(Interviewed by Louis James, Editor, International Speculator)
This interview was first published on September 30, 2009.
Editor’s Note: In yesterday’s Weekend Edition, Casey Research founder Doug Casey explained why gold stocks can offer 10 times or even 100 times return on your money. Today, Doug explains how to stack the odds in your favor when buying gold stocks…
Doug: You know, I first started looking at gold stocks back in the early 1970s. In those days, South African stocks were the “blue chips” of the mining industry. As a country, South Africa mined about 60% of all the gold mined in the world, and costs were very low. Gold was controlled at $35 per ounce until Nixon closed the gold window in 1971, but some South Africans were able to mine it for $20 an ounce or less. They were paying huge dividends.
Gold had run up from $35 to $200 in early 1974, then corrected down to $100 by 1976. It had come off 50%, but at the same time that gold was bottoming around $100, they had some serious riots in Soweto. So the gold stocks got a double hit: falling gold prices and fear of revolution in South Africa. That made it possible, in those days, to buy into short-lived, high-cost mining companies very cheaply; the stocks of the marginal companies were yielding current dividends of 50-75%. They were penny stocks in those days. They no longer exist; they’ve all been merged into mining finance houses long since then. Three names I remember from those days were Leslie, Bracken, Grootvlei…I owned a lot of shares in them. If you bought Leslie for 80 cents a share, you’d expect, based on previous dividends, to get about 60 cents a share in that year. But then gold started flying upward, the psychology regarding South Africa changed, and by 1980—the next real peak—you were getting several times what you paid for the stock in dividends alone, per year.
Louis James: Wow. I can think of some leveraged companies that might be able to deliver that sort of performance if gold goes where we think it will. So, where do you think we are in the current trend or metals cycle? You’ve spoken of the Stealth, Wall of Worry, and Mania Phases of a bull market for metals—do you still think of our market in those terms?
Doug: That’s the big question, isn’t it? Well, the last major bottom in this sector was from 1998 to 2002. Many of these junior mining stocks—mostly traded in Canada, where about 75% of all the gold stocks in the world trade—were trading for less than cash in the bank. Literally. You’d get all their properties, their technology, the expertise of their management, totally for free. Or less.
L: I remember seeing past issues in which you said, “If I could call your broker and order these stocks for you, I would.”
Doug: Yes. But nobody wanted to hear about it at that time. Gold was low, and there was a bubble in Internet stocks—why would anyone want to get involved in a dead duck, 19th century, “choo-choo train” industry like gold mining? It had been completely discredited by the long bear market—but that made it the ideal time to buy them, of course. That was deep in the Stealth Phase.
Over the next six to eight years, these stocks took off, moving us into the Wall of Worry Phase. But the stocks didn’t fly the way they did in past bull markets. I think that’s mostly because they were so depleted of capital, they were selling lots of shares. So their market capitalizations—the aggregate value given to them by the market—were increasing, but their share prices weren’t. Not as much. Remember, these companies very rarely have any earnings, but they always need capital, and the only way they can get it is by selling new shares, which dilutes the value of the individual shares, including those held by existing shareholders.
Then last fall hit, and nobody, but nobody, wanted anything speculative. These most volatile of stocks showed their nature and plunged through the floor in the general flight to safety. That made last fall the second best time to buy mining shares this cycle, and I know you recommended some pretty aggressive buying last fall, near the bottom. Now, many of these shares—the better ones at least—have recovered substantially, and some have even surpassed pre-crash highs. Again, the Wall of Worry Phase is characterized by large fluctuations that separate the wolves from the sheep (and the sheep from their cash).
Where does that leave us? Well, as you know, I think gold is going to go much, much higher. And that is going to direct a lot of attention toward these gold stocks. When people get gold fever, they are not just driven by greed, they’re usually driven by fear as well, so you get both of the most powerful market motivators working for you at once.
It’s a rare class of securities that can benefit from fear and greed at once.
Remember that the Fed’s pumping up of the money supply ignited a huge bubble in tech stocks, and then an even more massive global bubble in real estate—which is over for a long time, incidentally—but they’re still creating tons of dollars. That will inevitably ignite other asset bubbles. Where? I can’t say for certain, but I say the odds are extremely high that as gold goes up, for all the reasons we spoke about last week and more, a lot of this funny money is going to be directed into these gold stocks, which are not just a microcap area of the market but a nanocap area of the market.
