-- Weekly Market Update for the Week Commencing 5th February 2018

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.

The BULL market in US Treasury Bonds that began in the early 1980s ended in mid-2016, but there will be many years of topping action in bond prices and bottoming action in bond yields before major new trends get underway. A major decline in government bond prices will unfold during the 2020s. (Last update: 11 September 2017)

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.), gold-denominated prices and inflation-adjusted prices. This secular trend will bottom in 2020 or later. (Last update: 11 September 2017)

A cyclical BEAR market in the US Dollar began in 2016-2017. (Last update: 11 September 2017)

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 in 2020 or later. (Last update: 11 September 2017)

Commodities, as represented by the CRB Index, 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 2020 or later. (Last update: 11 September 2017)

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True Fundamentals Summary [Notes: 1) The date shown next to the current True Fundamentals Model (TFM) signal is when the most recent change occurred. 2) Charts of the Gold and Equity TFMs are included in the "Charts and Indicators" section of the TSI web site]

Last week's posts at the TSI Blog

What everyone is missing about the US tax cuts

Summary of current thinking/positioning

1) Thinking that the US$ gold price will trend downward over the next several weeks but will go on to make new highs for the year during the second quarter.

2) Still not expecting anything more bearish than a normal (5%-10%) correction in the US stock market, but recognising that short-term stock market risk will ramp up if bond yields continue to rise.

3) Thinking that industrial commodities such as oil and copper will make short-term price highs during the first two months of 2018.

4) Expecting the Dollar Index (DX) to rebound over the next few weeks.

5) Thinking that the T-Bond will build on last week's downside breakout over the next few months.

6) Holding a cash reserve of 25%-30% and looking for opportunities to increase it.

T-Bond Breakdown

By far the most important financial-market development over the past week was the downside breakout in the 30-year T-Bond price illustrated by the following weekly chart. The breakout was expected, although we thought it might wait until the second quarter.



The T-Bond's weekly close below support at 146-147 completes a multi-year topping pattern and projects more downside over the next few months. There probably won't be a major T-Bond decline this year, but there's a good chance of the T-Bond trading at least 10% below its current price before reaching an intermediate-term bottom.

Last week's downside breakout by the T-Bond price has far-reaching implications because it is further evidence that the generational decline in interest rates ended in 2016. That being said, the waters have been muddied by the fact that the downside breakout in the T-Bond price has not been confirmed by an upside breakout in the T-Bond yield (the 30-year interest rate). A lot of market participants care more about the bond yield than the bond price, and the following weekly chart shows that the bond yield has not yet broken out to a new multi-year extreme.



We are confident that a confirming upside breakout in the bond yield is coming, if not in the next three weeks then in the next three months.

US Recession Watch

The previous edition of our monthly "US Recession Watch" feature was in the 3rd January Interim Update. At that time we concluded:

"Taking into account the NOI [New Orders Index] surge (bullish), the fact that the yield curve is still in a flattening trend (bullish) and the decline in the monetary inflation rate (bearish), we think that:

a) The probability that a US recession will start in Q1-2018 is 0%.

b) The probability that a US recession will start in Q2-2018 is 10%.

c) The probability that a US recession will start in Q3-2018 is 30%.

d) The probability that a US recession will start in Q4-2018 is 50%."

Considering subsequent data, the probabilities haven't changed. In particular, the latest iteration of the quarterly Real Gross Private Domestic Investment (RGPDI) number was a new all-time high. Refer to the first of the following charts for details. RGPDI tends to reverse downward at least 2 quarters prior to the start of a recession, so the fact that it made a new high in Q4-2017 points to H2-2018 as the earliest time for the start of the next recession. Secondly, although the latest iteration of the monthly ISM Manufacturing New Orders Index (NOI), which was reported on Thursday 1st February, was lower than the 13-year high achieved in the preceding month, it was still near the top of its long-term range. Refer to the second of the following charts for details. Thirdly, the yield curve is not yet close to signaling a reversal from flattening to steepening. There is little chance that a recession will begin prior to such a signal.

There is almost no chance of a recession beginning during the first half of this year, but there's a high risk of a recession getting underway before year-end. The reason is the slow rate of US monetary inflation. It's likely that at some point within the next 12 months the 'bubble ventures' that were incentivised by the rapid monetary inflation of 2009-2016 will begin to collapse.

