Copyright Reminder

The commentaries that appear at TSI may not be distributed, in full or in part, without our written permission. In particular, please note that the posting of extracts from TSI commentaries at other web sites or providing links to TSI commentaries at other web sites (for example, at discussion boards) without our written permission is prohibited.

We reserve the right to immediately terminate the subscription of any TSI subscriber who distributes the TSI commentaries without our written permission.

The Employment Numbers Hubbub

In the midst of a sea of data pointing to a deteriorating US economy, the Bureau of Labor and Statistics (BLS), a US government agency, reported last Friday that the unemployment rate had fallen from 8.1% to 7.8%. This prompted former General Electric CEO Jack Welsh to tweet: "Unbelievable jobs numbers…these Chicago guys will do anything.. can't debate so change numbers." This, in turn, prompted an almost universal expression of outrage. It was widely acknowledged that a) the employment situation is lousy, b) the substantial drop in the unemployment rate reported by the BLS was strange, and c) the strange number probably boosts the re-election prospects of Obama. But be that as it may, how dare anyone suggest that the fine people at the BLS would deliberately skew the data!

From our perspective, one of the inadvertently funniest reactions to Welsh's "tweet" came from John Mauldin. In his weekly letter Mauldin wrote:

"Before we wade into the data...I want to analyze the reaction. What if someone said, "The military is manipulating the data from Iraq and Afghanistan in order to help the election of the current administration," (whether Republican or Democrat)? The appropriate response to such a statement would be to suggest that such a characterization was demeaning to the professionalism and integrity of our military professionals. I think it is doubtful that a statement like that would get much airplay or gain much credence in the public discourse. The military is a well-respected institution in the United States."

We thought it would go without saying that the US military now routinely manipulates the data emanating from its various war zones, having learned a harsh lesson from the failure to effectively manipulate the media coverage of the Vietnam War. But apparently not. The US military, an organisation that by its own admission can't account for about 25% of its spending, is beyond reproach, according to Mauldin. Unfortunately, Mauldin is correct when he states that the military is a well-respected institution in the United States. That's part of the problem.

Getting back to the employment numbers, Jack Welsh was almost certainly wrong to claim that the numbers reported last Friday were deliberately altered to benefit Obama. It simply wouldn't be possible to secretly manipulate BLS data in such a way. Changing the numbers to suit one party is not something that could be done by having a quiet word to a senior person at the BLS, because the people at the top of the BLS wouldn't be the ones who put the numbers together. Rather, tallying the final numbers would involve dozens, perhaps even hundreds, of individuals. Getting this many people involved in a scheme to report a false number would be impractical, and reporting a number that many people in the organisation knew to be false would be very risky. In other words, Welsh was probably wrong due to the near impossibility of doing what he implied was done.

While last Friday's numbers probably weren't deliberately altered to benefit the Obama administration, the widespread outrage provoked by Welsh's comment was, itself, outrageous. The BLS and the other government agencies that compile economic data only exist for propaganda purposes. To put it another way, these agencies only exist so that the government can exert some control over the statistics that are reported to the public. There is no other reason for the government's involvement in such data-gathering and reporting endeavours. If the economic numbers compiled by government agencies were genuinely useful outside the political process, then private companies would compile them.

Unlike in China, where the government reports whatever numbers it wants to report, in the US the government exerts control over the economic statistics by controlling the calculation methodology. The calculation methodology is adjusted over time to skew the results in the government's favour, regardless of which party happens to be in power. In this way, the employees of the statistics agencies can honestly go about their work and come up with numbers that bear no resemblance to reality.

The Stock Market

The S&P500 Index (SPX) has pulled back to just above important support in the 1420s. If there is going to be another -- likely final -- move to a new high for the year, the SPX will probably hold above 1420 on a daily closing basis. This means that a solid daily close below 1420 would be preliminary evidence that an intermediate-term top is in place.



