-- Weekly Market Update for 1st July 2019

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.

The BULL market in US Treasury Bonds that began in the early 1980s ended in mid-2016, but there will be many years of topping action in bond prices and bottoming action in bond yields before major new trends get underway. A major decline in government bond prices will unfold during the 2020s. (Last update: 11 September 2017)

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.), gold-denominated prices and inflation-adjusted prices. This secular trend will bottom in 2020 or later. (Last update: 11 September 2017)

A cyclical BEAR market in the US Dollar began in 2016-2017. (Last update: 11 September 2017)

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 in 2020 or later. (Last update: 11 September 2017)

Commodities, as represented by the CRB Index, 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 2020 or later. (Last update: 11 September 2017)

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True Fundamentals Summary [Notes: 1) The date shown next to the current True Fundamentals Model (TFM) signal is when the most recent change occurred. 2) Charts of the Gold and Equity TFMs are included in the "Charts and Indicators" section of the TSI web site]

Last week's posts at the TSI Blog

US monetary inflation with and without the Fed

Summary of current thinking/positioning

1) The Dollar Index (DX) has commenced a downward trend, but it could be a few months before the new trend becomes consistent. In the meantime the price action could be choppy, beginning with a counter-trend rebound that kicks off within the next week or so.

2) The US$ gold price has broken out to the upside on a monthly basis. Significant additional gains are likely within the next three months, but a test of the recent upside breakout probably will occur within the next three weeks (possibly following a spike to a new multi-year high this week). The US$ silver price stands a good chance of making a catch-up move over the months ahead.

3) Although they are a long way from following gold bullion to new 5-year highs, on a short-term basis the gold-mining indices/ETFs are in similar positions to gold. They are extremely 'overbought' and should soon enter -- if they haven't already entered -- correction mode.

4) The SPX probably will commence a sizable multi-week decline by mid-July at the latest.

5) An upside blow-off has set the stage for a large T-Bond decline. The decline should begin very soon, but it could be September-October before the market starts trending downward with conviction.

6) Oil's correction is probably over, although there is still a risk that stock market weakness during July-August could push the oil price to a new multi-month low.

7) We are holding a cash reserve of 25%-30%.

No Interim Update this week

Please note that we will be taking a short break and as a result there will be no Interim Update this week. The next report will be the Weekly Update scheduled for Sunday 7th July.

The Monthly Closing Prices

At around this time every month we review some of the most important (from our perspective) monthly charts. We do this because monthly closing prices can confirm or deny intermediate-term trend changes.

We'll start with the US$ gold price. A month ago we wrote:

"For two reasons, gold's position on the monthly chart became even more bullish in May. The first reason is that gold traded below its 21-month and 8-month MAs during the month before recovering enough to end the month comfortably above both MAs. The second and more significant reason is that the 8-month MA has just crossed from below to above the 21-month MA."

And:

"During long-term gold bear markets, the 8-month MA crossing from below to above the 21-month MA tends to be followed by either a rapid 1-2 month price rise or a long-and-slow (two steps forward followed by one step backward) upward trend. In the current case the latter scenario appears to be more likely.

Regardless of whether we get a 1-2 month surge or a steady 1-2 year upward trend, the rising 8-month MA is now an important support level on a monthly closing basis. To maintain its bullish posture the US$ gold price must not end a month below this MA."

Gold gained more than US$100/oz during the month of June, which suggests that of the two scenarios mentioned above we more likely are dealing with the 1-2 month surge. However, by ending the month above its highs of the past few years the US$ gold price has achieved a breakout that points to significant additional gains over several months (potentially more than a year). This breakout should be respected.

The 8-month MA is way down at $1307. This is too far below the current price to be a useful demarcation level, but it is beginning to accelerate upward and could become useful within the next few months. In the meantime, the February-2019 high ($1350) should be viewed as critical monthly-closing support.



The T-Bond performed better than expected during June. Over the course of the month it gained only 1 point, but in doing so it remained above its 84-month MA. This means that the 84-month MA is not acting as resistance the way we thought it would, but doesn't alter our view that the T-Bond commenced a bear market in 2016.

A substantial T-Bond decline is coming, but the market could spend 2-3 more months in a topping process before beginning to trend downward with conviction.