Cryptomania Update

Our most recent "Cryptomania Update" was in the 22nd January Weekly Update, at which time we wrote:

"There's a good chance that within the next few weeks the Bitcoin price will close below its 22nd December low, removing most of the remaining doubt that the price top on 18th December (the day that futures trading commenced on the CME and a week after futures trading commenced on the CBOE) was the ultimate top. It just hasn't happened yet."

Last week the Bitcoin price closed below its 22nd December low. Therefore, there is little remaining doubt that the price top on 18th December was the ultimate top.



It's testament to the rapidity of last year's rally that the 60% plunge of the past 6 weeks has done no more than take the price back to where it was in November-2017. This means that every current holder of Bitcoin who bought before November-2017 still has a substantial profit, albeit nowhere near as substantial as it was several weeks ago.

Although the Bitcoin bubble has burst, the 'cryptocurrency' concept is not going to die. Also, distributed ledger technology, the first successful attempt at which is the "blockchain" developed for Bitcoin, looks set to become extremely important in many industries over the years ahead.

The Stock Market

Mind-Boggling Valuation

We thought we understood the extent of the US stock market's over-valuation, but we were wrong. The valuation-related information contained in the article posted HERE, which was sent to us by a friend, blew us away. The market appears to be much more expensive than we thought.

The above-linked article focuses on the combined valuation of four blue chip stocks: McDonald's, Caterpillar, Boeing and 3M. Between 1997 and the end of 2015, the price/revenue ratio of an index comprising these four stocks (MCBM) oscillated between 1.5 and 2.5. Then, in 2016 the index broke out of this range and now trades at almost twice the HIGHEST valuation of the 1997-2015 period.

Moreover, today's extraordinarily high valuation for MCBM can't be explained by investors extrapolating unusually-fast revenue growth. This is because the average 5-year revenue growth of MCBM is at a 20-year low!

The following chart from the article illustrates what we've described above. Notice the spectacular rise in valuation (the blue line) in parallel with declining revenue growth (the red line) over the past two years.



'Investors' are prepared to pay such high prices for the shares of these large and relatively staid companies because in most cases they aren't buying the shares directly. Instead, they are buying ETFs that hold these shares and paying no attention to the valuations of the individual stocks in the ETFs. As pointed out in the article, there are 32 ETFs that count McDonald's among their top 15 holdings, 25 ETFs that count Caterpillar among their top 15 holdings, 83 ETFs that overweight Boeing to this degree and 44 ETFs that overweight 3M.

This is passive investing run amuck. The stage is now set for conservative investors to lose as much as aggressive investors, because ETFs that hold supposedly-safe, blue-chip stocks are going to collapse in price during the next bear market.

Marijuana Stocks Update

When we wrote about the enthusiasm for marijuana stocks in the 8th January Weekly Update, the Horizons Marijuana ETF (HMLSF) had just pulled back in reaction to a decision by US Attorney General Jeff Sessions to rescind the "Cole Memo", leading to some concern that there would be a federal crackdown on marijuana sales and consumption. However, the pullback was minor and the ETF was still trading near its high. Here's how we summed up the situation:

"[Speculation in marijuana-related equities]...is yet another stock-market bubble. Marijuana production is essentially a low-margin commodity business deserving of a relatively low valuation, but most marijuana-related stocks now have extremely high valuations. Therefore, buying these stocks should not be called investing; it should be called betting on future sentiment. As long as the industry continues to grow rapidly and market participants fixate on this growth while ignoring the realistic earnings potential of the companies involved, the bull market could continue.

Although the downward price-spike prompted by Jeff Sessions' burst of idiocy was largely retraced on Friday, there's a high risk that the marijuana sector will soon commence a substantial correction. This is partly because the sector has just experienced what appears to be an upside blow-off and partly because the speculation in this sector would be interrupted by weakness in the broad stock market.

A substantial correction may create a new speculative buying opportunity."

As illustrated by the following daily chart of HMLSF, a substantial correction has since begun. In our opinion, it's too soon to view the price decline as a buying opportunity.



