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The most common of all investing/speculating errors

Trying to get rich quick is probably the most common and the most costly of the errors made by speculators. It is certainly the most important mistake we made early in our speculating career, pushing us back to "square one" a few times before we finally woke up. It encompasses the following:

a) Allocating a large portion of the overall portfolio to high-risk situations, such as options and early-stage resource stocks. Based on our experience and observations, the less capital someone has the more likely they are to take big risks in order to quickly grow their capital. However, such an approach actually has a high probability of slowing, or putting into reverse, the capital accumulation process.

b) Short-term trading. Only a tiny percentage of short-term traders end up doing well over the long-term, one reason being that at least 95% of the population is psychologically ill-suited to it. Another reason is that short-term trading is a zero-sum game in which a small number of players -- for example, the members of Goldman Sach's proprietary trading team -- have huge advantages in terms of information, technology and ability.

c) Over-trading. There is a strong temptation to be constantly 'in there' doing something to make money, but there will be many times when it will be best to do nothing.

Over-trading leads to money being put at risk in trades where the odds of success are unacceptably low, and is often associated with the mistake of watching prices too closely. If you have done the appropriate amount of planning/preparation then there should be no need to watch the intra-day price fluctuations.

d) Risking an excessive (relative to overall portfolio size) amount on a single stock or a single short-term market forecast.

e) Not maintaining an adequate cash reserve. To be in a position to take advantage of the unexpected opportunities that crop-up and in recognition of the fact that the future is always uncertain, a substantial cash reserve should be maintained at all times. For example, the 2008 crash created one of the best buying opportunities ever in the gold mining sector, but the only people who could take advantage of it were the ones who had plenty of cash in reserve.

f) Not taking money off the table during periods of extreme strength in the market for fear of missing out on additional gains.

g) Fixating on the upside potential and largely ignoring what could go wrong.

h) Buying stocks on margin. As soon as you begin using margin debt you become a 'weak hand', that is, you become someone who will likely be forced to sell at a time when they should probably be doing some buying.

i) 'Doubling up' in an effort to recoup earlier losses.

The Stock Market

One interpretation of the S&P500's price action is that it is tracing out a bearish "rising wedge" pattern. Rising wedges aren't inherently bearish; rather, they are only confirmed as being bearish if the price subsequently breaks below the bottom of the wedge. At this time a break below the bottom of the wedge would require a solid daily close below 1100.

Even if the bearish "rising wedge" interpretation is correct there could still be another 1-2 weeks of upward drift before a meaningful decline gets underway.

We continue to think that there is substantial downside risk in the industrial-metal mining sector of the stock market. We have regularly used FCX (the world's largest listed copper producer) as a proxy for this sector, but for a change we will now look at charts of the world's two largest diversified mining companies: BHP and VALE.

BHP trended higher from March-2009 through to April-2010 within the confines of a well-defined channel. It broke out of its channel to the downside in late April and plunged to a short-term bottom in late May. Our interpretation is that the late-May bottom marked the end of the first downward leg in an intermediate-term decline, giving way to a counter-trend rebound. We expect that this rebound will be followed by another downward leg to a new 52-week low.

Like BHP, VALE has been rebounding since reaching a short-term bottom in late May. It has very clear support at $24, the breaching of which would create a measured objective of $14. In other words, the chart suggests that VALE has downside risk of around 50%.

Lastly, let's take a look at the status of Hong Kong's Hang Seng Index (HSI). The HSI peaked back in November, meaning that there was a 5-month period when the HSI diverged bearishly from the US stock market (the US market didn't peak until April). The jury is still out, though, as to whether the HSI's decline since its November peak is a routine consolidation within a bull market or the start of something far more bearish. We suspect the latter based on fundamentals and long-term cycles, but the chart could reasonably be interpreted either way.

Gold and the Dollar

Gold

The rebound in the gold market that began on Wednesday 28th July persisted through to this Wednesday. It could test resistance at $1220-$1230 before it is over, but we doubt that it will do significantly better than that.

An October-November correction low remains the most likely outcome.

Gold Stocks

The Minyanville article posted HERE has a couple of interesting charts. We are referring to the long-term chart of the BGMI/S&P500 ratio, which shows that the gold sector is still in the bottom quartile of its historical range relative to the broad stock market, and the chart of gold-related investments as a percentage of global assets, which shows that the combination of gold and gold mining was often more than 20% of global assets during 1920-1981 and is now only 0.8%.

In our discussions of the gold sector's short-term price action we generally include a chart of the HUI, but today we are including a daily chart of the XAU (see below). This is because the XAU's chart pattern is a little more clear-cut. In particular, the XAU's downward spikes in mid July and mid May ended at roughly the same place, thus creating a distinct level of support in the low-160s. Also, both of the XAU's prior rebounds over the past month ended at the 50-day moving average, and its current rebound reached the 50-day moving average on Wednesday. The current rebound could therefore be almost complete.

