Hey Gold, Don’t Get Cocky!

Gold Fever - Article Header

Seen this movie?  If not, it appears to be starting another theatrical run.

With the recent action in gold, the precious metals bugs are all stirred up.  Price action has been constructive.  Big time asset management names are mentioning it and the metal is definitely conveying a message.  New songbirds are putting their price calls out there for short-term and long-term destinations.  The old songbirds are putting their same old calls out there as they suffer permanently from the fever.

There’s no fever like gold fever, and I’m an expert in the symptoms.

We’re already seeing the $10,000 and up per oz. calls for gold.  What’s funny is you see the same old reasons for why precious metals are going to boom.  Everybody was selling the same handful of points in the last gold bull run and those same points are being tossed out there again as if they have meaning or truth.

– Negative real interest rates

– Excessive debt loads

– Accommodating monetary policy by central banks

– US Dollar losing value via debasement

– Inflation expectations

– Supply shortcomings

This is folly.  These are not reasons for anything; merely convenient sales pitches that still work on the zealous subset of speculators that are looking for either a reason to stay devoted to the precious metals or believe an amazing amount of money will be made by a small speculation.

From a technical analysis standpoint, it’s time for a rally and the price action hasn’t disappointed thus far.  However, technical analysis has virtually no merit any more due to the advent of the internet.  This has been statistically proven.  Tape-reading still has merit in conjunction with technical analysis and fundamental analysis, but it takes real talent and luck to fight the machines.  Here’s a Captain Obvious chart of gold proving higher prices in the making.

Snarky Gold Chart (7-13-2019)

But there’s only one thing that could potentially drive the price of gold and the precious metals to those high price levels so blithely forecasted.  Here it is in plain, bold English:

A HIGH PERCENTAGE LOSS OF RESERVE STATUS IN THE USD

That’s it.  I believe that to be the only driver that will get gold up over $5,000/oz. or higher.  Something in the order of the USD losing perhaps 35% or more of it’s reserve status which will coincide with decreased use of dollar-settlement in international trade.  Or said another way, chaos.  Because if the rest of the world decides to shift part of the USD’s reserve status to another currency whether it’s gold, Bitcoin, SDR, yuan, etc.; you can bet those in power in the US will be wreaking havoc as a result.  This will be adjoined to the financial/economic chaos that will already be in place.

There still exists old-world faith in the precious metals, and blockchain currencies do not have enough cumulative faith by investors to reel in allocation decisions.  This is the path for significantly higher prices in gold, silver, and the PGM complex; potentially even for the commodity complex.

Regime changes in currency reserves are not fast.  They don’t just happen like a stock market correction.  Many powerful and wealthy nations have a vested interest in the USD maintaining it’s ultimate reserve status.  Just bear that in mind as we watch the dynamics between all asset classes, markets, economies, and countries play out in real time going forward.

It’s tough to visualize if you can’t foresee a world where the USD loses place and face.  But hell, don’t take my word for it.  Google and consider the opinions about the subject of some of the most powerful financial insiders in the world:  Larry Fink – Head of Blackrock, Ray Dalio – Largest principal in the largest hedge fund in the world, and Mark Carney – Head of the Bank of England.

Ain’t no fever like gold fever.  Keep your wits goldbugs.

A Green Island in a Sea of Red

Like many a speculator, I’ve dabbled in the juniors. Specifically, I’m referring to junior gold and silver explorers and miners. Before 2011 it was a successful endeavor, post 2011, not so much. One of the things I did before altogether stopping the placement of new capital in any juniors was to compile a list of what I deemed to be some of the top opportunities for when precious metals finally make their turn back to positive. For the record, I don’t know when that’s going to be. The gold price languished for 20 years in the 80’s and 90’s. Do I think we’re in that type of 20-year-bear? No, but I don’t have a clue as to when the ship will right itself.

I simply believe in the long-term thesis for holding gold, but more importantly, I believe in the cyclicality of the commodity markets and historical precedence. There are any number of arguments in favor of allocating capital into precious metals, but for most speculators, the current price action in gold and silver pretty much tells the entire story. A declining market is not exactly the best moment to deploy new capital into the most riskiest ventures of a loss-leading sector. Thusly, it’s been at least 2 years since I speculated with any capital in a junior.

Which brings me to the list. One of the companies I had kept a passive eye on was Duluth Minerals. If you’re unfamiliar with their story, they’re the proud majority-owners of some prime property through a joint venture in the Twin Metals complex in Minnesota. Their land package and joint venture partner was what first attracted me to them. Duluth possesses one of the most promising platinum group metals (“PGM”) resources outside of Africa or Russia. In fact in North America, there’s really only two primary PGM producers of consequence, and they are Stillwater Mining and North American Palladium. So access to a nice PGM resource in a jurisdiction like North America is coveted.

