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    - Interim Update 11th March 2015

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Interesting Quotes

"There will never be a Grexit. The country is and will remain a member of monetary union. A Greek withdrawal would lead to an irreparable loss of global prestige for the whole EU."
    - Jean-Claude Junker, March-2015

"When it becomes serious, you have to lie."
    - Jean-Claude Junker, 2011

China and Japan Monetary Inflation Update

China's central bank doesn't provide enough information to enable the calculation of True Money Supply (TMS), so we use M1. In China's case, M1 appears to be a reasonable proxy for TMS.

The following chart shows the year-over-year (YOY) rate of change in China's M1 money supply since the beginning of 2001. The chart suggests that over recent years China's monetary authorities have been making an effort to curb the rampant monetary inflation that led to the greatest mal-investment since the days of the Egyptian pharaohs. Whereas the YOY M1 growth rate almost never went below 10% prior to mid-2011, over the past four years it has mostly oscillated in the 3%-10% range.

It looks like the decline in China's monetary inflation rate has caused that country's real estate bubble to burst, although the bursting is happening in slow motion. This is largely because China's banks are allowed to pretend that they have almost no non-performing loans, even though they are inundated with them.



For Japan we use M2 as our TMS proxy. This is not because the BOJ doesn't provide enough information to enable the calculation of TMS, but because in Japan the M2 rate of change closely tracks the TMS rate of change.

Monetary inflation in Japan is highly seasonal, meaning that there are certain periods of the year when the money supply almost always grows relatively quickly and other periods when the money supply almost always grows relatively slowly. This is the case regardless of what the BOJ happens to be doing on the QE front.

The strong seasonality of Japan's monetary inflation is evident on the following chart of the annualised 3-month rate of change in M2 money supply. Specifically, there are usually short-term money-supply growth peaks in January and May-June and there are usually short-term growth troughs in March and September-October, with the high for the year usually occurring in May-June and the low for the year almost always occurring in September-October.

Interestingly, the chart shows that the spectacular QE program introduced by the BOJ in 2013 has, to date, had a fairly minor effect on Japan's monetary inflation. The effect has been a small upward shift in the range in which the annualised 3-month rate of M2 growth oscillates. For example, rather than bottoming just below zero, which is what was happening prior to 2013, the annualised 3-month rate of change in Japan's M2 now tends to bottom just above zero.

Hardly the inflationary conflagration that poorly-informed analysts continue to claim is happening in Japan.

The Stock Market

Mexico: Another "Peso Problem" could be on the way

The following daily chart shows the performance over the past three years of Mexico's stock market in US$ terms. This chart is a picture of a market that is short-term 'oversold' and could soon bounce.



If we take a long-term view, however, the picture appears to be of a market in the process of completing a major topping pattern, that is, a picture of a market with substantial downside potential.



When a stock market makes the sort of massive percentage gains that were made by Mexico's market during 2009-2013, it is a sign of rampant monetary inflation. More accurately, it is a sign of an unstable economic boom fueled by a huge increase in the supply of money. It is unequivocally not a sign of economic progress.

When (not if) Mexico's inflation-fueled boom rolls over into the inevitable bust phase, most of the US$-denominated gains achieved by the stock market during the boom phase will be given back. This is likely to happen within the next two years, but the precise timing is unknowable.

Due to its large downside potential it could be worth taking a bearish (that is, short or put-option) position in Mexico iShares (EWW), especially if there's a near-term rebound to the vicinity of the 50-day MA ($58-$59). However, we aren't going to make any formal recommendation. This is just an idea presented for your consideration/interest/amusement.

The US

A strong jobs growth number was reported last Friday. However, a weak ISM Manufacturing report was published last Monday and, as noted in a ZeroHedge.com article, the wholesale inventory/sales ratio is at its highest level since the middle of the last recession and over the past 12 months there has been no growth in wholesale trade and factory orders (the volume of factory orders has actually contracted). A mixed picture, indeed.

The recent price action of the S&P500 Index (SPX) is potentially ominous. As illustrated by the following daily chart, there was a clear-cut break to a new high and then a sharp pullback that negated the breakout.



The current chart pattern is potentially ominous for two reasons. First, false upside breakouts are reliable bearish signals. Second, there is an eerie similarity between the current pattern and the major topping patterns of 2000 and 2007. To show what we mean, here is a chart of the NYSE Composite Index (NYA) during 2000 and a chart of the SPX during 2007. It's also worth pointing out that the 20% stock market plunge of 1998 began soon after a clear-cut upside breakout to a new high.

On a side note, we obviously have a bearish bias towards the US stock market that should be taken into account. As a result of this bias, we've called eleven of the past two bear markets. However, we are undaunted and will continue to call it as we see it.



With the benefit of hindsight it is obvious that the ultimate price high was the optimum place to have established a bearish position in 2000 and 2007, but when trading in real time we never have the benefit of hindsight. That's why the notes on the above charts say that the optimum place to have 'gone short' was near the top of the rebound that followed the initial decline from the ultimate price high. This was the optimum place to establish a bearish position because it was the place at which it would have taken only a small amount of additional strength to invalidate the trading idea. More specifically, it was the place at which a position could have been taken in anticipation of a substantial decline with the intention of quickly exiting at a small loss if the market invalidated the basis of the trade by making a new high.

