David Skarica, author of the Addicted to Profits newsletter, gives The Gold Report an exclusive preview of coming market attractions including double-digit inflation, a super pop in gold stocks, and the demise of an empire. A financial advisor who earned his reputation as a contrarian before he turned 30 by predicting the dot.com bust, Skarica was the youngest person ever to pass the Canadian Securities Course. He incorporates technical analysis, historical precedent, demographics and investor behavior into his forecasts and names some likely beneficiaries of the next market move.
[Editor’s note: To read Part I of this interview, please click here.]
TGR: Where will gold be in the next 12 to 18 months?
DS: That’s a tough call. Right now it’s really interesting because the U.S. dollar has been trading opposite to the market since September. We’ve seen the rally in the dollar; we saw the decline in other currencies because of the flight to the dollar. When we talk about the redemption of hedge funds, most of the people who own those funds are actually outside of the U.S. When you speculate all over the world, you’ve got to buy U.S. dollars just to pay people back their redemption, right? That was part of what was going on. If we get this retest to the market in December after the short-term decline in the dollar, you might see another rally out which can hit gold maybe back to around this low $700 area. But if I’m right and the market rallies next year, and this fourth quarter is really the bottom, gold will reach $1,000, even $1,100. The opportunity right now is not in gold; it’s in the gold stocks. Even with this rally that we’ve seen in the gold stocks – for example, the XAU to gold ratio, which is the percentage of the XAU’s trading of the price of gold—it’s usually 22%, which means, for example, gold – let’s make it easy – is $1,000, the XAU is $220—even with today’s rally, the XAU is about $90 and gold is about $750, right?
TGR: Right.
DS: When you do the math that’s about 12%— almost half of the historical ratio. So if gold were to go to $1,000, the gold stocks can more than double. There’s a time to buy gold instead of stocks and there’s a time to buy stocks. I’d be looking at the smaller, lower-cost producers like Agnico-Eagle Mines Ltd. (TSX: T.AEM, Stock Forum). That company will return to its regular valuation. Gold could go to $600 and if the XAU went back to that 22%, it’d be trading at like $130. So the XAU could go up 40% if gold went down over $100 to get back to its normal valuation. That’s not the gold stock saying that gold’s going to go down, they’re feeling it or whatever. That was just like the hedge funds were all in the gold stock. The gold stock market is a smaller market than the equity market. They all had to sell everything and that was it.
TGR: What about buying seniors who have just been battered versus juniors that have a potentially higher upside?
DS: For the average investor, I’d be looking at seniors because they are so cheap. When I say juniors, I’m talking about junior producers with lower levels of production because they have cash flow. And, again, it’s the whole leveraging thing. Hedge funds own them, too, and they’re even more liquid than seniors. So instead of the seniors, which all went down, say, 60 to 70%, the juniors, in many instances, went down 70 to 80% or even 90%.
Look at a stock like El Dorado Gold (TSX: T.ELD, Stock Forum), a junior producer in the late 1990s when all the gold stocks went down 70 or 80%. Eldorado was a 40 to 50 cent penny stock and, because it was a junior producer, it had more leverage when gold went up and ultimately it got as high as $8 or $9. A lot of these little penny stock gold and silver producers with cash flow, could become the next Eldorado. They could bring a lot of 10 or 20:1 deals over the next three to five years.
Another thing that’s going to be really positive for gold and resources going forward has to do with the behavior of 15 to 20-year bear markets. Usually the big busts come in the first half of that secular trend. If you look at 1929 to 1948, the two worst parts of that bear market were 1929 to 1932, with a 90% decline in the Dow, and 1937 to 1938, with a 50% decline. After that, most of the climbs were muted, like 30% down and 25% up. The same thing happened in the 1970s. The 1970 bear market was 36% off and the 1974 bear market was 48% off. From 1975 to 1976 to 1982 at the bottom, the climbs are more gradual. So we had a bad bear market when the tech stocks blew up, which was over 40%. This bear market is over 40%, assuming we hit the bottom a few weeks ago. What you’re going to see now— as volatile as it’s been, it sounds crazy to say this – but, say, we get a one or two-year bull market after this bear, you’re going to see volatility dry up. By the way, that’s how you start bull markets. When you start, when the sellers are all out, you usually get everybody giving up, not in a panic, but when the market hasn’t done everything for years. During those times when the market is doing nothing, that’s where resources and gold usually do well.
TGR: So, David, do you have some stock ideas for our readers?
