Gold Mining Stocks: Is this the Breakout

Sep. 11, 2011 11:29 PM ETGOLD
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Bob Kirtley's Blog
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Long/Short Equity, Precious Metals, Gold

Contributor Since 2006

Bob Kirtley has traded options and stocks since 1980. Bob Kirtley spent many years working on Oil projects including some in Alberta, such as the tar sands installations in Fort McMurray. He lived and worked in many different countries, as that is the nature of the construction business. Planning and cost control are key to a projects success and he tries to apply those disciplines on a daily basis when dealing with investments. His training in such areas as SWOT and Risk analysis can be applied from time to time. His qualifications include being chartered in the United Kingdom, which is similar to that of a Professional Engineer in Canada, along with a Masters Degree in Project Management from South Bank University, London, England. He has been working for a number of years on a full time basis representing a group of investors in England.

When this bull market in precious metals began the mining stocks outperformed the metals, at least for the first few years and they delivered some very nice returns to us all. The last few years they have performed poorly and not only have they not outperformed the metals, many stocks have failed to keep pace with gold and silver, So, are we now seeing a major sea change in the outlook for mining stocks?

We kick off with a quick look at the above chart where we can see that the long overdue breakout of the mining stocks has finally arrived with this move to 628.34 on the HUI Index. The HUI is the Gold BUGS Index and broadly represents a group of unhedged gold stocks. This breakout is significant as these stocks have been stuck in a sideways consolidation pattern for some time now as gold prices have outperformed in what has been an excellent summer so far. Also in support is the recent golden crossover, whereby the 50dma has crossed over the 200dma in an upward swinging movement. So we now expect the mining stocks to make some serious price gains and reward their patient investors. On the negative side we can also see that the three technical indicators shown, the RSI, the STO and the MACD are in the overbought zone at the moment, so we may see a breather, but don’t count on it.

Some of the fundamental issues to be considered are the recent moves by the Swiss to curtail the appreciation of the Franc, which makes it less appealing as a safe haven. There is also a dark shadow hanging over Greece which could default sooner rather than later as their fiscal situation becomes more perilous. If the Greeks do default and decide to walk away from the European Union and go it alone, a number of banks will be running to their governments for a bailout in order to plug the gap on their balance sheets caused by non payment by the Greeks. The solution would be to crank up the printing presses which will further debase the currency and increase the attractiveness of gold. Across the border we have Italy which is finally going to implement new austerity measures. It remains to be seen if the Italian public will be accepting of such measures or if they will take to the streets in via country wide demonstrations throwing their country into chaos too.

Lifting our heads and scanning the world in general, there a number of major events to note and look out for as they will give us a few clues as to what action or lack of it, will be taken in both Europe and the United States, regarding the economic and financial mess both are enduring.

In Europe, Germany has an important vote coming up on the 29th September regarding the continuing support for increased resources for the European Financial Stability Fund (EFSF) to fight the debt crisis. There exists a prior agreement between the Eurocrats to increase their financial fire power which includes a second bailout package for Greece. This move will see Germany’s share of EFSF loan guarantees rise to €211bn euros or approximately US$305bn from €123bn previously. When we put this vote into a context of Angela Merkel’s waning popularity, as evidenced via the recent regional election failures and a slowing German economy, those responsible for backing this scheme will be doing so with much trepidation. A ‘no’ vote could well be a game changer for the Eurocrats.

Prior to the above event we have two days of the Federal Reserve Board, Ben Bernanke and his team, meeting to discuss the state of play in the United States. The world eagerly awaits the outcome of this meeting as to whether there will be more or less fiscal stimulus. Ben Bernanke has already trailed that there are ‘measures’ at his disposal and so the investment community will be watching to see if he can indeed pull a rabbit out of his federal hat. If we get more stimulus then the general market participants may cheer the move for a day or two, however, that means more debasement of the dollar and gold prices will be spurred on once again. If there is no change to the status quo then the stock market will plunge, which as previous actions have shown, is not desirous by the Federal Reserve as they see it as a reflection of how well the economy is doing. Note how the language has changed as we go along, the green shoots of recovery don’t warrant a mention these days having been replaced with such phrases as a ‘jobless’ recovery. Will quantitative easing being mentioned, maybe not, we could be in for a whole new set of phrases which could stall us for awhile, until we work out that its inflation in drag. There’s an old adage that a week is a long time in politics, so don’t be surprised if a black swan event pops up from left field to throw a spanner into the works resulting in yet more volatility, before we get to these meetings.

While we are on the subject of officialdom, isn’t it rather sad that we find ourselves in a situation where politicians now occupy center stage. Its akin to a touch line judge being the star of a sporting event, we really don’t want to see them or hear them. We want our performers to be under the spotlight for the right reasons. Bring on smaller government.

All of the above, although bad for the economy at large bodes well for gold. However, there a number of negative factors that may well impede golds progress. Firstly the US Dollar has started to rebound and is still considered by some to be a safe haven during times of economic and financial stress. The dollars progress may attract the investment cash that was heading towards gold, it will be interesting to see if both can rise at the same time. Another negative that springs to mind is the need for cash as those who are heavily leveraged face margin calls. When this happens anything and everything gets sold in order to raise cash, regardless of its value. We have also mentioned volatility a number of times in our articles and it should not be underestimated, as extreme volatility will will put pressure on investors to sell their holdings as the emotional stress mounts up on them.

Finally our strategy remains intact as it has been since this bull market in gold began. The purchase, outright, of physical gold to be retained in your very own hands is still the top priority. A small selection of quality miners that you are capable of getting to know very well indeed is still the next priority. However, the future in our very humble opinion, for the gold producers is now looking brighter as each day goes by. Those of you who have read our previous articles will be aware that we have in third place the use of a few well thought option trades. This strategy has worked out well for us, but each to their own. You must find your own balance on this bull, one that you are comfortable with. However, we will leave you to ponder this: If gold prices continue to make good progress and the gold producing companies regain their leverage to gold and outperform gold, what would that do to the Call Options on these very same stocks?

Just a thought

Stay on your toes, volatility will be the order of the day and have a good one

Disclaimer: or SK Options Trading makes no guarantee or warranty on the accuracy or completeness of the data provided. Nothing contained herein is intended or shall be deemed to be investment advice, implied or otherwise. This letter represents our views and replicates trades that we are making but nothing more than that. Always consult your registered adviser to assist you with your investments. We accept no liability for any loss arising from the use of the data contained on this letter. Options contain a high level or risk that may result in the loss of part or all invested capital and therefore are suitable for experienced and professional investors and traders only. Past performance is not a guide nor guarantee of future success.

Disclosure: I am long GLD, SLV.

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