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Commodities

The commodity markets have almost certainly turned upward on an intermediate-term basis and are showing signs of having turned upward on a long-term basis. However, on a short-term basis the Continuous Commodity Index (CCI) and many individual commodities are 'overbought' and likely to experience multi-week pullbacks/consolidations. During the upcoming correction the CCI's performance relative to the S&P500 Index (SPX) could be informative.

Regardless of whether the CCI rises or falls in nominal terms over the weeks ahead, it could provide more evidence of an important trend reversal by outperforming (rising by more than or falling by less than) the SPX. This is because the current rebound in the CCI/SPX ratio is close to breaching levels that would differentiate it from the counter-trend rebounds of 2012-2013. The following two charts illustrate what we mean.

Our first chart shows CCI/SPX's daily performance over the past three years. Notice that it would take only a small amount of additional strength in the CCI relative to the SPX to break the ratio above lateral resistance and a trend-line that dates back to the 2011 peak.



Breaching the aforementioned levels on the daily chart would be significant, but a more definitive and important signal would come from a weekly close above CCI/SPX's 50-week moving average. Here's why:

Our second chart shows that all counter-trend rebounds during the cyclical CCI/SPX declines of 1995-1999 and 2011-2013 ended at or below the 50-week MA (the blue line), and that the first weekly close above the 50-week MA during the late-1990s signaled that the bottom was in.

The CCI/SPX ratio is presently about 3% below its 50-week MA.

The Stock Market

We won't have anything new to say about the broad stock market until we see where the S&P500 Index closes this week.

By far the most interesting price action over the first three days of this week occurred in the uranium-mining sector of the stock market. As illustrated by the following weekly chart of the Global X Uranium ETF (URA), a proxy for uranium-mining stocks, the uranium miners have risen sharply over the past three trading days (URA is up 13.5% since the end of last week). As long as it doesn't give back most of these gains over the next two trading days, when this week comes to an end URA will have achieved a weekly close above its 50-week moving average (the blue line on the chart) for the first time in more than 2.5 years. If this happens, the current rally will have differentiated itself from the counter-trend rallies that occurred during 2012-2013 and we will have a clear sign of a major trend reversal.



The catalyst for this week's surge in uranium mining stocks was news that the political environment in Japan is becoming more favourable for nuclear power, potentially enabling not only the restarting of many of the reactors that were shut down in response to Fukushima but also the construction of new reactors. It should be understood, however, that the entire rebound in uranium-mining stocks has been based on anticipation of something that has not yet happened: a rebound in the uranium price.

To underpin the equity rally that has already occurred and to enable the equities to make additional price gains, the uranium price will soon have to commence an upward trend. There's a high probability that it will.

Gold and the Dollar

Gold

Confusing Cause and Effect

As we explained in multiple TSI commentaries last year, the large 2013 decline in the Comex gold inventory was an effect of the large decline in the gold price, not a cause of it. Furthermore, based on the historical record it was a predictable effect, in that over the past 35 years major trends in Comex gold inventories have followed major trends in the gold price. In other words, there was nothing untoward, suspicious or even the slightest bit strange about last year's Comex inventory decline.

It's a similar story with the physical gold inventory of bullion ETFs such as GLD. There's a nuance here in that changes in the quantity of gold held by GLD are not directly driven by changes in the gold price, they are driven by arbitrage. More specifically, if the price of a GLD share rises relative to the gold price then arbitrage activity will cause physical gold to be added to GLD's inventory, and if the price of a GLD share falls relative to the gold price then arbitrage activity will cause physical gold to be removed from GLD's inventory. (It's this arbitrage activity that prevents the GLD price from ever wandering far from its net asset value.) This means that a rising gold price won't necessarily result in gold flowing into GLD's inventory and a falling gold price won't necessarily result in gold flowing out of GLD's inventory. However, because trend-followers and other short-term traders exert a greater influence on the price of GLD shares than on the price of gold bullion, GLD's price will tend to rise faster than the gold price during a strong upward trend and fall faster than the gold price during a strong downward trend. This creates a tendency for the arbitrage activity mentioned above to add gold to GLD's inventory during strong gold markets and remove gold from GLD's inventory during weak gold markets.

The main point we want to make is that a likely EFFECT of an upward trend in the gold price over the months/years ahead will be the addition of gold to the Comex and GLD inventories, but going by past performance many analysts will confuse cause and effect and wrongly interpret the inventory change as the cause and the price change as the effect. There is a self-reinforcing element in that as physical gold is added to the GLD inventory there will be marginally less gold to satisfy demand elsewhere, but the process begins with a change in the price trend.

Current Market Situation

In the latest Weekly Update, we wrote:

"Gold is 'overbought', but not by enough to create significant downside risk. However, if it rises to around $1350 without first experiencing a multi-week consolidation then the short-term downside risk will be as high as the remaining short-term upside potential. Our short-term outlook will therefore shift from "bullish" to "neutral" if gold trades in the $1340s this week."