Gold and the Dollar

Silver

Both silver and gold are alleviating their short-term 'overbought' conditions by trading sideways. This is more evident in silver's chart than in gold's chart. By early September silver had become very 'overbought', and despite the Fed's announcement of a new QE program it has essentially gone nowhere over the ensuing 5 weeks.



Silver's recent price action is evidence that an intermediate-term peak was NOT put in place last month. The reason is that the vast majority of intermediate-term peaks in the silver market are quickly followed by sharp declines. In fact, there is often a single-day decline of more than 5% soon after an intermediate-term peak in the silver price.

To create a new low-risk short-term buying opportunity, silver will have to move down to the region of its 50-day and 200-day moving averages. This currently means $30-$32, but note that both moving averages are now rising.

Gold Stocks

Current Market Situation

In last week's Interim Update we wrote that short-term HUI corrections almost always accomplish two things -- a price decline to near the 50-day moving average and a decline by the daily RSI(14) to the 40-50 range. The following daily chart shows that the HUI's 50-day MA is now around 470, which suggests that the correction isn't complete. The chart also shows that the RSI hit the top of its expected bottoming range during the first half of this week.

Our guess is that the correction will end within the next seven trading days at no more than 6% below the current price.



Updating an interesting comparison

In the 16th May 2012 Interim Update (right at an intermediate-term bottom for the gold-stock indices, as it turned out) we presented a chart comparison between the NASDAQ Composite Index from the time of the 1987 crash and the XAU from the time of the 2008 crash. Here is an updated version of the same chart:



Back then we wrote that while we wouldn't hang any hats on the NASDAQ-XAU comparison illustrated above, we did think that useful information could be gleaned from it. In particular:

"For starters, although these are two different markets at two different times subject to very different fundamental backdrops, there is a potentially important similarity. We are referring to the fact that the NASDAQ suffered a crash, followed by a 2-year rally, followed by a substantial correction lasting about one year that retraced more than half of the preceding 2-year rally, all within the context of a long-term bull market, and to the strong likelihood that the XAU is in the process of doing something similar. For seconds, imagine (or remember, if you were involved in the US stock market at that time), what sentiment towards NASDAQ stocks was like in October-November of 1990. With the market having just given back almost two years of hard-fought gains, the negativity was almost palpable. Very few people had any inkling of what was to come and that one of the best buying opportunities in history was staring them in the face. For thirds, notice the NASDAQ's price action immediately following its 1990 bottom. What eventually evolved into a major upward trend began with a choppy 1-2 month rebound and then a 1-month correction that retraced about half the gain from the bottom. At this point most people probably thought the bearish trend was still in force. It wasn't until the market broke above the peak of the initial rebound that bullish conviction began to grow."

The correction that followed the XAU's initial 1-2 month rebound was actually deep enough to test the May low, but apart from that the XAU appears to be recovering from its soul-destroying 2011-2012 downturn in similar fashion to how the NASDAQ recovered from its crushing (for anyone who was 'long' throughout) 1989-1990 downturn.

As the NASDAQ trended upward during the 1990s, belief in the bull market's staying power increased and the market became increasingly speculative. It should be a similar story with the gold sector over the years ahead, although we probably won't show the above comparison again. It has served its purpose, and there is no good reason to expect that the XAU's bull market will continue to mimic the major twists and turns of the NASDAQ's bull market.

Country risk in general and Bolivia risk in particular

South American Silver (SAC.TO) is an exploration-stage silver mining company that first came to our attention in mid-2010 when it was trading at C$0.50-$0.70. Although it appeared to offer very good value at that time, we never seriously considered adding it to the TSI Stocks List. This was due to its flagship Malku Khota project being located in Bolivia, a very high-risk country. At that time the Bolivian government had already demonstrated its willingness to expropriate the assets of foreign companies.