However, PGM’s won’t even be the primary metals mined at Twin Metals. It’s primarily a copper and nickel mine. The PGM’s are a just a very nice by-product. Hence Antofagasta’s interest and investment in Duluth. Just a little background on Antofagasta (“Anto”), they are one of the largest, pure copper players in the world. Based in Chile with 4 operating mines, 90% of the company’s revenues are derived from mining operations. In 2013, they generated approximately $6 billion in revenue which is in line with large US copper player Southern Copper (SCCO) but far below the diversified mining giants such as Vale (VALE), Rio Tinto (RIO), or Freeport-McMoRan (FCX).

Before getting to the point of this post, some additional background is in order. So we have a major copper player with concentrated interests in Chile attempting to diversify their portfolio with the Twin Metals joint venture. In 2010, Antofagasta partnered with Duluth and over the next few years provided approximately $220 million in funds in order for Duluth to develop the properties. Duluth completed a ton of drilling to really prove out the potential of Twin Metals. They contracted with Bechtel, one of the largest and most powerful privately owned corporations in the US, to assist with the planning for the build-out of a mine.

But by 2014, Duluth had not done enough to build investor sentiment behind their company and access to capital was drying up in light of overall commodity underperformance, let alone precious metals performance. The stock price was badly languishing. Duluth’s cash reserves were drying up fast, and in July, Anto neglected to capitalize on an additional financing round that would have increased their ownership stake in the mine and provide much needed capital for Duluth. Clearly, Anto saw the writing on the wall and knew a better opportunity would avail itself very shortly.

One month later in August of this year, Duluth released a highly detailed presser of its Pre-feasibility Study (“PFS”) for the Twin Metals. The PFS was essentially a disaster as expectations were way too large. The stock price, trading at $0.40 a share the day before the PFS release, dropped 25% down to $0.30 a share on the day of the release. I think too many speculators in Duluth thought an outlandish estimate of PGM production was going to be reported, and that was obviously foolish. I sincerely believe that speculators really thought Twin Metals could annually pump out 300k or 400k ounces of PGM’s along with a couple million ounces total of combined silver/gold output.

The numbers were very solid, though. Specifically, the report estimated a 30 year mine life with total estimated production of 5.8 billion pounds of copper, 1.2 billion pounds of nickel, 1.5 million ounces of platinum, 4.0 million ounces of palladium, 1.0 million ounces of gold, and 25.2 million ounces of silver. Annually, that breaks down to approximately 88,000 tonnes of copper, 18,000 tonnes of nickel, 50,000 ounces of platinum, 133,000 ounces of palladium, 33,000 ounces of gold, and 840,000 ounces of silver. At spot prices for each of these commodities as of August 20th, that would’ve resulted in approximately $612M in copper revenues, $340M in nickel revenues, $187M in total PGM revenues, and $59M in gold & silver revenues. All product sales would theoretically total about $1.2 billion at those prices if the August 20th spot prices were the average for an operating year.

Now I don’t know about you, but for the right price, that’s definitely a resource I’d like to have my hands on. And that’s exactly why Anto did not participate in the July scheduled financing. They figured why bother. They’d already funded over $200M in project development. Duluth management was floundering while swirling the drain of bad finance options. Why not strike at the opportune moment and simply own the entire asset versus partnering in a JV. Just 9 days ago, that’s precisely what happened. This chart, courtesy of Inka Kola News, tells the story via price action.

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The PFS calculated a net present value of the Twin Metals project at $1.4 billion USD using an 8% discount rate. Anto already owned approximately 10% of Duluth. So Anto already invested approximately $220M into Twin Metals and only has to come up with roughly another $85M(including convertible debt and additional operating funds) to own the asset outright. That’s an absolute steal and congratulations to Anto’s management for deftly structuring the deal in obtaining the buy-in of Duluth’s board and of Wallbridge as well.

Now the reason this little sale is a green island in a sea of red is because I was able to perfectly time this trade. I watched the stock languish all year and when I saw that move two Friday’s ago, where Duluth dropped from 12 cents a share to 7 cents a share, I decided it was time to pull the trigger. I maintain a portfolio for my children’s future. It’s reserved for only the best businesses with the best long-term outlook that possess the best brands and continue to raise dividends decade after decade; names like Hershey and McDonalds. However, I thought why not buy a several-thousand block of shares as a little lottery ticket. At $0.07 a share, I simply thought the risk-reward was well justified for my wee ones in light of the quality of the underlying asset.

