An Outlook For Precious Metals

My best guess is that precious metals have made a short term bottom. But I can be wrong. Intermediate term however I am still wary of a mid-year dip. A bull market often tries to shake off as many people before embarking a big advance.

Both gold & silver have made the MACD bullish crossover on the daily chart. GDX & GDXJ have both made the crossover by just about a couple of days earlier. The upturn has been quite sharp, and is subjected to sharp pullback. It’s going to take a lot more work to get this market back to bullish stand.

Based on my reading of the Elliot Wave Theory applying to gold & mining stocks, I believe that we should definitely be in major wave 3. Initially, I thought the 5 of 1 of 3rd major wave would be here. After the recent correction, I’m not sure if 2 of the 3rd major wave has begun. The second wave down is usually the most painful. GDX correct some 70% in its 2nd major wave in 2008/2009. Therefore, I would be cautious about the 2nd wave of the 3rd major Elliot wave too. The other disturbing trend for mining stocks is that oil prices are going up fast if not faster than gold. The gold to oil ratio must be carefully watched to decide on whether to over-weigh precious metal mining or oil drilling stocks.

I have been extremely busy with my day job & investment for the last month. Inevitably my blog suffers. After all, I’ve got only 24 hours a day. I’m going to make an effort to blog more regularly. Hope that my work schedule won’t get overwhelmingly busy again.

The Fair Price For Gold

“Gold closed at new high!” That was the Tuesday headline on Marketwatch.com. I checked right away, but didn’t see gold cash price breaking new high at $1265. After reading the article, it’s really just a new high in the nearest futures market.

“Investing” in gold is probably one of the hardest arguments to make, since gold simply doesn’t generate any interests nor dividends. Plus that many people who are interested in the commodity market will try to make the argument that nobody needs gold to survive. On the other hand, we all need oil/energy & grains. However, that simply doesn’t matter much for the last 10 years for gold investment. After all, everybody sells his or her investment at the end (whether it’s before or after death), and the only thing that matters is whether you are able to buy low and sell high.

After observing this market for almost 8 years myself since my initial investment back in 2002/2003, I can clearly see that the character of this market is slowly changing from stage 1 to stage 2, with more new participants coming in. Based on my judgment, it’s probably not at the mid-point of stage 2 yet. However, the price has probably reached slightly more than what its “fair price” should be. My definition of “fair price” probably will upset both gold bulls & bears. For the perma-bulls, gold should be trading at above $2200, an inflation-adjusted price from last peak set back in 1980 at about $850. For the perma-bears, gold at any price is probably too high, especially its historical record of hedging against inflation from 1980 to the low of about $250 in 1999/2001 is simply ridiculous (and that is definitely true). I take the middle ground, and would use $400 and adjust it by inflation for the last 20 years, and I would get just $1085.

Why do I use an ad-hoc $400 instead of $850? Peak prices (of $850) are crazy prices. They are always outliers. They do not make sense. A little less than half of the peak prices based on the trading around the peak of $850 before & after 1980 appears to make more sense to me.

I also believe that the inflation-hedging power for gold is valid, but it needs to be judged from a very very long term (way beyond 20 years from 1980 to 2000), just like the argument for housing prices always go up or stock prices always go up in the long term. In fact, all of them (gold/house/stock) do go up in the long term, but the only problem is that we humans only live for about 100 years, out of which we may earn & accumulate for some 40 years, and invest for just 20/30 years at best. The true “long-term” (in the order of 100 years) is simply too long for us. That makes all the differences in the whole world when it comes to “investment”. Depending on the era that we were born, we may or may not enjoy the prosperity at our respective ages.

So is today’s gold price too expensive? Based on all short-term technical indications, I think gold will soon come to a short-term top, possibly exceeding the last high. For the timeframe, I would say probably give or take 1 to 2 weeks. My own actions in this market have been mostly neutral. Try to buy the next dip if you can catch the break. Think of saving away in terms of GLD/SGOL or better yet in physical gold (so that your gold won’t shrink in size due to ETF fee). Such saving definitely won’t make you rich overnight, but at least you should be able to preserve your wealth.

Review On The New Gold ETF GDXJ GDX

GDXJ was debut this Wednesday. Both GDX and GDXJ (the junior companies) are offered by Van Eck.

Here are the links to the company site for GDX and GDXJ. The complete weighting of the components are listed below:

Fund Holdings of GDX as of 2009/11/12

 

Number

 

Holding

 

Ticker

 

Shares

 

Market Value

 

% of net assets

 

1

 

Barrick Gold Corp

 

ABX

 

18,718,639

 

$783,749,414.93

 

14.49%

 

2

 

Goldcorp Inc

 

GG

 

14,249,524

 

$614,011,989.16

 

11.36%

 

3

 

Newmont Mining Corp

 

NEM

 

9,475,288

 

$470,353,296.32

 

8.70%

 

4

 

AngloGold Ashanti Ltd

 

AU

 

6,999,199

 

$304,045,204.56

 

5.62%

 

5

 

Lihir Gold Ltd

 

LIHR

 

8,569,682

 

$265,317,354.72

 

4.93%

 

6

 

Cia de Minas Buenaventura SA

 

BVN

 

7,114,374

 

$263,587,556.70

 

