Money Flow- Road Map to Profits.

By Neil Charnock
www.goldoz.com.au
info@goldoz.com.au



In my last article I touched briefly on giant capital flows and how investors, who establish where the money flow is going, or has been going, will be the ones who reap the greatest rewards during 2007. Oceans of liquidity looking for a safe / and or profitable destination.

How do we differentiate between smart money and other money flows? After all there are two sides to each transaction. The more obvious answer is that selling pressure or buying pressure will move the market in the direction of least resistance and this is certainly true. I am examining something else though, a more subtle underlying force related to the smart money flow.

Money that flows into a top formation by following bullish sentiment and momentum had better be short-term investment capital or it is certainly less smart money. It feels right to invest at such times however and this is how many investors get trapped. Long top formations form due to selling pressure from the smart money flows from the bigger players and the behavior is quite different. Rallies get capped time after time, divergences begin to repeat between price and various technical indictors, press is favorable, strong prices engender misplaced confidence. Smart money flows out of the sector or market during such times, covertly at first when the highs are reached and then in ever accelerating volumes. The final rush for the exits causes the eventual change of trend as buyers are overwhelmed.

Conversely money that flows into a bottom formation when sentiment is poor indicates the opposite. One can observe buying support in the face of “unloved status”, often accompanied by poor press coverage or better still none at all.

Big money, and I mean really big money players must surely take years to exit markets without crashing them, also long periods to accumulate market share in a sector. There is an old observation that 95% of investors own 5% of the shares and 5% own 95% of the market. Large superannuation funds do not count as large players in this instance because they still represent a large volume of individual investors.

I admire the investing logic of the big money crowd and surely they buy during bottoms across base formations and in the early phases (and corrections) of bull markets too. On the way down as the bear rallies near completion one can observe large bids, patiently soaking up stock at ever lower prices, base formation or equilibrium then materializes as selling fear turns to apathy and holders in losing positions decide to hold anyway as the damage is done. Buying supports reduced (exhausted) selling supply and volume drops.

The price then bumps along a base formation at a higher level (new higher price plateau) until all the apathy washes out as holders of depressed parcels finally decide the sector will never recover and finally sell. (The last few months has been such a time and yet we have seen choppy trading conditions where technical indicators like the Stochastic Oscillators have pointed to entry and exit points for short term traders.) As the base nears completion buying accelerates causing prices to rise which brings on “relief selling” by long term holders who were in at a loss and only too keen to offload into any improvement because they have not perceived that the trend is changing. Corrections in the early phases of a bull run merely increase market share of the big end of town.

Finally the time for a new rally approaches and the smart money flows accelerate their market share building programs which can be observed in RSI indicators but not yet price. Technical analysts start to move in but no momentum traders as yet, this comes later.

There comes a time when a secular trend (long term) is ready to take on wider investor participation and this is accompanied by increased press coverage. It would seem this has now arrived at least in the US from what I am reading. Do not get too carried away by pure contrarian “counter press” positioning at such times… positive press coverage is not always a negative indicator pointing to a top. In fact the current positive press after a period of selling, correction and higher plateau building in gold and silver these past months is a good sign. I see some classic tell tale signs of a new phase in gold and silver markets. Greater capital flows will ignite the next rally after this soaking up exercise by smart money is complete. Massive capital flows will accelerate and attract momentum players and bring back the gold investor communities that have lost faith in their own instincts. Many new players will be drawn into this rally as prices near record highs and press begins to hype up the rally with excited coverage.

We entered phase two of the precious metals bull when the prices started to move in all currencies, this happened in H2 2005. We saw an massive up-leg in gold and silver begin when this happened. Wider investor participation pushed the biggest leg of this precious metals bull to date. The correction we have witnessed since $730 gold was savage but the price did not retrace below the 300 day moving average, instead we saw consolidation at a higher level and this was caused by buying support. I strongly believe this was “market share” or serious portfolio building time for large investors, massive capital flows that patiently soaked up nervous short-term capital.

Even many of the major supporters of the gold and silver bull to date off loaded their stock because it was losing value. During the first weeks of 2007 this trend has accelerated and been pushed along by negative sector sentiment on copper and even gold and silver. Hey… if even the “gold bugs” / the gold favoring investment community were selling… who bought all that stock? This is where some of the smart money flow has been headed during the last three weeks and over the last several months.

Good news is that it is easier to buy back in when your capital is smaller and therefore more mobile, less cumbersome. Smaller investors, up to even tens of millions can get back into larger companies quickly without moving price dramatically. Not so with smaller stocks that will do better in the coming up-leg than they did in the first stage of the Gold Bull. The early out-performance of smaller precious metal stocks across global markets lately has indicated positioning for market share. We have seen this in the leading junior PM stocks in Australia lately. These smaller stocks have not acted this way during the Bull to date where we have seen large stocks leading the smaller ones at the beginning of rallies. This is a very interesting development.

