The 64 Month Bull Market Fractal

I don't know how familiar you may be with the emerging science of fractal market analysis, but there is an element of it that has a direct bearing on gold right now. To briefly overview fractals, they have found that stocks and indexes have a strong tendency to move in repeating chart patterns at various scales (self-similar, they call it). So a stock may consistently produce say a 2 year pattern which is also evident at a 2 month time frame. Sounds silly, I know. The theory is that there are well known fractal growth patterns in nature, crystals growing under a microscope and about any basic growth in nature; and these are abundant with self-similar, geometric, repeating patterns. They've known about these nature patterns for many decades, but only recently has anyone thought that financial markets may grow by these fractal patterns too. When they investigated, they found that the unchanging human nature did indeed infuse fractals into the trading charts.

David Nichols, a pioneer in this investigation, finds that there is a 64 month parabolic fractal signature that seems to show up at about every major bull market. The duration varies a couple months or so, but the pattern is a "sprouting" of a parabola, a bullish change in previously sleepy trading, followed by parabolic growth into a violent top about 64 months later. As an example, he points to Toll Brothers as a proxy for the housing bubble (click to enlarge charts):



The months are marked 1 through 65 for the parabolic progression. The Japanese Nikkei bubble of the '80s did the same thing:


I won't flood this piece with the other charts, but the same thing shows up in the Dow of the 1920s, the Nasdaq of the 1990s, and other bull markets. It also shows up in the more notable bull crazes of individual stocks. For example, Intuitive Surgical ISRG was such a craze:



Here the "sprout" of the parabola was a subtle change in trend from sideways or down to up.

Then there was Hansen Natural HANS, remember that hot potato?



Like the Nasdaq chart, the gain was so dramatic, you have to magnify the start point area to see the "sprout" point:


So what does all this have to do with gold today?



Nichols reckons the change in behavior "sprout" point as September 2005, although gold was already in an uptrend by then, but a very weak one. Since this chart was done, we have pretty much been following the fractal.

The end of this gold parabola is early 2011. This brings up some difficult questions. If the gold bull market is to end in 5 months, does that mean the entire commodities bull also dies in 5 months? It's hard to imagine a commodities bull without gold being a part of it. Do all the world's debt and currency problems go away in the next 5 months? That would be nice, but I somehow doubt that will happen. The hard assets/paper assets cycle runs about 12 to 18 years; our present commodity cycle is barely 9 years old with much more paper difficulty lying ahead:



So how can it be that the 64 month gold fractal is happening now, ending in 2011 and disrupting the cycle?

I'm not a fractal expert, but it strikes me that the parabola is just a part of a bull market, and it can occur either in the middle or at the end. In the case of the Nasdaq and the Nikkei, it occurred at the end. In another case that Nichols points out, the recent oil bubble, you have to seriously doubt that the bull market is over. There definitely was the parabola:



The parabola is clearly history. Does this mean that oil will never be over $100 again? It has already gone back to over $80 during a recession and its aftermath. At some point in a recovering global economy, demand will begin outpacing supply as it was starting to do 4 years ago.

If you examine the Intuitive Surgical and Hansen Natural charts above, you see that once the parabola phase was over, pricing remained high - even making new highs. I suspect that this will be the case with both gold and oil.

Cancel Breakout Alert

Continental Minerals is being acquired by Jinchuan Group it was announced Friday. There shouldn't be much more rise in the stock as it is near the present buyout price (I hadn't seen the announcement yet on Friday when I did the previous post). An agreement has been signed, it looks like a done deal.

Breakout Alert

Continental Minerals (KMKCF) is a junior Canadian gold/copper/silver miner that mines in China. From what I read, they have a promising property there with well over 4 million oz. of gold and 11 million oz. of silver. The stock seems to be doing a promising breakout (click to enlarge):



Since the big gold rally late last year, in which KMKCF participated nicely, the stock has been idling in a megaphone formation. After a false breakout in April to about $2.50, it may have completed this formation today with a real breakout with some building volume. I like the moving average geometry and the heavy 24% insider interest. If it doesn't do a breakout now, it probably will soon if gold keeps working its way higher.

Quantifying The Insider Edge

As a follow-on to the importance of insider ownership level in considering gold stocks discussed in my previous post, I'll present a little number crunching here. I looked at a bigger sample size of gold stocks than just the 10 listed before with their big out-performance of the HUI to get a better handle on the relation, if any, between insider ownership level, size of company, and stock performance. I tossed out the ultra-microcaps less than $50 million or trading for less than 50 cents. I also tossed out the slower moving majors, with insider percentages typically not much effected by insider buying. I took a sampling of 51 such gold mining stocks from my gold list that trade on US exchanges with SEC standards of reporting. I sliced and diced this group into 3 market cap sizes and plotted their 1 year stock performance vs level of insider interest. Here is the result:


There is much less sensitivity to company size than I was expecting to find. The middleweights move about as fast as the featherweights. There is also little sensitivity to price range. I was expecting to find that as you go down the price range, the heavily insider owned stocks would curve sharply up in gain - down to the trash threshold, which is around $2 for stocks in general, but seems to be more around $1 for gold stocks. When I did a cluster chart for this, however, I got essentially random clutter.

