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   -- Weekly Market Update for the Week Commencing 4th May 2009

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

Market
Short-Term
(0-3 month)
Intermediate-Term
(3-12 month)
Long-Term
(1-5 Year)
Gold
Neutral
(04-May-09)
Bullish
(12-May-08)
Bullish

US$ (Dollar Index)
Neutral
(23-Mar-09)
Neutral
(16-Feb-09)
Neutral
(19-Sep-07)

Bonds (US T-Bond)
Bearish
(06-Apr-09)
Bearish
(22-Sep-08)
Bearish
Stock Market (S&P500)
Neutral
(27-Apr-09)
Neutral
(02-Feb-09)
Bearish

Gold Stocks (HUI)
Bullish
(12-Jan-09)
Bullish
(12-May-08)
Bullish

OilBullish
(17-Nov-08)
Neutral
(22-Sep-08)
Bullish

Industrial Metals (GYX)
Neutral
(27-Apr-09)
Neutral
(22-Sep-08)
Bullish


Notes:

1. In those cases where we have been able to identify the commentary in which the most recent outlook change occurred we've put the date of the commentary below the current outlook.


2. "Neutral", in the above table, means that we either don't have a firm opinion or that we think risk and reward are roughly in balance with respect to the timeframe in question.

3. Long-term views are determined almost completely by fundamentals, intermediate-term views by giving an approximately equal weighting to fundmental and technical factors, and short-term views almost completely by technicals.

Central planning is back in vogue

At the root of central planning ideology is the belief that a group of well-meaning government officials and/or experts is more capable than the unrestrained free market of allocating resources for the betterment of society. However, whenever and wherever central planning of the economy has been attempted it has always been a failure, with the magnitude of the failure generally being proportional to the breadth of the central planning experiment (small-scale attempts to centrally plan have tended to create relatively minor problems whereas efforts to centrally plan the majority of economic activity have led to total disaster). It always fails because the market process is so complex, and yet so smooth, that any attempt by the government to control it will 'throw a spanner into the works'. But unfortunately, each new generation seems to operate under the assumption that the only reason central planning has never worked in the past is because the right people haven't been in charge.

Powerful (we say irrefutable) arguments can be made against central planning on both theoretical and empirical grounds, but we must invest based on the way things are as opposed to the way they should be; and right now there is a very strong trend towards increased government control of economic activity. We would rather not delve into politics when writing these commentaries, but we no longer have any choice in the matter because politics is coming to totally dominate the financial markets and the investing landscape.

Ironically, one of the primary drivers of today's relentless shift towards greater government control of the economy is the set of problems caused by governments' earlier attempts to control the economy. As Ludwig von Mises observed many decades ago, government intervention in the economy inevitably creates problems that provide the justification for more intervention. It helps, of course, that when government intervention leads to a crisis the finger of blame is invariably pointed at the free market, a mistake made possible by the fact that most people, including most economists, fail to understand that neither the 'cartelised' banking system of today nor the symbiotic relationship that exists between some large private corporations and the government has anything to do with Capitalism.

As has often been the case in the past, the focal point of the current batch of central planners is the energy industry. If you control energy production, energy-related investment and energy consumption then you exert considerable influence over the entire economy, especially if you already have total control over money and banking.

Displaying either a remarkable ignorance of history or a total disregard for the lessons of history, the latest generation of US central planners, led by a charismatic president, have decided to push the US energy industry in the direction that they believe will create the optimum mix of economic growth and clean air (and, of course, gain the most votes). If we are lucky then the havoc they cause will be no greater than the havoc caused by "Project Independence" during the 1970s and 1980s, but chances are we won't be so lucky.

At this point it's worth briefly reviewing the history of "Project Independence", particularly since some aspects of this earlier attempt by the US government to steer the energy industry in a politically desirable direction are similar to current plans.

"Project Independence" was introduced in 1973 by an earlier generation of central planners with the goal of making the US independent of foreign oil by 1980. It had many facets, including the provision of subsidies to synthetic fuel manufacturers, increased oil tariffs, conservation schemes, and increased government spending on mass transit systems. Later in the decade the government also imposed a "Windfall Profits Tax" on oil companies (the more things change...). Ironically -- the word "ironically" is often appropriate when discussing the effects of government intervention -- the various measures implemented by the US government with the aim of creating energy independence actually made America MORE dependent on oil from unstable regions such as the Middle East. They did so because they misdirected energy-related investment and crimped the abilities of US oil companies to increase production.

