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    - Interim Update 21st April 2010

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Don't be financially limited by your location

Spread your financial assets between institutions and between countries

If most of your financial assets are held by a single financial corporation then you will have a problem if that corporation goes bust or ceases to operate for a while. This even applies to government-insured deposits at banks, because there could be an inconveniently long period between a bank going under and the insurance kicking in. Also, governments have been known to renege on their commitments, so we would never leave our financial security in the hands of any government. You should therefore spread your assets across multiple financial corporations.

It is equally important to spread your financial assets across multiple countries to mitigate the risk to your financial security of any single government doing something untoward. This is the case regardless of where you happen to live. Furthermore, the time to diversify geographically is when there is no sign of an imminent problem, because it will usually be too late to do anything after evidence of a problem emerges. For example, it would be 'par for the course' for a government that was planning to take actions that would likely cause capital flight to introduce capital controls before announcing its plans.

The extent to which you should diversify geographically will depend on your wealth, in that the greater the monetary value of your assets the more diversification you should probably opt for.

The decision about where to relocate some of your assets will depend on personal preferences and current location, but in general terms the best country or countries in which to store wealth will be those that: a) you enjoy spending time in, b) do not have close political ties with your home country, and c) have a history of respecting property rights. For example, someone in Hong Kong would not achieve any diversification by shifting wealth to China, and a US resident could probably not achieve sufficient diversification by only shifting wealth to Canada. Also, nobody should seriously consider shifting wealth to Venezuela or North Korea. Some ideas of countries to consider for wealth diversification purposes are Hong Kong, Singapore, Malaysia, Switzerland, Panama, Uruguay, Canada, Australia, and New Zealand.

Lastly, the mechanics of internationalising your wealth will depend on the rules and regulations -- including the tax laws -- of your current jurisdiction. You should consult local experts regarding the best way to go about it.

Don't let your location limit where you trade

People tend to focus their stock-market-related trading and investing on the stock market of their home country, especially if they live in countries with highly developed markets. However, while it was once difficult for the average retail investor to do anything other than trade on his/her local exchange, it is now easy for most people to establish accounts with brokers that provide access to many different markets around the world. Consequently, there is no longer a good reason to let your physical location limit the markets on which you trade.

Your objective should be to trade where the best opportunities are, rather than restrict yourself to the opportunities that arise in your own backyard. And during a resource bull market, many of the best opportunities will be found on the Canadian stock market. The reason is that something like 80% of worldwide mineral exploration is carried out by companies listed in Canada.

So, everyone should have a brokerage account that gives them ready access to the TSX and the TSXV. For this purpose we have, in the past, suggested Interactivebrokers.com, which enables access to numerous stock markets around the world, and Penntrade.com, which enables access to the Canadian and US markets. These are US-based brokers, but accounts can be opened by people from most countries.

Goldman and Paulson

A lot has been written since last Friday about the SEC's decision to bring charges against Goldman Sachs (GS) and about the involvement of John Paulson's hedge fund (Paulson and Co.) in the deal that led to the SEC's charges. The upshot is that during 2007 Paulson & Co. (PC) wanted to place large bets against the US residential mortgage market and asked GS to create a financial product that would tank if there were major problems in this market, the idea being that PC would 'short' the product. GS created a billion-dollar "synthetic CDO" based on Residential Mortgage-Backed Securities (RMBS) for the purpose, with some input from PC regarding the CDO's structure. The synthetic CDO was insured by a now-defunct credit insurer (ACA) and subsequently purchased by a couple of institutional investors, which, judging by their actions, were convinced that there would be no major problems in the US residential mortgage market for the foreseeable future. So, these institutional investors ended up on one side of the trade and PC ended up on the other, with GS acting as intermediary. As is now common knowledge, PC was absolutely correct.

The question, now, is whether GS misled the institutional investors and violated regulations by not disclosing PC's involvement and by failing to mention that the synthetic CDO had been designed in such a way that it would implode if the US housing market continued to weaken.

We have no desire to get into a detailed analysis of the GS-PC-SEC issue, but we will make the following brief comments:

1. PC did not misrepresent anything and does not appear to have any liability here. The lack of any liability on PC's part has been confirmed by the SEC.

2. To put it mildly, the investors that lost on this deal should have known better. Their desire to make a large bet on the continuation of the mortgage boom at a time when considerable evidence of a trend reversal had already occurred brings to mind the adage: "A fool and his money are soon parted". Furthermore, had they not lost $1B on this particular deal they would almost certainly have lost the money on a similar deal given their apparent confidence that the mortgage market was sound. However, the stupidity of these investors does not relieve GS of all liability. The question is not whether the investors should have acted more sensibly, but whether GS acted in good faith and within the regulatory bounds.

