A Perfect Marriage

By: Captain Hook | Mon, Jul 21, 2003
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Is there such a thing these days? Based on the divorce rates in our society at present, one has to wonder. Certainly life is getting more stressful for many in this regard and I do not think things are going to get any better if a developing bull market in gold is an indication of what the future holds for us. The title of this excursus was derived as a product of what I think is a very attractive buying opportunity in South African gold stocks (SA's) at present, and a conversation I recently had with a friend of mine regarding his relationship with his wife. I dedicate this work to their efforts at maintaining harmony in their lives into the future.

So, the question still remains, "is there a perfect marriage these days?" Well, if I am right, investors with ready funds available in search of a good value based opportunity may want to examine the confluence of factors surrounding the attractiveness of South African gold stocks right now, as it appears a combination of both internal and external influences has converged to create an identifiable opportunity in them presently. Just as it seems with life in general, the markets appear to be developing into increasingly complex sources of frustration for many. The scale of this global mass mania in the financial markets has spawned an increasingly competitive environment, often completely void of logic, or even a trace of what could be perceived as reasonable behaviour. Certainly, investor's fixation with tech stocks through the year 2000, and amazingly enough, to this very day, has proven to be the largest measure of this phenomenon in the history of mankind. So, it's no wonder that even though the fundamentals surrounding the precious metals complex have been consistently improving over the past year, investment into this sector has not caught the attention of the public, and coincidentally, the majority of institutions in the business of financial markets, as well.

Indeed, it appears as though the majority of financial institutions involved in steering investor's funds in one direction or the other, still seem to think they can further their company's best interests by focusing both attention and capital into the sectors constituting a bubble gone bust. It almost seems as if they are attempting to ignore the precious metals arena, as who knows what could happen if the public is awakened from their current state of denial concerning their portfolios. This state of flux, along with other factors such as seasonality, have now come together to create one of the most attractive buying opportunities you will witness in the precious metals complex for many years to come, that being in the South African gold stocks.

It's time now, to start examining those factors, one by one. The first one I would like to touch on, which I alluded to above, is the influence of seasonality on the price of gold, as it appears we are heading right into the heart of the weakest time of the year for the metal of kings. (See Figure 1)

Figure 1

For anyone who has been an investor in gold over the past twenty years or so, it has certainly paid off to observe the metal's tendency to bottom around the end of August. As it were, it seems that this year is going to be no different by and large, as the price action in gold over the past two months has been less than stellar, if viewed through a bull's eye. (See Figure 2)

Figure 2

In fact, since gold's high was printed back in early February of this year, it has been trading in a consolidation/continuation pattern called a symmetrical triangle. Based on the fact gold has now come down to test the 200 day moving average, a volatility characteristic all markets possess at one time or another, in bull and bear markets alike, it is now technically in a position to begin it's ascent back up to the 50 day moving average, and far beyond, if the full body of our work is correct. This then, is a positive factor in favour of a decision to buy gold stocks at this time. But wait a minute, if we're going through all this trouble to discover if this is a good time to buy gold stocks, shouldn't we continue to be vigilant in attempting to find the ones with the best value? Indubitably, the answer must be yes.

As the saying goes, because of one thing or another, certain gold stocks have performed considerably better than others throughout the corrective sequence they have been mired in for essentially over a year now. If we measure the kind of gold stocks that we want to be in, which happen to be un-hedged, the standard in the industry has become the Amex Gold Bugs Index (HUI), which trades on the American Stock Exchange (AMEX).

Index Components as of: 07/18/03
Symbol % Weighting Symbol % Weighting
NEM 15.25% GLG 4.99%
GFI 13.63% IAG 4.86%
FCX 10.92% GG 4.83%
HL 5.90% AEM 4.72%
BGO 5.74% GOLD 4.66%
CDE 5.59% KGC 4.62%
MDG 5.08% HMY 4.16%
GSS 5.05%    

As can be observed in the above, pure South African gold stocks comprise approximately 17% of the HUI currently, being Harmony (HMY) and Goldfields (GFI), whereas if one where to have looked at the weightings last year, at the top in early June of 2002, you would have seen quite a different picture. At that time, the SA's comprised in excess of 20% of the index. And again, because of one thing or another, which I will get into more detail about now, they have lagged the rest of the index considerably for some time. Here's why.

The first factor, which started the ball rolling in the underperformance of the SA's against the HUI, was the swift and relentless climb of the South African currency, the Rand. The South African Central Bank maintained a high interest rate policy throughout last year, and into 2003, which was counter to US policy. Consequently, the Rand appreciated both considerably and fast against the dollar well into 2003, choking off investment into the SA's, as a result of the incrementally lower Rand gold price producers there would be receiving. Needless to say, profitability was squeezed for the SA's, not to mention the negative drag profit conversions would encounter via FX considerations to foreign investors. (See Figure 3)

Figure 3

Should the above considerations be important to investors in the long-term? Perhaps, if an outrageously strong Rand were to become a long-term trend in real terms against gold; however, I submit that this hypothesis is a completely ludicrous idea considering the depth of demand in the physical markets over the past several years, the growth in demand that will continue well into the future, and not to mention dwindling world-wide mine production that will befall the industry like a plague in the years to come. Gold prices are going to breakout of the restrictive currency "ratio box" which has served to confine its ascent since the inception of the bull, and make real gains across all fiat currencies simultaneously at some point in the future. But hey, give this market a reason not to buy gold stocks, and they will embrace it fully. These are the kinds of conditions that educated and value conscious investors thrive on, as once the reality of the total nexus of factors catch up to market perception, the prices of the SA's will be well off present levels in my opinion. In viewing a chart of Harmony, for example, one can see that it's trading very close to 52 week lows, but sitting on very strong support. (See Figure 4)

Figure 4

What is meant by "strong intermarket support?" Well, for one thing, but for the sake of both expediency and obviousness I will not cover in chart form here, the price of gold is higher today than it was last year on the whole, even though I fully recognize that it is not apparent yet whether it will be appreciating in Rand. In spite of this, its just too tempting and pleasant a thought for the eternal hopers to think the South African currency will take off on a tear like last year anytime. I can assure you this is very unlikely, as their Central Bank has now reversed its high interest rate policy, and begun to lower rates.

Not that it matters so much in the full measure anyway, as in actuality, and although the above machinations are valid in my opinion, the single biggest factor up until now that has been holding back the performance of the SA's has been the relatively strong performance of the other financial markets, and more specifically tech, against almost every important sector across the spectrum, with the exception of the financials of course. This has done much to keep the limelight off of the precious metals sector in general, no longer being perceived to be in the top-performing year over year, et al. measures in the financial pages anymore. Within this period, and for a plethora of other reasons, the SA's have suffered from intersectoral ration, in that for the first leg of the what seemed to an almost uninterrupted bull run coming out of 2000, the SA's lead the charge, by and large putting in the most impressive percentage gains, as well.

Have we now gone full circle then? Have what were some of the best performing stocks within the precious metals sector, turned worst performing during the lengthly corrective period rapidly coming to a close, going to now pick up where they left off in June of 2002? My assertion to this question is "yes" and let me now show you why I think the above reasoning has made this relationship the SA's have against the Nasdaq 100 so important. Lets start with Harmony. (See Figure 5)

Figure 5

The above chart should demonstrate we have now hit very strong inter-market support against one of the key sectors within the totality of the investment spectrum, the other being the financials, that has been restraining the deployment of investment capital into the precious metals arena. And to reiterate the point, the most affected issues have been the SA's, even considering where a particular stock sits within the hierarchy of the spectrum. Moreover, Harmony, newly trading on the New York Stock exchange, is now considered to be in the 'blue chip' category of the gold stock complex. So it's not that my reasoning just applies to lesser and more speculative issues within the SA's, it appears this factor, which has served to define the corrective period for the entire complex of gold stocks concerned (HUI), has indeed affected both larger and smaller companies alike. Harmony is chalked full of value at this point, something you won't see at the end of the coming run. Yes, that's right, I'm pounding the table on this one.

And another one the same table pounding is going on for right now is Durban Roodeport Deep, affectionately referred to via its symbol on the Nasdaq 100, as DROOY. I left this one for last, because in my opinion it's future is key to reviving the kind of hot money interest in the precious metals sector necessary to push prices in the stocks to their full potential going forward. That's right, the gold complex needs to see some of those kinds of players to push the stocks higher, and ignite a spark of interest within the broader investment community so that value can be unlocked. It's true that they will ultimately be the ones that push the complex over in the other direction as well, but then again, Rome wasn't built in a day, and retracements are to be expected. On to the DROOY chart now, it's a beauty. (See Figure 6)

Figure 6

In all honesty, and not that it matters, I wouldn't be surprised to see the gap at 2.03 filled, not that it has to be, only an attempt has to be made, but I sure would like to see the right shoulder on the very apparent 'Slanted Inverse Head & Shoulders Pattern' completed as soon as possible, wouldn't you, if you were a share holder. Based on the way it has been shunned of late, I may be the last man standing to see the opportunity to go full circle from the relative inter-market value position in which DROOY currently resides, to the go-go stock of 2001/2002, when it was not uncommon to see it put on 8 to 10% + moves in a single day. Maybe I'm the only one that remembers those days (I'm joking of course), and maybe I'm the only one that remembers how frustrated investors were with it in 2000, before it started the 'rocket' like ascent on it's way to being a ten bagger for those astute enough to buy at the bottom.

How fast can the turn around occur, when the assumptions that much of the trading market has been acting on is completely wrong? Answer: very fast. Notice the introduction of timing cells into the equation above, and that the next sequence is set to complete in one quarter, about the time we are looking for an intermediate top in the gold complex based on our other studies. That would be one hell of a swing trade, no?

So where are we now? At the bottom when measured against the Nasdaq 100 in terms of price and relative value, and three plus quarters through the current time cell. (See Figure 7)

Figure 7

The observation I find most encouraging about the numerous significant items one should cognize about the above relationship is that it appears this bull run will extend well into next year. In fact, the DROOY/NDX Ratio is confirming other work that suggests Primary Wave A of the bull market in gold stocks will likely end in and around the beginning of June in 2004, a cornerstone conclusion arrived at in this same work. Looking more specifically at what we can learn from the above about DROOY, some pertinent conclusions are as follows:

So what's the new high going to be? In all honesty, the best we can do here is to advise you to track the ratio and timing element, as we have not back tested the likely NDX target. But in round numbers, I would estimate that ~$10 is a fair guess, which is an approximate double (Phi) from last year's top. That's an ~ 400 % return from current levels, not quite as good as the 1,000% it put on in the first two progression sequences, but never the less, full circle in relation to what it's been doing the last twelve plus months.

In conclusion then, and based on a confluence of negative factors that have seemed to plague the SA's since October of 2002, it seems that all of bad news has finally been sufficiently discounted into the prices of these gold stocks, as measured by our excursus above. One may be thinking that the current labour dispute that is looming in the South African's is yet another reason to agree to sell your stock if your broker calls you up and says, "let's dump this dog." I'm sure that many, even without the prodding of some commission hungry professional have perhaps themselves experienced, "weak hands", and folded their cards already. After all, it just seems to be one problem after another with these guys lately, they're losers right? Wrong. I've been told by many professionals that, "I can assure the market knows everything it has to about a stock at all times to fairly discount a value for it." Wrong again. Stocks can often run divergent to fair value for extremely long periods of time. After long enough, even the most ardent bulls can call into question their belief system.

Bottom line, it takes a lot of hard work and patience to seek out value, act on it, and wait the prescribed amount of time to let your investment mature into an appropriate rationalization. And it sure helps to have some idea of what those potential targets using a proven formula could be, no?

Today, if I were an investor looking to put some hard earned investment capital into the precious metals sector, it wouldn't take me very long to conclude that participation in South African gold stocks over their next progression sequence, may just be, "a marriage made in heaven."

Good investing.


 

Captain Hook

Author: Captain Hook

Captain Hook
TreasureChests.info

Treasure Chests is a market timing service specializing in value-based position trading in the precious metals and equity markets with an orientation geared to identifying intermediate-term swing trading opportunities. Specific opportunities are identified utilizing a combination of fundamental, technical, and inter-market analysis. This style of investing has proven very successful for wealthy and sophisticated investors, as it reduces risk and enhances returns when the methodology is applied effectively. Those interested in discovering more about how the strategies described above can enhance your wealth should visit our web site at Treasure Chests.

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