The gold price moved into the $1340s on Tuesday 25th February, causing our short-term outlook to shift back to "neutral".

It is important to temper your enthusiasm as the price rises, especially when the market is 'overbought' and nearing a range of significant resistance. It is equally important to become increasingly enthusiastic as the price declines, especially when the intermediate-term trend appears to be 'up' and when the market is nearing a range of significant support. In gold's case, there is presently resistance at around $1350 and support at $1275-$1300.



There's a good chance that gold will test intermediate-term resistance in the low-$1400s by the middle of this year. Our short-term outlook will therefore become "bullish" again if the price drops to $1300, because at that point there will be more than $100 of short-term upside potential and probably no more than $25 of short-term downside risk.

Gold Stocks

The HUI still hasn't conclusively signaled the start of a multi-week consolidation, which means that there is still a realistic possibility of a rise to the 250s prior to the start of such a consolidation. This possibility would be kept alive if Thursday 27th February is an 'up' day for the HUI, but if the daily losing streak extends to three via a 'down' day on 27th February it will be reasonable to assume that a multi-week consolidation has begun.

Any 'corrective' activity over the days/weeks ahead will probably a) be limited by the support that extends from the mid-220s to the low-230s, and b) push the HUI's daily RSI (refer to the bottom section of the following chart) down to around 50.



Currency Market Update

For a few years we were either intermediate-term bearish or neutral on the senior commodity currencies (the A$ and the C$), but we recently became more optimistic about these currencies' intermediate-term prospects. This was because they had become extremely 'oversold' at the same time as signs had begun to emerge that a major upward reversal was underway in the commodity world.

By breaking above its 50-day MA, the A$ has provided preliminary evidence that it has turned the corner. However, the C$ has not yet provided any evidence of a reversal.

While it is certainly possible that the C$ will make a new multi-year low before making a sustained turn to the upside, we think it makes sense to average into a 'long' C$ position with C$ futures trading below 90.

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

Updates to short-term trading positions

In the 17th February Weekly Update we wrote that for TSI record purposes we would exit the short-term position in Evolution Mining (EVN.AX) if the stock traded at A$0.96. It traded at this price on Tuesday 25th February, so this position has been removed from the TSI List. The result was a profit of 55%.

Our decision to exit this short-term trade at A$0.96 was based on the stock's price chart (see below). EVN has resistance at A$1.00, so it would be normal for the stock to do some 'backing and filling' following a quick move up to around $1.00.

After A$1.00, there is resistance at A$1.25 and then at A$1.50. We suspect that the higher of these levels will be tested by mid-year, so some corrective activity over the next couple of weeks could prompt us to initiate a new EVN short-term trade. In any case, we are maintaining long-term exposure to the stock.

    Updates to TSI Small Stocks Watch List (SSWL)

1) Geomega Resources (GMA.V), an exploration-stage miner with a tiny market cap and a huge rare-earth-element (REE) deposit in Quebec, was added to the SSWL on 3rd February this year. The share price at the time was C$0.29.

The price of this stock has since been very volatile. Prior to this Tuesday most of the volatility was to the upside, but after trading as high as C$1.06 on Tuesday morning the stock reversed downward on huge volume and ended the day at C$0.68. It then fell further to close at C$0.59 on Wednesday. This week's price action appears to be a case of "buy the rumour and sell the news", in that the downward reversal in the stock price came shortly after the release of good news in the form of positive results from additional testing of the REE separation technology being pioneered by GMA.

The fundamental story is developing bullishly and at $25M the company's market cap is still very low relative to the potential value of its REE project. However, this is obviously not a stock that should be owned by risk-averse investors or anyone who is put off by extreme stock-price volatility. Also worth noting is that the company will soon have to do an equity financing. Perhaps the financing announcement will provide the next opportunity for high-risk speculators to buy some shares.



2) On 18th September last year we added East Africa Metals (EAM.V) to the SSWL. EAM owns an exploration-stage gold project with a 1M-oz resource in Tanzania, but the sole reason for our interest in this company was that it was trading at less than half the value of its cash in the bank.

Unfortunately, the company's management has substantially changed the situation for the worse via a takeover bid for Tigray Resources, a company with negative working capital and mining claims covering some elephant pasture in Ethiopia. This takeover is ethically questionable, as the same guy is CEO of both companies (it looks a lot like a bailout of Tigray at the expense of EAM shareholders), but ethical or not it will greatly reduce the amount of cash per EAM share and in doing so eliminate the reason for our interest. We have therefore removed EAM from the SSWL.

EAM has left at the same price it entered (C$0.13).

Chart Sources

Charts appearing in today's commentary are courtesy of:

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