The Best Contrarian Play on Gold I’ve Ever Seen…
Written on 28 May 2013
by Dr. Alex Cowie
Calling it ‘Wetting the baby’s head‘ is pure genius.
It sounds so innocent. All the boys get their leave pass. And before you know it: mayhem.
It was a fun night out celebrating the arrival of a mate’s baby son last Friday.
That is apart from when one of the guys wanted to talk about gold.
He pounced on me for a comment on the least loved metal in the market, and normally I’d be up for it. But I couldn’t have thought of anything I’d rather chat about less.
It was written all over me. He said, ‘Wow! When the gold bull goes quiet – THAT’S when I start buying.’
And I’ve got to say, he’s right.
Let Me Explain Why…
Buy low, sell high…investing’s easy right?
To ‘sell high’, you usually have to go against all your instincts. It took me years to learn that when I’m high-fiving myself, and planning a fancy a holiday with future winnings, THAT’s when you sell.
And to buy low, first you just have to stomach buying something everyone else wants to sell. To buy close to or at the bottom of the market, you have to buy an asset when it has no friends.
And gold has blown up, burnt, or deeply tested all of its friends recently.
Gold equity professionals are miserable. Funds loaded up on gold stocks have been getting redemptions. Long-term friends to gold, like me, have had a gutful too.
When the mood is bearish at the very core of the sector, only then can you have what we see in the chart below: the gold miners bullish percent index (BPGDM) hitting ZERO. There isn’t a shred of love out there for gold stocks. Wow.
But here’s the thing…
When the sentiment is at zero – then how much worse can things get? Really the only way from there…is up.
So when sentiment is at very rock bottom…then you’re probably at the very bottom of the market.
You can see what I mean below. The gold miners bullish percent index (in black) last hit zero in October 2008. Mood was as dire as it gets. But that was also immediately before gold stocks (in red) began to rally.
And they rallied for the next three years…
Major Gold Stock Rallies (red) Begin When Sentiment (black) is Zero – Like Now
This is exactly what my mate at the ‘head wetting’ recognised. That when even an ardent old gold bull like me didn’t want to talk about gold, then sentiment must be running pretty low in general. And like the man says, THAT’S when you buy.
You can see in the chart above, the gold miners bullish index has now bumped against zero twice in two months. That’s about as extreme as it gets. Maybe it could hit zero a third time. Who knows? It’s possible.
But when sentiment is at zero…logically things can only get better from there. Gold stocks have now become an incredible contrarian play.
We’re getting the same signal from other places. The Mark Hulbert Digest Gold Sentiment index has swung to an all-time low of -35%. This measures the gold stock positioning across a swathe of newsletters.
Over the last fifteen years, like clockwork, a fall to under -20% has signalled the start of a new rally. So to be a record low of -35% today is another warning shot to expect a seismic shift in this sector.
It’s the subjective things I use as signposts too. A well regarded international gold analyst emailed me this week simply saying:’I need some inspiration in this horrible market and was hoping you could give me some.‘If you wanted a contrarian signal, that’s it right there.
How can I be so positive when gold itself has been beaten up so badly, and is down 17% (in $US) for the year?
Two Reasons to Back Gold…
One: the best time to buy is when things are cheap. And right now, gold is cheap. All the reasons to buy gold when it was at $1700 are still in place, yet gold is selling for $1400. This is why bullion dealers worldwide have all had their busiest two months of sales on record.
Two: the gold price is following a well-trodden script. A script that should mean the worst is now behind us for gold. When I wrote to you last week, I told how I warned of gold pulling back again from $1470 to the $1300′s.
I thought it would play out like this based on how gold has traded after the three previous 30% corrections over the last decade.
The good news is that if it keeps following the same script, then…we’re now at the start of the bull market that follows.
Of course, it doesn’t feel like we’re in a bull market today. But as the age old saying goes, ‘Bull markets are born of pessimism, and grown on scepticism.‘ Well there are several large steaming truckloads of both to nurture gold stocks, so get ready.
And it’s not just the corrections in the last decade that offer a credible roadmap for a recovery from here.
Gold has also been following the trading pattern from the greatest shellacking gold has ever had: the 46% crash in price seen in the mid-70′s.
Back in 1976, I was too busy mastering potty training to be overly aware of this, but gold had just fallen by nearly half, after completing a multiyear rally. Bears declared the end of gold, and investors panicked.
What happened next was legendary. From its lows, gold then increased in price by eight times.
As you can see in the chart above, gold seems to have been following a remarkably similar pattern over the last six months.
So I’ve been sitting tight with the gold stocks that I’ve tipped already for Diggers and Drillers. When we get a clear signal that a bull market has started, I may add more.
Until then, I’m tipping cashed up stocks. Companies with cash are in short supply, but are your best bet in tricky markets. And if we see a resurgence in resource stocks like I expect, cashed up stocks will lead the way, just like they did last time.