The stock price of SAC subsequently moved a lot higher along with the silver price and the prices of most other silver mining stocks. Consequently, if we'd entered the stock at C$0.50-C$0.70 in mid 2010 and then exited in late 2010 or the first half of 2011, we could have recorded a profit of 200%-400%. However, the profit would have been due more to good luck than to good judgment. This is because the political risk we were concerned about could have materialised at any time. As it turned out, the risk materialised in 2012. First, the project was expropriated by the Bolivian government in July of 2012, at which point the possibility existed that SAC would receive some compensation for having their main asset taken away. Next, the possibility of compensation evaporated. Moreover, as well as refusing to make any compensatory payment to SAC, the Bolivian government has just threatened to sue SAC for damages on the trumped-up charge that the Canadian company had operated illegally in Bolivia.

Having traded above C$3.00 at one point last year, SAC now trades at C$0.33. It would be trading even lower if not for company's sizeable cash reserve (C$30M, or about C$0.26/share).



A characteristic of political risk is that everything always looks fine...until suddenly it doesn't. Superficially at least, everything appeared to be going fine for SAC during much of 2010-2011, but that was only because a possible problem in the future hadn't yet transformed into an actual problem in the present. This transformation could have happened at any time.

We are usually prepared to buy any investment if the price is low enough, but we make an effort to avoid high-risk countries even when the price is low. One reason is mentioned above: when country risk materialises, it often does so 'out of the blue'. Another reason is that there are usually enough good opportunities in relatively low-risk jurisdictions to keep us occupied.

The TSI Stocks List currently has some exposure to Bolivia via Orvana Minerals (ORV.TO). Although ORV has successfully operated in Bolivia for many years, we aren't comfortable with this exposure. We are, however, prepared to take the risk, especially at ORV's current low stock price. This is because we estimate that the Bolivian assets presently account for only about 40% of the company's total value and will account for no more than 30% of the company's total value by mid next year.

Currency Market Update

Due to anticipatory buying and selling, by the time the Fed announced its new QE program on 13th September the markets that benefit from QE were already at 'overbought' extremes and the US$ (the market that is most clearly hurt by QE) was already at an 'oversold' extreme. It's therefore not surprising that the immediate reaction to the QE announcement has been followed by a few weeks of consolidation, with the QE beneficiaries having a modest downward bias and the Dollar Index having a modest upward bias.

The Dollar Index is no longer 'oversold', although it could gain another point or so without calling into question the idea that the rebound from September's low will be followed by a decline to a new multi-month low.

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

Keegan Resources (TSX: KGN, NYSE: KGN). Shares: 76M issued, 83M fully diluted. Recent price: US$3.62

KGN announced an updated resource estimate for its Ghana-based Esaase gold project on Wednesday 10th Oct. The update was extremely positive. The previous estimate (September-2011) for the total resource was 5.19M ounces (3.64M M&I plus 1.55M Inferred) at an average grade of 1.1-g/t, using a cut-off grade of 0.40-g/t. The new estimate for the total resource is slightly lower at 5.08M ounces (3.83M M&I plus 1.25M Inferred), but the average grade is about 60% higher (1.73-g/t versus 1.1-g.t) and the cut-off grade is 100% higher. So, we are now dealing with a 5M-ounce open-pit-able gold resource that starts at surface and has a very healthy average grade of 1.73-g/t. This appears to be an economically-robust gold deposit.

The next milestone for KGN will be the completion of a revised Pre-Feasibility Study (PFS) in early 2013. The revised PFS will be based on the updated resource estimate mentioned above and selective mining of high-grade zones (as opposed to the bulk mining on which the original PFS was based).

KGN shares gained 16% on Wednesday in reaction to the updated resource estimate, but if anything this was an under-reaction. Unless the overall gold sector fares much worse than expected, KGN should be a good performer in the stock market over the next few months.

In last week's Interim Update we said that KGN was a good candidate for new buying in the low-$3 area. It is still a good candidate for new buying -- now in the mid-$3 area.

Chart Sources

Charts appearing in today's commentary are courtesy of:

http://stockcharts.com/index.html
http://bigcharts.marketwatch.com/