Category Archives: ETFs

Miners are down in the muck!

My father was out visiting back in early October and while he was out here he asked me what I’m currently investing in.  I told him I’m weighting in on the mining sector as it has been absolutely getting crushed.  He asked me to send him an email with the ETFs we discussed (GDX, GDXJ, SIL).

In the email I sent him, I made sure to comment that although I am confident that the miners will have vary large gains in the long term future from where they are now, they are currently down in the muck and suggested they could easily lose another 20-40%.

I gave him specific instructions, that because this sector is so far down in the muck, not to put all the money he intended to invest into the sector right away, even though I think they are currently dirt cheap.  I gave him a plan to purchase into the declines as the sector would potentially continue to get beat up.

I sent that email on October 4th when the price of GDXJ was at $32.  Over the last 2 months, there have been incredible daily swings, with a 2-month low of $22.71.

If he listened to my instructions, he would currently have 75% of his investment for the sector invested at an average price of $26.60.

If another friend or family member were to come to me with the same situation, I would give them the same investment plan, but not with the same numbers.  The plan I would give that person would not be geared toward the sector or any specific price target.  It would be based on that person’s timing and entry point.

I get so frustrated when I read investment newsletters where the “guru” gives specific buy and sell points based on his own “guru” portfolio. People are always frustrated and I’ve rarely seen anyone actually achieve the results the “guru” gets.

If you come in late to the “guru’s” game plan, that investor may have a long term gain, but because you got in late, you lost money as the “guru” lost 20% in the last X amount of trades which were the ones you were involved in.  So the “guru” claims success while you lose.

In the future, I plan to release a membership section to teach my strategy that is built on creating success for your individual situation based on your individual timing and investment funds.  Join my newsletter to stay up to date and get notified when it comes out.

 

Watch List: Biotech Sector Pullback

The biotech sector has had an extensive a run over the last 3 years, more than doubling its 2011 average price.  Recently, however, as you can see in the chart below, it has pulled back about 25% to $130 from its peak of $170.

xbi price pullback

As part of its decline, this sector also recently crossed the upward trend line of “higher lows” as can be seen in the chart below.

xbi biotech trend line

Breaking such a long term trend line is a fairly big deal and further decline is likely to come as technical traders start to weigh in on the negative side by shorting the stock until it hits lower “resistance” zones.

In the chart below, I put percentage drop markers at two areas of resistance beyond the recent drop.

SPDR S&P Biotech ETF recent pullback

I’m looking to start investing in this sector, should it drop into those resistance areas between $105 – $120.  I’d like to see it get back to the $90 range in the long term and that’s where I would start adding stronger positions as part of my purchasing technique.

Miner ETFs VS individual stocks

Depending on where you look on the web, you’ll find a different average cost for miners to pull gold out of the ground.  Whichever amount you choose to believe, you can fairly estimate that gold is currently selling at or below the cost to mine it.  Thus, the miners are not likely to be profiting.  Hence, their stock prices are currently trading at a significant discount (see my article on Why stock prices for mining companies can go so low).

I like the miners because when the price of their respective commodity drops significantly, they can scale back operations and go into more of a survival mode, by cutting production and lowering expenses until the commodity price starts to re-elevate. Once the commodity hits a price that becomes more profitable, they can kick things back into high gear while having learned a few lessons in efficiency due to the downturn.  Their biggest objective during the downturn is make their debt payments.

And that’s why I like holding ETFs over individual gold stocks.  Since I don’t have the time to investigate each of the miners and learn how each manages its debt (as well as many other business factors), I know that by buying an ETF, I’m buying the average.  Some companies will do well, and some will not do so great.

In fact, some companies will do so poorly with their debt that they may go out of business.  Since the actual mine is the collateral of the loans, what is likely to happen should a miner go out of business?

Well, the debtor would come in and foreclose on the property.  But the debtors can’t do anything with those mines as they are in the lending business, not the mining business, so they would just turn around and sell the mine to another mining company (or more realistically, one of the better managed miners will first step in and buyout the company/debt for a discount).

Thus, if you are in an ETF that holds many mining companies, you are likely to get that mine back through another company in the ETF.  So it sort of all comes out in the wash, which is another reason why I like holding an ETF over an individual stock at this point in my life (see about me page).  For every company that significantly under performs, another company is likely to significantly outperform.  You do give up the chance for even greater gains but you gain security of knowing you didn’t pick a catastrophic company (see my article about knowing your risk tolerance.)

