Getting to the Bottom of Gold's Gyrations

The crazy ride for stocks – and gold... Getting to the bottom of gold's gyrations... The short and long versions... What's different between London and New York?... COVID-19 throws off the supply chain... Why gold's 'official price' is much lower than what you'll pay... Access the first 'Extreme Value 30' recommendation...

What a wild ride...

First, stocks descended into bear market territory faster than ever before. Then, last week, the Dow Jones Industrial Average surged 21% in just three trading days...

By some definitions, that killed the 11-day-old bear market in its tracks and started a new bull market (20% climb off its bottom). But are you ready to go "all in" on stocks again?

With everything going on right now, it certainly doesn't feel like a new bull market yet. And it isn't just stocks. You've probably noticed that gold prices have been crazy lately, too...

Gold started the year at just more than $1,500 per ounce. Then, the precious metal peaked at about $1,675 per ounce in late February. And it hit that mark again in early March.

Next, gold crashed all the way down to $1,477 per ounce on March 18... soared back up to around $1,660 per ounce on March 24... and now trades at more than $1,600 per ounce.

Phew, what a whirlwind. You can see what I'm talking about in the following chart...

Extreme Value subscribers and Stansberry Investor Hour listeners e-mailed me (Dan Ferris) to ask why gold was gyrating so wildly. So I made a few phone calls and e-mailed a few of my closest contacts in the business of buying and selling physical gold and silver.

And today, I'll explain what I found out in those conversations...

We'll talk about how the gold market works and why it has been so crazy. And at the end of today's Digest, I'll also tell you a little bit about some stocks I'm really excited about now.

The short version of the situation in the gold market is... the coronavirus broke it. Like many other industries, the folks who make all the gold bars and coins have been hit hard.

The long version is a bit more complicated...

First, you must understand two of the most important gold markets in the world...

One is the London market, where physical bars of gold are traded. For the most part, this market is where large institutions buy 400-ounce "good delivery" bars of gold.

It's where the so-called "London fix" gold price comes from. The London Bullion Market Association ("LBMA") and its member banks agree on a price based on buying and selling. The LBMA sets the London fix gold price twice per day – in the morning and in the evening.

The other important market is COMEX, which operates out of New York City...

COMEX is the primary futures and options market for trading metals such as gold. According to its parent company, CME Group (CME), investors use COMEX gold futures to trade the equivalent of nearly 27 million ounces of the metal per day.

COMEX gold futures trade in 100-ounce contracts. But the majority of COMEX gold futures contracts are settled in cash, with no physical gold actually changing hands. Gold must be located in a COMEX warehouse to be eligible for the settlement of the futures contracts.

Investors and institutions of all sizes and types trade the COMEX gold futures. And they do it for a variety of reasons, too... For example, I e-mailed the CEO of a company that sells large amounts of physical gold to its clients in different forms (coins and bars of all types). He said the company sells short gold futures to hedge its existing inventory of physical gold.

Most times, the gold prices in the U.S.-based futures market and London-based physical gold market are close...

It's typical for the most current COMEX futures contract to trade at roughly the same amount as the London fix price for physical gold. So if futures traders need more of the metal from London to settle contracts in New York, it's easy to buy it at the London fix price, put it on a jet, fly it across the ocean, and take it for storage in a COMEX warehouse.

But last week, the relationship broke down...

At one point, I watched on my computer screen as the COMEX futures price traded for $52 per ounce higher than the London fix price. According to reports, the gap stretched to as much as $70 per ounce on March 24. That's a 4% premium over the London fix price.

So why did all these things happen? Why did gold crash with the stock market and then recover in a dramatic fashion? Isn't it supposed to be a "safe haven" that rises in value during a crisis? And why were the London fix and U.S.-based futures prices so different?

What the heck is going on with gold?

In a panic like the one we saw last month, investors sell everything – including gold...

As they sold, prices fell. And if they were using leverage, they received "margin calls." (A margin call means your broker demands that you put more money into your account or sell some assets when your securities decrease in value.) Some folks didn't even get margin calls... Their brokers just sold their positions to raise the cash levels in their accounts.

This week, I learned that many investment firms had been buying gold with maximum leverage – some as high as 33-to-1. That means they borrowed $33 for every $1 of capital they held.

That might sound familiar to longtime readers... Megabanks like Lehman Brothers had similar levels of leverage during the housing boom that preceded the 2008 financial crisis.

That's why the gold situation played out the way it did...

The price of gold initially climbed at the first signs of trouble in the stock market. Investors were treating it as a true safe-haven asset, buying it as the storm clouds approached. But then, its price plunged hard as leveraged commodity traders were forced to liquidate their positions to their meet margin calls (or simply had their positions sold out by their brokers).

And at the same time, the coronavirus (COVID-19) was throwing the supply chain into turmoil...

Fears about spreading the coronavirus led to mass shutdowns around the world – including many gold mines and refineries. Some Swiss refineries closed down completely due to their proximity to northern Italy, one of the hardest-hit regions of the COVID-19 pandemic.

