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Friday, May 26, 2006

 

Reallocating from U.S. Stock Market to Undervalued Commodity Stocks

Given our lack of confidence in the U.S. stock market for the long term at this point, we are doing a strategic reallocation from the overall U.S. stock market to undervalued commodity stocks. On this market rally, which started earlier this week as expected, we will significantly reduce or eliminate our remaining exposure to the overall U.S. stock market other than undervalued commodity stocks like MMGG. We don't know if this rally will last days, weeks, or months, but we're confident select commodity stocks will far outperform the overall market over the long term and are taking advantage of the discounted prices on these stocks during this very sharp commodity stock correction.

As evident from our recent postings, we have been been implementing this reallocation for several months already. We believe this stock market rally and the current correction in commodity stocks provide a great opportunity to complete this reallocation by decreasing exposure to the U.S. stock market and increasing exposure to select commodity stocks, particularly undervalued mining stocks. We don't know if the commodity stocks correction has ended already or will end a few months from now, but we're confident that the secular bull market in commodity stocks has a long way to go, and this correction is only a buying opportunity.



The above chart shows how, despite the recent sharp selloff in the overall stock market, gold and silver stocks have sold off even more sharply, bringing the ratio of the Gold & Silver stock index (XAU) to the S&P 500 (SPX) down significantly in the last 2 weeks. Junior mining stocks, which aren't included in the XAU, have sold off even more sharply than the major mining stocks represented by the XAU, creating what we believe is a significant long-term buying opportunity. You can see that, despite the sharp pullback in this ratio, the long-term trend remains intact. We believe, despite many skeptical analysts calling for a top on the "commodities bubble," the ratio will continue on this long-term uptrend for many years.

We are so confident that long-term investments in good commodity stocks will be extremely rewarding that we plan to cease active trading in the U.S. stock market. We expect a tougher market for traders in coming months/years, so we plan to take advantage of this bull market in commodity stocks and enjoy the ride with some select, undervalued stocks with events coming that should send their prices higher even if the underlying commodity prices head lower. The much lower long-term capital gains tax, the much lower stress level, and the much lighter required workload all tipped the scales in the decision to make this shift from active trading in an overvalued market to long-term investing in undervalued stocks.

We have set up this new Great Investments blog, where we've copied over the long-term investing posts for commodity stocks from here and will continue to post new long-term investing opportunities. We will continue to update Great Trades with the same posts, and may also continue to post shorter-term trades there occasionally. However, our focus and the bulk of our portfolio will be with the long-term investments in commodity stocks.

With sharp price increases in commodities in recent months/years, some may wonder if commodity stocks are in a bubble, and question whether there are any undervalued commodity stocks. However, while commodity prices have had huge price increases, most commodity stocks have lagged the underlying commodities significantly, pricing in far lower commodity prices. If commodity prices don't collapse as some people expect, these undervalued commodity stocks should do very well over the long term. If commodity prices go even higher over the long term, these stocks should be enormous winners with their leverage on the underlying commodities.

Unlike the tech boom, when you really had little idea which companies would become an ultimate growth success, we believe mining is much easier to evaluate, as once a deposit has been drilled, and grades defined, it can become a leading low cost project with very profitable returns, which we believe is the case for Metalline Mining, Avino, and Roxmark. Also unlike the tech boom, only a very small portion of the financial markets has invested in the resource and commodities sector.

While we believe investors in major commodity stocks will do very well, our focus is on junior mining stocks, as some of them provide much more upside given the inefficiency of the market for these stocks, the undervaluation and skepticism towards them given their lack of current income, and the consolidation in the industry that's already started to happen but will continue to increase significantly, in our opinion. Major mining companies have huge mines that are producing enormous cash flow today, but many of these mines will be closing in coming years, so they are running out of resources to develop for future income. With metals prices having increased significantly, they have extremely high levels of cash that they'll need to convert into future cash flow by investing in mining projects.

Finding and developing a resource can take 10-15 years or more, and many of the best resources in the world are in politically unstable areas of the world in the Middle East, Africa, South America, and Asia. As stated in our "Worldwide Zinc Crisis" post, "Other than Metalline Mining's mine in Mexico, the two biggest zinc mines scheduled to start production in the next 5 years are in Iran and Bolivia, two very unstable regions. If there's a war in Iran and if Bolivia nationalizes the mines in their country, the "zinc crisis" could become very dire." Major mining companies don't want to invest heavily in a project for 10 years only to have it seized by a militant government. Recent actions by the governments in Bolivia and Mongolia to potentially seize mines or mining income have raised the desirability of deposits in politically safe areas like North America.

Rather than investing heavily to try to develop productive mines on their own, many major mining companies are on the lookout for junior mining stocks with sizable metals deposits that they can buy out with their enormous cash piles. Junior mining stocks with large deposits that they can show can be economically extracted via a feasibility study will be in high demand. Because Metalline Mining's zinc deposit will likely be one of the top 5 or 10 producing zinc mines in the world, we'll be very surprised if they don't get several buyout offers upon completion of their ongoing feasibility study. However, shareholders of junior miners may be better off if these smaller companies can develop their deposits themselves, as the rewards when they get to production will be enormous, especially if metals prices continue higher in this secular bull market for commodities.

Our focus will be on junior mining stocks with deposits in North America and events coming up that should increase their stock prices even if commodity prices drop. For example, Roxmark Mines is applying for listing on the Toronto Venture exchange, giving it much more exposure than their current listing on the CNQ exchange, where many investors have difficulty buying it. They also will start producing revenue from their molybdenum in coming months and may restart activity on one of their 6 former-producing gold mines. Avino Silver & Gold will start producing revenue from the tailings at the Avino mine before getting the full mine into production in the next year or two. JER Envirotech, a non-mining commodity company, plans to open plants in Canada, Malaysia, the Philippines, China, and India in the next year or so as they focus on taking advantage of the industrialization of much of Asia. Metalline Mining is drill defining their high-grade silver/zinc/copper deposit that is separate from their ongoing feasibility study on the Iron Oxide manto, plus they will be applying for listing on a senior exchange in coming months.

As you can see, all of these companies have events coming up that should reward stockholders even if the underlying commodity prices drop. If commodity prices continue higher, they should be huge long-term winners. We will continue to look for these types of situations.

To help our readers understand why we are such strong advocates of investing for the long term in commodity stocks, we've created a repository of great investment articles at http://www.GreatInvestmentArticles.blogspot.com/. You can see there that some are calling this commodity stock correction "a buying opportunity of a lifetime" and "one of the best entry points into the junior market since the bottom in 2001-2002."

Comments:
Approach followed by Jim Puplava:

Jim Puplava’s formula for success in investing in junior mining companies (these companies are selling for big discounts): 1) Focus on safe political environments (i.e. U.S. Canada) 2) Focus on companies exploring prior abandoned producing mines (less risk than exploration company since was prior producer—rise in metal prices can make these deposits very economic--can say they used to PRODUCE gold or silver here !!) 3) Focus on late stage development companies (i.e. prefeasibility –their metals in the ground are given higher valuation in the marketplace) 4) Company is working on dual track: doing prefeasibility on one area so they can go to banks for financing and get into production and at same time expanding their discoveries (expand and build resources/reserves).
 
That's a great formula for success in investing in junior mining companies. We agree that companies that meet these criteria are selling for big discounts and should be very successful.

Metalline Mining, Roxmark Mines, and Avino Silver & Gold Mines all meet all 4 of Jim Puplava's criteria, as you can see from their writeups on the blog.
 
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