An indirect approach to investing in gold... - The Daily Reckoning
The Daily Reckoning by Bill Bonner
On This Day - 23 October 2014
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An indirect approach to investing in gold... A  A  A

Baltimore, Maryland

Dear Diary,

There is nothing quite so satisfying as coming upon an over-turned beer truck on a hot day.

In the same spirit, today we gawk at the wreck of the gold miners. They are 70% cheaper than they were 3 years ago. And they are 25% cheaper than they were just 2 months ago. What a delight!

Yesterday, the stock market fell...with the Dow down 153 points. Gold lost $9 and came to rest at $1,242. Generally, the yellow metal seems to have bottomed around $1,200 and resists going much lower. Now, it rises on hopes of more QE and sinks when it looks like QE might end on schedule - just like the stock market.

Before we forget...we get a good deal of correspondence from our dear readers. We read everything. But we can't answer it all. Sometimes, we don't have enough time. Most often, we don't know the answers.

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Still, we learn from it. And we try to pick up general themes, questions, and matters of interest in these Diary entries.

One reader wrote, for example, to ask about stop losses. Why 15%? Why not 20% or 30%?

Good question. We're not the best person to answer it. And we won't even try. Instead, we'd just like to remind readers that stop losses are not appropriate for value investing.

Stop losses work by automatically selling your position when it goes down by a pre-set amount. So, your total loss is limited - if the mechanism works - to the amount you are willing to lose at the get-go.

Nice little device, no? Like walking into a casino with only $100 in your pocket. Very useful if you are speculating; if the investment doesn't go up, as hoped, you get taken out with a small loss.

But, the kind of investments we like best are those that go down, not up. That is to say, we buy value. We want the most we can get for our money. If the price goes down, it means we can get even more for our money. So, we don't want to get stopped out. Instead, we tell our friends what happened. They laugh at us...and we buy more.

What kind of investments are gold mining stocks?

That is a good question too.

On the surface, they look like value. Compared to other stocks, they're cheap. The US stock market has more than doubled since '09, the gold miners have stoutly held its ground. They are still as smashed and dented up as they were when the crisis began. That is not to say that they won't be even more wrecked next year. But right now there are probably a few cans of beer intact, lying among the wreckage, ready to be picked up.

What caught our interest was a couple of articles written by colleagues Steve Sjuggerud and Chris Mayer. Simultaneously and independently both have concluded that the time to get back into gold miners is now.

That is especially significant because Steve and Chris are among the best stock pickers in the business. They have each approximately doubled the performance of the S&P over the last 10 years, a feat that the Efficient Market Hypothesis tells us is practically impossible.

It would take a brave stockbroker to recommend mining companies now. Not only are prices low, there is no reason to think they might rise. The world economy is slowing down, not speeding up. Commodity prices are falling, not rising. Inflation is ebbing, not flowing. And the dollar, against which gold and other commodities is measured, is going up.

Knowing these things, stockbrokers do not want to mention mining shares. And investors do not want to hear about them.

Which makes us wonder if the time has come to buy.

Says Steve Sjuggerud:

    "After a horrendous couple of months, gold stocks appear to be trying to bottom out. We have a glimmer of an uptrend setting up. The sun might be starting to rise."
Is the sun already peeping over the horizon? We don't get up early enough to know. But as long as the earth still turns, the sun must rise sooner or later. And we are tempted to take a position in these deep discount gold mining stocks and wait - just as though they were value plays.

Steve prefers to put in a stop-loss. He figures the most he can lose is 7%, while the upside is huge:
    "The last time god-mining stocks were this hated was in late 2008. The Sprott Zacks Gold Miners Index soared 242% from its bottom in late 2008 until the end of 2010 - just a little more than two years."
Steve is hoping for a re-run.

Buy now? Use a stop loss? Wait for a clear up-trend? We don't know which approach is best...but we're planning to study the issue and report back.

Bill Bonner is the President & Founder of Agora Inc, an international publisher of financial and special interest books and newsletters.

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