Selectivity

From the June 9, 2015 HRA Journal: Issue 234

Summer’s here.  That global warming thing sucks for most of the planet but its done wonders for the weather in the Pacific Northwest and Canada’s west coast. You can see the impact of longer sunnier days already in the local markets which are seeing lighter volumes and in calls to brokers during the trading day.  The background noise sounds suspiciously like a patio full of drinkers rather than an office.  Probably just a line problem.

We all expect summers to be slow and boring in the markets.  So much so that it’s usually a self-fulfilling prophesy. That doesn’t mean we should completely ignore the markets though.  Summer often gives us a foretaste of the autumn.  If we see even a little positive action during the doldrums we’re usually set up for a better fall market. 

This summer will be complicated by some outside factors like Greece (yeah, I’m sick of it too) and higher volatility that often accompanies periods of generally lower volume.  What we really need to watch through the summer is the small cadre of companies actively trying to improve their lot.  If that small group gets some traction it will bode well for the broader sector. Traders need to see some positive notes through the summer to convince them to buy ahead of a fall rally and to convince them a fall rally is actually possible, for that matter.

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With summer upon us traders are deserting the market and hoping things look better or at least no worse when they poke their heads up again in September.

Summer doldrums are so entrenched that many literally ignore the market from early June until Labour Day.  I don’t.  Not because I think the summer markets won’t be boring in general.  I’m pretty sure they will be.  What I’ll be watching for is advancement by specific names that are pushing forward to on plans to add value to projects and to their companies by getting traders to pay attention, preferably both.

I’ve lived through a few market cycles.   The market we’re in now reminds me of 2000.  Anyone who has traded resource stocks as long as I have will not look back fondly on that period.   It was horrible. 

The resource space was entering its third or fourth (depending on who was counting) year of a bear market. The combination of the Bre-X scandal and its aftermath and the Asian currency crisis decimating commodities had blown the speculative end of the sector out of the water. The 25 year chart above for the Venture Index and its precursors shows you the situation. 

I’m not a chart technician and am in fact a bit skeptical about the whole concept but there is little doubt there are eerie similarities between the 1996-2000 and 2011 to 2015 segments of the chart.

By late 1999, early 2000 pretty much everyone had given up on the resource sector.  It had just come off a major discovery bubble.  It’s not obvious from the chart but there were more explorers carrying stratospheric valuations in early 1996 than there were in 2008, however the chart may look.

One of the reasons it’s dangerous to try to read too much into long term chart is that things do change and it’s important to filter out anomalous events that aren’t likely to recur.  The year 2000 is a perfect example when it comes to the Venture Index.  Looking at the long term chart you’ll see a huge spike early in 2000.  That’s not what I’m expecting a repeat of (if only!). It had nothing to do with the resource sector. That was caused by the internet bubble finally filtering down to Howe St. To an even greater extent than its big brother on NASDAQ it was dominated by crap companies with no real business model. It deflated through the remainder of 2000 and into 2001 just as impressively as the QQQ itself.

To try and filter out some of the effects I added a HUI (NYSE ARCA Gold Bugs Index) chart below the Venture chart.  Be careful comparing them.  The HUI chart only goes back to 1997 but I wanted ted the Venture Index back to 1990 to capture the mid-1990s glory (and gory) days.

Like all chart comparison it’s far from perfect.  HUI is composed of gold producers only, mainly large ones. The Venture Index is the opposite end of the spectrum in terms of company size and level of advancement. It’s moved by “animal spirits” as well as by gold or other metal prices. 

As you can see from the HUI chart it made its bottom in late 2000.  That is about when things bottomed for the resource sector on the Venture though the tech gyrations mask it. 

The situation that developed in late 2000 is being repeated now, namely a tentative and jagged advance by the best positioned companies with the rest of the board flat lining. 

By 2001 many resource promoters had switched to tech.  Almost all of those deals blew up but they did provide plenty of volume and fees for the brokerage community.  In that sense this bear market is worse than that one was.  The current bear has been a lot tougher on brokers and that makes it that much harder to get a strong and broad rally going. 

