Jun 03, 2013 5 reasons gold stocks will keep suffering

by Peter Hodson

Having fun in junior gold land yet? The sector has been absolutely decimated this year, with some individual stocks, such as San Gold Corp. (SGR/TSX), down 83% so far in 2013, and we are only halfway through May.

We are advising customers to adopt a do-nothing approach. The bounce in the sector, when it occurs, is going to be big, but we can’t begin to guess when that bounce might occur.

Many market participants, on the other hand, think the junior gold sector is going to get worse. It might, of course, and we can certainly find some reasons for that possibility. Here are five:

1. Resource fund redemptions

Many gold funds are down 35%, 45% even 50% so far in 2013. Mutual-fund investors, of course, are notorious for doing the wrong thing: They get excited when things are surging, and panic when things are bad.

So, what are they doing — en masse — now? Selling gold funds. As redemptions rise, fund managers need to continually ditch gold company shares into an illiquid market. The result? More declines, which begets even more selling.

Some call it a death spiral, and it must certainly feel like one to investors.


2. Financing needs don’t change with lower share prices

Gold companies continually need money to drill and develop properties. But neither the price of a mine nor the cost of exploration declines with lower share prices.

If a company needs $20-million and its share price declines 50%, it needs to sell twice as many shares in order to fund its budget. Investors look at this potential dilution and get even more nervous.

Of course, all this assumes that a gold company can even get any equity financing — a doubtful situation, at best, right now.

3. Gold is losing its lustre

Gold started 2013 at US$1,675 an ounce and is now below US$1,400. After 12 straight years of gains, investors suddenly realize that, yes, gold can actually go down sometimes.

Blame it on U.S. dollar strength, the future reduction of stimulus, the fear of higher interest rates or even a conspiracy theory, but gold prices are still going down.

It is very hard to generate interest in the sector against the backdrop of a weak commodity price. The result: even more junior gold sellers.

4. Investors just can’t take it anymore

Sometimes you know it is wrong to panic and sell. But you do it anyway. You just can’t take it anymore. You can’t sleep, you can’t eat, so you can throw in the towel in an effort to get healthy again.

We have talked to dozens of gold-stock sellers like this. They know there will be a bounce one day, but they hardly even care anymore. They just want out.

5. Sector rotation continues

Mutual-fund managers like to compare themselves to the overall TSX Composite Index. It is pretty simple: Beat the index, get a bonus. What’s the easiest way to beat the index these days? That’s simple too: Don’t own any gold stocks.

This year, we have seen a nice rotation into other sectors, technology in particular. Companies such as Constellation Software Inc. (CVSU/TSX) and Sylogist Ltd. (SYV/TSX-V) continue to go the opposite way of the gold sector as investors change sectors and new money comes in.

This sector rotation results in — you guessed it — even more junior-gold sellers.

We still think the best thing to do is to hang in there. But at least you know the reasons why you might be still losing money in the sector.


Peter Hodson, CFA, is CEO of 5i Research Inc., an independent research network providing conflict-free advice to individual investors (www.5iresearch.ca).

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