Bearish times ahead - be cautious

Usually I try to come up with some analyses of undervalued stocks every now and then. I haven't posted anything during the past few weeks and I must admit that my perception of the market has recently changed. Before much of the subprime woes were dominating the news, I was still of the opinion that the major US indices would go up much further than 14,000 based on the simple fact that the Fed would keep printing more and more money. This would not specifically be good news for stocks, but it would certainly lead money to lose its value and that usually helps share prices to appreciate. I think there is no better example of this than the Zimbabwe stock exchange. But as I mentioned, my perception changed. I am not very bullish anymore, in fact, I am bearish. The subprime problems have certainly put the train in motion. Mortgage lenders are to a great extent responsible for the situation we're in now. They are directly or indirectly responsible for making lending more difficult, for rising interbank rates, for falling housing prices and to some extent for the (coming) drop in consumer spending. The same goes for credit card companies. I have always had my thoughts about capitalist countries where possessions are bought on credit. The only thing I will ever buy on credit is a house and I will never pay more for a house than five times my household income. American home owners now face situations that will wake them up. The American Dream was never meant to be bought with borrowed money, was it? Taking your borrowed money to the stock market is asking for trouble as well. This is where the Yen carry trade kicks in. We already saw this year that at times when the Dollar/Yen dropped, so did stock markets and so did for instance precious metals. This situation is slightly different now. The Yen has strengthened again since its June peak and this has certainly not helped the American and European indices, but precious metals prices are suddenly flourishing. Gold broke out of its sideways range and seems to be starting a new bull run. Silver may be behind, but gold's little brother will probably catch up in the coming months. From this point in time, I expect risk to be priced into stocks again. I have to admit that it continues to surprise me when I watch CNBC and hear analysts say that Apple is a steal at 37 times earnings. It continues to surprise me that analysts are advising to buy 'tech', since 'tech' is where the growth will be in the coming years. I strongly disagree. If you ask me, the only potential growth sectors will be mining, energy and base materials. Not because demand for oil, gold or steel will go up, but because both the Euro and the US Dollar are losing value. The Central Banks' capital injections haven't helped in this respect and they will soon be caught in a stagflation spiral (i.e. a stagnating economy in combination with high inflation rates). Add to this the recent 'Al Qaeda trades', where unknown parties have been buying huge quantities of out-the-money put options, both in Europe and on Wall Street, and we have a very dark and cloudy scenario. As if that's not enough, we are also in a Puetz Window (the days in between a full moon and a solar eclipse), which has historically been the likeliest time for stock market crashes. Last Friday, we could already see that all this uncertainty has led investors to buy precious metals as well as the Japanese Yen. These are also the positions that I am in today: I am short EUR/JPY, long silver, long mining companies and I hold puts and put spreads on major indices. Not because I am convinced that we will get a crash like we had in 1987, but because I am convinced that there are very weak times ahead of us. I am also convinced that stock valuations today are not what they were one year ago. With a possible recession coming up, the potential end of the carry trade period, the increased difficulty to attract money and the consequential drop in M&A activity, a stock valued at 37 times earnings is really not that cheap anymore.

Time to start shopping again...?