When the S&P500 Index (SPX) ended the month of October-2018 below its 12-month MA it signaled that either an intermediate-term correction or a bear market had begun. When it subsequently recovered from its Q4-2018 plunge to end the month of February-2019 above its 12-month MA, the intermediate-term correction scenario was confirmed.

At this stage, the price action during the period since last September looks similar to the price action that followed the intermediate-term top in 2011. The similar periods are indicated by the red boxes drawn on the monthly chart displayed below.

The bull market appears to be intact, but we aren't assuming that the similarities between the present and 2011-2012 will continue. On the contrary, we are anticipating significant additional weakness prior to a sustained move into new high territory.



The Treasury Market

A sentiment extreme

The following two charts from Sentimentrader.com make the case that sentiment in the T-Bond market is at/near an optimistic extreme. The first chart shows that the Optimism Index for bonds is 180 degrees from where it was last October (it has gone from a 3-year low to near a 3-year high). The second chart shows that small traders of T-Bond and T-Note futures are now as bullish as they have been at any time over the past 17 years.

A major sentiment extreme is a necessary, but not a sufficient, precondition for a major price extreme. For example, a market sometimes will continue to trend upward for an extended period, with only routine corrections along the way, while sentiment within the speculating community remains very optimistic. However, when speculators are very optimistic the market will be acutely vulnerable to a perceived adverse change in the fundamental backdrop.

The current sentiment situation suggests that it won't take much of a perception change to bring about a large price decline in the bond market.

A potential topping pattern

The upward trend in the iShares 20+ Year Treasury Bond ETF (TLT) lost momentum over the past month, but a downward reversal is yet to occur. A daily close below $130 would signal a reversal.

Based on what we expect to happen in other markets it could be 2-3 months before TLT begins to trend downward in earnest. The main reason is that stock market weakness within the next two months could lead to an increase in demand for the temporary safety offered by the Treasury market.

One plausible scenario is that a topping pattern involving a pullback to the 50-day MA followed by a rebound to test the high will precede the start of a substantial decline.



The Oil Market

The following daily chart shows that moving-average resistance at $59-$60 limited the upside in the oil price last week. This was expected and doesn't provide any useful clues about future performance. Having said that, over the past week the probability increased that oil's correction is over. The reason is associated with market sentiment.



As is the case with the Treasury market, there currently is a noteworthy sentiment extreme in the oil market. But whereas small traders (the 'dumb money') are uncommonly optimistic about the prices of T-Bonds and T-Notes, they are uncommonly pessimistic about the oil price. This is evidenced by the following weekly chart, the middle section of which shows that "NonReportable" traders of oil futures have their smallest net-long exposure in almost two years. This means that the 'dumb money' is positioned more bearishly now than it was when the oil price was bottoming 6 months ago.

Such negativity on the part of small traders in the face of fairly normal price action suggests that the June low was the final correction low.



Before leaving oil-related matters it's worth mentioning that the Oil Services ETF (OIH) has rebounded to near its 50-day MA following a successful re-test of its 15-year low. This ETF's intermediate-term downside risk is dwarfed by its upside potential.



The Stock Market

From last week's Interim Update:

"The meeting at the end of this week between presidents Trump and Xi constitutes a near-term risk for bearish stock market speculators. This is because although the meeting almost certainly won't result in a deal that brings the overall US-China conflict to an end, it probably will result in positive statements and the temporary removal of the US threat to impose tariffs on the roughly $300B of Chinese products that currently aren't subject to tariffs.

Therefore, a reasonable trading plan would involve entering a short-term bearish speculation now with the intention of adding to the position if next week's market reaction to the Trump-Xi meeting pushes the SPX up to near its all-time high or to a marginal new all-time high. Risk could then be managed by setting an initial 'stop' slightly above whatever high is in place by mid-July."

The outcome of the Trump-Xi meeting was as expected. Positive statements have been issued and the US government threat to impose new tariffs on $300B of Chinese products has been temporarily removed. In addition, Trump has promised to allow US companies to resume selling their wares to Huawei. This is a significant plus for US chipmakers such as Intel and Micron. It is also a significant plus for some US software companies, including Google.

