- Interim Update 10th October 2018

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Monetary inflation around the world, continued

The monetary situation in Canada is consistent with the theme that monetary inflation rates are low and/or declining across the developed world. As illustrated below, the year-over-year rate of growth in Canada's M1++ money supply (a reasonable proxy for TMS) recently hit a 15-year low. Like Australia, Canada is now in danger of experiencing monetary deflation. Also like Australia, Canada has a real-estate investment bubble that is acutely vulnerable to the reduced rate of monetary inflation.

The fact that interest rates are still low in real terms in almost every country creates the impression that the monetary backdrop is still accommodative, but that impression is wrong. Monetary conditions are now tighter than they have been in a long time.

The global tightening of monetary conditions eventually will set in motion large declines in asset prices. This will cause central banks to reverse course and in some cases reintroduce quantitative easing (QE), even though the perceived need for more QE will be clear-cut evidence that the earlier QE was a failure.

That being said, it doesn't make sense to start anticipating more QE at this time. There will be some major market moves before QE rears its ugly head again.

Vanadium Moonshot

In January of this year we wrote:

"At the present time more than 90% of the world's production of vanadium is used in steel alloys. This particular use of vanadium could grow due to, for example, China's government imposing new regulations requiring the use of stronger steel reinforcement bar (rebar) in concrete structures, but our interest in vanadium isn't related to its use as a steel strengthener. Our interest stems from the possibility that the consumption of vanadium will grow rapidly over the next several years due to the increasing popularity of Vanadium Redox Batteries (VRBs).

VRBs are heavy and bulky, so they can't be used in EVs [electric vehicles]. However, they are well suited for grid-level energy storage. This is because a) their energy capacity is only limited by the size of their storage tanks, b) they can be completely discharged for long periods with no performance degradation, c) they experience almost no capacity degeneration over time, and d) they are very stable.

The interest in VRBs is ramping up and so, as illustrated by the following two charts, is the vanadium (V2O5) price. The first chart covers the past three years and shows that the price is up from around $7/pound at this time last year to around $25/pound today. The second chart extends back to 1980 and shows that the current price roughly matches the all-time high achieved in 2005.

Unlike vanadium's surge to around $25/pound in 2005, the current surge should have staying power. There will, of course, be a substantial correction at some point, but we expect that the V2O5 price will make higher highs and higher lows over the coming few years. The difference is the progress that has been made with the development of VRBs and the perceived need for efficient grid-level energy storage to make 'clean' power generation more feasible.

Prophecy Development Corp. (PCY.TO), a member of the TSI Small Stocks Watch List, offers exposure to vanadium via its Gibellini project in Nevada. Based on a PEA completed earlier this year, Gibellini's economics were very positive (51% IRR) at around half the current vanadium price.

Despite its leverage to the vanadium price, for a while it looked like PCY was going to sit out the entire vanadium rally. However, the stock has suddenly started to draw some attention and has tripled in price -- from a very low level -- over the past two weeks.

PCY had very significant news on Wednesday. It announced that Gerald Panneton had been recruited as President and Chief Executive Officer, replacing John Lee who will remain as Chairman of the Board. Mr. Panneton is the founder of Detour Gold, a mid-tier gold producer, and was Detour's CEO from 2006 to 2013. This constitutes a major strengthening of the management team and should elevate the company's profile.

PCY is clearly 'overbought' on a short-term basis, but its valuation is very low. Its C$28M market cap (78M shares at C$0.35/share) is a small fraction of the current NPV of the Gibellini project.

The Stock Market

Current Market Situation

Many people will characterise the US stock market's plunge on Wednesday 10th October as a crash, but at this time the decline from the peak barely qualifies as a correction (the SPX is down by about 5% from its all-time high). The Dow Industrials Index (Dow) was down by 830 points on Wednesday, but these days an 800-point move in the Dow is only about 3%. That being said, some important support levels have been breached and the decline that got underway in early-October could evolve into a crash or at least a far more serious correction.