I’ve said it before, and I’ll say it again: When the public gets the bit in its teeth and wants to buy gold stocks, it’s going to be like trying to siphon the contents of the Hoover Dam through a garden hose.
Gold stocks, as a class, are going to be explosive. Now, you’ve got to remember that most of them are junk. Most will never, ever find an economical deposit. But it’s hopes and dreams that drive them, not reality, and even without merit, they can still go 10, 20, or 30 times your entry price. And the companies that actually have the goods can go much higher than that.
At the moment, gold stock prices are not as cheap, in either relative or absolute terms, as they were at the turn of the century, nor last fall. But given that the Mania Phase is still ahead, they are good speculations right now—especially the ones that have actually discovered gold deposits that look economical.
L: So, if you buy good companies now, with good projects, good management, working in stable jurisdictions, with a couple years of operating cash to see them through the Wall of Worry fluctuations—if you buy these and hold for the Mania Phase, you should come out very well. But you can’t blink and get stampeded out of your positions when the market fluctuates sharply.
Doug: That’s exactly right. At the particular stage where we are right now in this market for these extraordinarily volatile securities, if you buy a quality exploration company, or a quality development company (which is to say, a company that has found something and is advancing it toward production), those shares could still go down 10%, 20%, 30%, or even 50%. But ultimately, there’s an excellent chance that same stock will go up by 10, 50, or even 100 times. I hate to use such hard-to-believe numbers, but that is the way this market works. When the coming resource bubble is ignited, there are excellent odds you’ll be laughing all the way to the bank in a few years.
I should stress that I’m not saying this is the perfect time to buy. We’re not at a market bottom as we were in 2001, nor an interim bottom like last November, and I can’t say I know the Mania Phase is just around the corner. But I think this is a very reasonable time to be buying these stocks. And it’s absolutely a good time to start educating yourself about them. There’s just such a good chance a massive bubble is going to be ignited in this area.
L: These are obviously the kinds of things we research, make recommendations on, and educate about in our metals newsletters, but one thing we should stress for nonsubscribers reading this interview is that this strategy applies only to the speculative portion of your portfolio. No one should gamble with their rent money nor the money they’ve saved for college tuition, etc.
Doug: Right. The ideal speculator’s portfolio would be divided into 10 areas, each totally different and not correlated with each other. Each of these areas should have, in your subjective opinion, the ability to move 1,000% in price. Why is that? Because most of the time, we’re wrong when we pick areas to speculate in, certainly in areas where you can’t apply Graham-Dodd-type logic. But if you’re wrong on nine out of 10 of them—and it would be hard to do that badly—then you at least break even on the one 10-bagger (1,000% winner). What’s more likely is that a couple will blow up and go to zero, a couple will go down 30%, 40%, 50%, but you’ll also have a couple doubles or triples, and maybe, on one or two of them, you’ll get a 10-to-1 or better win.
So, it looks very risky (and falling in love with any single stock is very risky), but it’s actually an intelligent way to diversify your risk and stack the odds of profiting on volatility in your favor.
Note that I don’t mean that these “areas” should be 10 different stocks in the junior mining sector—that wouldn’t be diversification. As I say, ideally, I’d have 10 such areas with potential for 1,000% gains, but it’s usually impossible to find that many at once. If you can find only two or three, what do you do with the rest of your money? Well, at this point, I would put a lot of it into gold, in one form or another, while keeping your powder dry as you look for the next idea opportunity.
And ideally, I’d look at every market in every country in the world. People who look only in the U.S., or only in stocks, or only in real estate… they just don’t get to see enough balls to swing at.
L: Okay, got it. Thank you very much.
Doug: A pleasure, as always.
Editor’s Note: We just alerted readers to an extremely rare opportunity in gold stocks… one that could lead to 500%-plus gains in a short period. This situation has only occurred a handful of times in the last 20 years. But every time it occurs, some investors see gains as large as 1,700%, 4,300%, and 5,000%.
If you’re interested in this idea, please act now. With gold prices surging, the window of opportunity is closing fast. And once it’s closed, we likely won’t get another chance like this for years. Read more here.