Although the meeting outcome appears to be in line with what most market participants were expecting, the removal of a near-term source of uncertainty could give sentiment a sufficient boost to push the senior US stock indices to new all-time highs this week. As mentioned in last week's Interim Update, if this happens it would be an opportunity to establish or add to short-term bearish speculations, with risk then managed by placing an initial 'stop' slightly above whatever high is in place by mid-July. An alternative and more conservative tactic would be to wait for a downward reversal before entering or adding to a bearish speculation. For example, if the SPX were to close at a new all-time high (above 2964) early this week, then a subsequent daily close below 2940 could be viewed as a reversal signal.

With regard to the short-term price action, during the second half of last week the US stock market clearly was factoring in the temporary cessation of US-China hostilities on the trade front. The associated optimism pushed the SPX up to within 1% of its all-time high and pushed the NYSE Advance-Decline Line (ADL) to a new all-time high. The on-going strength of the ADL is a good reason to NOT expect anything more bearish within the coming two months than a steep multi-week decline.



Turning to Europe, the top section of the following daily chart shows that the EURO STOXX 50 ETF (FEZ) made a new high for the year last week but remains well below its 2018 high. The bottom section of the chart shows that FEZ stopped falling relative to the S&P500 ETF (SPY) late last year.

FEZ/SPY essentially has moved sideways for about 10 months. If this is a basing pattern (we think it is) then it will have bullish implications for the euro relative to the US$, but if it is a mid-trend consolidation then it will limit the euro's strength relative to the US$.

To explain, the euro/US$ exchange rate, and therefore the Dollar Index, is driven by relative interest rates and relative stock-market performance. At the moment, the relative interest-rate trend favours the euro, but the relative stock-market performance trend is still slightly in the US$'s favour. The net effect is a fundamental backdrop that could be viewed as favouring the euro, but not decisively so.

To get a substantial rally in the euro and decline in the DX it's necessary, we think, for the long period of sideways movement in FEZ/SPY to be a reversal pattern (a base) as opposed to a continuation pattern.



This week's significant US economic events [Notes: 1) The most important events (to the markets) are shown in bold. 2) A list of global economic events can be found HERE]

Gold and the Dollar

Gold

The US$ gold price potentially made a peak that will hold for at least a month when it spiked up to the low-$1440s early last week, but the price action leaves open the possibly of a short-lived move to a new multi-year prior to the start of a significant correction. A lot will depend on how the currency market reacts to the outcome of the Trump-Xi meeting.

We don't know if the Trump-Xi news will prompt US$ buying or selling. If the latter, gold could trade above last week's high before entering a correction that could/should result in a test of the recent upside breakout (a decline to $1350-$1380 would 'test' the breakout).



Overall speculative enthusiasm for gold naturally has risen with the price, but not by enough to constitute a threat to the upward trend at a time when the fundamental backdrop is decisively gold-bullish. Furthermore, the middle section of the following chart shows that the net-long exposure of the "NonReportable" traders (the 'dumb money') is roughly in the middle of its 3-year range and significantly smaller than it was when the gold price was making a short-term high in February.



Silver

Silver has lagged gold in a big way. As a result, unlike the gold market the silver market is not short-term 'overbought'. Also, due to being near an historic low relative to the gold price, the silver price has huge catch-up potential.

We think that silver's risk/reward is now more bullish than gold's over every timeframe, including the very short-term.

With reference to the following daily chart, silver has nearby resistance in the $15.60s and at $16.20 (the February-2019 high). If gold is able to test last week's high before commencing a significant correction then silver could test or exceed the higher of the aforementioned resistance levels before commencing a correction of its own.



On a weekly closing basis, silver has nearby resistance at around $15.60 (as defined by the downward-sloping trend-line drawn on the following weekly chart), $15.86 (the 100-week MA) and $16.20 (the February-2019 high). Ending a week above the lowest of these resistance levels would be evidence that an intermediate-term rally had begun, although gold's recent performance already has generated that evidence on silver's behalf.



To catch up with gold, the silver price will have to rise to at least $21-$22. That's the intermediate-term target we have in mind at the moment, although we are well aware that intermediate-term upward trends in the silver market usually develop into spectacular surges that blow past rational targets.