I have developed a proprietary investment technique for stable investing which I’ve developed over my many years of successful investing while going through major life changes. Having the knowledge above alone is not enough. You need to implement a stable, intelligent investing technique to get substantial, stable gains while protecting yourself from losing money.  I intend to release my technique in a membership section in the future. Please Join my mailing list to be notified when it will be available.

 

Why I now invest in Exchange Traded Funds (ETFs) over individual stocks

Before I was married, I would invest in individual stocks.  Individual stocks are inherently more riskier than something like an ETF, not only because individual stocks are more vulnerable to larger swings, but there’s always the likelyhood that the individual company could go out of business, causing you to lose your entire investment.

It takes a lot of time to research and individual stock.  Beyond higher level macro picture of evaluating the economy and indivdual sectors, you need to spend time looking at intricate details like the company’s target market, finances, outlook, and management.  Failure to spend time to accurately look at and understand any of the major components that makes a company successful will leave you vulnerable to investing in a company that may go out of business.

Even if you do your diligence, then you are still vulnerable to the illegal espionage that can take a company down.  Management could be mis-reporting or there could be embezzlement.

No matter how well you research a company something could go wrong.  When I was single and didn’t have any dependents, I was more willing to take these risks by investing more of my investment money in individual companies.

Now that I am married and starting a family, both my time and risk tolerance have decreased.  I no longer have the time to obsessively bury myself in balance sheets and research various companies intricate details.  I also can’t risk the possibility of investing a significant portion of my portfolio in an individual company and having the company go out of business.

I now invest primarily in ETFs (Exchange Traded Funds), and I have become more sector focused.  I look for sectors that are getting beaten up for one reason or another.  I look more at the macro picture and have cut out the extra time it takes to investigating the intricate details of a particular company.

ETFs are funds, so there is virtually no chance of losing your entire investment.  Things may get rough and the value may diminish.  A few of the companies within the fund may go out of business, but since each individual company only represent a small portion of the ETF portfolio, the loss of that business won’t erase your investment.    Also, due to the law of averages, in really bad times, a couple companies within the ETF may go out of business, but likely that business will be picked up by other companies within the ETF and those respective stocks will gain in value (especially when the sector picks up), which will mitigate the damage done to your portfolio by the loss of the weaker companies.

I like ETFs over mutual funds because they don’t have “load” fees and usually have lower “expense” costs.  Most ETFs I invest in have an “Expense Ratio” around 0.5%.  Mutual funds tend to have higher management fees of around 1-3%.

When you purchase a mutual fund, the higher expenses go towards paying the fund manger, administrative fees, and advertising fees.  I don’t like paying for a fund manager because there’s so many fund mangers out there that the chance of purchasing a fund that actually does have an exceptional manager that’s worth the fees the person is getting paid is minimal.  To me, mutual funds are for the ignorant.  You are paying someone to sell you something and make you feel good about your investment, though its really no better than lesser managed fund that simply tries to represent a market segment, as mosts ETFs do.

 

 

Why are the values of gold and silver mining stocks going so low?

With the price of gold taking over a 30% drop from its most recent peak in October of 2012 and nearly a 35% drop from its all time high in September of 2011, the precious metal mining sector has been absolutely crushed.

Specifically the large cap Market Vectors Gold Miners Index ETF fund (GDX) has dropped 58% and the small cap Market Vectors Junior Gold Miners ETF (GDXJ) has dropped 65% from their most recent peaks in September of 2012.  They are down substantially more from their all time peaks (65% and 80% respectively).

So why have the miners taken so much more drastic of a plunge than gold itself?  The following is a simplified analysis to help you get started understanding the answer.

Over the last hundred years (or so) we’ve removed all the easier to find gold from the near surface of the earth, and now miners have to do a lot more work, in more remote locations, while using bigger and more powerful equipment to get at harder to access deposits in the earth.  And that work and equipment costs more and more money.

If you add up all the expenses it takes for a company to pull as much gold as they can out of the ground in a year, then divide it by the total weight of that gold they extracted in that year, you get an average cost per weight that it takes for the company mine gold.

If that average price to mine gold is below the current price of gold, the miner obviously loses money when they sell their extracted gold.  If the price they can sell the gold for is greater than their average cost to pull it out of the ground, they obviously make money.

The kicker is that when the price of gold is bigger than than the cost to mine it, every extra amount that the selling price of gold goes up is pure extra profit.

Lets take an example.  Say it costs the mining company $1300/oz to extract the gold and get it ready to sell.  And, say the current price of gold is $1400/oz.  The miner profits $100/oz.

