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The Ultimate Gold Stock Trader - Chapter 11
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In the first edition of The Ultimate Gold Stock Trader, we did not give much time to consider rallies, or to rules for trading them or with buying and/or selling strategies.
There is an old stock market adage that advises us that stocks do not necessarily “fall of their own weight”. A precious metal stock can be buffeted by general market conditions, a sector pullback, a credit crisis or commodity price attrition. When this occurs, scant attention is paid to individual stock fundamentals. In our chapter on volatility and stock screening, we pointed out that stocks tend to break out on an individual time basis but fall back in unison. Time has been described as God’s way of making sure that everything does not happen at once. The collapse of Lehman Brothers caused a temporary suspension of this rule, and money poured into U.S. Treasuries creating the potential for another bubble.
Although the majority of stocks on the TSX and TSX Venture exchanges are commodity based, the Canadian market is essentially a “small cap market”. As a result, it also bears a strong correlation to the Russell 2000 index in the U.S.
The collapse of Lehman Brothers triggered the collapse of both commodities and securities markets, which fell in unison across the board causing collapses through June/July 2008 market price lows.
Small cap stocks tend to underperform going into a recession period and in return feel the impact of recovery first. They are more sensitive to the health of the domestic economy than large cap stocks. They suffer dramatically during a credit crunch as investors reduce their risk tolerance. Inversely, at any sign of stabilization or “green shoots” in the economy, they can often provide the astute investor large percentage gains over relatively short time frames.
These stocks, as they trade at low prices, also benefit from the “square root rule of volatility” that states: for a given bull or bear move in the market, and all other factors being equal, a low priced stock will gain more or lose more than a high priced stock regardless of market capitalization.
Even before the collapse of Lehman Brothers, the toll on manufacturing industry of escalating commodity prices, especially oil, was threatening to waylay the stock, real estate and commodity bull market in its tracks.
In a Tale of Two Cities by Charles Dickens, described that turbulent era as `the best of times and the worst of times”. For the average investor in the market in 2008, it became the worst of times. For the investor entering the market between October 2008 and March 2009, it can only be described as the best of the times.
Media pundits saw each sign of recovery in the market merely as a bear market rally. Focusing on the economy, they ignored the fact that stimulus spending has a major impact on financial markets long before it impacts on the wider economy. As a result, many of them missed out on some of the largest percentage gains ever made over a 24 to 28 week period of the stock market.
The renowned stock market strategist Barton Biggs declared that he had never seen such total capitulation on such a large scale before and suggested that the March 2009 low could well be a generational low.
The resource stock sector bear market occurred during a period of seasonal weakness, especially for gold stocks (July to the end of October 2008), and as a result the market collapse was extremely fast and pronounced. This led to most commodity based stocks bottoming out in October/November 2008, a few months before the overall market low in March 2009.
In the first edition of the book, we referred briefly to rallies as a chance to average down on stocks we had previously failed to sell at seasonal highs.
Prior to the current “rally phase” some of the largest gains were made by large, low--grade, high capital cost mining companies often in remote areas, as gold went over $800.00 U.S. an ounce Escalating commodity prices, labour and capital costs made many of them vulnerable in the credit crunch. This caused many of these stocks to decline sharply and rebound dramatically.
There is a lot of truth in the old market maxim “the best long-term cure for low prices is low prices”. Low oil prices led to reduced inflationary price cost levels, both in the oil patch and mining sector, as inflation in capital and operating costs had reduced the benefits of high commodity prices.
By numerous market metrics, the valuations of the markets were cheap by historical standards. Even short sellers, such as Steven Leathold of the Grizzly Short Selling Fund (+74% in 2008), declared it was time to go long to take advantage of rampant fear. Bill Fleckenstein, probably the most famous of short sellers, closed out his 13-year old bear fund.
Low weekly outflows from mutual funds coincided with stock market lows. Many of these funds have target allocations that mean that they had to increase positions in declining sectors.
Stock prices have a history of performing well after a period in which the VIX is declining from a high volatility ratio.
Market turnarounds often display strength during the last weeks of a calendar month into the first week of the following month. These periods are known as calendar juncture times.
With the exclusion of the bank bailout, government stimulus spending has almost been offset by the benefit to consumers and industry of low oil and commodity prices (estimated benefit of 1 to 1.2 billion dollars).
As in all volatile markets, “entrances are wide and exits narrow”.
Until the June/July 2008 support low, the overall resource stock market had been mired in slow attrition. Once the price of oil dropped below its June/July low, most stocks and commodities entered into a fast and steep decline.
The sheer speed and velocity of the recent bear market collapse led to a universality or commonality of steep declines across all market sectors which, in turn, led to fear of deflation, recession and potential depression. The normal correlation of gold with oil and the U.S. dollar was temporarily suspended by the market. A recent study of long-term gold stock behaviour concluded that when market volatility is extremely high gold stocks trade the same as non-gold equities. Only when volatility subsides do they return to their old relationship as “gold instruments”.
