May 3, 2008 – The Most Important Blog Post Ever – Thoughts on Gold, Uranium, and Research in Motion (RIM)

by JDH on May 3, 2008

Today I present to you, my dear readers, the most important blog posting on this web site I have written since starting the Buy High Sell Higher website in November, 2006. (Newsletter writers like to feel important by telling their readers how “important” they are 🙂 ). I think I’m finally starting to understand this whole stock market thing. This post includes the results of my deliberations on a number of issues, so please, grab a fresh coffee and read on. (I will ramble on for the next few paragraphs, but be patient, there will be actual intelligent commentary later in this posting).

As you are all painfully aware, the last year and a half have not been kind to resource stock investors. As of last week I was down 15.3% on the year, and after the pain of this week I am now down 17.3% on the year. In fact, the only significant stock in my portfolio that was up this week was AEM.TO – Agnico-Eagle Mines Ltd., which managed a meager 0.8% gain. Unfortunately the worst performer on the week was JNN.V – JNR Resources Inc. that fell almost 15% (more on that later).

The spot price of uranium has been falling for well over a year. Merv continues to be very bearish. Gold and silver made new highs, but have since pulled back, and the increase in the price of gold did not translate into similarly high prices for gold stocks. So where do we go from here?


Here’s a three year chart of gold::


The long term uptrend dating back to the summer of 2005 is still intact. Obviously the correction that started in March is also still going strong. Is gold going to break the uptrend by falling below $750? Perhaps, but I doubt it, for the following reasons:

First, the RSI has only fallen below 30 twice in the last three years. The first time was in June of 2006, and as you can see by the first green vertical line on the chart, gold has not fallen below that price level (around $550) since then, although it did retest that level in the fall of 2006. The second time was on Thursday, when it fell to 29.75. Historically it would be a very bizarre event for it to keep falling from these levels, and in fact the uptick that happened on Friday is exactly what we would expect at these levels. The RSI is now back to 32.94, but there is no indication we have found the bottom.

Second, commodities markets are volatile. They go up and down. If they always went up, you wouldn’t be wasting your time reading the nonsense written by some anonymous blog writer; we’d all be retired already. Here’s a quote from an alert issued on Friday by Casey’s Big Gold newsletter: “The 1970s show how rough the gold bull market sometimes got: from March 3 to April 27, 1978 (a time period eerily close to today’s), the price fell 13.4%. Then, in less than two years, it rose 428% to its peak in 1980. And more recently, in just six days last January, gold corrected 5.6%, bottoming at $608.40. ” In other words, volatility is not unusual; we’ve seen it all before. In fact, here’s a chart of the XAU for the last three years:

XAU chart

As you can see, the annual correction produced a drop of 28.8% in 2006, 20.7% in 2007, and a drop to the bottom on Thursday in 2008 of 19.6%. Seems pretty normal to me. In fact, it seems freakishly normal to me.

Third, the geniuses running the Federal Reserve in the U.S. keep printing money, and they are printing it at an accelerating rate. The geniuses running the U.S. government sent out “bribe” cheques (I guess in America that would be “checks”) to Americans this week, and they continue to spend billions daily fighting a war, and after November the new government, whomever they may be, will want to spend billions more on a new health care program. All of the above is inflationary (particularly the printing money part), and the continued debasement of the U.S. currency will continue to make non-Americans sell U.S. dollars and buy something that can’t be printed (namely gold).

Of course the correction may continue for a few more days, or weeks, or months, but eventually underlying fundamentals will trump the speculative excesses that are happening now, and higher prices will result.

So what should we be doing now? More on that below. (I told you earlier, you need to be patient; I like to ramble before I get to the good stuff).

As prices have fallen, have I sold? Not much. Why? Because I continue to stubbornly believe that the prices of gold, silver, and uranium will be much higher in the future, and therefore now is not the time to sell.

However, let’s be realistic here. After a 94% gain in 2006, my portfolio declined by 34% in 2007 (my second worst year ever, as noted on the Portfolio Performance page). Even worse, I am now down 17.3% so far in 2008, which means my wonderful gains from 2006 will soon be gone, if we don’t see a change in fortunes, or a change in strategy, very soon.

Now, to the “most important blog posting” part of this post:

After much soul searching, I have arrived at five conclusions:

Conclusion #1: The Trends The Thing, Sort Of

I have long believed that the genius of guys like Dines, Casey and Donald Coxe is that they are able to spot the macro trends. They all predicted gold’s resurgence, and I agree with Dines and Casey that uranium is the fuel of tomorrow. That’s why I believe these commodities will trade higher in the future.