DS: I like Agnico-Eagle Mines and Royal Gold (TSX: T.RGL, Stock Forum), which is a royalty company. The two juniors I really like are Fortuna Silver Mines (TSX: V.FVI, Stock Forum) and Silverstone Resources (TSX: V.SST, Stock Forum). They are both smaller silver producers. Actually, Fortuna was up quite nicely recently from about 55 to 70 cents but it had been over $2. Fortuna also fell from $4 to 50 cents. It’s back up to around 60 or 70 cents right now. Right now you’re still getting in at a good level. On a totally different sector, if you’re looking at the major market, you can get stuff that’s really beat up. If we get this retest in December, I’d be looking at – and a lot of people will think I’m nuts saying given the state of the economy —some of the casinos. MGM fell over 90% from its high and I usually find that unless the company is going bankrupt, you’re really safe buying something that’s down 90% from its high. For example, this summer I wrote an article in Investor’s Digest of Canada telling people to buy the airlines because the airline index in the States had gone from an all time high of $200 down to $14, which is 90+%. Now the airlines are one of the only sectors that have gone up since July. A lot of the airlines went up 50 to 100% since then. Even with the higher oil prices, airlines are very cheap, for example, WestJet (TSX: T.WJA, Stock Forum).
TGR: What’s that one?
DS: It’s a Canadian discount airline. I put WestJet in my newsletter at about $9.50. Now it’s $10.50. The nice thing about it is a lot of airlines are forward selling oil prices to $80. But a lot of them expired this quarter, so now they’re going to be able to go to $60, $70, and $80 oil and it won’t kill them. I also like some of the emerging markets. I like the India Fund (IFN) and the South Korean Fund (EWY) or the Templeton Russia Fund (TRF). They are more leveraged. They usually fall 80% in U.S. dollar terms in a decline and they’ll go up hundreds of percent in a bull market. But I would wait for that retest before going into the emerging markets. I’m kind of all over the place in terms of the types of sectors I like because of the valuation of some of these things. I look for the really beat up sectors—obviously all the precious metal stuff—because they are very, very cheap.
TGR: Dave, Are there any exploration companies that are catching your eye?
DS: Yes, there are a few. The problem with exploration at the moment is cash flow or lack thereof. These companies have no revenues; money is difficult to come by at the moment. They have burn rates. That is why if you are going to buy a smaller junior, you have to look at the producers first. Therefore, I think you have to look at companies who have cash on hand. One such company is Rimfire Minerals (TSX: V.RFM, Stock Forum). In the past they were criticized for being too conservative, much of their budget has their joint venture partners (which include majors) so they will not burn through their cash. They have about 25 cents (per share) in cash on hand, and the stock trades at 15 cents (per share) so you are getting the company at a 40% discount to cash. Basically, you are buying at 60 cents on the dollar to cash and getting all the properties thrown in for free. Also at their burn rate it will probably take them three years to go through their cash position and by then the credit markets will be back.
There are also companies I have on my list that have heaps of cash, large resources and are going into production next year, like ATW Gold (TSX: V.ATW, Stock Forum) and Avion Resources (TSX:V.AVR, Stock Forum). Again, I do not mind if a company is going into production, as it should get cash flow sooner rather than later. Avion is trading at cash.
I also like Full Metal Minerals (TSX: V.FMM, Stock Forum). The company has had strong results as of late; they are raising money to put their Lucky Shot mine into production. This will be a high grade mine, low cost. It will only have a few years of production, but again that will give them cash flow to survive. The financing they are doing is small and I think they will get it down, even in these markets.
In the case of Rimfire and Full Metal, these were C$2 per share companies not too long ago, it will take them a bit to base, but it could still happen.
Finally, for a shot in the dark I like Cityview Corporation (OTC:BB: CTVWF, Stock Forum). This is a very interesting little deal that has collapsed. They were doing a gigantic financing for offshore oil production in Angola, which fell through when the credit markets collapsed. They are now doubling the float of the company to raise capital to put a diamond mine into production in Angola; they are also looking at an oil refinery. This offering should allow them to survive and they will get production from the diamond mine. They will have a huge float (over 900 million shares), but they have the former Angolan Mines Minister as chairman and are positioned to be a leading company in Angola, Right now the stock has a market cap of about $8 million of the new offering. It is something that could turn around huge when this is finished or tank if they can't get the funds. It is worth a small roll of the dice at a penny.
For additional comments on Agnico-Eagle Mines Ltd. (TSX:AEM), El Dorado Gold Corp. (TSX:ELD) (AMEX:EGO) (ELD.TO), Royal Gold Inc. (RGLD), Fortuna Silver Mines Inc. (FVI), Silverstone Resources Corp. (TSX.V:SST), Rimfire Minerals Corp. (TSX.V:RFM), ATW Gold Corp. (TSX.V:ATW), Avion Resources Corp. (TSX.V:AVR), Full Metal Minerals Corp. (TSX.V:FMM), and Cityview Corporation (CTVWF) (ASX:CVI) from newsletter writers, money managers, and analysts, click on the respective links or visit The Gold Report.
Dave's first book "Stock Market Panic! How to Prosper in the Coming Bear Market" published in January 1999 provided thought provoking arguments on why this great bull market will end in the most vicious bear market of all history. He is also the author of "The Contrarian Who Saved the World," which explains how markets work. Dave has also been a contributing editor to Canadian MoneySaver and Investors Digest of Canada.
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