When gold finally puts in an extended rally it will be a small cadre of high net worth individuals and resource savvy brokers that lead the charge. They can’t be everywhere at once.  The deals they focus on will be the ones that move.

2001-2003 was similar.  Gold had its first up-leg but only a few resource companies really joined the party back then.  Think names like Virginia and Minefinders that had strong management, fund raising abilities and a better than average project base. 

The subset of early advancers weren’t afraid to toot their own horns either.  I’ve noted a real trend lately to dump on any company that takes a highly active stance to marketing.  Somewhere along the way many analysts and newsletter writers seem to have decided that any resource company that puts real effort into promotion has to be a scam or is just wasting money. 

This view may be charmingly naïve and allow the individual spouting it to feel morally superior but it’s also dead wrong.  Many of the companies, “paragons of the past” that get held up as some sort of standard of purity were heavy promoters themselves.  The fact that market observers lecturing everyone on the subject don’t know that says more about their lack of background than it does about the evils of promotion. The best promoters make a point of not broadcasting the fact they are doing it. Just because some outside observers didn’t know about doesn’t mean it wasn’t happening.

The market is a hard place and highly competitive.  I don’t want to see companies throw money away either but the “build it and they will come” mentality of many technical management groups doesn’t necessarily work best for shareholders.

If Company X has to issue 300 million shares instead of 100 million to get to development because it doesn’t promote and waits to be offered money its management purity will cost shareholders dearly in terms of potential for future gains.

Yes, Fortune 500 companies don’t do the same type of promotion but then junior resource companies can’t borrow a couple hundred billion a year and spend it on share buybacks, exercising options and selling into the self-created volume.  No one blinks an eye when that scam gets run so I find the singling out of small companies when it comes to promotion tiresome.  Ok. Rant du jour over.

In 2001 as now hundreds of resource names were broke or had become failed tech (or pot or…) promotions or both.  It took years for most of those deals to come back from the dead.  For the first two or three years of the bull market a select few companies carried the banner for the whole space.  This time will be no different.

The early late 2000-mid 2002 advance doesn't look like much in the context of the long term HUI chart but it was a pretty impressive move of about 200% in under two years.   The advance broadened in 2003 and again in 2005 but the first couple of years were a very selective affair.

When do we get some love?  Increasingly, I think it really starts after the Fed raises rates.  Counterintuitive I know but that is what happened the last few tightening cycles.  Until then we’re trapped in a market dominated by US futures speculators making book on Janet Yellen.

Is there hope for a reversal?  Yes, based on physical markets.  The most recent Shanghai gold withdrawals chart by Koos Jansen at bullionstar.com which I think is most accurate shows continued buying in China.  2014 still looks like it will be a record year.  I suspect if we see a top on the Shanghai market or the S&P, or both, the level of insurance buying will increase markedly.  Even traders on Wall St have heard of gold’s negative correlation to major equity indices.  They would probably be buying too.

The weatherman gave us some more good news for the gold market in the past couple of days which went unnoticed by most in the West.  India’s monsoon arrived on time and looks like it will have regular average strength.   India is the world’s second biggest gold buyer and farmers are the biggest buyers there. If predictions of a good monsoon are borne out that sets up for heavier bullion buying in India later in the year.

Many chartists continue to call for a final dip in gold prices.  No real reasons are given so I can’t speak to the odds though if it does happen it will probably come during the summer.  That would align with the “sell on Fed rumor” trade as well.

Be that as it may, I think the bottom is in even if it sees another test.  The key to generating gains will be sticking to companies that know how to get market traction.  The companies represented at the Metals Investor Forum and Subscriber Summits are good examples of the breed.  I noted that MIF presenters outperformed the market last week.  Not necessarily because of MIF but because they were companies that deserved to be selected for it.  Selectivity will count and quality will out.  Be selective to stay ahead of the game.

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