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The Stock Market

Regardless of the longer-term outlook, the NASDAQ100 Index (NDX) is likely to pull back to test its recent break above resistance at 2850-2870 within the coming few weeks. The further it moves away from this former resistance (now support) in the very short-term, the larger the eventual pullback will have to be.



There's no way of knowing how long it will continue, but an equity-market rotation is underway. The rotation began late last month and entails a shift away from the "defensive" dividend plays, most notably the utility stocks, towards global growth plays such as mining and emerging-market equities.

The rotation can be seen by comparing the following charts of the Dow Jones Utility Average (UTIL) and the iShares Emerging Markets ETF (EEM).

Note that regardless of reputation, no sector of the stock market can be genuinely defensive after it has gone parabolic to the upside. Parabolic up-moves usually lead to crashes, with the main question being one of timing (how far will the parabolic up-move go before the inevitable collapse occurs?). So, while it could reasonably be said that buyers of utility stocks near last year's lows were playing defense, the same couldn't be said of buyers of utility stocks near the April-2013 highs.

Also note that we perceive substantial intermediate-term downside risk in both UTIL and EEM, but on a short-term basis EEM has the advantage that it is rebounding from an 'oversold' extreme.

In early January, when we wrote our Yearly Forecast for 2013, we had no opinion on what the stock market would do over the course of the year and saw no point in pretending otherwise. However, for what it's worth (probably not much) the price action of the past couple of weeks has led us to a forecast of what the stock market is likely to do over the final 7.5 months of this year. We'll outline this forecast in the next Weekly Update.

Gold and the Dollar

Gold and Silver

Five basic FACTS that many commentators on the gold market either don't know or deliberately ignore:

1) The amount of gold produced by the mining industry is not the supply of gold. The supply of gold is the sum total of all the gold mined throughout the ages that is still available in saleable form today. This is at least 100,000 tonnes and could be as much as 150,000 tonnes. The amount of gold produced by the mining industry each year can reasonably be thought of as the gold inflation rate. Over the past 100 years the gold inflation rate spent almost all of its time in the 1.7%-2.0% range.

2) Further to 1) above, any analysis of the gold market will be illogical if it is based in any way on the premise that the supply of gold is the amount of gold produced in a year by the mining industry.

3) The demand for gold cannot be determined independently of price. To be more specific, the change in the price over a period is the only reliable indicator of what happened to the demand for gold relative to the supply of gold over the period.

4) The volume of gold moving from one part of the world to another part of the world provides no reliable information about the past, present or future performance of the gold price.

5) Reliable information about the overall demand for physical gold cannot be obtained by looking at demand in one small part of the market. Of special relevance at this time, the change in the public's demand for gold coins and small gold bars is not a reliable indicator of the overall change in the demand for physical gold.

Something that isn't a fact, but is highly probable: If at any time there is a 'disconnect' between the physical and "paper" gold markets, with the total demand/supply ratio for physical gold increasing sharply relative to the total demand/supply ratio for "paper" gold, the disconnect will be indicated by substantial and sustained backwardation in the gold futures market.

Gold's price action since the 26th April high is looking more and more like a consolidation within a short-term upward trend, as opposed to the start of a decline that ultimately takes the price back to the vicinity of its mid-April low. If so, gold's next move of significance will be a rise to former support (now resistance) at $1525-$1550.

Note that a daily close below $1445 would invalidate the idea that gold is consolidating ahead of a rise to new multi-week highs. Also note that an eventual test of the mid-April low is likely. If the test doesn't happen within the next couple of weeks then it will probably happen during the final quarter of this year.



Silver's rebound from its mid-April low has been weaker than gold's. However, on a short-term basis the overall financial-market backdrop is more bullish for silver than for gold. Whether rational or not, the performances of broad stock indices and credit market indicators suggest that we are in a period of rising economic confidence. This has just begun to support the base metals and should create strength in silver relative to gold. Therefore, if gold manages to break out to the upside from its range of the past 9 trading days then we will probably get a decent bounce in the silver price.

Resistance for gold at $1525-$1550 is equivalent to resistance for silver at $26-$27.



Gold Stocks

Comparing long-term bull markets in gold stocks

The last long-term bull market in gold-mining stocks, which ran from the early-1960s through to 1980, occurred in parallel with a major upward trend in interest rates, a steady undercurrent of "inflation" fear, and the occasional dramatic "inflation" scare. However, the current -- we think it's still current, although this won't be proven until the gold-stock indices exceed their 2011 peaks -- long-term bull market in gold-mining stocks has unfolded in parallel with a major downward trend in interest rates, a steady undercurrent of "deflation" fear, and the occasional dramatic "deflation" scare. These differences could have -- and preferably would have -- resulted in gold-mining stocks performing differently relative to gold and the broad stock market during the current bull market than they did during the last bull market, but that wasn't to be. Gold-mining stocks are putting in a similar showing this time around.

