Big Picture View

Here is a summary of our big picture view of the markets. Note that our short-term views may differ from our big picture view.

In nominal dollar terms, the BULL market in US Treasury Bonds that began in the early 1980s will end by mid-2010. In real (gold) terms, bonds commenced a secular BEAR market in 2001 that will continue until 2014-2020. (Last update: 09 February 2009)

The stock market, as represented by the S&P500 Index, commenced a secular BEAR market during the first quarter of 2000, where "secular bear market" is defined as a long-term downward trend in valuations (P/E ratios, etc.) and gold-denominated prices. This secular trend will bottom sometime between 2014 and 2020. (Last update: 22 October 2007)

A secular BEAR market in the Dollar began during the final quarter of 2000 and ended in July of 2008. This secular bear market will be followed by a multi-year period of range trading. (Last update: 09 February 2009)

Gold commenced a secular bull market relative to all fiat currencies, the CRB Index, bonds and most stock market indices during 1999-2001. This secular trend will peak sometime between 2014 and 2020. (Last update: 22 October 2007)

Commodities, as represented by the Continuous Commodity Index (CCI), commenced a secular BULL market in 2001 in nominal dollar terms. The first major upward leg in this bull market ended during the first half of 2008, but a long-term peak won't occur until 2014-2020. In real (gold) terms, commodities commenced a secular BEAR market in 2001 that will continue until 2014-2020. (Last update: 09 February 2009)

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Outlook Summary

Inflation Update

Money Confusion

The total supply of US dollars, as measured by TMS, is about 10% higher now than it was a year ago. Also, the total amount of credit within the US economy is higher now than it was a year ago thanks to the government's yeoman-like efforts to replace the bursting private-sector credit bubble with a public-sector credit bubble. With the supply of money and credit continuing to expand -- at an accelerated pace, in the case of the money supply -- you have to be inventive in order to make an argument that the US is experiencing deflation. You must either argue that non-monetary quantities such as collateralised debt securities and other derivatives form part of the money supply, which is the tack taken by the author of the article posted HERE, or argue that a decline in the combined market value of debt counts as deflation, which is what Mike Shedlock routinely does at his web site. Neither argument is valid, in our opinion.

The idea that collateralised debt and other products of the "shadow banking system" constitute money holds no water because you can't use these things to buy goods and services. If you don't believe us, try handing an ABS (Asset Backed Security) to the person at the Walmart checkout and see how far you get. Securities of various types can be posted as collateral when purchasing other investments, but that just means they have perceived value, not that they are money. Money is the general medium of exchange.

The idea that a decline in the market value of debt constitutes deflation boils down to defining deflation in terms of prices (the price of debt, in this case). However, the market values of debt and other investments rise and fall for many reasons, some of which are related to inflation/deflation and some of which aren't. The point is that a decline in the market value of anything (including debt) does not, in and of itself, constitute deflation.

What we have observed in the financial world over the past year are the symptoms of a bursting credit bubble. Such an event creates an enormous deflationary bias, but up until now this bias has been more than offset by the inflationary biases built into today's monetary and political systems.

Rising Fear of Inflation

Suddenly, the financial world is again fretting about inflation. Or, to put it more aptly, the financial world is again becoming excited by the prospect of rising prices (most people believe that inflation is equivalent to rising prices and that rising prices are good).

One of the strange things about the way the financial world tends to work these days is that the general level of fear/excitement about inflation moves inversely to the actual rate of monetary inflation. This happens because a) very few people understand what inflation is, and b) the monetary authorities react to the lagged effects of inflation rather than the inflation itself. To be more specific, economic weakness and/or rapid declines in asset prices cause almost everyone (the public, professional money managers, economists, most journalists and newsletter writers, the central bank and the government) to become concerned about deflation, which prompts policies designed to rapidly increase the money supply. Due to the normal lead-lag relationship between changes in the money supply and changes in prices, the initial phase of this rapid monetary inflation is usually accompanied by a further reduction in prices, which leads to heightened fear of deflation. Some time later the INEVITABLE effects of the money-supply growth begin to emerge, but by then the rate of monetary inflation has tapered off. As time goes by the increasingly blatant effects of the preceding money-supply growth lead to the widespread perception of an inflation problem and to more restrictive monetary policies, even while the actual inflation (money-supply growth) rate shifts to a relatively low level.

