Mar 13, 2011

Watch for this at the Real Top of the Gold Bubble

By Andrew Mickey, Q1 Publishing

The precious metals correction didn’t last long. Gold is up 7% and silver is up more than 30% since bottoming out in late January.

The run has brought gold and silver to the forefront of the financial headlines once again.

Not all investors, however, have yet to take the plunge into gold. A recent survey by CNN Money found “experts aren't convinced the [gold’s] gains will continue, with nearly 90% of survey respondents saying the precious metal will lose some luster as turmoil in North Africa and the Middle East eases.”

Although gold forecasts are still range across from the spectrum – stay away, it’s a bubble vs. this will be the last time ever to buy under $2000 an ounce - we continue to look at what the market’s really doing.

And right now one pattern is signaling the uptrend will continue and we’re nowhere near the top of a gold bubble.

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When Risk Isn’t Risky Anymore

At the height of all market manias risk is completely disregarded.

At the extreme highs, investors disregard risk completely. When times are good, the future is bright, and everyone is making money, risk is the last concern for most investors.

Investors completely disregarded risk at the height tech boom. The higher tech shares soared (and therefore the less reward and greater downside risk) the more investors bought them.

The feeling at the time was risk didn’t matter because everything went up. Investors were looking to make 10% to 20% on a hot tech stock even. They were taking huge risks to eke out a tiny gain. The strategy worked for a while, but as with all mains, most of those investors gave up their small gains and a lot of their capital when it call came apart.

The housing bubble was no different either. The mantra for the industry was “house prices only go up.” There was no risk at all. Any price was a good price as it was sure to go up the next year.

Again, the complete disregard for risk worked great until it didn’t. And then all of the small gains made in the final stages of the bubble were all given back and then some.

It’s the living embodiment of Warren Buffett’s sage advice: be fearful when others are greedy and greedy when others are fearful.

The run up in precious metals has brought a lot of risk-disregarding greed to the gold market for sure.

But one key indicator of how much greed and disregard for risk in precious metals sector still hasn’t reached or surpassed past extreme highs.

When Investors to Get Too Greedy

When professional investors get greedy, they look for greater returns and are willing to take on greater risk to get them.

To find that risk in the precious metals sector, they move progressively down the risk spectrum.

They move from gold bullion (minimal risk) to major gold stocks (moderate risk, most are real mines that were profitable at $300 and $400 gold prices) to junior gold exploration and development stocks (risky as hell, but enormously profitable at the right times).

In short, when money managers’ greed pushes more and more money down to the riskiest end of the spectrum, it’s time to be fearful.

That’s why even though gold has is comfortably above $1400, it’s surprising to see the big money investors still haven’t gone down the risk spectrum as far as they have in the past.

For example, mining and resource exploration financings (the private placements used by big money investors to get in on the highest risk opportunities in the precious metals and commodities sector) are still far behind recent highs.

The table below – put together from data in Dundee Capital Market’s annual research report, shows a surprising trend in these high-risk financings:

As you can see, equity financings increased steadily throughout the first leg of the commodity boom. The total dollar value of financings increased every year from 2000 to 2007.

The pre-credit crunch “top of the market” came in 2007 when the value of financings spiked 271% from the previous year and were nearly 16 times higher than in 2000.

At that point investors were very greedy and wanted the returns that came with the risk.

Given the extreme surge in financings though, it was clear the majority of investors disregarded the risk involved. And they weren’t immune from the punishment of disregarding risk either. The credit crunch sent the value of many of these high-risk mineral resource and exploration shares down 90% or more.

Jump ahead to today though and the value of the financings signal investors haven’t hit peak greed quite.

The table shows the total value of resource company financings is still in a reasonably normal territory. In fact, total financing in 2010 is less than half of what it was at the 2007 top.

Given that gold prices are 40% higher and silver prices are nearly double what they were in 2007, this is a good indicator investors haven’t succumbed completely to greed and disregarded risk to the levels that would signify a top in the market.

Gold: Big Gains and Small Packages

This is yet another reason we think the precious metals bull market still has a lot of room to run.

All the fundamentals are in place for it. The long run devaluation of currencies, negative real interest rates, increasing investor flight to safety, vast government budget deficits, and the coming stagflation are all bullish for precious metals. They’re all widely known and increasingly accepted too.

But when it comes to capitalizing on the bull market, we are still recommending looking to more aggressive precious metals plays.

Since we haven’t seen the complete disregard for risk that has marked the top of past doubles, we’re still looking to take it one while it’s still cheap.

And that means that even though the TSX Venture Index, where the majority of junior gold companies are found, has come a long way from its 2008 lows when we urged investors to get excited about taking risks, the relative lack of high-risk financing volume shows the point where everyone’s in and the pain begins is still a ways away.

Good investing,

Andrew Mickey
Chief Investment Strategist, Q1 Publishing

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