The wager paid off a lot faster than I expected. Waking up the following Monday morning and reading various headlines from various sites I frequent, I read that Duluth was selling itself to Anto. I immediately jumped over to Yahoo Finance to see this:

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Well, hot damn! From a percentage gain standpoint, this is by far the most I’ve ever earned in a single trade for only holding a single trading day. I won’t annualize it as I’m sure I’ll probably never get this lucky again. Of course, the net income off the trade is minimal in light of the total amount of capital risked, but still it’s a nice little boost for the year to my children’s future. I haven’t actually realized the gain yet as I’m holding for a little currency translation to work in my favor first. Mistake? I don’t think so, as I think Canada will approve the sale of Duluth so I have the $0.38 locked in at today’s Loonie rates. The dollar looks set for a little breather and I suspect that just may translate into the higher liquidation price I’m reaching for.

Coming back to Anto and what the future holds for Twin Metals. They’ve admitted they have a long way to go, with their own projections putting production out to 2020 at the earliest and possibly even farther. The next step from the PFS is the Bankable Feasibility Report (“BFS”). It’s this report which will allow Anto to secure financing for the construction of the mine. Actually, they probably won’t even bother. Consider that the pre-fease reported mine construction expenses at $2.8 billion. We know that’s aggressive, so I think it’s safe to arbitrarily add another $400 million onto that total. Conservatively, building the mine is going to cost approximately $3.2 billion. But even with a staggering expense number like that, Anto should have no issues securing financing.

This is especially so if the cost of capital continues to stay cheap for players with access to the liquidity. Looking at free cash flow (“FCF”) for Anto, they’ve averaged $1.9 billion USD in FCF for the last 4 years. With that kind of cash generation, I don’t think they’re going to have a hard time obtaining financing at favorable rates. The money is not the issue. What’s more worrisome is of course receiving all the requisite permits to construct and operate the mine. The project is located in a state that calls itself “the land of a 1,000 lakes.” That’s a lot of water ways that can be affected. There will be a tremendous amount of pushback from environmentalists who will attempt to deter Anto. Just look at Pebble and the fight in Alaska. However, with a safe and environmentally friendly construction plan along with a superabundance of funds allocated to remediation of the lands, I feel confident Anto will pull it off. Just not without a fight. Although they do have this going for them:

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When you have a day named after you in a state, I think it’s pretty safe to assume that the state is going to be very cooperative in light of the economic benefits to be garnered.

Just remember, you had a chance to own a fractional share in a billion dollar mine for a little over a nickel a share. The junior space is beginning to heat up as quality assets are beginning to be circled. The sharks are starting to get restless as a vast majority of the juniors simply will not be able to obtain sustainable financing in light of their current share prices. We’re talking about companies that simply throw cash down a hole with zero immediate economic return and too much G&A digging into value creation. New Gold snatched up Bayfield to round out its Rainy River package. Nord Gold is positioning on Columbus. Romarco just received all of its final permitting and negotiated a $200M dollar debt package that will allow them to begin construction immediately on their Haile mine. How long before a bidding war starts on their potential 150k ounce per year mine?

There’s value to be had and money to be made in the junior space, but it’s highly dangerous and not worth the capital risk for the average investor. I’ve been fortunate on a few junior trades in this terrible gold market with Romarco, Lake Shore, and now Duluth. I could easily replace the word fortunate with lucky, however, I did my homework on those companies. I’ve also screwed the pooch in names like Aurcana, Kaminak, and McEwen Mining with poorly timed purchases. All companies that have very good potential if or when the precious metals resume a bull market.

Despite my luck in the Duluth trade, I am a strong proponent of buying the right stocks for long-term holdings. As I stated before, that means companies with mega-brands who produce enormous amounts of free cash flow and consistently raise their dividends. Buying these kinds of companies when they go on sale is essentially a sure-fire bet to building wealth, but a little flyer every now and then is worth the risk.

Being Early is the Same as Being Wrong?

How many times have you heard that saying from the post title in the world of speculation? A bazillion to be sure and it’s true, but the beautiful thing about that saying is that it only applies to timing. It does not necessarily always apply to analysis. Traders lose all the time. It’s just a way of trading life. That’s why the discipline to cut and run is all important. Just because your analysis may have led you to be early on a move, doesn’t mean you cut and run from the analysis. There could be profit left to squeeze out of it and if you let your emotions get the best of you, then you might leave money on the table…and we all know that’s a trading sin.

Observe the following 2 charts from a June post for a perfect example of this notion in action with the Aussie Dollar Currency Shares.