The inverse relationship described above is exemplified by last year's events. Recall that 12 months ago the fear of inflation was palpable. This fear was a reaction to the combination of rising bond yields, a falling US$, a very strong oil market and sharp rises in goods/services prices, but it was occurring at a time when the rate of monetary inflation was low and had been low for quite a while. Our view at the time was that the stark mismatch between inflation reality and inflation perception created substantial downside risk for commodities and the potential for multi-month rallies in the bond market and the US$. Moreover, by July-August of last year we were talking about the likelihood of a deflation scare. But despite our concerns at the time, it turned out that we were actually UNDER-estimating the downside risk in commodities and the speed with which fear of inflation would transmogrify into fear of deflation.

Naturally, the fear of deflation that overtook the financial world last September-December provoked a massive inflationary response from the central banking community, leading, as usual, to the fear of deflation peaking at around the same time as the rate of monetary inflation was probing its highs of the past 20 years.

Equally naturally, the effects of the September-December monetary binge have recently started to become evident in some prices, causing the public's attention to shift from the so-called deflation monster to the potential for an inflation problem. And this is going on even though the rate of monetary inflation has since tapered off (M2 money supply has expanded by 2% -- equivalent to a relatively modest 5.2% annualised growth rate -- since the beginning of this year, and has not expanded at all over the past two months).

In 2008 the perceived inflation threat continued to grow until July, thanks largely to a relentless upward trend in the oil price. Perhaps it will do the same again this year, but it would be risky to bet on it given the remarkable speed with which financial-market sentiment is now swinging from one extreme to the other.

Our view is that a major inflation problem is growing like a cancer within the US and global economies, but another deflation scare is likely during the second half of this year in response to another round of asset price declines and de-leveraging.

Bonds

Natural Gas

The Stock Market

Current Market Situation

The financial world loves a weak US dollar. What we mean is that the investment demand for growth-oriented investments such as equities has tended to rise in parallel with a weakening dollar and fall in parallel with a strengthening dollar. This is clearly evident on the following chart comparison of the S&P500 Index (SPX) and the Dollar Index. Notice that important peaks and troughs in the US$ over the past year have invariably coincided with important troughs and peaks in the SPX.

It's very likely that the start of the next multi-month stock market decline will coincide with the start of the next multi-month US$ rally.

Even though the SPX and the Dow are yet to exceed their early May highs, it is beginning to look like a significant top is not yet in place. Here's why:

1. The NDX has been the leading senior stock index over the past several months and the NDX ended last week at a marginal new 6-month high

2. The Dollar Index made a new low for the year on Friday

3. Gold has not yet begun to strengthen relative to industrial commodities

4. The price patterns for both the SPX and the Dow now look more like short-term consolidations than short-term tops

If the SPX and the Dow soon confirm the NDX's recent move to a new multi-month high then there will probably be a minimum of 2-3 weeks of additional upside in store for the overall market. Alternatively, a daily close below 880 by the SPX would indicate that a short-term, and possibly an intermediate-term, top is in place.

In light of the above, we have upgraded our short-term stock market outlook from "bearish" to "neutral".

This week's important US economic events

Gold and the Dollar

Gold and Silver

The Yield-Spread and the Boom/Bust Cycle

For some reason many analysts view a widening yield-spread (a steepening yield curve) as bullish and a contracting yield-spread (a flattening yield curve) as bearish, but it's actually the other way around. Specifically, a widening trend for the yield spread (long-term interest rates rising relative to short-term interest rates) tends to be associated with the bust phase of the central-bank-created boom/bust cycle, whereas a narrowing trend for the yield spread (short-term interest rates rising relative to long-term interest rates) tends to be associated with the boom phase.

