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 2013. In real (gold) terms, bonds commenced a secular BEAR market in 2001 that will continue until 2014-2020. (Last update: 23 January 2012)

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

The ever-changing 'yardstick'

To illustrate the difficulty of measuring performance in terms of the US dollar, today we are presenting three inflation-adjusted (IA) gold charts. Our method of inflation adjustment was outlined in the December-2010 article posted HERE.

First, we present the long-term monthly chart that we normally use to show gold's 'real' performance. This chart puts historical prices into current (in this case, December-2012) dollar terms, which means that prices from past times are adjusted upward to reflect the estimated decline in the dollar's purchasing power from the past time to the present. For example, we calculate that the January-1980 gold price of $722 is the equivalent of around $3100 in current dollar terms. This means that by our calculations it takes more than four dollars today to buy what one dollar would have bought in January-1980, or, to put it another way, the US$ has lost more than 75% of its purchasing power since January of 1980.

Note that our chart uses monthly closing prices for gold. For example, the 1980 high of around $3100/oz shown on the chart is the current-dollar equivalent of $722, the monthly close in January of that year. Had we used intra-day prices then our chart would show a 1980 high of around $3600, since $3600 is roughly the current-dollar equivalent of the January-1980 intra-day high of $850.



Next, here's the long-term monthly gold chart in terms of January-1980 dollars. In January-1980 dollars, today's gold price is around $400/oz.



Last, here's the long-term monthly gold chart in terms of 1959 dollars. In terms of a 1959 dollar, today's gold price would be around $250/oz. That the gold price in current dollar terms is about $1650/oz means that it now takes about $6.60 to buy what $1 would have bought in 1959.



The above charts look identical. The only difference is the scale on the Y-axis. This illustrates the problem of measuring performance in terms of a 'yardstick' that is constantly changing (shrinking).

A related point worth explaining is that if there hadn't been any depreciation of the US$ from 1959 through to today, that is, if the dollar had the same purchasing power today as it had in 1959, then the gold price would not now be $250/oz (our calculation of the current gold price in 1959 dollar terms). It would probably still be around $35/oz. The increase from the $35/oz price of 1959 to today's price in 1959 dollar terms of $250/oz constitutes a large real gain. This real gain stems mainly from the long-term economy-weakening costs of currency depreciation.

As we've argued many times in the past, if all that happened due to monetary inflation was a reduction in the purchasing power of the currency then monetary inflation wouldn't be a big deal. Who cares if all prices rise uniformly across the economy? Everyone will have to spend more money, but they will also have more money to spend.

The problem isn't so much that prices rise in response to monetary inflation. The problem is that due to the way money makes its way into the economy and due to the distorting effect that the money-creation process has on interest rates, prices rise non-uniformly and investment booms occur. Each large-scale investment boom, in turn, leads to a vast wastage of resources and eventually an economy-wide bust. In short, monetary inflation causes the boom-bust cycle.

As the economy oscillates between boom and bust, a long-term effect is that capital gets allocated less efficiently and the rate of economic progress slows. In addition, the more aggressive the efforts of the central planners to alleviate the pain caused by the bursting of an inflation-fueled boom by creating even more inflation, the greater the economic oscillations and the slower the long-term rate of real economic progress are apt to become. There is no doubt that the central monetary planners became far more aggressive in their efforts to manipulate the economy after the monetary system was 'cut loose' from its golden anchor in 1971, the result being booms and busts of greater magnitude and a pronounced slowdown in the rate of real economic progress.

The long-term decline in the rate of economic progress stemming from the more aggressive and more regular use of the monetary inflation policy-tool has had important side effects. One of these side effects is an increasing propensity to save in terms of something with money-like attributes that can't be debased by the policy-makers. That's why gold is in a very long-term upward trend in REAL terms. It's also why analysts who try to calculate a fair value for gold by only considering changes in the supply of money and the supply of gold tend to be too pessimistic about gold's prospects. 

Economic Numbers Update

The negative print for US GDP growth published last Wednesday garnered a lot of attention, but as briefly discussed in last week's Interim Update the GDP calculation is almost irrelevant aside from its effect on sentiment at the Federal Reserve. A far more useful indicator of economic performance was published last Friday. We are referring to the ISM report on US manufacturing.

