Risk On…Risk Off


"It doesn’t matter if you’re naughty or nice; Santa has been coming early to resource investors everywhere this year. A somewhat ironic combination of fear buying in precious metals and fearless buying in most everything else has generated gains across the sector this month."

It doesn’t matter if you’re naughty or nice; Santa has been coming early to resource investors everywhere this year. A somewhat ironic combination of fear buying in precious metals and fearless buying in most everything else has generated gains across the sector this month.

In fact, the gains were good enough to have us checking the numbers on many development stories to make sure we were not wearing rose-coloured glasses. We were mildly surprised to find that many stories looked, if not cheap, then at least like they still had headroom. That is a testament to just how good metal price moves were this month.

While still comfortable, it’s worth remembering that no small part of those gains were generated by late- to-the-party funds that might want to book some profits for year-end. There are doubtless plenty of itchy- fingered traders just waiting to ease into the next tax year to take some money off the table. Neither of those is fatal flaws, but the potential for year-end turbulence should not be underestimated.

Happily, there are plenty of exploration stories to keep the adventure in the Venture exchange. There are also many worthy causes in what is still a tough year for many, should you choose to book some profits early and want to play Santa yourself.

This past July, the TSX .V S&P index bottomed for the year around 1350, double its post-Crunch base in late ‘08, on 75 MM of volume. The index has now passed 2100 and has days approaching 250 MM of turnover that have never been seen before. The gain of the past two years required five years to achieve from the bear market low at a similar level in 2000. Even though the Venture exchange is still a 1000 points shy of its pre Crunch peak range, the increasing turnover suggests interest in its listings continues to build.

That’s what a venture market looks like during a bull run, and TSX.V has a very heavy resource component. Of course the peak of a venture market is like an equatorial sunset—blue sky to a brilliant play of color and then darkness all before the ice chips melt away. Are we approaching late afternoon for this market?

We keep saying this market is driven by underlying fundamentals. In going through valuations for a broad swath of companies on our list we are impressed that, despite some large recent gains, as a group they are at or below levels justified by current metal pricing. We still think the resource market is closer to noon than sunset. However, noon is when the shadows shift around and we don't lack for caution.

Gains in the precious metals space have been large. Gold and silver are go-to assets right now, and are being priced higher without the usual reference to the U.S. dollar (see below). Silver has doubled from post Crunch lows in two years, and half that gain has come in the past three months. Gold is just shy of doubling through that period, on a chart that is steady as well as persistent. Palladium has better than tripled, and platinum has more than doubled but is still below its 2008 high.

These gains are of course exaggerated by the hammering down of prices during the Crunch panic. There are supply concerns for all but platinum, but for gold and silver much of that concern is because of investment demand. It’s possible that demand will simply grow larger, but at some point it will level off and generate profits taking. We aren't looking for an end to this secular market, but a leveling off that will impact buying of related companies. Nor are we suggesting we can date that shift. Rather, our concern is that no one can time it other than recognizing it gets more likely as gains continue. It's therefore important to stay on top what has been driving the gains.

Fear has been a major contributor to rising metal prices. Fear for the U.S. economy and its dollar has been most important. The reactive gains for metals, and gold in particular, when the U.S. dollar weakens is a market standard. It’s a simple equation that also has a comfortable normalcy in abnormal times. The problem is it isn't just the U.S. that is grappling with debt.

The euro world became a scarier place again in the past while. Ireland, the former Celtic Tiger, finally gave up trying to deal with its debt hangover alone. The EU has fronted it a €90 billion loan package under the emergency program it had hoped to never to actually use. In return, Ireland is promising some serious budget cuts, though it will continue to be a tax haven of sorts. Many Continental types are none too pleased about that. The fact they granted the funding anyway is a measure of how serious the problem was getting. Among other things this will mean consolidating Ireland’s overextended bank sector.

The country’s PM is promising an election now that the austerity plan is laid out. The Irish public isn’t happy about the situation. The cuts and tax increases are large in relation to Ireland’s budget, yet some doubt they are going to be enough. A change in government seems likely but whoever wins the election will still have to make hard choices.

That is just how it’s going to be in Ireland and plenty of other places until deleveraging is worked through. It won’t be the last Eurozone member government to announce a budget that has the citizenry up in arms. No small part of the problem is that little sovereign debt is considered "safe." A government perceived to be weak on reducing debt load sees its bonds hammered, which only increases the load if debt needs rolling over.