The US Government's efforts to promote the production of synthetic fuels under the banner of "Project Independence" amount to a classic example of how schemes designed to circumvent the market often pan out. As explained by Thomas DiLorenzo in his book "How Capitalism Saved America":

"In 1979 the federal government created a Synthetic Fuels Corporation...that would make low-interest loan guarantees to companies developing synthetic fuels. As with all government programs, however, the indirect subsidies were distributed according to whichever members of Congress had the most clout and could funnel the subsidies into their home districts or states, not according to whatever firms held the most promise in developing synthetic fuels. In other words, it was a giant political pork barrel.

The government promised to be producing 500,000 barrels of synthetic fuel per day by 1987, but it never supplied more than 10,000 barrels. Moreover, the loan guarantees were limited to those companies that had such poor prospects that they could not obtain private funding. In other words, only the most unprofitable companies qualified.

There is even evidence that the Synfuels Corporation IMPEDED the development of synthetic fuels. Energy industry analyst Milton Copulos explains that "virtually all lending [by investment banks] for alcohol fuel plant construction came to a halt as the banking community waited to see what the federal programs would eventually include." As a result, says Copulos, "construction of alcohol plants came to a virtual halt." Thankfully, the whole program was scrapped in 1986."

Energy independence is still a policy goal, but the main thrust of the US government's current efforts to centrally plan the energy industry is Global Warming (GW). In the hope of arresting the GW trend the Obama Administration has already committed to spending hundreds of billions of dollars, and will probably end up spending trillions of dollars, to promote methods of power generation that emit less carbon. It will also be taking steps to increase the cost of energy sources that are presently far more economical, but are perceived to be less environmentally friendly. These actions will impose huge direct and indirect costs on the US economy even if the Climate Alarmists are right and the global warming trend that began around 1980 was primarily driven by an increase in human-generated carbon emissions. It will impose still greater costs if, as we suspect, the trend was part of a natural cycle that has already run its course. In other words, the unshakable belief in the Global Warming threat is providing the justification for government action that could cripple an economy that is already in a severely weakened state. As an aside, we have singled out the US Government but it should be noted that the governments of most developed-world countries are headed down the same poorly chosen path.

As the government becomes increasingly involved in deciding how resources are allocated, the overall economy and the average standard of living will be losers. Based on the historical tendency for the actual effects of government intervention to be the opposite of the intended effects, the environment will probably also be a loser. There will, however, be winners, and as mentioned earlier in this discussion we must invest based on the way things are as opposed to the way they should be. Amongst the most likely winners are the alternative -- alternative, here, meaning renewable and/or "green" -- energy companies that will benefit directly from the government's largesse and forced redirection of resources. In fact, there is a reasonable chance that "alternative energy" will be one of the next decade's investment bubbles. The uranium industry is also a likely winner because uranium is the only relatively-clean energy source that can be applied on a large scale and that will be economically feasible within the ranks of the world's developing nations.

The Stock Market

Current Market Situation

The S&P500 Index traded in a narrow range and eked out an 11-point gain over the course of the past week (it ended the week at 877). Our view is that the 200-day moving average in the mid-900s defines the short-term upside potential while the 50-day moving average at around 800 defines the short-term downside potential.

Uranium and Alternative Energy Stocks

As mentioned above, government policy could be setting the stage for an alternative energy investment bubble. With central banks dedicated to providing abundant liquidity and politicians intent upon steering investment towards various alternative energies, the right ingredients for such a bubble are certainly being added into the mix. 

As also mentioned above and in last week's Interim Update, the uranium industry is another potential beneficiary from the "climate change" hysteria driving government policy. And uranium has the advantage of being an economically viable alternative to fossil fuels without government support.

Here are quick updates on our current uranium and alternative energy stock selections, beginning with uranium.

The tide appears to have turned for the uranium-mining sector of the stock market. It was the first industrial-commodity sector to peak and it could well be the first to enter a new bull market. For some uranium stocks the short-term risk/reward has become skewed towards risk due to the large gains achieved over the past several weeks, but we think the intermediate-term outlook is bullish.

There are three uranium stocks in the TSI List -- one mid-tier producer (UUU.TO) and two small exploration/development-stage miners (EFR.TO and KRI.TO). Below is a chart of each stock along with a few comments.

