Learn to Invest Money - Protect Your Stocks During Turbulent Times, Part II

This is a special article in response to the global market’s recent correction.

In the U.S., the Dow is down 4% , the Nasdaq about 6%, and the S&P 500 about 5% in a week. European stocks posted their biggest drop since May 2003, and the FTSE 100 in the UK had its biggest 2 day loss in 3 years. On the other hand, in Asia, as of May 11th, the HK Hang Seng index was up 22%, the South Korean index up 55%, the Australian markets up 31%, and China was up 50% before these markets also corrected with the global market correction in the past 7 days.

In addition, the U.S. is allocating $2 billion very soon to shore up its borders, major conflict still is going on in Iraq and Afghanistan, and Venezuela has increased the top royalty rates on oil to 33% from 16.67% after raising this rate from just 1% in October, 2004. In Bolivia, Evo Morales has followed his friend Chavez’s lead, and nationalized his country’s oil and natural gas resources. In Mexico, political unrest, according to subcomandante Marcos, is the worst since 1994 as it nears its next Presidential election. In Iran, the threat of nuclear confrontation with Israel and the United States looms, and returning to the U.S., record trade deficits that won’t turn around any time soon, a falling dollar, and another bad expected hurricane season (due to global warming) is what lies ahead.

So What is an Investor to Do?

In Part I of this article you learned the first lesson about hedging against turbulent markets by holding stocks in the precious metals sector. In Part II, I'll teach you the final two lessons.

LESSON #2: An examination of facts will remove much of the “speculative” cloud that hangs over investments in precious metals.

When financial consultants discuss the diversification of your stock portfolio, they always discuss standard industries like Transportation, Agriculture, Pharmaceuticals, Technology, Retail, Manufacturing, Energy & Utilities and so on. But they never discuss metals as an asset class.

Perhaps one reason they don’t is because of its label as a “speculative” investment as we have already discussed. Secondly, like every other asset, precious metals go through cycles and longer more drawn out cycles than the sectors people typically look at it in the stock market. For example I can only recall two great bull markets for gold and silver in my lifetime, including the one we are in the middle of right now. The last one was when gold rose in price from about $100 an ounce in 1976 to $850 an ounce in 1980 and silver peaked at about $50 an ounce that same year. Over the next 21 years, the metal markets were in decline. Gold declined from its peak of $850 to a low price of about $250 and silver slid from its high of around $50 to $4.

If we take the rate of gold and silver in 1980 and adjust those prices to today’s dollars for inflation, gold’s peak price was over $2,000 and silver was over $100. Looking at these figures, it is easy to see that it is not far-fetched for gold and silver to increase much higher than their current highs in April of 2006, although we will undoubtedly see one or two big pullbacks in price before it climbs higher. As of now, we are most likely in the second “consolidation” phase of the precious metal bull run before prices mount another run.

The reason that this lesson is so important is that some of the largest gains you will ever make from stock investing will come from investing in the gold exploration and development companies during bull runs in precious metals.

LESSON #3: The average person does not understand the upside or downside of investing in precious metal stocks because it has never properly been explained to them.

Lesson #1 is so critical that it is also the point of lesson #3. Every high school and university should have classes on how to benefit from not only precious metal bull markets like silver, gold, and palladium but how to benefit from global demand from commodities in general such as oil, natural gas, cotton, corn, sugar, uranium, steel and coal as well. But back to precious metals.

Occasionally, certain global conditions create a “perfect storm”. War, the threat of more war, developing countries asserting their independence, huge trade deficits in the largest global economy, and a weak U.S. dollar may cause cause great volatility and depression in the markets.

Most people either keep hoping for markets to rise again and keep losing money or pull their money out and hold it in cash (a situation that still leads to a loss of money because with inflation, currency always loses value over time). But what most people don’t realize is that when domestic currencies and domestic stocks are sinking, that precious metals often will rise considerably and that considerable gains can be earned by investing in the stocks that will benefit from this overlooked sector. Again, note that I do not recommend an investment in precious metals themselves, but in the companies that will benefit from the increasing value of these metals.

