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

Interesting quote or fact of the week

A neat summary of what the US government and central bank have accomplished over the past two years:

"...the government seized Fannie and Freddie, thereby effectively nationalizing a large portion of the entire US housing market; the Fed nationalized AIG; the treasury secretary told everybody that he needed $700 billion pronto to patch up the financial sector or the world would end; the treasury secretary then proceeded to partially nationalize the US financial sector; the federal government took over two of the Big Three car companies and threw traditional creditor rights out the window; the Fed more than doubled the monetary base in six months' time; the new Obama administration borrowed almost $800 billion to spend on "stimulus"; the federal government has taken a giant leap forward to socialized medicine; and just for kicks, the federal government also banned offshore drilling (though the rules are yet again undergoing revision)."
  - From Robert Murphy's article "Putting Austrian Business-Cycle Theory to the Test"

The above summary leaves out a lot, including the $8000 tax credit and other subsidies designed to encourage greater spending on houses, the "Cash For Clunkers" program designed to encourage greater spending on cars, the push for "Cap and Trade" and other legislation designed to address the imaginary hobgoblin that was originally known as "Global Warning" and is now known as "Climate Change", and the altering of accounting rules that miraculously transformed insolvent, loss-making banks into highly profitable enterprises. It does, however, paint an accurate picture of a raging bull market in government interventionism.

If the problem is that you are running in the wrong direction, the solution isn't to run faster

More debt obviously can't help

A big week coming up

The Stock Market

"Economic stimulus" in its various forms can't possibly help the economy, but it can cause some prices to rise. For example, the effect of the 2008-2009 stimulus is clearly evident in the following daily chart of the NASDAQ100 Index (NDX). The NDX has now recovered almost all of its 2007-2008 losses, even though the US economy has never really emerged from the recession that began in 2007.

A 5-10% pullback could begin at any time, but at this stage there is no evidence that the stock market's post-November-2008 rally is over. In fact, put/call ratios suggest that a major top is not yet at hand. In particular, the 10-day moving average of the OEX put/call ratio, an indicator of how the "smart money" perceives the US stock market's risk/reward, has just dropped back to near its lows of the past several years. This means that the "smart money" is now relatively unconcerned about downside risk. To provide some context, the 2000-2003 and 2007-2008 bear markets commenced with the 10-day MA of the OEX put/call ratio near a 52-week high. This year's intermediate-term decline also began with the aforementioned indicator at a comparatively high level.

Our guess is that a major stock market peak will be put in place within the next couple of months at not far above current prices, but sentiment- and price-related evidence of such a peak has not yet appeared.

This week's important US economic events

Gold and the Dollar

Gold

The faith-based metal

The following note about gold was included towards the end of the Jeremy Grantham letter that we linked earlier in today's report:

"Everyone asks about gold. This is the irony: just as Jim Grant tells us (correctly) that we all have faith-based paper currencies backed by nothing, it is equally fair to say that gold is a faith-based metal. It pays no dividend, cannot be eaten, and is mostly used for nothing more useful than jewelry. I would say that anything of which 75% sits idly and expensively in bank vaults is, as a measure of value, only one step up from the Polynesian islands that attached value to certain well-known large rocks that were traded. But only one step up. I own some personally, but really more for amusement and speculation than for serious investing. It may well work and it may not. In the longer run, I believe that resources in the ground, forestry, agriculture, common stocks, and even real estate are more certain to resist any inflation or paper currency crisis than is gold."

We agree that gold is a faith-based metal, although we don't like the term "faith-based". It is more appropriate to say that gold's value is not primarily determined by how much of it gets consumed in industrial, commercial or digestive processes. Gold is not "mostly used for nothing more useful than jewelry", as Grantham claims. It is mostly used as a store of purchasing power. And at a time when there are good reasons to believe that the official money will be subject to increasingly rapid inflation, a reliable store of purchasing power is extremely useful.

While it is true that commodities other than gold can be reasonable stores of purchasing power, gold is best suited to the role. One reason is that so much of it "sits idly" in vaults. The fact that industrial/commercial uses account for only a tiny fraction of its total demand makes gold the only commodity that can be accumulated in large amounts by investors without adversely affecting the economy.

