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Stockscom Report for Sunday May 12 2002

Publisher: Colin Alexander     Editor: Ken Wilson

Subscriptions and Administration: Pierre Fichaud (toll-free: 866-487-9711)

 

Market Synopsis

 

Market volatility is the predominant theme this week as Cisco was the spark that lead to rising tech prices, which were then stoked to further heights through short covering. The announcement of better than expected earnings albeit on the backs of cost cutting, greater market share and lower margins resulted in a feeling of euphoria in La-La Land otherwise known as Wall Street. Investors piled into tech shares believing that the worst was over and the much anticipated recovery had now begun. Few seemed to care what the CEO of Cisco, John Chambers, had to say with regards to future earnings and the business environment, for plain guidance was no match for a company’s ability to surpass earnings expectations in an environment conspicuously starved for good news. After a short bout of indigestion, traders recognized the folly of their ways and as fast as prices rose on Wednesday, they fell on Thursday and Friday giving up much of their ephemeral gains.

 

In looking over the financial landscape of the past few months, few sectors have been consistently profitable and that is truly one of the goals, which we strive to achieve. The few include oil service companies, homebuilders, and our favorite, gold. More and more we see gold as the one place to park money in this market and feel secure that possession of gold mining shares won’t cause us any nightmares. This week was a terrific case in point: the blast off due to Cisco beating expectations and a vastly oversold market failed miserably and by week’s end had resulted in another down week in the markets. Gold shares naturally bucked this trend and by week’s end were up again.

 

But there is more to gold than simply rising on the misfortune of other corporate entities. (Sharp drops in stock markets have always brightened gold’s allure because of the security that such a hard asset entails.) A strong bullish case can be made for the glittering yellow metal to stand on its own. Technically, we have a series of successive rises separated by smaller dips and the price of the actual metal has truly rounded the bend and is primed to pursue higher levels not seen in recent memory. These successive new recent highs show a definite accumulation trend in place notwithstanding an unusual American reluctance to hold gold or gold shares in investment portfolios.

 

Fundamentally the reasons for holding gold are even more compelling for a couple of reasons: hedging programs and reduced production. We’ll start with the latter which is much more simpler. Lower production means available supplies dwindle and the desire to own gold encourages investors to pay an even greater price in order to achieve their goals. To wit, once the price of gold began falling below $300 an ounce in recent years, the principal gold mining companies rolled back the development of any new mines. With prices so low, the risk of failing to profit from further exploration and development was too great. Thus the current appreciation in the price of gold is simply a balance between current supply and demand.

 

The risk remains though that central banks could theoretically sell their holdings and consequently depress the price, but the reality is that this is hardly likely. Why would a central bank liquidate a portion of their immense stockpiles when price is going up? So while this situation is always a possibility, it becomes more and more unlikely as the price of gold increases.

 

Hedging is also playing a role in this game. Historically many of the larger gold mining firms have sought to increase their return on assets by hedging production meaning that gold yet to be produced was being sold forward under call option contracts. By fixing the price to be received, the companies assured themselves of extraordinary profits as long as the price of gold continued to fall or remained stable. Now however, the situation has changed dramatically.

 

Barrick Gold (ABX) is an excellent example of how hedging could potentially destroy a company. At this moment, ABX has 24 million ounces hedged (with a goal to reduce this by 3 million this year) and produces a little less than 6 million ounces per year. The call options sold vary in price up to a maximum of $375 an ounce. As long as the price of gold remains under this price, ABX is safe but if price began to move higher than this level, the company could be in trouble.

 

If the price of gold rose to $400 for example, ABX would have the holders of the options on their doorstep waiting to redeem them and paying a maximum of $375 per ounce for $400 worth of gold. As more holders approach ABX to redeem their paper, pressure mounts on ABX to find the gold with which to pay the holders even to the point of possibly purchasing it on the open market. An increase in demand such as this could snowball rapidly and ruin ABX. At this point, it is worth remembering that there isn’t simply one company living with this threat but rather several of the largest companies have been hedging production for years and the cumulative demand for gold could be much greater thus pushing up the price exponentially.

 

Gold companies without hedging programs are the best leveraged to benefit from the rising gold price. In our recommended list of stocks, Agnico-Eagle, Gold Fields and Glamis have made it a point to not participate in hedging programs.

 

 

Our Stock Picks

The stop losses of $7.80 on AOF and $11.20 on MUO are maintained. We’re still watching our Dow stocks carefully but believe they’re supported strongly at the 9750-9800 level. Stochastics remain oversold and therefore a bounce higher is expected.

 

 

New Buy Recommendations:

 

None. Market risk is far too high to initiate new positions in anything but gold at this point. 

 

New Short Sales

None.

 

Stock Positions to Sell/Exit:

 

We were exited from ADPT at our stop of $13.50.

 

List of Current Stock Recommendations:

Action Ratings. The following is the legend for designating immediate action
for our stock recommendations. The first is B, meaning the stock is timely
to buy but the case for doing so right here is not overwhelming. Either the
stock may have gotten ahead of itself and may be vulnerable to a retracement or
else the stock has been performing disappointingly but may simply be
regrouping. B+ and B++ indicate stocks for which there is a technical case
to buy now, with plusses adding weight according to how many there are, up
to a maximum of two. Stocks rated H are ones to hold, awaiting confirmation
to buy more or to sell. SELL, of course, means what it says. It seldom pays
to override this designation. In the case of stocks held short, the rating is S where positions should be retained. S+ and S++ indicate stocks for which there is a technical case to add to the positions with plusses adding weight similar to long positions. The maximum number of plus signs is 2.

Stocks marked # are eligible as Canadian content in Canadian RSP funds. Otherwise there is a 30 percent restriction on foreign stocks held in these accounts.

Date of Entry	Name	Symbol	Entry Price	Current Price	Action Rating
22/04/02	Acclaim Entertain.	AKLM	5.79	5.03	H
02/01/01	Acm Government Opportunity Fund	AOF	7.99	8.83	B
03/11/02	Adaptec	ADPT	13.89	13.50	SOLD
10/08/01	Agnico-Eagle Mine	AEM #	10.85	15.52	B
22/04/02	Aspect Comms.		4.92	4.29	H
03/11/02	Caterpillar	CAT	59.08	52.81	H
22/04/02	Cobalt	CBZ	15.15	18.90	B
03/18/02	Dupont	DD	48.70	45.40	H
10/22/01	Glamis Gold	GLG #	3.28	7.79	B
10/08/01	Gold Fields ADR	GOLD	4.97	14.66	B
03/18/02	Johnson & Johnson	JNJ	64.70	61.85	H
03/11/02	Modis Prof. Srvcs	MPS	7.75	8.35	H
03/04/02	Moore Corp	MCL #	11.50	13.85	B
02/01/01	Pioneer Interest Shares	MUO	11.95	11.60	H
03/11/02	United Tech	UTX	75.32	68.75	H