I am sure that the past weeks have been disastrous for many investors as very few had seen this drop (and its timing) in the stock markets coming. Even those who did saw it coming may not have expected it to be this fierce. I think I may include myself in that last category. With the lion share of my portfolio invested in American stocks and a long gold position, this week has certainly been one that I do not wish to experience a second time. My long position in gold has been liquidated and I was too early to close my short position on the Dutch AEX index, which generally follows the US indices.
Now is the time to sit and think about what steps to take. Do I sell my shares, waiting for further drops? Do I move extra money into my trading account? Do I sit and wait until the bottom is there, knowing that current valuations are ludicrously low? This is probably a choice that many private investors are now thinking of and their decision partly determines the future course of the markets.
Let's have a look at the signs that we're getting. The move that we've seen since the year-highs was fiercely downward, then sideways, then fiercely downward again. Corrections like these are never ended with a sideways move. They always end after a last fierce sell-off, followed by a quick rise. The first downward move was mainly caused by financials that were (or were not) affected by the subprime woes. The second downward move, the one that we're in now, is not caused by financials - even though all newspapers, television stations and websites will tell you that investors are selling on subprime fears. And the financial sector is the only one that is going up again! The main sectors that are now hit are services, basic materials and to a lesser extent the energy sector. These are the sectors that had not yet had serious sell-offs and investors are now simply taking profits, based on fear or emotions if you like. In addition to that, the carry trade has its effect as well, which has affected precious metals prices as well.
All this means that you're now able to buy dividend cannons like Southern Copper at a p/e below 10, a growth company like Companhia Vale at a p/e of 9 and Freeport-McMoran at a p/e of 8.4. And these are not companies that have performed badly so far this year! This Thursday's sell-offs also mean that telecom stocks are reasonably priced again, even though this is not one of my favourite sectors. It means you can buy Apple at $112, where hardly anything's changed since everyone wanted the stock at $140. (I personally continue to think that it's crazy to pay over 30 x earnings for any company, unless it's a junior company with great prospects, but I seem to be the only one)
All I can say is that today we are one step closer to a turnaround, which doesn't necessarily mean that 12500 was the bottom for the Dow. There may be a further drop, but I am pretty confident that we will not see a drop as fierce as the one we've seen this Thursday. Profit has now been taken in the sectors that are fundamentally the strongest sectors and these best-performing sectors are the last ones to get hit.
From this I can conclude that the bottom is near. I will therefore not sell any of my stocks and wait for better times to come, however painful this may be. The only thing one can do is write some calls or buy some puts, just in case we haven't seen the bottom yet. I still think the precious metals are the sector to be in and especially gold. I will therefore look for a new long position in gold, once again with a stoploss. To all investors who felt the way I felt this week, hold on tight, start shopping again, but whatever you do, don't be the last one selling. After all the economy can't be that bad, because my fiancee's still out there shopping for shoes as if nothing changed this week...
Disclaimer: The author has no position in any of the above-mentioned stocks.

North American Galvanizing: buy 'on the dip'

Earlier this year, in March to be more precise, a company called North American Galvanizing and Coatings (NGA) caught my eye. NGA is a company that uses zinc for its galvanizing processes. As a result of the growing zinc prices, the company had booked impressive revenue growth as well as earnings growth. I added NGA to my list of stock picks at a price of $5.18 and closed that position at $12.06 in May. After that, the stock went up a bit further and then had a 3:2 reverse stock split before it fell down all the way to its current price of $5.75. I can imagine this stock has been quite a pain for those that have held this stock all the way from its peak in May. But the fundamentals don't lie: NGA saw its sales double in two years and its EPS increase tenfold in two years. And the story continues as the first halfyear results showed net earnings that were 80% higher than last year at $0.36 per share. Fact is that NGA trades at a P/E of 10.7 with, I repeat 80% EPS growth over the first halfyear! Technically, the stock shows a bearish picture. I would expect the RSI to bottom out anywhere around 40 in the weekchart in order for the stock to stay in its bull range. Keeping in mind the long term uptrend that zinc prices show, I will add NGA to my list of stock picks at a price of $5.75 with a $10.00 price target for mid 2008, based on the earnings growth reported in the first halfyear and the company's continued impressive growth.
The author had no position in NGA at the time of writing.

Long gold again with $700 coming close?

After this month's changes in my mining portfolio, I have now decided that it's the right time to invest in precious metals again. I already bought (speculatively) DRDGold at $0.78 and after the 10:1 reverse split, the stock kept going down. I consider $6.50 a critical level and decided to sell once that level was broken. At $6.42 my sell order was executed, while the stock ended above $6.50 again. I am still quite convinced that DRDGold will manage to get its act together, but I am also certain that it is not the best stock for short term profits. Instead, I took a long position in gold at $662, knowing that there should be some support at $660 (being 61.8% retracement level), which was successfully tested and spot gold moved up to $665 today. Should gold move below $660, there is a high likelihood of a full retracement to $640 which for me would be a very bearish sign and possibly a reason to liquidate all my positions in precious metals and certainly a reason to reduce the mining share in my portfolio. But, being the positive-minded chap that I am, I added a position in Taseko Mines Limited (TGB). I actually bought back shares in TGB. Previously, I bought TGB at $2.30 and sold at minor profits as there was little news to move the stock up. Now the situation is a lot more fruitful. The company is one of the very few AMEX-listed precious metals miners that actually makes money. Taseko has successfully positioned itself as a copper & gold miner and has a good cash position with a positive cashflow. Taseko's Prosperity and Harmony mines alone should account for some 7.5 mio ounces of proven & probable gold reserves, which already makes the company's USD 600M market capitalisation look reasonable. Add to that the company's young & producing Gibraltar copper mine and you have a clearly undervalued stock, despite its recent rise. This stock will go through the roofs in two or three years from now as the Prosperity mine will get closer to production. I think we have a winner.
The author bought TGB at $4.60 and closed his position in DROOD at $6.42.

