Why You Should Sell Your Gold Miners

In today’s Money Morning…what the future holds for gold stocks…why the real crisis is in bonds…the strategy to make steady returns in a market where dividend and capital gains are becoming increasingly difficult to find…and more…

Let’s talk financial markets…

After their worst yearly start in history, US stocks made fresh highs last week.

The US S&P 500, the large-cap benchmark, rose 0.1%, to 2184.05 points. The S&P 500 is up 6.9% for the year.

The Dow Jones Industrial Average Index gained 0.2%. The institutional money index closed the week at 18,576.47, after hitting a high of 18,638.34 points on Thursday. The Dow is up 6.6% for the year.

Despite a bit of volatility, the ASX 200 rose by 0.6%, to 4474 points, last week. Our market has jumped nearly 8% over the past six weeks, aided by the strong surge in commodity prices. Unfortunately, this momentum appears to be slowing. For example, in line with the precious metals pullback, the gold miners fell across the board last week.

The question is: With most having doubled this year, what’s next for gold stocks?

Should we follow the money?

To start, let’s look at what the big boys are doing…

Two months ago, lured by opportunities to profit from what he sees as coming economic troubles, billionaire George Soros came out of retirement. The Wall Street Journal reported on 9 June:

Soros Fund Management LLC, which manages $30 billion for Mr. Soros and his family, sold stocks and bought gold and shares of gold miners, anticipating weakness in various markets. Investors often view gold as a haven during times of turmoil.

Mr. Soros’s bearish investments have had mixed success. His firm bought over 19 million shares of Barrick Gold Corp. in the first quarter, according to securities filings, making it the firm’s largest stockholding at the end of the quarter.  

Mr. Soros also adopted bearish derivative positions that serve as wagers against U.S. stocks. It isn’t clear when those positions were placed and at what levels during the first quarter, but the S&P 500 index has climbed 3% since the beginning of the second period, suggesting Mr. Soros could be facing losses on some of those moves.

While buying the gold miners has been profitable for Soros (at least so far), shorting the stock market — with derivatives — has been a disaster. That’s why Bloomberg reported on Friday that Ted Burdick, Soros’ US$25 billion family office Chief Investment Officer, has stepped down. Burdick held the position for just eight months! Remember, Soros’ fund doubled down — with derivatives — on his bearish view in mid-May. MarketWatch reported on the trade:

Billionaire investor George Soros, who made a fortune betting against the British pound in 1992, on Monday disclosed a big bet on gold during the first quarter and doubled the wager against the S&P 500, according to a regulatory filing.

The 85-year-old’s fund disclosed a 2.1-million-share “put” option in an exchange-traded fund that tracks the S&P stock index.

A short note: Derivatives are dangerous. They’re only fun when you’re on the right side of the trade. Derivatives can amplify your potential gains, and losses. In Soros’ case, while the US S&P 500 is up about 7.5% since the mid-May low, his losses would far exceed this number.

Ouch!

At least Soros has some comfort. He’s not the only legend bearish on stocks…

In early March, billionaire trader Stanley Druckenmiller told the world that he was bullish on gold — and bearish on stocks. He warned that ‘the bull market is exhausting itself’ in an investor presentation. Druckenmiller’s message was clear: ‘Get out of the stock market, own gold.

Druckenmiller’s gold position has done alright so far, as you would imagine. But he may be in for a bit of a shock…

Searching for the bubble

Leon Cooperman, Founder & Chief Executive Officer of billion dollar hedge fund Omega Advisors, doesn’t subscribe to the bearish outlook for stocks. During the SkyBridge Alternatives (SALT) conference in Las Vegas in May, Cooperman told the audience (my emphasis added):

The market will have to go higher before it becomes vulnerable. Out of the four phases — pessimism, skepticism, optimism and euphoria — I can say pessimism ended in 2009-2010 — we are between optimism and skepticism — I don’t see any euphoria. 50% of stocks yield more than bonds. The bubble is in fixed income and not equities. Individuals have taken US$800 billion out of markets this cycle and are very conservatively postured.

