The bad news keeps coming, with Bear Stearns collapsing and the US Federal Reserve Bank taking the chainsaw to US interest rates. Australian shares have not been spared.
But there is some brighter news. This week, the gold price surged to a record high above US$1,030 an ounce. We celebrate by looking at two smaller gold stocks we think are uniquely placed to benefit from rising gold prices.
We urge nervous investors to hang in there, and encourage gutsy investors to look to accumulate selected resources shares whilst they are cheap, like the two small oil companies we look at below.
Dear Battered and Bruised Stock Market Investor,
This was the week when real fear gripped global stock markets.
The effective failure of what was the 5th largest
It all ended up in Wall Street playing a game of “Who’s Next?” as nervous, jittery and outright fearful investors indiscriminately sold out of financials.
We have market pundits talking about the current credit-crisis and the Great Depression in the same breath. We have references to the 1987 stock market crash, as witnessed by this quote in The Australian Financial Review by ABN Amro equities strategist Greg Goodsell…
“Arguably 1987 was a bigger market correction at this point…but in terms of broad based concerns on confidence in the market, it is probably the worst I have seen for a while.”
Welcome to the Great Bear Market of 2007-8.
There’s A Vicious Bear In There
Make no mistake, we are in the grip of a vicious bear market. In bear markets, investors can do one of two things.
1. Succumb to fear and 'get out'.
2. Be very careful, preserve capital as best they can, and be ready to take advantage of the attractive stock prices that bear markets inevitably produce.
There are no prizes for guessing which camp we are in here.
Take Advantage Of Fear
We encourage our Members to do the latter. Dumping shares for no other reason than fear creates the sort of opportunities we are hoping to find. Our aim is to take advantage of fear, not be held hostage by it.
To this end, over the past six months or so we have mostly been recommending gold, oil and commodity based companies, and recommend avoiding financial and banking stocks.
Banking stocks have been absolutely hammered, with the S&P/ASX 200 Banks Index down a massive 33% from its November 2007 high. Ouch.
As for oil and gold, even though oil recently hit a record US$110 a barrel and gold also hit a record US$1030 an ounce, not all oil and gold stocks have risen. In fact, some have fallen quite savagely, particularly smaller oil and gold stocks.
A Bear Market Teaches The Best Lessons
We are in a bear market. No investor is immune from declining share prices. To paraphrase Richard Russell, octogenarian editor of the Dow Theory Letters; everyone loses in a bear market, he who loses least, wins.
So don't be disheartened by paper losses. Everyone is experiencing them. If you're genuine about being a long term investor, experiencing a bear market is one of the best educations you can get. We'd guess that more lessons are learned in a six month bear market than a six year bull market.
There is one other point to make about a bear market – money flows from the small companies to the large companies.
The share prices of many small companies have been hit hard despite having sound earnings, business models, and little of no debt. As the need to raise cash from margin calls sweeps the market, the smaller, illiquid stocks are usually the hardest hit.
Selective Buying Of Small Companies
In our view many small cap stocks are trading well below their actual value. So if you're holding sound companies at the smaller end, sit tight. You might even start selectively adding to some of your existing small company holdings, and adding new positions.
Having said that, be aware that in bear markets, stocks can trade below value for some time, and there is nothing to stop the share price of a company that looks a screaming bargain today falling even further.
How To Lose Over $1 Billion
Just ask billionaire investor Joe Lewis, the second-largest shareholder in Bear Stearns. Having spent almost US$1.2 billion to accumulate 11 million Bear Stearns shares, following JP Morgan Chase’s “takeover”, he is staring at a loss of close to a cool US$1 billion.
However bad your own personal stock market losses, they won’t be as bad as those just incurred by Joe Lewis. Still, we are sure some people are sitting on losses they consider significant, and that’s always difficult to swallow.
At this stage it is worth reminder people about the difference between paper losses and permanent losses.
A Paper Loss Is A Bearable Loss
In a bear market like this, where most share prices are falling, paper losses are commonplace. A paper loss happens when a fairly valued or cheap company becomes cheaper, despite the underlying business remaining largely unchanged.