Now say that the cost to mine remains the same at $1300/oz, but the price of gold rises to $1500/oz.   Now the miner profits $200/oz.  So the miner’s profits doubled without them doing anything different.

A company who’s profits double, is (in simple terms) worth twice as much, or will have a 100% increase in value above its price before the profit change.  Whereas in the scenario above, gold only increased in value 7%.  So a 7% increase in gold price, caused a 100% increase in the value of the average company mining it.

From the example above, you should be able to see that relatively small changes in the price of gold can have significant impacts on the profits, and therefore, the trading prices of gold mining companies.

Currently, depending on what source you find and decide to believe, the price of gold is near or below what it costs for for an average mining company to mine it.  So the mining companies are, on average, losing money.

If a company loses money for more than a short period of time, it is likely to go out of business.  A company that is likely going to go out of business is worth very little and nobody wants to buy it.

So with the price of gold going down, and the miners seemingly losing money, it appears as though miner stocks are not worth purchasing, and their trading prices have plummeted to those apparent levels.

Beyond the basic examples above, it is also helpful to know that pricing gets taken to extremes as the sum of people trading in the market make up a virtual mob that is actually quite emotional. When things are going in a certain direction, the mob becomes increasingly focused in that unilateral direction and pays less and less attention to the extremeness of the trend.

It starts with the basic economics of supply and demand. Because just about everyone is doing the same thing, there is usually not enough of whatever the mob is buying (supply) for the amount of people in the mob trying to buy it (demand).  Therefore the price of that thing goes up to balance the limited supply and growing demand.

In the opposite direction, as is happening with the miners, there is too much supply because everyone is selling, creating an oversupply, and the price therefore goes down.

On top of this, add in the effect that people psychologically see that a trend is happening and expect that it will go on forever and you get an extreme overall sentiment in the mob.  People see that everyone is doing something, and expect that because everyone is doing it that same thing it will go on forever.  So it becomes seemingly obvious that one should join the crowd.

We saw this with the housing bubble.  People bought houses because they prices were going up so drastically.  If you didn’t by a house “now”, you’d never be able to own one, because the prices just kept going up and up.  Loans were easy and cheap so people bought as much house as they could afford the payments on, expecting that if anything went wrong, they could just sell the house for a profit as everyone had heard about “those people” that bought a house and sold it a few months later for a 50% profit.  This caused prices to surge.

Of course the reverse also turned out to be true.  When the short term interest rates on those easy loans started adjusting up, people could no longer afford the payments on their homes and suddenly everyone started having to sell their houses.  With virtually everyone selling and nobody buying, the prices plummeted.  Many homeowners, even though they could afford their payments, walked away from their houses, because there was “no way it would ever get its value back”.

Bringing this thought pattern back to gold and the gold miners, we currently have a situation where the price of gold and the miners are going down.  So we have a trend that is snowballing downward.  The mob is becoming unilaterally focused on the downward trend.  People believe that because the price of gold is going down, it is going to continue going down forever, and therefore the miners are never going to be profitable again.  So more and more investors are joining in on selling and “cutting their losses”.  So the miners seem to have virtually no value and their stocks are trading at such a value.

Now… there’s one more effect I need to mention that adds to exponentially increase the already exponential effect of the mob mentality.  And that is the wonderful and exciting ability for market participants in the mob to “short” sell a stock.  This means that a company (stock) can be sold by a person that doesn’t even own it!

What?!!

Yes, that’s right! And you can even short sell gold!  Yes, there are ways to sell gold that you don’t even yet own!

As this article is already getting long, we can get into the details of “short” selling stock and gold in another article, but for now you just need to know that people try to profit on the downtrend of a stock or commodities price.  They “sell” a stock they don’t yet own, and if the price goes down, they can make money.

This (somewhat virtual) selling makes it look like the mob is more focused on selling than it really is. This amplification effect causes the a fore mentioned psychological reasons to sell to be exponentially stronger, as the situation looks like even more of the mob is aligned in one selling direction, causing the trend to look even more negative.  A trend develops and the psychological effect to join in and sell before the value becomes worthless sets in.

So the miners are currently really getting hit hard by all these effects and their prices have plummeted.

So is it time to invest in the mining sector?

I have been buying and I believe it is a great time to start purchasing down in a proprietary pyramid fashion that I’ve developed over my years of successful investing, and I’ll discuss what that means and give deeper reasoning why I believe its time to purchase the mining sector in another article.

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UPDATE:  See my article on ETFs creating shares for short positions for yet another reason why miner ETF prices get overly extended on the down (and up) side.