Everyone selling? It's time to buy

The gold price fall means some investors are averaging down. When the gold price plummeted last week, hitting a two-year low, not everyone panicked and sold all their gold stocks.

The gold price fall means some investors are averaging down. When the gold price plummeted last week, hitting a two-year low, not everyone panicked and sold all their gold stocks.

"I'd buy some more; that's what I'm doing myself," says David Coates, a Sydney-based analyst with Baker Steel Capital Managers, one of the biggest investors in gold companies in the world.

The fundamentals of these companies have changed because of a lower gold price, but Coates believes that the value is there because gold will bounce back. At the time of writing, the gold price had stabilised. He adds: "Companies with good assets and good balance sheets are really cheap down here ... the recent gold price move is not representative of the true state of the global economy."

Coates has been topping up his holdings of both big and small gold producers, including Northern Star, Lachlan Star, Evolution Mining, Endeavour Mining, Resolute Mining, and St Barbara, as well as the explorer Chesser Resources.

Over the years, I have spoken to hundreds of fund managers, and all believe that if you have a strong "conviction" about a stock, and its price moves down, you should buy some more.

As Geoff Wilson of Wilson Asset Management says: "The best time to buy is when everyone is selling." Peter Mouatt of Adam Smith Asset Management concurs, and says that his fund bought salary packages specialist McMillan Shakespeare after it fell 30 per cent in the wake of a government review of fringe benefits tax.

In contrast, if you kept buying building services company Hastie Group after successive falls in the past three years, you would have been left with nothing because the company eventually collapsed.

"Generally, [averaging down] is a sound approach as long as you have a longer-term time horizon and the company's fundamentals are strong," Mouatt says.

But for smaller investors, who don't have deep pockets, should this always be the case? Should you "average down" and achieve a lower entry price in a stock that you like? It's a question subscribers often ask.

Investing more money in a company does depend on whether you have the cash. And if you don't have the cash, maybe you should have a "stop loss", meaning if a stock goes below a certain level, you automatically sell.

Many fund managers dismiss such an idea, though not all. Todd Gilmore was previously a trader for Citigroup and for ABN AMRO, and now trades successfully on his own.

Gilmore believes that a stop loss is absolutely necessary only if you are using debt or leverage to fund your positions, or if you are trading in leveraged vehicles such as futures or options. He makes a good observation aimed at investors who do have cash, however:

"Whenever people get spare money, it's probable that everyone else is as well. You might get $25,000 and buy CBA today [its shares are trading close to $70], but if you're wise, you would think about where it is that you are comfortable buying that stock, which is, say, $50. If it comes back there, then that's when you buy some more."

His next comment harks back to what Wilson says: "If you bought stock every time Australia went into recession, you would have made a lot of money."

In the view of this columnist - with a focus on small caps - averaging down is not always a good thing in a market that is notorious for its lack of information. Sure, this factor can mean you can take advantage, and make a lot of money, if it works out in your favour.

But in many cases when a share price falls without news, there could be something you don't know. This is why we encourage investors to put limited funds into individual stocks, and to not be afraid of selling, and re-evaluating whether or not to buy at lower levels.

There is no doubt you can make a lot of money from small caps, but the idea is also to limit your risk.

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