1. Uranium One (TSX: UUU). Recent price: C$3.43

We think UUU is now fully valued based on the current spot uranium price of US$44/pound, but remains under-valued based on the current contract price of US$70/pound. A rise to resistance in the C$4.50-C$5.00 range would create a short-term selling opportunity, whereas a pullback to around C$2.50 would create a short- and intermediate-term buying opportunity.


2. Energy Fuels Inc. (TSX: EFR). Recent price: C$0.42

EFR has minimal political risk (its assets are in the US), near-term production capability, and a reasonable balance sheet. It is extremely under-valued and has huge upside potential, but the stock's volatility and the fact that a higher uranium price will be required to justify bringing its mines into production make it unsuitable for widows and orphans. In a nutshell, at its current price it is a highly leveraged speculation on the uranium price.

It recently broke out from a long-term downward-sloping channel and has moved above its 200-day moving average for the first time in more than two years. It is presently testing resistance at C$0.45. Above C$0.45 there is minor resistance at C$0.70 (the September rebound peak) and then 'round number' resistance at C$1.00.

EFR is so under-valued that selling should be based solely on money management considerations. New speculative buying would be appropriate in the C$0.30-C$0.45 range.


3. Khan Resources (TSX: KRI). Recent price: C$0.53

The Dornod project has an indicated uranium resource 64.3M pounds, KRI's share of which is 44M pounds. 52.9M pounds of this resource is in the reserve category (KRI's share of the reserve is 36M pounds).

A Feasibility Study completed earlier this year determined a net present value of US$339M for the Dornod project (KRI's share: US$234M) based on a 10% discount rate and a uranium price of US$70/pound. So, what value is the stock market currently assigning to KRI's Dornod stake? Very little given that KRI has no debt and about C$0.35/share of cash in the bank (the company's enterprise value is presently about US$8M).

There are two reasons for KRI's absurdly low valuation. One, the two-year bear market in the uranium sector led to the widespread mispricing of in-ground uranium. Two, the Dornod project is located in Mongolia.

The country risk is substantial, but KRI is an interesting speculation at its current price because its assets are trading at such a huge discount to their potential value.

Chart-wise, KRI is in a similar position to EFR; and like EFR it is so under-valued that selling should be based solely on money management considerations. New speculative buying would be appropriate in the C$0.40-C$0.55 range.


Moving along to renewable energy, our sole representative at this stage is the Wind Energy ETF (NYSE: FAN). With reference to the following chart, FAN has resistance at US$14. A move up to US$14-$15 at some point over the next few weeks would create a short-term selling opportunity, whereas a pullback to near the 50-day moving average would create a short- and intermediate-term buying opportunity.


Natural Gas Stocks

Natural gas stocks are generally down a long way from last year's highs, but have rebounded strongly from this year's lows and are mostly now 'overbought' on a short-term basis. Furthermore and as discussed last week, they are now expensive relative to the price of natural gas. We therefore think that traders who bought positions in natgas stocks over the past few months should be locking-in some gains and/or tightening their stops. It is probably also wise for investors with substantial exposure to the natgas sector to do some selling into the current strength, even if their positions are still well underwater.

Here is an interesting article containing figures on US natural gas reserves, production, drilling, and consumption:
http://seekingalpha.com/article/134574-natural-gas-is-cheap-volatility-is-here-to-stay?source=yahoo

And here is a quick chart-based update of some of the natgas positions in the TSI Stocks List. Most of our natgas stocks look overbought on a short-term basis and will not be suitable for new buying until they drop back to near their 50-day moving averages.

1. Fairborne Energy (TSX: FEL). Recent price: C$5.05

When FEL was trading at C$2.55 in mid March we said that a fair valuation for the stock in the current depressed natgas environment would be C$4.65, and that it was a good candidate for new buying in anticipation of a rebound to resistance at C$4.50-C$5.00 (and to much higher levels when the natgas market eventually recovers).

FEL ended Friday's session at C$5.05. Its current valuation is still low based on where we think natgas will be trading in 12 months time, but it is now fully valued based on the current natgas price and, as evidenced by the following chart, is poised at intermediate-term resistance.


