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    - Interim Update 30th July 2003

The Long-Term Gold Bull

Below is the long-term chart of the Swiss Franc that was included in the 16th April Interim Update. We haven't bothered to update the chart because the current picture looks very much the same as it did back in April.

We used the above chart in the earlier commentary to come up with a rough target, in terms of both time and price, for the bull market in the SF that began in October of 2000. Our reasoning was simply that the SF has been in a long-term up-trend since the early 1970s, but within that long-term up-trend there have been two (completed) cyclical bull markets and two cyclical bear markets. Each of the cyclical bull markets reached the top of the long-term upward-sloping channel and lasted 8-10 years while each of the cyclical bear markets ended at the channel bottom and lasted 6 years. If we assume that this cyclical behaviour is going to continue, an assumption that seems reasonable given the price action of the past 3 years and the dollar's poor fundamentals, then the SF will peak in the 2008-2010 period at a SF/US$ rate of greater than 1. In other words, we think the bear market in the US$, relative to the SF, is presently less than half over in terms of both time and price.

Now, as we've explained on many occasions in the past, there is a high positive correlation between the gold price and the SF. We expect this positive correlation to continue, so on this basis it is probable that the long-term trend for gold will remain bullish until 2008-2010. 

Despite the high positive correlation between gold and the SF which has, by the way, been as strong over the past 2 years as it has been at any time over the past 30 years, the long-term gold chart looks different from the long-term SF chart shown above. This is perhaps because gold is a less-liquid market and therefore tends to make larger moves in both directions. In any case, the below chart shows that gold, like the SF, has been in a long-term bull market against the US$ since the early 1970s and that another leg in gold's long-term bull market began over the past 3 years. As opposed to a steady progression within an upward-sloping channel, as has been the case with the SF, gold's long-term chart can best be described as a 5-wave structure. The way we see it, Wave 3 was complete at the 1980 blow-off top, Wave 4 was complete at the 1999 bottom, and Wave 5 to a new all-time high is currently underway.

It is important to keep the above 'big picture' views in mind at all times and to continue checking the evidence against these views to make sure they remain valid. However, it really isn't enough to simply understand that the gold price is probably going to reach a long-term peak in 5-7 years time. This is because at some point there is probably going to be a large counter-trend move lasting 1-3 years, which, unless you are a masochist, you will want to avoid. For example, the SF rose strongly during the 1972-1975 period, but then spent 2-3 years trading sideways before rocketing higher to its major peak. And, during this period of currency market stability that occurred between the two big dollar declines of the 1970s the gold price fell by around 50% and the average gold stock fell by around 70%. If you are an investor in gold and gold stocks at the present time it is therefore important to understand what could bring about a multi-year period of stability in the currency market. 

In the latest Weekly Update we discussed the role that the Fed will potentially play in bringing about a lengthy period of currency market stability. The driving force behind gold's bull market is falling confidence in the US$ in particular and fiat currency in general, but no market moves from the point of maximum confidence to the point of minimum confidence in a straight line. We are therefore anticipating that a substantial counter-trend move in 'dollar confidence' will begin at some point over the next 12 months. As discussed in the Weekly Update, such a period is likely to begin when the markets come to believe that the Fed has a handle on the inflation problem.

The US Stock Market

The 1987 Comparison

There are some striking similarities between the current market environment and the environment during the months leading up to the 1987 stock market crash. However, there are also enough important differences to all but guarantee that what happens in the markets over the next 6-12 months will be very different to what happened during 1987-1988. We don't have time to go into any detail on this topic now, but we'll cover it in the next Weekly Market Update.

Current Market Situation

We expect that the NASDAQ100/Dow ratio will drop below its 70-day moving average during the early stages of the next MAJOR decline. Conversely, any decline that does NOT result in the NDX/Dow ratio moving below its 70-day MA will probably not evolve into anything more serious than a correction within an on-going up-trend. The below 2-year chart of the NASDAQ100/Dow ratio indicates that there is not, as yet, any reason to get excited about the prospect of a major decline.

The below chart shows that the Dow Industrials Index has now been trading sideways for about 2 months. When a market trends strongly in one direction and then becomes essentially trendless for an extended period, the next big move is usually in the direction of the preceding trend. In the Dow's case this would mean that the next big move would be to the upside.

As has been the case now for 2-3 months, sentiment indicators are consistent with a major peak being close at hand. Price action, however, indicates that one final upward burst is probably going to occur BEFORE a major peak is in place. If the Dow breaks out to the upside in the near future then a major peak would probably be in place before the end of August. However, a downside breakout from the recent consolidation would potentially extend the overall advance by a couple of months. In either case we expect that the market will be trading well below its current level by the end of the year.

Bonds

After a market reaches a long-term peak it is normal for the initial sharp decline to be followed by a substantial rebound before a long and relentless downtrend gets underway. Our view is that bonds reached a long-term peak in mid-June and that the drop, to date, has been the initial sharp decline mentioned above. The initial decline following a major peak often ends about 2 months after the peak, so it is possible that the first important bottom in the bond bear market won't occur until around mid-August. In terms of price, though, the initial bond market decline has already exceeded our expectations.

The below chart shows the yield on the 30-year T-Bond, which is effectively the inverse of the bond price (whereas the bond price experienced an upside blow-off during May-June, the bond yield experienced a downside blow-off). The chart shows a rough projection of what we expect to happen in the future based on the typical post-major-peak pattern described above and the tendency of bond yields to reach a low during the final quarter of the year.  

On the above chart we've allowed for one final upward spike in the bond yield (downward spike in the bond price) into mid-August prior to a substantial correction getting underway. However, given that the bond yield has exceeded the most likely upside targets for its initial advance there's a reasonable chance that an intermediate-term peak is already in place. The stock market certainly seems to be operating under the assumption that a yield peak is close at hand because the interest rate sensitive stocks have performed quite well over the past week. For example, the S&P Homebuilding Index bottomed more than one week ago, Real Estate iShares made a new 52-week high on Wednesday, and the Dow Utilities Index has held above the important support that exists at 231.

Gold and the Dollar

Gold Stocks

In the latest Weekly Update we said that a move above 0.50 by the HUI/gold ratio would be a warning sign that risk in the gold sector was approaching a dangerous level and, therefore, that it would be time to start lightening-up on gold stocks. The ratio hit a peak of 0.47 on Monday and is likely to move higher after the current correction is complete. However, even at 0.47 the ratio is at a level where it is not reasonable to expect much additional upside in the MAJOR gold stocks RELATIVE TO the gold price. For example, based on technical considerations we think Newmont Mining (NYSE: NEM) will trade at $40 before the end of this year and $50 within 12 months, but such gains from its current price of around $35 will probably require roughly-equivalent percentage gains in the gold price. Another way of putting this is that the major gold stocks such as NEM currently don't offer much leverage to the gold price because the leverage they did have has been priced out. 

The high prices of the major North American gold stocks relative to the gold price has been a consistent problem for more than 12 months now and is one of the main reasons we chose to focus on the junior gold companies. Unlike the NA majors, many of the NA juniors offer huge leverage to the spot gold price. 

If you feel uncomfortable investing in the junior gold stocks then you should perhaps consider buying physical gold rather than investing in the major gold stocks. This is because the percentage gains achieved by the bullion will probably be only slightly less if gold's uptrend continues, while the downside risk is much lower than it is with the gold stocks.

Current Market Situation

Below is a daily chart of August gold futures. In the e-mail alert sent to subscribers following Monday's trading action we said that a short-term peak had probably just been put in place in the gold market and that a drop to around $355 was likely over the next 1-3 weeks. As noted on the below chart we don't think there is substantial downside risk in the gold price from its current level, but suspect that more time will have to elapse before the next sizeable advance gets underway.

In the above-mentioned e-mail alert we also said: "Silver broke above the important resistance at 4.90 last week and has just surged above last year's peak. In doing so it has probably also created a short-term peak. Obvious upside breakouts are often followed by pullbacks of sufficient magnitude to punish the 'buy the breakouts' crowd. In silver's case a pullback over the next few weeks to 4.90, or perhaps a bit lower, would be normal."

With regard to the AMEX Gold BUGS Index (HUI), a pullback to the former resistance in the 154-157 range would be normal.

