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    - Interim Update 6th October 2010

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Everyone who's bullish looks right

Almost regardless of what you are bullish on, as long as you are bullish on something there's a good chance that you currently look right. The reason is that the price of almost everything (developed-market equities, emerging-market equities, gold, industrial commodities, agricultural commodities, Treasury Bonds, investment-grade corporate bonds, junk bonds, emerging-market bonds) has been rising. Everything, it seems, is currently being elevated in response to the belief that the Fed is preparing to depreciate the dollar by dramatically expanding its supply. Moreover, while at this stage the most blatant price rises are those that are expressed in terms of US dollars, prices are rising in terms of money in general. Today's reality is that many countries attempt to gain a trade advantage or avoid a trade disadvantage by limiting the extent to which their currencies appreciate against the US$. The Fed's inflation-promoting antics thus spread like a wildfire through the global economy, causing money to 'go up in smoke' and bringing about a general rise in money-denominated prices.

The present set of circumstances can't persist beyond the very short-term (the next few weeks). If equities and commodities continue to rise in anticipation of monetary inflation, then interest rates will soon begin to rise and Treasury Bonds to fall. On the other hand, more evidence of economic weakness or the inevitable return of financial crisis associated with the "PIIGS" governments would probably bring about more upside in T-Bonds and cause sharp declines in equities and industrial commodities. A third possibility is that the Fed will become sufficiently worried by the way the markets are front-running its next round of "quantitative easing" that it will officially put QE2 on hold, thus prompting declines in everything that has recently been rising.

The point is that something will soon have to give. It is not possible that everything will continue to levitate.

Oil Update

The following chart shows that the oil price keeps moving in lockstep with the US stock market. Most recently, the stock market's rebound from its late-August low was accompanied by an oil market rebound.



The past month's strength in the stock market has changed the look of oil's chart, in that what had earlier looked like a multi-month topping pattern now looks more like a consolidation within a continuing intermediate-term advance.

Oil's fundamentals don't seem to matter at this time. Regardless of oil supply and commercial demand, if the stock market rises to test its April peak over the next two months (an outcome that now appears to be likely) then the oil price will stand a good chance of making a new high for the year. Additionally, the oil market will probably reach an important peak within a few weeks of the stock market doing the same.

Government Debt Clock

This is interesting:
http://www.economist.com/content/global_debt_clock&fsrc=nwl

Not sure about the debt figures, though. For example, US public debt is shown as $8.5T on the above-linked page, but it is actually around $13.6T (refer to http://www.treasurydirect.gov/NP/BPDLogin?application=np for the exact amount).

The Stock Market

The S&P500 Index (SPX) broke above the top of a little consolidation pattern on Tuesday. This mini-breakout suggests a measured objective of around 1175, but it now looks like a test of the April high (1220) lies in store.


The stock market's rebound has created the impression that various risks, such as the risk of another large economic downturn in the US or a government debt crisis in Europe, have dissipated, but this impression isn't correct. All the fundamental problems and risks that existed two months ago are still in existence; all that's happened is that prices have risen on the back of monetary inflation or anticipated monetary inflation. This is probably not be a great time to be making bearish bets, but it is definitely not a great time to be ploughing money into investments predicated on recovery/stability persisting beyond the short-term.

Gold and the Dollar


Gold and Silver

The US$ gold price has now trended upward for 50 trading days without experiencing a single daily decline in excess of 1%. We are still anticipating a pullback to the vicinity of the 50-day moving, and we are also expecting an increase in volatility.

The following daily chart of the December gold futures contract shows that the 50-day moving average has just moved up to the low-$1250s and that there is well-defined lateral support at around $1260. Regardless of whether or not the gold futures market extends its advance by a few more days, this support will be a likely target for the next correction.


Silver has just broken decisively above its March-2008 peak, which means that it is now at its highest level since 1980 and that in order to identify a chart-based resistance level we must look at a chart that goes back more than 30 years. The following monthly chart from www.mrci.com fits the bill. It suggests that resistance will be encountered at $25 (the peak of the rebound that followed the early-1980 crash).

