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Today's Market WrapUp  01.28.2003  Mon  Tue  Wed  Thu  Fri  Puplava Archive

True Believers
The Big Squeeze
BY JAMES J. PUPLAVA, CFP

The gold camp is divided into several investor classes. There are mainly four categories when it comes to investing in gold. They are as follows:

1. True Believers

2. Nonbelievers, Hedgers & Short-Sellers

3. Momentum Traders

4. Clueless John Q's

The True Believers are the gold bugs. Their belief in gold borders on the religious. To true believers, gold represents real money, liberty and freedom. Gold isn’t a liability. Gold as real money doesn’t depend on any other entity to back it. It stands all by itself. Its value is universal, nonperishable, and non-depreciable. It has served as real money for more than 5,000 years of recorded history. Some of the first recorded manuscripts that we have in history contain commerce transactions in silver and gold. Precious metals, both gold and silver, have outlasted any government, empire, or fiat currency that tried to supplant it. Therefore, to gold bugs, precious metals represent real money and not a commodity used for industrial or jewelry uses. Gold bugs have held on to their gold and silver during the decades of famine. They still own it and are in the process of accumulating even more of it given the perilous monetary and economic storms that are swirling around the globe, especially here in the United States.

The True Believers category also includes The Smart Money, which is a class of investors who understand the monetary condition we now find ourselves in. They understand the oncoming deflationary forces that will be unleashed upon the financial system because of the implosion of credit. They also understand the supply/demand imbalances that exist for both silver and gold that have resulted from central bank selling, hedging, and short-selling. They know that supply imbalances can’t last forever and that eventually prices will explode due to artificial price restraints that have kept gold from rising. Those restraints are being removed day by day as the rest of the world is getting rid of its paper, especially US dollars. In Japan, after more than a decade of deflation as a result of the huge Japanese monetary bubble of the 80’s, Japanese investors are getting out of paper and buying gold. Gold buying is increasing around the globe, in Europe, the Middle East and especially in Asia.

Nonbelievers, Hedgers & Short Sellers
This leads me to the next class of investors, which are the Nonbelievers, Hedgers, and Short-Sellers. This group includes governments and their central banks, hedged mining companies, hedge funds, bullion banks, and many Wall Street Investment banks. This group can be hostile towards gold and silver because it represents real money that competes with the fiat/credit-based paper system. This group views gold and silver as barbaric relics of the past. Governments don’t like gold because it represents freedom from the debt-based money system it imposes on its citizens. Gold is discipline and governments don’t like discipline or anything that inhibits their ability to tax its citizens directly through the tax system or indirectly through the debasement of the currency. As shown in these graphs below, the supply of money and credit have expanded by close to $2 trillion since the beginning of 2000. The result of the expansion of money and credit and a ballooning trade deficit is one reason why the dollar has lost over 20% of its value over the last 12 months. The depreciating dollar is one of three major storm fronts that contribute to The Perfect Financial Storm™ when all three-storm fronts merge.

Added to governments and their central banks, the list of Nonbelievers also includes much of Wall Street, which doesn’t believe in gold, does not understand it, and feels that it competes directly with its ability to sell paper assets to investors. Wall Street’s investment banks, bullion banks and hedge fund community are short the metal and the metals stocks. As shown in the table below, they are responsible for creating an enormous short position in the precious metals stocks. They are short major unhedged gold producers, junior gold producers and silver mining stocks. You can see this in the short positions that have built up in all major categories of precious metals stocks --  whether it is the majors or the juniors.

What these short-sellers don’t understand is that this universe of gold and silver stocks is very small. The total value of all precious metals stocks is less than the market value of Coca-Cola.

One would have to wonder, especially in the case of juniors and silver mining stocks, how they will cover their short positions when the ten-sigma event I see coming hits the morning newsstand. There are just too many financial and political storms rapidly building in force and they are in danger of colliding. To be short the metals at this time not only smacks of hubris, arrogance and stupidity, but is also equally suicidal.

Many have wondered why the precious metals stocks have lagged behind the rise in bullion. The huge short position in metals stocks goes a long way towards explaining the difference. However, there are two sides to any short sale. Once a stock is sold short, the short seller eventually has to cover that short position by buying back that stock. It is going to be the covering of this huge short position that is going to send the price of precious metals stocks up like a NASA space launch, especially if a ten-sigma event occurs. Ten-sigma’s don’t appear on the charts until after they have occurred. The attacks on 9-11 weren’t’ readable on any chart. The repercussions of September 11^th were visible only after the event occurred, not before.

