Philippine Mining Momentum Gains; Gold’s Potential Mania

``Truth, like gold, is to be obtained not by its growth, but by washing away from it all that is not gold." - Leo Tolstoy

The recent resurgence of major commodities such as gold (+2.14% w-o-w), silver (+4.43%) and crude oil (+2.14%~above $60!) appears to have given some traction to the newfound vigor in our mining industry.

As previously discussed in our January 15 to 19 edition, [see No Trend Goes In A Straight Line], the mining sector have been behaving divergently from the Phisix markets since 2006, where it first led the gains during the first half but following the May selloffs, the rally within the sector stalled.

As the Phisix underwent a massive run-up since July, except for some speculative issues, the mines either stagnated or underwent several occasional selling pressures. As the mines failed to pick-up with the general market, a sectoral rotation occurred where many speculators who had been previously bullish with the mines took turns shifting to the other sectors by dumping the mining shares. The wave of selling pressures practically left most of the mining majors to trade in a range while the general market ascended.

I have also noted that because the mining issues had missed the July-Dow inspired rally that they looked LESS vulnerable to a potential exogenous inspired correction or could be deemed as LESS risky when compared to the general market, which has risen significantly.

And that since the market operates in a “Rising Tide Lifts All boats” scenario, the probability looks favorable for the mines to benefit from a forthcoming sectoral rotation. But since I am no clairvoyant and nor am I a seer, I do not KNOW when this shifting should transpire.

Figure 5: Phi-Mining: Breakout looks Strong

With the recent price action of the mining majors as shown in Figure 5, it appears that the rally could get extended, as the momentum looks quite strong and could represent as the inception of the sectoral rotation trend towards the mines.

Yet there could short term risks facing gold prices and the mines, if one would consider the present positioning by investors in the Commodity Futures market, according to Jeff Clark of Growth Stock Wire,

``Commercial short interest in gold is now at a level that typically occurs at short-term tops in the market. According to a report from the Commodity Futures Trading Commission, the commercial net-short interest in gold futures and options is 177,000 contracts. That’s higher than the 172,000 net-short position we saw when the gold market peaked last May. And it’s higher than the 140,000 and 119,000 net-short positions that occurred during the September and December tops.”

So while we may face certain selling pressures in gold prices over the interim which may affect the activities in our mining sector, possibly sectoral rotation could provide for a support.

Let me further add that when investing in themes we try to avoid timing the markets because essentially it is hard to ascertain the tops and bottoms of the cycles, instead the prudent approach is simply to sit and wait until the cyclical shifts becomes evident.

And because we look at themed investing as a long term proposition, this germane outlook from BCA Research on Gold makes us want to keep our long positions of gold until the mania unfolds.

BCA Research as shown in figure 6, opines that Gold is playing out a reprise of the 1970-1980 cycle pillared on four factors (emphasis mine),

``First, global liquidity settings will remain plentiful because inflation will stay low. Second, investor demand for gold will rise in response to higher gold prices after an extended bear market. Third, central bank selling could take time to re-emerge after the wave of liquidation in recent years. Finally, Chinese and Indian private sector gold demand should improve as their wealth and incomes rise.”

While I don’t share the view that inflation will stay low as global monetary authorities continue to pump immense liquidity into the financial system and don’t think much can be done with Central bank selling [they could likely be buyers instead of sellers in the long run], I generally think that gold will eventually go beyond US $1,000.

While we think somehow that investing in mines could serve as a proxy to gold investing since we don’t have a gold market, it is important to realize that not all mines are of the same quality. As such we want to remain invested in mining companies which have the following criteria, as expounded by Craig Walters of the Sleuth.com (emphasis mine);

Evaluate the Level of Sales and Earnings: Many risky exploration companies exist in the marketplace today that have no real sales or profitability. They may have been clever enough to attract lots of cash in the hopes of making a large discovery, though. Unless your risk tolerance is extremely high, you’ll want to own the companies that are actually generating cash flow from selling gold.

Examine the Company’s Reserves: The amount of gold a company has is measured by its reserve level. The higher the reserve, the more gold that can be translated into sales and earnings. It’s important to pay close attention to a company's proven and probable reserves numbers. This will clue you into the possible amount of gold the company can reasonably expect to extract and turn into a product for sale.

Location: It’s important in real estate, and it’s important in gold investing. Well, it’s not so much the location per se, but the politics that control it. It's better to pay a slight premium for gold in a politically stable area than to risk having a dictator seize your company’s mine, leaving your investment worthless. Obviously, gold plays in North America are among the safest in which you can place your money from a political perspective.

Funding: It’s important to look for gold companies that are able to self-fund their operations. That is, they are generating positive operating cash flows, and hopefully positive free cash flow as well. A gold company might have to tap the equity and debt markets from time to time to fund major new projects, but we don’t want to invest in companies turning over sofa cushions to stay alive.

While some mining firms may be in a hot streak for other reasons than the above, we’d like to get a good night sleep and position on issues that “won’t turn sofa cushions to stay alive”.