Junior gold stocks suffer in market meltdown - is this 2008 over again?

Comments yesterday from the president of the ECB on the spreading Eurozone debt crisis precipitated a general global stock market crash with the mining sector and metals amongst the major fallers.

Author: Lawrence Williams
Posted: Friday , 05 Aug 2011

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LONDON -

What a day on the stock markets! Major indices dropped like a stone with the FTSE, S&P and Dow all diving between 3 and 5% in the worst fallout for nearly three years. Will it end here or are we seeing another major market meltdown similar to that of October 2008? The meltdown continued overnight with the Nikkei, Hang Seng and Australian stock exchanges all also plunging around 5% or more.

If indeed we are seeing a new meltdown what lessons are to be learnt from the 2008 crash? Firstly that good stocks fall alongside the dogs and secondly perhaps that although gold itself may fall, its fall will tend to be limited and its recovery far quicker than that of the stock market in general, and of junior miners in particular. Major and mid tier stocks are unlikely to fall as much as the juniors - and silver investors may be in for a particularly rough ride.

But the other lesson to be learnt is that such stock market episodes provide huge buying opportunities. In 2008 some of the better junior miners with strong balance sheets and good ore deposits fell back pari passu with the others, but if you can pick anywhere near the bottom some of the subsequent gains in the better equities made were enormous - maybe 1,000% in some cases. Metals prices likewise. Gold actually fell back relatively little in relation to stocks and made a rapid recovery getting back to its pre-crash levels within a couple of months. Significant gold producers also held up relatively well in comparison with those of other metals - except perhaps iron ore and coal - while base metal prices, the platinum group metals and silver in particular suffered really badly. And, mostly, they took the best part of 2 years to recover fully. One might hazard a guess though that silver's strong subsequent recovery - although it took over a year to really take off - may keep this precious metal's fall relatively muted on this occasion - if there is indeed a full blown market crash.

Gold fell - not because of fundamentals but because people needed liquidity to counter losses elsewhere so anything of value needed to be sold.

Maybe it was something that Chris Powell of GATA said in the GATA Gold Rush press conference in London - we went into it with gold riding high at a new record level above $1680, but came out of it an hour later with the yellow metal having fallen to around $1640. It later made a small recovery, but Asian investors appeared to have piled in again and it was back to close on $1660 again overnight. It will be interesting to hear what the principal speakers at the GATA event will make of what is happening given that nearly all are hard money proponents. One could hazard a guess that a few of them will be burning the midnight oil to rewrite parts of their presentations.

But, if gold holds at anywhere near this level, producing gold miners will still smiling. As we noted in an article published yesterday, June quarter profits - with gold probably averaging around $1500 an ounce - were already hitting high points, and some of the big companies were substantially increasing dividends. Gold at $1600 and above means that profits are likely to be substantially higher still in the current quarter should the price be maintained - or even if it falls back a few percent. Something which the market probably won't take note of if it does continue into panic selling mode.

The big problem last time round in the 2008/9 junior mining stock crash was that the banks were themselves facing liquidity problems and lending dried up putting the squeeze on junior miners looking for capital to continue their exploration programmes and indeed to stay in existence. While the eventual outcome was not quite as bad as some experts predicted - quotes of 50% of junior miners going to the wall were being thrown around - it was still not a great time to be in the sector and many projects subsequently faced major delays from which the market was only recently recovering. To be hit by a second dose of banks cutting back on lending is extremely unfortunate, although those who have recently put new deals in place, or are otherwise flush with cash, should be far better placed to ride out any storm. The worry for the miners is that banks have been amongst the hardest hit in the stock price falls and there is already evidence that many major banks are already cutting back lending money to anything which appears to carry the slightest risk, which doesn't bode well for junior miners. Self preservation time again.

There will be much trepidation regarding the possibility of another market rout in Europe and the U.S. today. Selling breeds selling and a downwards spiral could be on the way. Some have been predicting another market crash like 2008 - but worse - for some time now - but then others have been looking for markets to rise. We shall see who is right.

Eurozone debt is still probably perhaps the major concern and any defaults here could see the banks under huge liquidity pressures again, while there is growing awareness of the fragile state of the U.S. economy brought on by exposure to it in the internecine wrangling over the debt ceiling. It's not looking good for the markets, but safe haven investment will again come to the fore and gold is almost certain to be the major beneficiary!