Current Market Situation

The S&P500 Index (SPX) has fallen by 4% from the all-time high it hit during the week before last. A 4% decline isn't much and at this stage the index hasn't even dropped far enough to reach its 50-day MA, so there hasn't been a significant correction yet. However, the recent decline feels significant because it has been well over a year since the SPX experienced a run-of-the-mill 5% pullback from an all-time high. In other words, the extraordinary lack of volatility over the past 12-18 months makes the recent up-tick in volatility seem more meaningful than it is.



We continue to expect that there will be a 5%-10% correction during the first quarter of the year followed by a move to new highs. This would be consistent with the momentum extremes that were reached over the past few weeks. It would also be consistent with the sentiment backdrop, which is already becoming constructive thanks to our put/call indicator generating a buy signal (the first buy signal since January of last year) at the end of last week, and with the neutral fundamental backdrop. However, last week's downside breakout in the bond market has increased the risk that something more bearish than a 5%-10% correction will occur in the stock market within the next couple of months.

There will be a further increase in the stock market's short-term risk if the downside breakout in the T-Bond price is confirmed by an upside breakout in the T-Bond yield. In fact, if the T-Bond yield breaks above 3.20% and continues to surge then the probability of something resembling a stock market crash will become uncomfortably -- or comfortably, depending on your perspective -- high.

Almost regardless of what's in store over the next two months, a multi-week bottom probably will be put in place this week. There should then be a rebound that recoups at least half of the loss from the January high followed by a drop to new lows for the move.

If you want to establish or add to a bearish/hedge position then the aforementioned rebound -- assuming it happens -- will create the best opportunity to do so. If you currently have no hedges or bearish speculations it also could make sense to take an initial position now, via either an inverse index fund or options with an expiry date of April or later. The reason is that even if we are dealing with nothing more than a short-term correction, the decline is probably less than half complete.

The most ridiculous price action yet?

Many absurd things have happened in the stock market over the past 12 months. The latest absurdity worth highlighting is the price action of Amazon.com (AMZN) since the beginning of the year. This large-cap low-margin retailer was already trading at a nosebleed valuation when 2017 came to a close, but it has risen in almost a straight line since the start of this year and at Friday's high was up 28% year-to-date. That is, it was up by 28% in less than 5 weeks.



This could be written off as just another in a long line of upside blow-offs, but adding to the absurdity of the situation is that AMZN's stock price accelerated upward last week as the broad market retreated. It seems, therefore, that 'investors' are viewing AMZN as a safe haven -- a place to take shelter in times of increasing financial-market instability. AMZN is the new gold!

We assume that the logic, or what passes for logic these days, is that AMZN has a) no dividend yield, b) no chance of having a dividend yield within the next couple of years, and c) almost no earnings yield*. Consequently, as stocks that provide a significant yield are made less attractive by rising interest rates, liquid stocks that provide almost no yield become relatively attractive.

The 'investors' who jumped into AMZN shares last week to escape the consequences of rising interest rates can look forward to large losses.

    *The earnings yield is the reciprocal of the P/E ratio. A stock such as AMZN that has a P/E ratio of about 360 therefore can be said to have an earnings yield of about 0.28%.

This week's significant US economic events [Notes: 1) The most important events (to the markets) are shown in bold. 2) A list of global economic events can be found HERE]

Gold and the Dollar

Gold

Here's a summary of our views regarding gold's short-term situation and prospects as expressed in TSI commentaries over the past three weeks:

1) Gold's rally from its December-2017 bottom was almost solely a sentiment-driven reaction to US$ weakness. This was evidenced by the lack of fundamental support for the price rise. It was also evidenced by gold remaining near a 10-year low relative to the SPX and near a 2-year low relative to commodities in general, and by gold only managing minor rebounds from its December-2017 low relative to currencies other than the US$.

2) The US$ gold price probably won't break above resistance at $1360-$1377 during the first quarter but probably will do so during the second quarter in response to additional US$ weakness.

3) The gold price probably was close to a short-term peak when it rose to the $1360s during the week before last, but it would be reasonable for short-term traders to give the rally the benefit of the doubt until there is a daily close below the 20-day MA.