4.87%

 

7

 

Yamana Gold Inc

 

AUY

 

21,130,631

 

$259,484,148.68

 

4.80%

 

8

 

Randgold Resources Ltd

 

GOLD US

 

3,203,698

 

$255,110,471.74

 

4.72%

 

9

 

Kinross Gold Corp

 

KGC

 

13,436,964

 

$252,883,662.48

 

4.68%

 

10

 

IAMGOLD Corp

 

IAG

 

14,744,197

 

$251,536,000.82

 

4.65%

 

11

 

Gold Fields Ltd

 

GFI

 

16,291,819

 

$229,714,647.90

 

4.25%

 

12

 

Agnico-Eagle Mines Ltd

 

AEM US

 

3,748,931

 

$223,736,202.08

 

4.14%

 

13

 

Eldorado Gold Corp

 

EGO

 

16,025,187

 

$207,205,667.91

 

3.83%

 

14

 

Silver Wheaton Corp

 

SLW

 

13,420,202

 

$199,692,605.76

 

3.69%

 

15

 

Harmony Gold Mining Co Ltd

 

HMY

 

17,100,638

 

$175,452,545.88

 

3.24%

 

16

 

PAN American Silver Corp

 

PAAS

 

3,501,327

 

$82,036,091.61

 

1.52%

 

17

 

Royal Gold Inc

 

RGLD

 

1,636,283

 

$81,715,973.02

 

1.51%

 

18

 

Coeur d’Alene Mines Corp.

 

CDE US

 

3,026,689

 

$63,378,867.66

 

1.17%

 

19

 

New Gold Inc

 

NGD

 

15,532,015

 

$59,176,977.15

 

1.09%

 

20

 

Silver Standard Resources Inc

 

SSRI US

 

2,878,399

 

$56,071,212.52

 

1.04%

 

21

 

Hecla Mining Co

 

HL US

 

9,493,058

 

$50,692,929.72

 

0.94%

 

22

 

Gammon Gold Inc

 

GRS US

 

4,993,219

 

$49,233,139.34

 

0.91%

 

23

 

Seabridge Gold Inc

 

SA

 

1,505,674

 

$35,142,431.16

 

0.65%

 

24

 

Golden Star Resources Ltd

 

GSS US

 

9,492,472

 

$32,369,329.52

 

0.60%

 

25

 

Aurizon Mines Ltd

 

AZK

 

6,375,413

 

$30,219,457.62

 

0.56%

 

26

 

Northgate Minerals Corp

 

NXG US

 

10,274,632

 

$30,207,418.08

 

0.56%

 

27

 

Minefinders Corp

 

MFN US

 

2,376,917

 

$23,674,093.32

 

0.44%

 

28

 

Great Basin Gold Ltd

 

GBG

 

13,386,929

 

$20,883,609.24

 

0.39%

 

29

 

Nevsun Resources Ltd

 

NSU

 

5,149,665

 

$14,882,531.85

 

0.28%

 

30

 

Tanzanian Royalty Exploration Corp

 

TRE

 

3,603,954

 

$12,469,680.84

 

0.23%

 

31

 

Cash

 

6,655,296

 

$6,655,380.14

 

0.12%

 

32

 

Vista Gold Corp

 

VGZ CN

 

1,705,026

 

$4,569,469.68

 

0.08%

 

Fund Holdings of GDXJ as of 2009/11/12

 

Number

 

Holding

 

Ticker

 

Shares

 

Market Value

 

% of net assets

 

1

 

Coeur d’Alene Mines Corp.

 

CDE US

 

56,910

 

$1,191,695.40

 

6.42%

 

2

 

Silver Standard Resources Inc

 

SSRI US

 

51,510

 

$1,003,414.80

 

5.40%

 

3

 

New Gold Inc

 

NGD CN

 

251,160

 

$972,587.72

 

5.24%

 

4

 

Hecla Mining Co

 

HL US

 

177,285

 

$946,701.90

 

5.10%

 

5

 

Gammon Gold Inc

 

GRS US

 

89,085

 

$878,378.10

 

4.73%

 

6

 

Alamos Gold Inc

 

AGI CN

 

80,610

 

$808,060.57

 

4.35%

 

7

 

Silvercorp Metals Inc

 

SVM CN

 

117,615

 

$712,342.27

 

3.84%

 

8

 

Semafo Inc

 

SMF CN

 

187,800

 

$707,530.16

 

3.81%

 

9

 

European Goldfields Ltd

 

EGU CN

 

95,100

 

$648,543.09

 

3.49%

 

10

 

Golden Star Resources Ltd

 

GSS US

 

175,590

 

$598,761.90

 

3.22%

 

11

 

Northgate Minerals Corp

 

NXG US

 

192,960

 

$567,302.40

 

3.06%

 

12

 

Kingsgate Consolidated Ltd

 

KCN AU

 

65,010

 

$548,420.73

 

2.95%

 

13

 

Jaguar Mining Inc

 

JAG CN

 

52,200

 

$545,176.21

 

2.94%

 

14

 

San Gold Corp

 

SGR CN

 

185,925

 

$530,226.29

 

2.86%

 

15

 

Aurizon Mines Ltd

 

ARZ CN

 

112,455

 

$528,783.59

 