Our view is that the recovery rally in the Dollar Index peaked about 2 weeks ago and that the rebound that has occurred over the past few days will, at best, result in a test of the peak reached earlier this month. A daily close below $350 in August gold would, however, cause us to re-think this view.

Update on Stock Selections

Below are charts of the three stocks added to the Stocks List at the beginning of this week. Our reasons for adding these stocks were summarised in Stock Selection Update #1, which was e-mailed to paid-up subscribers prior to the start of trading on Monday and has now been archived at http://www.speculative-investor.com/new/stockemail.asp.

Below is a 3-year daily chart of Ivanhoe Mines (TSX: IVN). IVN has been trending higher for a few years but had been in a consolidation range for much of the past 18 months. We generally prefer NOT to buy after a stock has just moved up to near important resistance, which was where Ivanhoe's stock price was situated at the end of last week, but we thought the risk of an upside breakout from its long-term consolidation was high enough to warrant taking at least an initial position in the stock at around C$3.70. The stock subsequently did breakout to the upside and is now likely to hold above 3.70 during future pullbacks.

Below is a 1-year chart of Northern Orion Resources (TSX: NNO). The massive stock dilution that occurred a couple of months ago has now been mostly factored into the market and the NNO stock price appears to be on its way to higher levels. There might be some downward pressure over the next week or so because the shares that were issued to finance the purchase of a 12.5% stake in Alumbrera are now able to be traded, but any weakness should be considered as a buying opportunity.

Below is a 2-year chart of Metallica Resources (OTC BB: METLF, TSX: MR). METLF has spent much of the past 18 months oscillating within the 0.80-1.20 range, although it moved above trend-line resistance earlier this week. In the absence of any market-moving news from the company we would expect the stock to hold in the 0.95-1.00 range during the current pullback. The biggest risk with this stock, though, is that the company will almost certainly raise about US$40M via the issue of new equity at some point over the next several months in order to finance the construction of a mine. Ideally, the equity-financing won't be done until after the stock price has moved considerably higher. However, if the stock is still around current levels when the financing is done then the total number of outstanding shares in the company would more than double and this, in turn, would send the share price down to a much lower level. Our guess is that the stock would trade down to around 0.75 if the equity raising were done now. This would, though, create a wonderful and probably short-lived buying opportunity because the stock represents excellent value at its current price of around US$1.06. Our approach would be to take an initial position now and to buy more after the financing is announced.

As an aside, shareholders in small mining companies sometimes complain when a company in which they own shares does a private placement of new equity, that is, when the company issues a bunch of new shares in order to raise money. However, people should understand that the ONLY way most exploration and development stage companies can obtain additional funds is to issue additional equity. Companies that don't yet have operational mines have no revenue, so debt-financing is usually not possible and nor would it be advisable even if it were possible. The best that the management of these companies can do is to time any private placements to coincide with periods of stock-price strength.

We expect that almost all the junior gold/silver companies in the TSI Stocks List will do a private placement of new equity over the next 12 months and some of the companies will do multiple placements. If all goes according to plan then each new placement will be done at a significantly higher price than the previous placement. For example, Aquiline Resources did a placement at C$0.25/share in April. It has recently announced a placement at C$0.65/share and the NEXT placement will hopefully be done at more than C$1.00/share.

Below is a chart of Alcoa (NYSE: AA). AA was stopped out of the TSI Stocks List a couple of weeks ago, but the recent price action in AA and a few other large-cap commodity-cyclical stocks prompted us to add copper plays IVN and NNO to the List. A surge in the commodity-cyclicals over the next few months looks likely.

Below is a chart of International Paper (NYSE: IP). A close above $40 would decisively break a 3.5-year downtrend in this stock and suggest that a large rally was underway. We've previously added the IP January-2004 $50 call options (IPAJ) to the Stocks List as a speculation that IP would manage to break out and move sharply higher. These options, which last traded at $0.10, are still a reasonable speculation, as are the IP January-2004 $45 call options which last traded at $0.40. As previously advised, any money risked in purchasing out-of-the-money options should be money that can be written off without losing a minute's sleep. 

Chart Sources

Charts appearing in today's commentary are courtesy of:

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

 
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