The End of Low Prices

The title of today's post applies to two items that are of great interest here - both of them are sure to cost more in the future, however, the timing of the price increase for one is far more certain than the other.

This week marks the six month anniversary of the launch of the companion investment website Iacono Research and an end to the "Introductory Offer" that has been advertised in the right side-bar for months now.

This is the one where the timing of the price increase is certain.

Where the end of low prices is uncertain is in commodities - the subject of the work done at the website. For those paying close attention, the long-term direction of prices for items such as oil and precious metals is quite certain - if for no other reason than that they are denominated in U.S. Dollars - the timing however, is more difficult to assess.

Subscription rates will be going up this weekend, but before they do, the members-only area of the website is being opened up to the general public - a FREE WEEK for everybody.

(Actually, it will only be five days, but who's really counting?)

For access to the Subscribers area, just use the following:

• Username: exp1119
• Password: fpwrnhzc

Be sure to have a look at the Model Portfolio and the Weekend Update Archive.

For those of you who feel that typing in the username and password requires way too much effort, here's an excerpt from the most recent Weekend Update where the performance of two categories within the model portfolio was reviewed.

Gold and Silver Bullion and Shares of Mining Companies

The more exciting parts of the model portfolio this year have been the Gold and Silver Bullion and Shares of Mining Companies categories. Factoring in the sales from April, gains in the mining shares stand at 42 percent for the year while the total value of gold and silver bullion has risen 32 percent. The launch of the website in May coincided with a correction from highs that have yet to be recaptured - this is all part and parcel of investing in this sector. I truly believe that we really haven't seen anything yet - what's coming in the years ahead in these two categories will surprise many, many people, making them wonder why on earth they agonized over a $50 drop in the price of gold when it could still be purchased for less than $700.

After having peaked at $720, then retreating to near $550, and now standing about midway between these two levels, gold is growing in appeal as investors around the world realize that the high prices of earlier this year have not collapsed like share prices for dot-com stocks just a few years ago.

It is now accepted wisdom to have about 10 percent of an investment portfolio in precious metals - mostly for "insurance" they say. I read this all the time now and this is much different than the conventional wisdom of just a couple years ago.

Many first time investors had their fingers burned during the events of May and June earlier this year, but they are sure to be coming back for more as precious metal prices continue to show strength and the rest of the world realizes that they "need" gold. I hear many stories of people who bought gold earlier in the year and then sold during the panic of May or June and who are now back in. Having experienced this myself years ago, I know what this is like and it is very much part of the process of "growing acceptance" by the investment public.

This is likely to happen in waves in the years ahead where those people who bought their first gold or mining stocks this year will hold firm during the next correction while a whole new group of first time investors fight the human emotional responses of "fight or flight", choosing "flight" in the wake of the first big pull back they experience with "skin in the game".

Silver has had a similar but much wilder ride than gold this year and its weight in the model portfolio has been slowly creeping up to a point where it is almost at par with gold. The ratio at the beginning of the year was 1.34-to-1 (gold to silver) while this now stands at 1.11-to-1, evidence of the strength of silver, albeit with even more volatility.

The price of silver has showed tremendous strength in recent weeks, likely a sign of things to come.

As for shares of companies mining precious metals, the journey has been bumpier than that of gold and in many cases disappointingly so. If investors were only to own the larger mining companies, they are surely displeased at this juncture as shown in the chart below where the price of the gold and silver ETFs (GLD and SLV - blue and red) appear alongside the Gold Bugs Index of unhedged gold miners (^HUI - green) and the Philadelphia Gold and Silver Index (^XAU - gold).

Click to enlarge

Note that the silver price in the chart above would have a completely different look if an entire year of data were available for the ETF. Having risen almost 50 percent for the year, the complete data set for silver would push the high end of the scale much higher and the red line would ride on top of all the others. I thought it was helpful to show it in the chart above anyway, as it represents the unfortunate experience of many whose first silver purchases were via the new ETF that launched on the last day of April, just prior to the May sell off.

Again, it's that timing thing and the difficulty of entering positions.

But back to the gold stocks as represented by the indexes in the chart above, I must say I was a bit surprised to see the end points for both of the indexes - plus 12 percent and plus two percent hardly seems worth the effort of going against a crowd that is still largely unaware of this investment sector.

The good news however, is that the Shares of Mining Companies category in the model portfolio has had a completely different experience this year - at plus 42 percent, far better than these indexes of larger mining companies.

There are two simple reasons for the difference in performance:

a) smaller companies
b) taking profits in April

Larger gold mining companies are having a tough time of it lately because they are subject to the same valuation metrics by which any other company is judged. The actual business of mining precious metals is just not that profitable these days due to high material and energy costs in this capital intensive business. Time after time, reports are heard of feasibility studies completed just a year or two ago that have to be updated because costs have risen 25 percent.

By contrast, smaller exploration companies are low-budget operations that are much more difficult to value, continually in need of new financing in a manner not very different than internet startups of a decade ago. Think of how IBM did back in the 1990s versus newcomers like Yahoo! and Cisco. Similar to internet startups, once a mining exploration company can prove that it has something that is likely to be profitable in the future (i.e., a property with proven resources where it would be feasible to construct a mine that could be operated at a profit), they are more likely to be acquired by a larger company than to actually commence mine construction themselves.

As the price of gold heads higher, large mining companies will become more profitable and share prices will rise dramatically as a result of new money flowing into this "safer" part of the gold mining sector first, however, the economics of mining must change in order for this to happen. Either the miners must be able to sell gold at higher prices or their operating costs must go down. Until then, the best performing mining stocks are more likely to be exploration companies.

It is important to note that the effect of higher metal prices on share prices can already be seen, to some degree at least, with silver producers over the last month or so. One look at the recent share price of Silver Wheaton (SLW) demonstrates what higher prices can do for the bottom line and hence investor enthusiasm (granted, the unique Silver Wheaton business model helps tremendously).

The second major factor contributing to the good performance of the stocks in the Shares of Mining Companies category is that profits were taken in April. As shown on the Portfolio page under Closed Positions, more than half of the total gains for this category are a result of these sales. Again, selling into strength and buying on weakness are critical aspects to getting the most out of a portfolio, though it's also hard to argue with a more passive approach where returns are still very substantial.

For example, just holding a precious metals mutual fund such as Fidelity Select Gold (FSAGX), now up 22 percent on the year, would make a lot of sense for someone who doesn't want the bother, the risk, or the excitement of the junior mining sector. Note that a mutual fund such as this one holds many of the "juniors", hence the reason for outperforming the indexes shown above - the key difference is that they hold enough of them to make the risk/reward equation a bit less daunting than for someone buying individual stocks for themselves.

Overall, it's hard to find fault with these two categories in the model portfolio. I sometimes wonder if it wouldn't be better to just put everything into precious metals and related equities, but then I'm reminded of 2004 when this sector languished and other commodities and related equities soared.

Although things are a bit different in other parts of the world, precious metals are still not widely accepted as an investment class here in the U.S. Awareness has been raised in recent years, especially after the events of earlier this year, but it's going to take a little while for the general investing public to come to the party.

That's when it will really get good.