3. Paulson was largely unknown at the time this deal was done. Therefore, being made aware of PC's involvement would probably not have altered the behaviour of the investors that lost money. Again, though, this does not mean that GS has no liability.

4. Although the buyers of the synthetic CDO may not have been aware that Paulson was on the other side of the trade, they MUST have known that a large speculator was betting against them. The reason is that a synthetic CDO is a zero-sum trade with a 'long side' and a 'short side'. As stated above, it probably wouldn't have made any difference if they had known it was Paulson because Paulson was not well known back then.

5. The fact that the SEC has brought a civil case rather than a criminal case against GS suggests a belief on the part of the SEC that criminal charges wouldn't stick.

6. GS and some other large financial corporations directly and indirectly received hundreds of billions of dollars of taxpayer funds as part of the Great Bailout of 2008-2009. This represents wrongdoing (blatant theft, not fraud) on a colossal scale. However, we are having trouble seeing any wrongdoing with regard to the specific charges that have recently been made by the SEC. Based on our admittedly limited understanding of the details, the SEC's case against GS can be likened to the police attempting to pin a trumped-up shoplifting charge on a serial killer.

7. The financial crisis's biggest wrongdoers will never be charged with anything because they walk the "hallowed halls" of government and have always acted in the "public interest".

8. Although the SEC's current case looks flimsy, cases such as this could create big problems for GS and other large financial corporations over the coming 12 months as people look for someone to blame for the economic malaise. However, we do not believe that these legal problems will be the primary cause of the next major downward trend in the US stock market. Our view is that the market is destined to head much lower with or without these issues.

9. It is always possible to concoct an explanation for a market move after the fact. In this instance, by using some imagination it is possible to explain last Friday's decline in the gold price as a reaction to the tenuous link between Paulson (the owner of several billion dollars of gold-related investments) and GS. However, if such an explanation 'holds water' then large speculators in gold futures are, on average, a lot dumber than we currently believe. There is no good reason to spend much time analysing 2% fluctuations in the gold price, but as far as explanations for small price moves go the one we posited in the latest Weekly Update -- that de-leveraging in response to the declines in financial assets caused the pullback in the gold price -- is plausible.

Measuring the Money Supply

Click on THIS LINK for a detailed explanation of what should, and should not, be included in the money supply. We think the explanation is correct and as clear as it can be given the nebulous nature of today's money.

The Stock Market

When trading, the single most important consideration is: how will risk be managed? In other words, what tactics will be used to ensure that a lot of money will not be lost if things go wrong?

Although not the only way, the setting of protective stops is the most efficient way to manage risk when trading in markets with good liquidity. Before entering a trade, a trader that employs the protective stop method of risk management must determine the position of the protective stop. This means that trades should generally be avoided unless a logical place for a protective stop can be determined. That's why we wrote the following in the latest Weekly Update:

"A major peak [in the US stock market] could be at hand, but this is not necessarily a good time to be making a bearish bet. The reason is that there is no effective way to manage risk when betting against a market that has consistently been making new 52-week highs. You may be lucky enough to pick the top, but you would be gambling rather than intelligently speculating. In our opinion, if you want to try to profit from the coming intermediate-term stock market decline then the optimum time to build your bearish position will be during the rebound that follows the initial decline from the peak. Risk could then be managed by placing a protective stop just above the peak."

But while risk management considerations probably mean that this is not a good time to be making a bearish bet against the senior US stock indices, there are stock indices and individual stocks that have substantial downside potential and for which the risk management parameters are clear. One example is Hong Kong's Hang Seng Index, which is turning downward after failing to exceed its November-2009 peak. Charts of three other examples are presented below. Interestingly, each of these charts is related to the commodity theme.

The first of the following charts shows that major copper producer FCX has reversed downward after testing its November and January highs. We mentioned FCX as a put-option candidate when it was trading in the mid $80s a few weeks ago. The second chart shows that FXI, an ETF that tracks large-cap Chinese equities, has begun to decline after making a lower high early this month. And the third chart shows that EWZ, a proxy for the Brazilian stock market, also appears to be turning downward after making a lower high. In each of these examples, bearish speculators could manage risk by placing a stop either just above this month's high or just above the 52-week high.






Gold and the Dollar

Gold

The following weekly gold chart reveals an orderly advance over the past 16 months. It shows that gold hit its channel top in February of 2009, after which there was a routine pullback to the channel bottom. The advance then resumed. It also shows that gold hit its channel top again in December of 2010, after which there was another routine pullback to the channel bottom prior to the resumption of the advance. At least, that's the way it looks at the moment.

Short-term resistance lies in the low-$1160s.


Gold Stocks

Current Market Situation

As far as we can tell, the HUI's price action over the first three days of this week contained no clues as to what we should expect over the days/weeks ahead. The HUI was essentially flat on Monday and Tuesday before rising enough on Wednesday to test short-term resistance in the low-430s.