Let's take a look at some charts that reveal the breaches of support levels that have just occurred and also the support levels that are now being threatened.

The SPX consolidated by moving sideways over the first two days of this week. On both days it closed above its 50-day MA and important lateral support near 2870. On Wednesday, however, it not only broke through the aforementioned support, but also broke below the bottom of the channel that defined its progress over the past 6.5 months.

The next support is the 200-day MA, which is less than 1% below Wednesday's close. The 200-day MA limited the downside during the early-2018 correction.

The Dow Industrials and Dow Transportation indices had classic false breakouts above obvious resistance levels -- in September for the Transports and early-October for the Industrials. The Transport index now has broken decisively below its 200-day MA, a development that distinguishes the current decline from those that happened earlier this year. The Industrials index has broken below its 50-day MA, but remains comfortably above its 200-day MA.

The Russell2000 SmallCap Index (RUT) ended last week precariously poised at its 200-day MA and lateral support defined by its January-2018 high. This support held during the first two days of the new week, but the first of the following daily charts clearly shows that it was broken in a definitive manner on Wednesday. As is the case with the Dow Transports, this distinguishes the current decline from those that happened earlier this year.

The second of the following daily charts shows that Wednesday's sharp decline ended at longer-term support (the bottom of a 2-year price channel).

The NASDAQ100 Index (NDX) achieved a minor downside breakout when it closed below its 50-day MA at the end of last week. On Wednesday of this week it plunged to the more important support offered by its 200-day MA.

So, the SPX and the NDX ended Wednesday's session at or slightly above their 200-day MAs while the RUT is now testing the bottom of its 2-year channel. Also, by some measures the market is already at an 'oversold' extreme. For example, the SPX's daily RSI(14) is at its lowest level since August-2015. This could result in the US stock indices making at least 1-2 week bottoms as soon as Thursday 11th October, perhaps following spikes below the aforementioned support levels.

At the same time, short-term fear indicators are not yet close to the sorts of extremes that often precede or coincide with the lows of significant corrections. The Volatility Index (VIX), for example, has risen only to the low-20s. This suggests that an immediate reversal to the upside wouldn't be sustainable.

The downward move that got underway in some stock indices and accelerated in other stock indices over the past week is about fundamentals and sentiment. On the 'fundamentals front', our Equity True Fundamentals Model (ETFM) most recently turned bearish on 7th September, so the overall fundamental backdrop turned bearish for equities then. It remains so today. Of greater importance, the bond market broke out to the downside (bond yields broke out to the upside) last week. This ramped up the downward fundamental pressure on equity prices.

On the 'sentiment front', our put/call indicator generated a rare sell signal on 26th September. Despite the recent stock market sell-off, this indicator is still much closer to its sell zone than its buy zone.

Possible Short-Term Outcomes

One possibility is a correction low within the next few days. This will be most likely if the SPX's decline extends well beyond its 200-day MA -- perhaps to as low as 2650 -- without more than an intervening 1-day bounce.

A second possibility is an interim low within the next three days and within 3% of Wednesday's close, followed by a 1-3 week rebound and then a decline that tests the October low in November. In this scenario, taking out the October low could lead to a crash.

What to do?

We don't pretend to know what anyone else should do, because each person's financial situation, experience and risk tolerance is different. However, we do provide ideas.

For example, in the latest Weekly Update we wrote: "For those looking for an opportunity to enter a bearish short-term stock market trade (via options or inverse index funds), we would view a rebound early this week as such an opportunity." The intra-day rebounds on Monday and Tuesday could have been used to establish positions.

Although there is a good chance of at least a brief extension of the plunge, we don't think that this is the right time to add to bearish exposure. On the contrary, we took profits on most of our SPY October put options near the close of trading on Wednesday 10th October due to the SPX's proximity to its 200-day MA and will exit our remaining October puts within the next 2 days.

Apart from getting out of October options ASAP, what we do from here will depend largely on the amount of additional weakness. For example, we will exit our SPY December puts if the SPX drops to the mid-2600s within the next few days.