With silver having already come this far, it will likely go a bit further and test resistance at $25 within the next two months. Whether it continues beyond that is anybody's guess, but we would probably view a rise to $25 later this year as an invitation to purchase some more insurance in the form of put options.


Gold Stocks

Recap and Overview

The gold sector, as represented by the HUI, made a major low on 24th October 2008 and tested its low on 20th November 2008. It is now obvious to every man and his dog that October-November of 2008 was a wonderful time to be buying gold stocks, but who, apart from the few fanatics who are always bullish on gold stocks come hell or high water, thought it was a wonderful buying opportunity in real time? We did. Here are some excerpts from the TSI commentaries posted when the gold sector was bottoming in 2008:

a) In the 20th October 2008 Weekly Update we wrote: "The gold sector is now at its most oversold extreme ever..." and "... this month's low will probably be the major variety (the type that sets the stage for a multi-year bull market)...".

b) In the 22nd October 2008 Interim Update we wrote: "...the longer-term outlook for gold and gold stocks is an order of magnitude more bullish today than it was in October of 1987" and "...the sharp rebound that follows the 2008 crash should prove to be the first leg of a new cyclical bull market".

c) In the email alert sent on 21st November 2008 we wrote: "Perhaps there will be 1-2 more days of pain before the gold sector begins to rally, but whether it begins today (Friday) or early next week we suspect that the coming rally will be explosive".

d) In the 24th November 2008 Weekly Update we wrote: "The similarities with the early 1930s potentially pave the way for a more consistent upward trend in the gold sector over the next two years than was seen during the two-year periods following the corrections of the late-1960s and mid-1970s. In any case, regardless of whether we are talking 1930s or 1970s we should now be in the early part of a new multi-year upward trend in the gold sector".

e) In the 26th November 2008 Interim Update we wrote: "...we not only view the break above 225 as confirmation that a short-term bottom was put in place last month; we view it as confirmation that a new 4-5 year bull market has begun. As mentioned earlier in today's report and in previous commentaries, the gold sector's fundamentals were improving over the past few months even while stock prices were getting hammered in response to the global de-leveraging. This suggests that the gold sector has a lot of catching up to do over the months ahead."

It's too early to tell whether the prediction of a new 4-5 year bull market will prove to be accurate. Due to this week's move by the HUI above its December-2009 peak, what we can unequivocally state at this time is that a new bull market of at least 2 years duration began in October of 2008. In any case, the point isn't that a particular prediction proved to be close to the mark. As we've noted many times over the years, it's an ill-conceived investment approach that relies on being able to consistently predict specific market outcomes. A much better approach involves having a good general understanding of what's likely to happen in the financial world over the long-term and to let this general understanding be a rough guide to overall positioning, but to base specific buy/sell decisions on real time information and analysis. For example, in October-November of 2008 there was no need to even have an opinion on what was likely to happen over the ensuing few years; the combination of valuation and sentiment measures made it crystal clear that a great buying opportunity was at hand.

The more extreme the situation in terms of valuation and sentiment, the more clear-cut the appropriate investing and speculating decisions. However, most of the time the situation is not extreme. Most of the time the risk/reward is nowhere near as skewed towards reward as it was for the average gold stock in Q4-2008, or as skewed towards risk as it was for the average tech stock in Q1-2000.

With regard to the gold sector, now is one of those times when the situation is far from extreme. We think the risk/reward is skewed towards reward across all timeframes, but to nowhere near the extent it was in late 2008. A lot of upside potential remains, although the bulk of the really low-risk money has been made. This is especially the case at the junior end of the market, where you could buy gold in the ground for literally nothing towards the end of 2008 (many exploration-stage miners with proven gold resources were trading below their cash values at that time). There are plenty of juniors that still trade at very attractive valuations considering the price of gold, but downside risk is generally a lot higher today than it was back then.

