Phase I:

In the early years a rising gold price is greeted with suspicion, doubt and often complete disbelief. The market is dominated by speculators and traders seeking relatively quick short term profits. Although gold may double or even triple in price during this phase(which can last five or more years) the price is subject to periodic violent selloffs of 20%-30% as short term traders are easily routed by the bullion banks. During this period gold bullion dramatically outperforms gold mining stocks as the market is disciplined to distrust the rise and avoid buying assets in the ground.  Indeed, most investors completely avoid gold during this period.

How to recognize when phase I is coming to a close:

Throughout the first phase the periodic selloffs follow a specific pattern. During the early years the selloffs are frequent, deep and can last for months. The gold mining stocks often decline as much as 50%, underperforming the metal in both directions.  However as time goes on the frequency, intensity and duration of the selloffs moderate as physical bullion buyers gain in strength and gradually erode the capability of the bullion banks to raid and manipulate the paper gold futures market. The mining stocks continue to react but begin to close the gap of underperformance. Phase I will come to a close when paper gold futures sell off for a few days but the gold mining stocks give up little or no ground or even a few of the stronger issues appreciate. Of course, mass media and so called market pundits will continue to call the top in gold which will keep most investors on the sidelines.

Phase II:

During phase II the rising pattern of gold will begin to accelerate .  However, the gold mining stocks will experience rising relative strength verses the metal as explosive quarterly earnings reports bring attention to the sector. Takeovers will begin to populate the landscape at substantial market premiums as the larger companies bid for the successful exploration companies that have toiled quietly for more than a decade. Sometime before the end of this phase the major Wall Street brokerage firms will scramble to rebuild a research presence and recommendation lists in an area they have long proselytized against. All of a sudden the smaller companies will successfully be able to come to market and new funds will flood into the exploration area. Very quickly a drilling equipment shortage will emerge and all participants in the industry will experience labor shortages.

Phase III:

Now the fun begins. This is the shortest but most explosive phase of the secular bull market in gold. This is the phase when all the sleepy financial institutions and the public finally wake up. Almost every week a new precious metals mutual fund or exchange traded fund will be launched as money pours into the sector. This is the inflection point when the public clamors to get aboard in true “gold rush” fashion and Wall Street is more than happy to accommodate with a constant flow of recommendations. Prices will continue to climb considerably beyond all prior fundamental benchmarks. Abrupt corrections will still occur as the COMEX will progressively raise futures margin requirements and so called pundits repeatedly try to foolishly call the top. But no top will be reached until the final excessive quantitative easing of fiat currencies (printed by the U.S. Federal Reserve, the European Central Bank and the Japanese Central Bank) finds its way into the gold market.

At Rosenthal Capital Management we recognize that QE has become a permanent drug of western central banks and believe no cure will be forthcoming for this long term addiction.  Over the last five years we have developed a considerable global research expertise in precious metals which has been a core focus in Fortune’s Favor I(our flagship fund) and guided Fortune’s Favor Precious Metals to significant returns since inception in the fall of 2006. Our primary focus has been owning bullion but we have recently begun to shift to the mining stocks as we enter the second phase outlined above. In addition to a mixture of the senior and junior issues we have broadened our approach to encompass what we believe is a global collection of the potentially most successful smaller exploration entities. While these issues collectively may occupy the smallest portion of our funds together they have the potential to have the greatest impact on the portfolio. We believe phase III of the current bull market may be able to yield a speculative exploration crop superior to the 1975-80 list below:

Name                         1975                      1980

Lion Mines              $0.07/share       $380/share

Bankeno                    $1.25                    $430

Wharf Resources   $0.40                    $560

Steep Rock                $.93                      $440

Mineral Resources $.60                       $415

Azure Resources     $0.05                    $109

An investment in Lion Mines of $700(10,000 shares) in 1975 would have netted a total profit of around $3,799,300 if held for the 5 years.

Final Comments:

First, we have purposely left out any comments on silver. Suffice it to say that if you research the archives of the Rosenthal Capital Management blog you will discover we believe silver will outperform gold in the current environment and is a major focus of our investment activities. Finally, in case you missed it, we believe Phase I of the current secular bull market in gold ended last week!

Positions: Long Gold and Silver assets. Not long stocks mentioned

              Inflation concerns have been on economists’ minds since the Fed started passing drastic measures to combat our country’s troubled economy. Now, as the worst of the storm appears to be behind us, the concerns about the repercussions of our government’s monetary actions are under the microscope. The Fed’s commitment to keep the interest rate near zero for the next year has fueled speculation that other central banks will raise interest rates first—which would make other currencies more attractive than the dollar. Australia’s decision last week to raise interest rates already hurt the dollar and suggested that resource-based economies might recover quicker, and be more attractive to investors, than the United States. 

