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Excitement is building...but there are risks

Well that was quite the week! The third week of January is mining conference week in Vancouver, with three back-to-back-to-back events running across seven days. It’s enough to attract a large swath of the mining industry to town and meetings between juniors, majors, funds, investors, analysts, and brokers take over coffee shops and restaurants for blocks around the Vancouver Convention Center.

I certainly drank my fair share of coffee while learning about deals I didn’t yet know and getting updates on those I did. Every day also offers a packed schedule of talks – project presentations, commodity outlooks, investment themes, social governance, jurisdictional risks and opportunities, regional exploration overviews, and more.

Having emerged from the other side of it all, my editorial in the weekend edition of the Maven Letter covered the concepts that stuck with me the most, including the biggest risks I see to our bullish excitement. Included in today's Maven Monday is one part of that discussion.

Subscribers also heard about a new recommendation, and two additional ideas will follow shortly. If you'd like to hear what Maven is buying and selling and why, subscribe to the Maven Letter.


From The Maven Letter: Jan 26, 2018...

Excitement Building
The most common conversation I had during the conferences reflected my recent thinking: that the outlook for commodities, as a class, is better now than it has been for many years. That was the focus of my talk on day 1 of the Metals Investor Forum(video available here).

Whether I was talking to resource-focused investors, commodity analysts (who are usually pretty conservative), sector executives, or other researchers/writers, people were generally excited about the current outlook. From dollar weakness to potential inflation, global economic growth to metal supply-demand gaps, the relative fire sale pricing for commodity stocks versus everything else to shifting perspectives on risk and diversification – forces are aligning in favor of commodities.

That will really matter when it starts to manifest in generalist investors rotating into commodities for opportunity and diversification. And it won’t take much: the metals sector is so tiny that a tiny rotation of investment dollars will have outsized impact.

It’s starting to happen. I’ve already quoted Jeff Gundlach of DoubleLine Capital encouraging investors to move into commodities this year. I’ve noted Goldman Sachs saying investors should overweight commodities. This week a friend pointed out another fund making similar moves: the table below shows Fidelity Global’s top ten holdings as per the end of 2017.
The highlighting is mine…but deservedly so, I would argue, because how long has it been since two base metal miners have made a list like that from a large generalist fund, alongside Alphabet, Amazon, and the like??

Within that broadly bullish outlook, I keep suggesting that the immediate question is: will gold break up through resistance in this seasonal run (i.e. before March) or will we have to wait until late summer? Here gold is simply the windsock for the sector: if there’s enough interest to push the yellow metal up through resistance, then it’s likely Game On for the whole metals complex.

Resistance is at US$1360 or $1365 per oz., depending how you draw your lines. And yes, gold did get to that level on Wednesday – in dramatic fashion! The catalyst was Treasury Secretary Steve Mnuchin bluntly saying that a weaker dollar would be good for the United States.

“Obviously a weaker dollar would be good for us as it relates to trade and opportunities.”
-- Treasury Secretary Steve Mnuchin at the Davos Summit

Many have argued this for some time now, suggesting that dollar strength was hurting exports, limiting multinationals’ ability to expand and encouraging imports over domestic production. There is also the more basic argument that the greenback has taken its turn as the ‘strong’ currency in the room; it’s now time for another to take that mantle, and the advantages and disadvantages that go along with it. With economies strengthening in Europe and Japan, it seemed reasonable that the dollar could take a break.

All that, however, was an undercurrent, a set of ideas that many assumed Washington backed but would never actually say because politicians hardly ever argue that their currency should be weaker. In America such hasn’t happened since the Carter administration, when the stance led to massive depreciation of the dollar.

But this is the Trump administration, where we get what we least expect. Certainly Mnuchin’s statement at Davos about how a weaker dollar would benefit America fits that bill! You can see the shock in the charts of the dollar and gold:

The blue line shows the gold price on the day Mnuchin spoke. It marked a steady ascent from the moment he opened his mouth, up through $1350 like the line didn’t exist and up to touch $1360 before relaxing a touch. The next morning (the end of the blue line and start of the red) it went on another run, getting above $1365!

The dollar did the opposite, declining steadily all through Wednesday to end the day down 1.1%. That is a very significant move given that we’re talking about the world’s reserve currency.

