NOW THAT PRECIOUS METALS HAVE MADE A DOWNSIDE BREAKOUT, BUY THE SHARES OF THEIR PRODUCERS (October 31, 2014): If you go to any financial web site, you will find one or more articles about how gold and silver have made downside breakouts and will continue lower until they have plummeted to incredibly low prices such as one thousand U.S. dollars per troy ounce for gold or even lower targets. You'll discover plenty of analyses explaining why deflation is a serious global risk, and how the U.S. dollar will continue to climb because the U.S. has allegedly favorable interest rates and growth prospects when compared with the rest of the world. You'll see cable TV commentators telling you why the U.S. stock market will keep rallying for several more years, and why the U.S. economy will outperform nearly all other countries including emerging markets. You'll receive plenty of literature from mutual fund companies detailing why bond funds are a useful diversification for your stock funds, so you will have a pleasantly balanced portfolio of both.Naturally, all of the above theories are nonsense, because they assume that multi-year extremes are completely rational and will become even more extreme in upcoming years. It's certainly the case that extremes can go to greater extremes, and they often do in the short run, but eventually everything regresses toward fair value. If something is especially overvalued, it will almost always slump to an equal and nearly opposite point of undervaluation. Buying something which is close to its all-time peak is very dangerous, because you're assuming that there will be an even less knowledgeable person who will be willing to pay even more for something which is already ridiculously overpriced. You might get away with this for awhile, but eventually you'll lose money. You should instead be eager to purchase assets which are trading close to their lowest levels in several years primarily because they're unpopular and continue to receive persistently negative media coverage. A blend of stocks and bonds is not necessarily safe if both are near historic tops, since they have periodically declined in tandem in past decades.
Many funds of commodity producers and emerging markets recently slumped to their lowest points in more than five years. If you look at charts of several of these, including EWZ, RSX, KOL, and FCG, you will see that all of the above have recovered from deep bottoms which had been achieved earlier in October 2014. They are still compelling bargains in most cases, but there is one subsector which just today slumped to a six-year nadir. These are the shares of gold and silver mining companies, along with their funds including GDXJ, GDX, SIL, GLDX, and SILJ. Obsessed with the idea of a perpetually rising U.S. dollar, pervasive worldwide deflation, and similar popular concepts which will all be proven to be transient conditions, investors have abandoned the equity group which will likely deliver the greatest percentage gains between now and late 2015 or early 2016.
It is emotionally difficult for many investors to purchase "falling knives," because they hear, read, or see a flurry of negative commentary about such assets on a daily basis, and become subconsciously brainwashed into believing that it must be true. It was just as easy to be convinced 3-1/2 years ago that inflation would continue to accelerate worldwide, and that emerging markets would continue to outpace developed markets. The current myths will prove to be just as wrong as the opposite beliefs had been in April 2011. As any trend becomes especially extended, more and more people become convinced that it will continue indefinitely, until almost everyone is certain that something must be true just before it is dramatically proven to be false. Everyone "knew" in early 2009 that stock markets around the world would probably "never" recover, and if they did it would allegedly take many years for a moderate rebound. Today, everyone is certain that the U.S. stock market will climb for many more years, mainly because it is difficult to envision the next few years being meaningfully different from the last few years. As humans, one of the biggest mistakes we make in life, with investing and everything else, is to project the recent past into the indefinite future.
There have never been more intense outflows from several funds of assets related to precious metals in their entire history. In December 2013, the total outflows were greater from some of these funds, but they occurred over a more extended period of trading days, and of course the bargains available at that time were also compelling. Other than that, you have to go all the way back to the summer of 1976 to find a similar period in which these were highly disliked for similar reasons: they were slumping at the same time that the overall U.S. stock market was rallying. Investors dislike owning losing assets, but they hate even more to own losing assets when other securities are approaching or setting new all-time highs. This drives an emotional desire to own the winners, no matter how dangerous they are, and to discard the losers usually just before they enjoy especially powerful rebounds.
Gold and silver mining shares appear to be a Halloween trick. They are actually an unexpected treat--buy them.
Disclosure: In August-September 2013, and again during the first ten months of 2014, I have been aggressively buying the shares of emerging-market country funds whenever they appeared to be most undervalued. Since June 2013, I have added periodically to funds of mining shares and related assets especially following their most extended pullbacks. Starting in December 2013 I have been buying HDGE whenever it has traded below 13 dollars per share, and more recently whenever it has retreated below 12, with the idea of selling it in 2016-2017 as we are completing the next U.S. equity bear-market bottoming pattern; HDGE is an actively managed fund which sells short various U.S. equities. From my largest to my smallest position, I currently own GDXJ, KOL, XME, HDGE, GDX, SIL, COPX, REMX, EWZ, RSX, IDX, GXG, ECH, GLDX, URA, VGPMX, BGEIX, VNM, ZJG (Toronto), PLTM, EPU, TUR, SILJ, SOIL, EPHE, and THD. In the late spring of 2014, I sold all of my SCIF which had briefly become my fourth-largest holding, because euphoria over the Indian election was irrationally overdone and this fund had more than doubled; since then, SCIF has been one of the biggest losers of all emerging-market funds. I have reduced my total cash position since June 2013 to approximately one twelfth of my total liquid net worth in order to increase my holdings in the above assets. I have now sold all of my SLX by acting whenever steel insiders were doing likewise. I expect the S&P 500 to eventually lose about two thirds of its 2014 peak value--with most of that decline occurring from some point around the middle of 2015 through late 2016 or early 2017. The Russell 2000 Index barely achieved a new all-time top on July 1, 2014 compared with its early March 2014 highs, while the S&P 500 did so numerous times over the same four-month period. The Russell Micro-cap Index has been even weaker since it completed a historic top on March 6, 2014. This marked a classic negative divergence which previously occurred in years including 1928-1929, 1972-1973, and 2007. Those who have "forgotten" or never learned the lessons of past bear markets are doomed to repeat their mistakes.