Something we must bear in mind is that at some point over the next few years valuations will probably become as crazy on the upside as they were on the downside in late 2008. We would like to avoid getting involved in a "greater fool" game, but we would also like to avoid making a complete exit during the early phase of a mania.

Current Market Situation

The HUI finally broke above major resistance at 520 during the first half of this week. To confirm the breakout it needs to end the week above this resistance.

The 50-day moving average remains the most likely target for the next short-term correction. It is now at 480 and continues to rise.


It's remarkable that the HUI first reached 520 in March of 2008 when the gold price was $1025, and that it took a rise in the gold price to $1340 to finally push the HUI above 520. This dramatic relative under-performance on the part of the HUI can largely be explained by the extent to which some of the senior gold stocks were over-valued in March of 2008, but the result is that gold shares are now generally under-valued relative to gold bullion.

The chart-based objectives for the HUI suggested by this week's upside breakout are 650 and 900. 650 looks like a reasonable 6-12 month objective, but it will probably take the HUI a few years to reach 900.

Currency Market Update

The last two intermediate-term bottoms for the Dollar Index were in November of 2009 and April of 2008. Interestingly, the following chart shows that an intermediate-term peak in the British pound preceded each of these Dollar Index bottoms by 3-5 months. In other words, over the past few years the pound has tended to peak against the US$ well ahead of most other major currencies. This makes sense because the pound is fundamentally the weakest of the major currencies.


Due to its fundamental weakness, there's a good chance that the pound will once again peak well ahead of most other major currencies; that is, that an intermediate-term peak in the pound will lead an intermediate-term bottom in the Dollar Index. In fact, it is possible that the pound reached its peak two months ago.

Further to the above, we will be watching the pound more closely than usual over the weeks ahead. If it is able to exceed its August high at some point it will be a sign that the US dollar's downward trend is likely to continue into early 2011, but if it fails to make a new multi-month high and then takes out its early September low it will be a sign that the US dollar's next intermediate-term low will likely be in place before year-end.

Update on Stock Selections

(Notes: 1) To review the complete list of current TSI stock selections, logon at http://www.speculative-investor.com/new/market_logon.asp and then click on "Stock Selections" in the menu. When at the Stock Selections page, click on a stock's symbol to bring-up an archive of our comments on the stock in question. 2) The Small Stock Watch List is located at http://www.speculative-investor.com/new/smallstockwatch.html)

Orvana Minerals (TSX: ORV). Shares: 115M issued, 119M fully diluted. Recent price: C$2.60

The report by O B Research linked HERE contains a detailed analysis of ORV and arrives at an intermediate-term valuation-based target of C$4.20 for the stock.

We are comfortable with the above-mentioned valuation. In our opinion, the company's gold-producing assets (100K-oz/yr from a project in Spain and 20K-oz/yr from a project in Bolivia) are conservatively worth around C$3.00/share. The company will also have annual copper production of 28M pounds beginning next year, which is probably worth about $1.00/share. Lastly, the exploration-stage Copperwood copper project in the US should be worth at least C$0.20/share.

As is the case with quite a few other junior gold/silver stocks, ORV's problem is that it has run up very quickly over the past couple of months (refer to the following chart). This increases the risk of a sizeable downward correction, so although ORV still offers good value we wouldn't do any new buying unless it pulled back to around C$2.00.


    Ideas for new buying

We prefer to buy stocks BEFORE they 'go vertical', not after. This generally means buying stocks that are not the current focus of the market's attention, or buying stocks that have hit a temporary obstacle. For example, NXG hit a temporary obstacle last week in the form of a convertible debt financing. This financing will help the company over the coming 1-2 years, but it created short-term downward pressure.

Other gold/silver stocks that are reasonable candidates for new buying near their current prices are ADM.V, CFO.V, GOZ.TO and THM. The Franco Nevada warrants (TSX: FNV.WT) and the Kinross Gold D-Series warrants (TSX: K.WT.D) also look like good speculations at this time.

Chart Sources

Charts appearing in today's commentary are courtesy of:

http://stockcharts.com/index.html
http://www.futuresource.com/

 
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