A 1-2 week rebound could create a new opportunity to enter bearish speculations, but we will cross that bridge when we come to it.

Gold and the Dollar


Gold sentiment revisited

The following chart shows that the Consensus-inc bullish percentage for gold (the percentage of brokerage house analysts and independent advisory services monitored by Consensus that are bullish on gold) remains near its low of the past two months. This means that it remains near its lowest level since 2004 and its second-lowest level in 17 years. In other words, gold sentiment remains near a pessimistic extreme based on the past 17 years.

However, the chart also shows that the current sentiment situation is not extreme relative to what happened during the 1980s and 1990s. Whereas bullish-percentage moves below 30% have been rare, shallow and short-lived over the past 17 years, during the 1980s they were commonplace and sometimes deep. Moreover, during the 1980s the bullish percentage spent a significant amount of time below 20.

We mention this to reiterate the point that one of the pitfalls of using sentiment to identify buying and selling opportunities is that what constitutes an extreme depends on the long-term price trend. Of particular relevance to gold, what constituted an extreme low for bullish sentiment over the past 17 years will not necessarily constitute an extreme low for bullish sentiment in the future.

Current Market Situation

The US$ gold price fell $17 on Monday and then drifted sideways. This price action does not look significant. Also, the stock-market volatility has improved the fundamental backdrop (from gold's perspective), but by nowhere near enough at this stage to make a difference.

Further to the above, gold's situation now is essentially the same as it was when we published the latest Weekly Update. Consequently, this comment from the Weekly Update remains applicable: "Our guess is that the gold price will extend its counter-trend rebound over the weeks ahead, but be aware that until there is a daily close above $1220 there will be a significant near-term risk of a decline to a new low for the year."

Gold Stocks

In the latest Weekly Update we wrote that a decline in the broad stock market shouldn't pose a threat to the gold-mining indices unless it develops into a crash. All equities would get clobbered in a crash, but the gold-mining sector can benefit from non-crash-like weakness in the broad stock market. That's especially so when the gold sector is depressed prior to the start of the weakness in the broad market.

Even though the gold price was flat, the gold-mining indices and ETFs held up well during Wednesday's broad market sell-off. As illustrated below, GDX is roughly unchanged since the end of last week.

Gold Fields Ltd. (GFI), a major gold producer that we are focused on at the moment, is beginning to outperform and achieved a marginal upside breakout on Wednesday (see chart below). If Wednesday's breakout is maintained over the final two days of this week, it will suggest a near-term target of US$3.00.

It still appears as if a) the gold-mining sector is basing and stands a good chance of rallying over the next few weeks, b) the rally from the September low is another counter-trend move within a longer-term bearish trend.

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

More information about last week's crash in the Golden Arrow (GRG.V) stock price

In the latest Weekly Update we wrote: "On Wednesday of last week the GRG stock price plummeted from C$0.35 to C$0.23 and then recovered to around C$0.30 on the highest daily trading volume in 5 years and the second-highest daily trading volume in the stock's history...

...There was no news to explain the action and we suspect that it had nothing to do with any company-specific developments. Our best guess is that it was due to an institutional shareholder dumping its stake for tax purposes."

Thanks to information provided by one of our readers (thanks JR), we now know what caused the 'out of the blue' high-volume plunge in the price of GRG shares immediately after the start of trading on Wednesday 3rd October. It was caused by a sell recommendation by a widely followed newsletter. Specifically, until last week GRG was one the "Favourite Five" silver-mining stocks recommended by John Doody's Gold Stock Analyst (GSA) newsletter. After the close of trading on 2nd October, GSA called "sell" on the stock. This caused an avalanche of selling when trading commenced the next day.

Significantly, Joe Grosso, GRG's chairman, was a buyer during the sell-off. Mr. Grosso bought 450K shares during 3rd-5th October.

Chart Sources

Charts appearing in today's commentary are courtesy of: