I have a gross and rhetorical question for you. What does the bottom of a bear (market, that is) smell like? What does it sound like and what does it look like. I'm speaking of any kind of bear market.
For the sake of brevity, let's focus in on gold. The naysayers and the self-appointed pundits are saying that the goldbugs have bats in their bellfry and that we have entered a bear market for gold and the other precious metals. How do they know?
Are you ready for their number one answer? They've "read the charts" or "gold has broken down below long-term support" on some other chart. My goodness, are they reading palms and tea leaves too?
I don't smell a bear market, I smell manipulators, paper-traders and self-styled gurus trying to tell you and me that they know as much as a crystall-ball gazer.
Here's a recent 30-day price chart of gold used by permission from www.Kitco.com:
Now we don't have to be stargazers, rocket scientists or clairvoyants to clearly see that gold has had a significantcorrection. And the fact of the matter is the world that supported gold at $970 hasn't become a safer, friendlier, less inflationary place where the US dollar remains the bastion of safe paper currencies.
On the contrary, the things that usually make gold a safe haven, money-preserving cache are increasing.
Dr. Stephen Leeb wrote the following to those of us who subscribe to The Complete Investor:
So why is it that the best hedge against inflation and other forms of economic turbulence, gold, took a massive dive? Could it be a bear trap?
Typically, when such a big drop in commodity prices occurs it is the result of forced selling. Too many people who bought gold on margin at higher prices may have been forced to meet margin calls by liquidating their holdings. (We hope you are not one of them, because we certainly don't recommend trading on margin because of the higher risk.) The result is a sharp plunge that makes no sense fundamentally.
For some time, we have been saying that the lowest gold is likely to go in this correction was somewhere in the upper $700s. Now our target has been reached, but we are not going to lower it. Instead, we feel gold is close to making a bottom. It may not necessarily be at the bottom, but it is close. Here's why ...
We Smell a Bargain
Plunges caused by forced liquidation don't usually last long, because the fundamentals simply aren't there to justify prices so low. Usually the smart investors, who have cash on hand, recognize the opportunity and pounce on it. For this reason, we expect a rebound will occur fairly quickly. Gold is a compelling buy under $800, with little downside risk and tremendous upside potential.
The same can be said for gold stocks, many of which are now trading at near or below market multiples -- a clear sign that investors have grown out of touch with what's happening in the world today. How is it that a medium-term producer like IAM Gold (IAG) is selling for less than eleven times forward earning,17X current earnings?
Another example, Barrick (ABX) is now trading at 15X earnings -- likely the lowest it has in history. To justify gold stocks being this cheap, the world would have to be safer than it ever has been. We would have to be sailing into incredibly calm and benign economic waters. Yet all you need to do is open a newspaper to see that the world is actually more dangerous than ever.
"Of course, we'd love to be wrong about this" writes Dr. Leeb. " I've spent most of my professional career optimistically following big bull markets. Those were happy days, which I'd like to see again. But the world situation denies that possibility."
So the only explanation we can see for gold selling off is forced liquidation. And like other bargain hunters, we're ready to take advantage of the liquidation sale within the next week or so. We doubt we'll ever find a buying opportunity this good again.
Of course, nothing in this business is ever a sure thing, but the opportunities we see in gold today look as promising as any we ever have.
Like gold, oil has also been on a fairly sharp downtrend for the past month or so. In the case of oil, however, the correction makes a little more sense. The "Texas tea" did get a little ahead of itself this spring. Some retrenchment was to be expected. However, in the past couple of weeks, some very telling data has emerged.
Running Out of Bearish Reasons
We, like Dr. Leeb,are starting to suspect that oil has fallen to the point where it too has gotten out of line with fundamentals. As with gold, last week's 1% drop may have resulted mostly from forced liquidation. In other words, the bottom may be nearing.
Two brokerage reports we learned about recently lend evidence to this interpretation. The first was an evaluation of Fluor (FLR), one solid, oil-related growth company. The report gave Fluor a lower rating, even though Fluor reported sharply higher earnings and sharply higher forecasted earnings.
The analyst, however, felt that Fluor's P/E ratio was too high and did not reflect today's lower oil prices. (Fluor makes a lot of its money building infrastructure for oil fields.) We have to wonder how anyone can call oil prices "low" today.
A year ago, oil was selling for around $70 a barrel, so how does $114 now qualify as cheap? The fact that they have corrected a little recently does not justify predicting that oil prices will remain low for the indefinite future. P/Es are supposed to reflect the consensus view of the future, after all.
Dr. Leeb opines,
The correction in oil certainly doesn't mean that the 1.3 billion Chinese and 1 billion Indians have suddenly given up their desire to own cars, or that the Middle East nations have suddenly stopped developing. Demand for oil will keep rising as before.
The analyst who wrote this report seems to have made irrational conclusions. It reminds us of the kind of crazy rationalizations made in the days of the technology bubble, when people were predicting annual sales of 20-30 billion cell phones and that Cisco would become a trillion-dollar company.
The second strange report that caught our eye was quoted in the Financial Times by the chief economist at Lehman Bros., Edward Morse. In the piece, Mr. Morse predicted oil would reach $90-100 a barrel sometime before the new year.
He may be correct about this -- we don't try to make short-term forecasts. But we hope he's wrong, because the world urgently needs to develop alternative energy, and it won't unless oil prices go a little higher than they are today. Low prices now will actually mean much higher prices later.
However, the article is just one more sign the bearish sentiment around oil has reached irrational levels, and even rational analysts are speaking in crazy ways.
For instance, in his article, Morse compares China today to Japan in 1973 and South Korea in 1997. There are many things wrong about these comparisons. Most notably, Japan in 1973 was an almost fully industrialized economy. Its oil consumption per capital was double the world average. Ditto for Korea in 1997.
China, however, despite its massive growth over the past decade, has yet to even reach the world average in oil consumption. In fact, if China's per capita oil consumption was the equal of Japan's in 1973, analysts like Morse would be speculating whether oil prices would decline to $300 a barrel. Clearly, China has a lot of room to grow, which means oil has a lot of room to rise.
As Dr. Leeb puts it,
Whenever you see people coming up with irrational reasons for why oil prices will fall, it usually means they've run out of sound reasons. In other words, oil prices are probably near a bottom. The same can be said about the downtrend in gold and other commodities.
George Soros pointed out once that the key to making a fortune is to find a trend whose premise is false and bet against it. We think the downtrend in commodity prices looks hollow.Of course, when markets become irrational, it is hard to predict when sanity will return. But again, gold prices look close to a bottom. Oil could decline as far as $95 or $100 (that's not a prediction, just a possibility). Nonetheless, both markets have tremendous upside potential and very little downside.
Those are the kind of markets I like to smell (I'm a gardenia and roses kind of guy), and those are the markets I'm investing in with every sweet price pullback. How about you?
Disclosure: Author holds long positions in ABX, IAG and OXY
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This article has 9 comments:
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bold4gold
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45 Comments
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Aug 20 08:38 AM-
GMiki
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331 Comments
Aug 20 10:50 AM-
CaptBob
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198 Comments
Aug 20 11:22 AMThere's a huckster for every point of view.--Don't listen.
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fabricator
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Aug 20 11:45 AM-
mark mchugh
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154 Comments
Aug 20 12:08 PMI think a little manipulative nudge can set off an avalanche of forced liquidations. People should know better.
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knot2hazy
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20 Comments
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Aug 20 12:21 PM-
knot2hazy
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Aug 20 03:44 PM-
User 245744
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Aug 21 02:28 PM-
User 245744
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Aug 21 02:34 PM