2.85%

 

16

 

Novagold Resources Inc

 

NG US

 

97,935

 

$509,262.00

 

2.74%

 

17

 

Andean Resources Ltd

 

AND CN

 

229,485

 

$503,424.58

 

2.71%

 

18

 

Gabriel Resources Ltd

 

GBU CN

 

147,360

 

$444,139.06

 

2.39%

 

19

 

Minefinders Corp

 

MFN US

 

43,560

 

$433,857.60

 

2.34%

 

20

 

Allied Nevada Gold Corp

 

ANV US

 

38,055

 

$428,499.30

 

2.31%

 

21

 

Ventana Gold Corp

 

VEN CN

 

38,040

 

$420,147.07

 

2.26%

 

22

 

Rubicon Minerals Corp

 

RMX CN

 

99,240

 

$411,744.96

 

2.22%

 

23

 

Great Basin Gold Ltd

 

GBG CN

 

251,820

 

$393,900.33

 

2.12%

 

24

 

Lake Shore Gold Corp

 

LSG CN

 

92,505

 

$355,567.89

 

1.91%

 

25

 

St Barbara Ltd

 

SBM AU

 

1,032,395

 

$343,436.08

 

1.85%

 

26

 

Kirkland Lake Gold Inc

 

KGI CN

 

38,685

 

$332,075.92

 

1.79%

 

27

 

Avoca Resources Ltd

 

AVO AU

 

194,325

 

$333,011.01

 

1.79%

 

28

 

Fronteer Development Group Inc

 

FRG US

 

79,110

 

$328,306.50

 

1.77%

 

29

 

Romarco Minerals Inc

 

R CN

 

245,175

 

$327,383.28

 

1.76%

 

30

 

Medusa Mining Ltd

 

MML AU

 

77,745

 

$284,326.89

 

1.53%

 

31

 

Detour Gold Corp

 

DGC CN

 

20,685

 

$271,275.45

 

1.46%

 

32

 

Gold Wheaton Gold Corp

 

GLW CN

 

759,960

 

$217,452.43

 

1.17%

 

33

 

Dominion Mining Ltd

 

DOM AU

 

55,260

 

$202,474.00

 

1.09%

 

34

 

Real Gold Mining Ltd

 

246 HK

 

127,500

 

$194,484.35

 

1.05%

 

35

 

Colossus Minerals Inc

 

CSI CN

 

37,230

 

$187,135.39

 

1.01%

 

36

 

U S Gold Corp

 

UXG US

 

61,875

 

$167,681.25

 

0.90%

 

37

 

Avocet Mining Plc

 

AVM LN

 

97,665

 

$156,218.24

 

0.84%

 

38

 

Lingbao Gold Co Ltd-H

 

3330 HK

 

210,000

 

$81,009.51

 

0.44%

 

GDX is a tracking ETF to GDM index, a mining index determined by Nyse. The component weighting cannot be determined by Van Eck. Unfortunately, the top holding ABX at 14.5% is probably one of the worst choice. ABX recently announced to dehedge its gold forward sale, which was costing ABX some 4 billion dollars. ABX is also rumored to be the accomplice of gold suppression scheme together with JPM & Fed. The other components in GDX that I don’t like are AU at 5.62%, GFI at 4.25%, HMY at 3.24%, all are deriving 100% or significant gold productions in Africa. As the gold prices zoom upward, mining gold in an impoverished (relatively speaking) continent will tend to be problematic. I expect more labor and theft and political problems. Also gold production from Africa is declining as a whole. With the exception of GFI, which has expanded its production to other continents, the other two companies are definitely not my preferred choice (especially HMY). GFI is probably the “cheapest” company among major gold producers that one can buy, since its mine life is still quite long. HMY may have the highest leverage to gold price, due to its very high cost basis. At later stages of gold bull market, HMY could easily come back with a vengeance despite the terrible management. Although one may consider shorting out those components when owning GDX, I hesitate to do that. The other company that derive its production from Africa is RangGold (GOLD) at 4.72%. This has been one of the company that has baffled me, easily outperforming all other components, without me owning it. Definitely one should not short this component out.

Onto the new GDXJ, top components (CDE, SSRI, HL, SVM) are taken by all silver mining companies instead of gold mining companies. That’s 21% of the GDXJ. My ongoing concern about investing in silver companies is that they will couple to the general stock market a lot more than gold mining companies (at least initially). In a deflation, gold/silver ratio will zoom upward, relatively depressing the price of silver. I would have hoped to have less silver components. By the way, junior companies or small-cap stocks also tend to get depressed more in a downwave. Regardless, CDE and HL (and MFN) don’t seem to have good management in shareholders’ interests, raising big amount of capital at the recent zenith of 2008/2009, diluting a big percentage of their stockholders. I suspect that the deals were hammered out with hedge funds in the Wallstreet who have shorted all these companies in the backroom. With a big short ratio, it was simply not possible to cover those short position via open market purchases without driving up the stock prices. And what is the chance of having so many companies silmultaneously raising capital all the the absolute zenith of the stock market?

Most of the rest of the GDXJ components beyond top ten are not familiar to me. And that is the beauty of investing in an ETF, not needing to know every individual company. Assuming that gold bull market continues, GDXJ will eventually outperform GDX, with much higher volatility. I expect the rallies in both will be kind of in stages, with GDX the big cap leading the way.