2. Precision Drilling Trust (NYSE: PDS, TSX: PD.UN). Recent price: US$4.68

Although PDS remains very under-valued, it has experienced an uninterrupted rise since bottoming in March and is now 'overbought' on a short-term basis. At the same time, there is still a significant gap between the current price and the next meaningful resistance level at US$6.00.


In the TSI Stocks List there are two PDS positions -- a longer-term holding that sits at a substantial loss and a trading position that sits at a healthy profit. We have been running a trailing stop on the trading position and it would be reasonable to keep doing so, particularly as long as the stock price is well below resistance at US$6.00. On the other hand, making at least a partial exit now would ensure that we do not give back a chunk of the gains achieved to date if there is a downward reversal.

When running a portfolio we can scale into and out of positions, but with the TSI Stocks List we don't have that option because it is not designed to be a portfolio. With the TSI Stocks List a stock is either 100% in or 100% out. That is, we don't have the option of making a partial exit from the PDS trading position.

To protect the gains achieved to date we have decided to exit the PDS trading position at Friday's closing price of US$4.68. After adjusting our entry price for the sale of the rights issued to unit-holders on 1st May (the rights closed at US$0.34 on Friday), the profit on this trade was 117%.

We remain bulls on PDS, but it will probably take a long time for the stock to recoup all the ground it lost between July of 2008 and March of 2009. This is because the overall stock market is likely to remain weak for the foreseeable future and because PDS has issued a lot of new units at low prices over the past few months to shore-up its balance sheet.

3. Advantage Energy Trust (TSX: AVN.UN, NYSE: AAV). Recent price: US$2.80

Amongst the natural gas plays included in the TSI Stocks List, AAV has been the worst performer over the past few months. One reason for the relatively poor performance is management's decision to change from a trust structure to a growth-oriented company structure. This change in structure could well be the right move, but it put short-term downward pressure on the unit price because it meant that anyone holding AAV for income purposes had to sell.

Thanks to its relative weakness, AAV is not far above its 50-day moving average and is certainly not 'overbought'. It would have to move up to near resistance at US$4.00 to be a candidate for selling.


4. Daylight Resources Trust (TSX: DAY.UN). Recent price: C$7.27. Current yield: 13.2%.

DAY's progress in the stock market has been hampered over the past couple of weeks by news of an equity financing and the acquisition of a private gas producer. Also, it has come up against some psychological resistance in the form of the downward-sloping trend-line drawn on the following chart.

Although it is not helping matters in the here and now, we like the fact that DAY's management is attempting, via acquisitions, to take advantage of the low valuations at which small natgas producers are currently trading.

DAY is presently not far above its 50-day moving average and would only be a candidate for partial selling if it rose to near resistance at C$9.00.


5. Peyto Energy Trust (TSX: PEY.UN). Recent price: C$9.34. Current yield: 15.4%

PEY has pulled back after moving well above its 50-day moving average. It would be a candidate for partial selling at around C$11 and a candidate for new buying at around C$8.00.


This week's important US economic events

Date Description
Monday May 04
Pending Home Sales
Construction Spending
Tuesday May 05ISM Non-Manufacturing Index
Wednesday May 06 No important events scheduled
Thursday May 07 Q1 Labour Productivity and Costs
Consumer Credit
Friday May 08 Monthly Employment Report

Gold and the Dollar

Gold and Silver

The gold market has gone very quiet. The reason, we think, is that a semblance of confidence has returned to the financial world, prompting large speculators to direct their collective attention away from safe havens such as gold and towards growth-oriented markets such as industrial commodities, general equities and high-yield debt securities.

Last week's downward drift in the gold market led to a Friday close below $890. This close below a minor support level is not a bearish signal and does not tell us much, if anything, about gold's likely direction over the coming weeks. However, it does cancel-out the bullish signal generated during the preceding week. Since this bullish signal was the sole reason for upgrading our short-term outlook from "neutral" to "bullish", we have returned to "neutral".

A daily close above $925 would probably take us back to a short-term "bullish" stance, as would a decline to the $850s. A daily close above $925 would break the market out of the downward-sloping channel drawn on the following daily chart of June gold futures, while a decline to the $850s would reduce the short-term downside potential to around 5% (we think the low-$800s defines gold's short-term downside risk).

One of our concerns continues to be that gold's downward correction has not yet put a dent in the public's (the dumb money's) gold-related optimism, even though the correction has just entered its third month. The very high premiums to their net asset values at which CEF and GTU presently trade is evidence that the public remains stubbornly bullish despite the price decline.