The bull is not over and the late start to the rally this year does not mean a 2007 rally will not happen either. Let’s be clear here, prices moved in all currencies, start of phase two. Institutional participation and now press coverage after a long correction (not at a top) signals an exciting continuation of the gold and silver bull markets.


Global supply:


Now let us consider global supply while we look at market share in this sector. How many low sovereign risk mining centers are there? How big is the global gold equities market to start with? I have not done the math but I have read that all gold and silver companies combined do not add up to the market capitalization of Google or Microsoft.

If the gold market is so small and actual bullion supply so limited in gold and silver then it follows that as larger capital flows are attracted the upward movement will be greater. Make no mistake, when this second phase gets going (I believe this will be fairly soon) the updraft will make a whoosh sound as capital enters expands. There are not enough PM securities or supply of bullion on Earth to satisfy potential demand. Multi currency metal price appreciation and multi continent investment participation will cause sharply higher equity prices in stable mining centers such as Canada, the USA and Australia in particular.

Because the beginning phase of the gold bull occurred in North America, mainly due to loss of value of the USD, we have already seen a wider price appreciation is the resource sectors on those exchanges. The greatest leverage and profits will occur from the lowest bases, that is how the mathematics of investing works. This makes Australian mining shares more interesting than ever at this time; do not underestimate the importance of the low sovereign risk Australian continent in this coming phase. Buying will be forced to flow into the ASX due to the limited nature of global supply as compared to the coming global demand.

I have been saying for the last few months that commodities were not finished, many have held up very nicely thank you. I have commented that copper is not dead, it is good for a rebound and the current price correction is nearing completion so I have begun to invest in some of our more interesting and deeply sold copper plays. I bought in a little early on one such stock so I have been selling smaller rallies and buying the dips (10-15% moves) to lower my buy price average while I increase my personal market share. This practice is not for the feint hearted or ill informed; I have done my homework carefully. I just took an initial position in an oil stock that has been hammered down by 50% this last year and is now almost completing its base formation complete with a significant series of divergences. I may be a little early however I have bought very close to the bottom of the base so down side risk is limited, upside price potential is exceptional.

Because commodities and the commodity sector are gaining more and more value there is increased risk from unstable mining centers, confiscation and disruption will only increase. This is a trend not a “flash in the pan”, poorer Governments want a slice of the action and this gains popularity as prices rise. DO not ignore sovereign risk, it will become more important as the current covert resource war continues, supply shocks will contribute to price spikes.

A last factor to consider is the behavior of the real mining business as opposed to the share market and commodity exchanges. There is the business of mining and this has been going along nicely with greater levels of capital raising, investment, exploration and development activity in Australia. The global producers are having trouble replacing reserves so take over activity is high. Companies are reluctant to open new hedges so forward selling is capped, this is further restricting supply. Does this sound like an end to a market run?

Then, related to this point, there is the share market that deals in shares in these companies being exchanged on a daily basis. Many investors do not understand that shares are undated derivatives, a secondary market to company activities and the business of mining. Hence share behavior does not always match actual business activity in market sectors providing opportunity for those investors who do understand the bigger picture.

In Australia we have several very sound producers with low P:E ratios, excellent management, excellent tenements and projects. One company of note is increasing copper production x 8 and zinc production by x 3, it is currently cheap considering the project pipeline and recent correction. It has upside from gold assets and nickel exposure too.

International investors may contact us about buying ASX stocks as we can provide links to a selection of resource savvy brokers and the exchange here in Australia if you need help. Best trading results are achieved with wider education so widen your knowledge as much as you can. I will be away on business most of this week but back on Wednesday to handle replies for Kitco readers. Everything back to normal next week, thank you for your understanding.


Good trading / investing.
Regards,
Neil Charnock



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Neil Charnock is not a registered investment advisor. He is a private investor who, in addition to his essay publication offerings, has now assembled a highly experienced panel to assist in the presentation of various research information services. The opinions and statements made in the above publication are the result of extensive research and are believed to be accurate and from reliable sources. The contents are my current opinion only, further more conditions may cause my opinions to change without notice. The insights herein published are made solely for international and educational purposes. The contents in this publication are not to be construed as solicitation or recommendation to be used for formulation of investment decisions in any type of market whatsoever. WARNING share market investment or speculation is a high risk activity. Investors enter such activity at their own risk and must conduct their own due diligence to research and verify all aspects of any investment decision, if necessary seeking competent professional assistance.