Gold investors, especially the True Believers, hold on to their shares. Therefore, liquidity is reduced. That is why you see metals stocks soar when investors rush to buy, because they drive demand up when supply is limited. Unfortunately for the hedge funds who are short the metals stocks the gold share, believers aren’t dumb like the technical traders who buy the actual bullion in the futures pit. For years now, the Smart Money commercials have been outsmarting the gold and silver traders by going long and short opposite the technical traders. Given the scarcity of  precious metals, especially silver, the technical traders don’t realize they could start wining the battle by simply demanding delivery of their bullion positions. By taking gold and silver off the exchange, the game would be over very quickly. Instead, the technical traders get bushwhacked every time by the shorts who have greater financial staying power and enjoy special exchange privileges. Sun-Tzu once wrote that the simplest battle strategy is the most effective to deploy and execute. If only silver and gold traders would understand the position of the short-sellers, they could win the war in one battle by demanding delivery of the metal and taking it off the exchange. I have seen the short positions in silver and gold equal ten times the amount of paper shorts. It is the short sellers' worst nightmare that one day bullion investors would see the weak link that has robbed them of their profits. One day this will be obvious and I believe that "one day" is coming soon thanks to the Internet.

The Art of War for True Believers
Now back to this short position in silver and gold stocks. I believe there are two ways to look at the current situation. The best time to buy is when prices are down. So therefore, use the opportunity that the short seller has given you in shorting the stock and bringing down its price to take those shares off their hands. In effect, they are providing you with an investment subsidy. Take advantage of it. Our best buys in junior stocks over the last year took place at the expense of short sellers.

STEP ONE
Here’s how to play their game. First, find a stock you believe in -- especially if it is a junior. Make sure it is a credible junior. Look for large reserves that have been verified by a credible engineering company. Some juniors I know of are nothing more than a Potemkin village; heavily promoted and publicized with very little reserves. If they do have reserves, they become recoverable only under higher gold prices. You want to avoid owning these shares until the third phase of the gold bull market when John Q jumps on board. John Q will be buying anything the investment bankers sell them.

STEP TWO
Once you find a company you believe in, go to their web site and download their financials. Look at how management has run the company. Pay special attention to the reserves added each year. If possible, break it down to reserves per share. Then look at debt. In the case of juniors, avoid all companies with a heavy debt burden. Being debt-free gives a junior a greater chance of survival. In the exploration business, you don’t want to have the threat of a debt burden put the company into bankruptcy. Next, look at the shareholder dilution. What has management done for the shareholders in creating value? Value is accomplished by adding more ounces of reserves to the balance sheet per each dollar of equity. Also look at total shares outstanding on a fully diluted basis and the float and short interest.

STEP THREE
Once you have found a good company, then look at a chart of its stock. Pay particular attention to volume. Most juniors and second-tiered gold companies are thinly traded. It doesn’t take much to move the price of the stock. What you want to look for is the average trading volume of the shares. This becomes important when you begin your accumulation of the stock. Finally, find out the short position and how large it is to the average daily trading of the shares. I prefer to buy when the short position is huge. My orders are easier to fill since short sellers want to keep the price of the shares down. Once you begin building your position, move to STEP FOUR

STEP FOUR
Hold your position and don’t panic when shares prices correct. Instead, use those times to add to positions, especially when short positions build. There is a huge supply deficit that is going to have to be filled. The majors have stopped exploring for gold and the only way they are going to replace their reserves is through acquisitions. Your liquidity will come through a buyout. Think like Warren Buffett. Buy a good company at a good price, then have the good sense to hold on until your beliefs are recognized by the investment public or a major or second-tiered gold producer who will be looking out for smart acquisitions.

I have more to say about this in “The Perfect Option Part II” but first “Ten-Sigma." [See The Perfect Option]

Momentum Traders
Going back to my categories of gold investors, the last two categories momentum traders and John Q Public, ignore them. They will be your strongest ally as this long-term gold bull market unfolds. Momentum traders usually help to drive share prices up and down in a maniacal fashion. They are the equivalent to Ben Graham’s Mr. Market. One day they are optimistic, bidding shares prices up. The next day, they can turn manic-depressive, selling off their shares and driving prices down. Remain disciplined and take advantage of their manic-depressive state of mind. When they sell en masse, driving prices down, that is when you want to be a buyer.

