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Part 2 - Changes in the Junior Gold Stock ETF: How to Triple Your Money After a Panic
Editor’s note: Late last week, we detailed how big changes in the popular Junior Gold Stock ETF could create a “fire sale” in high-quality junior gold stocks. The changes could create self-reinforcing liquidation cycles (read about them here) that knock down shares of good gold companies down by at least 33%. Today, we share Part 2 of our series on this situation...
By Marin Katusa
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To give you an idea of how self-reinforcing liquidation cycles create great opportunities in the resource market, we can look at the story of Glencore…
Glencore is one of the world’s biggest commodity companies. It owns mines, refining facilities, and transportation networks. It deals in commodity trading. It’s a giant company that has a hand in almost every resource you can think of.
As large and powerful as it is, Glencore was in crisis back in late 2015. In the years prior, Glencore had borrowed massive amounts of money. Then, commodity prices plummeted from 2014 levels, which crushed profit margins and impaired Glencore’s ability to service its debts.
Some industry experts believed it was headed for bankruptcy. With these concerns in mind, large investors began to sell Glencore shares.
The share price fell from 300 pence (this is what British shares are quoted in) per share to 250 pence per share in one month. The share price decline caused other Glencore investors to hit stop losses and dump their shares, which created more selling pressure.
Glencore shares fell another 50 pence to 200 pence per share.
This decline caused more investors to hit stop losses and dump more shares… which in turn set off more stop losses and created more forced selling. It was a chain reaction that fed on itself. Short sellers, who bet on falling prices, jumped into the market and created even more selling pressure.
Soon, Glencore shares hit 120 pence… then 100 pence… then 80 pence. It was a vicious cycle with seemingly no end in sight. Everyone was selling because everyone was selling.
Eventually, the last few “weak” holders gave up the ghost and sold their shares in the fall of 2015. They couldn’t take any more pain… they couldn’t take any more losses. This final climactic “puke out” sent shares below 70 pence per share. It was a 78% decline from the 2015 high. |
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At this deeply depressed level, the fire sale was on. Smart investors stepped in and started buying Glencore. These investors realized the company would find a way out of its dire situation. The horrible commodity market would get less horrible. Glencore would somehow raise more capital, keep going, and make it through the valley of death.
After the smart money accumulated heaps of bargain shares, the rest of the market caught on. Depressed like a coiled spring by the self-reinforcing liquidation cycle, Glencore shares rebounded spectacularly.
Shares leapt 50% from their lows to hit 100 pence… and then leapt another 50% to hit 150 pence… and then leapt another 50% to hit 225 pence… and eventually hit 300 pence per share. Shares climbed 385% off their depressed levels in just 14 months. |
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Of course, Glencore was going through a tough time. But the self-reinforcing liquidation cycle forced the share price much, much lower than the fundamentals merited. People had to sell because other people had to sell.
This caused Glencore’s real business value to “decouple” from its market value. That’s when smart operators bought from dumb operators. When a bit of normalcy returned to Glencore shares, they rebounded spectacularly and produced huge returns for alligatorswaiting at the bottom with cash.
The global financial crisis of 2008 provides another example of how self-reinforcing liquidation cycles create big opportunities…
Why You Should Learn to Appreciate a Good Crisis
If you remember the 2008 financial crisis, you remember it was a time where most people sold first and asked questions later. Asset prices of all kinds were marked down quickly and suddenly.
The junior resource sector was particularly hard hit.
Take small cap copper miner Taseko Mines for example. Taseko owns the open pit copper-molybdenum Gibraltar mine in Canada. Its management team is experienced and well respected in the industry. Its mine is among the largest copper producing mines in North America. But that didn’t count for much in 2008. As you probably recall, it was an epic case of everyone selling because everyone is selling.
Taseko went into the financial crisis with a share price of CAD$5.50 per share. But once investors began selling all kind of stocks and bonds, Taseko shares declined to CAD$4 per share.
The decline in Taseko and the rest of the sector triggered stop losses and massive fund redemptions, which produced more selling. This forced selling sent Taseko down to CAD$3 per share… then CAD$2 per share. The selling fed on itself until a final climactic “puke out” sent shares below CAD$1.
Around this time, smart operators stepped in to buy bargains in the junior resource sector, including Taseko. Just like Glencore, Taseko was going through a tough time. But the self-reinforcing liquidation cycle forced the share price much, much lower than the fundamentals merited. People had to sell because other people had to sell. So, the company’s intrinsic value decoupled from its market value. You can guess what happened next…
As investors realized the world wasn’t really falling apart, Taseko shares rallied 100% off their lows to reach CAD$2... and then to CAD$3… then to CAD$4… then to CAD$5. Shares rallied more than 400% of their lows in just over a year.
