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Fear and Greed
by Lawrence Roulston

Those opposite poles of investor sentiment are rarely used to maximum advantage.

Investor fears of a collapse of the American financial system led to panic selling and a downward spiral of investment values. The damage is mounting and the consequences are not easy to determine. Yet, we all know, at some time the situation will turn around. At this time, all we can do is maximize our benefits on the eventual upturn.

News of the financial crisis that has engulfed the world has created an intense sense of negativity in the minds of investors – indeed in the minds of anybody who takes even the slightest notice of the news. The flames of panic are being fed by irresponsible reporting: The media routinely presents the worst case possible as if that cataclysmic outcome were a certainty. Subtle suggestions of the disaster scenario include a Time magazine cover showing a picture of a 1930’s soup-kitchen line up as if to say that is the inevitable outlook for the American consumer.

The popular press has become so entrenched in their negative stance that good news tends to get buried. It takes remarkable courage to present a news item that is out of step with the established wisdom. For example, media reports about the sharp rise in house sales in September – to the highest level in a year – got only a fraction of the exposure given to the bad news stories. In most cases, the good news was qualified by news that the value of houses had dropped over the past year. We all know that house prices have declined sharply over the past year, but news that activity in the housing market had picked up in the month was significant.

The negative reporting has created a downward spiral that feeds on itself, setting up the danger of a self-fulfilling prophesy as consumers cut back on spending and business owners start cutting employees on the basis of what might come to pass.

Those images of soup lines and other references to the depression era have terribly distorted the perceptions of the man-in-the-street. I wonder how many people have any sort of realistic outlook of what is likely to happen in the economy. For example, many people are not aware that a recession means the cessation of economic growth – not the cessation of economic activity. The economy will continue to perform at a level just a couple of percentage points behind last year. The country will not stop functioning, as some people have come to believe. Importantly, few Americans have a realistic understanding of the level of economic activity in other parts of the world. They remain caught up in the out of date notion that the U.S. is the only important driver of world economic activity.

The financial crisis in the U.S. is indeed serious. The entire financial sector teetered on the brink of collapse. The government bailout of Wall Street has given a degree of confidence that the financial sector will survive. There are still big problems, as the reduction in the amount of liquidity in the financial sector has caused serious strains that are spreading to other sectors of the economy. The banks may still be solvent, but they don’t have as much cash to lend as they once did. Consumers and businesses are all feeling the credit squeeze. Not just is there less cash available: the pendulum has swung from giving loans to anybody that had a measurable pulse to making even credit-worthy investors jump through hoops.

It will take some time to regain the level of growth that Americans have come to expect. In fact, the consequences of the financial bail-out may impose a drag on economic growth in the U.S. for years to come. Nevertheless, the economy will muddle through the current crisis, and then it will recover, as it has so many times in the past.

The key questions, of course, are: how much worse will the situation get before it turns around? when will the recovery get underway?

It’s hard to imagine the situation in the junior resource sector getting any worse. Some stocks that not so long ago were trading for dollars a share are now trading for pennies a share. Some high quality companies are trading at less than the value of their cash in the bank. (Maybe that’s because investors are discounting the value of the bank deposits due to concerns about the banks?)

Banks that were bastions of security for a century or more have vanished, leaving investors in those institutions with little or nothing. General Motors, a stalwart pillar of the American economy for decades, lost more than 90% of its value. Tens of other companies recently deemed “blue chip” are down by 80% or more from their highs this year.

Average share prices around the world have plummeted by 40 – 50%, with the losses still mounting. On average, in a recession the share prices have fallen by about 35%. The decline in share values to date implies that a worse than usual recession has already been factored into share prices.

Ironically, the U.S. dollar has suddenly become a tower of strength. Investors, seeking the greatest level of safety, are flocking into Treasury bills. No doubt that T-bills provide near-term security, as the U.S. government is unlikely to go bust in the next 30, 60 or 90 days. At this moment, the realization that the euro is falling faster than the greenback makes the dollar look like a safe haven refuge.

Looking beyond the end of the panic selling, it is inevitable that investors will recognize that the massive give-aways to prop up Wall Street are going to add further downward pressure to a currency that was already in a free fall.

Nobody can tell you precisely when the recovery will get underway. Nor can they give you any meaningful assurances that the share prices will not continue to erode. However, from these levels, for many companies the downside risk is tiny in relation to the upside potential.

Warren Buffet made that point recently when he urged Americans to buy shares in an article he wrote for the New York Times. In that piece, he emphasized the basic principle that led to his stature as the world’s most successful investor; “Be fearful when others are greedy, and be greedy when others are fearful.”

We now have fear in abundance. Those who become greedy in the face of that fear stand to profit in a big way.

Now, let’s look at some of the investment notions that flow out of the current situation with regard to the junior resource sector.

Firstly, not all companies in the junior resource sector will survive. Companies with big obligations and little cash face monumental challenges. Those with good assets will find partners or buyers or investors. The early stage exploration projects will be hard to finance for some time. Looking longer term, the development pipeline will again face shortages of good projects.

The recent strength in the U.S dollar has hurt the gold price, along with all commodities. As the price of bullion plummeted, the shares of exploration and development companies dropped like rocks. At their current oversold positions, some small gold companies have share prices that value them at less than $1 per ounce for the gold in their deposits.

Any hint of slowing in the dollar’s ascendancy will see a return of investor interest to gold. It seems apparent that the gold companies with established deposits will benefit from a recovery in the gold market.

The base metal companies will also recover, but the move will likely follow moves in the gold sector. Many of the base metal companies are trading at absurdly low prices. It may require patience, but some of these companies will appreciate in value by several-fold as the world eventually returns to normalcy.

The major mining companies, whether precious or base metal, are still producing at or near capacity. That means that deposits are being steadily depleted. Just to stay even, the gold mining industry needs to develop about 80 million ounces of new reserves each and every year. The same concept applies to all metals. That means undeveloped metal deposits will continue to have enormous value, even if that value is not reflected in the share prices at this moment.

Investors who become greedy (selectively) in the face of the intense fear that pervades the resources sector stand to reap big rewards over time.

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