- Interim Update 10th May 2017

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What is a bull market?

A reasonable definition of a bull market must be practical. This means that it must take into account the fact that what people really want from an investment is an increase in purchasing power, not just an increase in price. Figuring out whether or not an investment is in a bull market is therefore not as straightforward as observing its long-term trend in nominal currency terms.

Here's a great example of why looking only at nominal price change doesn't necessarily indicate whether or not something is in a bull market: Ten years ago, the price of everything in the world was in a powerful upward trend when price was expressed in terms of the Zimbabwe dollar. Obviously, it was far more reasonable in this case to say that the Zimbabwe dollar was in a bear market than to say that everything else was in a bull market.

The Zimbabwe example is extreme, but the fact is that all of today's official currencies are losing purchasing power (PP). They are losing PP at different rates and some are losing PP quite slowly at the present time, but not one of them is likely to be a good measuring stick over a long period.

Unfortunately, determining whether or not an investment is gaining value in real terms is problematic due to the impossibility of coming up with a single number that reflects the economy-wide PP of money. We have a method of adjusting for the effects of monetary inflation that should be 'in the right ballpark' over periods of more than 5 years, but our method could be wildly inaccurate over periods of less than 2 years. Inflation-adjusting using the official CPI, on the other hand, is likely to be inaccurate over all periods and wildly inaccurate over the long-term.

In a world where the official currencies make poor measuring sticks due to their relentless and variable depreciation, looking at the relative performances of different investments is probably the best way to determine which ones are in bull markets. Furthermore, because they are effectively at opposite ends of an investment seesaw, with one doing best when confidence in money, central banking and government is rising and the other doing best when confidence in money, central banking and government is falling, this is a concept that works especially well for gold bullion and the S&P500 Index (SPX).

There will be times when both gold and the SPX are rising in US$ terms, but it will always be possible to tell the one that is in a genuine bull market because it will be the one that is the stronger. More specifically, if the SPX/gold ratio is in a multi-year upward trend then the SPX is in a bull market and gold is not, whereas if the SPX/gold ratio is in a multi-year downward trend then gold is in a bull market and the SPX is not. There will naturally be periods of a year or longer when it will be impossible to determine whether a multi-year trend has reversed or is consolidating (we are now in the midst of such a period), but, as discussed last week, there is a moving-average crossover that can be used to confirm a reversal in timely fashion.

In conclusion, it is reasonable to say that an investment is in a bull market if it is in a multi-year upward trend in nominal currency terms AND relative to its main competition.

Iron-Ore

In the world of industrial commodities, the iron-ore market led the way higher from a January-2016 low and then confirmed an intermediate-term downward reversal when it broke below $80/tonne in March of this year.

Due to its leadership, over the past year we have paid more attention to iron-ore than we normally would. We will continue to do so, because at some point over the next few months it could provide timely confirmation of an intermediate-term reversal to the upside.

As illustrated below, the iron-ore price has found some support near $60. However, it would need to get back above $75 on a weekly closing basis to suggest that the bottom was in.



The Stock Market

The following daily chart shows the SPX and the Volatility Index (VIX).

During the second half of April the SPX quickly rose from near a 2-month low to near its 1st March all-time high. It has since hovered near its all-time high, not showing any signs of weakness but also not managing to break out to the upside. This lack of volatility with the price near an all-time high has pushed the VIX down to a 20-year low.



With the VIX at such a low level it is tempting to buy VIX call options. At least, it would be if the options weren't so expensive.

VIX call options with a few months to expiry often seem expensive because they are based on VIX futures prices rather than on the index itself. For example, even though the VIX ended the 10th May session at only 10.2, the October-2017 VIX futures contract ended the same session at 15.6. Consequently, if you were to buy October-2017 VIX calls right now you would be buying calls that are priced on the basis of an underlying index value of 15.6.

The large premium to the spot index at which VIX futures contracts usually trade is the reason you will lose money buying a volatility ETF/ETN such as VXX unless you get the timing exactly right. These ETFs/ETNs are regularly rolling from relatively low-priced nearer-dated contracts into relatively high-priced later-dated contracts, leaking value as they go.