Clueless John Q's
Finally, there is John Q. who remains clueless of the new bull market in metals. John Q doesn’t come into the market until its third and final stage. A good example is the 90’s mutual fund investors who stayed out of the market until 1995. John Q will eventually catch on to the fact that the emperor has no clothes. Right now John Q is borrowing the equity out of his home, spending money on consumables, and buying real estate. John Q is still holding on to his mutual funds out of sheer fright and confusion. He is like a deer in the face of headlights, frightened, and scared -- not knowing where to turn. Eventually John Q WILL GET IT RIGHT AND MOVE EN MASSE. WHEN HE DOES, HE’LL USHER IN THE THIRD STAGE OF THE BULL MARKET. That is when the price of bullion and equities will soar, handing you your biggest profits. When your neighbor starts talking to you about how he just got into the latest junior mining IPO and made a fortune, it will be your queue to sell. When your neighbor's wife starts appearing in public sporting heavy jewelry or recommends that they selling the family silver heirlooms, you will have another signal the end is near.

But be grateful. It is the public's participation en masse when it experiences a collective loss of its senses that the greatest fortunes are made. We’re still a long way away from that. This is still phase one and the time for accumulation while shares and bullion prices are still cheap. Take advantage of the gift that has been given to you by the short sellers. Stay focused and disciplined. A look at the charts of the HUI should keep you focused on your goal. Don’t be side tracked by Wall Street who is clueless and short. These same people have recommended that you stay invested in the market. Need I say more?

Today's Market Finally, I come to today’s events. As I said yesterday with the Fed meeting in Washington, look for a flagpole rally. We got them throughout the day as shown in this graph of the Nasdaq. It was a similar situation in the Dow and the S&P 500. Since I‘m getting ready to watch the State of the Union Address, I promised Mary that this day's wrap would be brief. I lied. I need to end this shortly, so I’ll be brief. There was nothing new today to keep the markets elevated. A list of some of today’s headlines tells the story:

• Consumer Confidence hits nine-year low in US

• Talk of another Fed Rate Cut because of a declining economy

• US pension agency loses $8 billion

• Nevada State jobless rate rises

• First equity outflow in 14 years

• At Davos economist predict falling US dollar

• Wall Street Analysts still coming up rosy

• Top Bankers wary of quarterly reports

• Credit rating agencies under SEC microscope

• SBC expects 2003 revenues to fall

• Retailers plod through dismal January

• I2 facing informal SEC inquiry

• Japanese bond yield falls to 1 basis pint of record low

• Venezuela keeps ban on currency trading

• China may bail out Banks for 2^nd time in four years

In other words, it was a typical day in the neighborhood, earnings and the economy slowing down, currencies falling, debt problems, and more possible accounting improprieties. On Wall Street, they were calling it a 99-point blue chip special. The markets turned meager gains into an afternoon flagpole rally. The reason given was upbeat earnings from Merck and Procter & Gamble. P&G’s earnings rose 15% in the fourth quarter thanks to cutting 16,000 jobs in the last three years. The company forecasted lower earnings for this year. Merck beat Street estimates by reporting that Q4 profits rose 1.6%. There was nothing earth-shattering that would have gone along with the flagpole rallies other than companies and economic reports, including declining consumer confidence beat lower expectations.

Volume was light at 1.44 billion shares on the NYSE and 1.41 on the Nasdaq. Once again, momentum keeps declining. There doesn’t seem to be any force or conviction behind the rallies. Maybe that is because only Big Daddy is buying.  Market breath was positive by 20-11 on the NYSE and 20-12 on the Nasdaq. The VXN ended the session slightly higher at 46.73 and the VIX fell to close out at 35.52.

Overseas Markets
European stocks advanced after brokerages raised recommendations for Deutsche Bank AG and GlaxoSmithKline Plc following share-price slumps. The Dow Jones Stoxx 50 Index gained for the first day in 10. The Stoxx 50 added 0.9% to 2163.72, snapping its longest losing streak since Sept. 13, 1993. The Stoxx 600 Index gained 0.6%.

Asian stocks fell, led by exporters such as Canon Inc. and Samsung Electronics Co., after U.S. Secretary of State Colin Powell said the U.S. is prepared to act alone to disarm Iraq. Japan's Nikkei 225 Stock Average lost 1.4% to 8609.47. South Korea's Kospi index sank 2.7% and Singapore's Straits Times Index shed 2%, its biggest slide in almost three months. Exporters led declines on concern a war with Iraq may hurt consumer confidence, increase fuel prices and reduce corporate spending in the U.S.

Copyright © 2003 Jim Puplava
January 28, 2003

Further Archive Reference: 10/03/2002  Short Story on Silver - Part 1 and Short Story on Silver - Part 2

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