The following weekly chart of the BGMI/gold ratio (the Barrons Gold Mining Index relative to the bullion price) reveals that the gold mining sector did very well relative to gold during 1964-1968 and then embarked on a substantial long-term decline. The major bottom for the BGMI/gold ratio actually coincided with the major peak in the gold price in January of 1980, at which point the gold-mining stocks commenced a 2-year rally relative to gold. Something similar has transpired during the current bull market, in that strength in the gold-mining sector during the first few years of the bull market was followed by a substantial long-term decline.

Notice that BGMI/gold's long-term decline of 1968-1980 was interrupted by two meaningful (1-2 year) counter-trend rallies, one during 1970-1971 and the other during 1973-1974. To date, the long-term decline in BGMI/gold that began in 2006 has only been interrupted by one meaningful counter-trend rally (the sharp 12-month rally that began in October of 2008). It's a good bet that a second counter-trend rally will begin this year -- from either an April-May low or an October-November low.



The next chart reveals that while the BGMI/SPX ratio (the gold-mining sector relative to the broad US stock market) trended higher during the 1960s and 1970s, there were two substantial counter-trend moves. The current long-term upward trend in the BGMI/SPX ratio is immersed in its first substantial counter-trend move.



The bottom line is that rather than being evidence that the gold sector's long-term bull market has come to an end, the recent extreme weakness in gold mining stocks relative to gold bullion and the broad stock market is consistent with what happened during the middle stages of the last bull market.

Current Market Situation

The HUI dropped to short-term support at 270 on Tuesday then moved up to just below resistance at 290-300 on Wednesday. The testing/holding of support followed by the surge to resistance is bullish. As is the case with gold, the price action since the late-April interim high is looking more and more like a consolidation within a short-term upward trend.

If the HUI can end this week above 300 it will be a clear sign that a multi-month low was put in place in mid-April and that additional upside is likely over the weeks ahead.

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

Eliminating Belo Sun Mining (BSX.TO) from contention

BSX owns the multi-million-ounce exploration-stage Volta Grande gold project in Brazil. We have never previously mentioned this company at TSI, but based on the size, grade, location and open-pit-able nature of its project we have had it in mind over the past several months as a potential future addition to the TSI Stocks List. However, that is no longer the case. Even though BSX is down by more than 60% from its early-2013 high and is now trading at its lowest level in more than two years, the stock is no longer on a short list of potential future TSI stocks. The reason is basic economics.

According to the just-completed Pre-Feasibility Study (PFS), the results of which were announced after the close of trading on Monday, the Volta Grande project has an after-tax NPV(5%) of $472M at a gold price of $1450/oz and an initial capital cost (CC) of $750M. The stock's enterprise value (EV) at Wednesday's closing price of C$0.65/share is about $133M (266M shares at 0.65/share minus $40M of cash). This means that the sum of the CC and the EV is almost twice the NPV at a gold price of $1450/oz. That is, the EVCC/NPV ratio is almost 2.

With valuations for many exploration-stage gold mining stocks at extraordinarily depressed levels, we would need a very good reason to be interested in an exploration-stage gold miner that had been shown, via a PEA, PFS or FS, to have an EVCC/NPV ratio of well over 1. In the absence of a much higher gold price or new information that indicates a much improved cost structure for Volta Grande, we can therefore remove BSX from consideration.

The Volta Grande project still has significant value and the stock is dramatically 'oversold', so BSX will probably enjoy a sizeable rebound in the near future. Its problem is one of relative unattractiveness in a market environment where terrific values are plentiful. For example, at its current stock price SBB.TO has an EVCC/NPV ratio of only 0.50, even if no value is assigned to its Hackett River silver royalty.

    Kinross Gold (KGC) reports good quarterly results

For a pleasant change, KGC reported good operating results for the latest quarter. We have an interest in KGC via some long-dated call options.

Production during the March quarter was slightly ahead of plan at 649K ounces, but the most positive aspect of the production performance was the relatively low cost. The reported "cash cost" was $729/oz, which is $9 lower than the March quarter of last year. The "all-in" cost was $1038/oz, versus $1180/oz during the March quarter of last year. However, the large reduction in the "all-in" cost is mainly due to the timing of capital expenditures and therefore won't be sustained. KGC has maintained its 2013 "all-in cost" guidance of $1100-$1200/oz, which is in the same ballpark as the costs expected by Barrick Gold, Newmont Mining and Agnico Eagle.

KGC's balance sheet is in good shape. Of particular significance, the company had working capital of $2.20B at 31st March. This is down from $2.28B at 31st December 2012, but the reduction is due to the payment of a cash dividend to shareholders.

The financial statements reveal that KGC's book value is $8.75/share, so at Wednesday's closing price of $5.60 the company was trading at a 36% discount to book value. In a more normal market environment a senior gold producer would trade at a substantial premium to book value.

Chart Sources

Charts appearing in today's commentary are courtesy of:

http://stockcharts.com/index.html