Both the Headline ISM index and the New Orders index moved up from just below 50 in December to around 53 in January. We pay more attention to the New Orders than the Headline, because the New Orders component tends to lead the overall index at major turning points. Here is a chart of the New Orders index:



The shaded regions on the above chart show the periods when the US economy was officially in recession. Note that a recession usually isn't officially confirmed until about one year after it begins. For example, the recession that got underway in late-2007 wasn't officially recognised by the NBER (National Bureau of Economic Research) until late-2008.

The New Orders number reported last week doesn't show much strength, but it is significant due to the fact that it doesn't show weakness. Our thinking has been that the US economy was in recession for the final three quarters of last year, which may or may not be true. We've also thought that the NBER would eventually recognise mid-2012 as the starting point of a recession, but for this to be the case the ISM numbers would now have to be a lot lower than they are.

That many US stock indices have achieved new multi-year highs since the beginning of this year also indicates that a recession didn't officially begin last year. These new stock-index highs tell us nothing about the future, because it is not uncommon for the stock market and the economy to peak at around the same time. For example, the S&P500 and NASDAQ100 indices made new multi-year highs during the final quarter of 2007 -- at around the same time that the US economy was commencing its worst recession in decades. However, the recent new stock-index highs tell us something about the past, because it would be unprecedented for the stock market to make new multi-year highs several months after an official recession had begun.

While most of the reliable leading economic indicators moved in a way that suggested recession over the final three quarters of last year, one notable exception was "Real Gross Private Domestic Investment" (the blue line on the following chart). Unlike employment (the red line on the following chart), which usually doesn't turn down until well after a recession has begun, there was a pronounced downward reversal in Real Gross Private Domestic Investment prior to the official start of every US recession of the past 40 years. Such a reversal hasn't yet occurred during the current cycle.



Indicators that normally work have not worked over the past several months. This is probably because the Fed is doing things that it has never done before, such as ramping up the money pumps at a time when the stock market is strong and inflation expectations are in the top quartile of their 5-year range.

The Stock Market

Over the past four months the NASDAQ100 Index (NDX) has diverged bearishly from the S&P500 and most of the other important US stock indices. The NDX remains well below its September-2012 high and failed to make a new high for the year last week.



We don't know if the NDX's recent relative weakness is important for the overall market. It could be a warning, or it could be nothing more than a reflection of Apple's decline.

While the NDX has underperformed over the past few months, it has outperformed by a wide margin since the end of the 2007-2008 financial crisis. Thanks to its recent gains the S&P500 Index is now only a few percent below its 2007 peak, but the NDX broke above its 2007 peak way back in 2011 and is now more than 20% above it.

The NDX's good long-term performance is reflected in the following chart, but notice that the more recent relative weakness has potentially created the right shoulder of a "head and shoulders" topping pattern. Potential "head and shoulders" patterns regularly appear in the financial markets, but the patterns often don't complete and if they do complete the follow-through to the upside or the downside isn't as great as predicted by the technical analysts. We don't know if the NDX is about to complete a "head and shoulders" top, as the pattern could just as easily be a consolidation within an upward trend. This is just something to be aware of.



We are obviously going out of our way to consider what could go wrong. A lot could go wrong, although a major stock market decline is very unlikely within the next few months. What is likely is a correction of sufficient magnitude to turn sentiment from complacent to fearful. When that correction happens we'll re-assess our bearish stance, but it makes no sense to become less bearish as the market becomes increasingly 'overbought'.

We'll now take a look at two ETF charts that together paint an interesting picture. The first chart shows that the Metals and Mining ETF (XME) has largely been left out of the 'bull run'. This ETF is up by around 20% from its Mid-2012 low, but is still about 40% below its early-2011 top. The second chart shows that the Energy ETF (XLE) has fared much better over the past two years and is now testing its 2011 peak.

In our opinion, the dramatic underperformance of XME over the past two years creates the potential for equally dramatic outperformance beginning within the next few months.

This week's important US economic events

Gold and the Dollar

Gold

The US$ gold price keeps moving up to its 50-day moving average and then dropping back. Consecutive daily closes above this moving average will therefore signal that the gold bulls are getting the upper hand. After the 50-day moving average and the channel top at around $1700, the next resistance of significance is at $1800.