Unfortunately, if an intermediate-term decline is now getting underway there is no certainty of a rebound that facilitates the establishment of a bearish position at slightly below the recent peak. Another possibility is that the SPX will drop to the vicinity of its 200-day MA over the days immediately ahead before beginning to rebound, which would likely result in a rebound that ends at or below the 50-day MA.

Europe

The downside blow-off in the euro is occurring in parallel with an upside blow-off in European equities, led by Germany's DAX Index. The index representing Europe's largest stock market is up by 25% since early-January. This is an annualised increase of 130%.

It's just as well that deflation is such a threat in Europe, because imagine how rapidly the DAX would be advancing if there were actually some inflation happening there.



Gold and the Dollar

Gold

The US$ gold price has just declined for 8 days in a row, although the decline has been more like water torture than a waterfall as 7 of the 8 daily declines were small. The exception was the plunge last Friday in reaction to the US employment data. In any case, a result of the 8-day decline is a market that is short-term 'oversold' and not far from major support defined by last year's low. Wednesday's upward reversal in the gold-mining sector indicates that the support will probably hold for now, but there is definitely a risk that it will be breached during the second quarter after an intervening multi-week rebound.

Gold's performance relative to the Dollar Index has been more than a little interesting over the past four months. This is illustrated by the following chart.

When gold was bottoming in the $1130s in early-November of last year, the Dollar Index was at 88. When the Dollar Index came very close to touching 100 on Wednesday of this week, the US$ gold price was still above its November-2014 bottom. In other words, from early-November through to this Wednesday there was a 12-point rally in the Dollar Index with no new low in the US$ gold price. This is remarkable, considering that the other fundamental gold drivers were not unanimously bullish during the period.



The most simple way we can explain gold's ability to hold its ground in the face of a 12-point gain in the Dollar Index is that the strengthening US$ only has only been a bearish force over the past 8 trading days. During November and December, and especially during the first three weeks of January, gold was being helped by the same force that was elevating the Dollar Index: growing fear about the stability of Europe's monetary union. When this fear peaked during 22nd-26th January, the Dollar Index began to trade sideways and gold began to 'correct'. This correction seemed to be running a fairly normal course until last week, when the view that the US economy was doing well enough to prompt an early start to the Fed's rate-hiking campaign began to gain in popularity.

Gold Stocks

The XAU, which has been weaker than the HUI since the November-2014 bottom, came close to its 2014 low before reversing upward on Wednesday 11th March.

The upward reversal from just above major support following seven consecutive down days and with no help from the bullion market (the gold price was down on the day) suggests that a multi-week bottom is now in place. However, the short-term outlook isn't as clear as it was after the first up-day in early-November.

Perhaps the situation will become clearer over the final two days of this trading week.



The Currency Market

Here is an update of the chart that we've been using to illustrate the extent to which the Dollar Index is stretched to the upside.

Thanks to this week's continuing surge to near the 'magical' 100 level, the Dollar Index's 250-day rate-of-change (ROC) has exceeded its 2008 peak. This means that the current 250-day ROC is second only to the early-1985 extreme. Therefore, in terms of position relative to MA envelope (the top section of the chart) the Dollar Index is now at its most 'overbought' level ever and in terms of 250-day ROC (the bottom section of the chart) the Dollar Index is now at its second-most 'overbought' level ever.



As mentioned in the latest Weekly Update, the historical record tells us to expect the Dollar Index to suffer a 1-2 month decline of at least 10% after the current blow-off runs out of steam.

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

In the latest Weekly Update, we wrote:

"...if there is significant sector-wide follow-through to the downside then better buying opportunities [than the ones listed in the "candidates for new buying" section] could arise elsewhere. In particular, be on the lookout for opportunities to buy Dalradian Resources (DNA.TO) in the low-C$0.80s, McEwen Mining (MUX) in the low-US$0.90s, Premier Gold (PG.TO) in the C$2.00-$2.20 range and Pretium Resources (PVG) at around US$4.80."

Of these stocks, only DNA.TO held up well enough over the first three trading days of this week to avoid creating the buying opportunity mentioned above. With regard to the other stocks, MUX traded as low as US$0.90 and in so doing tested its 2014 low (refer to the chart below), PG.TO traded as low as C$2.20 and PVG traded as low as US$4.85.

MUX was the only stock we bought this week. Specifically, we doubled our position in the stock when a below-the-market buy order at US$0.92 was filled on Tuesday. We still have only two-thirds of what we consider a full position and are in no hurry to buy the final third. We had orders in place to buy a few other stocks and expected that some of these orders would be filled on Wednesday, but the sector-wide upward reversal prevented that from happening.

Timmins Gold (TGD) was the weakest stock in the TSI List over the first three days of this week as the market continues to punish it for the ill-conceived decision to acquire Newstrike Capital (NES.V). As well as destroying per-share value and increasing risk, this acquisition boosted TGD's leverage to the spot gold price. The leverage will be a positive influence during the next substantial gold rally, but at the moment it is adding to the downward pressure.

Chart Sources

Charts appearing in today's commentary are courtesy of:

http://stockcharts.com/index.html

 
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