Big Picture View (Most recent update: 12 January 2004)

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.

Bond yields (long-term interest rates) bottomed in June of 2003 and will move considerably higher during 2004 and 2005.

The stock market rally that began in October of 2002 will end during the first half of 2004. The October-2002 bottom will be tested during 2005.

The Dollar will make an intermediate-term bottom during the first half of 2004 in the vicinity of its 1995 low and then rally for at least 6 months, but a long-term bottom won't occur until 2008-2010.

Gold will make an intermediate-term peak during the first half of 2004 and then consolidate for at least 6 months, but a long-term peak won't occur until 2008-2010. 

Commodities, as represented by the CRB Index, will make an intermediate-term peak during the first half of 2004 and then consolidate for at least 6 months, but a long-term peak won't occur until 2008-2010. 

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TSI Vacation

As mentioned is last week's Interim Update, we will be AWOL for the next couple of weeks. We'll be leaving a few hours after today's Weekly Update is posted and won't be back in the office until Friday 13th February, so the next report after this one will be the Weekly Update on the 15th February.

While we are away we should (hopefully) have access to e-mail and will endeavour to address any administrative matters (forgotten passwords, access problems, billing questions, etc.) that arise, but please note that we won't be answering any market-related questions. If something dramatic happens in the markets while we are away, such as a $100 single-day gain in the gold price or a 2,000-point drop in the Dow, then we'll send out a market alert e-mail to paid-up subscribers; but hopefully (fingers crossed) that won't be necessary. 

Our expectation is that the short-term trends that are currently in progress will continue over the next two weeks. In particular, we expect a continuation of the corrections in gold and gold stocks (although the bulk of the downside is probably behind us), some additional strength in the US$, and consolidation/weakness in the stock market.

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Gold and the Dollar

Gold Stocks - Relative Value

The two main methods to assess the value of a gold mining company are to a) estimate the value of its gold-in-the-ground by taking into account the amount of gold reserves and the expected cost to mine the reserves, and b) to estimate the current value of the cash-flows that are likely to be generated by the company. We generally stick to method a) because it is quicker, easier, and fine for our purposes, but based on what we've observed we think the market uses a combination of a) and b).

Using method a) we can arrive at a rough estimate of the fair value of a gold producing company at the current spot gold price as follows:

Enterprise Value (EV) = (gold price - reported cash cost) x reserves, where enterprise value is the company's stock-market capitalisation minus its net debt. For example, if a company has 5M ounces of reserves and reports a cash cost of $200/ounce then the company's theoretical enterprise value at a gold price of $400 would be (400 - 200)*5M = US$1,000M. If this company had no debt and US$100M of cash in the bank, that is, if its net debt were negative $100M, then its theoretical market cap would be US$1,100. We could then compare this figure with the actual market cap to estimate by how much the company is being over-valued or under-valued by the stock market.

By starting with a company's current enterprise value and its reported cash cost the above equation can also be used to estimate the gold price implied by the current stock price (implied gold price = cash cost + EV/reserves), and that is what we've done in the below table for ten large and mid-tier gold producers. The table is organised in terms of relative value with the best value at the top and the worst value at the bottom.

Obviously, the above calculation leaves out some important factors. For example, a company that is likely to achieve rapid growth in its reserves over the next few years deserves to sell at a premium to a slow-growing company. It does, however, provide a reasonable starting point.

Notes:

1. The table highlights the extreme under-valuation of Northgate (AMEX: NXG). Something that could be contributing to NXG's relative cheapness is the fact that it has forward-sold the equivalent of one-year's production at a low gold price, but these forward sales only represent about 5% of reserves. Note: We've assumed that 3M ounces of the 5.4M-ounce Kemess North resource will be added to NXG's reserves when the feasibility study is completed at the end of this quarter. This, we think, is a reasonable assumption, although perhaps the market will need to see the official numbers before attributing more value to NXG. 

2. ABX appears to be very good value when looked at in this way, but note that we haven't taken into account the large unrealised loss on its hedge book. Even so, if the market began to believe that ABX was going to be able to make a staged and not-overly-painful exit from its excessive forward-sales position that stock would likely experience a period of substantial out-performance relative to the more expensive Newmont.

3. The lacklustre performance of the Kinross stock price over the past year means that the stock is now substantially under-valued relative to Agnico Eagle, Glamis and Goldcorp. With the exception of Northgate, KGC appears to offer the best leverage to the gold price amongst the large and mid-tier North American gold miners.

4. Although Gold Fields and Harmony appear in the top half of the table, the above calculations don't do justice to the relative attractiveness of these companies. This is because we have used the cash costs reported by the companies for their December-2003 quarters, but due to a weakening Rand this year's costs, in US$ terms, are likely to be substantially lower. 

5. Despite the 30% drop in its stock price over the past two months Goldcorp is still priced for perfection. No wonder the CEO sold 40% of his stake in December.

Central Banks and their Gold

From time to time there are discussions in the press about how much gold the central banks are going to sell in the future. However, although the gold price often jumps or pulls back in knee-jerk reactions to stories about potential or actual central bank gold sales, such news is really is just 'noise'. What central banks do or don't do with their gold can have no bearing on the underlying price-trend in the gold market because this trend is determined by what is happening in the other financial markets and by the general level of confidence in fiat currency. 

The only way that the central banks could reverse the longer-term upward trend in the gold price would be to start pursuing responsible monetary policies. In the mean time there will be corrections in the gold market and these corrections might happen to coincide with central bank announcements, but there won't be a change in the longer-term trend.