The following daily chart shows that the US$ gold price traded below its 20-day MA on Friday 2nd February but managed to close above it. That is, the gold price still hasn't confirmed a short-term top by closing below its 20-day MA. However, taking into account the relative weakness of the gold-mining sector (discussed below), the bearish fundamental backdrop and the non-supportive sentiment situation (speculators in gold futures recently became very optimistic), it's reasonable to assume that a short-term top is in place for gold bullion.

A decline to $1300 or lower is likely within the next six weeks.



Silver

Silver has been volatile over the past two weeks, first spiking to a multi-week low, then surging to a multi-month high and lastly plunging to a new multi-week low. Prior to Friday 2nd February there was a decent chance that the silver price would get as high as $18.00-$18.50 before making a short-term top, but it seems that such a top was put in place near $17.70 during the week before last.

Silver's upside breakout failure and violation of MA support indicate that the December low may be revisited before the next tradable rally gets underway. The COT data should help us to identify the next relatively-low-risk buying opportunity.



Gold Stocks

Current Market Situation

Last week we wrote that we did not expect the HUI to breach its December-2017 low this year, but we also wrote that nothing had happened to date to differentiate the current rally from the 1-2 month counter-trend rebounds that occurred during 2017.

To greatly reduce the risk that the rally from the December-2017 low was more significant than the 1-2 month counter-trend rebounds that occurred during 2017 the HUI needed to at least test the 220 resistance level before making a short-term top. It failed to do so. For this and two other reasons, the risk has increased that the HUI will breach its December-2017 low this year. In fact, a Q1-2018 breach of the December-2017 low is now the short-term scenario with the highest probability.

The less important of the two other reasons mentioned above is Friday's close below the 50-day MA (refer to the following daily chart for details). Routine corrections within short-term upward trends generally hold at or above the 50-day MA.



The more important reason is the performance of the gold-mining sector relative to gold bullion as indicated by the HUI/gold ratio. A point we've made repeatedly since the near the start of the rally from the December-2017 low is that the HUI/gold ratio was not as strong as it should have been if we were dealing with the early part of a major rally. As illustrated below, last week the HUI/gold ratio dropped back to near its December-2017 low, which means that it is close to a 21-month low.



Our guess is that a 1-3 week rebound will soon begin, after which the gold-mining indices and ETFs will decline to new multi-quarter lows. At this stage, March appears to be the most likely time for the start of the next tradable gold-stock rally.

What to do?

In our 22nd January and 24th January commentaries we suggested scaling back exposure to the gold-mining sector. This suggestion was based on the dictates of prudent money management, not on an expectation that a sizable decline was about to begin.

A new opportunity to do some selling or to hedge using put options would be provided by a rebound in the HUI to the high-190s within the next two weeks.

The Currency Market

The Dollar Index (DX)

A week ago we wrote:

"The DX's rebound from its early-September low lasted two months and was followed by a new short-term downward trend. This short-term downward trend accelerated over the past three weeks and if it hasn't already done so should climax within the next two weeks, leading to another significant DX rebound. Our guess is that the next rebound will be shorter and sharper than the one that began in early-September of last year, but in any case it is reasonable to expect the DX to make new multi-year lows following whatever correction occurs during February-March."

Last week's price action didn't change anything. The DX hasn't yet signaled that a short-term low is in place and that a significant rebound has begun, so there could be a final spike to a new low for the move this week. However, it is certainly possible that the 1st February decline to a new daily-closing low resulted in a successful test of the previous week's intra-day low. Either way, we expect that by this time next week the DX will be in rebound mode.



The Euro

The following weekly chart shows that over the past two weeks the euro tested the top of the channel that limited its intermediate-term trends over the past 10 years. The positioning of the channel lines is somewhat subjective, so it's possible that the actual channel top is 1-2 points above the level indicated on our chart. The point, however, is that the euro is close to a very important psychological resistance area.

Even if an upside breakout is destined to occur within the next few months, the test of long-term resistance combined with the stretched sentiment and momentum situations paves the way for a significant short-term correction.



The Australian Dollar (A$)

The A$ rebounded strongly from its December-2017 low, propelled in part by a very bullish COT situation. The rally ended early last week at resistance defined by last year's peak.

A normal correction would take the price down to around 78, at which point the A$ could be worth buying for a multi-month trade. We'll cross that bridge when we come to it.