Lord Keynes advised us to only regard history as a guide to the future if the same set of circumstances existed during both periods and at the juncture of the period being forecasted. We would like to add our own caveat that we should look to see if politicians and regulators take similar or different approaches to dealing with the current conditions as their predecessors dealt with their economic circumstances.
The political and regulatory response to the financial crisis has led to a startling recovery in investor risk appetite over the past 3 months in almost all sectors of the financial world. The market has shrugged off concerns about deflation and breathed a sigh of relief at the prospect of banks surviving and perhaps thriving.
As one analyst in London described it, “The market is beginning to show scale, duration and breadth and far more momentum than in previous bear market rallies with the “green shoots” of recovery popping up in many different sectors”. In the case of commodities, low prices have begun to revive demand and China’s decision to take advantage of those commodity prices in order to safeguard its economic growth, over the next 5 years has created a commodity price recovery faster than most pundits predicted. This has led to the Baltic Dry index recovering 300% from its low, copper +70% and oil +100%.
Trading Rules for Selection and Trading of Gold and Precious Metals Stock Rallies in a Major Bear Market
- A review of the June 2008 Independent Survey Resource Chart book showed quite clearly that over 80% of the stocks in the book had at some time over the past 3 years demonstrated both substantial percentage and net price appreciation. Thus for any significant future price appreciation to occur for these stocks was almost entirely dependent upon rallies from future price declines.
- The starting point for consideration of rallies was the June/July 2008 bi-monthly price low breakdown. Once this occurred, one should not try to be a hero, anticipating the low is like attempting to catch a falling knife; one should let the market indicate when a stock has bottomed.
- Time has been described as God’s way of making sure everything does not occur at once. Thus, commonality can be seen as an aberration of “God’s Law”. When oil, commodities and stocks broke down through the June/July 2008 low, they were all in unison, displaying precipitous price drops.
- A recent study of chart patterns, 14,000 over the period 1991 to 2008, showed an alarming failure rate of standard chart patterns in 2008 compared to 1991. Most major brokerage houses have recently released their technical analysts, replacing them with quantitative computer models. We have always subscribed to quantitative and empirical analysis.
- One should select potential rally candidates on the basis of their visibility and liquidity. If you are familiar with a stock, odds are that thousands of other investors will be also.
- Once the decline sets in for a specific stock, look for the first week the stock low is higher than the previous week’s low – e.g. Agnico-Eagle in the final week of October 2008.
- Ideally, the high, low and close should be higher in the week following the actual realized post decline low.
- Look to see if other securities in the same sector are also evidencing lows, followed by higher prices in all of these three categories (we ignore opening prices) for evidence of commonalities.
- When high volume occurs on the downside, it often speeds up the decline to subsequent market lows.
- Overall market volume is not as necessary as it is on major stock screening breakouts in a bull market, as outlined in The Ultimate Gold Stock Trader. As in seasonality, rally lows often occur in conjunction with relatively low volumes, as selling subsides rather than as substantial increases in buyer volumes.
- Investors and speculators in the current bear market have been looking for signs that a company will survive before purchasing specific stocks; in the next stage, they will be looking for them to thrive.
- Look for commonality both on the sell side and the buy side, most declines ran for an average of 13 weeks. Most rallies seem to have run out of steam around the 22 to 24 week stage of the uptrend.
- The largest drops and rebounds occurred on the large-scale, low-grade and large resource/reserve stocks for whom ultimate success is dependent on high gold prices.
- A study of 20 stocks entering the bear market with large cash positions did not demonstrate outperformance of the other stocks on our list. In fact, an excellent prospective property stock that gets funding early in the rally can often draw the attention of investors as a vote of confidence in management and its properties.
Detailed 2008/2009 Report of 36 Gold and Precious Metals Stock Rallies
Average Number of Weeks to Decline Low: 13
Average Number Weeks to Subsequent High: 21
Average Percentage Gain to Subsequent High: 378%
For your copy of the detailed list of 36 gold and precious metals resource stock rallies and/or the complete 250 resource stock rally list please e-mail Reg Ogden at: ogden@ultimategold.ca
Reginald W. Ogden
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This article is solely the work of the author for the private information of readers. Although the author is a registered investment advisor at Canaccord Capital Corporation ("Canaccord Capital"), this is not an official publication of Canaccord Capital and the author is not a Canaccord Capital analyst. The views (including any recommendations) expressed in this article are those of the author alone, and are not necessarily those of Canaccord Capital.
The information contained in this article is drawn from sources believed to be reliable, but the accuracy and completeness of the information is not guaranteed, nor in providing it does the author or Canaccord Capital assume any liability. This information is given as of the date appearing on the article, and neither the author nor Canaccord Capital assume any obligation to update the information or advise on further developments relating to the information provided herein. This article is intended for distribution in those jurisdictions where both the author and Canaccord Capital are registered to do business in securities. Any distribution or dissemination of this article in any other jurisdiction is strictly prohibited. The holdings of the author, Canaccord Capital, its affiliated companies and holdings of their respective directors, officers and employees and companies with which they are associated may, from time to time, include the securities mentioned in this article.
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