Inertia: The tendency of a body in motion to stay in motion unless acted on by an outside force.
As investors, we see price inertia in action every day. Prices move in one direction until something happens to force a change in direction. And one of the biggest mistakes investors make is to arbitrarily decide a turning point for price is at hand.
Now, it’s important to understand that a reversal in price alone does NOT qualify as an outside force.
When an asset price falls for days or weeks and then bounces higher, it doesn’t mean the downtrend is over. Stock prices can bounce for a lot of reasons. Shorts may cover, funds may average down, or other investors may think the asset is finally “cheap enough.”
None of these mean squat. Prices can always get cheaper. And they usually do get cheaper… until something happens.
The first thing that will happen is production of the asset will slow or stop. This is a function of price, in that it’s no longer economical to produce the asset.
Then, if there’s any economic potential at the lower price, someone will buy the means of production.
Now, these two events have names: capitulation and consolidation. Capitulation is giving up — throwing up your hands and walking away because it’s just not working. This should be the moment when we, the investors, get interested, because the next phase — consolidation — may be coming soon.
Consolidation is the phase where value gets established because other companies are willing to buy production from those who have given up.
In the gold sector, we are at the point of consolidation…
Gold’s Long, Strange Trip
I’m sure I don’t have to recount the agonizing 15-month decline for gold prices. I’m equally sure you’ve seen plenty of “this is the bottom for gold” pronouncements.
Yes, plenty of people who should know better have been fooled by temporary reversals in the price of gold. And there’s a reason for this…
Many people have a dogmatic approach to valuing gold. “The Fed’s QE will push gold higher,” they say. “Demand from China,” they say. “The dollar will lose its reserve status,” they say.
None of these matter one whit as gold prices fall. And none of them make gold go higher, either. These statements are comfort blankets only — all they do is let investors feel better about their decisions to lose money with gold.
I don’t mean to be harsh here. But let’s face it: A + B does not always equal C. The only reason prices move higher is because there are more buyers than sellers.
There hasn’t been a majority of buyers in gold for 15 months… but that is changing. Consolidation is happening right now. And this is the time to buy gold mining stocks — if you want to make some money.
The capitulation phase happened last summer. In June of 2013, Tanami Gold and Focus Minerals closed two Australian mines, taking 125,000 ounces of gold off the market. In August, Barrick (NYSE: ABX) announced it would close or slow production at 12 of its 27 sites. Also in August, Kinross (NYSE: KGC) announced plans to shut a Chilean mine.
Ashanti and Harmony Gold shut down South African mines. Barrick, Harmony, Goldcorp (NYSE: GG), and Newmont (NYSE: NEM) all announced severe cuts on the amount of money they would invest in 2013 production.
There are plenty more examples of gold companies giving up and taking production off-line. But still, gold prices — and mining stock prices — continued to fall until December 19, 2013.
You know, inertia and all…
The Buyouts Have Started
Just this week, it seems an outside force is starting to exert some influence over the price of gold mining stocks. On Monday, Goldcorp announced it wanted to buy out Osisko Mining (TSX: OSK). Then, yesterday, a Chinese company announced its intention to take out Allied Nevada (NYSE: ANV) at a 70% premium.
Allied Nevada has questioned the validity of the offer. But one thing’s for sure: The current prices of gold mining stocks are attracting buyout offers. That means there’s finally value in the sector… and investors should take this as a cue to own them.
I like Allied Nevada fine, and I was actually in the due diligence process when yesterday’s buyout pushed shares up 50%. They’ve come back down, but I won’t be surprised to see more upside action from them.
I also came across a small-cap miner with very little debt that looks intriguing. It’s called McEwen Mining (NASDAQ: MUX) and trades around $2.25. It used to be known as U.S. Gold…
The company is hovering around profitability now and is expected to do $0.06 a share in its next fiscal year. That’s more than you can say for most miners…
Now that consolidation has emerged, the downward inertia for gold mining stocks has likely been broken. The risk/reward scenario now looks in favor of owning gold mining stocks.
Act accordingly.
Until next time,
Until next time,
Briton Ryle
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A 21-year veteran of the newsletter business, Briton Ryle is the editor of The Wealth Advisory income stock newsletter, with a focus on top-quality dividend growth stocks and REITs. Briton also manages the Real Income Trader advisory service, where his readers take regular cash payouts using a low-risk covered call option strategy. He is also the managing editor of the Wealth Daily e-letter. To learn more about Briton, click here.