Unfortunately you can only make money from a macro trend if you get the timing correct. We all know that one day the sun will run out of energy and die, but unless I know when it will happen I can’t profit from that trend.

As uranium has demonstrated over the last two years, the long term uptrend can be accelerated by the arrival of hedge funds and other speculators, and the departure of those hedge funds can accelerate the downward spiral. If we chart the price or uranium over the last ten years and the next ten years there is little doubt that the trend will be upward, but obviously there can be one, two or three year pauses in that uptrend. If you are fully invested during the pauses, you get killed.

Therefore we should keep the long term uptrend in mind, but we must also be mindful of interruptions along the way. (I’ll have more thoughts in Conclusion #5 below about how to spot these macro trends).

Conclusion #2: Not Losing Money is More Important Than Making Money

This one may not appear obvious, but making 100% and then giving it all back is not a profit. Profits must be taken off the table, and risk minimized. Of course I have already described this in my Investment Rules, where I specifically state that if any stock drops 20% from it’s high, it should be sold.

However, the mere fact that I have lost as much as I have since 2006 demonstrates that I am not following my own rules, so a greater level of discipline is needed on my part. To that end, I plan to keep the uptick of the last two days on a very short leash, and start skimming profits early in the week, probably on Monday or Tuesday.

Conclusion #3: In a correction, quality is better than crap

Back in the good old days of 2006, you could buy whatever uranium stock you wanted, and it went up. It was easy. Quality didn’t matter, everything went up. (There was a good discussion on the Buy High Sell Higher Forum yesterday on this very topic; check out davidslane’s post responding to honeytart’s question about the future).

2008 is different. Very different. The sub prime crisis has drained liquidity from the market. Speculators who had their “play money” in the uranium market have long since vanished, since they need that money to stave off bankruptcy in their other funds and investments. It will be increasingly difficult for tiny little exploration companies to raise money.

Investors don’t have much cash, and they want to minimize their risk, so where will they put their money? In a Junior Unknown No-name Kid-sized company (ie. JUNK) or in a quality, blue-chip company? Common sense tells us that companies with cash on the balance sheet, proven resources, and experienced management will be the logical investments for risk averse investors.

That’s not to say that speculative juniors have no place in a portfolio, but they call them “speculative juniors” for a reason. They are very risky. If an exploration company hits a big deposit they can become a ten-bagger. If they don’t, they can become worthless. Hence, my next conclusion:

Conclusion #4: Limit Speculation to 20% (or whatever) of the portfolio

Your individual level of speculation will depend on your age, amount of wealth, and level of risk tolerance. A twenty-year old with no family responsibilities will probably speculate with the entire portfolio. Someone who will be retiring next year may only speculate with 5% of the portfolio, and only with money they are willing to lose.

I am neither young nor old, but I still need to put a cap on my risk level. I think 20% in purely speculative plays is more than enough. By speculative I don’t mean crap. I will only invest in companies that are fundamentally sound, and have solid management. However, if a solid management team raises cash and begins exploring in a promising area, that may be a company worthy of the speculative component of my portfolio.

The rest of the portfolio should be in “blue chip” plays like AEM.TO – Agnico-Eagle Mines Ltd., G.TO – Goldcorp Inc. and K.TO – Kinross Gold Corp., for example.

And now for the most important rule of all:

Conclusion #5: Buy High Sell Higher

I called this blog and web site Buy High Sell Higher for a reason. I believe that the time to buy a stock is when it’s making a new high after a period of consolidation. Why? Because that’s the least risky and most profitable time to by a stock. It’s the time when risk is minimized, but significant profit potential still exists.

Of course being stupid, I have not taken my own advice. Just read some past blog entries for proof. Here’s a classic: Back on April 9, 2008 I recommended the purchase of JNN.V – JNR Resources Inc. because it appeared that it had bottomed and was heading up. It appeared that $1 was a multi-year low, and therefore the risk of further downward motion was minimal, with lots of upside.

Guess again, JDH. On April 30, 2008 JNR traded at 75 cents, a 25% drop from where I said the bottom was. (It recovered to close at 81 cents on Friday, but was still my biggest loser on the week).

We all know the old saying: You can’t catch a falling safe (or piano, or knife, or whatever expression you like). You might get lucky and actually catch the safe, but it’s more likely that the falling safe will crush you, as has happened with me and JNR. (You can also look at the chart of FRG.TO – Fronteer Development Group Inc. for a similarly painful example of this; fortunately I got out a while ago, and since the chart is painful, I won’t subject you to it by posting it here).

