Choosing between current and near-term gold producers, joint-ventures vs. royalty miners...
ANDREW MICKEY runs Q1 Publishing as Chief Investment Strategist, offering private investors what he calls "well-researched, level-headed, no-nonsense" business analysis and advice.
Over the past few years Andrew has visited Indonesia, the Ukraine, Papua New Guinea, Russia, Mexico, Australia, China, Thailand, Albania, Croatia, Norway and many other places in search of strong investment opportunities for Q1 Publishing's subscribers.
Here he speaks to the Gold Report about why he expects the stock market to fall back to a fair-value level over the next six months to a year, and why there will still be plenty of opportunities for those in the right spot in junior Gold Mining...
The Gold Report: In one of your recent articles, you suggest that even if good economic news continues coming out next year, the stock market is likely to drop 20% to 25%. Would you go through the logic that leads you to that conclusion?
Andrew Mickey: If we look back to the way the stock market has moved over the past 20 to 30 years, it has always been valued relative to earnings. The most common valuation for the market has 15 to 20 times the 10-year average annual earnings. That smoothes out the up-and-down years and brings you to a fair valuation – with the S&P 500 between 800 and 1000.
Granted the stock market goes much higher and much lower than that – and can stay at an extreme for longer than most investors expect – but it always returns to its fair value.
Now that so many stocks have had a great run, the S&P is up to around 1050, which means it is overvalued. The market basically has a lot of positive expectations built in. Earnings estimates are starting to rise, although all CEOs are still trying to keep expectations low. Economic expectations are rising. Expectations for everything are rising and we've learned consistently throughout the years – great expectations usually lead to great disappointments.
So as long as GDP growth is low the market will fall right back to fair value. That's why, even with the big picture news getting better, the very real risk is that it's still insufficient to hold the S&P up at 1050, 1100, or wherever it does eventually top out at.
We may not have an outright crash because everyone is still on watch, but probably a slow, steady fall over maybe six months to a year.
TGR: Are all sectors currently overpriced, or will some continue to appreciate?
Andrew Mickey: There will be some that will appreciate. But it won't be a case of great and greater returns like we've had. There is some great historical research done on the way stocks move. One important factor is the factors of market, sector, and stock. If you break it down, basically 50% of a stock's movement is usually tied the overall market. There's nothing you can do about that; it depends on the market. Another 30% of that stock's move depends on the sector. And the remaining 20% can be attributed to the individual company.
In other words, you can expect the initial impact across all sectors. We see it all the time when the markets go down. Just look at what happened last fall. Everything is very closely tied together. Over time though, there will be the divergence between the quality and value and all the speculative stuff.
TGR: How much focus should individual investors put on international investments versus North American-based investments in this environment?
Andrew Mickey: A lot of it depends on your time horizon. If you have five years or more, you can build a reasonable case for focusing 30% to 50% of your money in international stocks.
That's a very high concentration for any portfolio in any particular sector. If you're looking out that far, you definitely want to be in the emerging markets. In the short term, the falling Dollar has been very helpful to some of the really large, high-quality US companies.
But if we look at the massive US Dollar carry trade right now, we can see that is going to be driving everything. We watched the Yen carry trade last for about four years and then the credit crunch forcing the sudden unwinding of it. With the US Dollar carry trade, it is going be even bigger, could last even longer, and the when it is unwound, the volatility and fear even bigger.
TGR: In another of your recent articles, you said that junior gold stocks offer exceptional value because they're still in the relatively early stages of recovery. With gold up 30%, major gold stocks down 15%, and junior gold stocks down 60%, you asked, "Which one would you like to buy now?"
But with the greatest opportunities for appreciation, don't those junior Gold Mining stocks also present a correspondingly greater risk? If so, how do you minimize the risks of investing in juniors?
Andrew Mickey: There are two ways. The first is timing and picking the bottom, which is a very tough thing to do. The other is diversification; I'd recommend owning at least five to 10 across the board. In addition, you'd want to buy consistently. The way we see it, we'll be Buying Gold juniors for the next two years.
We don't want to exhaust all of our capital right away. It's a lot less stressful and you don't have to be exactly right to make a fortune.
Also, when they're still deeply undervalued on a relative basis, you don't have to risk nearly as much capital. So you could make 20% in big gold stocks, but you may have missed 50% to 100% in juniors. The juniors are riskier, but the amount of capital required to earn the equivalent nominal gains is less. Risk is always relative to a lot more factors than simple percentage moves, positions sizes are as equally important.
TGR: When you're looking at juniors, do you differentiate between current producers and near-term producers? Or joint-venture models versus royalty companies?
Andrew Mickey: Most of our valuations are based on traditional metrics such as net present value of future cash flows for producers. Of course, once a company is producing and we know much gold it is producing, there's a clear way to value it through the cash flow model. That's how the big money values things, so that's how you have to do it.
If you really want to swing for something with just a little bit more upside potential, maybe you select a near-term producer. There's a lot more room to value them differently because as the big money managers continue to look at gold, they're going to have to come up with ways to value those stocks.
Think of it like the dot-com days. If a company had earnings, there was a way to value it traditionally. But if a company didn't even have a chance of being profitable, traders and investors would come up with all kinds of ridiculous ways to justify lofty prices and bid them up even more. That's why the worse a company was fundamentally, the better it actually did.
That happens in all euphoric bubbles. And when it does, it will feel great, but that's also the time to start taking money off the table.