This year has started brightly with gold, silver and the miners all posting sharp gains. This sudden move upwards brings with it much jubilation with many believing that the illusive bottom is now in and therefore behind us. One day they will be correct with this synopsis and the precious metals sector will take off generating huge profits for its participants.
However, as with all investment success it is all about timing your entry and exit points. This is of course easier said than done and we will all be wrong footed by the markets from time to time. The precious metals sector is as volatile as they come and this current phase is particularly treacherous. The first 10 years of the bull market in gold was in hindsight plain sailing allowing us to generate profits by sticking with the trend. Alas all good things come to an end and so they did in 2011 when gold peaked at $1900/oz. Silver, despite having numerous industrial uses also caught a cold and fell dramatically along with the mining sector which lost approximately 70% of its value during a 3 year period of pure carnage.
Gold Mining Stocks
On the back of falling precious metals prices the miners have been battered as this chart of The Gold Bugs Index (HUI) clearly shows:
The HUI has fallen by 70% since making a high at 630 and has re-visited its lows of 2008, an important support level, but it has managed not to fall through it and now stands at 192. The question now is can the HUI hold above this support level and form a good base from which to rally into the next bullish phase of this bull market.
The tail winds for gold always read well and make sense such as the money printing that is the central planners answer to all of our economic woes. The latest bank to join the party is the European Central Bank via the introduction of a large program of quantitative easing (QE), in order to boost inflation in the euro zone and to prevent their economy heading into deflation. From March 2015 until September 2016 the ECB will buy around €60 billion ($68 billion) of assets each month, committing a total of €1.1 trillion.
We have always held the view that liquidity is not the remedy for insolvency and so this move may mask the structural problems of the economy in the near term, but sooner or later they will have to be faced. The cure for insolvency is bankruptcy as this process removes those that can't hack it from the market place. Banks have been going bust since banking began and this idea that we can keep the non-performers afloat with an infusion of electronic cash derived from thin air is doomed to fail.
The road to prosperity is to work your socks off and save a little each week. This requires discipline and is something that every household is aware of, though this necessity has gone largely unnoticed by the powers that be.
The United States has recently terminated its program of QE and the dollar has been the major beneficiary and has outperformed gold over the last year or so. However, if you are a European then gold would have been a very good investment as it has outperformed the Euro dramatically. From this we can deduct that gold is not a "one size fits all" investment, a lot depends on your geographical location and the currency that is used in your daily lives.
Assuming that you are an American and you can see that the dollar is on a roll, it makes sense not to be in gold or gold mining companies. Will this roll continue you ask? Yes it will as long as the data; such as the non-farm payroll jobs report remains solid, inflation starts to move up and earnings improve, etc., then in the eyes of the Fed a mid-year interest rate rise could be the cards. This would only serve to strengthen the dollar which would in turn hamper gold's ability to rise in dollar terms. Conversely if the "cat hits the fan" then the Fed could easily re-introduce QE and that would catapult gold to new all-time highs.
In terms of what to do at this stage of the proceedings if you reside in the US we would recommend the following;
Keep the lion's share of your investment funds in cash for now. Wait for the data to confirm that the economy is either going well or falling apart. Watch the Fed for what they say and what actions they take. Do not assume that this is the time to buy the producers because they are cheaper than they have been, cheaper does not necessarily mean cheap. Watch for a final capitulation in this sector as most bear markets end with the throwing in of the towel and severe fall in prices.
This recent bounce in prices could be another false dawn and we have had enough of those over the last three years to at least be a little weary of this market.
At the moment we have 70% of our funds in dollars and are happy to be in cash as it is strengthening; giving us more spending power when the time comes.
Stay flexible and don't be afraid to short this market if a rally looks to be overbought and go long when the stocks have been flattened. These trades are not long term investments and should be considered on a hit and run approach, taking small profits quickly and hopefully minimizing the risks. Finally, only deploy small amounts of capital until the new bull is confirmed, we all need to live to fight another day.
Got a comment, then please fire it in whether you agree with us or not, as the more diverse comments we get the more balance we will have in this debate and hopefully our trading decisions will be better informed and more profitable.