Sunday, 11 August 2013

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Dear Daily Crux reader,

"Get out… Don't try to pick the bottom. Don't look for cheap stocks. Just get to the sidelines… because it could get worse."

This was the warning our colleague Matt Badiali, editor of the S&A Resource Report, sent to readers early this year. And as we've seen, he was exactly right.

The bear market in gold stocks turned into a full-blown crash… and extremely cheap stocks got even cheaper.

But now, something has changed.

Matt is getting bullish… and when a respected analyst turns from bearish to bullish on a cheap asset, it always gets our attention.

This week, we sat down with Matt to learn why he thinks the worst is over, and why it's finally time to buy.

If you're looking to profit from gold stocks now, this is required reading.

Good investing,

Justin Brill
Managing Editor, The Daily Crux


The Daily Crux Sunday Interview

Why a longtime bear has finally turned bullish on gold stocks
The Daily Crux: Matt, for months you've been warning your readers to be careful with gold stocks… that despite the huge declines we'd already seen and despite how incredibly cheap many gold stocks had become, many of these stocks could fall even further. And you were right.

But recently, you told readers the worst could finally be over. Why the sudden change of heart?

Matt Badiali: Before I explain why I'm getting bullish, I should probably remind readers why I was so bearish to begin with.

As most readers probably know, gold topped in May 2011 near $1,900 and trended lower ever since. And this decline revealed a serious problem with most gold-mining stocks.

You see, from 2001 when the bull market started until 2011, gold prices went almost straight up. Even during the financial crisis, gold ended the year higher than it started.

This continuous rise in gold prices allowed gold miners to get away with some very bad practices. Companies were actually rewarded for making big acquisitions, even if they grossly overpaid. And that's what many of them did.

But when gold started falling, everything changed.

The revenue these companies could make selling gold dropped significantly… but the costs to mine that gold didn't change. Suddenly, companies were sitting on projects that had looked extremely profitable at higher gold prices, but were worth much less at lower gold prices. In many cases, these deposits actually have a negative value now… meaning the company would lose money to produce that gold.

So what we've been seeing is a wave of "write-offs." This is when a company adjusts the true value of the asset on their books. In other words, it's the company "coming clean" and admitting they paid way too much for those assets.

In the last 18 months or so, gold miners have "written off" almost $30 billion dollars. Let that sink in for a second. Companies have admitted to wasting $30 billion on stupid, expensive acquisitions over the last five to 10 years. That's more than the total market value of the biggest gold miner in the world.

So while many of these stocks looked cheap, much of that "cheapness" was based on assets values that were overinflated. As companies have written off the value of these assets, share prices have followed them lower.

I expect we'll see more write-offs before it's all said and done, but I'm now seeing signs that the worst is over for gold-stock prices.

Crux: What's changed?

Some gold worth hundreds of times more than others?

If you've invested in gold, you'd probably be happy if the price went higher… But not if you've invested in the wrong kind of gold.

In a shocking exposé, Porter Stansberry explains why some gold investments could soon be worth hundreds of times more than the price of gold… and why some could soon become worthless. Click here for the full details.


Badiali: Well, we know gold stocks look cheap and are oversold… but that's been true to some extent for several months.

Sentiment toward gold miners, and the precious metals sector in general, is terrible and consistent with levels that have led to significant rallies in the past. But again, that's been true for some time.

What's changed recently is we've seen companies announce write-offs, and the stocks have refused to fall further. Let me explain.

Typically, bad news like a write-off will cause a company's shares to fall. This makes sense… Lower asset values suggest lower revenues and lower profits for shareholders.

But sometimes a stock has fallen so far, and sentiment is so bad, even bad news can't push the shares any lower. All the bad news is "priced in," and there's no one left to sell.

That could be what we're starting to see in gold stocks. Giant gold miners Goldcorp, Newmont Mining, and Barrick Gold all reported multibillion-dollar write-offs last month, and are trading higher today.

