Big News on Gold Stocks and Notes on the Juniors You Need to Know
by Kenneth J. Gerbino
24 April, 2008
Here is my assessment of the current gold share market.
  • The gold price is taking a much needed correction and bullion corrections are almost always severe and volatile and the shares follow.

  • Obviously gold coming down could mean less profits and cash flow for companies and this unnerves some holders to sell.

  • With major investment banks projecting a long term gold price of $700, some portfolio managers that usually invest in GE or IBM are thinking that this may be the start of a major downturn. They are therefore selling.

  • These managers don’t understand that 95% of the mining analysts have never got it right on the metal prices the 35 years I have been investing in the mines. Analysts are conservative and they are cautious. They are usually from a geology or engineering background. What do they know about global economics? And if they are economists -- God help us.

  • Lot’s of new money has come into the gold mining sector the past year and this is money that is not philosophically tuned into gold as money and most think the Fed can actually manage the currency and printing money is the normal thing to do. They saw gold going up and the stocks having positive momentum and this made sense for them to buy. When this momentum stopped they were ready to sell.

Good News

Currently there is plenty of money on the sidelines from gold share sellers that have been liquidating since November. There has been a 3-5 month topping formation in all the major gold shares (We will talk about the juniors later). Many of these sellers will most likely be back in the market for five reasons:

1. They did very well getting out at higher prices and are now somewhat familiar and comfortable with the valuations and the companies and after a 20-30% correction that is obviously overdone, they will be anxious to get back in

2. Worldwide food riots, and the globally reported inflation numbers from just about every country is a leading indicator of higher consumer prices and hence higher gold prices. This is easy for anyone to understand.

3. The financial situation with the banking system is without a doubt enough to convince even a small portion of these non gold bug portfolio managers that a small allocation to the gold miners is probably a good idea. Since they control tens of trillions of dollars, even a small portion in mining shares will eventually create a substantial market.

4. There are also thousands if not tens of thousands of money managers and hedge fund managers that totally missed the first leg up of the gold market and the gold shares and have been patiently waiting for a correction to finally get in. These people are now aware of how bad the possible financial repercussions of the leverage and derivative craze could become and will certainly want some exposure to the metals and the shares. This correction will allow them an entry point.

5. In March the PPI and CPI in the U.S. both annualized over 11%. This is a stat that money managers and global investors will not ignore. Inflation is heating up and the Fed is still lowering interest rates. Even establishment Fed lovers know that this means they should hedge a bit with some gold.

The Market Right Now

With the recent sell off in the gold shares this week plenty of short sellers, weak holders and investors that bought at the top are selling and creating a real wicked sell off. I would think that Friday the 25th or Monday the 28th will be the end of this sell off and a substantial rally could develop. The market is very oversold. If the sell off continues then it just means an even better entry point is coming up and probably very soon.

The Juniors

The Junior shares have been in the doldrums for two years and here are the reasons:

  • In the last three years there have been probably 3,000 new mining companies formed. Even with average $10 million market caps, this represents a $30 billion dilution to the junior market and a potential windfall to the promoters and insiders that are mostly dealing with moose pasture and geological dreams. Most gold bugs are suckers for a great gold story. So they sell 1,000 shares of a decent junior and buy a 1,000 shares of the moose pasture stock and when enough people do this the decent stock goes down and eventually the moose pasture stock collapses.
  • The Canadian mining industry was built on prospectors going out into the wilds with a mule and supplies for a season or so to explore and look for mineral traces on surface. This was high risk and speculators and investors for their grubstake were given a big piece of the action if anything ever developed. This tradition now continues but on a grander scale with the investment banks demanding cheap stock and warrants from the company for their own account and customers. The warrant kicker is now so prevalent in Canada that it has ruined the share structure of many small companies. Insiders sell the newly issued stock as soon as allowable and keep the warrant at no cost. If the deal works they have a free ride. But their selling kills most stocks.
  • Drilling rig shortages, assay backlogs and permitting etc. now can add 1-2 more years for a successful discovery to become a buy out or a mine. Time is money and these delays dilute the present value of the company.
  • Most management teams of small mining companies usually take very modest salaries. But they can own 2-3 million shares of stock at basically zero cost. They can’t send their kids to college unless they sell some shares. They also can’t wait 5-8 years for the mine they hope they will discover or for the ore body they actually have discovered to become a mine. When you are buying stock after a great press release the seller is most likely an insider.
  • After the last two years and lower junior stock prices people give up and start looking for larger companies. They then add selling to the market.

Unfortunately all these factors have really hurt the junior sector so if you are not an expert you should be careful. Thinking of holding on to a loser means you will most likely have your capital die a slow death.

Unless you own a junior mining company that is loaded to the gills with gold and silver reserves and resources you are in trouble. The ore body better be an economic ore body that actually without a doubt (almost) can become a profitable mine. The stock should be so undervalued that even the insiders are buying.

Most hard money investors would be well served to use these rules:

  • Sell any stock that is issuing warrants with their next financing and tell your broker why and have him call the company as well.
  • Never put more than 5% of your money in exploration stocks unless it is an advanced exploration play with plenty of prior drill success.
  • Look for developmental companies that are within a year from bringing on new production. This is my favorite area for our Fund and one that you should pay attention to.
  • Make sure that even with much lower metal prices (gold at $600) the company will still sell for less than 15 times after tax cash flow per share.
  • Always look for companies with giant deposits that have economic grade. Even if the company is small, a big deposit gets attention.
  • I hate to say good management because almost all companies can make it look like they have good management. But good people make things happen, not rocks.

In the coming years one of the best sectors for investors will be the mining industry for reasons you already know about. Progress in China and India, paper money, derivatives, insane governments, debt, etc. all point towards much higher metal prices for perhaps a decade. Don’t shortchange yourself. Stay with the companies that have the real goods in the ground.

Kenneth J. Gerbino



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