In the following chart the yield-spread is represented by the TYX/FVX ratio (the 30-year T-Bond yield divided by the 5-year T-Note yield). The vertical lines on the chart mark the boom-bust transitions.

Strangely, most of today's economists and market analysts see nothing inherently wrong with the huge oscillations in the yield-spread depicted below. It doesn't occur to them that under a stable monetary system there would never be much difference between the risk-free short-term interest rate and the risk-free long-term interest rate. 

Gold performs well relative to industrial commodities during the bust phase of the cycle and relatively poorly during the boom phase. A sort of 'mini boom' has been in progress since March, with the yield-spread contracting and gold under-performing most other commodities.

Current Market Situation

As the investing community becomes increasingly confident that the economy will enter a new growth phase during the second half of this year, gold is losing its appeal relative to most other commodities. For example, the following chart shows that gold is in a downward trend relative to silver.

The next chart shows that silver is approaching intermediate-term resistance at US$16.

If our economic outlook is close to the mark then silver should now be close to an intermediate-term peak in both gold and US$ terms. There is no evidence yet that the recent trends are complete, but in our opinion the current environment is providing a good opportunity for investors to shift from silver into gold.

The June gold futures contract broke above short-term resistance at $960 last week and appears to be headed for a test of its February peak (just above $1000). The possibility that gold is about to make a sustained break above $1000 is generating considerable excitement and has resulted in the speculative net-long position in COMEX gold futures rising to a new high for the year. At the same time, though, gold is doing nothing in real terms (relative to other commodities, that is) and very little in euro terms. For example, the following chart of gold/euro does not look particularly bullish.

Gold is actually doing exactly what it should be doing given the overall sentiment backdrop. Optimism about economic prospects has been increasing, so the US$ gold price has been doing little more than reflecting the decline in the Dollar Index.

We think gold will do extremely well over the next year, and over the next 2 years, and over the next three years, relative to pretty much everything, but in the short-term we don't see a good reason to expect it to do much more than test its February peak.

Gold Stocks

Changes in the real gold price drive profit margins in the gold mining business and therefore have a much greater influence on gold stock prices over the long-term than do changes in the nominal gold price. However, changes in the nominal gold price are much more important in the short-term.

The top section of the following monthly DecisionPoint.com XAU chart shows that the XAU ended last week at long-term resistance. The middle section of the chart shows that the monthly Price Momentum Oscillator (PMO) is in the process of turning upward. And the bottom section of the chart shows that the XAU is still at a low level relative to the gold price.

Last week's upward acceleration in the gold sector has resulted in the AMEX Gold BUGS Index (HUI) moving to near its highs of the past decade RELATIVE TO its 50-day moving average (it ended last week 22% above this moving average). This increases the risk that an intermediate-term peak is close at hand, especially considering that we are still within the May turning-point window (since the beginning of the long-term bull market there have been several important gold-sector turning points between the first week of May and the first 2 trading days of June). Consequently, we have downgraded our intermediate-term outlook from "bullish" to "neutral".

The most plausible intermediate-term bearish scenario goes something like this: The rally that began in mid April is the final leg of the intermediate-term advance that began last October. This rally, which is now close to an end, will be followed by a correction that will most likely bottom during October-November of this year in the vicinity of the HUI's 200-day moving average.

Alternatively, it is possible that the sideways movement in the HUI between mid-December and mid-April effectively reset the clock, meaning that the rally of the past 6 weeks is just the first upward leg of a NEW intermediate-term advance.

Due to last week's upward acceleration we think the odds are now slightly in favour of the intermediate-term bearish scenario. However, under either scenario the HUI will trade at or below its 50-day moving average within the next 2 months. This could be accomplished via a quick downward correction over the next few weeks, but given that the 50-day moving average is now rising at the rate of about 8 points per week it could also be accomplished by the HUI rising further over the coming 2-3 weeks and then pulling back over the ensuing 4-6 weeks to near its current level.

