$1000 Gold in the Ground

Trading and valuing small-cap Gold Mining stocks...

STUDYING FOR A DOCTORATE in aeronautical engineering at Princeton, Chen Lin found his investment strategies more profitable and put his PhD on the back burner.

Working in the internet and computer arena to found start-up companies, Chen Lin successfully moved his portfolio into the hard asset and natural resource sectors as the tech bubble burst in 2000. Now Lin writes the popular stock newsletter What Is Chen Buying? What Is Chen Selling? – published and distributed by Taylor Hard Money Advisors. Here he speaks to The Gold Report about what's happening in China – home to the world's largest Gold Mining output...

The Gold Report: How important is technical analysis for you? Is charting more useful as an entrance and exit point for a stock, or do you use technical indicators for a longer-term approach?

Chen Lin: That's a very good question. I know technical analysis pretty well, and I watch a lot of indicators. Technical analysis probably helps most when entering or exiting a stock. You can also see some pretty good entrance points. Technical analysis also helps when the technical indicators improve and a lot of new technical buyers come into the picture; you can predict the stock will do well. But fundamental analysis is always most important for me, and value is the most important factor.

TGR: What indicators do you use – moving averages?

Chen Lin: I don't follow those too closely; I look at the chart and I can see the trend. I set up an alert at my Fidelity account to email me whenever gold is crossing certain moving averages, such as the 200-day moving average. I use these as reference points to see the general trend for the stock. I also use Relative Strength Index (RSI) as a good indicator to see how a stock is overbought and oversold.

In general, you want to start selling when a stock is overbought and buy when it's greatly oversold. But the company's fundamentals are the most important. If it's undervalued, it may still rise – like one stock I own that recently had a 90 RSI – which is extremely overbought – but is going higher still because the stock is undervalued from any perspective. It just rose so sharply, I had to sell some; but I'm keeping a lot of shares.

TGR: After a stock is fully valued, do you attempt to ride it as a momentum play to squeeze out more juice? Or are you just happy to take your money off the table and use it to enter another value play?

Chen Lin: Usually when a value stock reaches its valuation, it rides higher than its valuation and tends to get overvalued. Day and momentum traders rush in; so, stocks actually appreciate a lot in a very short period. Then I just start selling and taking profits gradually. Sometimes it will get a very big pop in one day when I'm selling, and I use those indicators to sell more. But in general it's very hard to catch a peak. So, taking profits is a process instead of a one-day event.

TGR: You play anywhere from penny stocks in the single-digit millions up to the $3-4 billion market-cap level. That's a real advantage for an independent or non-institutional investor. Even most hedge funds don't have that luxury. Obviously, liquidity issues don't scare you. How do you manage those situations when a stock may not be marketable?

Chen Lin: I generally follow different rules, but first you have to know where the market is going. If the market has just started to rise, you can get into illiquid or risky stocks because, as the market rises, liquidity will come and illiquid stocks will become more and more liquid. But if the market is getting more mature and dangerous, you might want to sell them; for example, back in summer 2008, I sold all my junior stocks. For every stock, I set a rule for when I would sell. When they got to a certain level, I got out. By the end of 2008, I started to buy junior stocks – illiquid stocks.

TGR: You buy when you see activity in very small stocks?

Chen Lin: Activity is a good indicator, but it's not the only indicator. I'm a value investor, so I look mostly at the valuation. But in general you want to invest in companies with rising volume and increased trading activity. That means more people are interested in the stock. So, if you believe that liquidity will be on the rise, then you can take a heavy position in a small-cap stock.

TGR: How do you start when you're looking for a metals stock versus, let's say, an energy stock?

Chen Lin: Metals stocks are very different in valuation from energy stocks. I generally like a metals stock with a world-class asset or potentially world-class asset. For a Gold Mining exploration company with 5 million ounces gold or gold-equivalent in a desirable location that a major might be interested in taking over, you can put a value on the company. That's because we know what price majors are paying for the gold.

The most recent takeover was for almost $1000-per-ounce in the ground. Of course, there's a potential to expand the resource too. For production companies, you look at the production profile. You look at the average cost, the cash flow and the balance sheet. A production company can immediately leverage to higher gold and Silver Prices. Use those numbers to calculate cash flow, and you have an objective valuation of the company.

TGR: Chen, do you currently favor silver over gold? Is there more upside, percentage-wise, to silver than there is to gold?

Chen Lin: Yes, I think so. I probably have a little more silver than gold because silver started relatively late and is just coming up. Gold starts first, and silver always outperforms gold in the second half of a bull market. That happened in the '70s, and I think it could happen in this round.

On February 18, the margin of silver reserve requirements for silver contracts was increased by the exchange. Silver exploded because funds were betting heavily against silver, and they had to cover their shorts. It could easily go to $40 and $50 per ounce. There's still a big short position in silver, and it could outperform Gold Bullion.

TGR: Where would you be investing today if commodities weren't in an upswing?

Chen Lin: If the underlying commodities were not in an upswing, I would be more focused on stocks with high liquidity – those with strong balance sheets and strong cash flow. When they generate cash flow, they don't need to come to market to raise money. So, then they're relatively insensitive to commodity prices. Another very important factor to consider is the cost of producing the commodity. That's also in the cash flow model. If the commodity price stopped rising, or started to go down, I would invest in those stocks.

TGR: Thank you, Chen. This has been very informative.

Buying Silver today? Make it secure, low-cost and simple using the award-winning BullionVault...