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Unless you’ve been in Tweedledee Land, or you prepare budgets for the Government for a living, you will know that the price of virtually every commodity, be it animal, vegetable or mineral, has risen dramatically since the turn of the century. This boom has two key drivers. The most obvious is the huge rise in demand for raw materials, largely from the Far East, without a corresponding increase in supply.
The other is less widely recognised – inflation. The definition of inflation, according to the Oxford or Webster’s English Dictionary from 1983, is “an increase in the amount of currency in circulation, resulting in a relatively sharp and sudden fall in its value and rise in prices”. But over the past 20 years or so, people’s understanding of the word inflation has changed. The 2007 OED defines inflation as “a general increase in prices and fall in the purchasing value of money”. This change is in no small part due to the fact that governments have massaged inflation figures lower using measures like the consumer price index (CPI) or by only counting ‘core’ measures of inflation, which ignore food and fuel prices. But the old definition is still the best. If you increase ‘the amount of currency in circulation’, or the supply of money – in other words, you issue more money, but don’t increase the supply of goods – the price of those goods will, sooner or later, go up. Similarly, if you inflate the supply of goods – that is, increase productivity – as we have seen with computers, DVD players and other electronic products, the price of those goods is going to fall.
At the moment, 19 of the top 20 economies in the world have double-digit money-supply growth, with Putin’s Russia in pole position. Russia’s money supply is growing at a whopping 43.7%, India’s at 20.2%, China’s at 17.1%, Australia’s at 16.6%, while the UK slips in at 13.1%. The US meanwhile has stopped reporting its M3 money-supply figures, deeming it too expensive a job – they do have wars in Iraq to pay for after all, so they must offset this spending somewhere. But John Williams at Shadowstats.com generously does it for free. He puts US M3 money-supply growth at 14%. It doesn’t matter whether you call this frightening phenomenon ‘money-supply growth’, or plain old ‘inflation’. It doesn’t matter how many indices you re-jig, or figures you fudge to hide it. It doesn’t matter how little people understand it, or how well you manage ‘inflation expectations’. It’s still there. And it will keep driving prices higher.
This ‘inflation tax’, as US libertarian politician Ron Paul calls it, erodes the value of your savings – even in these post-Northern Rock days, you certainly won’t find a savings account paying 14%. The only winners in the inflation game are long-term borrowers who have fixed their debt at cheap rates, and those who hold hard assets – or commodities. In short, you want to be out of money and in things. Now, anyone who’s interested in finance knows about the industrial revolution in the Far East, which is part of the reason why energy and base metals – the commodities driven by this phenomenon – have all hit all-time highs in the past year or so. But not everybody knows about inflation. When they do, the commodities whose main use is to store and protect wealth will go the same way as the base metals. I’m talking, of course, about the monetary metals, gold and silver. These are the only two metals that have not reached their all-time highs, set in 1980. There’s an old Wall Street saying that you should have 10% of your wealth in gold and hope it doesn’t go up.
I have bad news – it is going to go up. Silver is still a whopping 80% off its all-time high of $50, and despite the recent run-up, gold is still cheap in inflation-adjusted terms. Imagine where the price will be if gold and silver follow nickel or zinc.
Now here is the problem. I am a terrible bottom-fisher – by that I mean I do it a lot, not that I’m bad at it. The market is a lot more forgiving to those who attempt to find bottoms, buy cheap, look for value – whatever you want to call it – than to those who buy after the market has made its move. The time to buy gold and silver, as in most years, was August. Since then gold is up some 20% and the HUI (the index of gold mining stocks) is up a whopping 45%. The market is wildly overbought and entering short-term bubble territory. Now would not appear to be a good entry point. Seasonally, October is not normally a good month for gold, though an October low can be a good month to buy gold (as the chart below shows). But we didn’t get the usual October correction this year.
Will it come in November? Who knows? However, the cautious angel in me thinks we are going to get a pullback. This is based on no fundamentals whatsoever, which are all in favour of higher gold prices. It’s just that the dollar is due a bounce and gold a breather. So what I’m saying is: long-term higher, medium-term higher, short-term possibly lower, but don’t count on it. The solution is to ‘pound-cost average’ into this market, probably on a weekly basis. The other piece of good news is that despite what gold and the major miners have done, the juniors are only just starting to get going. Let’s take a look at the very clear pattern of the HUI since this bull market began (see chart below).
It tends to have year-or-so periods of sideways consolidation before bursting up. Each burst-up seems to last six to nine months, with the HUI rising roughly 150%. We are just over two months into this move and are up about 40%. If past performance is anything to go by (and if you read a lot of disclaimers, you’ll know it isn’t), we have at least another four months to go with an upside target price somewhere in the 700s. For what little it’s worth, I think we may see $1,000 gold by the spring, and $22 silver – possibly even $25. If we get that high by then, then sell, sell, sell. Since August, as is fairly typical, we have seen a big move in gold and in the XAU (the index of the major gold miners), but the junior miners and silver have lagged. Many investors are frustrated by this. There is nothing more annoying – except possibly dealing with the council, traffic wardens, congestion charge, VAT, unsolicited phone calls after 6pm and Gordon Brown – than owning a quality junior that has barely moved in price, while gold has risen by some 20%.
