Even Bema Went Crazy!!

Rick’s Picks

Friday, August 20, 2004

For investors who’d rather be smart than lucky

Even Bema Went Crazy!

Lordy! Even Pacific Rim and Bema Gold were up yesterday, the latter by a whopping ten percent. By way of recommendations made earlier in Rick’s Picks, we’ve been long a manageable handful of mining stocks, including Newmont, Coeur d’Alene, Goldcorp, Iamgold and Pacific Rim. It is Newmont that we shall focus on, though, since the stock, along with the HUI Gold Bugs Index, is an important bellwether for the precious metals sector as well as a reliable proxy for the mindset of institutional buyers. As of yesterday’s close, Newmont had pushed the September 42.50 calls that we bought a while back for 1.00 to an intraday high of 2.55. Of course, the stock will need to achieve even greater heights to resuscitate the September 45 calls that we also hold.

How optimistic should we be that this will occur? Quite. My forecast for Newmont calls for an imminent surge to an important hidden pivot at 47.73 that I’d flagged here earlier (see chart in the Current Touts section of Friday’s newsletter.) You may also recall that I’d said a move decisively above that number would be a sign that the rally has the wattage to eventually reach a long-term target at 60.75. (By “decisively,” I mean a two-day close above 47.73, or an intraday move past it of at least 0.80 points.) Meanwhile, the purpose of holding NEM call options is to reduce the cost basis of any stock we may buy as the rally progresses. We don’t want to miss a runaway rally, but we also don’t want to get stuck holding 800 shares of stock if this move should prove to be a dud. The options will help to reduce our risk, and, for a relatively small cost, to participate if Newmont continues to rise.

Gold-Mania? Not Yet…

Concerning our other bellwether, the Gold Bugs Index (aka the HUE-ee), its price action will help to confirm any signs of strength we observe in high-beta miners that may pull ahead of the pack from time to time. Unfortunately, we cannot buy puts or calls on the HUI because they are simply too illiquid and pricey. For instance, even yesterday, when precious-metal shares were going crazy, only about 220 HUI puts and calls traded all day in the August series.

I have little doubt that when gold’s bull market shifts into high gear a few years down the road, tens of thousands of HUI options will trade daily. But their relative deadness right now reflects the fact that gold-mania still lies an unknowable distance down the road. Also, the evident lack of interest in mining-sector buyouts and mergers of late, notably the ones involving Wheaton, is a sign that investors are far from becoming infatuated with precious-metal stocks.

$5,000 Gold? Think $452.30 for Now

While they dither, we can continue to maneuver in and out of such stocks, and to use options to help control risk while building an edge. All of this should be done strictly by-the-numbers. I don’t scoff at those who think gold prices could eventually climb to $5,000 or more. But as a practical matter and for the time being, I will advise using $452.30 as your price objective, since that’s about as high as I can forecast right now using the continuous monthly chart. Lest you should find this modest projection disappointing, I should mention that a $452.30 print would be just enough to inch past a key high made in 1990, thereby creating a bullish impulse leg capable of pushing gold significantly higher, to at least $620.

Taking it one step at a time will keep us out of trouble but still in synch with the bull market. Meanwhile, we should never lose sight of the risks, which are considerable. The biggest danger to precious-metals investors is that deflationary forces will cause real interest rates to soar relative to falling asset values (i.e., mortgaged homes). This would effectively strengthen the dollar despite its fundamental worthlessness. We should therefore continue to take a measured approach toward bullion and to manage risk in a way that will allow us maximum flexibility whenever conditions turn adverse.