For own accounts we did some buying last week from amongst the micro-cap gold/silver stocks mentioned in the latest Interim Update, and did some partial profit-taking during the Thursday-Friday surge within the ranks of the larger/more-liquid juniors that have recently had big run-ups (stocks such as WGW, NGD and NXG). However, we were net sellers. Also, we have a few above-the-market sell orders in place with the aim of raising even more cash if there's an extension of 'the surge' over the coming week or so.

It's almost a mechanical process for us. We methodically scale into our favourite gold/silver stocks during extreme weakness or following long periods of dormancy and then methodically scale out during extreme strength, all the while maintaining sizeable core exposure to the gold/silver sector in line with the long-term bullish trend. 

Update on Stock Selections

(Note: 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)

Fortuna Silver (TSXV: FVI). Shares: 92M issued, 111M fully diluted. Recent price: C$1.01

An interview with Simon Ridgway, FVI's Chairman, has been posted at http://caseyresearch.com/displayXl.php?e=true. This interview contains a good summary of the FVI story.

The interview also covers Radius Gold (TSXV: RDU), another company in the Ridgway stable. We currently don't know much about RDU, but we might be forced to learn about it because a future takeover of RDU by FVI is a possibility.

    Northgate Minerals (AMEX: NXG, TSX: NGX). Shares: 256M issued, 263M fully diluted. Recent price: US$2.41

The TSI Stocks List contains two NXG positions -- a short-term trading position and a longer-term holding. In the 20th May Interim Update we said we would exit the short-term position if the stock traded at US$2.40, which it did late last week. The profit on the trade was 64%.

    New Gold (AMEX: NGD, TSX: NGD). Shares: 348M issued, 436M fully diluted. Recent price: US$3.10

When NGD was pummeled down to below US$1 per share last October we explained that our worst-case valuation for the stock was US$3.20. In a number of subsequent commentaries over the ensuing few months we stated that US$3.00-US$3.50 was a reasonable upside target for the first half of this year based on our worst-case valuation and the price chart. This target range has just been reached and an opportunity to take some money off the table is therefore at hand.

A valuation for the new NGD (the NGD-WGW combination) of around US$4.00/share was outlined in the 9th March Weekly Update. This is not a worst-case assessment, but it is still based on conservative assumptions.

    We have been running a 15% trailing stop on our Great Basin Gold (AMEX: GBG) trading position, but are now tightening the trailing stop to 10% (based on closing prices, as before). We are also initiating a 10% trailing stop on our Hecla Mines (NYSE: HL) trading position (based on closing prices).

    Constructive Equity Financings

Keegan Resources (TSX and AMEX: KGN) and Andina Minerals (TSXV: ADM) have either just completed (in KGN's case) or will soon complete (in ADM's case) equity financings that will leave the companies fully funded for at least the next 12 months. Neither company found it necessary to issue warrants to encourage participation in the placements, which is a good sign. Both companies are likely takeover candidates, but we hope that the inevitable takeover bids will not arrive until after the stock prices have reached much higher levels.

Of the two companies, KGN will probably have the more exciting (from the market's perspective) news flow over the remainder of this year because it is in the "sweet spot"*. However, its stock price is more extended and closer to intermediate-term resistance, thanks to a 500% rise from the Q4-2008 low.

ADM is a candidate for new buying near its current price (C$1.70) and especially if it pulls back to the C$1.50s.

    *From the mine development risk profile included in the 2nd February 2009 Weekly Update: "Post-discovery exploration / pre-feasibility (Stage 2) is what we think of as the 'sweet spot'. In this stage the company has proven that it has an attractive deposit on its hands; it's just a question of how big. Companies that are in Stage 2 tend to issue drilling results on a regular basis and each set of results tends to be good. At the same time there is minimal scope for negative surprises such as cost increases and delays."

Chart Sources

Charts appearing in today's commentary are courtesy of: