How To Ride This Precious Metals Bull Market To The Top

October 16, 2020
Expert Gold & Silver Mining Stock Analyst

fine gold

Summary

  • Focus on quality mid-tier producers that have good upside potential.
  • Create a strategy that is dependent on assumptions on how long this precious metals bull market will last.
  • Use an exit strategy that allows you to ride the precious metals bull market to the top.

Intended Audience

This article is for investors who already own a gold/silver mining stock and are considering adding more. Or perhaps a savvy investor who is comfortable with risk tolerance and has a general understanding of the gold/silver mining sector.

Gold/Silver Bull Market

We are currently in a gold and silver bull market. The gold bull market began in July 2019 (see chart below). We reached an ATH (all-time high) of $2079 on August 3rd, 2020, and have been consolidating for about a month now. The next move could go either way in the near term, but if the bull market remains, then we should go much higher.

The silver bull market began in July 2020 (see chart below). Once silver breached its channel at $18.50, it ran to $29 in about six weeks. After it reached $29.90 on August 3rd, silver has been consolidating between $26 and $29. The next key level, in my opinion, is $31, because once we get above $30, there is not a lot of technical resistance to prevent a big run to a new ATH at $50. Conversely, I think that we could easily retest $21 or $22 before reaching $31.

What is significant about these charts is how strong they both are. Both broke out from multi-year channels of 6 years or more. That 6-year base created a foundation for a long bull market rally. Of course, there is no guarantee that we will get one, but the odds favor one.

This precious metal bull market creates opportunity. In this article, I am focusing on mid-tier producers. There are not many silver and gold producers with market caps between $100 million and $3 billion. This is the mid-tier category and can be very explosive for share price appreciation. Whereas large-cap stocks, with market caps above $3 billion, are hindered with the inability to appreciate quickly, the mid-tiers can be fast gainers.

I personally believe the mid-tier category has the best risk-reward profile for the miners. Yes, they can have more financial risk than large caps, which tend to have deeper pockets and more financial options. However, most mid-tier producers tend to be somewhat resilient to financial risk. Some of them can get into financial difficulty, but the upside potential can offset that risk.

From my experience, most of the risk associated with mid-tier producers comes from lower gold/silver prices. So, as long as gold/silver prices trend higher, the risk diminishes substantially.

What’s Missing?

I’m not including any development stocks or exploration plays. By excluding them, I am limiting my upside potential. There are a lot of exciting stocks that I could probably include that have huge upside potential. However, when I do the math of what these mid-tier producers could do, there is really no reason to add that risk to the portfolio.

I could probably increase my upside by including several exploration and development stocks, but I am leaving them off this portfolio. If you do it, make sure you have high confidence in these stocks.

I’m not including any large caps (anything larger than $3 billion) because I feel the diversification is not necessary and the upside potential of large caps will only diminish my returns.

Mid-Tiers and the Sweet Spot

Ideally, the best entry points for mid-tier producers are FD (fully diluted) market caps between $100 million and $200 million. Many of these size companies can grow into billion-dollar companies. The one factor that seems to be pervasive with mid-tier producers is that they tend to grow their resources and production. This is the factor that makes them so appealing - they tend to be growth companies.

While the sweet spot is acquiring mid-tiers with lower market caps ($100-200 million), I think the returns are sufficient all the way up to $3 billion. Of course, I don’t only use the market cap to determine if a stock is suitable. I also look at the upside and downside ratings. If a stock has an upside rating of only a 2 (rating descriptions are included at the end of this article), then I will check it carefully to see if it should be included. Basically, it had to be a very good 2-rated stock to be included.

Below, I have a list of 27 mid-tier producers (MAG Silver (MAG) is a near-term producer) that all look good if this bull market has legs. If I was going to create a gold/silver mining stock ETF today, this would be my list.

Underlying Assumptions

This portfolio is built for only one reason: to capture the upside of a bull market in precious metals. Moreover, the underlying assumption is that gold and silver prices are going higher. We expect gold and silver prices to not only rise, but to rise substantially.

What is substantial? For gold, I will use a minimum of $2,300 and a maximum of $3,500. For silver, I will use a minimum of $60 and a maximum of $120.

These minimums and maximums are based on my expectations for this precious metals bull market. We recently reached $2079 gold, and I don't think this bull market is over. In fact, it could easily just be warming up and last for several more years. I think a minimum of $2,300 gold and $60 silver are very conservative expectations if this precious metals bull market has legs.

If you don't believe in this underlying assumption, then this trade is not for you. It is important that we set targets for this trade; otherwise, we won't be able to analyze our expected returns or create an exit strategy (both discussed below).