Remember, as I said earlier, the London physical gold market trades in 400-ounce bars... not the COMEX-eligible 100-ounce bars. So normally, for London gold to be used to settle a COMEX contract, it must be sent to a refinery and recast into four 100-ounce bars. (With the recent chaos, COMEX made it possible to settle futures contracts with 400-ounce bars.)

Metals refineries that didn't completely shut down experienced another problem...

Smaller types of gold coins and bars are more labor intensive and require more workers to make. So it's nearly impossible to follow "social distancing" to stop the spread of COVID-19.

Even if a refinery is still open today, to keep workers safe, it's likely that it isn't making the smaller coins and bars that most investors demand. I recently learned that the Royal Canadian Mint – one of the most famous mints in the world – isn't even making 100-ounce bars as it keeps operating with a reduced staff. It's only making 400-ounce bars right now.

Another problem is reduced commercial air traffic...

A lot of gold is shipped as cargo on commercial passenger flights. Fewer passenger flights means less gold can move. And you can't just load an empty plane with tons of gold. No insurance company would take on the risk of such a large shipment of that type of cargo.

Because of these supply issues, soon after gold crashed all the way down to about $1,475 per ounce in mid-March, it quickly soared back up to more than $1,600 per ounce. The market began pricing in shortages caused by refinery shutdowns and transportation issues.

Meanwhile, demand for physical gold and silver is soaring...

That's what a large institution that buys physical gold and silver for its clients told me this week. And I've heard from more than one company that they're having some of the best days and weeks of sales in their histories.

However, these record sales aren't coming without hiccups. An executive of one metals company said it's not easy to buy physical gold and silver for his big client base right now...

His traders will call one bank that sells the metals one day, and the bank might say, "Sorry, we can't even give you a quote because we can't get any metal to sell you today." Then, they'll call another bank, which says, "We have metal to sell you... but you're gonna have to pay a big premium over the quoted price." And if you call both banks the next day, they'll tell you the opposite story... as if the limited gold supply were simply playing musical chairs.

Individual gold buyers have told me the same thing. And I've experienced it myself, too...

If you can even find physical gold or silver to buy, you'll have to pay quite a bit more than the quoted price per ounce. One colleague told me this week that he saw silver coins on sale at 100% premiums over the spot price (currently about $14.50 per ounce).

And as I explained recently, I went to a coin shop a couple weeks ago. It didn't have South African Krugerrands or gold American Eagle coins, my two favorite options. I did order some Canadian Gold Maple Leaf coins... The shop charged me an extra $95 per ounce and told me to come back in eight weeks to pick them up. I got in at the last minute... On March 20, the Royal Canadian Mint stopped making its Gold and Silver Maple Leaf coins for two weeks.

You can buy real gold today, but you'll need to pay a premium for it...

For example, search for "gold bullion coins" on online marketplace eBay (EBAY). You'll find one-ounce American Eagle coins selling for roughly $1,800. Go to your local coin shop... Whatever physical coins they can get will cost you much more than the quoted price of gold.

Yet the London fix price – the so-called benchmark gold price – is around $1,600 per ounce today. Why is the official price so much less than what you'll actually pay for the coins?

Remember what I said earlier about refineries and social-distancing measures...

The London fix price is based on 400-ounce bars. Because making these bars doesn't require as many workers standing close to each other as it does to make smaller bars and coins, the refineries continue making them... As a result, there's no uncertainty or shortage of 400-ounce bars in London. They're not hard to find, so they don't trade at a premium.

But here's the thing... most individual investors trade in much smaller denominations.

The big premiums on smaller bars and coins reflect the current supply shortage... plus the uncertainty of when refineries can start making those more labor-intensive products again.

When will this situation clear up?

You tell me, amigo.

It likely depends on when the refineries can reopen at full capacity. And of course, that likely depends on humanity's progress in its fight against the COVID-19 pandemic. A deadly virus is a formidable opponent... But humanity has fought them before, and we're still here.

So we'll get there one day. I can't tell you when, but things will return to normal eventually.

And believe it or not, it's not all doom and gloom in the commodity markets...

For years, I've been telling Extreme Value subscribers that the best way to invest in the mining space is to own its lowest-risk parts – prospect generators and royalty companies.

Prospect generators deploy small amounts of capital to stake out mineral prospects. They deploy many small investments over a large portfolio of these prospects. And in order to strike it rich, all they need is for one of these prospects to pay off... I saw one company make more than $200 million on an investment of less than $1 million.

Royalties are great, too. They allow the royalty owner to take a share of the revenue off the top of a producing mine, without any liability for operating expenses or capital expenditures. After the initial investment, they just collect checks... sometimes for several decades.

If you know where to look, it's a pretty exciting time for some of the better-quality mining and commodity companies...

