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 ended in 2012. In real (gold) terms, bonds commenced a secular BEAR market in 2001 that will continue until 2018-2020. (Last update: 20 January 2014)

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

Last week's posts at the TSI Blog

Strange Bedfellows

Economics Myths

Volcker's Undeserved Reputation

Can the Bear get much worse?

By the way, today we discovered a problem with the email address linked to the TSI Blog (steve@tsi-blog.com), which, as far as we can tell, arose when the blog was migrated to a different server in early January. When the problem was fixed we were inundated with two months of emails that we previously hadn't seen.

We are confident that future emails sent to the blog address will get through and apologise for the lack of response to questions sent over the past two months.

A potential early-March turning point

Money-supply explosion in euro-land

In the 2nd February Weekly Update we mentioned that even though the ECB's new QE program was not due to start until March, the year-over-year (YOY) rate of growth in euro TMS (True Money Supply) had already accelerated to around 9%. This was the highest rate of monetary inflation since the first half of 2010. As it turned out, though, the sharp rise to 9% was just a taste of what was to come, as the monetary data published by the ECB last Thursday revealed that the euro-zone's YOY TMS growth rate jumped to 11.5% in January.

We don't know the reason for the dramatic acceleration in euro-zone monetary inflation over the past few months, as European commercial banks don't appear to be doing much on the lending front and the ECB's QE program hasn't yet begun. Our guess is that it's because the commercial banks have been busily monetising government bonds. Anyhow, at this time we are more concerned about what's happening than why it's happening.

Here is the relevant chart.



So, the euro-zone (EZ) has a current monetary inflation rate of 11.5% and a new central-bank money-pumping program set to begin later this month. Look no further for an explanation of the recent rapid advances in European equity prices.

A consequence is that even as many pundits fret over the possibility of deflation in the EZ, the EZ is now heading full steam towards a major inflation problem. This would be funny if it weren't so serious.

Relative stability in the US monetary inflation rate (the YOY rate of growth in US TMS has remained in the 7.0-7.5% range over the past few months) combined with the recent surge in euro supply has pushed our measure of the G2 (US plus euro-zone) monetary inflation rate up to 9%, which, as illustrated below, is not far from its high of the past 4 years.



The moderate-to-high rate of G2 monetary inflation over the past 12 months all but eliminates the possibility of a 2008-style crisis this year, but it is probably setting the scene for extreme volatility in stocks and bonds. For example, the realisation that the euro-zone is about to experience rising "inflation" could prompt some frenetic re-positioning by large speculators, with EZ government bonds likely taking a big hit.

The Stock Market

Japan

Here is a long-term monthly chart of the Nikkei225 Index prepared by BOA Merrill Lynch. We found the chart, along with some accompanying "technical analysis" about a potential breakout into a secular bull market, at Barry Ritholtz's blog.



The above chart (along with the associated analysis) is of interest to us because it reflects a mainstream view that Japan's stock market is turning upward on a very long-term basis. Japan's stock market, like most stock markets around the world, is 'overbought' on a short-term basis, but if the 'new secular bull market' idea becomes popular then corrections over the next couple of months could be short-lived as investors quickly buy the dips in an effort to get positioned for the new long-term trend.

Additionally, Japanese policy-makers are effectively forcing some large Japan-based pension funds and other large investors 'into' the stock market by all but closing down the market for Japanese Government Bonds (the BOJ is now the buyer of almost all JGBs put up for sale) and by promising to create "inflation".

Europe

The most important European stock indices continued their rallies last week and are now very 'overbought' on a short-term basis. Daily charts of the two best examples are displayed below.

We suspect that short-term peaks will be put in place this week and that these peaks will be followed by 5%-10% declines.

The US

Despite the fact that transportation companies are among the most clear-cut beneficiaries of the large decline in the oil price, the Dow Transportation Average (TRAN) is still refusing to confirm the new multi-year highs recently achieved by many other US stock indices. We don't know the reason for this non-confirmation. It could reasonably be construed as a short-term bearish sign, but we do not think it has long-term importance.



On a longer-term basis, the performance of the NYSE Composite Index (NYA) probably has greater significance. The NYA came close to breaking above its 2014 double top last week, but Friday's pullback was enough to avoid an upside breakout.

The price action that would lend the most support to the intermediate-term bearish case would involve an upside breakout this week that failed within the ensuing two weeks. This would logically be the next step in a topping process that was similar to the 2000 top.



Regardless of the big picture (ending bull market or continuing bull market), a short-term top is probably close at hand.

This week's significant US economic events (The most important events are shown in bold)

Gold and the Dollar

Gold

How to tell whether a price move was driven by the physical market or the paper (that is, futures) market

When the gold price rallies or suddenly reverses upward, many gold-market commentators will be quick to claim that the bullish price action was caused by physical buying. And when the gold price falls or suddenly reverses downward, the same commentators will be quick to claim that the bearish price action was caused by the short-selling of 'paper' gold. In reality, the opposite is often the case.