Of course, the reason there is so much gold sitting idly in vaults is that gold has proven itself in the past to be extremely useful as a store of purchasing power. This usefulness relates to its physical properties. For example, it is much easier and cheaper to transport and store $10M worth of gold than to transport and store the same dollar amount of oil or base metals. For another example, diamonds offer the advantage of being cheap and easy to transport and store, but for many people diamonds are disqualified as convenient depositories of purchasing power by their lack of homogeneity (every diamond is different and it takes an expert to assess the monetary significance of the differences) and divisibility. The precious metals (gold, silver and the platinum group metals) are really the only commodities that have near-ideal physical characteristics to be stores of purchasing power, but the platinum group metals must be immediately eliminated from consideration by the fact that all of their supply goes to satisfy industrial/commercial demand.

Land, especially land that generates an income from the production of crops, livestock or timber, could turn out to be an excellent store of purchasing power over the next 10 years, but land has the disadvantage of being illiquid and immobile. You couldn't, for example, move your land in order to sidestep an adverse change in the political environment, and you might not be able to sell it in a hurry.

Common stocks can be good investments if bought at reasonable prices, but they aren't reliable stores of purchasing power. One reason is that the real return provided by the shares of a company will largely depend on the decisions made by the company's management. One wrong decision by management could wipe out a lot of purchasing power.

In summary, Grantham is correct when he says that gold is a "faith-based" metal. Like paper currencies, gold has no "intrinsic" value. Grantham's mistake is assuming that gold's lack of use in industrial/commercial applications makes gold useless. The reality is that a reliable, convenient and widely-accepted store of purchasing power will be very useful at all times, and will deserve a hefty premium at times when a policy of currency depreciation is being aggressively pursued by the stewards of the official money.

Current Market Situation

As soon as the US$ gold price began to 'correct' from its early October peak, the 50-day moving average became a likely near-term target. It is possible that the correction ended last week at a slightly higher level, but it is also possible that last week's strength will turn out to be the 'B' rebound within an A-B-C decline (with the 50-day MA and lateral support at $1260-$1270 being reasonable targets for the 'C' leg of the decline). There is no way of knowing.

This week's action will be dominated by the anticipation of, and the reaction to, Wednesday's Fed statement. We don't have an opinion on exactly what the market will do, other than we suspect that a rally during the first half of the week will be followed by a post-statement pullback and a decline during the first half of the week will be followed by a post-statement rally.

Silver Versus Gold

On a long-term basis, silver tends to strengthen relative to gold when the stock market is trending upward and weaken relative to gold when the stock market is trending downward. For example, the silver/gold ratio weakened in parallel with the 2000-2003 equity bear market, strengthened in parallel with the 2003-2007 equity bull market, crashed with the stock market in 2008, and then recovered with the stock market from October-November of 2008* through to the present. The silver/gold ratio ended last week at a 2-year high, which makes sense given that the NASDAQ100 Index, Hong Kong's Hang Seng Index, Brazil's Bovespa Index and the German DAX Index all made new 2-year highs over the past three weeks.

The implication is that silver will likely remain strong relative to gold while the stock market remains in rally mode, but not for much longer than that. Or, looking at it from another angle, the stock market will likely remain in rally mode as long as silver remains strong relative to gold, but not for much longer than that.

The Relative Strength Index (RSI) at the bottom of the following weekly chart reveals that the silver/gold ratio is now as 'overbought' as it was at the December-2006 and March-2008 peaks, but is not yet as 'overbought' as it was at the April-2004 and April-2006 peaks. In early 2004 and early 2006 it continued its steep rise for 1-3 months after it became as 'overbought' as it is right now.

The weekly RSI's message, then, is that the silver/gold ratio could peak at any time and should peak by January-2011 at the latest.

    *Although the S&P500 and Dow Industrials indices bottomed in March of 2009, a good argument can be made that stocks bottomed on a global basis along with the silver/gold ratio in October-November of 2008. The reason is that October-November of 2008 marked: a) the internal bottom for the broad US stock market, b) the bottom for the NASDAQ100 Index, c) the bottoms for several important/leading stock markets around the world, most notably the Hong Kong, Shanghai and Brazil stock markets.