At this stage there is no way to tell whether the price action of the past 8 trading days is a correction within a continuing short-term upward trend or the start of a new short-term downward trend. In favour of the former possibility is the performance of the bullion market.

New ETFs for silver and copper miners

Here are the opening two paragraphs of a 20th April article about the introduction of new ETFs for silver and copper mining stocks:

"Global X Funds, the New York-based provider of Exchange Traded Funds, launched today [20th April] the Global X Silver Miners ETF (ticker: SIL) and Global X Copper Miners ETF (ticker: COPX). SIL and COPX have a 0.65% expense ratio.

The Global X Silver Miners ETF is the only ETF in the world targeting silver mining companies. It tracks the Solactive Global Silver Miners Index, comprised of the largest and most liquid silver mining companies in the world. The majority of holdings are Canadian based companies but also include companies based in the US, Mexico, Peru, and Russia. As of March 31, 2010, the largest index components were Fresnillo, Industrias Penoles, Silver Wheaton, and Pan American Silver."

These ETFs don't interest us right now, but they will almost certainly interest us in the future. In particular, SIL could prove to be a good vehicle for trading intermediate-term rallies in the silver sector.

Currency Market Update

Our view continues to be that the euro is bottoming on a short-term basis, although it is certainly having difficulty establishing an upward trend and has once again pulled back to test its March low. This pullback has set up a reasonable opportunity for traders of currency futures to take a 'long' position, because risk can now be managed by placing a protective stop just below the March low.


We are currently bearish on the commodity currencies, but we happen to be 'long' the C$ and the A$ in our own accounts. We are long these currencies for two reasons. First, due mainly to our interest in natural-resource-related companies we have sizeable investments in assets located in Canada and Australia. Second, we expect that natural resources in general and gold in particular will continue to be among the best areas in which to speculate over the years ahead, so it makes sense for us to have plenty of C$s and A$s 'at the ready'. Our biggest cash position at this time is in US dollars and US$ surrogates (the Yuan and the HK$), after which comes the C$ and then the A$. This is definitely not a recommended currency mix; it is the mix of currencies that happens to fit our peculiar objectives and situation.

Because we perceive a lot of downside risk in the commodity currencies we will be partially hedging our exposure to these currencies using FXC and FXA put options. For example, on Tuesday of this week we began to average into September-2010 FXC put options. We would prefer a later expiry date, but September is presently the most distant month for which there are FXC options with reasonable liquidity.

Note that the difference between a speculation and a hedge is that a speculation is undertaken with the aim of making a profit whereas a hedge is undertaken with the aim of reducing the risk of loss.

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)

Chesapeake Gold (TSXV: CKG). Shares: 38M issued, 45M fully diluted. Recent price: C$9.10

CKG announced the results of the Preliminary Economic Assessment (PEA) for its Metates gold/silver project after the close of trading on Wednesday.

The PEA incorporated a revised resource estimate. The M&I resource is now estimated to be 17.2M ounces of gold plus 467M ounces of silver (24M ounces of gold-equivalent). In other words, it's an enormous deposit.

As befitting such a large deposit, the projected capital cost and annual production are substantial. According to the PEA, it will cost about $3B to build a mine that produces about 960,000 gold-equivalent ounces per year during its first 7 years of operation. With zinc as a byproduct, the cash cost during the first 7 years is currently estimated to be only $267/oz.

Most importantly, the PEA reveals positive economics at "base case" metal prices of $900/oz for gold and $14/oz for silver. Specifically, the base case reveals a Net Present Value (NPV) and an Internal Rate of Return (IRR) of $2.5B and 13%, respectively, at a discount rate of 5%. Boosting the assumed metal prices by 10% increases the NPV (at a 5% discount rate) and the IRR to $3.5B and 15.7%, respectively. These numbers suggest that the NPV would be close to $5B at current metal prices.

The PEA was as positive as we had hoped/expected and supports our bullish outlook for CKG. The $3B cost of building a mine is way too high for a company such as CKG to manage, but this is irrelevant because we are sure that CKG's management has no intention of taking this project into the construction phase. We expect that the Metates project will be purchased by a major gold miner such as Newmont or Goldcorp or Barrick -- at somewhere north of $20 per CKG share -- well before it enters the mine construction phase.

We have no idea how the stock market will react to the PEA. The stock only trades about 20,000 shares on an average day, so relatively small changes in supply or demand can cause large price changes.

Current holders of CKG should continue to hold in anticipation of a buyout within the next 18 months. Prospective new shareholders could either take an initial position near the current price or wait for the news-related dust to settle before making a purchase.

Chart Sources

Charts appearing in today's commentary are courtesy of:

http://stockcharts.com/index.html

 
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