The routine claims that the market is being supported by physical buying and regularly being depressed by 'paper' selling are generally backed-up by nothing more than anecdotes. There is, of course, always substantial buying and selling of physical gold and there is always substantial buying and selling of 'paper' gold, with the amount bought always equal to the amount sold. It will therefore always be possible to come up with specific examples of physical buying or physical selling or 'paper' buying or 'paper' selling to support any claim you wish to make. However, you would only do this if you were more interested in promoting an agenda than reporting useful information.

We are sceptical that there's significant value in knowing whether a gold price move was driven by the physical market or the 'paper' market, but such information is available to anyone who wants it. The information can be found in relative market prices.

Since the amount of gold sold during a period will always be exactly equal to the amount of gold bought during the same period, counting up the total number of ounces that were bought or sold would be a complete waste of time even if it were possible. Instead, if you want to know whether the change in price during a certain brief period was driven by the physical market or the paper market then you must look at the change in the spot price relative to futures prices. For example, if a particular price rise was driven by physical buying then the spot price will have risen relative to the price of the nearest liquid futures contract. Alternatively, if the price rise was accompanied by a rise in the futures price relative to the spot price then 'paper' buying was the primary driver.

Actually, to be totally accurate the final two sentences in the above paragraph should contain the words "all else remaining equal", because a change in the zero-risk US$ interest rate will have an effect on the gold futures price relative to the spot price. For example, the differences between the spot gold price and the prices of gold for future delivery are a lot smaller today than they were 10 years ago because the yields on US Treasury bills and notes are now much lower. Therefore, to find out whether a change in the gold price over a short period was driven by the physical market or the paper market you must consider changes in futures prices relative to the spot price and you must account for changes in US$ interest rates. Our point, however, is that there is no need to guess or rely on anecdotal evidence. The information is contained in market prices.

As we said, we are sceptical that there is much value in knowing whether a price change was primarily driven by the physical market or the 'paper' market. Therefore, if we had to do the spot versus futures calculations ourselves, we wouldn't bother. Fortunately, we can get the information without going to any trouble because Keith Weiner makes it available every week in his Monetary Metals Supply and Demand Report.

Current Market Situation

In last week's Interim Update, we wrote:

"Our impression is that gold's correction has done as much as it needed to do (in US$ terms, but not in terms of the euro and some other currencies), but this doesn't imply that the correction is over. We suspect that a short-term bottom is either in place or will be put in place next week, after which there will be a multi-week rally that results in a lower high for the year in gold bullion and a higher high for the year in the HUI."

Nothing of significance has changed since the Interim Update.

Gold's rebound during the second half of last week wasn't strong enough to signal the start of the expected multi-week rally, but the on-going strength in the gold-mining indices relative to gold bullion (the HUI/gold ratio is not far below its January peak) and the fact that the rebound followed a spike below $1200 are reasons for optimism.



Gold Stocks

The HUI tested its 50-day MA and lateral support at 180 during the first half of last week and then rebounded to its 20-day MA. The price action continues to be consistent with a routine short-term correction, but the rebound during the second half of last week wasn't strong enough to signal an end to the correction. A preliminary signal would be generated by a daily close above the 20-day MA.



Like the HUI, many individual gold stocks have experienced what currently appear to be normal pullbacks to near their 50-day MAs. Three examples from the TSI Stocks List are shown below. Some stocks have done better and some stocks have done worse, but the three depicted below are typical.

The Currency Market

During the final two days of last week the Dollar Index broke out to the upside from its narrow, contracting range. This paves the way for a test of the January high or a marginal new high within the next several days, but does not point to a substantial extension of the upward trend that began in mid-2014.

A substantial extension of the Dollar's upward trend is very unlikely. The reason is illustrated by the following chart.

The bottom section of the chart shows that last week's upside breakout from a narrow multi-week trading range has pushed the Dollar Index's 250-day rate of change (ROC) to 19%. Based on this ROC and the Dollar Index's position relative to the MA envelope indicated on the top section of the chart, a comparable situation has occurred only five times over the past 27 years. These comparable situations are identified by downward-pointing arrows on the top section of the chart.

Regardless of whether or not the Dollar Index makes a marginal new high during the days immediately ahead, the historical record suggests two intermediate-term possibilities. Neither of these possibilities is bullish.

The first possibility, which we think has the lower probability, is that a multi-quarter downward trend is about to begin. The second and more likely possibility is that a high during the coming six trading days will be followed by this sequence:

1) A sharp multi-week decline of at least 5 points

2) A rally to slightly above the January-March peak

3) A larger decline

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 ended Friday 27th February 2015:

[Note: AISC = All-In Sustaining Cost, FS = Feasibility Study, IRR = Internal Rate of Return, 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%, P&P = Proven and Probable, PEA = Preliminary Economic Assessment, PFS = Pre-Feasibility Study]

  *Clifton Star (CFO.V) published its financial report for the quarter ending 31st December 2014. The report showed that the company had working capital of about C$3M at the end of last year. This is sufficient to keep the doors open and continue the legal action against Osisko's new owners (Agnico Eagle and Yamana Gold) for a few more quarters, but nothing more.

