Thursday, December 20, 2012

"The fishermen know that the sea is dangerous and the storm terrible, but they have never found these dangers sufficient reason for remaining ashore." --Vincent van Gogh


GOLD MINING SHARES ARE THE LAST GREAT BARGAIN OF 2012 (December 20, 2012): Since November 16, 2012, nearly all cyclical equities have been rallying strongly, even those which had slumped to their lowest levels since the summer of 2009. There is one important exception: gold mining shares, which today traded at their lowest prices since August 15, 2012 and which have been in downtrends for more than three months. Funds of such shares including GDX, GDXJ, and GLDX have been among the weakest equity subsectors in recent weeks. Of the above, GDXJ is my favorite one: it is a fund of 80 junior gold producers which had bottomed at 17.37 on May 16, 2012 and which traded as low as 19.85 late this morning. Many investors have sold these shares primarily out of disappointment with their performance, which is almost always the best time to buy anything especially whenever it has been in an extended downtrend.

The most important factors impacting the prices of gold mining shares of course include the prices of gold and silver which have been notably depressed. However, another critical element is the U.S. dollar which has a strong inverse correlation with the yellow metal and its shares. The U.S. dollar index earlier this week dropped to its lowest point in three months. Meanwhile, the S&P 500 and other funds of commodity producers have been climbing energetically in recent weeks; these have a long-term positive interrelationship with gold mining shares. Thus, GDXJ is not only undervalued in an absolute sense, but it has fallen far out of line with its peer group. As it inevitably catches up, it will likely end up gaining about twice as much in percentage terms as many of my other favorite cyclical equity funds which are listed below and which I have discussed in detail in previous postings (visible below) during the past several months.

In early 2008, many investors believed foolishly that outperforming emerging markets including Brazil and Russia could continue to rally while U.S. equities retreated. This "decoupling" theory proved to be nonsense; eventually, the above markets plummeted far more than the S&P 500 in order to correct proportionately for their temporary outperformance. In August-September 2011, many others thought that gold mining shares could keep climbing while other equities slumped. This also proved to be spectacularly wrong. Those who believe that there is a logical "reason" for gold mining shares to act differently from other shares of commodity producers aren't properly respecting the historical record. I wouldn't sell shares of coal mining companies and similar assets which could gain 20%-30% during the next several months, but I think that gold mining shares will end up rising by 40%-50% in order to compensate for their recent lagging behavior.

Disclosure: Since May 2012 I have been progressively accumulating long positions in funds of commodity producers into pullbacks and especially whenever they are forming higher lows. From my largest to my smallest position, I own GDXJ, VFWPX, KOL, XME, EWZ, REMX, SLX, VEMPX, VINIX, RERGX, RSX, TNRPX, VGPMX, TRIEX, FCG, TRSPX, ACTIX, TAN, GDX, and NLR.