The one big sensitivity that reaches off the page and slaps me in the face is what happens as you go below 2% insider interest level - a huge booby trap for performance. The individual stock performances vary widely, but this is an extremely poor averaging group - to be avoided like the plague. The large size group doesn't fall off as bad as the other two, but their size could be masking decent insider interest in many cases without having the needle moved much in percent. But the smaller companies, where any serious insider interest moves the needle off zero, are poison at these small numbers.

I have three chronic pains in my gold stock line-up in my fund, I call them the three stooges, and when I checked what their number was, sure enough all three stooges were toting less than 2%. That may be the last straw for them.

The Problem With Gold Stocks

I like to analyze stocks by looking at a company's long-term financial results - cash flow, revenue, and what not, and looking at the interplay of these things with stock price. But I have found this approach to be all but useless in picking gold stocks. The performance of gold miners has nothing to do with their current financials other than simply having enough capital to pursue their projects. You see valuation ratios all over the map during their big climbs, much more so than with any other type of stock. They defy about any monetary type of analysis that may work reasonably well on stocks in general.

So how do you analyze the miners other than projecting the price of gold? Well, you have to resort to leaning on the expert opinion from the people who know more about gold mining than you ever will. These people can be book writers, commentators, newsletter writers, or Ralph, your barber. But all these people suffer from one or both of two key shortcomings (1) they are not geologists and (2) they are not officers of the mining company. It stands to reason that these are the people who know at least as much as the most informed newsletter writer, and probably more. I wouldn't think the company's officers surrender all the key information they possess to anyone on the outside.

So how does the average Joe Investor glean guidance from these people in the know ? First, you can get a feel for how good a management is by just looking at their stock performance over the course of the gold bull market so far. If the stock persistently shows little correlation to a rising gold price over the years, you have to wonder about the market's judgment on the management's ability. If the stock is to take advantage of a future rise in gold's price, it means this company's leaders are going to have to suddenly find a lot of new gold or change their management stripes. The odds are against both. I ran across a thoughtful piece in the archives at kitco.com "Industry Overview: Gold Mining & Exploration" by Derrick Irwin CFA that discusses this dilemma of gold stock analysis. His take:

We believe the most important factor to consider when evaluating an exploration company is the quality of management. In analyzing mining companies, we evaluate managements' experience in the exploration industry, and their track record for discovering gold deposits in the past. This is particularly relevant in regards to the geology team members, who will need to make important decisions regarding where to look for gold anomalies and how to proceed with drilling. On the management side, can the team attract continued investment to fund ongoing exploration activities?

But there is perhaps a more direct way of tapping the knowledge and confidence of the management of a public mining company - insider buying and ownership level. They are putting their money where their knowledge is when they make these publicly available transactions. When these people place their personal money with an individual company in an arena where individual stock performance is very shaky, it means something. Irwin's opinion:

In our view, significant insider ownership is one of the most promising indicators of a healthy exploration company. Management is close to the exploration process and clearly understands how encouraging exploration results actually are, or what the status of agreements with vendors and development partners actually is. We also view management participation in follow-on offerings as a sign of continued faith in the prospects of an exploration company. We do not look at a "threshold" level of management ownership, but we do place higher value on larger ownership percentages. Also, we look for depth of ownership among management - does the whole board and management team hold significant shares, or are the shares concentrated in the hands of a founder or one large owner? A strong board and management team with significant share ownership is one of the most positive signs that an exploration company is healthy, in our view.

With that in mind, I surveyed the miners that report insider activity (in the US anyway) and found some that currently have unusually high levels of insider held shares. Here is the top tier:

AZC Augusta Resource Corp 20%
NSU Nevsun Resources Ltd. 20%
XPL Solitario Exploration & Royalty Corp 15%
MDW Midway Gold Corp 11%
TLR Timberline Resources Corp 22%
PZG Paramount Gold & Silver Corp 34%
UXG US Gold 25%
GORO Gold Resource Corp 49%
NG NovaGold Resources Inc 32%
ANV Allied Nevada Gold 35%
RBY Rubicon Mineral Corp 21%

Midway Gold is the laggard of this group with 11%, but a whopping 64% of that insider ownership level has come about just over the last two years - a lot of recent insider buying.

How is this strong insider interest line up playing out over the past year ? Well, if you take the top 10, leaving off the low 11% of Midway, a lot of which is recent buying; and figure this portfolio's performance, you get +65% vs about +19% for the HUI gold stock index since this time last year.