To illustrate what I mean, let me ask you a simple question. Do you know who Bill Gates and Warren Buffet are? Now let me ask you another question. Do you know who Ian Tellfer is? Probably not, right? But you should. Because he is like the Bill Gates of the precious metals world. And there are a handful of other people with Ian Telfer’s reputation in the mining industry. In fact, I discovered another person like Ian that currently holds an approximately $90 million stake in his own company’s shares. Combined with his reputation in the industry, that’s a good enough information for me to bet on his company’s success. Have you heard of Barrick Gold Corporation? If you asked 100 random people to name the world’s biggest gold producer, 90% or more probably could not. And it’s Barrick (though I don’t like Barrick as a stock to buy now for numerous reasons).

In 2006, the world’s central banks held about 31,000 tons of gold worth over half a trillion dollars. So this is no small industry that we are talking about. Yet nobody ever looks at this industry as an asset class like they do small cap stocks and large cap stocks. Also this asset class has a few huge players and hundreds of smaller players. And most people do not know about the smaller players because some 60% of gold mining companies are listed on the Canadian stock exchanges and not in the U.S. So while there is tremendous upside to investing in gold mining companies during precious metal bull markets there are also lots of land mines to navigate through.

Many companies that used to explore for different minerals all of a sudden change their name to include “Gold” in some way in their name in an attempt to sell more stock. Furthermore, many companies jump into the game with less than experienced personnel and technical experience in gold exploration or development and will lose tons of money. That’s why it is critical to understand the people who run the gold mining and precious metal mining companies that you buy. Even more so than with other types of companies. Gold mining stocks often jump on news of geographical surveys that show that the land they own is rich in gold deposits. But many companies will take the best drill samples from their findings and infer that all of the land they hold is of the same high grade, mineral rich content when this is far from the truth. That’s why you need to research the people running the company, see how long they’ve been in the business, discover their past successes and discover if their press releases have reasonable expectations of being reliable.

In the gold mining business, companies often also explore in difficult political environments such as Russia, Mongolia, Bolivia, Argentina, Africa, and sovereign Indian tribal grounds in Canada that make mining permits extremely difficult to secure. You need to be aware of the management team in place at these companies to gauge whether or not these companies have good chances of securing these permits or not (if these companies own mining rights in some of these “politically-difficult” geographic regions). In addition, the term “world-class gold deposits” is often abused in this industry in an attempt to pump up stock prices. As of May, 2006, there is no standard that regulates what this term means, so again, one must be very wary of press releases that state “ABC Gold company has secured rights to 500,000 acres of world-class gold deposits” because your interpretation of that statement may be drastically different than reality. So as you can see, this is not an easy sector to invest in and one that must be intensely researched before making decisions to invest in these companies.

A general rule that one can abide by, however, is to find out who the other “Bill Gates” of the mining industries are in addition to Ian Telfer. And if you find the companies that they advise and run, it will always be a safer bet to buy these types of companies. But while this asset class must be deeply researched, it is also one that historically has produced some of the largest returns an investor is likely to see during his or her lifetime during precious metal bull market runs. For this reason alone, despite the difficulties of investing in this asset class, it is one you should not ignore.

Let’s look and one last statistic to drive that last point home. In 2000, in what would be the first of the three worst years in the U.S. stock market since the Great Depression, only 1% of the total amount of money invested in the U.S. equity market was invested in gold stocks. That is not a misprint. 1%! Again part of this reason for this ridiculously low percentage is that most financial consultants never look to invest abroad or explain foreign stocks as risky, so therefore are not qualified to suggest foreign stocks to their clients. However, the true risk for the remainder of this year will be to not consider precious metals and to not consider global markets.

A FINAL WORD

So precious metals is one arena to definitely consider investing in right now. But this consideration comes with a heavy warning. This is a very complex industry to understand, and the smaller exploration companies are the ones that will move the highest but are also the most difficult to analyze. So if you enter, only do so with someone that you trust has the knowledge to do so. Or another novel idea. Perform the research yourself.

© 2006 Global Market Opportunities

(May 18, 2006)
This article may be freely reprinted on another website as long as it is not modified, changed, or altered in any way and as long as the below author byline is included along with the active hyperlinks below:

J.S. Kim is the Managing Director of SmartKnowledgeU™ and editor of the SmartKnowledgeU™ investment newsletters. He is the inventor of the revolutionary SmartKnowledgeU™ investment strategies that are designed to grant the average investor a very high probability of earning 25% or more returns annually from his or her investment portfolio.

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expert: J.S. Kim