By the way, despite what they say the large CBs must retain most of their gold reserves because without these reserves they would not be able to maintain the illusion of control. 

The Australian Dollar

Australia has a higher current account deficit than the US (as a % of GDP), a lower savings rate than the US, higher household debt levels than the US (as a % of household income), and a higher money-supply growth rate than the US. And yet, the A$ has been very strong over the past year. 

In some respects, the A$ is in a similar position now to the one in which the US$ found itself during the late 1990s and early-2000s. Specifically, there are some major fundamental negatives but these negatives are being offset by rising foreign-investment demand. That is, the A$ currently sports a substantial investment premium. Furthermore, like the US a few years ago Australia, today, has a large private-sector deficit combined with a government surplus. 

There is no evidence that the A$'s investment premium -- which is based on relatively high nominal interest rates and the bull market in commodities -- is about to disappear. However, after the US$ bottoms during the next several months the A$'s inherent weaknesses will probably result in it falling further, during the subsequent US$ rally, than many of the other major currencies. Therefore, investors might consider scaling-out of the A$ into strength during the first half of this year.

We've been long-term bullish on the A$ over the past two years and expect that it will move much higher over the next 5 years due, more than anything else, to US$ weakness. Our concern at this stage, though, is the coming 6-18 months. As such, for our own account we have begun to scale-out of the A$ and expect to continue this process over the next few months. 

Current Market Situation

Gold Stocks

The following comments from last week's Interim Update are still applicable:

"...there is no evidence that the correction in the gold sector is over. In fact, the HUI and the XAU will probably reach lower levels over the next two weeks. However, we now have a more optimistic short-term view on the sector because a lot of the downside risk appears to have been wrung-out. In particular, the XAU is now within 10% of major support ... and many of the individual stocks we follow are close to levels at which support is likely to emerge."

And "...we think it is reasonable for both investors and traders to do some buying now and during any additional weakness over the next two weeks. In this regard, please refer to [the 14th January Interim Update] for some specific ideas on stocks to buy."

As far as the gold sector is concerned, one of the biggest risks over the next few weeks is the potential for a sharp pullback in the overall stock market. This is one reason that a scale-in approach should be emphasized. In other words, it's reasonable to do some buying now but don't jump in with both feet.

Our view is that the HUI might have reached a major peak (a peak that will hold for at least 12 months) last December, but regardless of whether it has or hasn't already peaked we expect that a good multi-month rally will follow the current correction. Furthermore, even if the next rally results in a lower high for the HUI we expect that the unhedged South African majors (Harmony and Gold Fields) and many of the exploration-stage juniors will move to new highs. In fact, one of our favourite exploration plays -- Exeter Resources (TSXV: XRC) -- made a new high last week and another of our favourites -- Aquiline Resource (TSXV: AQI) - was only a few percent below its all-time high at the end of last week. 

Gold

Below is a daily chart of April gold futures. In the 12th January Weekly Update -- with gold trading at around $426 -- we said to expect a correction of similar duration and magnitude to the one that occurred during June-July of last year. Our expectation remains the same.

At this stage there is no evidence that a bottom is in place. 

For one thing, gold stocks have exhibited a strong tendency to lead the metal at significant turning points over the past couple of years. Last Thursday's new low in the HUI therefore indicates that further corrective activity in the bullion market is likely over the next few weeks. 

In addition, the drop in the gold price from $423 on 13th January to $409 on 27th January was accompanied by a reduction of only 3,000 contracts (from 50,000 to 47,000) in the net-long position of small traders in COMEX gold futures. This is bearish because it means that most of the weak hands were not shaken out of their long positions by the drop from the 420s down to the low-400s. Note, though, that last Thursday's $16 plunge in the gold price occurred after the latest Commitments of Traders (COT) data were issued so the next COT report will probably be more bullish.

Both price and time are important during any correction because when price has run too far too fast a necessary 'pause to refresh' can take the form of a short and sharp price decline or a more modest price decline over a longer period. As far as price is concerned, we think last Thursday's plunge has removed a lot of the short-term downside risk. What the market probably needs now is another 2-4 weeks to build a base in the 390s before returning to its upward path. 

A sign that a bottom is in place would be a daily close above the short-term resistance shown on the above chart. A more definitive sign would be two consecutive daily closes above the 18-day moving average (currently at $415.50 and falling).

From a sentiment perspective, we would like to see the net-long position of small traders in COMEX gold futures fall to around 30,000 over the next few weeks in order to set the stage for the next substantial advance.

The Dollar

By moving up to near its 50-day moving average late last week the Dollar Index has fulfilled our minimum expectation for the current rebound. As the below chart illustrates, it is also now quite close to the top of its short-term channel. It is therefore possible that a top is already in place or will be put in place during the next few days. In fact, this would become probable, rather than just possible, if the Dollar began to move lower immediately or spiked higher and then reversed lower during the first half of this week.

There are, however, two reasons we expect to see a bit more upside in the Dollar over the next few weeks. First, just as the gold stocks have tended to lead gold over the past two years, gold has tended to lead the Dollar. It would therefore be typical for gold to reach a correction low -- something it has probably not yet done -- before the Dollar's rebound runs its course. Second, the euro is still about 2% above support (the support we are referring to here is the trend-line drawn on the below chart of March euro futures). 

A sign that a correction low is already in place for the euro would be a daily close above the short-term downtrend-line shown on the below chart.

Silver

As mentioned in last week's Interim Update, the silver price is likely to drop back to around $5.80 over the next few weeks.

This week's important economic events
 

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