 The V-Shaped Climb 

              As manufacturing gains its footing, the stock market strengthens, housing inventories fall and retail spending returns; our economy will continue traveling up the V. However, government provides the stability in many market rebounds.  Once government funds are pulled back, the likelihood of dropping back into a recession could increase.

              Until spending is once again a consumer behavior, instead of a government one, the underlying economic problems will remain—threatening to pull us into another deep recession. In order for consumers to spend again, they are going to need to be convinced that their hours will not be cut, their jobs will not be lost and their wages will not be dropped. Of course, before they can be convinced of any of this, the unemployed will have to be reintroduced into the workforce. 

              We will continue wrestling with high unemployment numbers until business owners are confident that their products and services are once again in demand. Currently, businesses are getting by with nearly-depleted inventories. But, as consumer demand rises, business owners will beef up inventories; which will produce the need for more employees in the manufacturing industry. Business owners are scraping by with the bare-minimum number of employees. Larger inventories require new employees to sell, stock, ship and manage the products. 

              So, as consumer demand slowly returns, so too will new jobs. As we crawl out of this recession, a number of positive signs fuel consumer demand. As home prices continue to rise, homeowners will no longer be underwater and their confidence will get a boost. As the stock market continues to climb, so too will investors’ confidence. Major markets are all interrelated. Signs of growth in one market have the ability to positively impact another. The process is slow and filled with pockets of discomfort, but the climb has begun and the journey is forecasted to be slow and steady. Being patient and taking the right steps now will help our economy avoid falling down the second trap in the dreaded W-shaped recovery.  

Protecting Your Wimpy Dollar, Not Fearing it 

              Fearing inflation is a reactive investor’s behavior. This group of investors waits until something drastic happens in the marketplace that demands they respond. Active investors prefer to take more proactive measures to prepare for unappealing market conditions, such as inflation. Wise investors salt the slugs of inflation long before they have the chance to take over their gardens and devalue their investments.

              First, let us be clear that our country still may be on track to side step a nasty bout of hyper-inflation; which could cause a gallon of milk to cost a truckload of fifties. Our policy makers have to make the right decisions as we trudge through this recovery. To recognize the silver lining, an economy needs to have ultra-low unemployment levels and rising wages to effectively foster a period of hyper-inflation—both of which we are lacking at the moment. Unemployment is flirting with the 10-percent mark and real average hourly wages fell from December, when they were at their recent high point, to August at a seasonally-adjusted 1.5 percent.[1]

              Some may consider worries about inflation to be premature, but there are countless signs suggesting that the dollar will continue to considerably weaken over the next couple of years. The most concerning: Our government has borrowed hundreds of billions of dollars in efforts to hold up our banking system and this has added to our country’s already-enormous debt responsibilities. Having far too much money and too few goods is the root cause of inflation. Therefore, the biggest worry is that our government will continue to print money to pay for its extraordinary debt. Even if some experts are arguing that inflation concerns are premature, there are proactive actions an investor can take to protect his or her investments.

              Some assets rise in value during times of inflation and having a dose of them in your investment portfolio can do wonders for its performance. The following are widely-considered to be the best performers:  

·      Real estate: Traditionally, investors have used real estate as a hedge against the spontaneous performance of portfolios that are overloaded with stocks and bonds. Real-estate assets can also act as a hedge against inflation. Plus, today’s affordable prices and availability have real estate looking extremely appealing as an investment opportunity.

·      Commodities: Inflation causes the price of materials to rise. So, why not hold interest in the materials themselves? Investing in commodities through exchange-traded funds can help small investors avoid the many drawbacks that come with investing in commodities (like deciding where to store 1,000 barrels of oil).

·      Gold: With our currency no longer anchored to gold, it can lose value—and often does. The magic with gold is that it often moves opposite the value of the U.S. dollar.

·      TIPS: Treasury Inflation-Protected Securities are similar to other Treasury securities in that they are long-term IOUs that pay a fixed rate of interest until they mature. But, with TIPS, the government adjusts the payments up or down each month according to inflation levels.  

All My Best, 

Thomas J. Powell 

The discussion of investment strategies in this article should not be considered an offer to buy or sell any investment. As always, consult an investment professional to assist you in meeting your investment goals.

[1] See http://www.bls.gov/news.release/realer.nr0.htm