Portfolio shake-up

The past months I have been busy trying to diversify to a certain degree. This was highly necessary as a great part of my portfolio was in mining stocks. I usually do not buy the very risky junior miners - which does lower my risk profile - but having to great a share in mining makes your portfolio very volatile. I sold Yamana Gold earlier this month at USD 12.65 as the technical picture started to become a bit more cloudy. This was followed by the announcement of a proposed threeway deal with Northern Orion and Meridian Gold, which made the stock drop to the lowest close of this year at USD 11.12. Among my current mining favourites are still Endeavour Silver Corp and uranium miner Uranerz. These will stay in my portfolio, whilst other miners I may sell off in the coming months. Aurizon Mines (AZK) may be added to this. I sold AZK last week at $3.90 as I expected there to be some resistance around that level. I might buy back at a later stage. I sold EGO last week at $4.80. To replace these miners, I am specifically looking out for alternative energy stocks. One of my favourites is still the slugglishly moving Evergreen Solar, which I believe is suffering from a temporary correction in a multi-year uptrend to be followed by a higher peak - well past the previous high of USD 17.50. I bought this stock in February of this year around current levels. Before that, I benefited of the 2005/2006 uptrend from USD 8.60 to USD 15.00. Even though this month I sold Beacon Power Corp at USD 1.50 (bought at USD 0.89), it is certainly not my idea to all of a sudden neglect this stock. I was purely safeguarding some profits and plan to get on the Beacon train again at lower levels. The excitement surrounding Beacon Power Corp is triggered by growing interest for the company's flywheel technology, which I believe will further grow from this point. However, the current hype cannot be argumented by numbers. Beacon Power is still not making any money and therefore any gains are purely based on prophecies. I do believe in this company, but it will take some time until earnings reports can justify a USD 1.50 share price. I will continue to keep an eye on the technical picture and will buy when much of the excitement has evaporated. At the same time, I am looking at Fuelcell; a company that produces fuel cell power plants that are ideal for the replacement of 'dirty energy' and thereby help reduce emissions. With a number of customers ranging from hospitals and universities to utility companies and manufacturing plants, the fuelcell technology is gaining popularity across industries. To come back to the mining industry, I added DRD Gold (now changed into ticker code DROOD) at $0.78 because of improving technical indicators. DRD Gold remains a very uncertain share to invest in. I see it purely as a speculative buy and I watch the technical indicators very closely to determine whether to buy or to sell. Investors seem to be a bit cautious because of the management change. Looking at the first quarter, the main issue for DRD is that the reserves are there, but the production is not. There have been too many hiccups in the past few years and even this first quarter showed a drop in production, both in Australasian and South African mining operations. On the positive side, I consider the Argonaut project to certainly have very high potential. A positive response to the Prospecting Right Application of the company's Argonaut project may be applauded. Once again, I still consider this stock a speculative one. Not a good basis for a stable portfolio but like my earlier purchases of GRZ and KRY, speculative buys are not always bad buys! Finally, with regard to the indices, I am currently short AEX and short S&P. 1520 will be a critical level for the S&P as will 550 for the AEX. Later this year, I plan to move some of my investments from North America to Europe as I see better growth prospects for European companies. The author holds long positions in EXK, URZ, ESLR and DROOD at the time of writing.