$1800 will be a logical short-term objective once $1700 is breached.



With the speculative net-long position in COMEX gold futures dropping sharply last week and Market Vane's bullish percentage in the high-50s, sentiment in the gold market remains constructive.

The following chart is one way of illustrating how gold has performed in non-US$ terms over the past three years. The reason is that by dividing the US$ gold price by UDN (a US$ bear fund), we effectively take changes in the Dollar Index out of the equation.

In non-US$ terms, gold has spent the past 18 months oscillating within a horizontal range. This looks nothing like how we'd expect a major gold market top to look. This price action is consistent with our fundamentals-based view that gold is experiencing a mid-trend consolidation.



Gold Stocks

The HUI rebounded on Friday, but it hasn't yet done anything to indicate that a short-term bottom is in place. As previously noted, a daily close above 409 would be preliminary evidence and a daily close above 420 would be conclusive evidence that a short-term bottom was in place.

As also previously noted, we think that if the HUI tests its 2012 bottom (375-385) as part of the current short-term decline then the early-February low will turn out to be the low for the year; otherwise, a test of the 2012 bottom will probably happen a few months from now.



Currency Market Update

Below is a weekly chart of the Yen. Based on the RSI shown at the bottom of the chart and the distance between the current price and the 70-week moving average (the blue line on the chart), the Yen is now at its most 'oversold' level in more than 20 years. We are in uncharted territory.



The Yen's waterfall decline is more than a little strange considering that there has been no fundamental change. Of particular relevance, the BOJ has not only taken no additional steps to weaken the Yen, it has stated that it plans to take no additional Yen-weakening steps until at least 2014. The entire Yen decline is therefore based on anticipation of something that may never happen.

The strangeness doesn't end with the lack of a fundamental basis for the Yen's decline, though. What's even more strange is that while the Yen has sold off in dramatic fashion in response to the idea that it will eventually be inflated to oblivion, the yield on Japanese Government Bonds has barely moved. The current yield on the 10-year JGB is only 7 basis points (seven one-hundredths of one percent) above the multi-year low reached in December!

Even if the Yen's bear market isn't complete (it probably isn't), the next rebound is likely to be substantial. A return to the 70-week moving average is possible.

There are so many weird and wonderful things happening in the financial markets right now that it's difficult to know what to mention in these commentaries and what to leave out. Another one of these things that we'll mention is the divergence, since late last year, between the global stock market (as represented by the Dow Jones World Index - DJW) and the major commodity currencies (the A$ and the C$). As evidenced by the following chart, the major commodity currencies and the DJW had consistently moved in synch until mid-December. At that time the commodity currencies began downward corrections while the DJW (the green line on the chart) continued along a steeply-sloped upward path.

This divergence will probably close over the next month or so, via the C$ and A$ rallying strongly or a sharp downward correction in the stock market. We expect the latter.

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

Company news/developments for the week ended Friday 1st February 2013:

[Note: 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]

  *Batero Gold (BAT.V) issued its mandatory reports for the 3-month period ended 30th November 2012. The financial statements showed that BAT had working capital of only $1.2M at 30th November, but due to a subsequent equity financing the company now has about $18M in the bank and should be fully funded for the next 12 months. BAT will also have access to a $2M loan from its major shareholder if needed.

  *Dragon Mining (DRA.AX) issued its quarterly report for the quarter ended 31st December.

At 13.6K ounces, production was almost 3K ounces higher than the previous quarter. This is a good result. However, at $1219, the per-ounce cash cost of production was $350 higher than the previous quarter. This is a very poor result. With the increase in production we would have expected the company to be strongly cash-flow positive during the latest quarter, but due to the high cost of production it actually burned through $8.4M of cash. As a result, working capital fell to around $14M. Excluding a $4M deposit lodged with a Swedish authority as a rehabilitation bond, working capital is now down to around $10M.

There are reasons to expect that the first quarter of this year will be a lot better from a cash-flow perspective than the final quarter of last year, but it is beginning to look like DRA will need a large rise in the gold price to become consistently profitable. This is not what we want. What we want are gold producers that will benefit greatly from a higher gold price but don't need a higher gold price to be profitable.

