Doug Casey on Gold Stocks

Tuesday, October 6th, 2009

Doug Casey is an American free-market market economist, financial author and entrepreneur. He has been writing a monthly investment newsletter, the International Speculator since 1979 and I always find his ideas quite refreshing. He is also somewhat of a perma gold bull as gleaned from an interview posted here a few days ago. In a follow-up discussion with Louis James, editor of the International Speculator, Casey focused on the outlook for gold stocks.

Here is the first section of Casey’s interview:

L: Doug, we were talking about gold last week, so we should follow up with a look at gold stocks. If one of the reasons to own gold is that it’s real - it’s not paper, it’s not simultaneously someone else’s liability - why own gold stocks?

Doug: Leverage. Gold stocks are problematical as investments. That’s true of all resource stocks, especially stocks in exploration companies, as opposed to producers. If you want to make a proper investment, the way to do that is to follow the dictates of Graham and Dodd, or use the method Warren Buffett has proven to be so successful over many years. Unfortunately, resource stocks in general and metals exploration stocks in particular just don’t lend themselves to such methodologies. They are another class of security entirely.

L: “Security” may not be the right word. As I was reading the latest edition of Graham & Dodd’s classic book on securities analysis, I realized that their minimum criteria for investment wouldn’t even apply to the gold majors. The business is just too volatile. You can’t apply standard metrics.

Doug: It’s just impossible. For one thing, they cannot grow consistently, because their assets are always depleting. Nor can they predict what their rate of exploration success is going to be.

L: Right. As an asset, a mine is something that gets used up, as you dig it up and sell it off.

Doug: Exactly. And the underlying commodity prices can fluctuate wildly for all sorts of reasons. Mining stocks, and resource stocks in general, have to be viewed as speculations, as opposed to investments.

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But that can be a good thing. For example, many of the best speculations have a political element to them. Governments are constantly creating distortions in the market, causing misallocations of capital. Whenever possible, the speculator tries to find out what these distortions are, because their consequences are predictable. They result in trends you can bet on. It’s like the government is guaranteeing your success, because you can almost always count on the government to do the wrong thing.

The classic example, not just coincidentally, concerns gold. The U.S. government suppressed its price for decades while creating huge numbers of dollars before it exploded upward in 1971. Speculators that understood some basic economics positioned themselves accordingly. As applied to metals stocks, governments are constantly distorting the monetary situation, and gold in particular, being the market’s alternative to government money, is always affected by that. So gold stocks are really a way to short government - or go long on government stupidity, as it were.

The bad news is that governments act chaotically, spastically. The beast jerks to the tugs on its strings held by its various puppeteers. So it’s hard to predict price movements in the short term. You can only bet on the end results of chronic government monetary stupidity.

The good news is that, for that very same reason, these stocks are extremely volatile. That makes it possible, from time to time, to get not just doubles or triples but ten-baggers, twenty-baggers, and even a hundred-to-one shots in these mining stocks.

That kind of upside makes up for the fact that these stocks are lousy investments and that you will lose money on some of them.

L: One of our mantras: volatility can be your best friend.

Doug: Yes, volatility can be your best friend, as long as your timing is reasonable. I don’t mean timing tops and bottoms - no one can do that. I mean spotting the trend and betting on it when others are not, so you can buy low to later sell high. If you chase momentum and excitement, if you run with the crowd, buying when others are buying, you’re guaranteed to lose. You have to be a contrarian. In this business, you’re either a contrarian or road kill. When everyone is talking about these stocks on TV, you know the masses are interested, and that means they’ve gone to a level at which you should be a seller and not a buyer.

That makes it more a game of playing the psychology of the market, rather than doing securities analysis.

I’m not sure how many thousands of gold mining stocks there are in the world today - I’ll guess about 3,000 - but most of them are junk. If they have any gold, it’s mainly in the words written on the stock certificates. So, in addition to knowing when to buy and when to sell, your choice of individual stocks has to be intelligent too. Remember, most mining companies are burning matches.

L: All they do is spend money.

Doug: Exactly. That’s because most mining companies are really exploration companies. They are looking for viable deposits, which is quite literally like looking for a needle in a haystack. Finding gold is one thing. Finding an economical deposit of gold is something else entirely. And even if you do find an economical deposit of gold, it’s exceptionally difficult to make money mining it. Most of your capital costs are up front. The regulatory environment today is onerous in the extreme. Labor costs are far above what they used to be. It’s a really tough business.

Click here for the full interview.

Source: Conversations with Casey, September 30, 2009.

