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Monetary Inflation Update

When it comes to publishing money-supply data, the ECB is always 2-3 weeks behind the Fed. With Europe's shorter working hours, this is probably not going to change. When it comes to depreciating money by juicing its supply, the ECB is usually years behind the Fed. In this endeavour, though, the ECB is steadily making inroads into the Fed's lead.

The following chart shows the year-over-year growth rate of euro-zone True Money Supply (TMS). The growth rate bottomed at around 1% in mid-2011, at which time there was a very real prospect of deflation. However, it then began trending upward and was at 6.1% in October of 2012. There is no longer a realistic chance of the euro-zone experiencing deflation anytime soon. In fact, further acceleration in the rate of monetary inflation is the most likely outcome over the next several months.



With the rate of US$ inflation having drifted lower and the rate of euro inflation having drifted higher over the past 12 months, the rate of growth in what we call G2 money supply (US TMS plus euro-zone TMS) has essentially gone sideways. The year-over-year change in G2 TMS is illustrated below.

Due to the Fed's QE3 program and the ECB's increasingly easy monetary policy the G2 monetary inflation rate is more likely to rise than to fall over the months ahead.



From a practical speculation standpoint, the year-over-year growth rate of G2 TMS has been the best monetary indicator over the past 12 years. This indicator's current message is that there is almost no chance of deflation or even a serious deflation scare within the next 6 months.

The Stock Market

Most stock indices dropped a little on Monday and Tuesday of this week. On Wednesday the decline was starting to build some momentum, but an upward reversal then occurred. It seems that the path of least resistance is now to the upside.

After leading to the downside from early-September through to early-November, the NASDAQ100 Index (NDX) is now leading to the upside. The current upside leadership is primarily a function of the preceding downside leadership, in that the relative strength shown by the NDX and its most important component (AAPL) over the past two weeks is largely due to how 'oversold' they had become.

As illustrated below, the NDX has quickly rebounded to its 200-day moving average. This effectively means that the 'easy lifting' has been done, but doesn't mean that the rebound from the November low is complete.



Our guess (we could say our detailed analysis of all relevant factors, but guess is more accurate) is that the stock indices will maintain an upward bias for 2-4 more weeks, with a couple of intervening multi-day pullbacks.

Gold and the Dollar

Gold and Silver

Chronically low long-term gold price forecasts

The chart displayed below was taken from a recent article at The Daily Reckoning and shows the median gold price forecasts of analysts monitored by Bloomberg. It shows that from 2007 onwards the average forecast has been for the gold price to be flat or higher over the coming 1-2 years and to then decline sharply such that the price is much lower after 4-5 years. For example, in 2007 the average forecast was for the gold price to trade at $650-$700 during the current year, move up to $750-$800 during 2008, and then decline to below $600 by 2012. They have always expected the price to be lower in 4 years than it is today. Despite being consistently wrong, they still expect the price to be lower in 4 years than it is today.

This is absolutely not the sort of sentiment that would likely be evident if gold's long-term bull market were near its end. There's a high probability, verging on a certainty, that near the end of gold's bull market the average analyst will be forecasting an upward price-trend extending many years into the future.



On a different matter, the article linked above contains some serious errors. One notable error is the assertion that China and India account for 47% of the demand for gold. To make this assertion you have to make the mistake of applying a traditional commodity-type analysis to the gold market.

With all commodities except gold the so-called stocks-to-flow ratio is relatively low, meaning that the amount of the commodity held in inventory (warehouses, storage containers, vaults, etc.) is low compared to the amount consumed in commercial processes. It is almost always less than one year and is often just a few weeks. This means that when doing a supply-demand analysis for any commodity except gold it will generally make sense to compare the current year's consumption to the current year's new production. With gold, however, the existing aboveground supply is more than 75-times greater than annual mine production. This means that if the entire gold mining industry were to shut down for a year it would not make a significant difference to total gold supply. It also means that it makes no sense to compare the amount of gold sold in a country in a year with the world's new mine supply and to use the result of this comparison as an indicator of that country's contribution to global gold demand.

A related error is to downplay the actions of the Fed. The US$ gold price is mostly determined by the general perception of what's happening and what's likely to happen to the US$, which, in turn, is mostly determined by the actions of the Fed. For example, a negative real interest rate constitutes a powerful bullish force in the gold market, but real interest rates in the US could not be negative in the absence of the Fed.

Gold is a global market and what happens to gold demand in one part of the world can have an effect on how gold is priced in another part of the world, but gold is never going to make large and sustainable gains relative to a sound currency. If, for example, the US$ were suddenly transformed into a sound currency due to the Fed making a credible promise not to further inflate the US$ supply, we have no doubt that the US$ gold price would decline to a much lower level regardless of what was happening in China and India. In this hypothetical situation the gold price would decline in US$ terms, but it wouldn't necessarily decline in terms of any other currency.

The main reason to be bullish on the US$ gold price is that the economics ignoramuses at the upper echelons of the Fed truly believe that they can help the US economy by conjuring money out of nothing. The weaker the economy becomes the more money they will create, and the more money they create the weaker the economy will become.

