Sunday, April 15, 2012

"In those days he was wiser than he is now; he used to frequently take my advice." --Winston Churchill

REGARDLESS OF WHAT EQUITIES DO IN GENERAL, GOLD MINING SHARES ARE A COMPELLING BUY (April 15, 2012): I remain bearish toward global equities over the next several months, regardless of the fact that they will enjoy periodic upward bounces. We have likely transitioned to a severe bear market which could last until the end of 2014, and therefore I have a position in HDGE which I tend to increase each time it drops below 21 dollars per share. HDGE is the only actively-managed U.S. exchange-traded fund which holds pure equity short positions--usually about 45--and which currently has its expense ratio capped at 1.85%. The head of the management team, John Del Vecchio, has a track record of more than two decades in being able to do frequent trading to rebalance the conglomeration of short positions which are most appropriate at any given time. This fund outperformed nearly all other short-selling ideas when the stock market slumped during the summer of 2011, and is likely to once again be a winner during any major equity decline. The high ratio of insider selling to insider buying by top corporate executives during the first quarter of 2012 confirms that the primary direction for well-known equity indices including the S&P 500 will continue to be lower for another 2 or 2-1/2 years.

What has been overlooked, even by the few who understand the general bearish thesis, is that gold mining shares are unusually undervalued relative to the price of gold bullion. XAU is an index of gold mining shares which has been in existence since 1984. In 28 years, there have been only six days when the ratio of XAU to the price of spot gold was lower than it has been in recent trading days--with all of those six days occurring during October and November 2008. Therefore, gold mining shares are a compelling buy. Of course, whenever the stock market is especially weak, gold mining shares will suffer along with the overall downtrend, as we experienced in September and most of October 2008. However, gold mining shares have a proven track record of being able to dramatically outperform the overall equity market during periods when stocks in general are relatively flat or are rebounding.

Out of the universe of gold mining shares, junior producers are even cheaper than their senior cousins. Therefore, I have been progressively accumulating GDXJ, a fund of 85 small-cap gold mining companies. During the past several trading days, this fund has repeatedly fallen below 23 dollars per share, which has presented a compelling historic opportunity. I plan to continue to purchase more of it into weakness using a ladder of good-until-cancelled orders, as I do whenever I am establishing a position in any security. If you live in Canada and you don't have access to U.S. exchange-traded funds, ZJG which trades in Toronto is an approximate substitute, although it tends to be concentrated more in mid-cap rather than small-cap names, and it is not as diversified as GDXJ.

It is worth noting that bearish noises have been heard from several analysts who had been bullish toward gold for years, and who recently made comments of varying degrees of bearishness. These include Jim Rogers, Dennis Gartman, and Steve Sjuggerud. Once gold rallies strongly, one or more of the above might not admit that they had become gloomy, but their comments are on the internet for all to see today. Near any critical bottom for any asset, there will be some notable folks who had been bullish for a lengthy period of time and who can't bear continuing to lose money and to be ridiculed, and who will finally switch to the opposite side--just in time for their original viewpoint to be powerfully validated. This is analogous to the way in which investors inevitably make the greatest inflows into a particular asset class just before it collapses, such as the all-time record amount of money which poured into the stock market in February 2000. Similarly, during February-March 2009, investors worldwide made record withdrawals from equities just before the strongest two-year bull market since the Great Depression.

Gold mining shares will be assisted whenever the U.S. dollar is declining versus most major currencies, and when the stock market in general is rising, and U.S. Treasuries are retreating out of fear of rising inflation. However, none of these three is essential for gold mining shares to rally strongly during the next few months, because of their pervasive unpopularity and undervaluation.

In addition to gold mining shares, some other commodity-producer subsectors have become unusually undervalued, including coal mining shares and metals mining in general. The shares of steel manufacturers have been steadily declining since early February 2012. It is likely that the exchange-traded funds KOL, XME, and SLX, which represent the above industry groups respectively, will progressively become more attractive for purchase during the next several weeks.

Disclosure: I am currently long both GDXJ and HDGE, with most of the rest in cash and stable-value funds.