Capital Will Flow From Tech Stocks To Gold And Silver Miners

by: Simit Patel

The thesis of this post is that we are in the early stages of a flow in capital out of technology stocks and into resource stocks, and I suspect this will play a critical role in setting off the mania in gold junior exploration stocks that is widely anticipated by many gold bugs.

Let's look at the evidence to support this:

1. Bubble 2.0 is popping. As I've noted in my latest article on Bubble 2.0, I believe the bubble that has been brewing in social media companies is now in the process of popping. Sarbanes-Oxley and other regulation has made it more difficult to go public in the U.S. The primary result of this is that the bubble is confined to private equity markets, and the public markets is where early investors and Goldman Sachs (NYSE:GS) unload them. Groupon's (NASDAQ:GRPN) accounting problems and insiders exiting Zynga (NASDAQ:ZNGA) are the kind of news stories we would expect to hear when the bubble is getting ready to pop. I believe a short pop after Facebook's IPO could be the point where capital really starts to rush out of these new IPOs. Facebook (NASDAQ:FB) is the mother ship of Bubble 2.0, and after the initial pop, I suspect there will be a massive wave of selling. Where will all the capital go next? I would suspect to something that is currently very cheap.

2. High P/E ratios. Tech stocks also have very high P/E ratios. Amazon (NASDAQ:AMZN) in particular draws a lot of attention for its P/E ratio, which currently tops 190. I am of the opinion that the market is awarding these stocks such high valuations not only because of anticipated earnings growth, but also because of anticipated stability. This is particularly true for Amazon, a notoriously low-margin - but extremely stable - business. It is critical for stock market investors to understand the weakness in the Treasury bond market, which yields nothing while the country's national debt is over $15.6 trillion - and counting. This is a recipe for capital going out of bonds and into stable stocks that can survive in a world with no savings and high unemployment. Amazon's loyal customer base, multiple large revenue streams, and tangible assets related to packing and shipping are why the company has such a high P/E ratio, and perhaps, if we indulge a desire for paradox, we can say Amazon's acclimation to low margins makes the company a strong candidate for survival and thus enable it to sustain an above average P/E.

I suspect P/E ratios as a whole in the technology sector will decline as capital coming from the bond market see tech stocks as stretched to the upside and would prefer to look to dividends for long-term safety and income they previously secured via bonds with yields.

3. Resource stocks cheapest in years. The rapid price acceleration we've seen in tech stocks over the past few years is in stark contrast to where resource stocks have gone over the past few years. Gold stocks are the cheapest they've been in years. Barrick Gold (NYSE:ABX), for instance, is the world's largest gold producer, with earnings and dividends growth, yet it has a P/E of under 10. The situation reminds me of a quote I heard from James Dines in one of his presentations: In the short-term the markets are a voting mechanism, but over the long-term they are a balancing mechanism. Eventually, the profits in tech stocks on open positions will need to be closed, and the hedge funds will need to move to their next opportunity. As gold miners increase dividends and as capital rushes out of bonds due to the $7.6 trillion in bond coupon payments coming due, the stage is set for capital to flow into the resource sector.

For those interested in trading this capital flow, I think Apple (NASDAQ:AAPL), (NYSE:CRM), Netflix (NASDAQ:NFLX), LinkedIn (LNKD) and Pandora (NYSE:P) are ideal short candidates, while Goldcorp (NYSE:GG), AuRico (NYSE:AUQ) and McEwen Mining (NYSE:MUX) are good long candidates. Alternatively, a more mathematical way of playing this is to simply short technology stocks with high P/E ratios and buy precious metals miners with low P/E ratios. For instance, Rackspace (OTCPK:RACK) and LinkedIn have P/E ratios over 100, while Zynga and Groupon are reporting losses; a short position in these stocks could be paired with a long position in Hecla Mining (NYSE:HL) and AngloGold Ashanti (NYSE:AU) - precious metals miners with P/E ratios under 10, positive earnings and regular dividends.

While I regard gold and silver miners as being the primary beneficiaries of the coming flow of capital out of the technology sector because of the sovereign debt crisis that puts an especially high premium on monetary assets unexposed to debt, I do think more aggressive funds that want exceptional growth opportunities will look at base metal miners, uranium miners and natural gas/oil drillers as well, as they are all in the basic business of digging stuff up out of the ground. They are a natural complement to gold and silver miners and make for an easy sales pitch to investors that have already expressed an interest in precious metals miners.

Disclosure: I am long GG, MUX, ABX, AUQ, GDX.