Take one of our old favourites BHP Billiton for example. Late last year, the shares peaked at over $47. Today they trade around the $38 mark. Yet in 2008 alone, the prices of aluminium, copper, nickel, tin and gold have all risen by more than 20%. Iron ore contract prices are expected to rise by 60-70%.
We think BHP shareholders who bought at $47 are today sitting on paper losses, and that over the medium to long term, their investment at $47 a share will turn out to be a good, profitable investment.
Compare that to people who bought Allco Finance Group when they traded at $12 under a year ago. With the shares today trading around 32 cents, they have unfortunately incurred a permanent loss. Even if the share price were to triple from here, their loss would still be over 90%.
Commonwealth Bank shareholders who bought at around $60 late last year are facing a very long wait before they make a profit on their capital. The shares today trade at around $38, meaning they would have to rise close to 60% for an investor to get back to break even.
That is not going to happen any time soon. On the contrary, we think Commonwealth Bank and other Australian banking shares are more likely to fall than to rise in the weeks and months ahead. But more on that next week, including why we think Australian house prices are in real danger of falling.
The Market Remains Bearish
The short term outlook for the stock market remains bearish. The main source of anxiety is the ongoing contraction and accompanying uncertainty in global credit markets.
The whole de-leveraging process has resulted in forced selling, lower prices and a fresh round of margin calls. It’s a vicious downward spiral. Investors are incredibly nervous, fearing another Bear Stearns (US), another Northern Rock (UK) or another MFS (
In such an acute de-leveraging process, no asset is entirely immune. When large amount of debts need to be repaid, there is a rush to liquidate assets. There are generally no buyers for the poor quality assets, so higher quality assets are sold to raise cash.
This is why making sense of price movements in this type of market is very difficult. For example, why are some resource stocks going down, including oil and gold stocks, when the prices of the underlying commodities are generally rising?
It all adds up to uncertainty, irrationality and ultimately opportunity.
Irrespective of what happens in the short term, we are still of the view that we are in a secular bull market for commodities. While a correction in commodity prices would not be surprising, our strategy is to continue holding through the duration of the bull market and buy the dips.
We believe the commodity sector is still underpinned by strong supply versus demand fundamentals. Despite the
Whilst there will be some slowing of Chinese exports as the US economy stalls, domestically driven demand for commodities, driven by things like new factories, bridges, roads, railways and buildings, continues unabated.
On top of that, the outlook for the US dollar continues to be bleak. As we’ve said many times before, falling US interest rates and the resulting falling US dollar is very bullish for commodities and precious metals in particular – witness oil this week at over US$110 a barrel and gold this week at over US$1030 an ounce.
The US Federal Reserve has made it abundantly clear it will do anything it can to prop up the ailing
As reported on
“The government is prepared to do what it takes to maintain the stability of our financial system…Our focus, our number one priority, is the stability of our financial system.”
You can be sure US interest rates are set to fall even further than Tuesday’s 75 basis points cut. Ethan Harris, an economist with Lehman Brothers, was quoted in the AFR this week as saying he expects US interest rates to be cut to 1% in early 2009.
Our strategy remains the same. Maintain exposure to precious metals including gold, oil and resources in general. Continue to accumulate cash. Although the banks are heavily oversold and due for a rally, we caution against buying into the sector just yet. We believe a great buying opportunity in the banks is still some time away.
Gold At $US1030, And Set To Go Higher
Getting back to gold, you may have noticed that during the latest bout of stock market wobbles on Monday this week, gold mining stocks were bucking the downward trend. For example, Newcrest Mining added 2.6% to $38.70, Lihir Gold rose 4.6% to $4.37 and Kingsgate Consolidated gained 3.1% to $4.00.
It shouldn’t be surprising, given that on Monday, the price of gold raced to an historic peak above US$1,030.
In our very latest Report, we provided an update on gold stocks portfolio. At last count we had around 17 pure gold plays within our portfolio. Rather than cover all stocks, we focused only on some of the advanced exploration/emerging producers in our portfolio.
