No Time For Panic: Too Late To Sell…But Too Early For Broad Buying

March 18, 2020
Founder of Adrian Day Asset Management

Rather than focusing on individual companies, money manager Adrian Day turns his attention to the overall markets, noting "recent events are unusual, and demand some commentary."

As everyone knows, these past couple of weeks have seen the markets on a wild ride, based on concerns about the coronavirus, culminating in the sharpest declines in most markets since 2008, and many for much longer. By Friday, no market or sector had escaped the slaughter. The S&P lost a quarter of its value over the past four weeks before Friday's rally. Most European markets are down over 30% this year. The Brazilian market lost almost 25% of its value on just Wednesday and Thursday. Gold stocks fell 26% over the last three days. And so on.

It was a bubble in search of a pin

We have few stocks in global markets on our list. Needless to say, we were not preparing for a coronavirus to wreak havoc on global markets. But as Peter Schiff reminds us, it's the bubble, not the pin, that's important. Looking at any specific stock we still hold, rather than how few we hold in global markets, is missing the forest for the trees.

Gold is a different matter. We have many gold and precious metals stocks on our list and had in recent months added more. This emphasis on gold was based primarily on global monetary policy. Nothing has changed there, at least nothing to change our mind about gold being the asset of choice. As gold—and gold stocks—moved up even sharper as corona took hold, we continued to hold. Gold stocks finally fell when both the broad stock market and gold fell. Gold stocks are stocks, after all, and fell with the broad market.

What is outlook for economy?

What now? We are not public health experts and lay no claim for our prognosis on likely extent of epidemic before it's over. We can say, however, that the epidemic—and more, the response to it—is engendering fear, and is having and will have a devastating impact on global trade and the global economy. I am not suggesting that the epidemic is no more than a media-induced panic. Rather, the response—right or wrong, justified or not, necessary or otherwise—is the main causes of public concern. Global trade, and with it the global supply chain, has been hurt, and the impact will show up a month or two from now. A sharp economic downturn is likely, even if a short one (and we don't know that yet). After it's all over—and they won't ring the bells to indicate the end— some sectors may see a rapid catch up from pent-up demand, some industries will take a while to recover, and some business simply will not survive.

The worst decision an investor can make now

It is too late to be selling—and certainly the very worst decision an investor can make is to liquidate in the midst of a liquidity-driven selloff. But it is too soon for aggressive, broad buying. Stock market prices do not yet reflect the worse scenario. The S&P is trading at 18 times earnings, and yielding only just a tad over 2% after the declines—hardly bargain levels. It is trading more or less where it was just a year ago. In general, rallies are to be sold rather than declines to be bought. Of course, we are looking at certain sectors and markets for extreme oversold situations, and will make recommendations. See our list of "top buys" at the end of this letter.

Among non-resources, the business development companies appear a good hunting ground, with yields over 10% and as high as 12.5%, dividends fully covered by income, and (as in the case of Ares Capital Corp. (ARCC:NASDAQ)) some companies with a large backlog of income still to be distributed. These stocks are trading at price-to-book values of 70–85%. We could see some loans default and the stocks would still represent good value.

Gold and gold stocks are likely to recovery first

Gold is a different story. Gold was sold because it was a source of liquidity in a liquidity-deprived panic. The gold stocks fell as both gold and the broad stock market fell. (It is also true in the gold market that the worst possible decision is to liquidate in the middle of a liquidity-driven panic.)

If previous liquidity panics are any guide—2008, 2001, 1999, 1987—gold will recover very soon as the worst of the forced liquidation passes, and the gold stocks will be the first sector to recover. It may take a week or two, or more likely a month or two; gold stocks fell with the broad market into the October 2008 lows, and then started to recover. By the time the broad market had bottomed, not until March 2009, the gold stocks had more than doubled, far more. Within a year, the gold stocks were back at all-time highs.

So, it is too late to sell gold stocks as well. When they do bottom, not only will they likely be the first to move, but in the past have moved very fast off the bottom.

The new bull market in gold started well before 2020, certainly the middle of 2018, if not the end of 2015. Taking this longer view, only the run up in last several weeks has been caused by coronavirus, meaning even if that stopped in its tracks and gold gave back all its "corona gains," it would still be in a bull market. Gold is reacting to monetary policy, stock market volatility and geopolitical concerns. The coronavirus is only one more factor.

The gold stocks are very undervalued

The gold stocks are undervalued right now. The producers are very cheap. Right now they have the benefit of higher gold prices, and lower oil prices as well as generally lower commodity currency prices (Canadian and Australian dollars, the Brazilian real and so on), making costs lower even as gold moves up. Most of them have better balance sheets now than they did few years ago. The exploration stocks are also very cheap, but they need to be cashed up. It is difficult to raise money at a reasonable level now. In addition, the producers will tend to recover before the exploration companies do.

The panic can last a while, particularly if we see further developments with the coronavirus. But, given that the gold stocks can move more rapidly when they turn, I see this as a time to get into the market and pick up some great buys, but to do so cautiously and methodically. I certainly would not be selling, aiming—hoping?—to buy back cheaper. You do not want to wait until it is clear the market has turned before buying.

So, this is a good time to be picking up the very best companies, and at the best prices, as they become available. In some cases, you can double up, which will provide us with the opportunity to trim as prices recover and still maintain positions.

Keep calm and carry on

In short, this is not a time to panic, not time—never is—to be reactive. It is too late for broad, aggressive selling, even though rallies can be sold. If it is too soon for broad aggressive buying, the best gold stocks and a few other oversold stocks can be bought.

Top Buys Now: Fortuna Silver Mines Inc. (FSM:NYSE; FVI:TSX; FVI:BVL; F4S:FSE, US$1.81); Franco-Nevada Corp. (FNV:TSX; FNV:NYSE, US$87.98); Evrim Resources Corp. (EVM:TSX.V, 0.205 x 0.25); Ares Capital Corp. (ARCC:NASDAQ, 14.65). Remember, stocks are extremely volatile in these markets, so the importance of using limits cannot be stressed too highly.

If you are underweight particular stocks or sectors, other great buys now include: Osisko Gold Royalties Ltd. (OR:TSX; OR:NYSE, US$5.26); Midland Exploration Inc. (MD:TSX.V, 0.55); Lara Exploration Ltd. (LRA:TSX.V, 0.48); Altius Minerals Corp. (ALS:TSX.V, 8.25); and Gladstone Investment Corp. (GAIN:NASDAQ, 9.55).

You may be interested in some of my recent interviews for further thoughts on how I see the markets are this time. All of these were conducted at the PDAC conference in Toronto, from March 2 to March 4; that is, before the devastation of last week. But the interviews provide an idea of my general thinking on markets. There is a focus on gold because this was a gold conference.

Fed stimulus is useless

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Adrian Day

Adrian Day is London-born and a graduate of the London School of Economics, heads the money management firm Adrian Day Asset Management, where he manages discretionary accounts in both global and resource areas. Day is also sub-adviser to the EuroPacific Gold Fund (EPGFX). His latest book is "Investing in Resources: How to Profit from the Outsized Potential and Avoid the Risks."

The California Gold Rush began on January 24, 1848 when gold was found by James W. Marshall at Sutter's Mill in Coloma.

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