Both gold & mining companies are short-term overbought, and had a tremendous recovery since 2008 crash. Based on Elliot wave reading, I’m fairly certain that we are looking at major wave 3. It is hard to tell whether wave 2 of 3 has happened or not. Regardless, if you have the nerves to buy and the stomach to ride out the tremendous volatility (20% to 50% up and down probably for more than 4 times per year), I think the reward may be good.

Granted, I’m still holding back due to my expectation of a significant general stock market correction in Q1/Q2 next year. But no one can predict the stock market with certainty. The best thing to do is to pick and weigh each of your portfolio position carefully, and stand firmly to ride out the combined volatility.

Frugal at 1stMillionAt33.com

Excellon Resources

By lottery ticket I’m talking about lowly priced, speculative stocks with great potential; rather than actually trying your luck at the latest Powerball or the Big Game, although I’ve been known to do that too! In the investing game my lottery ticket is (surprise, surprise) a junior silver exploration company, Excellon Resources. It trades in Canada under the symbol EXN.V and in the US on the pink sheets under the symbol EXLLF. [See here for a discussion on pink sheets.]

I won’t belabor the bull case for silver. Instead, this post will be a fairly in-depth (for me anyway) look at the fundamentals of this company with some technical considerations thrown in at the end.

Background
Excellon’s claim to fame is its Platosa property in northeastern Durango State, Mexico. Mexico has one of the friendliest legal environment for mining companies. Given the victory of Felipe Calderón over the leftist López Obrador last year, this situation is expected to continue. Platosa is located down the Eastern slope of the Sierra Madres, along the famous Mexican CRD (carbonate replace deposits) belt where many massive silver/zinc/lead/copper mines have been found.

Extremely high ore grades
The Platosa property is characterized by its extremely high ore grade. The company presentation (PDF) shows mineralization of 50 oz/t for silver and around 10% for both lead and zinc. I just about fell off my chair when I first saw these numbers which are so high that a quarter to a tenth of them may make somebody else’s flagship property.

On the other hand, this highly concentrated ore body is not great in extent which I guess is nature’s way of evening things out. The NI43-101 (a Canadian standard for reporting reserves and recourse for mining companies) conforming report prepared in August 2006 shows only 184,500 tons of resource, although if more recent discoveries were included, the total would like be around 350,000 tons. This is miniscule compared with the 5-50 million tons that a large scale CRD could contain.

The high grade ore does allow even a small scale test mining to be profitable. This is precisely what the company has been doing for the past two quarters: generating positive cash flow from test mining to self-finance its exploration activities. For now, Excellon needs to deliver half of the silver it mines to satisfy a silver backed debenture. Its bottom line will improve significantly when the debenture matures this July.

The company currently has 146 million shares outstanding at approximately US$1.20 each which gives it a market cap of US$175 million. It also has 13 millions options outstanding.

Intrinsic value

The intrinsic mineral value can be calculated from the resource amount, mineralization level and valuation for metal-in-the-ground as outlined in the table below. My assumption of $5/oz for silver, $0.25/lb for lead and $0.40/lb for zinc was fairly conservative. A smaller silver concentration than the company currently claim was assumed. I arrived at an intrinsic value of US$114 million, or 65% of the current market cap.

Income model
The picture is rosier when one considers the potential income after retiring the silver debenture. Using the annual tonnage, ore grade and recovery rate contained in the most recent report, it’s reasonable to expect the company to generate US$26 million in the first year based on current metal prices.

If the company were to cease exploration altogether and concentrate on its small scale mine activities, there may be six years of mine life left. Using US$26 million as a baseline and a discount rate of 12% and growth rate of 15% (both are subject to debate of course) the DCF model gives a present value of US$163.5 million, which is close to the current market cap of US$175 million.

Latest quarterly report
Excellon’s stock price was temporarily depressed following the latest earnings announcement where the bottom line number was a measly $216k, a big let-down form the $7+ million in the prior quarter. However, over $2 million was an accounting artifact due to the re-valuation of the silver debenture. In addition, there was some operation problems at the mill that reduced the amount of ore processed in the quarter. The company further stated that they encountered an unexpected mineralized zone while constructing an access ramp. Rather than letting the ore going to waste it was processed and resulted in a drop in the overall ore grade for the quarter. It seems one can’t avoid hitting something when digging in this place!

The technical picture
The weekly chart shows that Excellon has consolidated along the top rail of a large triangle that it broke out from at the end of 2006. The daily chart shows a “W” formation off the strong support at C$1.25-1.27. Short term momentum indicators are pointing up.

Conclusion
Much of this article was written prior to Wednesday, April 11 when the stock jumped over 9% following a new drilling announcement, although I would have to say the content of the announcement was very much expected if one actually paid attention to the map of the property and previous drilling results. I believe my analysis above still stands.

In summary, Excellon is a profitable, exploration company – a combination that is exceedingly rare. Naturally, the stock is leveraged to metal prices, but the real jackpot potential lies in the possibility of discovering a large CRD in the vicinity of its Platosa mine. According to my DCF model, current valuation is largely supported by the test mining activities alone; therefore, investors are getting a near “free ride” on Excellon’s exploration potential.