Despite its low valuation, DRA is not an ideal candidate for new buying at this time.

  *Some interesting information about the progress of Elgin Mining (ELG.TO) was posted at the company's Stockhouse.com message board last week. The information comes from ELG's investor relations manager.

The main point is the difficulty (near-impossibility) of small mining companies getting financing to build new mines in the current market environment. Due to the inability to obtain reasonable-cost financing, the estimated production start-up date for ELG's Lupin project in Nunavut has been pushed out to 2015.

Fortunately for ELG, it has a healthy balance sheet and a producing cash-flow-positive mine. It can therefore afford to wait-out the difficult period.

  *Evolution Mining (EVN.AX) reported that flooding in Queensland had affected production at one of its gold mines, but at this stage it doesn't look like the effect will be significant. The company still expects to meet its 2013 production guidance.

Also, EVN issued its quarterly activities report for the December quarter. Production for the quarter was 102K ounces at an average "cash cost" of A$764/oz. This was 12K ounces above the upper end of previous guidance and is therefore a very good result.

EVN's operations generated about $74M of cash during the quarter, but all of this and more was consumed via capital expenditure. Consequently, EVN went from a net cash (cash minus debt) position of $42M at the end of September to a net cash position of -$33M at the end of December. That is, its net cash position deteriorated by $75M during the quarter. It is still in good financial shape, though, because it has undrawn credit of about $120M and should see a large decline in capital expenditure over the next two quarters.

The biggest contributor to the deterioration in the net cash position was investment in the Mt Carlton project. Mt Carlton entered the commissioning phase in December and should soon stop being a drain on the company's financial resources. We expect that it will become a significant cash producer for EVN during the June quarter of this year.

Following the nascent industry-wide change in the way costs are reported, EVN reported an "all-in cash cost" of A$1,127/oz. In addition to the direct mining cost, the "all-in" cost includes royalties, sustaining capital expenditure, exploration and G&A. It is a more realistic assessment of the cost of producing an ounce of gold.

Due to the completion of the Mt Carlton mine construction and reduced capital spending at its other mines, EVN expects to begin adding cash to its balance sheet in the June quarter of this year.

We continue to view A$2.50 as a reasonable intermediate-term target for EVN's stock price.

  *Golden Predator (GPD.TO) announced that it, along with the other members of the "Predator Group", had signed an exploration agreement with the Kaska Nation to "promote a cooperative and mutually respectful relationship in respect of ...exploration projects located within the Kaska Nation's traditional territory". The Kaska Nation includes five First Nation communities in the southeast Yukon and northern British Columbia.

This sort of news is never going to move a stock, but it is important nonetheless. It indicates that GPD's management is taking the right steps to mitigate the risk of encountering permitting problems and coming into conflict with local communities in the future.

Past and possibly future TSI Stock Selection: Chesapeake Gold (TSXV: CKG). Shares: 44M. Recent price: C$9.45

CKG is a former TSI Stock that we still follow from afar.

Last Friday CKG reported the results of the PFS for its Metates gold-silver-zinc project in Mexico. Metates contains a very large, low-grade mineral deposit with the potential to be developed into a mine with average annual production of around 1M gold-equivalent (gold + silver) ounces.

The PFS indicates favourable economics. For example, the after-tax NPV(5%) and the IRR are estimated to be $5.7B and 19.4%, respectively, assuming a gold price of $1487/oz and a silver price of $28.80/oz. However, the initial capex is estimated to be around $4.4B, which would likely represent an insurmountable hurdle in the current market environment. Only a major gold miner like Barrick, Goldcorp or Newmont would be capable of financing the construction of such a mine, but these companies are now shying away from low-grade projects with huge initial capex requirements.

That being said, the market conditions of today are not going to exist forever. At some point in the future the large low-grade gold deposits with good economics will come back into favour, leading to much higher valuations for stocks like CKG. We will therefore continue to keep an eye on CKG's progress.

Chart Sources

Charts appearing in today's commentary are courtesy of:

http://stockcharts.com/index.html
http://www.economagic.com/
http://research.stlouisfed.org/