Again, the self-reinforcing liquidation cycle depressed the shares like a coiled spring. When the horrible conditions abated, shares soared. |
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How Much Pain and How Much Gain is Ahead?
In addition to pressure from the forced investor selling I just described, shares face pressure from a group of market players called “short sellers.”
Short sellers are traders who bet on stocks falling, rather than rising. When they see shares falling, they often “pile on” and push weak shares even lower. Their actions can crush the share prices of thinly-traded stocks. These traders will increase selling pressure and the speed at which stock prices break down.
To be clear, I’m not saying what’s ahead for the junior gold sector will be a repeat of the 2008 financial crisis. I’m sharing these stories to show you what’s possible when companies are sold to levels far below what the fundamentals merit.
Could junior gold stocks decline 33% - 50% in a weak gold market marked by large amounts of forced selling? Absolutely.
Are we guaranteed to see declines of this size? Absolutely not.
There are no guarantees in the market. But there are situations you need to stay informed on and be prepared for. This is one of them. In just a few months, we could see some of the world’s best junior gold companies go on sale. Given the never-seen-before levels of government around the world, the never-seen-before amount of central bank credit creation around the world, and the huge political wildcard of Donald Trump, I believe we are very likely to see $2,000 gold in the next five years.
This means the coming fire sale in junior gold stocks could be the last great gold stock buying opportunity we see for many years.
Here’s how I’m preparing… and how I suggest you prepare as well.
The Ultimate Gold Stock Shopping List for Summer 2017
A major decline in junior gold stocks will create panic with many gold stock investors, but smart operators will use this panic to their advantage.
The ideal set ups will occur if GDXJ selling pressure forces lots of other investors to sell as well… creating self-reinforcing liquidation cycles… which leaves shares very cheap.
To capitalize on the forced selling I expect we’ll see, I’ve taken the list of GDXJ holdings and created my own method for analyzing their assets, liquidity, market values, and various other qualities.
A key part of my team’s analysis is something called the “Days to Liquidate Position” number.
This is the number of days it would take to sell the fund's entire position in a stock based on the number of shares the fund owns and the stock's average daily trading volume of the past 90 days.
To be clear, the fund won't liquidate or reduce positions based on the time frames in our table. This is just a measure of how much of a stock the fund owns in relation to its typical trading volume. You can think of it as a measure that factors in how much water needs to be drained out of a bathtub and the size of the drain.
This measure is critically important to our analysis because simply looking at a GDXJ’s holding’s market value in a vacuum doesn’t tell you enough. We need to know how much of it GDXJ owns and what kind of trading liquidity it has.
The higher a stock’s Days to Liquidate Position number, the more selling pressure from GDXJ that stock will experience, should GDXJ make a major move in it.
We expect stocks with very high Days to Liquidate Position ratings will get hit the hardest.
For reference, here is a snapshot of how our spreadsheet looks for 20 GDXJ holdings that are expected to be reduced: |
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In addition to using Days to Liquidate analysis, I’m also tracking the actions of the short sellers I described above. I plan on using these guys as my allies and I will use their negative energy and short dollars to my advantage. I am tracking the short positions in every gold company in the GDXJ fund and I update this data constantly.
In addition to the analytical tools cited above, we use good old fashioned security analysis to pinpoint the best opportunities. As longtime Katusa Research readers know, the people running the business is the most important factor in my analytical process (read all about it here).
In Summary
Although some of the holdings in GDXJ have sold off recently, I believe the biggest and most important selling phase is ahead of us. I believe it will play out over the next 120 days.
The GDXJ is a multi-billion-dollar fund making large moves in a small sector. These moves will create big swings in junior gold stock share prices. Again, I believe share prices could decline as much as 50% in the months ahead, which will open windows of great opportunities for smart operators. This will be one of those rare market opportunities where values become decoupled from prices.
I doubt these windows of opportunity will stay open more than a month. Windows in some individual stocks will be open for just a few days. That’s why we need to be armed with information in advance, prepared to profit, and be ready to scoop heaps of bargain gold shares into our baskets. I expect to make big moves for myself and my subscribers in the coming months.
Regards,
Marin
P.S. To make sure you’re armed with the right information and you receive critical “buy” updates when quality junior gold companies go on fire sale, consider coming on board as a member of Katusa’s Resource Opportunities. Click here to learn more. Again, the coming fire sale in junior gold stocks could be the last great gold stock buying opportunity we see for many years. |
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