The problem with gold stocks is you can't depend on our trusty valuation ratios, cash flow curves, or other normally useful parameters. Gold stock value is not about money put on past statements, its all about pulling future ore from their properties. You have to analyze the price of gold with all its complexity and danger. But most importantly, you must look inside the minds of the people who run the companies.

Are Smartphones A New Recession Play ?

By past investment norms, you wouldn't think an expensive electronic gadget would be considered a secular growth investment to fall back on in a weak economic time. But expensive electronic gadgets have insidiously wound their way into the fabric of our daily lives since past recessions. The coup de grace to the old view of gadgets has to be the smartphone. We have come to depend on these just like our bar of soap in the shower. Companies like Apple have become the new Procter and Gambles, only faster growing.

Along with this changing view of secular growth, Wall Street is coming to the morning after realization that delevering down from the debt binge is going to be a chronic condition afflicting the investing world for some time to come. "Derivatives" used to be thought of as a good and sophisticated thing. Now, when CNBC's in-house rock band thinks up a name for themselves, they come up with "The Derivatives". It reminds me of that episode of the old Dick Van Dyke Show from the mid '60s, when bands first started naming themselves after the most unsettling, disgusting thing they could think of. Rob was second guessing the naming of a band, wondering why they hadn't called themselves "The Festering Sores".

Derivatives and their aftermath are going to be a festering sore for us for a long time to come, unfortunately. So whatever the good secular growth investments are, that's what we want. Smartphones and gold are two that come to mind among defensive, but fast growers. CBS news.com ran a smartphone article last week calling them "seemingly recession proof" and running into the problem of not being able to get enough chips from a chip industry underestimating Jim Cramer's "smartphone tsunami". Cramer seems to be right about what he said well over a year ago - that everyone was underestimating it. He felt so strongly about it that he made up a whole separate stock market, a smartphone index, on August 11, 2009 to show off it's market beating performance. I thought it was a neat idea, because I agreed with him that the market was underestimating it. But upon perusing through the tech stocks, I found some that I felt should be in any such index that he didn't include. So I jotted down a list and called it the "supplemental" index.

So is this index beating the market over a year later? Well, let's see. If you had invested $10,000 in each name, here's how they would have done (as of Sept 2):

Original Index
+ 5694.68 STAR (merged)
- 5777.46 PALM (merged)
+ 1228.08 CIEN
+ 2096.77 TLAB
+ 3956.40 ADCT (merged)
- 3148.23 TKLC
- 2230.68 CTV
- 1211.65 QCOM
+ 2255.40 BRCM
+ 2849.55 NETL
+ 1784.10 XLNX
+ 5247.34 SWKS
+ 833.32 RFMD
- 1200.00 ONNN
+ 1057.65 CY
- 3725.90 TSRA
+11487.36 SNDK
- 377.36 CSCO
+ 176.24 GOOG
- 3869.73 RIMM
+ 5394.40 AAPL
_________
+22520.28 on $210,000 +10.7% vs +8.6% f0r S&P 500

My Supplemental Index
+ 1481.48 WRLS
- 769.20 NTE
+18003.60 ARMH
- 20.00 CHA
- 370.37 SYNA
+ 357.15 CHU
+ 1842.87 LLTC
+ 7459.27 OVTI
+ 16367.93 AKAM
+ 5999.64 CREE
- 2000.00 ERTS
- 833.30 STX
__________
+47519.07 on $120,000 +39.6% vs +8.6% for S&P 500

Combining the two lists together, we get +21.2% - a serious outclimbing of the market, but taking a back seat to gold's +31.8% over that period. Let the bad times roll!

Simulations Plus Is Worth Watching

There aren't many stocks outside the gold universe that reside on my "A" list, but this is one of them. Stocks in general seem to be in a condition where they get jerked around by the latest fret or relief rally over global finances. Finding those that are dancing to their own music these days is tough. Simulations Plus (SLP) is a tiny company that seems to be doing just that. They in a good area of the market, "para-pharma". They assist drug companies with research programs, so they aren't that economy dependent. And the healthcare overhaul uncertainty storm has blown over. It's technical condition presents a plethoria of positives:


In addition to a nice looking cup and handle bottom, long since completed, it has been working on a resistance level at around $2. Earlier this year, this resistance was broken then successfully tested as support. This seems to be one of those stocks that likes to sneak up on investors and clobber them with a big climb after they've left the building. The chart shows the big moves up only after volume has gotten very quiet. It is at such a stage right now. It's trading close to a parallel 140/200 ema that has established a smooth uptrend. The stock was totally oblivious to the nasty tumble in February and the dive after April.

Fundamentally, eps has been in a steady climb since '05 with only a mild interruption in '09 (up over 100% in 5 years), and the ttm eps is up from '07 while the stock has been smashed from $8 to less than $2. Debt is zero, current ratio over 9, and the insiders love it, carrying a whopping 47% of the shares.

It's no gold stock, and it's not smartphone, but maybe the next best thing.