Debt-fuelled 'fake prosperity' runs out

Mining stock specialist Mike Kachanovsky says now is the time to buy heavily discounted precious metals stocks and capture a rebound in this sector that is long overdue.

Mining stock specialist Mike Kachanovsky says: "the best way to play this setup is to consider buying a few of the large silver producers."

It seems that the concept of prudent investing ended with the financial crisis of 2008. Thereafter, people were content to accept unlikely narratives promising growth and prosperity that were issued by government agencies. The issuance of almost unlimited money and access to low-interest credit appeared to work for almost a decade. New stock market highs were regularly reported and any threats of a serious correction along the way mysteriously dissipated.

Those carefree days came to an end late in 2019. Structural economic weaknesses have emerged.

The long winning streak encouraged too many participants to take on too much debt. Much of this was used to fund share buybacks that served to artificially improve financial results presented on a per-share basis.

As stock values were rising, insiders were cashing out. Almost none of the easy money was used to actually increase productivity or build lasting value within these corporations.

Is more debt the cure for a debt crisis?

Meanwhile, speculative margin debt by retail investors reached even higher levels than the extremes prior to the last crisis. The greatest bull market in history became unstable as cracks appeared in the foundation.

Financial policymakers believe they can force the market to behave in line with their agendas. Constant interference using monetary initiatives and adjustments to interest rates has created a massive mispricing of risk that is now undermining the fake prosperity.

Issuing more debt cannot be the answer to a debt crisis but even today that appears to be the 'solution' these people roll out to fix problems. And if handing out helicopter money was good for the economy, then Zimbabwe should be an economic powerhouse today.

Suffice to say that the methods employed to solve the last financial crisis fixed nothing. The same problems are emerging again right now and worse. Yet the press conferences continue and the same flawed solutions are offered yet again. The bailout money will flow and some of the most reckless and inept institutions will once again be rescued while the overall economy goes down the drain.

Supply and demand will regain traction

World markets are on the precipice of a collapse. Some analysts are predicting the next great depression is upon us. Investment decisions are suddenly more perilous. Perhaps another tsunami of easy money will be enough to hold things together a little while longer in these distorted and critically flawed markets. I will admit that I am astonished it took this long for the financial problems to return and would have expected a collapse many years ago.

The lessons of history are rarely remembered but investors should recall that gold and silver once served as the refuge of safety during times of market duress. Alas, even precious metals have now succumbed to the latest financial alchemy. The spot prices for gold and silver have been captured by high-volume trading strategies in a paper derivative market.

By design, gold and silver have suddenly been driven lower so they become unattractive to speculative money. This is often precisely timed for when prudent investors are most likely to seek an alternative to the overvalued general equities, or the absurdly low interest offered by bonds.

Ironically, after the most recent slam on the precious metals, their spot prices were driven so low that a surge of buying cleaned out the inventory of most bullion dealers worldwide. Supply and demand fundamentals for the metals will regain traction as the inevitable bear market grinds lower for the markets. Count on it.

Money will shift to established senior producers

The similarities between this current regime and the great financial crisis of 2008 are instructive. Gold and silver were taken down to extreme lows in the initial phases then, too.

Thereafter, both metals surged to achieve gains of several hundred per cent in the following years. I expect a similar resolution this time around. With the inventory of physical bullion already difficult to find, money flow will probably shift to established senior producers as a value strategy to hold leverage in the precious metals sector.

It should be noted that silver is currently mined at a ratio of roughly 10 ounces for each ounce of gold mined. However the gold-to-silver ratio (GSR) has been distorted to extreme levels, reaching as high as 125 in mid-March (a level in the 80s is normal). This means it took the equivalent of 125 ounces of silver to buy one ounce of gold. Expect that obscene imbalance to be corrected in time, along with so many other market anomalies.

Therefore I would suggest that perhaps the best way to play this setup is to consider buying a few of the large silver producers.

Next price move will be to the upside

My two favourites in this category are Coeur Mining Inc. (NYSE-CDE) and First Majestic Silver Corp. (TSX-FR; NYSE-AG). Both companies are multi-mine producers and each provides internal diversification with some leverage to gold and base metals production as well. Both companies have demonstrated the ability to prosper during bear market conditions, with seasoned management and low-cost operations.

These companies were trading at the higher end of their ranges just weeks ago, and plummeted to new 52-week lows this month. Many speculators are unwilling to buy weakness, and perhaps especially now during the most severe market sell-off in decades. I believe the sentiment level for the sector overall is now a contrary indicator and the bad news is fully priced in. The next move for these stocks will be to the upside.

Silver is also positioned to recover from multi-year lows. The spot price is currently trending below the cost of production for many currently operating mines. Worldwide mine output is declining even as silver demand is growing. An increase in the price of silver usually corresponds to an even greater surge in the market value for the silver producers.

Cheaper oil will boost profits

One final bullish point to note is that the price of oil has also undergone a severe correction in recent months. Most of the larger mining companies are closely linked with the price of energy, as massive trucks and earth-moving equipment burn through diesel fuel in daily operations.

The sudden reduction of energy costs will go right to the bottom line for these stocks. The potential for a surge of positive earnings news will just make these stories even more attractive if the rest of the market continues rolling over.

I have avoided even mentioning the impact of the coronavirus amidst all of the other market turmoil. The systemic imbalances that created the chaos we are experiencing today were laid down years before COVID-19 added yet another layer of complications.

This regime of mispricing risk and distorted valuations will not be unraveled quickly and easily. There will be more traumatic sell-offs ahead, and lower lows for the already stressed world markets. Gold and silver will regain their lustre as the safe haven to ride out financial shock-waves.

Now is the time to buy heavily discounted precious metals sector leaders and capture a rebound in this sector that is long overdue.

Mike Kachanovsky is a freelance writer who specializes in junior mining stocks and also covers technology companies.

This is an edited version of an article that was originally published for subscribers in the April 3, 2020, issue of Investor's Digest of Canada. You can profit from the award-winning advice subscribers receive regularly in Investor's Digest of Canada.

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