There is no easy balance between citizens who had planned against promised services, and debt holders who don't want to be stuck with the bill for those services. Within the Eurozone a partial solution could be creation of €bonds for all users of the common currency. Of course Germans aren’t happy with the thought of their interest rates being boosted for of the sake of leveling the euro playing field. Many are reminiscing about the D-Mark. The banks Germans stash savings wouldn't be any more solvent with D-Mark if the government bond issues those savings have been placed in default.

The other suggested solution is to curb the shorting of government bonds to stabilize rates. Problem is capital would simply shift away from those bond markets, which is much the same in the end. The reality is that reducing sovereign debt is the only real solution. It will require prolonged economic pain, but doing anything would only put that pain off.

On the other side of the globe, North Korea is saber rattling again. Some see this as Kim Jong Un, the dictator’s youngest offspring and political heir, earning his chops. Others take it as the military sending a message to everyone, including the ruling family, which they really call the shots in the Hermit Kingdom.

Either way, the omens don’t look good at the moment. It could be another in the long line of extortion attempts disguised as nuclear disarmament talks, but shelling civilians is beyond even that outer pale. The Hermit King not seeing that is as scary as flexing nuclear muscle. This is how war is backed into.

These events have led to some wild swings in the market as traders go from "risk on" responses to events to "risk off" trades when incremental economic gains show up in stats. Interestingly, "risk on" selling hasn't included the gold market. Most other metals have seen selling, though mostly in short term reactions. Gold has become a general uncertainly hedge, and its price has survived most shifts back to the U.S. dollar. At least so far.

Base metals have had an expected correction, though a short lived one. Copper is again hitting new highs on quite real supply concerns. Other base metals have also been recovering, which we consider more follow the red metal leader than fundamentals. These will be determined by China and other growth economies.

Inflation has continued rising in China and its government has increased bank reserve requirements again. Many believe Beijing will be forced to move to interest rate increases to cool its real estate sector. That should lead to even more upward pressure on the yuan. If China finally let the currency rise the way it should it would be a big help on the inflation front.

Traders recently snapped up a yuan denominated bond issue in minutes in the expectation that increased currency value would make up for any loss on the interest rate side. Whether that turns out to be wishful thinking remains to be seen. It has become a working premise for this market simply because yuan is the only paper most people like these days. What China’s government mostly wants is stability. Economic gains have provided that so far, but if a cooler economy is needed to still unruly crowds cold water will be found. It wouldn't end China’s growth, but it could slow metal markets.

Resources, but metals in particular, have become the easy money trades. Financings in the base metal space have multiplied in recent weeks, and on the basis of real fundamentals. We are not concerned about the medium term, nor are we worried about a wholesale exit from the sector any time soon. But after rapid gains it’s important to look for signs of fatigue, and to turn paper gains into actual gains before it sets in.

It’s a secular bull market for metals and resources. We’ve been saying that for nine years. And we’ve been right. Another thing we’ve been right about is the growing importance of the Yukon as an exploration destination and, more recently, Area Play. HRA was there early and continues to follow several of the biggest winners in the play and is tracking dozens of others for potential inclusion in HRA publications.

CLICK HERE to access your FREE Yukon Report from HRA now! HRA initiated coverage on 19 companies since early 2009 – the average gain to December 1, 2010 is 288%!

The HRA Journal, HRA Dispatch and HRA Special Delivery are independent publications produced and distributed by Stockwork Consulting Ltd, which is committed to providing timely and factual analysis of junior mining, resource, and other venture capital companies. Companies are chosen on the basis of a speculative potential for significant upside gains resulting from asset-base expansion. These are generally high-risk securities, and opinions contained herein are time and market sensitive. No statement or expression of opinion, or any other matter herein, directly or indirectly, is an offer, solicitation or recommendation to buy or sell any securities mentioned. While we believe all sources of information to be factual and reliable, we in no way represent or guarantee the accuracy thereof, nor of the statements made herein. We do not receive or request compensation in any form in order to feature companies in these publications. We may, or may not, own securities and/or options to acquire securities of the companies mentioned herein. This document is protected by the copyright laws of Canada and the U.S. and may not be reproduced in any form for other than for personal use without the prior written consent of the publisher. This document may be quoted, in context, provided proper credit is given.

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