But first a word on gold. Not content with hitting the US$1000 an ounce mark, this week gold kept charging higher, hitting US$1030 on Monday.
We wouldn’t be surprised to see the gold price take a breather, even potentially falling back below US$1000. But bear in mind that gold's previous high of US$850 per ounce in 1980 represents at least US$2,200 per ounce in today's inflation-adjusted terms, so whilst gold's rise from US$250 lows just a few years ago may seem significant (and it is), we believe there is a lot more upside to come.
These Two Golden Stocks Look Set To Soar
As you can probably imagine, amongst the advanced exploration/emerging gold producers in our portfolio, we have what we consider to be some real hidden gems of stocks.
Hidden Gem Gold Stock #1
We have long regarded this West Australian company as a highly attractive, emerging gold play. In a sector dominated by projects with high-cost operations and flagging profitability, this company is set to be a fresh new face on the block, with strong operating margins.
Just recently the company announced that it had substantially boosted its resource base at its flagship mining location by 23% to 1.35 million ounces of gold.
We remain overwhelmingly positive on this company’s story. There are very few emerging, high-quality gold producers in the Australian market, which means that the company should undergo a significant re-rating as first stand-alone gold production approaches during the middle of 2008.
Hidden Gem Gold Stock #2
The poor share price performance of this fellow West Australian gold explorer continues to stagger us.
We have had numerous meetings with their Managing Director, and we must reiterate that in our view the company appears to be doing everything right. Yet it still is unable to generate any sort of positive share price momentum.
We think the current price weakness presents an outstanding buying opportunity for astute investors in the near-term.
The Greatest Boom In The History Of Capitalism
During these turbulent stock market times, when the good stocks are being thrown out with the bad and ugly, it pays to remain focused on the big picture and on the long-term.
We see no reason why the resources boom can’t carry on for years to come.
In last weekend’s AFR, journalist Stephen Wyatt said…
“The resources boom, the greatest boom in the history of capitalism, is alive and kicking.”
In the same article, Deutsche Bank commodity analyst Michael Lewis is quoted as saying “the supply side of commodities is likely to remain bullish”.
As we’ve said previously, we think the world is experiencing a once-in-a-century boom via
For a country with over 1.3 billion people, giving it more than 20% of the world’s population, that sort of growth is simply stunning. We think resource-rich
Buying When All Others Are Selling
Uniquely placed or not, these are tough times for Australian stock market investors.
But it is worth remembering that the market usually goes down a lot faster than it goes up, yet over the market's past hundred years, two out of every three years go up.
Australian stocks have had a magnificent run over the past 5 years. Just take a look at the returns of the All Ordinaries Index…
· 2007 – UP 14%
· 2006 – UP 20%
· 2005 – UP 16%
· 2004 – UP 23%
· 2003 – UP 11%
That is a phenomenal performance. Yet hidden in those percentage returns are the daily, weekly and even monthly ups and downs of the share market.
For example, in August last year, just as the
At that point in time, it was all doom and gloom. Just as it is now.
Set-backs, corrections and pauses are part and parcel of the long-term investing game. Yet if you focus on the big picture, and constantly remind yourself that stock market investing is a marathon, not a sprint, over the long-term you should be well rewarded.
Right now, it is hard to see the bottom of the market. There will still be some fall-out from the sub-prime correction, and it’s likely we’ll see some more big names tumble.
Know Exactly Which Shares To Buy When The Market Rebounds
But if you do nothing else during these turbulent times, the least you can do is be prepared for the inevitable stock market bounce.
When the market tanks, like it has during 2008, you need to know which stocks to buy. Some share price falls will be justified, especially in the highly speculative mining penny shares sector.
But some falls will create compelling buying opportunities.
If you are prepared, you’ll know exactly which shares to buy, and at what price to buy them.
We pride ourselves on being prepared. We currently have OVER 100 different companies in our hypothetical portfolios.