The stock market is currently a high-risk proposition, but it is not going to 'fall out of bed' with no warning. Ideally, a warning will come in the form of a failed upside breakout (a surge into new-high territory that is quickly reversed), as this would create a relatively low-risk setup for a bearish speculation. Alternatively, any decline that takes out the SPX's March low would be a clear-cut warning.

Gold and the Dollar

Gold

Based on the daily RSI(14), on Tuesday of this week the gold market became short-term 'oversold' for the first time this year. However, while there is some support in the $1215-$1220 range, the price could still drop to lateral support in the $1190s before a 1-3 week counter-trend rebound gets underway.

Assuming that an interim low is either already in place or will soon be put in place via a spike down to the $1190s, the $1245-$1255 range is a likely place for a rebound peak.



Silver

The silver extreme became even more so over the first two days of this week. In particular, by the close of trading on Tuesday 9th May silver's daily RSI(14) was near a 20-year low of only 17.4 and the price had fallen on 15 of the latest 16 trading days.

The relentlessness of the decline was made possible by the price having reversed course after speculators had built up a record-high net-long position in silver futures. We will therefore be more interested than usual to see the COT data at the end of this week. The data will show the positioning at the close of Tuesday's trading session and will therefore reveal the extent to which speculators in the futures market liquidated their collective long exposure in response to the price weakness.



Based on what happened in the past following similar short-term momentum extremes (as indicated by the daily RSI), this week's low will NOT be the final low but it will hold for a few weeks. Here's the sequence that we can reasonably expect:

1) A rebound from this week's low that lasts about 2 weeks and reaches the 20-day MA (the black line on the above chart) or a little higher. The rebound target range noted in the latest Weekly Update ($17.00-$17.50) is still applicable.

2) A decline that takes the price either slightly below the May low or well below the May low. Whether it's slightly below or well below will mostly be determined by the extent to which the speculative net-long position has been reduced and what's happening in the gold market at the time the May low is breached.

3) A tradable multi-month rally.

Gold Stocks

The HUI successfully tested support at 180 last week and is now rebounding. The 50-day MA near 196 or a few points higher is the most likely area for a rebound peak, although a counter-trend rebound could possibly go as high as the 200-day MA near 210.

We expect that this rebound will be followed by a decline to new lows for the year, with the likely time-window for an intermediate-term bottom having narrowed from May-July to June-July due to the absence of a capitulation over the past week.



Due to the liquidity problems recently experienced by GDXJ and the resulting decision of the ETF's manager to shift the fund's focus towards mid-tier gold-mining companies, from now on we will use the Global X Gold Explorers ETF (GOEX) as our main proxy for the junior end of the gold-mining sector.

Even though GOEX broke below support defined by its March low last week, it is likely that a multi-week low is in place. A rebound to near the 50-day MA ($23) would be normal.



The Currency Market

The Dollar Index

Macron predictably won the French Presidency on Sunday 7th May and the market reaction was minor. This supposedly euro-bullish political outcome resulted in only a small upward spike in the euro and downward spike in the Dollar Index on Monday, no doubt because the polls had all but ruled out any other outcome well before 7th May. However, it did cause both the euro and the Dollar Index to make marginal new extremes for the year before reversals occurred.

This week's reversal increases the probability that May-2017 will be the fourth in a series of important May lows for the Dollar Index (the Dollar Index made a multi-month or multi-quarter low in May-2014, May-2015 and May-2016).

Needless to say, Monday's intra-day low is now a very significant support level. Going the other way, there is trend-line resistance slightly above 100 and more important resistance defined by the April high at 101.3. It would take a daily close above 101.3 to remove most of the remaining doubt that a multi-month low is in place.



The Canadian Dollar (C$)

A reversal over the past few days has signaled an interim low and the start of what will probably turn out to be a 2-3 week rebound for the C$. A routine rebound would take the C$ up to around 74 to test its previous downside breakout, after which the longer-term decline would resume.

As noted in an earlier commentary, the short-term technical objective is 71.



Updates 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

Chart Sources

Charts appearing in today's commentary are courtesy of:

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