In Extreme Value, I recommended what I believe is the single-best combination prospect generator and royalty company in the world. I spoke with the company's founder and CEO this week, and I wasn't shocked when he said, "It's pretty much business as usual for us."

That's because most of the mines under his company's royalty interests are deemed "essential services" in their jurisdictions. So they won't be shut down by the coronavirus.

Of course, his company's share price has been hit just like every other company's share price these days. But the major difference is that his shareholders won't hear about debt troubles or permanent asset impairments. Instead, in the coming months, they'll hear about how the company's revenues are still strong and the balance sheet is still in great shape.

It's one of the best managed companies on Earth. I've always thought every Stansberry Research subscriber should own at least a few shares of this company and never sell them. And best of all, this stock has never been cheaper and more attractive than it is today.

Another mining industry executive told me this week that his company is firing on all cylinders, despite the pandemic... and in some ways, because of it. This company's competitors are watching their businesses evaporate, but his business is actually growing due to its unique market positioning. It's in our Extreme Value model portfolio, too.

I'm excited about gold, mining stocks, and commodities today. They're all dirt-cheap.

But I'm even more thrilled about the 'Extreme Value 30'...

It's a list of 30 great businesses that my research analyst Mike Barrett and I have identified.

I bet you've never heard of most of them... And many have never been recommended by any Stansberry Research publication.

We've waited years for these companies to become cheap enough to get excited about. They were all too expensive until the last couple of weeks... as the longest-running bull market ever devolved into a bear market. Now, they're so cheap that I'm licking my chops...

We track two important valuation metrics for each stock. And right now, 10 of the 30 stocks are mouth-wateringly cheap, trading at huge discounts to their fair value, according to both metrics. These stocks usually never get cheap enough to get excited.

But now that the world has turned upside down and investors have panicked... our main problem is deciding which of these fantastic businesses to recommend first to subscribers.

We'll start with a company that all Extreme Value subscribers will recognize...

Subscribers who followed our advice the first time we recommended this stock made several times their money. And now, it's time to get back in... Our full write-up about this company will appear in the April issue of Extreme Value, which comes out in a couple of weeks. (We normally publish on the second Friday of the month, but the markets are closed next week.)

Every decade or so, the world gets so worried about something that it can't imagine life going back to anything close to normal anytime soon. It happened in 2008 and 2009...

Between March 2008 and June 2009 – the heart of the crisis – we recommended 21 stocks in Extreme Value. We've booked 14 winners and five losers for an average gain of 72% in an average holding period of 957 days – a remarkable average annual return of about 23%.

Two of the positions are still open today...

One is up more than 450%, and the other has been knocked down to just above its original 2009 levels. It's one of the two incredible bargains I just mentioned in the previous section.

If you can't buy stocks when nobody wants them, maybe the stock market isn't for you.

It is for me... and for all my thousands of Extreme Value subscribers. They're about to get recommendations on several of the greatest businesses in the world starting this month.

I don't know where the market will go from here or where the bottom is.

And frankly, I don't care any more than I knew or cared in 2008 and 2009, when I recommended some of the biggest winners in Stansberry Research history.

In November 2008, I wrote an issue of Extreme Value called "No Time For Chickens."

And now, almost a dozen years later, here we are again.

If you're not already joining me for this ride, I hope you'll consider doing so today...

We've put together a special offer so as many folks as possible can get in before I start unveiling my Extreme Value 30 recommendations. Get 20% off the regular price right here.

New 52-week highs (as of 4/2/20): none.

In today's mailbag, a few more comments on Wednesday's Digest about the COVID-19 "surge"... the health care sector... and using technology at home. Do you have a question or comment? As always, send your thoughts to feedback@stansberryresearch.com.

"General Douglas MacArthur, a soldier also highly decorated for valor in combat, once said that, 'courage is grace under fire.' Having two combat tours, carrying a rifle in the first one and a stethoscope in the second, I was never a hero but did my 'duty' in both tours. In the first one you were shot at and worse, and in the second, you were rocketed while you cared for patients. Either way each tour was different but essentially equally dangerous.

"My point is that all physicians gave their word in an oath to be a physician long since dead to care for ALL patients. Now, this is their moment for 'grace under fire'; the only rockets they are getting is from dollar-oriented corporate-types who know everything but never seem to show in the ER or ICU, etc. because there might be sick people there.

"I was board certified in Emergency Medicine for 30 years so I have walked the walk; the biggest problem with medicine in America today is the collective thirst for profit-hungry corporations and their Learjet fleets!!!

"Now happily retired and quarantined abroad." – Paid-up subscriber William Z.

Corey McLaughlin comment: Thank you for your service, William, and glad to hear you're enjoying retirement!

"Corey, Cyber School is already here, not one or two years from now. My children have been going to Cyber School since March 13th because of the COVID-19 pandemic and they will end the school year on time because of it." – Paid-up subscriber Kevin S.

Good investing,

Dan Ferris
Vancouver, Washington
April 3, 2020