The Ugly Truth About the Gold Industry
by Michael Swanson
August 25/05
Dear Investor,
In 2002 I came to the conclusion that the opportunities to profit in the new gold bull were going to become a once in a lifetime opportunity that I had to take advantage of. I decided that I needed to make contacts with gold analysts, newsletter writers, and management teams. I wanted to know what makes the gold community tick so that I could build off of their advice and get access to the private market place.
I started to travel to industry shows across the country. Most of them were organized in the same fashion. They rented out a conference center and divided up in two sections. First there are speaker panels and smaller workshops where you can get one on one attention and secondly there is almost always an exhibition hall with booths.
These booths were made up of brokers, trading software, small cap companies trying to attract investor interest. There were about a dozen of these, all but one of which were gold companies. Despite the dozen or so major gold conferences a year, in reality the gold community is small.
When I first started attending these conferences, very little money was actually flowing into gold companies, even though the stocks were going higher. The simple fact of the matter is that gold and the gold stocks are only a small segment of the financial world. At the start of 2001 the combined market cap for all publicly traded gold stocks was less than the market cap of Disney. As I write this Wall Street is still shunning them. Mainstream investors and CNBC talking heads have not accepted the fact that gold is in a bull market. They still think that the gold rally will fail and are afraid to commit money. This is why the small gold companies still use private investors for financing and depend on newsletters and investment conferences for exposure.
On one hand this is a good thing. You can make contacts with the leaders of the gold industry and most gold companies are very compliant with individual investors. This is a virtual impossibility right now in sectors such as technology. You would have a difficult time trying to meet Bill Gates or Larry Ellison at an investment conference, but you can meet Ian Telfer, the CEO of GoldCorp, a company with a market cap of over 3 billion, at a gold conference.
On the other hand, many tiny gold companies are nothing but pieces of paper and their reliance on small newsletter writers for exposure is a sign of their lack of investment merit. In fact many of them border on being outright frauds. When I started to go to investment conferences that featured gold companies, I made it a point to have private conversations with the gold CEO's to get a better feel for the industry. I spent one night with one of them on a $3 1/2 million dollar yacht watching football and drinking beer. Loose lips are more revealing.
I have never had a position in this man's company and don't now. I took
a liking to this guy and he seemed straight to me. Of course he believed
that gold will go up, but warned me that 80% of the small cap exploration
companies are "fake.". He had a 15-year background in the industry
and knew most of the key players. I asked him who can the small investors
rely on? The analysts don't follow the stocks so all you have are newsletter
writers. He laughed and said that most of them are bought off with stock.
He told me of one or two that were good, but then added, "you need
to understand that they need to make a living."
He went on to tell me that when it comes to exploration companies it is
all about promotion. His words made comments that I heard from another
CEO of a small exploration company earlier that day bounce in my head.
During a conversation with this man he made a side remark to the effect
that gold companies are the best companies to run, because the balance
sheet doesn't matter. Earnings don't matter. People don't know how to
value your properties and it is all about its unknown potential and the
"psychology" of gold.
The last time I heard CEO's say that their earnings didn't matter was during the Internet mania. Those stocks flew and crashed to nothing. When the gold bull is over most of small cap gold stocks will go back to nothing too. However, they are still in the 1st quarter of their bull run and just like Internets you will eventually see bunches of new companies appear out of nowhere and have their moment in the sun.
I got the impression from both men that stock promotion is central to the junior and gold exploration stocks. The man on the yacht point blank told me that it is not the shares of companies with good resources that go up the most, but the ones with the heaviest promotion that does. The way he put it if you have good properties and no promotion the stock will lag, but if you have crap properties and heavy promotion it will fly as gold goes higher. And if you have both then you have a rocket.
The easiest way for people to promote a gold stock is to get newsletter writers involved, especially those that specialize in the gold market. They are the people who can directly reach potential investors. Promoters get them involved by allowing them to buy stock at steep discounts on the private market, paying them money, or by simply giving them shares.
One of the most popular ways to promote a stock is to send out mass mail flyers to investors. These fliers almost always will feature a newsletter writer, who supposedly has earned his subscribers unbelievable profits, and a write up for the company that is should go up 1000% or even more. That write up is the real purpose of the mailing. The newsletter writer is just there to give it credibility.
The problem is that more often than not the investor who buys on these mailings is buying in near a top. The promoter, the newsletter writer, and everyone else involved in pumping the stock already got in way before the flier is sent out. After the last sucker gets in the stocks always go back down. With no earnings or real prospects they have nowhere else to go.
For the record I do not engage in any of these promotional activities. I am not paid to promote stocks. In the gold industry, it is rare to find a newsletter writer who isn't involved in this sort of activity. I've even heard of one writer calling the gold companies himself and asking them how much they will pay him to write up their stock! Luckily there are ways that you can determine whether or not a newsletter writer is doing real analysis or is just giving you a sales pitch. And there are indeed a few top-notch analysts out there.
There is a simple way to separate the wheat from the chaff. Anyone who recommends a stock must put a disclosure with their recommendation if they already own shares or were given stock or paid cash by the company or a third-party. Read the writer's disclaimer very carefully to see this disclosure. If they simply own shares that they bought that is one thing, but if they are being compensated to promote the stock be very wary of what you are reading. It is not an unbiased piece of research.
As time goes on I expect these conflicts of interest to become a big issue. Investor awareness will increase. I just hope that it won't take a scandal for it to start. For now you must carefully choose which newsletters that you follow and make sure they are being written by real independent analysts and aren't just tout sheets.
I learned from talking to these CEO's that I needed to be careful in what I invest in. I needed to learn for myself what is the best way to evaluate a gold company. I put lots of my own money into work in the market and I want to buy the best stocks, not just ones that are going up because everything else is, or because they are being promoted. If you are going to buy into a basket of gold stocks you should just buy the best ones.
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Sincerely,
Michael Swanson,
WallStreetWindow.com
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