In the first part of this three-part series, I discussed the importance of cycles such as four-year presidential elections and the life of a gold mine, and how they play into our investment strategy here at U. S. Global Investors. Part II dealt with statistical diagnostic tools, in which I strived to simplify the definitions of standard deviation and mean reversion and explain how they’re applied.
The third part of this series on managing expectations is devoted to fundamental resource stock evaluation. I’ll discuss some of the statistical tools we use to pick quality stocks during a treacherous bear market, such as what we’ve seen in gold stocks the last three years.
Let it be known, however, that, though our approach might vary slightly depending on the condition of the market, we fervently seek to pick the best stocks at the best price and execution.
How I Learned to Respect the Bear
The traditional definition of a bear market is when broad stock market indices fall more than 20 percent from a previous high – which sounds like a catastrophe, but is in fact ‘normal’ market behavior. According to self-professed ‘investing nut’ Ryan Barnes, a contributor for Investopedia, ‘bear markets… are a natural way to regulate the occasional imbalances that sprout up between corporate earnings, consumer demand and combined legislative and regulatory changes in the marketplace.’
Think of bear markets, then, as the gradual transition from warm summers into frozen winters. Trees lose their leaves, snow and ice blanket the ground, many animals – the bear the most notable – hibernate for the season. All life seems to take a breather. But just as you can always count on spring to emerge and, with it, new life, you as an investor can count on the market to rebound with fresh vigor.
As you might have known, the tail end of ‘winter’ is when you want to take part in the inevitable recovery. If the market never had a winter season, if it were perpetually trapped in an endless summer, investors would be hard-pressed to find an ideal entry point.
It’s easy to determine when winter becomes spring. But what about the end of a bear market? How do you know when it’s bottomed and the optimal buying time has been reached?
CLSA consultant Russell Napier, in his now-classic 2009 book Anatomy of the Bear, describes the determinants of the end of a bear market:
‘The bottom is preceded by a period in which the market declines on low volumes and rises on high volumes. The end of a bear market is characterized by a final slump of prices on low trading volumes. Confirmation that the bear trend is over will be rising volumes at the new higher levels after the first rebound in equity prices.’
Look at the chart below. You’ll see that, in three decades, the Philadelphia Gold & Silver Index (XAU) has never had a losing streak for more than three years.
This post was published at Gold-Eagle on August 25, 2014.