Gold Stocks

Even though the gold mining indices and ETFs reached 'overbought' extremes during the week before last, they managed to extend their near-vertical ascents early last week before beginning to consolidate. There's a realistic chance of a spike to a new high prior to the start of a multi-week correction, but a reasonable expectation is that if a correction didn't begin last Tuesday then it will be underway by the end of this week.

A routine correction within a short-term upward trend would result in a test of the 50-day MA and/or a decline in the daily RSI(14) to around 50.



In April, the GDX/SPY ratio broke below its 50-week MA. This was potentially an ominous development, but five weeks ago the ratio moved back above its 50-week MA. Continuing with our theme of comparing the current situation with the mid-1980s, this is similar to what happened in early-1987. To illustrate what we mean, here are weekly charts showing the present-day GDX/SPY ratio and the XAU/SPX ratio during 1984-1987.

The Currency Market

During the week before last the DX broke out to the downside. Last week it traded within a very narrow range and achieved no net change, thus consolidating the previous week's breakout.



The fundamental backdrop remains neutral, but, as discussed in the stock market section of today's report, fundamental downward pressure on the DX will ramp up if it turns out that the many months of sideways movement in the FEZ/SPY ratio is a basing pattern.

Aside from the potential for the true fundamental currency-market drivers to move further in the euro's favour, a reason to believe that the DX is in the early part of an intermediate-term decline is the performance of the gold market. Gold's recent upside breakout was not only a reaction to a downside breakout in the DX, it was also a prediction of additional US$ weakness to come. This is because gold has broken out in nominal currency terms, but not in terms of the S&P500 Index or the GSCI Spot Commodity Index. The implication is that at this time gold appears to be anticipating currency weakness more than economic weakness.

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

Company news/developments for the week ending Friday 28th June 2019:

[Note: AISC = All-In Sustaining Cost, EBITDA = Earnings Before Interest, Tax, Depreciation and Amortisation (a measure of cash flow), EV = Enterprise Value or Electric Vehicle, FS = Feasibility Study, FY = Financial Year, IRR = Internal Rate of Return, ISR = In-Situ Recovery, JV = Joint Venture, MD&A = Management Discussion and Analysis, M&I = Measured and Indicated, NAV = Net Asset Value, NPV(X%) = Net Present Value using a discount rate of X%, NSR = Net Smelter Return or Net Smelter Royalty, P&P = Proven and Probable, PEA = Preliminary Economic Assessment, PFS = Pre-Feasibility Study]

  *Africa Oil (AOI.TO) advised that the Heads of Terms agreement between the Government of Kenya and joint venture partners Africa Oil (25%), Tullow Oil (50%) and TOTAL (25%) has been signed for the development of the oil fields in the South Lokichar Basin. This means that key fiscal and commercial principles for Project Oil Kenya have been agreed and documented between the government and the JV partners. AOI also advised that the project's Front End Engineering and Design (FEED) studies are complete.

However, the Environmental and Social Impact Assessments are taking longer than expected, so a Final Investment Decision (FID), which was expected to happen late this year, has been pushed into 2020. The plan is that it will take three years from FID to initial oil production.

In addition, AOI reported that significant progress has been made on South Lokichar's Early Oil Production Scheme (EOPS) -- a pilot test of the planned production methods. EOPS production has been ramped up to 2,000 bopd and the reservoirs, wells and associated facilities have been performing as expected. The oil is being delivered to Mombasa for shipment.

  *Continental Gold (CNL.TO) announced that Eric Sprott has invested US$25M in the company at C$3.10/share. This appears to be an unnecessary financing that was done mainly for promotional purposes -- to show the market that Eric Sprott is optimistic about CNL's prospects.

CNL's Buritica project is host to what appears to be an outstanding gold deposit, but as we saw last year there are security risks associated with building a mine in Colombia. When these risks materialised during the final few months of last year in the form of employee deaths due to attacks by terrorists, the stock was clobbered. We thought at the time that if the project stayed on track and there were no new problems on the security front then the market's perception of the company would improve and the stock would get an upward re-rating. That has happened, but the security risk has not disappeared.

Depending on exposure to this stock and the overall gold-mining sector, it could make sense to do some selling of CNL shares in the C$3.80-$4.00 range, that is, near the current price. It comes down to personal money management considerations and risk tolerance, because the stock still offers reasonable value.

