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Where's The Beef?

Remember that Wendy's television commercial from the 1970's? I sure do. Still laugh whenever I think about that gruff elderly lady spouting out that tune. It never hurts to incorporate a little humor into a more serious topic. The message being conveyed in the above as it pertains to the precious metals market presently is aimed at value, and where to find it, as we certainly have already had quite a run in the precious metals stocks (PM's). In fact, the Amex Gold Bugs Index (HUI), which is an index comprised of primarily un-hedged PM's has produced an astounding 400% gain in just under three years. (See Figure 1)

Figure 1

Now that's got to qualify as a great ride in just about anybody's books, and the good part of it is over the long-term, the party is just getting started. And, for those of you who have been invested since 2000 your perspective must be one of "job well done" at present, and confidence you have made some good decisions a few years back. But, for those who are not invested in the PM's at present, want to get in, and at the same time feel a little gun shy, I don't blame you as we are talking about one volatile sector here. What to do? Well, I'll see if I can't help you out with that proposition.

First and foremost, the best thing you can do is educate yourself. No big news there I'm sure; however, this process can be long and arduous and I am not here to take you through the "Full Monty" today. In fact, I'm going to pick up the beat here a tad, so I hope you can follow along, and consider this a 'building block' in your learning foundation.

There's one basic rule to successful investing I have learned and adhere to adamantly, 'buy low and sell high.' No kidding right? Wrong! As most people who invest in any market never make a penny. Why? Because of a multitude of reasons, but the basic answer is the emotional battles investors encounter throughout the process involving greed and fear. For most, it's a lot easier to buy an investment when it's already moving, perhaps after making some significant gains. This is generally the wrong time and circumstance to invest under, as when this occurs, even if only in a relatively limited degree, too many others have gone before you.

Something, which is much harder, but better to do from an investment standpoint, is buy when others don't want what they have, and are willing to give it to you "on the cheap." Assuming the underpinnings of what you are looking at buying are sound, and in very basic terms, this is called value investing. It is also often referred to as contrarian investing, and it is an area which I have done much work in lately, as it involves the PM's. The attached is an example of this approach, and I believe it deserves a revisit and update.

If you have taken the time to review the above, it should be very obvious that I fully endorse value investing as a cornerstone within the foundation of sound investment principles. Moreover, it would not be unreasonable to say that truly sophisticated investor places the highest degree of importance on the precepts involved in value investing, as to be a successful investor, one must always strive to identify those opportunities that offer excellent capital appreciation potential, while attempting to minimize risk. In other words, buying relatively low priced value opportunities to sell to someone else once it morphs into an expensive momentum play is always a good idea, and hopefully the ones I will discuss now will turn out that way, no?

Although I will not revisit the charts of the particular securities covered in A Perfect Marriage above, suffice it to say that one of those opportunities is well on it's way to becoming a great decision in the rear-view mirror, of course I am referring to Harmony Gold Mining Co. Ltd. (HMY:NYSE), and one has yet to join the party.It's one thing to talk about identifying optimal value points in a security, and it's another thing to do it. The term value as it pertains to a particular security, can be measured utilizing a plethora variables and attributes. Some of these measures are more applicable than others, but often not so obvious. The measure of value as it pertains to identifying the optimal buy point for Durban Roodeport Deep Ltd. (DROOY:Nasdaq) is still very present in the important relationships I have already covered, and also apparent in this new one, as well. (See Figure 2)

Figure 2

Looks like a fairly compelling chart if you ask me. What essentially happened in the relationship presented above is a test, and a fairly dramatic test at that, denoting extreme investor pessimism in the face of a very bullish condition. The idea here, if you are wondering why I'm comparing DROOY to Anglo is that the latter company is the blue chip of the South African (SA's) gold stocks, and the former is the high cost low margin producer of the main stream SA's. Indeed, there is a fair amount of negativity and resentment towards DROOY being expressed on the gold forums these days, a message to the wise that it's time to buy, and this rally in the PM's has a long way to go in general.

Does the rally in precious metals have a long way to go? I think so. The price of gold certainly has a long way to go just to get back to its previous highs.

And it's been a long time since those highs have been seen, well over twenty years in fact. (See Figure 3)

Figure 3

The first thing you should notice about the above chart is there are only two trend lines, or resistance rails, that matter. The first one, the steeply sloped downtrend line has already been breached to the upside, and gold (USD) is now forming a pennant, which is the handle, on the "cup with handle formation" originating in 1995. The second trend line, is the upward sloping resistance rail which has yet to be breached, but which I believe will at least be tested sometime before the summer of 2004. My views on this topic can be found here.

Returning to a more near-term view, and in keeping with the goal of identifying value in the PM's, it now seems appropriate to examine just how cheap, or expensive, precious metals shares are in relation the gold at present. The PM's have a tendency to lead when the trend is up, and that is exactly what they are doing at present. (See Figure 4)

Figure 4

While there may be a necessity to retest this breakout as well, which would involve returning to the neckline before continuing higher, this is not a rule that is written in stone. However, and unlike the good value that can be found in the SA's right now, there are quite a few PM's that are in a technically overbought condition right now. Certainly, the large capitalization North American based producers fall into this category, and Newmont Mining Corp. (NEM:NYSE) is the flagship in that department. (See Figure 5)

Figure 5

You may have noticed I am not using any indicators on the charts presented today. The reason for this is to remove any possible distraction from the big messages the charts are telling us at present. And while the indicators may be signaling that some PM's like NEM are overbought right now, which means its not a value play at present, I did want to make the point it has been leading the PM's higher this rally cycle, has blown through all significant technical barriers, and the moving averages (MA's) are indicating further strength is immanent with the 13 month EMA now crossing the 100 month MA.