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Now I lost money on that first trade as the short energy simply had not dissipated yet. I thought the up-turn had occurred, but we had yet to even see a bottom in FXA. Serves me right for playing Mr. Pseudo-currency trader. My wheel-house is equities, but you read enough charts and conduct enough analysis and you just feel like you can trade anything. I kept my eye on the action in the Aussie dollar while also following the RBA decisions, amongst other indicators. As some real heavy hitters were reported to be short the Aussie dollar, it seemed as if the move had reached total extremis and a short covering rally was a distinct possibility. Additionally, the political hijinks of America were going to produce a counter-trend rally for some well-regarded international currencies, and the Aussie was as ripe as any. Observe the current action.

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If I had given up on this trade and just moved on to another asset class, then the profit would have totally been squandered along with the opportunity to reclaim the loss from being originally stopped out. You have to have conviction in your beliefs if you know your analysis is sound. Obviously, it doesn’t pay to fight the market but that doesn’t mean that the market will keep fighting you. Markets capitulate at extremes, providing fantastic opportunities for the diligent. And just for laughs, an ancient chart pattern, The Double Bottom, actually proved its efficacy in this particular instance in portending the trend change. Score one for classic technical analysis against the hyper-algo houses, however, don’t get used to it though. You’ll just lose money with that kind of thinking, that classical patterns will definitely play out in your favor. Have a look at Peter Brandt’s note on the H&S in GOOG back on October 9th. Granted, he did do the full disclosure thing stating that all patterns are subject to failure. Brandt is a true OG in the trading game, but everyone gets it wrong sometimes. Now I may miss out on some more upside in FXA, but I’m cool with recouping previous trade losses and harvesting new profits under my original analysis.

It can’t be reiterated enough how important it is to mind your stops with absolute discipline. You never want to enter your stops into the market because our algo-driven world has the ability to sniff these out and run them. Of course it takes position size for that to occur and an aggregation of sloppy retail holders may provide that size. Although if you simply cannot be disciplined enough to close out the trade when warranted, then do what you have to do by entering the stop. Again, I’m not abdicating for the usage of actually entering your stops into the broker. That’s amateur hour even for amateurs, but it takes time to learn how to cut and run. The primary thought process of the average amateur speculator goes something like this, “Well it’s moved so far below my purchase price that I might as well wait for it to come back and then at least I can break even.” Or if it’s an option, they foolishly allow it to expire with a total loss. Discipline is key and the trailing stop is one of the trader’s best friends.

It’s difficult to touch on this subject and not comment on the gold market. For the gold bugs, faithfully holding onto the precious metal and the precious shares it’s been a nightmare of a dislocation. For the “finanical-assets-are-the-only-place-to-be-and-a-gold-allocation-is-stupid” crowd, then this dislocation is providing the music for them to tap-dance on the hearts of the “sit-tight-and-be-right” hopeful holders of precious metals related assets. But are those tap-dancers early themselves? Are the people who have gathered precious metals related assets going to have the last laugh? Nobody can say or predict with any true credibility. There are credible sources on both sides of the argument for the gold price direction. The short-term extrapolation by the pro-financial-asset side is so glaringly and willfully ignorant of the many historical facts and the current trends that are racking up in favor of precious metals. But on the opposite side of the coin, the assumed guarantee of certain actions in the economy and thus the precious metals by the Hayek/Mises followers can also be labeled as glaringly and willfully ignorant of modern market & monetary dynamics.

Full disclosure: I do lean toward the Austrian line of thinking, but I’m not a blind fool. Let’s be real. You have to be allocated across multiple asset classes. If you have the means, it makes sense to take advantage of real estate values and advantageous financing…even after 1 year run-up’s in values and mortgage rates. The long-term statistics behind holding dividend growing, cash gushing mega brand companies speaks for itself. And nowhere has that been more recently evident than after the 2008 downturn. Fixed income is not dead. There are some sectors within that asset class that are struggling for breath, but fixed income will always be a sound allocation within a well balanced portfolio. Commodities are volatile and to over-allocate based on some historical precedents is unsound money management. As I stated though, maybe the goldbugs end up having the last laugh in that sort of The Big Short kind of way. To ignore the following chart, courtesy of Tom Fitzpatrick at CitiFX, is to think this time is different and mean reversion doesn’t work.

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Can you find a better, more consistent, and tighter correlation to gold than the US Debt Limit? If yes, then please feel free to comment below or e-mail. I’d like to hear other opinions, biased or unbiased. I’ve observed plenty of indicators over the years and this continues to be one of the strongest. Actually, there may just be one that is stronger. For some more ha-ha’s, I’ll include the following gold charts by the consistently insightful Tom McClellan. The gold price runs quite nicely with a certain 13 & 1/2 month cycle.