Our experienced analysts also have a solid working knowledge of hundreds of other companies too. Many of the companies we follow are smaller companies, some of which have been hammered during the recent market sell-offs.
But rather than panic, we see many of the share price falls in smaller resource stocks are great buying opportunities.
Searching For Great Small Companies
We are value investors. We don’t just search for cheap companies. We search for cheap companies with excellent management, outstanding assets and sustainable competitive advantages.
We generally focus on smaller companies because they are generally over-looked and under-researched, allowing us to find companies with outstanding prospects, yet valued at a fraction of the price of larger companies.
Some of our very best recommendations have been smaller companies.
For example, each of these companies was initially recommended when they were worth less than $30 million. Just look at the stunning gains they’ve racked up since…
Carnarvon Petroleum – Up an amazing 733%* in just under 2 years!
Terramin
Platinum
(Share prices taken on Monday 18th March 2008. Gains don’t include dividends.)
Don’t just take our word for it. Wilson Asset Management principal Geoff Wilson was recently quoted in the AFR as saying some “exceptional” opportunities have presented themselves, particularly in the mid-to-small company sector.
“I am more excited about the next 12 months than I have been in the last two or three years.”
Two Small Oil Stocks For A Rising Oil Price
Take the beaten down small oil company we told you about last week. It is a small oil production and exploration company whose share price has fallen 50% from its recent peak, leaving the whole company valued at around $75 million, of which $11 million is cash.
Today the company is forecasting profits of over $16 million in 2008, putting the company on a price to earnings ratio of just 4 times. If that’s not enough, the company themselves think their own shares might be worth around $1.55, some 384% above their current share price.
Then there’s the mid-sized oil exploration company we previously mentioned, the company about whom we recently said “…is sure to generate exploration excitement.”
The potential oil resource in place in the area they are drilling is estimated to lie somewhere between 6 million and 40 million barrels, with mean oil resources estimated at 20 million barrels.
We first recommended this exciting oil explorer as a BUY in January last year when the shares were $1.64. We re-recommended them as a BUY in January this year at around the same price, despite the company making excellent progress over the intervening 12 months.
Fast forward to today, and largely courtesy of the sub-prime fall out, the shares currently trade around the $1.20 mark. All in all, we think this company adds up to an excellent medium-high risk/high reward oil explorer.
Our Top Ten Stock Market Investing Tips
At this stage, amidst all the short-term stock market chaos and carnage, it is worth reminding readers of our top ten stock market investing tips…
1. Buy the right shares.
2. Buy the right shares at the right time.
3. Buy the right shares at the right price.
4. Invest with a long-term perspective.
5. Accept that losses are part of stock market investing.
6. Don’t panic when all about are acting like propeller heads.
7. Buy shares when others are fearful.
8. Sell shares when others are greedy.
9. Sell the right shares at the right time.
10. Sell the right shares at the right price.
Our Proprietary Stock Picking Formula
Easy hey?
In theory…yes.
In reality…no.
But that’s where we can help.
Picking the right shares is the obvious first step to making your stockmarket riches.
We have devised a proprietary stock picking formula which has served us rather well in the 7+ years of our existence.
· We search for value.
o We don’t just search for cheap companies. As we said previously, we search for cheap companies with excellent management, outstanding assets and sustainable competitive advantages.
· We identify companies that are able to out-perform.
o These are often found in smaller companies. Smaller companies are generally over-looked and under-researched, allowing us to find companies with outstanding prospects, yet valued at a fraction of the price of larger companies.
· We search out unloved companies and sectors.
o We don’t follow the crowd. When others see doom and gloom, we search for opportunities, like the smaller gold and oil companies mentioned above.
· We are investors, not traders.
o We look at the company and not the share price. Over the medium to long-term, if we identify the right companies at the right price, the share price will eventually track the underlying progress of the company, and our Members will hopefully be well rewarded.
With many experts suggesting the market is over-sold and headed for a bounce, we urge you to act now.
We wish you happy and profitable long-term investing.
P.S. One of our favourite quotes is from Christopher Davis of
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