Eldorado Gold sees Turkish mine shut down

It came to me as a complete shock, seeing one of my favourite mines down 30% on Thursday. A Turkish court had apparently ordered the shut down of Eldorado Gold's cash cow, the Kisladag mine, responsible for 60% of the company's gold production in 2006. According to Eldorado, the final decision by the court is still pending "on the appeal of a lower court order in favour of the company confirming the legality and validity of the Mine's Environmental Impact Assessment". The closure will be implemented in about 30 days. To clarify things, the company planned a conference call on Thursday evening and I was all ears. During the conference call, CEO Paul Wright was talking of a group of people whose only interest was to discourage mining in the country. He did not know the name of that group and he did not go into details on the specificalities of the court case. Last year, there was a problem with cyanide poisoning of villagers, which means that high levels of cyanide were found in villagers' blood. This was a result of the sodium cyanide heap leach method that was used by Eldorado during trial production and that presumably has been used until now. From what I found, the Environment Impact Assessment was initially accepted in 2003, but was later found incorrect by doctors and scientists and challenged in court by villagers, combined through a group called "Elele" (hand in hand). In addition to the cyanide poisoning, there were also reports of levels of arsenic in local drinking water. I can imagine if this all has been proven correct, that there are serious issues. Unfortunately, nothing was said about all this during the call. Problems with people opposing to the use of cyanide in the Kisladag region have been known since 1999, at the company did exploratory work. The first mining company that used cyanide in Turkey was Newmont Mining at its Ovacik mine in 2001. The mine was sold in 2005 to Turkish printing and mining company Koza Davetiye. The reason then given for the sale was the divestment of non-core assets. However, the Ovacik mine was - like the Kisladag mine - given bad publicity by Greenpeace and fought by locals in court, despite the company's approvals from Turkish Government. It sounds to me that this may be the start of something bad. According to Eldorado Gold's CEO, the decision that has been made was not supported by legal proof. But opposition against the use of cyanide in the local mining industry is clearly nothing new in Turkey. Maybe Newmont was not to keen on bad publicity either? I am however forced to review my position in Eldorado as the bad publicity is certainly not going to do the company any good and these environmental issues are usually not solved overnight.
At the time of writing, the author had a long position in the above-mentioned stock.

An early June update...

My "stockpicks fund" showed only minor gains the past month as mining companies had a difficult time. The gold price struggled and fell 6% to 652, while only Capitalia benefited from M&A news. June should be a better month for mining companies (GRZ, KRY, DROOY, CVRD, ORM.L), which should help my virtual fund to further outpace most global stock markets.

Date	Fund	Purchase	Current	ROI%	Target
18Dec2006	Aareal Bank	35.50	38.50	+8.5%	44.40
13Dec2006	ABN Amro*	24.10	28.00	+16.2%	28.00
16Feb2007	Ahold	7.97	9.21	+15.6%	10.00
16Nov2006	Banco Pastor*	14.15	18.00	+27.2%	18.00
27Nov2006	Capitalia	7.00	7.60	+8.6%	8.50
19Feb2007	Companhia Vale	$35.90	$47.02	+31.0%	$55.00
12Jan2007	Crystallex	$3.12	$4.55	+45.8%	$6.00
24Jan2007	DRDGold	$0.83	$0.85	+2.4%	$1.10
21Dec2006	Fiat Group	14.50	21.47	+48.1%	19.33
12Jan2007	Gold Reserve	$3.94	$5.70	+44.7%	$12.00
10Dec2006	Hagemeyer	3.64	3.63	-0.3%	5.00
16Dec2006	Iberia*	2.81	3.30	+17.4%	3.30
10Mar2007	North Am. Galvanising*	5.18	12.06	+132.8%	8.00
28Nov2006	Ormonde Mining	0.24	0.16	-33.3%	0.40
7Dec2006	Rhodia	2.60	3.07	+18.1%	3.20
30Nov2006	SolarWorld	46.10	65.65	+42.4%	69.12
25May2007	Tsakos Energy Nav.	$63.50	$64.23	+1.1%	$90.00
2Dec2006	Vallourec	204.00	234.89	+15.1%	250.00
				+25.5%

All stocks in euro unless mentioned otherwise. Stocks marked (*) have been sold as target price has been reached.