Many analysts are expecting a huge move up in gold and silver during this precious metals bull market. My targets are much lower in comparison. I have read several gold targets above $5,000 and silver targets above $300. My targets are tame in comparison.

Note that we could use lower minimums and higher maximums, but I feel these are sufficient to achieve our goals.

The Math

Now that we understand our assumptions, we can do the math and get an understanding of our upside potential and when to plan for an exit.

Let’s use First Majestic Silver (AG) as an example.

Today, First Majestic Silver is trading at $12. In 2011, when silver was at $49, it traded at $28. I think it is a good estimate to expect First Majestic to reach $28 again at $49 silver, or at least close to $28.

So, if silver reaches $50, we can expect First Majestic to increase by about 140%. Our minimum silver target is $60, so our expectation is that First Majestic will be above $30, perhaps $35.

Thus, at our minimum target, all we get is a 2-bagger. Not exactly exciting. However, First Majestic is one of the larger-cap stocks in our portfolio. Most of the other stocks in the portfolio should outperform First Majestic.

So, if the bull market unfolds and we reach our minimum targets, we should have a portfolio that returns at least 200% and likely much better.

Above our minimum targets is where it gets interesting. Once we reach our minimum targets of $60 silver and $2,300 gold, the leverage becomes exponential. Why? Because the margins will be huge at these levels. Today, at $1,950 gold, the margins for gold producers are about $500-700 per oz., depending on the cost structure of the company. That’s already very high. At $2,300 gold, the margins get massive.

So, what does First Majestic stock do as silver rises from $60 to $100? With the added leverage, I think it grows to $60-70 per share. If we do the math, the return is around 400% at $100 silver. Moreover, all we need to do is get close to our upper targets and we should get a 500% return. I don’t think we will have to hit them, but only come close.

I used First Majestic as an example because it is one of the larger-cap stocks, and it’s is somewhat easy to project its returns. If I am right about the company’s returns, then it gives me confidence for the overall portfolio. The math should be sufficient.

Thus, all we need to do is select a solid group of mid-tier producers and then hope that our assumptions hold. If we are right that this precious metal bull market has legs, then we should hit our expected returns.

Exit Plan

We want to ride this bull market in precious metals all the way to the top. So, the way to do that is by using trailing stops and selling on the way up. After we reach certain levels (for instance, $60, $70, $80, etc.), we need to look at our stocks and decide if it is time to take profits.

At each level, you look at which stocks have big gains and take profits. You don’t want to sell all of a stock because we are not at the top. Instead, keep at least 25%.

With the remaining position, set a trailing stop of around 20%, then wait for the final 25% to get stopped out. Ideally, you will be able to keep increasing the trailing stop as the silver price rises, riding it to the top.

You use this strategy for each of the stocks in your portfolio. Ideally, each one will eventually get partially sold (holding back at least 25%), with the remaining amount stopped out at the top.

Market Timing

Now is a dangerous time to create this portfolio. Why? Because the timing is bad. The general markets have been running since March and are overdue for a correction. Look at the S&P 500 daily chart below for the past year. It has run from 2200 to an ATH at 3600.

My concern is that the stock market has had a "V-shaped" recovery, but the economy has not. For this reason, the odds favor a correction. It makes more sense to wait for the correction and then get in.

Investment Strategy (Trading or Holding)

You have to decide if you are going to buy and hold your positions or trade them. Ideally, it’s probably better to trade them using stops. This creates more risk management in case of a crash. Back in 2011, after the gold market topped, it then proceeded to crash. Thus, that could happen again.

If you do decide to trade your positions, you will need to decide where to put your stops. You could be very aggressive and use 50% or very risk averse and use 10%, or somewhere in between.

One benefit of using a trading strategy is that is a good fit for an exit strategy that uses a trailing stop.

Conclusion

Since the August highs, gold and silver have both retraced. Some of you may think this bull market in precious metals is now over and that the high at $2079 will hold. That is not my expectation. As I wrote above, I expected this correction. I also expect the correction to be short-lived and a resumption of an uptrend, although that might not begin for a few weeks or months.

I wrote this article because I think the odds favor that we are in a significant precious metals bull market, one that could last for several years. Following the strategy laid out in this article, you could easily ride it to the top - at least that is my plan.

Rating Descriptions

For more insight visit Don at GoldStockData.com

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Don Durrett

Don is an expert gold and silver mining stock analyst, author, and founder/owner of GoldStockData.com – a website for gold and silver mining stock data. He is the author of How to Invest in Gold and Silver: A Complete Guide with a Focus on Mining Stocks. He is a contributing analyst on SeekingAlpha.com and a frequent guest on internet financial podcasts. 

The purity of gold is measured in carat weight.

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