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 ending Friday 2nd February 2018:

[Note: AISC = All-In Sustaining Cost, FS = Feasibility Study, FY = Financial Year, IRR = Internal Rate of Return, ISR = In-Situ Recovery, 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]

  *Alio Gold (ALO) provided production guidance for its San Francisco (SF) gold mine in Mexico. In 2018 the mine is expected to produce 90K-100K ounces, which compares favourably with the 83.5K ounces produced last year. The AISC is expected to be between US$1000/oz and US$1100/oz.

If this guidance is achieved and the gold price averages at least $1300/oz then the SF mine should add US$15M-$20M of cash to ALO's balance sheet this year.

  *Blackham Resources (BLK.AX) issued its quarterly report for the December-2017 quarter (the second quarter of the 2018 FY). The company emphasised the improvements in its rate and cost of production that became evident in December and continued during the first four weeks of the current quarter. Production during the December quarter was only 14.9K ounces, but production during the next few quarters is expected to average 20K-25K ounces.

BLK's recapitalisation is proceeding as planned. Eligible shareholders who want to exercise their rights under the Entitlement Issue must do so by the end of this week.

  *Evolution Mining (EVN.AX) issued its quarterly report for the December-2017 quarter (the second quarter of the 2018 FY). It was another set of good results from this company.

Gold production during the quarter was 186K ounces at an AISC of only US$602 per ounce. This puts EVN on track to exceed the mid-point of its FY2018 production guidance range of 750K-805K ounces and to come in below the bottom of its cost guidance range. Net mine cash-flow was A$134M during the quarter and net debt at 31st December was A$231M. The net debt figure has fallen by A$357M over the past 12 months thanks to strong cash generation.

As far as we know, EVN has the lowest production cost of any mid-tier or major gold producer. It also has the lowest geopolitical risk profile of any mid-tier or major gold producer.

At current prices for gold and copper we estimate fair value for EVN to be about A$3.20/share.

  *Premier Gold (PG.TO) announced a 2018 project development and exploration budget of up to US$83M, US$44M of which would be provided by its JV partners (Centerra and Barrick). This guarantees that 2018 will be another very active year for PG.

  *Ramelius Resources (RMS.AX) issued its quarterly report for the December-2017 quarter (the second quarter of FY2018).

Most of the salient numbers, including the good quarterly production result of 58K ounces, were reported about two weeks earlier and noted in the 15th January Weekly Update. The most important new information is that production guidance for the current Financial Year (FY2018) has slightly increased from 195K-205K ounces to 200K-210K ounces. The forecast AISC remains unchanged at A$1100-A$1200/oz (US$880-US$960/oz).

The company is debt free and had liquidity (cash plus bullion on hand) of A$62M at 31st December, although the working capital position won't be known until the Half-Year financial report is published later this month. We estimate that the working capital position was A$55M-A$60M at 31st December.

With 527M shares outstanding and assuming net cash of A$55M, RMS has an enterprise value of A$192M (US$154M) at its current share price of A$0.47. This is low for a 200K-oz/year gold producer operating in a low-risk jurisdiction.

  *Sandfire Resources (SFR.AX), an Australian mid-tier copper producer, reported that it produced 36M pounds of copper and 8K ounces of gold during the December-2017 quarter (the second quarter of the 2018 FY). Accounting for gold as a byproduct, the cash cost of the copper production was US$1.02/pound.

This was an in-line result and the company is maintaining its FY2018 guidance of 138M-145M pounds.

SFR has a strong balance sheet with A$164M of cash and no long-term debt. We continue to have in mind a valuation-based target of A$10, which is about 35% above the current market price.

  *US Gold Corp. (USAU) has identified a new zone of gold-copper-zinc mineralisation about 200m from the existing resource at its Copper King project in Wyoming. The discovered mineralisation was very low grade and would not be economic, but it indicates that there is potential for the project's existing resource to be expanded via additional step-out drilling.

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$0.92)

2) ALK.AX (last Friday's closing price: A$0.29)

3) NSU (last Friday's closing price: US$2.02)

4) PRQ.TO (last Friday's closing price: C$1.35)

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
http://www.barchart.com/