So if NEM is not a value opportunity now, "where's the beef", or value within the PM's outside of the SA's, because after all, we can't just buy them. This is a very important point to take note of, as diversification in any portfolio is a key consideration. Well, I have to tell you its getting harder and harder to find value these days.

If we take a look at a chart of Bema Gold Corp. (BGO:AMEX), which is a junior producer, you will discover its not impossible however, if you know what to look for. (See Figure 6)

Figure 6

If you compare the 'big picture' observations between the charts of BGO and NEM, you will notice that they have both come out of 'head and shoulders bottoming formations', taken out all significant MA resistance, and appear to be on their way to heading back to previous high ground levels. That being said, which means they have both accomplished the same technical objectives, there is one observation you should not miss, and if you look closely enough at the two charts, it can be distinguished visually. Look at how far away BGO is from its previous highs when compared to NEM. On a closing price basis, it is a full 300% away from the previous highs seen in the mid 90's, whereas NEM is only 57% away from the same measure. When you express this differential, or value gap mathematically, the ratio that is produced looks quite compelling in BGO's favor. (See Figure 7)

Figure 7

Where's the beef? You are looking at in the above chart. The value, in a broader context, currently resides in the juniors buy and large, pun intended, and it behooves me to drive this point home in spades at this point, because the opportunities that are present today in the juniors, both producing and exploration only, will not remain for much longer in my opinion. Without getting into some of the more fine details in the above chart, and with the big picture message currently screaming "buy", it should be noted that the relationship between BGO and NEM is only one example of the value in the juniors presently. Remarkably, the juniors as a sub-sector have not even broken out yet. (See Figure 8)

Figure 8

For lack of a better term, there are gobs of value currently present in the juniors. Indeed, the beef is on the hoof and walking away if you do not participate to at least some degree. That beef will not always be on the hoof. Definitely not, one day it will be in the butcher shop getting cut up into steaks, and ground into hamburger, just like some investors who are either unaware of the opportunity now, or perhaps hesitate because of past experiences in the juniors. I want to make it perfectly clear at this point that much fundamental research should go into security selection when it comes to the juniors, a topic I will visit with you in more detail at a future date.

I know a lot of investors have been what they would term "burned" in the juniors throughout the years, but lets take a look at the circumstances as they exist today, instead of dwelling on the past, which we now have a much better understanding of by the way. It should be no surprise to anybody that the juniors are going to perform the worst of all the tiers within the sector in the bear phase, as most of them do not possess the attributes of major producers in terms of resources to get them through those hard times. So, when the price of the commodity is in a bear market, juniors characteristically tend to get slaughtered, pun intended again, as the prospects of their long-term survival come under serious scrutiny, often causing a mutiny among investors.

The opposite is true when the precious metals are in their bull phase however, and I think we are about to make the fact painfully clear, as the metals, PM's, and commodities as a whole are about to embark on an upward trajectory that may make the dot.coms look pale in comparison in the end, or the gold's technicals wouldn't look so positive. (See Figure 9)

Figure 9

Source: Sharelynx.net

If volume is important in any breakout of significance, which it is, the picture of steadily rising volume in the above chart should strike you profoundly. Of even greater importance as an indication that investors are viewing gold in a different light these days is their willingness to hold the positions they put on, with Open Interest in futures contracts currently not far off peak levels for the move, and set to double once again off the base established in the 160,000 area [a Phi (2) progression], back in March of this year. That would put the target in the 320,000-contract range, and this goal should be achieved by approximately January (nine month cycle) if history repeats, which I am confident it will. And, I don't think we're going to have to wait too long to get started either. Recently gold has been acting quite differently compared to the past when the US Dollar (USD) has been in an upward correction. It could be that the correction in the USD is now complete. (See Figure 10)

Figure 10

The above chart assumes the trend is down, and if you haven't come to that realization yet, you better get with the program. The other part of the program is protecting your wealth in the face of monetary/price inflation, compounded by the deflationary effects/episodes that will characterize an unwinding of a plethora of bubbles present on the global financial landscape now. None of these bubbles should be more apparent to you than the one in the USD, because of the spin-off effects it will unleash on the other bubbles once we enter panic mode, so as the saying goes, "got gold?" (See Figure 11)

Figure 11

Fairly compelling looking short-term chart in gold right now. If we break up out of the cup with handle/triangle(s) gold has put in over the past several months, something tells me a lot of people who currently don't hold PM's are going to want to get on board quickly. And as I have endeavored to establish for you over the course of this analysis, well placed investments in value based PM opportunities is in all likelihood going to pan out to be a very wise decision when looked back on in the not too distant future.

Well, that's about all I have to say right now. The above may not be erudite, but I hope its both a practical appraisal of some potential opportunities for new investors, and a bit of a refresher course for some of the old pros out there that may have gotten caught up chasing momentum in the PM's right now. Inter-sectoral rotations can be very painful to watch if you are stuck in the sub-group that is already almost fully discounted, as some investors may discover over the next little while.

Good investing all.

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