What’s happening to the stocks of the Gold mining companies? It’s a question being asked a lot these days as the stocks of these companies sink to new lows, even as the Gold price holds the $270 area. I think the following reasons explain what is happening.
1) Tax-Loss Selling – The fourth quarter is the season for tax-loss selling, and this year is no exception. With the Gold stocks down this year pretty much across the board, there is ample opportunity to take some tax losses, and the Gold stocks are clearly seeing some selling pressure for this reason.
Tax-loss selling pressure should begin to dissipate by early December, but it will remain a factor until then. Even if the mining stocks were to rally from here, any bounce between now and early December will be adversely affected by tax-loss selling pressure hitting the market.
2) General Market Weakness – When the overall stock market swoons, we often see selling in the Gold stocks. While sentiment plays a role in this phenomenon in that everything tends to get sold in a general market collapse like we’ve seen over the past few weeks, there is also a logical reason for this phenomenon, namely, margin selling.
Many traders and investors use margin (note that I do not recommend it) in order to leverage up the potential gains on their portfolio. If their timing is right, the use of margin works well, but margin buying is a very dangerous game because the leverage works against you if your timing is wrong and the market swoons. Given the big hits so many stocks have been taking in recent weeks – not only on the Nasdaq but even in some Dow stocks as well – there is no doubt that the number of margin calls have increased, and margin selling as a result has increased along with it.
3) Hedging Worries – There are rumors circulating that one or more Australian mining companies are in financial trouble because of their hedging books. These companies are having trouble, so the rumors go, because the Gold price is soaring in Australian Dollar terms. How can that be as Gold remains stable around US$270-$275?
Four months ago it took US$0.61 to purchase A$1.00. It now takes only US$0.52, a 15% decline in the Australian Dollar. So even though Gold is unchanged in US Dollar terms, it’s up 15% in Australian terms over the past few months, and nearly 20% year-to-date. And this rise in the Gold price is ironically the event that is creating the worry that is causing investors to sell the mining stocks. How can a rising Gold price be bad for a Gold mining company?
Good question, but all one has to do to answer it is to look at Ashanti and Cambior, two Gold mining companies that ‘blew-up’ when the Gold price rallied last year. The rumors suggest that another debacle is imminent in Australia. Will it happen? Who knows, but it is of course possible, and in the meantime it creates investor nervousness, and therefore selling pressure, and not just in the Australian mining stocks.
Clearly, not all companies hedge (except in Australian because I believe each company has used hedging to some degree). But even though some companies don’t hedge, the babies (non-hedgers) are being thrown out with the bath water (the hedgers). This may appear to be an unreasonable result, but it’s not really when one considers what has happened in recent years. Non-hedgers have become hedgers without prior warning to investors.
Investors have seen companies that historically have not hedged (like Newmont Mining) ending up with hedges, often done at unfavorable prices and terms. Therefore, there exists a high level of uncertainty among investors that even if one were to buy a non-hedger, it may end up hedging anyway, and this condition leads to the fourth reason.
4) Bad Sentiment – Sentiment for the Gold mining stocks is awful. This bad sentiment has accumulated over the past four years as the Gold price has been declining, but sentiment continues to worsen for new reasons. For example, the recent collapse of the proposed merger between Gold Fields and Franco-Nevada has added to the bad sentiment that already permeates the Gold market.
If one were to look at the mining stocks purely on the basis of emotion – and in their investment decisions many people, wittingly or not, use emotion instead of logic – there appear to be many reasons to sell these stocks. But, it is important to note, that there always are countless reasons to sell near the end of a bear market. When sentiment is bad it is useful to recognize and to keep in mind that for every seller there is a buyer, which leads to the fifth reason the mining stocks are doing so poorly.
5) Capitulation – Bear markets end when people are throwing in the towel. They just can’t take the pressure anymore of watching their stocks sink seemingly hopelessly, usually day-in and day-out. So they capitulate. They throw in the towel. And I think we are seeing capitulation now.
The condition at bear market bottoms is one that is often described as “no liquidity”. I don’t think this term is accurate, because if there truly were “no liquidity”, there would be no trading. In other words, the fact that the mining stocks are trading is proof that there is indeed liquidity. The only thing that changes at bear market bottoms is not the liquidity, but rather, the type of buyer. At bear market bottoms, the reality is that the bargain hunter reigns supreme, and we can see that happening now in the mining stocks. Bargain hunters recognize two things. First, they are in there buying because they see value, which is something the sellers don’t see. So the bargain hunters are willing to go against the tide because they are looking at the risk/reward in a way differently than the sellers. Second, the bargain hunters see the sellers selling because of an emotional, rather than logical, reason. Therefore, the bargain hunters recognize that they are in the driver’s seat, and they prove this in the market by dropping their bids. It is a very logical response on their part.
The bargain hunters see the emotional selling. They see the tax-loss selling. They see the capitulation. So why, they ask themselves, should I do the sellers any favors by making it too easy for them to sell by making my bid too high? In short, they don’t, which explains why the name bargain hunters is so appropriate.
In summary, the above reasons I think explain why the mining stocks are doing so poorly here. However, to tell the other side of the story, we have to recognize that I might be wrong. It could be that the Gold stocks are leading the way down, so that in time, the Gold price will follow. It is of course a possible outcome, but I don’t think it is the most likely alternative.
Back on July 17th in Letter No. 267 when the XAU was holding stubbornly in the mid-50’s, I said to expect one last drop in the XAU below its August 31, 1998 low of 48.89. Then in Letter No. 271 on September 25th, I noted that the XAU had dropped to a new low, and I said then that this event was important because it created a bullish non-confirmation. In other words, the XAU went to a new low, but bullion did not break below (then or now) its July 1999 low. This bullish non-confirmation remains in place.
I must admit that I am concerned that the price of Gold has not yet even seriously challenged the $282 area. Also, Gold’s tendency to drop easily back toward the $270 area is another source of concern. But looking beyond the day-to-day action of the market, there clearly is value here if you believe, as I very much do, that there is a role for Gold to play in the future because it is the only money that is no one’s liability.
I’ll have more to say about Gold’s monetary role before the end of the year. We are rapidly approaching the launch of GoldMoney.com, my Internet venture that aims to make GoldGrams an important currency in ecommerce. And I intend to introduce GoldMoney in these letters before it is launched.