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Where were are
The new realities
of the precious metal markets are inescapably obvious. In the classic -
three legs up, two legs down - bull market pattern, we are undoubtedly in the
second "institutional" or "big money" stage. For
Elliott Wave fans this would be the 'C' wave, characterized as the longest
with a potential break mid-way. Regardless of your
interpretation, the evidence suggests that big money is moving into this
space in earnest. One could argue that the breakdown in the second half
of 2008 threw a monkey wrench into this theory. Indeed, it was a rather
painful event for most investors, but in technical terms it did not look all
that bad as evidenced here.
If anything, it helped anchor the previous move from $253 to $1000.
We're not chart experts and are only using this to establish a base for the
points we really want to make.
If you're still
questioning the main premise of this article, we'll briefly remind you that
the likes of John Paulson, Paul Tudor Jones, David Einhorn and a host of lesser known money
managers have recently joined the party as has been amply discussed by
others. The purpose of this missive is to shed some light into what it
might mean to you, the "average investor" and if there are angles
to be exploited in that regard.
We also have to
mention the blockbuster purchase of 200 metric tonnes of gold by India's Central Bank from the IMF.
With that deal in the books there should be no doubt in anyone's mind that
gold and silver are hitting the mainstream.
What does it mean?
Assuming that is
the case, the logical question to ponder is: what does it mean? In
other words: how will this fundamental factor impact the market, how will it
manifest itself in the share price of mining companies, and how can you and I
get in on the action? During this stage, we envision the emergence of
two major developments that should be of interest you.
1) These
early and prominent leaders into precious metals will be imitated and
followed by their less bold or, if you prefer, more conservative peers.
That goes for both fund managers and central banks. In that light, if
there ever was a time to follow the trend/money, this would be it.
We're in the early stages of acceptance of gold (to be followed by silver) by
the establishment as a legitimate investment instrument. These are not
yet panic days, but naming gold as an investment choice won't raise eye-brows
at cocktail parties going forward. You might still get some show of
bewilderment, though not far beyond this coming Christmas season.
Better yet, it might buy you a few nods of approval on this stretch.
Certainly, you won't be instantly discarded as a screw-loose maverick, as was
the case only a couple of years ago.
Further into 2010
and beyond, it is likely to become fashionable and perhaps understood that
anyone with any sense of the market "has to have SOME gold"; and if
you don't, your fellow fund managers will send you condescending looks as if
to say "Don't you know everyone is in on the gold game?". But
everyone won't be, it will take time for a lot of newly converted believers
to move into gold space and, more importantly, there isn't enough capacity
in the sector to accommodate any significant influx of money. The
thing to note here is that many funds that never had any exposure to precious
metals or commodities will enter this space for lack of better alternatives,
at least with a portion of their portfolios.
2) Expect
substantial growth in assets under management of the better established
precious metal funds, due to inflow of new funds from various sources,
including funds operating in other sectors. Another reason will be the
rise in share prices of precious metal fund holdings, which will suddenly
make them viable competitors for investment dollars with their peers.
For instance, a Vanguard Gold Fund would evolve from an obscure specialty
fund with comparatively measly assets under management into, at first, a
solid and sizeable fund, and later, a top performer and flagship within the
group. This should happen across the board and around the globe.
Since success breeds success, it should be followed by increased percentage
allocation of investment portfolios to the best performing funds.
Remember Fidelity's
Magellan fund getting so big it had to close
doors to new investors? We expect things to play out in that
direction. Not right away, but somewhere on the horizon, in the mania
stage.
What is a poor
fund manager to do?
Imagine you are a
fund manager in some non-hard asset sector: bonds, financials, healthcare,
tech, etc. Through some soul-searching and head-scratching (and some
kicking and screaming) you arrive at the idea that you have to move into hard
assets. Trouble is, you have no clue where to begin and how to value
resource stocks. Short of hiring a mining analyst, who will be hard to
come by for a while, and seeking outside help, these are the main options we
see available to ‘do it yourself’ money managers:
a) The
first thing you do is look at the ETFs and other
similar vehicles that provide exposure to the sector without having to deal
with the nitty-gritty picking stocks. But the space is crowded;
b) Then you
look at the indexes and drill down to the blue chips. That's nice, yet
you soon discover that valuations are defying gravity;
c) Next,
you check the top holdings of the best precious metals you can find and move
into them;
d) Do your
due diligence and try to make your own picks, but that is a whole lot of work.
This is where
things get interesting, so let us set the stage. In the diagram
below we tried to identify the dominant money flow trends and highlighted
them in shades of green based on where each group of investors is likely to
direct the majority of their investment capital (yes, every player in the
space will be at once the recipient and allocator of capital). We intentionally
downplayed the impact of retail investors at this time, as their day in the
spotlight is yet to come during the final blow-off stage of this bull market.
How to play it
One of the
biggest investment themes of the past decade has been the China
play. Everyone knew there was an opportunity there, but finding a way
to bet on it without excessive risk was difficult. Eventually it
evolved into a "Buy what China
buys" strategy. Taking a page from that book, we think a similar
approach can be applied here: one should buy what the best investors are
buying in the precious metals sector. When we say "best" we
don't mean in absolute returns, but rather, those best equipped to identify
the most attractive opportunities.
As you can see,
we believe the main beneficiaries from money flow trends will be the mid-tier
companies; those with established resources and production. This group
should be the main focus of precious metal/resource funds and at the same
time, become a takeover target for the majors. The acquisition of
Canplats by Goldcorp, is a good example of what we're talking about.
The main criteria
that may be helpful in spotting these companies are:
- Established
resources in the ground. Some of the hard and fast numbers to help
sort companies are 5+ million ounce gold or 100+ million ounce of silver
deposits will be picked off first, however all ounces are not created equal
and other considerations apply in the selection of potential takeover targets.
- Production
profile. Ultimately, production is the goal for majors, so the
closer the project is to production, the more attractive it becomes. We
would be looking at companies producing 200,000+ oz of gold with 15+ year
mine life.
- Market
capitalization. Another filter investors can use when
looking at these stocks is market capitalization. Mid-tier companies,
depending on various factors and development stage, will usually sport market
caps of $200-300 Million at the lower end for explorers, to $1-2 Billion at
the higher end for producers. Certainly, these are not all-encompassing
brackets, but by and large the companies discussed above will fair somewhere
in that range.
Most likely, all
three prerequisites listed above will be true for a good takeover
candidate. There are many other considerations which may be important
in each specific case – such as grade, project economics,
infrastructure, access to water, power and workforce, geopolitical concerns
in the country where the assets are, and so on. But we are trying to
keep it simple.
We certainly
don’t mean to imply that companies elsewhere in the spectrum will not
perform well or should not be considered. On the contrary, rising tide
will lift all boats without holes in them. Speaking of holes, this is
an industry where one drill hole can change the fortunes of all but the
largest companies on any given day. So, by all means, entertain all
options. That said, this market has gone institutional and the trend is
your friend.
Sean Rakhimov
Editor, www.silverstrategies.com/
Also
by Sean Rakhimov
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