Don't Give Up on Gold!
April 11, 2012
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It's been a rough road for gold and silver investors lately, and the thoroughly distressed valuations pervading the related production and exploration entities is enough to try the patience of even the most seasoned market participants.
I am here to remind Fools that the purpose of a corrective pause in a long-term bull market is to periodically shake-out the weaker hands, and as long-term investors we never want to play that role. My longstanding readers will recall my discussions of the 2006 gold correction, which struck a short time after I increased my precious metal allocation from somewhere around 40% to roughly 70%. I recall feeling an odd sense of relief when I sold some positions into weakness to place a limit on my losses, but ultimately I ended up buying back some of those positions at higher prices as my ongoing research and developing understanding of the fundamental outlook enhanced my confidence in the inevitability of the next major breakout.
The lessons learned through that experience served me well during the 2008 crisis and associated collapse of the precious metals and their equities. I watched with unbroken confidence in the long-term bull market as that brutal correction erased more than half my portfolio's market value and sent my CAPS score careening from the top to the bottom of the pack. I learned a different lesson during that chapter, which was to always build a cash position into strength so that I would never again be forced to watch a stock like Silver Wheaton fall to $2.51 per share without having the means to average down into my position.
The current correction in gold and silver has put all these lessons into practice, though the brief nature of the early-year rally only permitted a modest accumulation of cash reserves, and they have mostly been reinvested at this juncture. But since every stock purchase of late has been accompanied by a feeling of deep satisfaction at the values thus obtained, I have no regrets for having essentially depleted my cash reserves here. Physical buying is very strong beneath $1,650, and would only get stronger if gold were to test the $1,550 to $1,600 range (which I am not saying will happen). Because of the technical damage imparted by the recent break below $1,650, any failure to recapture $1,680 in short order does indeed keep the $1,550 to $1,600 range within the realm of possibility. I do not consider anything beneath $1,500 even remotely possible, and I consider it far more likely than not that the $1,600 level will hold.
I wrote the following article for you, my community of fellow gold and silver investors here on CAPS, to offer an encouraging word of reassurance during a period of weakness that has rattled the confidence of many gold and silver investors. I encourage you to see straight through the noise portraying reluctance by the FED to engage in further QE, and to understand instead just how inevitable further easing remains given the prevailing circumstances. I intend to write a follow-up piece specifically on that point, but rest assured that further easing will come from the FED. Additional measures of an unappetizing scale will likewise be forced upon the European continent. None of these measures will solve the underlying structural deficiencies infecting the global financial system, but rather will only buy the central banks some time.
http://www.fool.com/investing/general/2012/04/11/dont-give-up-on-gold.aspx
While a few good reasons exist behind the dramatic underperformance of the precious metal equities to date, for the most part I believe that prevailing valuations are a result of unjustified indifference toward the industry by financial markets that have still not internalized the full scope and longevity of the ongoing bull market trend. The time will come when gold and silver do begin to exhibit characteristics of a maturing bull market through the increased participation of investors, and because that is likely to occur in the midst of a meaningful breakout in the underlying metal prices, the corresponding appreciation in the quality shares out of such a deeply impaired state is likely to yield gains on a scale that seems difficult to contemplate while we remain mired here in relative weakness. Rising costs are a problem, but nothing that higher prices can't alleviate. The prolonged nature of this impaired state, furthermore, will feedback into the supply equation as mine supply will not be able to meet growing investment demand without substantial investment capital behind every tier of the equity space.
The gold and silver equities have enjoyed a few brief moments of remarkable strength within an otherwise dismal trajectory, and in no way does that experience correspond to the end-stages of bubblemania that some bears wrongly perceive in gold. We have not only a complete absence of speculative froth in the equities, but a longstanding indifference that points to the opposite extreme. Meanwhile, the more noteworthy speculative froth in the paper gold and silver markets occurs on the short side. Until we find long-side commitment on a scale to match the price-crippling shorts, we will not have even reached the maturing stages of a secular bull market. In the meantime, savvy market participants, including sovereign banks in China and elsewhere, continue to offload physical supply while the high-frequency circus continues with its paper games.
So stand strong with gold and silver. I stand with you. Don't let up on the discipline that keeps you intent on permitting only the most attractive and most carefully vetted companies into your portfolios. Remember the feelings you feel in the midst of this correction, as that memory will serve you well the next time gold enters another inevitable corrective pause. When we do finally get a breakout, remember to raise some cash into strength in preparation for the next pause. That cash position makes all the difference between mere frustration and despair. $2,000 remains an absurdly conservative price target for gold, but one that I retain nonetheless until such time as we strike through it. Until then, and in fact for some time beyond, please, don't give up on gold.
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