Current Market Situation

There were sharp intra-day declines in the gold and silver markets on Wednesday 28th November, but by the end of the US trading session the losses had been materially reduced. This was especially so in the silver market, with the nearest silver futures contract trading as low as $32.90 early in the day before recouping the bulk of its loss and ending the session at $33.78.

The following daily chart shows that silver has resistance at around $35 and then at around $37. There's a good chance that silver will test the lower of these resistance levels and a realistic possibility that silver will test the higher of these resistance levels within the next few weeks.



Gold Stocks

The HUI fell sharply during the early going on Wednesday 28th November, but then recovered to end the day with a small gain. This price action is bullish, but as warned in the past the price action during any single trading day usually doesn't provide reliable information about what the future holds in store.



The best reason to be optimistic about the gold sector's likely short-term performance is that the HUI reached an 'oversold' extreme during the week before last. This increases the probability that the sharp decline during the early part of Wednesday's trading session will turn out to be a successful test of the recent low.

GLDX, an ETF that holds junior gold mining stocks, continues to look good for a 3-5 month trade. The same applies to GDXJ, an ETF that also holds junior gold mining stocks. The difference between these two ETFs is that GLDX concentrates on companies that are at the exploration stage, whereas GDXJ's main holdings tend to be larger and less speculative. This difference is likely to result in GDXJ doing better during the first 1-2 months and GLDX doing better during the second half of the next 4-6 month gold-sector rally.



Currency Market Update

As part of the "extend and pretend" (E&P) program being run by the EZ's political and monetary leadership, a new deal to prolong the financial agony of Greece's government and banking industry was announced early this week. As reported in the article posted HERE:

"Lenders have agreed three steps to help Greece:

1) Cutting the interest rate on official loans, extend their maturity by 15 years to 30 years, and granting Athens a 10-year interest repayment deferral.

2) To return €11bn of profits accrued through the European Central Bank's purchase of distressed Greek government bonds

3) To conduct a debt-buyback scheme.

Greece will receive its aid tranche in stages, starting with €34.2bn next month. Much of the money will be used to recapitalise its banks.

That means the chatter about Athens running out of money should finally dampen down. However, this deal is only "tentative" - the IMF won't hand over its share of the money until the debt buyback has been conducted."

Details of the debt buyback scheme are expected within the next week.

The next big step in the E&P program is a formal request for a bailout from Spain's government. The financial world is likely to cheer the formal bailout request when it eventually comes because it will lead to tens of billions of additional euros being 'mobilised'.

We have been anticipating more short-term gains for the euro based largely on sentiment considerations, but the news of the day is starting to align with a short-term bullish outcome for this currency.

The following daily chart shows that the euro has resistance at 1.35 and then at 1.40. Our guess is that the lower of these resistance levels will be tested by January.

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

Financing status of exploration/development-stage gold miners

The "Gold and Silver" section of the TSI Stock Selections list contains current producers and exploration/development-stage companies. The latter are at least a year and in most cases more than two years away from having any production.

With the exception of Jaguar Mining (JAG), which is a special case that we've covered separately, the current producers are cash-flow positive and therefore self-financing. The exploration/development-stage companies, however, will burn through cash every month until they a) are purchased by a larger mining company or b) build a mine that generates cash or c) fade away to nothing. These companies rely on being able to periodically obtain fresh injections of money from 'investors', which means that they can be greatly affected by the general willingness of people to throw money at speculative ventures.

Right now the general willingness of people to throw money at speculative ventures is at a low ebb, and although the situation could (probably will, in our opinion) be very different 6 months from now there is presently no evidence that an easier financing environment is about to emerge. Consequently, anyone who speculates in the stocks of exploration/development-stage mining companies must pay close attention to the amount of cash on the balance sheet, the cash burn rate, and the ability to raise additional cash at a reasonable cost.

In the following table we have given the TSI exploration/development-stage gold miners a financial health rating of 1 through 5, where "1" indicates most healthy and "5" indicates least healthy. To be more specific, here's how our financial health rating should be interpreted:

1: Financing will probably never be a significant obstacle.

2: Additional financing will not be required within the next 12 months and will probably be available at a reasonable cost thereafter.

3: Additional financing will not be needed within the next 6 months but probably will be needed within the next 12 months.

4: Additional financing will not be needed within the next 3 months but probably will be needed within the next 6 months.

5: There is an urgent need for additional financing.

None of the companies are rated "5" at this time, but the bottom two will likely shift from "4" to "5" in Feb-Mar of next year if a financing deal isn't done in the interim.

Due to the unusually difficult conditions that now prevail, those who speculate in exploration/development-stage gold mining stocks should place more than the usual amount of emphasis on financial health (balance sheet strength and the ability to obtain additional financing at a reasonable cost as needed). That doesn't necessarily mean that companies with a poor health rating should be ignored, as there could be good reasons to take the financing risk. Just be aware of the risk when making a decision to buy/hold.

Chart Sources

Charts appearing in today's commentary are courtesy of:

http://stockcharts.com/index.html