Disclosure: I own this stock. My “lottery ticket” analogy was meant to highlight the speculative nature of this stock: just like any lottery game, the jackpot may be huge, but payout is far from guaranteed.

Robert Kiyosaki: A Smart Investor

Making predictions is a tough business, but learn from this master of words, Robert Kiyosaki (RK), on making “accurate” predictions.

What does this guy think of the recent stock market right now?

When my book “Rich Dad’s Prophecy” was released in 2002, most financial newspapers and magazines trashed it because I discussed a looming stock market crash. Ironically, much of what I predicted in the book is coming true earlier than I expected.

In fact, you can almost use RK as a pretty good contrarian indicator. Back in March of 2006, when I read RK recommending buying gold/silver, I really got a chill. I knew very well that he is not part of the smart money. And when the dumb money of the mass people come in, a significant top could be established. I didn’t follow my intuition, but rather I held out hoping for the PI date to come.

Do you still remember what books were published in bookstore near 2000 stock market mania? It was ‘Dow 36000″ and the like. Well, RK published his bearish book in year 2002 (when stock market bottomed), and now he wants to take credit for his “prediction”??? Don’t you think that if he is such a smart investor, he should have been publishing “SPY 1500″ to help people buying stocks at the bottom rather than the other way around?

I really wonder how much gold/silver RK is buying. I stand by my words, and I disclose my stake (3/20/07) by sectors here again (temporarily not available on my networth page, but I hope to make it available again as soon as possible on a daily basis):
Metals 57.5%
Energy 34.6%
Misc. 7.9% (water, agriculture, consumer staples)
Silver/Metals = 26%
My portfolio above is 61.24% of my total net worth.

For someone who never tells you what he is buying, and then tells you what he “did” with 20/20 hindsight, I would not take such “advice”. If you can really make some real money by reading RK’s books, I would be really surprised. No dates or concrete methods for any investing advice. Most of the things that he talks about are hard to achieve, making you to believe that “yeah, that’s why I’m not rich”.

A prediction without a date or a timeframe is usually not very useful. At the minimum, I’m willing to be wrong and add some dates or timeframe for my own expectation about markets. I think rather than playing to be always “smart” like RK, it is more pragmatic for you as readers if I take the chance to be wrong, and be battered by all of your comments.

Since RK has come out and said it again, I presume that by following contrarian thinking, stock market this year may not fall as hard. Unfortunately, I think his “glow” is waning, so this contrarian indicator is probably not as good as before.

I do believe that what he describes in that prophecy book may come true with some chance, but most probably NOT this year. I have marked his own words in boldface. He said it’s coming true earlier than he expected, so the best interpretation is that the scenarios in his book should be unfolding right now. We will see whether he is right or I’m.

Teck Cominco: The Next Acquisition Target Among Base Metal Mining Companies

In Counter currents in the market, I postulated upon a bear capitulation based on the resilience of major indices and the Dow Transports making a new high (a Dow Theory confirmation signal). No such capitulation came. Instead, the market wondered aimlessly with compressed volatility for several sessions. Then came the sub-prime debacle at HSBC and New Century (brief summary). The stress in the sub-prime market was well known, even I mentioned it in Counter currents in the market, yet the market still seemed surprised by how bad the news was. So is the market really efficient? Something to ponder. Anyhow, even though I was shorting home builders and mortgage lenders on and off, I wasn’t positioned for this implosion. I suppose I had a little too much trust in the market.

It’s doubly interesting to note that the market was once again on the ropes today and was able to pull through on the back of an acquisition rumor of Dow member Alcoa by either BHP Billiton or Rio Tinto for $40B or a 33% premium based on Tuesday’s closing price. I can just see the bears pulling their hairs out as everything they’ve been saying about the housing sector are being vindicated and the market still merrily chugs along. For this reason, I’m still expecting a capitulation top. After that, we can start talking about a market correction of some depth.

I haven’t owned any base metal miners since last May. As can be expected, the whole sector got a lift from the AA rumor today. I took the opportunity to purchase some Teck Cominco (TCK) in part based on its nice looking technical setup. It closed at $74.23 during regular hours and clocked in at $75.80 in after hours trading. This is well above the 50 dma at $73.06 and the upper boundary of the triangle. Moreover, momentum indicators are all pointing up.

The AA buyout rumor is a continuation of a torrent of M&A activities in the base metal mining sector. Not too long ago, TCK tried inviting itself to the courtship dance between Inco, Falconbridge with Xstrata also butting in. Inco completed the merger with Falconbridge only to be gobbled up later by CRVD. TCK has a market cap of $16B as of Tuesday. Compared with BHP Billiton (BHP, $133.6B), Rio Tinto (RTP, $71B), CRVD (RIO, $84.5B), Freeport McMoRan (FCX, $11.1B to complete purchase of Phelps Dodge, $25.3B), and Xstrata (~$45B), its figure is decidedly slim in an industry where size is a prerequisite for survival. Will it finally don the pretty white dress? I keep my fingers crossed.

Zecco Part 2

I’ve got some good feed back on my review (Part 1, Part 2) of Zecco.com the online broker with free trades. I was pretty even handed: Zecco does offer free trades as promised and their order execution was reasonable; however, I experienced some problems with withholdings and wasn’t happy with how the reporting was handled. In the end, the withholding was recorded in the monthly statement and it was already forwarded to the IRS by Penson Financial (Zeccon’s clearing firm) by the time I had all my paper works in. This is a big motivation for me to file my taxes as soon as possible this year. I haven’t made further trades with Zecco although the account is still open. I’ll re-evaluate the situation after I get my tax refund.

In the meantime, Zecco has been making improvements as described below. They cannot come at a better time as the competition for “zero commission” is heating up.

Zecco now offers IRAs

This is a new offering from Zecco. Roth IRA, traditional IRA and rollover IRAs are now available. The same free trading applies to IRA accounts as well. I’m still trying to get a clarification as to whether one can own a taxable account as well as an IRA account and get free trading in both. There was a rule that one cannot own more than one account (e.g. individual + corporate) and get free trading in both.

There is a serious drawback though, in that Zecco is charging an annual fee of $30 for IRAs. While it is not a deterrent for frequent-traders, it will be a big put-off for those who are price conscious and plan to adopt an ETF based index strategy, especially since there are so many other online brokers that offer no fee IRAs.

Virtual Trailing Stop Orders

A virtual trailing stop order (VTSO), is a stop order that adjusts as the price of a security moves. What you do is you enter a stop price is placed at a set distance above or below the market price, depending on whether it is on a long or short position. And, the stop price then adjusts as the price of the stock moves, maintaining the set distance. The purpose of this order is to maintain a set level of potential loss at any point in time while allowing for continued appreciation as long as the price does not fall to the stop loss.

Say you’re long stock ABC which is currently trading at $100, you want to protect yourself from a decline in the stock price, i.e. either protect existing profit or limit potential loss. You could enter a stop order (A stop order is an order that becomes a market order once the stop price is reached. For long positions, it’s a sell order below the current price; for short positions, it’s a buy to cover order above the market.) at $95 which limits potential loss to $5 per share from current levels, any slippage notwithstanding. However, if ABC appreciates to $120 and you haven’t kept up with your stop, you’re now opening yourself to a potential $25 decline.

This is a concern for those who can’t monitor their stops constantly. Don’t worry, trailing stop orders come to the rescue. Zecco’s implementation is a fixed distance trailing stop. In the above example, you enter a VTSO at $5 (note, not $95! This was confusing giving their interface. See this tread at the Zecco forum). As the stock appreciates, the stop price is lifted, always at $5 below the high after the order was entered. In the above example, when the stock makes a new high at $120, the stop would be at $115. This way, you still benefit from appreciation in the stock, and your gains will never slip away more than the pre-determined amount.

Trailing stops are best after an extended move when you want to protect your profit. Using a tight stop during a period of consolidation may get you out of the stock prematurely only to see it taking off without you.

Some online brokerages such as TDAmeritrade implement trailing stops using a percentage off the high. There isn’t a big difference between the two. Granted more sophisticated implementations would also allow a limit order instead of a market order to be triggered, this is still a big improvement from Zecco and I applaud their effort.

The competition is heating up
As implied in the opening paragraphs, even “zero commission” is not immune to competition. Previously, I have mentioned Bank of America which offers 30 free trades/month (vs. Zecco’s 40 free trades/month) in a dozen states around the country. One catch is that you have to have $25k in deposit accounts with them. The drawback is that BoA imposes a $50 semiannual “brokerage account maintenance fee” for accounts under $50k, so the deal is not attractive to investors with low account balances.

The latest contender is Wells Fargo which is offering 100 free trades/yr when the equity in the brokerage account meets a minimum of $25k. There are no minimum deposit account requirements. What sets it further apart is that many no-load mutual funds are also eligible for commission free trades. Trades beyond the first 100 cost $5.95 each which is also reasonable. With this offer, Wells Fargo has leapt to the front of the pack among ultra-low commission brokers in my opinion.

One of the main concerns with Zecco is how unproven it is. Even though the accounts are FDIC insured, no one knows how long it would take FDIC to respond if a catastrophic event does happen. On the other hand, both Wells Fargo and BoA are 1st class institutions. I hope Zecco can respond to this challenge. Competition can only be good for us individual investors.

Now for some idle speculation completely unrelated to online brokerage comparisons. If you’re wondering why Wells Fargo suddenly became so generous, or whether HSBC can make any money by offering a 6% interest rate on their savings account, my over-active mind has a theory. It is well known that consumer deposits are among the cheapest financing channels for banks. Is it purely coincidence then, that Wells Fargo and HSBC Household Finance top the list of subprime lenders according to this website? While I’m not suggesting either is going out of business, or their account holders are in any danger (HSBC is something like the #3 bank in the world and Wells Fargo is the highest rated bank in the US), the timing does strike me as a little too coincidental. It is entirely possible that their subprime lending divisions are under pressure and they want some extra liquidity to ensure that nothing “unexpected” happens. Just food for thought.

Important Update: Precious Metal Market

As I have said in one of my previous posts, you should always heed the words from the smart people. One of the very smart people Boy Hoye that I follow has come out quite bullish on gold right at the end of the year 2006. I advise you to read his full article here.

