sure your parachute is in good order. Be careful with your bond allocation. There is a huge bubble here inflated by more than $7 trillion in debt the past five years and as several of us have written, there are other major bubbles (in short gold positions and, to a lesser extent, equity prices) that will make this year stormy. Having endured significant YTD decline and a double plunge to new lows, the PM sector again represents value in a sea of otherwise inflated prices.

Disclosure: I am long 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.

Additional disclosure: I own various PM companies via Tocqueville Gold and Gabelli Gold.