With reference to the following daily chart of July silver futures, the silver market is in a similar situation to the gold market in that it has been drifting lower since late February. As is the case with gold, silver's slide since its February peak has the look of a correction within a continuing intermediate-term upward trend.


A chart of the gold/silver ratio is displayed below.

The gold/silver ratio soared during August-October of last year, which is exactly what it is supposed to do during a financial-market panic (because gold's price is driven almost totally by monetary/investment demand whereas silver's price is driven by a combination of industrial and monetary demand). It has since pulled back as panic has subsided, although it hasn't fallen by as much as we would have expected given what has happened in other markets. In particular, we would have expected silver to show significant strength relative to gold in parallel with the strong rallies in stock markets and industrial commodities over the past 6 weeks, but the gold/silver ratio has, instead, moved sideways within a narrow range. We don't know, yet, what to make of this.


Gold Stocks

The HUI's price action over the past two weeks was more bullish than gold's price action. This probably eventuated because strength in the broad stock market lent some support to gold stocks and because some gold-mining companies benefit from rising base-metal prices. Whatever the reason, last week's decline in the HUI did no damage to the technical picture and at this stage looks like a routine consolidation within a short-term upward trend.

As noted in last week's Interim Update, the HUI would have to close below support defined by its mid-April low (274) to completely negate the idea that a rally to the channel top (the 350s) or higher had begun.


Currency Market Update

Below is a daily chart of June euro futures.

The euro spent about 4 weeks retracing the 2-day surge of 18-19 March and has since been working its way higher. It achieved a mini upside breakout last Wednesday and looks set to strengthen further in the near future. However, we continue to believe that this currency's upside potential, and the Dollar Index's corresponding downside potential, is no more than a few percent.


We expect that the current short-term trends in the foreign exchange market will reverse at around the same time the stock market reaches a short-term peak. In particular, we think that peaks in the commodity currencies (the A$ and the C$) and the euro, and troughs in the safe-haven currencies (the US$ and the Yen), will roughly coincide with a peak in the global stock market rebound.

Update on Stock Selections

(Note: 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)

Gold-Ore Resources (TSXV: GOZ). Shares: 82M issued, 89M fully diluted. Recent price: C$0.59

The gold sector was in consolidation mode during the final two days of last week, and yet GOZ, a junior gold stock with an operating mine in Sweden (the Bjorkdal Mine), gained about 30% over that 2-day period on higher-than-usual volume. The catalyst for the move was the quarterly report issued by the company after the close of trading last Wednesday. This report confirmed that things are finally coming together for GOZ after a lengthy development phase at Bjorkdal. Specifically, it noted that Bjorkdal had reached commercial production and had generated C$0.06/share of cash flow during the first three months of this year. 0.06/share during one quarter implies 0.24/share on an annual basis, which, in turn, implies that GOZ is trading at only a little more than 2-times annual cash flow. Production and cash flow could be slightly lower during the current quarter due to scheduled maintenance, but after that the ramp up from the present 40K oz/yr production rate is expected to continue.

Our long-standing valuation-based target for GOZ has been C$2/share. This was our target a year ago when the stock was trading at around C$0.70, it was our target when the stock traded as low as C$0.12 during the height of the Q4-2008 panic, and it remains our target today (and is certainly supported by the Q1-2009 results). The valuation is what it is; it doesn't change just because the stock market goes crazy.

With reference to the following chart, last week's surge took GOZ to the lower boundary of intermediate-term resistance in the C$0.60-C$0.70 range. A sharp rise to an important resistance level often creates a short-term selling opportunity, but only on the first rise to the resistance. For example, GOZ's surge to C$0.60 during February created a short-term selling opportunity, but in our opinion last week's rise did not because the second test of an important resistance level is more likely to be followed in the near future by an upside breakout.

We won't be surprised if GOZ soon breaks above resistance at C$0.60, but we also won't be surprised if it spends some time consolidating in the C$0.48-C$0.60 range before breaking out. A move below C$0.48 would be a surprise and would probably require a large sector-wide decline, which is not expected.

New buying would be appropriate between the high-0.40s and the high-0.50s.


Chart Sources

Charts appearing in today's commentary are courtesy of:

http://stockcharts.com/index.html
http://www.futuresource.com/



 
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