Tags: Commodities, Commodity Prices, Dictates, Dodd, Doug Casey, Entrepreneur, Exploration Companies, Exploration Stocks, Exploration Success, Financial Author, Gold, gold stocks, International Speculator, Investment Newsletter, Leverage, Majors, Market Economist, Methodologies, Metrics, Minimum Criteria, Resource Stocks, Warren Buffett
Posted in Gold, Markets | No Comments »

James Grant: Return-Free Risk

Sunday, December 7th, 2008

James Grant, founder and editor of Grant’s Interest Rate Observer, and an editor of the newly published sixth edition of “Security Analysis,” by Benjamin Graham and David L. Dodd, has published a column at FT.com and been the subject of a 24-minute Bloomberg audio interview (below) about the new nature of the market and government securities.

Click Play for James Grant’s December 5, 2008 Bloomberg Audio Interview

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Grant very succinctly redefines the bond market as providing Return-Free Risk, rather than the old standby, Risk-Free Return. Here are a few excerpts:

The truth is that no investment asset is inherently safe. Risk or safety is an attribute of price. At the right price, a lowly convertible bond is a safer proposition than an exalted Treasury. Watching the government securities market zoom, many mistake price action for price.

Yes, Treasuries might conceivably redeem the hopes of their besotted admirers. Maybe a deflationary chasm is about to swallow us all. Never before has the US been so leveraged. And-just possibly-never before were lending standards so reckless as the ones that brought joy to so many astonished mortgage applicants in 2005 and 2006.

In their magnum opus Security Analysis Benjamin Graham and David L. Dodd advise that “bonds should be bought on their ability to withstand depression”. They wrote that in 1934. So far is that rule from being honoured by today’s financiers that not a few bonds-and boxcars full of mortgages - could hardly withstand prosperity. Two urgent questions present themselves. One: does something far worse than recession loom? Two: does that certain something definitely spell much lower interest rates?

On non-Treasury and corporate bonds:

The non-Treasury departments of the credit markets have crashed. No surprise then that prices and values are deranged. Market makers have closed up shop for the year, while hedge funds cower in fear of redemptions. You’d suppose that professional investors – doughty seekers of value – would be combing through the debris for bargains. Alas, no. Most seem content to lend money to Henry Paulson (subsequently to Timothy Geithner) at 2 per cent or 3 per cent.

In corporate debt and mortgages, anomalies and non sequiturs abound. They are especially prevalent in convertible bonds. More so than even the average stressed-out fund manager, convertible arbitrageurs have been through the mill. It was they—and almost they alone—who owned convertibles. Now many of these folk must sell them.

Few buyers are presenting themselves, however, though extraordinary bargains keep popping up.

“Risk‐free return” is the standard tag attached to the government’s solemn obligations. An investor I know, repulsed by prevailing government yields, has a timelier description - “return‐free risk”.

Read the complete article here.

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Posted in Bonds, Credit Markets, Economy, Markets | No Comments »

The Carry Trade and Markets? What is the relationship?

Thursday, January 3rd, 2008

We have been asked on numerous occasions about the carry-trade relationship to stock market movements, and have found an eloquent November 2007 article by Ken Fisher that elaborates on this relationship.

The Carry Trade Connection, By Ken Fisher, Forbes Magazine

A risk to the bull market, which I otherwise expect to continue, would be a materially rising yen.

The Chart [That column] explains how the correlation between daily moves in the global stock market and daily shifts in the yen/euro spread is 93%, startlingly high. On days the yen falls to the euro, stocks almost always rise; when the yen strengthens to the euro, stocks fall.

Emerging markets have benefited largely from the spillover effect of carry trade driven liquidity, and during Yen rallies have been affected adversely. This is due to the activity of carry trade end-users - hedge funds, and carry trade money is usually “hot “money in when the Yen softens, and “hot” money out when the Yen firms up against the Euro and Greenback.

Definitely a factor worth paying attention to, and is behind much of the volatility seen in emerging markets and commodities, May-June 2006, and March 2007, and November 2007.

Ken Fisher, of Fisher Investments, is one of our very long time favourite columnists, who publishes his thoughts in Forbes Magazine. Ken Fisher has an exceptional well-published track record.

He also happens to be Philip Fisher’s son, the dean of “Focused” investing, author of Common Stocks, Uncommon Profits, and the fellow responsible for mentoring Warren Buffett, as a focus investor, post his Graham-Dodd years.

Tags: BRICs, Carry Trade, Chart, Commodities, Common Stocks, Correlation, Currency, Dodd, Emerging Market, Emerging Markets, Euro, Euro Stocks, Focus, Forbes Magazine, Global Stock Market, Greenback, Hedge Fund, Hedge Funds, Hot Money, Investment, Investment Strategy, Ken Fisher, liquidity, Markets, Miscellaneous, Paying Attention, Philip Fisher, Spillover Effect, Trade Money, Trade Relationship, Uncommon Profits, Volatility, Warren Buffett, Yen Euro
Posted in Commodities, Emerging Markets, Markets | No Comments »