Cooperman does have a good point — the mum and dad punters, scared of what happened during 2008, aren’t piling into shares today. According to the latest Gallup survey on 20 April, ‘about half of Americans (52%) say they invest in stocks.’ That figure is down slightly from 2014 and 2015. Here’s the 19-year trend:


Source: Gallop.com
Click to enlarge

I agree with Leon Cooperman, and a number of other investment titans. The bubble exists in bonds — and not stocks. In my view, we’re facing a major crash in government bonds. Unfortunately, the majority of mum and dad investors are oblivious about the coming sovereign debt crisis. According to the Wall Street Journal on 11 August:

Stocks have bounced, but investors prefer bonds.

Emboldened by central-bank stimulus and a hefty price tag on equities, investor demand for bond funds relative to stocks is the highest on record, according to J.P. Morgan. Investors have poured $202 billion into global bond funds and withdrawn $47 billion from global equity funds this year, putting stocks on track for their first yearly outflow since 2008, according to the bank.

“The U.S. equity market is confounding everyone’s expectations by reaching new highs, but it has become quite expensive,” said Christopher Mahon, director of asset allocation research at Baring Asset Management.

A lot of developed-market government debt may also look expensive by historical standards. Around $12 trillion of global debt currently trades at a negative yield, according to Bank of America Merrill Lynch, including vast swaths of Japanese and European government bonds. But there are pockets of fixed income that still offer good returns, from emerging markets to U.S. corporate debt, some investors say.

The proverbial alarm bells are ringing!

If you don’t know, this was the kind of psychological attitude towards stocks in 2007, just before they nosedived by 50%.

The message is clear: Get out of fixed income — government bonds, emerging market debt, and low-grade corporate credit — while you can! (Investment grade corporate credit should survive).

When the European banking system melts down in the months ahead — owning the majority of government bonds — it won’t be pretty. The bond market is going to be a disaster, especially due to the lack of liquidity.

When the banking system starts to go pear-shaped, sure, the stock market will feel some heat. But it’s unlikely to crash. We’re probably looking at a 20–30% correction in the Dow Jones. Sure, Cooperman argues that the mum and dad investors aren’t in the market. But I don’t think that matters.

Confusion strikes

During the initial stages of the panic, it will take time to figure out what’s wrong.

Remember, institutional investors use financial models to back up their arguments. With stocks looking ‘stretched’ on their valuation models, they may be reluctant to jump into equities straight away.

The institutional investors, hedge funds, and sophisticated investors are likely to move into the US dollar. Most of these punters will probably buy US treasuries, or hold their money in a cash bank account until they figure out what’s wrong. The true speculators, like George Soros, will try to short the stock market.

Plus, let’s not forget. Market algorithms — that buy and sell stocks based on newspaper headlines — don’t have a brain. They will do what the computer code tells them to do. When the going gets tough, I’d expect the algorithms to sell stocks.

So, when the stock market starts to dive, will gold survive?

I doubt it. Gold — and gold stocks — crashed during the banking and stock market crisis of 2008/09. This time, albeit worse, should be no different.

When the European banking crisis becoming clearer in the months ahead, more punters are likely to buy US dollars. That won’t bode well for gold, which is priced in US dollars.

Everything could start to unravel this week. Japan’s GDP numbers and the US Federal Reserve’s July meeting minutes are both due. If they look towards raising rates, which is a possibility, the US dollar could start to strengthen. That probably won’t be good for gold.

If you want to know when to buy gold, check out Resource Speculator. I won’t tell you when to buy in Money Morning.

For now, check out your free report: ‘Three “Bounce-Back Mining Belters” to Buy NOW’. Implementing my top-down approach, I’ve found three resource stocks that could make you massive profits in the months ahead.

Read your FREE report, here.

Regards,

Jason Stevenson,
Resources Analyst

From the Port Phillip Publishing Library

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