It had fallen another half percent on Thursday when Trump stepped in with some damage control.

“The dollar is going to get stronger and stronger, and ultimately I want to see a strong dollar. Our country is becoming so economically strong again and strong in other ways too.”
-- President Trump at the Davos Summit

Is that what Trump actually wants or thinks? I think not. He is a trade protectionist and a capitalist who from the earliest days of his campaign decried the strength of the US dollar.

Whether he thinks it or not, Trumps comments talked the dollar up and gold down. The yellow metal is back below resistance and I still just don’t know if it will move up notably again in the next four weeks.

Whatever happens, the plan remains the same. If gold does break up through resistance, seasonal selling will be less important because the summer doldrums will be moderate. Take profits/use seasonal strength to sell only those stocks you no longer want to own. Hold those you have chosen as your bull market bets. And use slight summer weakness to add to positions or buy into good new opportunities before this thing really goes.

If gold doesn’t break up before March, we will have a more normal summer doldrums. That means seasonal selling will be more important – lock in gains on lots of stocks, with a plan to buy back in to those you really like mid-summer.

Also, whichever case happens I will be trimming back the portfolio in about a month. It is simply too large and includes some stocks where it’s becoming apparent the thesis isn’t playing out. I’m still holding out for a bit more seasonal strength before making those sells.

The Risks
I wish I saw only green lights ahead for our investments, but while the outlook is better than it has been for years there are also risks on the horizon.

Broadly, the risk is this: that we pile into mining stocks based on this bullish commodities outlook and then the US stock market corrects or crashes, pulling everything – including commodities, even though they don’t deserve it – down with it.

I don’t need to argue again that US stocks are expensive and that this bull market is long in the tooth. Those things are all accepted now, but so too is the mantra that A bull market is a bull market until it isn’t a bull market – and for now we remain solidly in the first half of that sentence!

That’s an acute fear. Underlying the fear of an acute event like that are a series of arguments around why US economic prospects aren’t that rosy.

I am the first to admit that I was wholly committed to that camp until recently. I just couldn’t see enough strength in the data to substantiate the stock market. Then I realized I was looking for a link that doesn’t really exist: the stock market rallied strongly because quantitative easing created immense inflation in financial assets, without helping the real economy that much. However, stock market strength fed the idea that the economy was recovering. And it actually was, if inordinately slowly.

Now we’re at an uneasy juncture. We have economic growth in the US, slow but steady. It’s good, but it still doesn’t justify stock prices. And yet growth now means monetary changes – rate hikes and tightening – as well as fiscal attitudes – backing a weaker dollar – that have the real potential to derail growth.

And here’s the key: should growth be derailed, the fairy tale falls apart. Inflated stock prices were supposedly based in a US economy recovering far faster than any other in the world…but if that recovery stops, the basis is gone. Then what?

I spend too much time thinking about these things. Right now my sense is that these threats to US growth will still take some time to manifest. As such, a stock market crash or correction based on weakening fundamentals is still a ways off. That works just fine from a metals investor standpoint – we just need two years of opportunity please!

I can’t have a sense of when or if the acute threat might manifest. That’s the same challenge every investor currently faces: how much longer will this go? Talk of market melt up and investor euphoria is increasing, but these things can last a long time, especially given that international growth is just joining the party. The supposed rationale keeps getting stronger, even as the valuations get stupid and the reality of actual growth forces monetary and fiscal moves that, ironically, threaten it all!

The Letter continued with a look at specific economic risks and how to monitor them...

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Great letter this morning Gwen. I am not "all aboard" with your picks but your understanding of how best to manage a high risk portfolio is second to none. And I did buy a lot of G when you made the call and sold it about a month later for a very healthy gain. Thank you very much!
As for "shiny ponies" that are moving on anticipation and will move big on good news, you need to get on the BAY train. Just sayin’..........

-PL (June 7, 2018)

Besides your far superior record, your format is the best I’ve seen in PM newsletters. It’s so easy to go back for older info on companies when appraising my portfolio. This compliment is from someone who has hired about a dozen letter writers so it has perspective. Keep up the good work.

-BJ (Feb 13, 2018)