With the option on the Duparquet project having been allowed to expire and with there seemingly being no chance to replace current senior management prior to a shareholders meeting scheduled for June, the only reason to continue holding CFO is the potential for a positive settlement of the aforementioned legal action. The legal action relates to a C$22.5M loan that should have been provided to CFO by Osisko in 2012, but wasn't.

At Friday's closing price of C$0.10/share, CFO's current market cap and enterprise value are only C$4M and C$1M, respectively.

  *Dalradian Resources (DNA.TO) reported that almost all of its C$0.90 February-2015 warrants were exercised, resulting in a C$8.6M cash injection. Taking into account the cash from the warrant exercise and the recent $11M equity placement to Ross Beaty, we estimate that DNA currently has about C$50M of cash in its treasury. This gives it one of the strongest balance sheets in the world of exploration-stage gold miners.

DNA moved to an 18-month high last week, making it a standout performer in a generally lacklustre equity sector. This prompted us to take another look at its valuation.



Since we last looked at DNA's valuation the stock price has increased from around C$0.60 to C$1.14, the share count has increased from 140M to 163M, and some cash has been added to the balance sheet. What we found is that despite the substantial percentage increase in market cap associated with the rising share count and share price, DNA still offers good value. In fact, based on the economics indicated in the October-2014 PEA for its Curraghinalt gold project in Northern Ireland, DNA is still one of the best value propositions in the world of exploration-stage gold mining stocks, with valuation-related upside potential at today's gold price of around 100%.

The most important caveat is that the 'P' is in PEA (Preliminary Economic Analysis) for a good reason. Assumptions are made in a PEA that might not survive more rigorous testing and engineering. According to DNA's current schedule, the more rigorous testing and engineering needed to generate a PFS will be completed before the end of this year.

A pullback to the low-C$0.80s would create an excellent opportunity for new buying, but that's unlikely to happen in the near future.

  *Endeavour Mining (EDV.TO, EVR.AX) reported unexpectedly bad financial results for the final quarter of 2014. We are referring to the reported deterioration in its net-debt position (long-term debt plus cash-related liabilities minus working capital), not the large impairment charge associated with the accounting values of its mining assets. The impairment charge is mostly the result of a lowered gold price assumption.

EDV reported a $70M deterioration in its net debt position for the final quarter of last year. This was unexpectedly bad, in that based on the excellent Q4 production results that were reported in January we had expected to see an improvement in the balance sheet. $23M of the deterioration was due to a tax payment that we should have expected, but most of it was due to large capital expenditures at the Tabakoto project (Mali).

According to the company, the growth-related capital spending program is now compete and non-sustaining capital expenditure will be only $20M during 2015, which is about $100M less than it was in 2014. Based on other information provided by EDV, at a gold price of $1200/oz this should allow the company to add US$50M-US$80M to its balance sheet in 2015. At a gold price of $1300-$1350/oz, which is where we currently expect the 2015 average to be, the net cash addition would likely be in the $100M-$150M range.

Based on its balance sheet and forecast 2015 production details, we think that EDV would be fully valued at around C$1.00/share assuming a gold price $1200/oz. In other words, we perceive 65%-70% valuation-related upside potential in EDV assuming no change in the gold price. At a significantly higher gold price assumption, the valuation-related upside potential would be much greater. For example, we estimate that an increase in the gold price from $1200/oz to $1350/oz would increase EDV's valuation from C$1.00/share to C$1.50/share.

  *The stock price of Evolution Mining (EVN.AX) fell 10% last Friday on massive volume. The sole reason for the decline was the sale by Newcrest Mining of more than half of its EVN shares at a 10% discount to the market price. As a result, Newcrest's EVN stake has fallen from 32.3% to 14.9%.

Newcrest is selling down its EVN position in an effort to strengthen its own balance sheet, not due to a problem with EVN. In fact, it was EVN's relatively good performance over the recent past that created the opportunity for Newcrest to sell.

  *UEX Corp. (UEX.TO) reported the results of the first 19 holes of its drilling program at the 100%-owned Hidden Bay project in Canada's Athabasca Basin. The press release was quite technical, but from our perspective the salient line was: "Anomalous radioactivity was not observed in the down-hole surveys".

    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) AAU (last Friday's closing price: US$1.11).

2) AKG (last Friday's closing price: US$1.58).

3) EDV.TO (last Friday's closing price: C$0.60).

4) EVN.AX (last Friday's closing price: A$0.84).

5) TGD (last Friday's closing price: US$0.88).

Note that the above list is limited to five stocks. It will sometimes contain less than five, but it will never 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:

http://stockcharts.com/index.html