Thursday July 26, 2012 Posted at 7:30 AM CST
The President of 321gold has a couple of graphs which illustrate just how irrational valuations are towards the miners right now.
Yesterday I admitted things are not going as planned and suggested those of you who are uncomfortable might well unload the losers. Before you put those orders in this morning, consider these pictures. This is an attempt to explain the nature and rationale of my thinking.
I started this b blog because like most others, I did not take advantage of the extreme irrational valuations in November of 2008 or March 2009. We are actually near those levels today in terms of what we have recommended. The fact that our accounts show great paper losses every day suggests that a reversal lies ahead, but where and how soon, waiting is indeed nerve racking.
It is easy to look at a chart, particularly one in which the onlooker has no physical position, and say, well obviously that was a great buy, if I had been there I would have scooped up the bargain. Yet in the real world where one has a position and it keeps going against one, it is a real psychological barrier to do that.
Let's use some ratio charts as 321gold did in the referenced article above to illustrate just where we are in the recent history of things. Are we near an extreme high in these ratios or near a multi-year bottom?
XAU to Gold
I have often referred to our Time Machine, the ability to reproduce charts for a particular past time. We are now back to the irrational undervaluation of mining stocks as represented by the XAU index to the price of gold. Looks like it took about four or five weeks of extreme low valuation in those frantic days of Fall 2008, when the world really was falling apart, for the market to bottom and reverse. We have had about that length of time so far but no reversal.
Pan American Silver to Stocks
Pan American Silver is at the same irrational extreme as the XAU compared to the overall stock market.
XME to SPX
Last Friday Afternoon a mere four days ago, I considered putting out a sell order for XES and XME. XES had a profit that would offset what was then a very small loss in XME. I did nothing, bad call or not? XME collapsed three dollars causing the loss there to zoom. The psychological problem here is that we as investors want this both ways.
Modern computerized trading shows us marked to market every day. A $500 paper loss in XME is now a $2300 paper loss, ouch! The psychological alarm bells go off as metaphorically we see the buffalo herd turning attempting to chase us down, and we are on foot, danger alarms ring loudly.
And so saddled with our primitive survival system, fear sets in. S
Sure we all claim to buy low. But there are really only two ways to do that.
One is to believe that somehow magically one will 'know' where the markets will bottom, step in at the moment, or with perfect premonition, place the order in advance cleverly catching the bottom, not too high nor low, and get in.
Get real, who can do that? Look a the above charts. Are we coming into, or are we at, a good buy zone? I would think so. But where is the reversal point, no one knows. We might indeed have to wait until Ed Carlson's 8/21/2012 projected low date, a tedious 19 trading days from now. Can one stand to do that with all this negative re enforcement?
Two, the other alternative is to start accumulating on the way down. But that will result in ever lower purchase prices (that buy low thing) and paper losses all the way down. Without knowing where the exact bottom will be, the tension mounts daily. In a world of 24/7 news or computer coverage, the re enforcement all the way down is also negative.Now that I think about it....
Indeed it is as though Mr. Market had created a sort of idealized mental torture obstacle track to keep one from buying low. As XME falls the investor gets a steady drumbeat of information telling he or she of the error of their ways.
Gorgeous women (the men aren't Chippendale quality but not bad) on Bloomberg or CNBC announce the disintegration of Europe, each point drop in the Euro sounds like the end of the Euro.
Technicians on stockcharts always following the trend line announcing with each price drop that the trend is re enforced to the downside, lower prices ahead. They NEVER suggest that lower prices are a bargain, NEVER. They always however suggest that HIGHER PRICES are (in the words of Wally to the Beaver) just swell. And so a higher price for TLT or UUP should always be bought, that you see re enforces positive feedback, we are winning. Buying lower and lower re enforces negative feedback, you silly putz why do you keep buying a loser?
And then there are the blogs on the internet, Business Insider is particularly adept at suggesting even a modest sell off is, oh, the end of Italy, one of the oldest civilized countries on the planet.
For every buyer there is a seller but buying lower and lower means enduring continual negative feedback until that low arrives. Not many can do that which is why most of us need day jobs or an accumulation program of buying dividend paying utility stocks and then doing just that for 20 years.
Now let's flip the ratios to see if this is valid looking the other way.
TLT to XAU
I have received several e mails from those of you who are rightly quite concerned that your accounts reflect mounting paper losses. Yeah, me too. This is the ratio chart of TLT, risk off bonds, to the XAU index of gold miners. I drew the blue box at left to emphasize that the top of this ratio, the time to buy XAU (note that is important) seemingly lasted for about five weeks. The absolute extreme at .2 probably only lasted a day, and has not been seen since. Note that was four years ago. Note the mathematics of the extreme.
The extreme was 1.2, three times the low ratio of .4. That is fear on display. Will we have the same scenario play out in the right hand box, as the Edward R Murrow used to say,
You Are There, now in this case.
What about the other choice for risk off, the dollar, let's take a look.
US Dollar to XAU
Since we are dealing in dollars it is the same 1.2 ratio. I suspect this scenario is further down the road, hard to imagine that we will see this extreme in the next few weeks, but who knows? Again the point is that the markets went to an incredible extreme before collapsing back to the 'normal' trading rance.
I sincerely hope that these ratio charts explain the rationale of our recommendations. Please review the two alternatives listed above for catching the low price. One is either perfectly prescient or one has to buy lower and lower enduring the inevitable paper loss before things reverse.
This is the most difficult game in the world. When I recommended buying bonds yielding 12% in 1984, I only found one taker, who had several million to spend. As the rally progressed, and by the time the yields fell to 8%, everyone wanted to buy. Now bonds yield 1.4% for ten years, and everyone wants to buy, I am getting e mails telling me I am nuts for wanting to buy irrationally valued mining stocks.
And of course the guys at stockcharts continue to intone
what does the bond market know about stocks, suggesting that of course, since bonds are still going up they must be the right place to be.
I at least hope this explains my thinking of the past few months and how,if you folowed it, you have come to see red on your computer printout of accounts, paper losses, and of course, no positive feeback from the media.
All my best.