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You may be thinking that the timeline is so short that this correlation is statistically worthless. Well he provided a longer chart for that, too.

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So if you didn’t read the original note back in August, then you’re wondering what the heck is this fairly tight sine wave correlation to the gold price. The answer as presented by Mr. McClellan:

I mentioned that I don’t know why gold exhibits this very regular 13-1/2 month cycle.  But I do know that there is a very real and important anchor which seems to control its regularity.  You may have noticed that these charts show a rather funny looking representation of a sine wave cycle, with bars instead of a wiggly line.  Those bars have an important meaning: They represent the distance between the earth and moon on the day of the full moon.  So the 13-1/2 month cycle which is evident in gold prices just happens to match up really well with the lunar apogee-perigee cycle.  Or at least it has for a couple of decades, which ought to be long enough to establish it as a real phenomenon.

Seriously! The damn distance between the earth and moon during a lunar cycle. Hard to ignore it whether you think it is laughable or not. Gold has been showing some constructive action since going sub-$1,200 in June. It’s doing the classic higher lows walk right now and everybody can see the hardcore resistance at the $1,430’s and $1,530’s. Those most obvious resistance areas that literally everybody in the world can see makes me suspect that the paper price of gold will be sold off hard at those levels, by whatever entity or entities you want to believe conducts those sorts of operations. What we’ll really want to look for is the buying action off those potential sell-offs that will provide insight into how constructive the ongoing move really is coming out of June.

I don’t usually provide precious metals shares trading recommendations as the action in the shares is predicated solely on the underlying asset. With the volatility swinging so wildly with what appears to be no fundamental reasoning, it can be highly dangerous to speculate in gold or silver miners. Consider yourself duly warned and take another gander at the disclaimer as I’m not an investment professional and readers bear all the risk of trading or investing in these markets off of anything read here. Now that that’s off my chest, observe the following weekly charts of two quality miners. The first is Yamana (AUY) and the second is New Gold (NGD).

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The reason you’ll want to follow these two miners is that you get a top flight major producer (AUY), albeit very small compared to the big dogs, and a high level mid-tier producer (NGD). Both trade at penny stock prices. AUY and NGD share some operational qualities that distinguish them as quality picks in the mining space. They both possess top shelf management. They both possess some of the best all-in sustaining cost numbers for producers their size compared to their peers. They both possess readily available access to funds for project development. A majority of their mining and exploring operations are in respected, safe jurisdictions; especially New Gold. Most importantly they have huge growth already built into their production schedules over the next several years, which if precious metals resume their bull advance, then earnings growth has the potential to be very significant.

As far as a short-term trade to potentially leverage a move in gold over the next several months, I prefer AUY. And look…you can see that classic chart pattern again, The Double Bottom, rearing its head to possibly portend a trend change. There are a multitude of ways to execute a trade on these two. Simply buy the shares and go long. Buy some calls a handful of months out and subsidize part of the purchase with a put sell. Buy some LEAPs by themselves; hedge with some puts on the GLD. The last two times I played LEAPs in AUY, before the beginning of the Precious Dislocation, I was able to liquidate each trade with a 200% gain. The first in just a few weeks; the second in just a few months. Remember to conduct your own due diligence and structure a trade in which you are comfortable and allows you to sleep. Also, a concerted move below October lows will negate any analysis for a positive move upward

As far as a major move in gold pushing the price multiples higher in the years to come, well I’m in the camp that believes it’s probably going to happen. Am I a blind follower who prays to the Precious Metal gods daily and reads passages from the King Lebron James version of the Great Book of Precious Metals? All while rotating my alternating gold and silver rosary beads in my hand to add heft to my precious metals prayers? Decidedly not. In attempting to evaluate all the historical information at hand and objectively assess the current data, my noggin tells me to be positioned for a potential continued advance through this decade. At this point there is still plenty of time to open positions and begin accumulating the actual metals or quality shares, but to absolutely refuse an allocation based on pure ignorance or ego is a shameful act of poor money management. There are a plethora of wealth managers and bloggers whom have bought into their published stances with such conviction and unparalleled vanity, that they can’t truly admit to utilizing an objective or agnostic approach and perhaps are surrounded by one too many sycophants. It all sort of reminds me of the South Park episode where some of the parents start purchasing Toyota Priuses(Priusci, Priusae, Prius’s, or Priussessez) and then loving the smell of their own farts. Thankfully I reside in a country where everyone is entitled to their opinion, but the anti-PM crowd just may be early in their celebrations and wrong in their analysis.