Here is some excerpts from his article:

….This study concludes that the real price has set a cyclical bottom in anticipation of a lengthy new bull market. Within this, gold stocks should outperform the bullion price as the exploration sector becomes the equivalent of the junior tech stocks in the mid-1990s….

I contacted their firm once. Subscription to their reports will cost upward of some $1000, and if you are multi-millionaire or managing tens or hundreds of millions, they will charge more based on your portfolio size. It’s very very expensive, and they have all the right to keep their name as “Institutional Investors”. Truly suitable for big investors.

I’ve read ALL of their free articles on their site. Consider the latest article on gold as a great gift from them. If you have time, you should read all of those other articles too. They provide such great insights into investing. Their May 11, 2006 article called the top in gold/silver about 3 weeks in advance. It was an excellent piece of work. I wish I was reading the articles back then. Please note that I did mention that he does not seem to believe in the energy and commodity super-cycle. It makes me kind of wary, but no one can be right all the time nor forever.

So how to play in this gold market? Bob did say that exploration stocks are the way to go. But they are the MOST volatile and illiquid of all also. I have an article on how to invest in precious metals. In short, you could buy GDX which tracks HUI index or BGEIX which tracks XAU, or any other PM funds (not the one by Vanguard VGPMX which has sufficient amount of energy-related stuffs). I would also suggest UNWPX, but it seems to have higher cash than usual closing Sep 06. By the way, don’t be alarmed by the big drop of these precious metal mutual funds at the end of year 2006. In recent years, these PM funds have been paying close to 10% or more in short-term, long term capital gains, and/or dividends at the end of calendar year. Lots of actions going on obviously.

Please do your own due diligence before investing. Read a lot more from other websites before you do any investing. And don’t be greedy. Diversify. PM can swing by some 50+% from peak to bottom. You don’t want to get burned.

As for myself, I am always “conservative”. I won’t be scooping up much at all without some pullback, since I’ve got a handful of PM stocks already.

As of now, I move my neutral/slightly bearish outlook on gold to neutral/slightly bullish stance. I’m still a little worried about a potential top in stock coinciding with a short-term bottom in PM in the upcoming months.

Zecco Trading

Gathering from your questions after the first part of this review, there is a lot of interest in Zecco.com and their promise of zero commission trades. In the concluding portion of this review, I’ll describe my impressions about their order execution, answer some reader questions, as well as relay some difficulties I’ve been having.

Order execution
First of all, Zecco is true to the name. Both buy and sell orders, market or limit, are free. You do have to pay the usual SEC fees upon selling. At $30.70 per million it shouldn’t break anyone’s bank.

Zecco claims the industry standard of 30 seconds for order handling. It doesn’t offer level II quotes but through another online broker I was able to see my limit orders routed through the Pacific Stock Exchange (PACX) only seconds after they were entered. On one occasion, I modified an existing limit order and it took over a minute to appear. It’s probably faster to cancel existing orders and enter new ones rather than using the “modify” function if such things matter to you.

Zecco also offers stop market and stop limit orders, but not conditional orders. I give their order execution a 4.5/5.

Reader questions
TJP asked if they offer dividend reinvestment. My original answer was “no” which was incorrect. From their FAQ,

Does Zecco Trading allow account holders to automatically reinvest dividends for equities and exchange traded funds?
Yes, dividend reinvestment is a feature that is available to our clients and can be setup during the account opening process. If you would like to add this feature after the account opening process is complete, you must submit the request in writing to our customer service department.

However, you can’t buy fractional shares at this moment.

Taz asked if there is a fee associated with ACH transfer. The answer is no, but it may take up to three days for the money to go through. Taz also asked a question regarding the $2500 minimum account balance to get zero commissions. The account balance is defined as the sum of the market value of all the securities and the free cash balance. The minimum applies to the account balance, not the free cash balance, so it doesn’t keep the $2500 tied up.

Trouble with my account
I’ve received reader comments about how thrilled they are with Zecco. Not surprising given what I’ve said so far. However, I have been experiencing some serious problems in my account personally.

This is what happened. I opened the account primarily to test a momentum trading model with holding period of several days on average. Naturally, the promise of zero commission was extremely attractive. My first trade involved 50% of the capital and lasted 5 days with a 1.4% profit. Everything went smoothly and I was able to use the full amount right after exiting that position (customary in a margin account). My second trade deployed close to 100% of the capital which I exited 2-3 days later at an average profit of 1%. However, I noticed that my cash was locked up for 3 days (customary in a cash account). To my horror, I also noticed that my balance became much less than what it should have been.

For some reason my account was deemed “subject to IRS backup withholding” of 28%. The punch line was that it was 28% of sales, not of profits. So after two profitable trades that turned over nearly 150% of my capital, my account is down 150% x 28% ~ 40% from what it should be.

Apparently, this was caused by some missing paper work. It happed frequently enough that Zecco actually has a page about this, titled, no joke, “Where is my money?” There is also an active thread in their forum about this.

Here are my gripes,

  • I followed the instructions after the on-line application and mailed in the signed W-9 form. My missing form (not required for all applicants) was not mentioned in those instructions. I found out about the missing form after the withholding had already taken place by calling customer service. As a matter of fact, the customer service rep promised that someone would contact me regarding the form, but no one did and I got the form myself from their website.
  • My biggest gripe was that nowhere on the website was there any record of the withholding. It was as if the money simply evaporated. If you follow the forum link above, you will find the issue was first raised at the end of October. The president of Zecco actually responded to that thread so I’m sure management is aware of this. Elsewhere on their website they say they are working with Penson, their clearing firm, to resolve that issue. At any rate, they have known the problem for at least 6 weeks and nothing has been done. This is unforgivable because I can’t imagine a more pressing concern than proper accounting of the customers’ money.
  • I faxed as well as mailed in the hard copies of the required forms last Tuesday. On Thursday there was a power outage in the middle of my call with a service rep. On Friday, I was finally able to confirm that all the needed paper work would be in place after the hard copy arrives.
  • Through out this ordeal, my emails were never answered. It was quite tricky to reach a live operator, although I’m getting good at it.
  • On more than one occasion, the customer service rep had to put me on hold for several minutes while looking up my file which makes me question their information organization system.

The other problem I had with money market sweep was probably related. Currently, I’m earning only 1% on the free cash balance. One person from Zecco’s marketing department contacted me to offer help after reading my remarks in the comment section of the previous post. I declined since I wanted to have the perspective of a typical customer.

They did say on their website that if they don’t receive the proper paper work within 30 days, Penson will forward the withholding to IRS. For now, I can only hope that I get money back soon.

Conclusion
One reason I waited so long to finish my review was that I was simply livid about the missing funds. As they say, you shouldn’t go food shopping while hungry… Bad analogy but you get the picture. Had I written this a week ago the tone would have been very much different.

I decided to try Zecco in the first place because of their “anti-establishment” feel, and I still want them to succeed. But I have to face up to how unpolished they are now. So I’ll make the following limited recommendations. I think Zecco is good for:

  • Experienced online investors who use Zecco as an alternative account. This is somebody who knows exactly what she wants and who sets up everything right in one shot.
  • Novice investors who care a great deal about trading cost and who is content with the basic buy and sell operations.

If you do decide to open up an account at Zecco, do learn from my experience: send in all your forms!

The Commercial and Vix Fear Index

VIX Background

The Volatility Index (VIX) was created by the Chicago Board Options Exchange (CBOE) in 1993; according to the CBOE, the ‘VIX measures market expectation of near term volatility conveyed by index option prices of the S&P 500.

In 2004 VIX futures were made available for trading providing investors with a unique opportunity to speculate on volatility. In general a rising VIX index is correlated with a declining stock-market while a declining VIX index is correlated with a rising stock-market.

(In the chart above, the missing data is a result of the VIX not meeting CFTC’s reporting requirements)

Recent Activity

As the VIX made new lows in November, commercials were big buyers (green rectangle) while large & small traders were sellers in the marketplace; meanwhile the stock-market was at new yearly highs. In other words, investors were becoming very complacent as commercials were buyers of volatility at these low levels. Soon after, volatility returned into the market place as the VIX broke out and went on to rally around 2.5%. As the VIX broke out, the Dow Jones declined around 200 points in two days.

Over the last two weeks net-commercial position decreased by 1,044 contracts but remains elevated at a total net-long position of 2,895 contracts. Watch for this week’s COT report for more clues on future direction for the VIX and consequently the stock-market.

Broad Markets

Russell 2000 [ http://www.buythebottom.com/rut.html ]
Net-commercial position decreased by 828 contracts. This is starting to look like a repeat of the commercial setup before May’s meltdown. Simply put commercials are sellers and large traders are buyers. As soon as the yellow line (net-commercials) crosses below the white dashed-line I would then start to look for a top in the stock-market. From the chart it would be logical to expect this setup in the early part of 2007.

S&P 500 [ http://www.buythebottom.com/spx.html ]
Net-commercial position decreased slightly by 440 contracts.

NASDAQ 100 [ http://www.buythebottom.com/ndx.html ]
Net-commercial position increased once more, this time by 1,252 contracts. What I find very interesting is that large traders are also big buyers over the last few weeks, which means that small-traders are responsible for all of the selling. This is a bullish setup in contrast to the other indexes.

Dow Jones [ http://www.buythebottom.com/indu.html ]
Net-commercial position continues to hover around the -22,000 level, increasing marginally this week by 117 contracts.

I would not expect a top in the stock-market just yet, especially when you look at the Nasdaq-100 chart, but the tide is slowly turning as best seen in the Russell 2000 chart.

Commodities

Crude Oil [ http://www.buythebottom.com/wtic.html ]
Net-commercial position increased by 4,343 contracts. I should note that commercials were buyers as oil rallied from $59 to $63. Meanwhile large traders were also buyers in the market, which leaves the small-traders as the lone sellers. Overall crude is setup for a rally, so keep watch for reversals and breakout opportunities.

Gold [ http://www.buythebottom.com/gold.html ]
Net-commercial position decreased by 2,444 contracts. From the commercial perspective I do not see a meaningful rally before we see a correction/consolidation.

Currencies

US Dollar [ http://www.buythebottom.com/usd.html ]
Net-commercial position decreased by 3,292 contracts. This is a critical point for the US dollar index, if commercials continue selling after the recent breakdown; this will be a big negative for this market. Unless that happens, look for higher prices as the dollar is setup for a rally.