Currency Market Update

Early this week an oil analyst commented that oil supply/demand fundamentals didn't seem to matter anymore because the oil market was simply following the stock market. His conclusion was that to figure out the oil market you now had to be a stock market analyst rather than an oil analyst.

Something similar could be said of the currency market, because what happens in the currency market these days is mostly a function of what happens in the stock market. If the stock market is trending upward then the Dollar Index will almost certainly be trending downward, and if the stock market is trending downward then the Dollar Index will almost certainly be trending upward.

The Dollar Index touched its 200-day moving average on Tuesday and Wednesday of this week. It is probably at or very close to a correction low, assuming, of course, that the stock market is at or very close to a correction high.

And now for something a little different. The ECB's definitions of money-supply aggregates are different to those of the Fed, meaning, for example, that euro M1 has a different composition to US M1. According to Mike Pollaro, an authority on money supply, the ECB's method of calculating M1 is very similar to the way we calculate TMS. In other words, we can use euro M1 to represent euro TMS.

Based on the assumption that the M1 figures published by the ECB are equivalent to TMS figures, we created the following chart of the euroTMS/US$TMS ratio. The line on this chart rises when the total supply of euros increases relative to the total supply of US dollars. In other words, a rising line on the chart indicates that the money-supply backdrop is becoming bullish for the US$.

When we compared the TMS ratio chart with a chart showing the euro/US$ exchange rate we found that there wasn't a consistent lead-lag relationship, which is actually not surprising given that the time from a change in money supply to a related change in the general price level can vary widely. However, it is possible to explain the major trends in euro/US$ by referring to preceding major trends in the money-supply ratio. For example, the rise in euro supply relative to US$ supply from 1993 through to 2000 helps explain the 1995-2001 downward trend in the euro; the 2000-2004 decline in euro supply relative to US$ supply helps explain the 2002-2007 rise in the euro; and the 2004-2007 rise in euro supply relative to US$ supply helps explain the 2008-2010 strength in the US$.

The most recent turning point occurred at the end of 2007, with euro supply beginning to taper-off relative to US$ supply at that time.

The only conclusion we can draw is that if the money supply trend hasn't already started to exert significant upward pressure on the euro, it should begin to do so by early next year. As far as the next few months are concerned, we expect that the stock market's performance will dominate long-term money-supply considerations.

Kinross Gold (NYSE: KGC, TSX: K). Recent price: US$15.72

Kinross, a >2M-ounce/year gold producer, is not a TSI stock selection, but we keep an eye on the stock because the C-Series Kinross warrants are in the TSI List. The warrants are interesting because they are a leveraged play on a stock that should do well if the gold price does what we expect over the next three years (the warrants don't expire until September-2013). However, if we were going to directly invest in a senior gold stock it wouldn't be Kinross. The reason is that the company's management appears to be focused on growth at any cost and in any location. Consequently, they have overpaid for assets, and with this week's news that they have agreed to purchase mid-tier producer Red Back Mining at a very high price they now have a hotchpotch of projects spanning South America, North America, Russia and West Africa.

Apart from the high price being paid, what interests us most about the news that Kinross has agreed to buy Red Back is that part of the payment to Red Back shareholders will be in the form of a new series of Kinross warrants. These new warrants will have 4 years of time and an exercise price of US$21.30, which means they will have a year more time and be a lot closer to the money than the C-Series warrants.

Depending on the price at which the new warrants trade relative to the price of Kinross shares, we could be very interested in owning them. Assuming shareholders of Kinross and Red Back approve the takeover, the new warrants will probably start trading during the second half of September or the first half of October.

The following weekly chart shows KGC's progress over the past decade. Everything that has happened since early 2008 is probably part of a large bullish basing pattern, but at this stage there is no telling how long the basing pattern will take to complete. A weekly close above US$20 would be a clear sign that the basing period had ended and that a new major up-leg had begun.

Chesapeake Gold (TSXV: CKG). Shares: 38M issued, 45M fully diluted. Recent price: C$7.10

All stocks eventually work their way back to their respective 200-day moving averages, so when a stock moves a long way above or a long way below its 200-day moving average the stage has been set for either a substantial move in the opposite direction or a lengthy sideways consolidation.

CKG, an exploration-stage gold miner with a massive (24M-oz) gold deposit in Mexico, moved way above its 200-day moving average during the first quarter of this year. Despite subsequently announcing positive results for the Feasibility Study at its flagship project, the stock has since been drifting downward. As illustrated by the following chart, this downward drift has just brought CKG back to the vicinity of its 200-day moving average.

Does this mean that the correction is over?

No. The correction could be over, but it is also possible that the stock will eventually work its way down to intermediate-term support at C$6.00. What we know is that CKG has a huge amount of upside potential courtesy of the low (US$13/oz) valuation currently being assigned by the stock market to its in-ground gold resource, and that the correction has completely eliminated the 'overbought' condition.

Gold bulls who don't mind illiquid exploration-stage mining stocks should consider scaling into CKG over the next three months.