The point is this: don’t try to guess the exact bottom, because you can’t do it. You may get lucky, but you are more likely to get crushed. Yes, the profit potential is greatest at the bottom, but since the bottom is only obvious with the benefit of hindsight, the perceived bottom is also the riskiest place to buy.

The real point: the spot on the curve with the lowest risk and a high potential for profit is at the point where the stock is breaking out after a period of consolidation. In other words: buy high, sell higher.

Let me give you an example. Here’s the chart of RIM.TO – Research in Motion Ltd., taken after the close on Thursday (American traders can also trade RIMM on the Nasdaq; the chart looks similar):

Research in Motion

There are three obvious buy points over the last three years: after the consolidations of April to October 2006, January to June 2007, and now, after the consolidation of October 2007 through April, 2008. I decided to jump in on Friday morning, and I bought some RIM at $133.60.

RIM - Research in Motion

So far, so good, as RIM closed Friday at $134.35, which is obviously another new high. Of course one day does not a trend make, but that’s exactly what you would expect would happen. After a period of consolidation, a stock moves to new highs, so everyone holding the stock is holding it at a profit. As of today, no-one who is long on RIM has lost money! Therefore no-one wants to sell to “get out even” or meet a margin call on the stock; there is no overhead resistance, so the stock is more likely to move up than down.

How Did I Pick RIM?

So how did I, Mr. Resource Stock Investor, decide to put money in RIM? Do I have some secret formula. Do I have a “research department”? No, but I have a secret.

Here’s the secret:

I go to the newspaper and look at the list of stocks making a new high. If the stock is making a new high after a period of consolidation, I take a look at the fundamentals and any news surrounding the company, and if it looks good, buy it.

(Of course I don’t actually look in a newspaper. That’s just a figure of speech. There’s lots of sites that give the you that information, including Globe, which gives you the information for the major North American markets; the exact link to the new high/low table for the TSX is here).

Let me emphasize the point again: the easiest way to “buy high”, is to buy a stock making a new high!

Of course I’m not going to buy everything making a new high. There were a bunch of Canadian bank stocks on the list, and given the massive amount of consumer debt out there, and the wave of foreclosures that has yet to hit Canada, I’m not prepared to invest in the banks just yet.

I like Research in Motion for a number of reasons. I wear a Blackberry on my belt, and have for many years. They are developing a new Blackberry to compete with the Apple iPhone. They are expanding big-time in places like China, and they are going after the consumer (non-business user) market in a big way. The company is solid, and the chart looks good.

Even better, Research in Motion gives me some diversification away from the more speculative and volatile resource stocks. Granted, I only bought a small number of shares, and I don’t consider it to be a long term hold, because it’s volatile as well. But as we enter the traditionally slower summer season, I think it’s a good addition to my portfolio.

So, what’s my plan from here?

First, I think there will be more bumps along the road. I picked up more AEM.TO – Agnico-Eagle Mines Ltd., G.TO – Goldcorp Inc. and K.TO – Kinross Gold Corp. this week, and if we have another good week I’ll sell what I bought and pocket the cash.

Note: This is earnings announcement week, with all the big gold producers announcing earnings, including G.TO – Goldcorp Inc. on Monday, K.TO – Kinross Gold Corp. and ABX.TO – Barrick Gold Corp. on Tuesday, and AEM.TO – Agnico-Eagle Mines Ltd. on Thursday. Obviously with the big uptick in the price of gold over the last year the earnings should be great, so the old adage to “buy on rumor, sell on news” will probably take hold this week, so I expect to do a lot of selling. After the initial spike the stocks will pull back, and I’ll re-join the party later this month, or perhaps later in the summer.

I’ll probably cash out of RIM after a 10% or so increase as well, which may be this week, or may be later.

I would like to rebuild my cash reserves for the summer (I’m only holding 4% cash after my purchases of this week), and I want cash for the summer shopping season in July and August.

Second, I plan to stay away from the highly speculative junior uranium and gold stocks. There will be lots of time to buy them if and when the mania stage strikes. It is more likely that the small ones will disappear, so there is no point in owning them. Companies with proven reserves that are beaten down are likely to be acquired by the big guys, so I don’t plan to ignore the sector; I simply plan to be much more prudent.

Third, I plan on having more cash invested in less speculative stocks. Research in Motion is one example; I’ll have a few more examples next week.

Finally, I won’t be chasing anything. Some below market stink bids when I resume buying will be the way to go.

So, are my conclusions valid? Where are you putting your money? Join the discussion over on the Buy High Sell Higher Forum and let me know what you think. As always, thanks for reading, and have a good week.

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