We will be looking for an opportunity to remove CNL from the TSI Stocks List over the next few months and possibly would view a rise in the stock price to around C$5.00 as such an opportunity.

  *eCobalt Solutions (ECS.V) continues to trade at a large discount to the implied value of the Jervois Mining (JRV.AX, JRV.V) takeover bid. Based on last Friday's closing price of JRV shares in Australia and the current A$/C$ exchange rate, the JRV bid is worth about C$0.32/share. However, ECS shares currently are priced at only C$0.22-$0.23.

  *Energold Drilling (EGD.V) advised that due to insufficient working capital it has defaulted on payment obligations and covenants associated with its debt. The main component of its debt is C$20M of convertible debentures issued in 2017.

We didn't see this coming. It was clear that the company had a cash shortage, but the shortage didn't appear to be a near-term threat to the company's survival. Given that it was/is a near-term life-threatening matter, we wonder why the company's management didn't do an equity financing months ago. A low-priced equity financing would have diluted the per-share value, but that's a lot better than going broke.

To get itself out of the current financial predicament EGD will have to issue a lot of new shares and also bring the conversion price of the existing debentures down to near the market price (the current conversion price is C$0.85). Also, the company will be engaging a "chief restructuring officer" to manage the financial-restoration process.

Will EGD recover?

The company probably will recover, especially with the gold price having broken out to the upside and the prices of other metals likely to follow in due course (higher metal prices should lead to improved sales and profits in the mineral-drilling side of the business). However, it won't be possible to reassess the risk/reward for the shares until the details of the financial restructuring are known. In particular, the post-restructuring fully-diluted share count will have to be known.

Due to the current unknowns, the small-but-significant risk of bankruptcy and the likelihood that massive equity dilution is coming, we view EGD as no better than a hold at its current price of C$0.09 and would be inclined to lighten-up in the C$0.12-$0.15 range.

In general, drilling has been a very tough business to be in over the past few years. The shrinkage of profit margins in both minerals drilling and energy drilling has been out of proportion to changes in the underlying commodity prices, such that even large and well-financed companies have struggled. This creates the potential for a huge recovery over the next few years in the stock prices of the drilling companies that survive without blowing out their share counts. We made the bet that EGD would be one of these companies, but this proved to be the wrong bet.

We still very much like the idea of having exposure to the coming recovery in the profitability of commodity-related drilling. For energy-related drilling exposure we prefer the Oil Services ETF (OIH), because we don't have the time or inclination to analyse individual companies in detail. For minerals-related drilling exposure we like Major Drilling (MDI.TO), which we discussed in the 19th June 2019 Interim Update.

  *Premier Gold (PG.TO) had positive and negative news last week.

On the plus side, the company reported that development of the El Nino underground and Phase 1 open pit mines at the South Arturo project in Nevada (40% PG, 60% Barrick) is on or ahead of schedule. El Nino is expected to be in production before the end of this year and Phase 1 is expected to be put into production next year.

On the minus side, about two months ago the company reported the discovery of high-grade gold mineralization in a Reverse Circulation (RC) hole drilled at the McCoy-Cove project's Antenna target (McCoy-Cove is another PG-Barrick JV). The discovery hole contained a 118.9m intercept grading 4.12 g/t gold. That was very good news, but it was reported last week that a core hole drilled to 'twin' the RC hole intersected a mineralized zone that was significantly narrower than the RC hole. The JV is now figuring out the best way to evaluate the Antenna target.

List of candidates for new buying

From within the ranks of TSI stock selections the best candidates for new buying at this time, listed in alphabetical order, are:

1) A40.AX (last Friday's closing price: A$0.14)

2) CGT.TO (last Friday's closing price: C$0.18)

3) ECS.V (last Friday's closing price: C$0.22)

4) PG.TO below C$1.90 (last Friday's closing price: C$2.04)

5) PPLT (last Friday's closing price: US$78.86)

The above list is limited to five stocks. It sometimes will contain less than five, but it never will contain more than five regardless of how many stocks are attractively priced for new buying.

Chart Sources

Charts appearing in today's commentary are courtesy of:

https://stockcharts.com/
https://sentimentrader.com/
http://www.goldchartsrus.com/