Speculative bubbles are destructive events where considerable wealth is transferred, personal relationships breakdown and when the music finally stops the post mortems can be harrowing affairs that usually result in numerous damages cases.

"Bear markets are periods where investors and governing bodies try to come to terms with how the majority went wrong in the bull market"

In 1998 I moved to Perth after deciding that a major career change was well worth the risk. Whilst I enjoyed my previous profession immensely I felt I needed a new challenge and the stockbroking industry was the plan of attack. After learning the ropes throughout early 1999, the speculative market began to takeoff and erupted into one of the most awesome financial frenzies in recorded history. Suddenly I was earning my previous yearly salary in a handful of weeks and I thought it was Hollywood. On Saturday mornings after a big night on the $100 blackjack table I would cruise the local streets in search of real estate bargains as I saw some growth potential within a 5km radius of the CBD.

When I look back at this period I came to the conclusion that my lifestyle was far from healthy, my spending was out of control and it was a stressful period, carrying significant financial risk where clients were taking huge risks on the overnight trade. I admit that taking home a kilo of prawns and a few dozen oysters with the grocery shopping gave me a warm and fuzzy feeling however when you have had around five years to analyse what was occurring it is a very sobering reality check.

I believe the fundamental outlook for gold is the best it has been for many years due mainly to the precarious state of the US dollar and the potential bursting of the debt bubble. With production in South Africa set to decrease significantly and numerous developments now shelved due to higher costs it is likely that the supply equation may take sometime to spoil the party.

WHERE WE ARE NOW IN THE CYCLE

The POG is now around $430 with many juniors strengthening on the back of announcing their uranium interests rather than moving on the underlying fundamentals relating to their gold projects. There have been a number of stunning exploration results released to the market, overseas funds and institutions are starting to take on equity raisings across the sector and I feel it is only a matter of time before we undergo another bout of rationalisation in the sector.

Those who take note of resource upgrades, exploration results and who is making noise in terms of investments could well be the ones to prosper during the next phase. With the gold price threatening to move higher and calls from industry leaders of $500+ by early 2006 accumulating large holdings in some gold stocks is becoming increasingly difficult and I believe this situation will be exacerbated as the trading conditions conducive to share price upside are building nicely. The resilience of the US Dollar has caught many by surprise and the temptation for gold enthusiasts to chase the uranium players must be overwhelming. This is the period where one has to hold their nerve, refuse to punt the blue sky and continue to build positions on any prevailing weakness.

MY GOLD BUBBLE FORECAST (CRYSTAL BALL)

Rationalisation and/or a major discovery

I believe the catalyst for the next phase of the multi-year gold bubble will come from either a major mineral discovery (in excess of 1m ounces) or corporate activity relating to a major Australian gold company in the shape of a takeover from an overseas predator or where two mid-tier companies agree to merge enhancing their investment appeal.

A number of gold companies are currently embarking on major drilling campaigns with recent results suggesting a major hit is not that far off. Although the results have been released into a disinterested market there has been a steady flow of clues emerging as to where one should be parking their investment funds. I have noted that the interest out of Canada is increasing and it would be no surprise to see some major producers eyeing off a number of our companies as being a cheap entry into Australia. With the costs of establishing a plant and infrastructure skyrocketing it would not take much for a major to come in and swoop on companies trading at a ridiculous EV (Enterprise value you divide the gold resources in the ground by the company's market capitalisation) It should be noted the current average EV for emerging/small producers is around $40.

Near-ology the driver of a "regional boom"

During 1996/1997 companies in the Gawler Craton reacted to the Helix (HLX) discovery, and in November 2001 we witnessed a brief flurry into those companies in the general area where Prominent Hill was discovered by Mintoaur (South Australia). :

Last week a private company RMG Services reported 67m @ 3.03% copper and 0.4 g/t gold in the Gawler Craton, South Australia, however with RMG not being a listed company there has only been a lukewarm response from the press and those companies with tenements near the discovery. Behind the scenes this news is likely to reinvigorate exploration in the area and hopefully lead to some further impressive hits to stimulate investor interest.

The Application of the "takeover premium"

When a company is the subject of corporate activity, investors tend to seek out similar companies then through speculation the takeover premium is eventually applied. It would only take one Australian gold company to fall prey to an overseas predator to see the big end of town re-rated quickly, which would then flow on to the smaller producers and those sitting on significant gold resources.

Gold breaks $450 again

Investors are hypnotised into a psychological trance when it comes to key price targets being approached or blasted through with little resistance. There could well be literally hundreds of cashed up market players waiting for gold to break $450 before they even contemplate buying gold shares. Once we have $450 out of the way, the next stop is wait for it….$500 and when it reaches that level it is time for even the stock market virgins to enter to the fray. The major gold producers would be the ones likely to initially benefit from such a move, however I would expect a buoyant speculative market to gradually re-rate the junior end of the market.

Adapting to higher market capitalisations

As the POG leaves $450 behind participants will now have no option but to apply higher market capitalisations in terms of their entry points. In some cases you are now able to purchase quality explorers for under $5m, however with a re-rating underway the bare bones cap could well be in the vicinity of $15m-$20m. (Allowing for some dilution). This is where the early movers will be staring down the barrel of 5-10 baggers and are likely to commence some strategic stock rotation to again capture some limited opportunities. With market depths solidifying I would expect the trading environment to improve significantly and the rallies based on exploration results are likely to translate to more sustainable re-ratings. Liquidity will be the major driver during this transitional phase.

The average age at mining conferences is now likely to be 2-3 years lower with a slight but noticeable increase in the number of females in attendance.

$500 here we come

As the key $500 level for gold becomes a reality I would expect that some healthy profits would have been taken from the majors and mid-capped gold companies, whilst the juniors were enjoying a major increase in investor attention. The failure to breach $500 during some sessions is likely to result in heavy selling pressure, as the anxiety levels of speculators would now be approaching breaking point.

I would expect many to sell out around these levels, as no doubt there will be considerable opinions broadcast on how gold was now on its way back to $300 and below. There could well be a number of graduation ceremonies for the new breed of "gold gurus", whilst the technical analysts would continue to apply their craft and present either bullish or bearish forecasts based on their methodology. Trading programs are likely to be geared towards the gold sector where information on resources, grade, location, and exploration costs will become more freely available. With increased prices and some share prices starting to get out of hand I would expect a significant increase in the number of commentators dismissing the rally as being short-lived and urging investors to treat the market activity with extreme caution. (Similar to what we have witnessed in the base metals and uranium sector)

Diverse portfolio mix and gold lease applications

With serious money now being made in the gold sector, the next phase will involve the uranium/thorium/REE/titanium/silver and biotech companies re-iterating that they indeed have gold potential on their leases or are in the process of assessing opportunities in the sector. With prospective ground hard to come by in Australia I would expect SE Asia to be swamped and this would also include a mini China gold rush, followed by an influx of gold lease applications in some more exotic countries. Already there has been some movement into the independent countries ending in STAN and I would expect this trend to gain considerable momentum based on the highly prospective nature of some countries. Greed overrides most things and political risk has always been a pushover when the whips are cracking.

IPO's and placements followed by a correction

By now the IPO and placement phase would be well underway as companies after their incubation phase were now ready to list. Stocks are now listing at substantial premiums and this serves to exacerbate the process. By this time with investment funds drying up in the short-term and many new investors entering the fray I would expect a nasty correction of sorts as share prices retreat from their 12 mth highs and stocks are hit hard by technical selling. This could be one of the more critical shakeouts leading towards the speculative blow off phase.

Run spot run!

The POG will now be called upon to lead the juniors out of their slumber and during the next phase I would expect new highs to be created in a number of situations with overseas buying and capital raisings providing stimulating the market. This is where the gold sector will be gaining considerable press attention and PM investments would now be more widely discussed.

The pick up joint and outperformance

With a positive lead from the POG and speculators now focussed on gold equities this is the phase where I would expect the share prices to disconnect from physical gold and run their own race. With the additional buying power available to company executives I would expect another bout of rationalisation in the sector where blue sky potential can be used to simply purchase more of the same then provide another re-rating where the process can simply repeat itself.

By now the average age of those attending mining conferences is in rapid decline, and sore necks are obtained from looking at a different specimen to the ones attendees were normally accustomed to. The old school would treat these events as reunions and the opportunity to see the world, rather than the source of their next acquisition. I would expect mining booths to host bikini clad investor relations staff, have circus animals perform tricks to draw the crowds in (to have something other than a booth bunny) and offer a seafood platter instead of the usual mints, free pens and cappuccinos.

At this stage PM investments would be well and truly established in the mainstream media and television segments would now be based on discussing the need to establish a diversified portfolio (containing gold stocks)

Forecasts for gold would now be widespread with the gap between bullish and bearish widening considerably. Those who purchased stocks at higher levels are now relying on the "Greater Fool Theory (GFT), whilst those who missed the boat completely will still be telling everyone to sell in order to be proven correct. This is where the market will be driven by the self interests of those involved and how the followers are able to adapt to a highly volatile market. We could well undergo one of the final corrections before the situation gets totally out of hand with share prices hinting towards a repeat of the 1978-1980 gold bull market.

The Speculative Blow Off

This is the period where the following could occur,

• A number of companies with forecast share prices well in excess of $100
• The market believes every drill hole is a mine and acquisitions are likely to provide financial windfalls to the predator.
• Gold exploration progressing to deep-sea operations and the development of new technology for treating sub economic deposits.
• Considerable selling from those linked to the company with their shares out of escrow from the IPO process.
• Trading activity to reach the "frenzied" stage where some juniors share prices are pushed well beyond any fundamental reasoning.
• An exhaustion of buying support and/or a major financial or socio-political event would see gold equity prices reach their peak and undergo a significant correction.

It should be noted that there is the likelihood that a number of bear market rallies would occur on the way down based on the market adapting to higher share prices and capitalisations and the term "bargain hunting" is likely to make a return.

PORTFOLIO PREPARATION

In preparation for the next phase of the gold bubble as an advisor I have suggested the following to clients,

• Look for emerging producers with a low EV in comparison to their peers. Grade has been taken into consideration along with the company's tenement locations. It is still possible to purchase some stocks with an EV of around $10 and many could be re-rated on their ounces in the ground only.
• Maintain the backing of companies that possess solid management and have maintained a share structure conducive to providing share price upside.
• Adopt a regional view and where possible identify quality juniors in historic gold producing regions that are likely to benefit from near-ology. Major mineral provinces may include, The Gawler and Curnamona Craton, Kalgoorlie, Kambalda, Lachlan and New England Fold Belts.
• Limit the exposure to major producers that will be driven on momentum. Look for gold producers that appear to possess a "growth profile" and would be an attractive target for a predator.
• Target those likely to undertake aggressive exploration (looking 6-12 mths ahead) and therefore provide a solid flow of news to the market. This drilling could be part of the feasibility process and/or enhancing the company's resource base.
• Identify those willing to increase their value through strategic acquisitions. As the market capitalisation increases so to does their capacity to buy ounces in the ground relatively cheaply.
• Do not dismiss gold explorers with very high grades but only small deposits. High-grade intersections in a stronger gold market will capture the bulk of the attention and could lead to significant re-ratings on the "blue sky" factor.
• Gold mines in countries where the political risk factors are high may provide excellent value due to the nature of the mineralisation in some areas (high grade epithermal) and the fact that overseas investors may be more risk averse. In these situations we are looking for situations where the tonnes and ounces are fairly similar. (Around 30 g/t)
• Allocate a small percentage of holdings to the promoters stocks at an early stage taking into account the current market cap, prices of recent placements to those close to the company and the previous track record of the promoter. The aim is to work out those most likely to create considerable noise during the more mature phase of the gold bubble. These stocks represent an excellent test of ones patience, as they are unlikely to provide much in the way of excitement during the early stages.

THOSE LIKELY TO PROSPER IN A GOLD BUBBLE

How people deal with every day situations could provide vital clues as to their ultimate success or failure during a gold bubble. There may have been a number of occasions where you visit friends or associates in a social atmosphere where at the end of the meal there are significant quantities of leftovers and the hosts are furiously trying to convince guests to take the food home with them. Other situations could include the failure to take into account what remains on the toilet paper roll before one embarks on their mission, or being in the difficult situation with someone who cannot judge the time factor in a lift and you either are forced to miss one or end up on another floor. It is all about analysing your surroundings, taking into consideration the risk/reward factors in a number of situations then successfully applying it to the market. I deal with those who can still comfortably hold onto a thirty-bagger yet at the other end of the spectrum am forced to hold the hand of those terrified over a purchase or sale they made only hours ago.

I have learnt that through the Nasdaq Bubble and the ensuing speculative activity that those who maintained a level head during the frenzy are prospering in the current environment and are likely to succeed through experience and their character traits. Although the methods of market analysis have become more scientific and sophisticated, human behaviour has not and it should be remembered that Bre-X was in 1997 not 1897.

3 August 2005

Disclaimer

I have direct/indirect holdings in the stocks listed/mentioned above. Clients have considerable holdings in each of the stocks and may change these holdings without notice. The information on each stock has been derived from ASX reports, company discussions and a site visit to Long Victor in 2002 and 2004 (Independence Group) and Arafura's Nolans Bore Project in April 2004). Each of the stocks listed is to be considered as speculative, and may not be appropriate for individual investors. No buy recommendations have been provided on the listed stocks, and the opinions on each are those of the author only. It should also be noted that some of the stocks may have very low levels of liquidity and may result in significant percentage rises and falls. Please conduct further research and consult your financial advisor before making an investment/trading decision.

About the Author
Tony Locantro is a Perth based Senior Private Client Advisor specialising in the junior resource market. He is the author of "The Green Room, A Guide To Speculating On The Australian Stock Market" (available free to prospective clients via email request) and presents on resource stock investment. He has been a contributor to a number of precious metals and market related forums.

If you would like further information or are interested in becoming a client I can be contacted at tlocantro@aapt.net.au