Investor Psychology Can Trump Market Fundamentals

gold timeWith gold and silver equities markets as volatile as ever and assets of many miners valued at pennies on the dollar, Eric Muschinski, editor of the Gold Investment Letter,believes being on the right side of the emotional curve when investing is critical. He pays as much attention to investor psychology as he does to market fundamentals. In this interview with The Gold Report, Muschinski explains how investors can use knowledge of market cycles to their advantage and profiles undervalued companies flying under the radar.

The Gold Report: You have published a recent e-letter for investors called “Fighting Battles to Win the War.” Please sum up the major themes of the issue, especially around how small-cap stock investors can combat impatience and deal with the emotional stress associated with temporary market downturns.

Eric Muschinski: Investor psychology is a major passion of mine and I write about it frequently. Stocks go up and down and sometimes moves are cyclical (shorter term) and some secular (long term). The “war” is referencing where we are in the junior mining, gold, and silver markets cycle and where we are heading. The battles referred to several of our recommendations that were experiencing retracements at the time. It’s good to remind myself and readers about the bigger picture because the battles are inconsequential if you have your head on straight, are patient and know the ultimate victor of the war.

Gold went up for 12 straight years from 2000–2011; that is simply unheard of in any asset class secular movement. If we take a step back and put that into perspective, it makes sense that gold would take a “breather” and consolidate for two or three years before its imminent “blow-off” phase.

“For big gains in mining stocks, we generally have to wait for the sector to turn in earnest and the tide will lift all boats.”

Frankly, the fact that we haven’t given up 50% since the 2011 highs is a testament to how strong this bull market is overall. The people who have emotional stress at this juncture likely were buyers when gold was $1,800/ounce ($1,800/oz) and silver in the $40s/oz, whether mining stocks or the physical metals.

However, I am quite confident that the market is going much higher and I am joyful beyond belief because this is gifting me more time to accumulate my favorite assets and mining stocks at substantial discounts. If gold is going to $3,000/oz or silver to $150/oz, do you want to own a little or a lot? This is a secular bull market that I am betting so significantly will change my life forever net worth-wise. I would encourage folks who have emotional distress to hit the reset button and get in the game; now is the time to be a buyer. Once gold is much higher, I’ll be selling it to investors who buy based on emotion and excitement; anyone who has a habit of buying/selling on emotion will always lose money over time.

TGR: Are the prices of shares in precious and base metal mining firms directly correlated to the overall market, or do they have some independent movements?

EM: It seems as though share prices of precious and base metal mining companies are now lacking correlation with the overall markets, which is good. Many investors are chasing the indices now for returns/alpha when the contrarian and wise investors are looking at hated assets like junior mining stocks. However, I learned years ago that any given stock tends to trade based on this breakdown, more or less: 50–60% due to overall market, 30–40% the sector it trades in and 10–15% the company’s business performance itself. This explains why all gold stocks are in the gutter. People often ask what’s up with this company or that and my typical reply is. . .nothing.

For big gains in mining stocks, we generally have to wait for the sector to turn in earnest and the tide will lift all boats. Sometimes, with very special discoveries, a junior can buck the trend, as we saw with our top pick the last year, Zenyatta Ventures Ltd. (ZEN:TSX.V), but large counter moves to a sector are rare. If the general market gets smoked and it’s a liquidation race, gold and silver stocks will get hit, but they tend to recover after the initial blast. And once we’re in full stride of the phase 3 bull frenzy, we will likely see the market going lower and mining stocks skyrocketing.

TGR: The gold markets have been lingering low for a while now. Why should investors contemplate buying gold stocks? Is bullion preferable to stock? If so, why?

EM: I recommend a mixture of both bullion and stock. First and foremost, investors in the space should initially take a position in physical gold and silver bullion, which is money. Second, mining companies indeed have leverage to the prices, as we’re experiencing now on the downside, and will again experience on the upside. The ounce-in-the-ground valuations for mining stocks are the lowest I’ve ever seen since I’ve been following the sector.

“The ounce-in-the-ground valuations for mining stocks are the lowest I’ve ever seen since I’ve been following the sector.” 

However, there are a handful of markets where the cyclical bear move was similarly devastating; 1975–1976 was very brutal and many investors capitulated right before we saw a four year, 850% rocket in the price of gold. Thirteen months after a bottom in gold stocks the average weighted return tends to be around 80%. That’s a violent bounce because it is a volatile sector, but I suspect the major move in gold stocks will see many multibaggers occur.

Once gold breaches $2,000/oz, the leverage in the junior miners will be incredible. There were gold stocks that went from pennies to hundreds of dollars per share between the mid-1970s and 1981. Even if we don’t see anything close to that, sometime in the next couple of years returns from current levels will be quite attractive.

Bottom line, every single soul in the world should have at least 10% of his or her investable assets in gold and silver. Folks with a lower risk tolerance who mainly want to protect their purchasing power should swing heavily in favor of gold. Those who want to take on more risk may want to weight more exposure in silver and mining stocks.

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