Picking a bottom is extremely difficult, but this is a great sign that the worst is over.

Crux: Are you giving your readers the "all clear" to get back into gold stocks?

Badiali: Obviously, there are no guarantees in the market, especially in the volatile resource sector.

But I do think it's a great time to make some smart speculations. In fact, I think folks buying today could easily see gains of 100% or more this year.

Crux: That's quite a prediction considering their performance over the past couple years…

Badiali: I'm sure that sounds crazy to some folks who have all but given up on the sector, but it's not far-fetched at all.

Now that the stocks are suggesting the selling is overdone, measures like valuation and sentiment that haven't "mattered" for so long, are likely to come back into play. And one of the most important measures of value – the gold-stocks-to-gold-ratio – has reached an incredible extreme.

For those who aren't familiar this ratio is simply the price of gold stocks – represented by the well-known AMEX Gold Bugs Index, otherwise known by its symbol "HUI" – compared to the price of gold.

For reference, this ratio reached an all-time extreme below .15 in late 2000, just before the bull market began. Following that extreme, gold stocks soared over 400%.

During the financial crisis in 2008 – when gold stocks were absolutely crushed – this ratio fell to just below .25. In the 12 months following that extreme, gold stocks rallied 150%.

Well, today the ratio has fallen well below .20. It hasn't been this low since January 2001.

These types of extremes are rare… and the rebound is often fast and powerful. So there's huge potential for another triple-digit rally this time.

Crux: Are there any major risks that could upset this rebound?

Badiali: Again, there are always risks in volatile stocks like these. But there are two in particular you should be aware of.

The first big one is the price of gold…

It's possible gold stocks could go nowhere, and the ratio could rise simply because the price of gold falls further. But I think that's unlikely.

Sentiment toward gold is terrible, too. Several measures are consistent with longer-term bottoms in gold. So I don't expect gold to decline significantly now.

But this risk can be minimized by the intelligent use of stop losses. Most gold stocks are still close to their yearly lows. Setting a hard stop a few percent below those lows would make sense in many cases… if a stock makes significant new lows, you'd simply sell and take a small loss.

On the other hand, if gold holds steady, or even rises a little, the gains in gold stocks could be spectacular.

The second major risk is company-specific risk. This is always a risk with gold stocks – after all, poor management is what got many of these companies in trouble in the first place – but it's elevated now.

There could be more significant write-offs coming for some companies. Some are in much worse shape than others… and some may not even survive. Single day losses of 30%, 40%, 50% or more are not unheard of following especially bad news.

Choosing the right companies could mean the difference between fantastic gains and serious losses.

Again you can reduce this risk somewhat with stop losses, but you could still be vulnerable to a large single-day decline. Smart diversification is a good idea. You could also consider buying one of the gold funds like the Market Vectors Gold Miners ETF (GDX), which hold a large basket of both the good and bad companies.

Of course, your best bet is to choose only the best companies… but this is easier said than done.

Over the past month, my team and I spent more than a hundred hours analyzing the gold mining sector, and we discovered some surprises.

We found a handful of well-known companies that are extremely vulnerable… and we found two companies in particular that are head-and-shoulders above the others right now.

It wouldn't be fair to my paid subscribers to reveal them here, but interested readers can find all details in my latest issue of the S&A Resource Report.

[Note: Following this interview, gold stocks enjoyed a big rally to end the week. This is another bullish sign for the sector… but it pushed both of Matt's new recommendations slightly above his maximum buy-up-to prices. Please do not chase them higher. Patient buyers should get a chance to pick them up on a pullback in the days ahead.]

Crux: Sounds great. Thanks for talking with us, Matt.

Badiali: My pleasure.
Editor's note: At just $39, our publisher has made the S&A Resource Report affordable for every investor. And if you aren't completely satisfied, we offer a four-month 100%-refund guarantee. Click here for access