What has happened before – and I see no reason why it can’t happen again – is a pyschological pattern that goes like this. Many have been on the sidelines watching this move in gold (one reason why you should always keep a core position). They have been burnt by gold’s volatility before, so are reluctant to get back in. Gold keeps rising but nobody ‘believes the move’. Finally, people start to. They’re now waiting for a pullback to get an entry, but it doesn’t come. Meanwhile, they and those that are already taking profits start hunting for bargains. Before long, the smarter money finds some quality junior producers – a much smaller market and therefore more volatile – and buys those. It is also noted that silver has lagged gold and so money flows into silver. Gradually, the junior producers begin to move, as does silver.
The trend followers jump on board, more money enters the market and these fly. Braver speculators move on to the explorers. These are the last to move, but they fly the highest. The juniors, the explorers and silver will make much bigger moves than gold; they’ll make those moves quicker, but later in the bull run. When this phase comes, you have to make sure you are already positioned and, what’s more, have a clear exit strategy in place. The market will eventually turn back the other way and you don’t want to be too burnt when it does. Unless, that is, you are planning to just buy and hold for the duration of this bull market – a noble and highly effective strategy. I believe this cycle which began in August will continue to move up until the spring.
I believe many investors now ‘believe the move’ and are ‘waiting for a pullback’, while silver and the juniors look like they’re starting to take off. In fact, one of the juniors I had been planning to tip, Capital Gold, leapt up 25% last week, which is rather inconsiderate of it. It could have done the right thing and waited. If you don’t have a position yet and you fear you may have missed the move, all is not lost. Below I have tipped some other quality miners untainted by expensive price tags. If my theory is right, these will move later in the cycle, so that, even if we do not get the short-term pullback I am expecting, indeed hoping for, you will not miss out on this run.
How long is the bull market going to go on for? All the way to 2012? 2015? How do we know when the top is? Good questions. Well, one person caught the market beautifully. The best indicator of a top I can think of is when Gordon Brown buys. That’ll be the time to get out. Don’t worry, though, he’ll tell the market he’s buying beforehand. You’ll have plenty of warning to sell.
Junior mining companies that have shown promise
Before you decide to invest in junior mining companies, it’s important to note a few rules. Firstly, juniors are extremely volatile. Don't chase them up. Be patient. Let the price come to you. If it doesn’t, don’t worry. There will always be another trade. Don't be scared to sell at a profit. Secondly, I only buy where I have met the management or seen them present. And finally, I only ever buy when I like the chart set-up.
The gold stocks to watch
Peak Gold (CA:PIK). Imagine a football team with Pele and Dalglish up front, Maradona on the left, Cruyff on the right and Beckenbauer at the back. That’s kind of what you’ve got with this management team: Frank Giustra, Ian Telfer, Julio Carvalho, Robert MD Cross, Gordon Keep and Pierre Lasonde. This is the nucleus of the side that brought you Wheaton River, Canada’s eighth-largest gold producer. With producing mines bought from Goldcorp, this is a buy at below C$0.70c.
Capital Gold (US:CGLD) made its first gold pour in the summer, then massively increased its reserves. This is a hugely underappreciated, well-managed, well-run Mexican-based miner with exploration and even takeover upside, which is producing at below US$300 an ounce. Buy below US$0.48 if you can, but it looks like it may already have broken out.
Gold Resource Corporation (US:GORO). One of my favourite companies. The only problem is it’s not looking cheap. But it is run by an excellent father, brother and son partnership in Bill, David and Jason Reid, has great properties in Mexico that produce consistently good drilling results and it could be moving into production by 2008. In short, it has loads of further upside potential, even without a move in the gold price. Put it on the watch list and buy if it moves back below US$3.50
Jinshan (CA:JIN) is now moving into production in China. A buy at C$2, or just above, if you can get it, on a correction.
I don’t usually like tipping Aim stocks, mainly because they tend to be illiquid and spreads are incredibly wide, but the following two stocks are worth a look.
Leyshon (AU/AIM:LRL) is another China gold play, which is not as far down the road as Jinshan, as it’s still at the exploration / development stage. But it has good management (and an excellent presenter/promoter) in Paul Atherley. A buy at 24p or below.
My other Aim tip is Kefi (UK:KEFI), which is exploring for gold in Turkey. If anyone can strike gold and build a mine, managing director and experienced geologist Jeffrey Rayner will. A buy at 3p – but only put in money you can afford to lose. If you are comfortable with the riskier end of what is already a risky sector, then sister firm EMED (EMED) is also worth a look.
Silver stocks to watch
Excellon Resources (CA:EXN). This cleverly financed silver producer in Mexico is growing through exploration, with innovative management. I like it. Unfortunately, the chart (left) looks like it’s broken out through long-term resistance at $1.50 and is no longer cheap. Buy below $1.40, if you can, on a pullback.
First Majestic (CA:FR). Another silver producer-explorer from Mexico with Keith Neumeyer (who also founded African-based miner First Quantum) in charge. Its share price has underperformed, and is highly volatile, but has a lot of upside potential. Keith is highly ambitious and could turn this company into a major. It’s a buy below $4.00 – but not a good stock to hold if you suffer from heart trouble.
Great Panther (CA:GPR). Another Mexican silver play which has been sold down aggressively. I’m almost reluctant to recommend this stock, because it has so underperformed, and it’s out of favour, but at $1.25 or below, it’s got to be a buy.
Aquiline (CA:AQI). This group’s Navidad project is one of the biggest undeveloped silver deposits in the world. Buy if it pulls back below $9.
Dominic Frisby is a private investor who concentrates on junior mining and energy stocks. He presents the internet radio show Commodity Watch Radio, which is run in association with Minesite.
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