FROM LETHARGY TO PANIC SELLING
After the volatile ride on world markets over the course of last week, the Australian precious metals sector, which had been exhibiting signs of lethargy, quickly became prone to panic selling as investors lined the sell sides of many of the popular issues prior to the market opening. All of a sudden those that had publicly announced their conversion to PM's, had later declared that they had in fact exited positions in the belief that the gold bull market was basically over.
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The strong performance of the POG, combined with increasing mainstream attention has resulted in Internet forums and the financial press becoming littered with articles on gold, and the benefits of portfolio diversification. Those that had only recently invested in the sector are now faced with significant near-term capital losses and may be forced to exit early next week unless conditions improve. Whether or not these new investors become "gold bugs" remains to be seen, however for many the memories of the Nasdaq debacle is simply another reason to steer clear of more speculative investments. There is now a ground swell of negative sentiment building towards the gold sector, and the bullish stance still taken by analysts is being drowned out in the rush for the nearest exit.
Average Down? No Way, Jose
Broker: Good Morning, there is some weakness in the gold sector at present due to the stronger USD and a rebound in the DJIA. That quality gold producer you purchased at 75c is currently 53c-54c on strong volume.
Client: Why has it fallen so heavily?
Broker: Basically there was a rush into the gold stocks as the USD weakened against the other currencies, and the weak hands and short-term traders that bought them at higher levels now wish to exit their positions, with some waiting until the POG can break through $330.
Client: What are you suggesting we do?
Broker: The stock you purchased has just announced a record profit, and is currently exploring to expand their resource base. I would suggest we place a bid at 52c and 50c, to lower your average entry price and build a stronger position.
Client: If the profits are so great, how come people are selling it? I bet they know something that you don't.
Broker: There is nothing wrong with the company, and as I have explained earlier in the conversation the POG has fallen and I now think this stock is back to excellent buying levels.
Client: If that is the case, why didn't you tell me to wait till the stock fell into the 50's instead of paying 75c for it? I could have used that extra few thousand dollars to pay some bills and maybe bought that other stock I was thinking about that is now going up, whilst this gold stock collapses.
Broker: (now totally frustrated, realises it is not going to happen). Well I suggest you watch the stock, and have a think about what you might like to do.
Client: That sounds better, let me read over the announcements and check what they are saying on the Internet, I might ring you later in the day.
The strategy of averaging down is one that is often scorned upon in the mainstream press and in a significant number of generic investment books, which tell investors to "never add to a losing trade".
Broker: Good afternoon, I wanted to mention that the gold stock I suggested to you at 55c is currently 80c bid on heavy volume. I have some other ideas where we can place the funds, as another stock has excellent growth potential that is yet to be picked up by the market.
Client: Well done, I knew once I read the charts this stock was a winner. I am turning into quite the investment guru aren't I?
Broker: Maybe we take half profits on this one and have a look at a small bid on the other stock. It tends to trade in low volumes so it may take a week or so to pick the stock up.
Client: Why would I want to sell the other one? It is clearly in uptrend, and on the Internet chat site someone said there is a takeover coming at $1.50 per share. Why would I want to buy that other stock that cannot find a buyer? Are you simply after the commission?
Broker: I have a research report on it, and they just had an independent valuation where the share price is over 50% undervalued. Why don't you have a look at it, and get back to me.
Client: That's a good idea, I will phone you Monday next week.
In both cases the client never phones the broker back, and the process will continue to repeat it indefinitely. The majority tend to chase stocks, but are not prepared to purchase those that are yet to become mainstream yet offer far greater value than the stocks constantly promoted.
Husband: Hey sweetie I see Target have 15% off everything today. Maybe we can go get some toys for the kids and some Manchester.
Wife: Really? I will go get changed now, we better be quick to snap them up before the crowd gets there.
Husband: Darling, those gold stocks are looking cheap again. Maybe we can put off the new car for a few months and buy some more producers that are paying dividends, and perhaps ones of those explorers we were talking about that is about to drill near that major gold mine.
Wife: What if the stocks fall further? I really want that new Commodore, and if we buy them we may have to settle for a used car. I suggest we stick with our plan, as you can always get back into those gold stocks. I met some of the ladies at the tennis club that said their brokers were telling them to sell the gold stocks and buy more tech stocks that are making somewhat of a comeback.
With attitudes like these dominating, it is painfully obvious to see why the buy sides of many gold stocks tomorrow will resemble ghost towns. The anxious sellers will have to tick down their orders several price steps in order to fill them.
GOLD BUGS OR THE SHORT-TERM TRADERS BUYING?
At some stage, possibly tomorrow a number of gold and silver stocks will become heavily oversold on a short-term basis. As we witnessed during the Nasdaq boom times the volumes seekers treat every stock as numbers on a screen and have no interest in what the company does let alone the sector they are buying. I would anticipate that the short-term traders would dominate, before we see any meaningful accumulation from those prepared to hold. The downside of the short-term traders gaining control is that the volume soaked up will be looking for the exits within a few days or at the first opportunity to realise a 1c profit. The stocks that did not enjoy the spectacular rise in May/June will continue to suffer from low liquidity and having their share price knocked down several percentage points on one or two modest sell orders.
VALUE INVESTING AS OPPOSED TO BUBBLE VISION
During the recent spike in the POG, a number of explorers were attracting market capitalisations in excess of $50m after the release of promising initial drilling results. Sure these valuations can be maintained with the POG soaring through $350, however once the panic starts there are not enough doors to handle the mass exodus. Those that bought at the peak of the excitement, find themselves not only with a hefty capital loss but also a severe loss of confidence to again enter the PM stocks. This process will take some time to sort itself out, however at the first sign of daylight I would expect a flood of new entrants again chasing the promise of a "fast buck". The stocks that have competent management and a resource to back their market capitalisation are the ones that will eventually recover from their shellacking, and prosper regardless of the "short-term noise" that tends to distract the longer-term value investor.
Despite the correction in the POG and calls from the mainstream press that the Dow and Nasdaq are near the bottom, gold bugs should ask themselves a simple question, "Have the fundamentals that took the POG to $330 in the first place, really changed that much". Your answer will be reflected in which side of the screen you occupy over the next coming week.
Tony Locantro
locantro@iinet.net.au
30 July 2002
Tony Locantro is a client advisor in Perth, Australia, and the author of "The Green Room", A Guide To Speculating on the Australian Stock Market. Tony was previously a major contributor to Australian Internet forums under the nick "Budfox" from 1998-2001.
Stocks mentioned in this article are for illustration purposes only and do not represent investment advice. The author has both direct and indirect interests in stocks mentioned in the article and these may change without notice.
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