Gold Stocks

The HUI is in a similar position to gold bullion in that it could have just completed a short downward correction or it could be about to complete the 'B' rebound of an A-B-C decline (in which case the 'C' leg could bottom anywhere from the 480s down to the 450s). As with gold bullion, there is no way of knowing. There is, however, one significant difference between the HUI's correction and that of gold bullion, which is that by dropping back to its 50-day MA the HUI has already achieved the minimum requirement for a normal correction. The HUI has also tested lateral support defined by its May-June peaks (the equivalent of $1260-$1270 for gold bullion).

Currency Market Update

The following daily chart shows that the Swiss Franc (SF) broke decisively above its March-2008 and November-2009 tops a few weeks ago. This break above resistance took the SF to a new all-time high. It has since pulled back to test the former resistance (now support) that lies just above parity.

The near-vertical upward move in the SF from June through to early October reflects the concerted attempt by the market to factor in a lot of future US$ inflation. This means that for the SF to continue its advance the market will have to factor in even more US$ inflation than has been anticipated up to now AND the market will have to believe that the Swiss central bank will maintain a relatively slow monetary inflation rate. In our opinion, this makes it unlikely that there will be a significant extension of the SF's upward trend. For one, it will be difficult for the Fed to exceed the market's expectations regarding US$ inflation. For another, it is unlikely that the Swiss central bank will maintain a relatively slow monetary inflation rate if the SF continues on its upward path.

Our view, then, is that the SF was at or close to a MAJOR high when it peaked in early October. A rise to a marginal new high at some point over the next couple of months wouldn't surprise us, but the SF's remaining upside potential now appears to be minimal.

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)

Clifton Star Resources (TSXV: CFO). Shares: 33M issued, 39M fully diluted. Recent price: C$4.17

In the 4th October Weekly Update, we wrote:

"We suspect that the current inability of CFO's stock price to get any traction is primarily due to the consistent selling of one large shareholder (Joe Dwek Management - JDM). This shareholder has indirect control over about 13% of CFO's fully diluted share count, and for reasons that in our opinion have nothing to do with CFO's speculative merits appears to be set on making a complete exit by selling into any strength."

Good news: Thursday's massive trading volume in CFO shares (2.8M shares, or about 8.5% of the company, changed hands on the day) was due to JDM selling the remainder of its shares. It still controls about 2.5M CFO warrants, but its ability to affect the market is now greatly reduced.

This year's drilling campaign at CFO's Quebec-based Duparquet project is complete, but the results of many holes are still to be reported. Consequently, we expect to see more drilling-related news from CFO over the next couple of months. The news that will likely have the greatest effect on CFO's stock price, though, will be the announcement of whether or not its joint-venture partner (Osisko - OSK) has decided to continue with the JV. We believe that this announcement will occur by January at the latest.

Confirmation that OSK has decided to continue with the JV would effectively be confirmation that CFO's Duparquet project contains at least 10M ounces of gold, because OSK would not likely be interested in the project unless it were of this magnitude. It would therefore also be confirmation that our C$13/share target is reasonable.

There are no guarantees, but we will be very surprised if OSK decides not to continue with the project.

CFO is a good candidate for new buying near its current price.

    Crocodile Gold (TSX: CRK). Shares: 203M issued, 237M fully diluted. Recent price: C$1.51

CRK is a 120K-oz/yr gold producer with multiple mining assets in Australia's Northern Territory. It has considerable growth potential, but a substantially higher stock price is probably justified based only on its current production and resources.

The stock broke out of a multi-week consolidation pattern at the start of October and then quickly gained about 30% before commencing another multi-week consolidation. At this stage, the latest consolidation looks very much like the preceding one.

We think CRK is a good candidate for new buying in the low-1.50s and below. Unless something totally unexpected happens, short-term downside risk is probably limited by support in the C$1.30s, while an upside breakout from the present consolidation could lead to a quick rise to around C$2.00.

Chart Sources

Charts appearing in today's commentary are courtesy of: