-- Weekly Market Update for the Week Commencing 5th March 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

The warning shots of 2007

Summary of current thinking/positioning

1) Thinking that the US$ gold price will go on to make new highs for the year during the second quarter, but that a short-term correction low is not yet in place.

2) Favouring a drop in the stock market to test the early-February low during March, but assigning a very low probability that the decline from the January peak is something more bearish than a short-term correction.

3) Thinking that industrial commodities such as oil and copper are in downward trends that will end in March.

4) Expecting the rebound in the Dollar Index (DX) to continue for a few more weeks before the longer-term downward trend resumes.

5) Expecting that the T-Bond will rebound for a few weeks and then resume its downward trend.

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

Economic Numbers

G2 Monetary Inflation

The ECB got around the publishing its January-2018 money-supply data last week, enabling us to update our calculation of the G2 (US plus euro-zone) monetary inflation rate. The G2 monetary inflation rate has a closer relationship to the overall financial-market and economic backdrop than does the US monetary inflation rate in isolation.

The following chart shows that the year-over-year rate of growth in G2 money supply was essentially unchanged in January and remains in the bottom quartile of its 20-year range. The monetary backdrop is therefore not supportive of equity prices or Keynesian measures of economic performance such as GDP, although we aren't yet seeing evidence in the monthly economic numbers and other high-frequency data that the tightening of monetary conditions has begun to matter.



US Recession Watch

The latest iteration of the ISM New Orders Index (NOI), one of our three primary leading indicators of US economic recession, was reported on Thursday 1st March. It was down a little from the preceding month but remains near the top of its 20-year range.



As a result, there has been no change in our expectations regarding the timing of the next US recession. The probability of a recession beginning during the first half of this year remains close to zero, but due to the tightening of monetary conditions there is a realistic chance that a recession will begin before year-end.

Commodities

Gains in the Grains

We don't know how to assess the fundamentals of the grain markets, but we've noticed that grain prices have turned upward from very depressed levels on long-term monthly charts and that the grains are cheap relative to many other commodities. Given that global grain consumption will almost certainly be higher in the future than it is in the present, the price up-turns from levels that are low by historical standards in both absolute and relative terms suggests to us that these commodities have bullish intermediate-term and long-term risk/reward ratios.

Here are the long-term monthly charts that have piqued our interest:

1) The wheat price made a 10-year low in mid-2016. It then rebounded for about 12 months, quickly retraced the bulk of its rebound, and then, in December-2017, resumed what could be a new long-term bullish trend.



2) Corn is in a similar position to wheat, except that the corn market's mid-2016 low was a successful test of the 2008-2009 financial-crisis low.



3) The soybean market has been stronger than the wheat and corn markets, in that the 2016 bottom for the soybean price was above the financial-crisis low. Also, over the past two years the soybean market has led the wheat and corn markets by several months.



4) Canola has been the strongest of the grain markets that we keep an eye on. It has been working its way higher since late-2014 and is now in the middle of its 10-year range.



And here are charts showing the recent reversals in the strength of the iPath Grains ETN (JJG) relative to the SPDR Gold ETF (GLD) and the iPath Copper ETN (JJC):

For us, a problem with being long-term bullish on the grains is that we don't know of a good way to participate in a grains bull market. JJG is fine for short- or intermediate-term trades, but due to contango-related value leakage it will tend to underperform the associated commodities by a wide margin over the long term. Displayed below is a chart showing the long-term performance of JJG.



Input Capital (INP.V), a stock we mentioned a few weeks ago, does canola streaming deals with farmers in Canada and should profit from a continuing upward trend in the canola price, but over the past few years there has been no relationship between the INP share price and the canola price.

At this stage we view the nascent long-term upward trends in grain prices mainly as supports for our view that bond yields have commenced long-term upward trends. The reason is that rising food prices will contribute to increasing concern about "inflation".

Platinum completes a routine correction

In late-January the platinum price was testing the bottom of its $1025-$1050 resistance range. At that time (in the 22nd January Weekly Update) we wrote:

"We will be surprised if the platinum price manages to break above $1050 before experiencing a multi-week correction. Note that a routine correction would retrace about half of the rally from the December low, implying that the mid-$900s would be a realistic target for the next tradable low if a correction were to begin near the current price."

Platinum traded as low as $956 last week, so the "realistic target for the next tradable low" has been reached. There's no evidence that the correction is complete, but the mid-$900s is a reasonable place for investors with a 6-12 month or longer timeframe to do some buying.



Due to falling demand for catalytic converters associated with the rising popularity of EVs, platinum's long-term supply/demand relationship is bearish for the price of the metal. A consequence could be that a platinum/gold ratio of 1 will transform from a signal that platinum is near a major price bottom to a signal that platinum is near a major price top. That is, what was major support for platinum relative to gold in the past will, in the future, be major resistance. However, assuming -- as we are -- that the gold price will move into the $1400-$1500 range later this year, there will be a lot of scope for platinum to rally while remaining cheaper than gold.

We are bullish on platinum with regard to the next 6-12 months.

Speculators get even more bearish on the T-Note

The total speculative net-short position in 10-year T-Note futures surged during the latest week and is now within a whisker of its all-time high. Refer to the following weekly chart for details.

The all-time high for the speculative net-short position occurred in January of last year and set the scene for an 8-month upward consolidation in the 10-year T-Note. The rise to a similar level over the past week means that this is not a good time to be placing short-term bets on lower bond prices (higher bond yields), although this time around we aren't expecting anything more than a multi-week upward consolidation.



The Stock Market

Is the high level of margin debt a problem?

The following chart was extracted from the article posted HERE and shows that US stock-market margin debt, which is reported monthly with a lag of about one month, moved sharply higher in January-2018 from an already-high level. Is this a problem?



According to FINRA (the Financial Industry Regulatory Authority) it is a problem. The above-linked article notes that FINRA issued an alert in January, warning: "...many investors may underestimate the risks of trading on margin and misunderstand the operation of, and reason for, margin calls." And: "Investors who cannot satisfy margin calls can have large portions of their accounts liquidated under unfavorable market conditions. These liquidations can create substantial losses for investors."

There is no doubt that the liquidation of margin debt will magnify and accelerate the next intermediate-term stock market decline or bear market, but there won't be a bear market as long as leverage continues to increase. To put it another way: regardless of how large the pile of margin debt becomes, the start of a bear market won't be imminent as long as the pile is still growing.

The debt pile would have shrunk a little in February, but it will take more than one month of shrinkage in margin debt to warn that the equity bull market is on its last legs.

Tariffs and the Stock Market

One of the few concepts that almost all economists agree on is that tariffs are bad for the economy. The reason for the agreement is that a deep understanding of how the economy works is not required to know that artificially raising the price of a good to help the local producers of the good will hurt the local consumers of the good. Since the number of local consumers will always be much greater than the number of local producers of a protected good, it is obvious that the price-boosting intervention will be harmful to the overall economy.

It will be harmful even if there is no retaliation from other governments, but retaliation in some form will often happen. The risk, therefore, is that the initial tariff will turn out to be the first shot in a trade war and an economic downward spiral.

That being said, the US tariffs on steel and aluminium that were announced last week by the Trump Administration were not the reason for last week's stock market downturn. To believe that they were you would have to believe at least one of the following fallacies:

1) The level of the stock market is first and foremost a reflection of the state or expected state of the economy. Note that if this were true then the S&P500 Index (SPX) would now be at least 30% lower.

2) In the absence of policy error there would never be a downward correction in the stock market.

3) If news event A is followed by market event B, then A must have caused B.

The third of the above fallacies forms the basis of most explanations of market action found in the mainstream press.

The reality is that at the late-January peak the US stock market was more stretched to the upside in both momentum and valuation terms than it had ever been. At that time the stage was therefore set for a significant correction, with the main unknowns being exactly when the correction would start and why the market had managed to rise for so long without a significant correction.

When the initial leg of a correction is large and fast, which is the situation we are currently dealing with, there will typically be a rebound and then a decline to test the low of the initial leg REGARDLESS of the news.

Current Market Situation

The US

The SPX broke above minor resistance at 2750 last Monday and then negated the breakout the next day. This was a bearish signal.

Last Tuesday's downward reversal was followed by additional weakness on Wednesday and Thursday that took the SPX below its 50-day and 20-day MAs. Friday's rebound did no more than take the index back to its declining 20-day MA and therefore wasn't significant.

The SPX's price action suggests that a test of the early-February low remains a good bet.



Last week's performance by the SPX has short-term bearish implications, but the waters are muddied by the performance of the NDX. After testing its January peak on Monday 26th February, the NDX did no more than pull back to test its rising 50-day MA.



Despite the resilience of the NDX, we expect that most US stock indices will test their early-February lows during March. The test could occur as soon as this week or wait until the second half of the month.

Our plan is to exit all short-term bearish speculations if the SPX tests its early-February low this week. Also, we will be stopped out of all short-term bearish speculations if the SPX closes above 2781.

Europe

Equities have been much weaker in Europe than in the US. This is evidenced by the fact that for the EURO STOXX 50 Index (STOX5E) last week's downward reversal has already led to a test of the early-February low. It is also evidenced by the STOX5E ending last week near a 12-month low.

The STOX5E has long-term support at 3100-3150. This is the most likely area for a multi-month bottom.



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

Late last week we got the expected breach of support at $1310, but instead of following through to the downside the gold price immediately rebounded. The rebound ended at the 50-day MA, which means that it wasn't particularly strong. However, when a reversal occurs soon after the break below an obvious support level it often has bullish implications.



The significance of an upward reversal following a breach of obvious support depends on the context. The greatest potential significance would involve a market that has been trending downward for years, and is very 'oversold' in both momentum and sentiment terms, reversing upward soon after breaking out to a new multi-year low. The smallest potential significance would involve an upward reversal soon after a break below short-term support in a market that is not 'oversold' in either momentum or sentiment terms.

The best recent example of the former type of reversal was the gold-mining sector in January-2016, when the HUI and the XAU broke out to new bear-market lows shortly before the start of an incredibly strong 7-month rally. Gold's performance last Thursday-Friday was the latter type of reversal.

We are open to being proved wrong by future price action, but at this time we don't have a good reason to believe that last week's reversal following the break below $1310 marked the end of gold's correction. We are still dealing with a gold-bearish fundamental backdrop, a sentiment backdrop that is neutral at best, the high probability that the Dollar Index will soon break out to the upside from its short-term trading range and weakness in the gold-mining indices relative to gold bullion.

Although the odds still favour a March low for gold ahead of a rally to new multi-year highs, there's a risk that last week's 'premature' upward reversal will extend the overall correction. Based on the history of gold-market turning points, if we don't get a correction low in March then the most likely time for such a low would shift to May.

The one thing that could derail our short-term outlook for gold is a sooner-than-expected break to new lows by the Dollar Index. A break to new lows by the DX would likely override all other considerations and cause the US$ gold price to rise to new multi-year highs.

Gold Stocks

For the 6th time in 12 months the HUI has tested support defined by the downward-sloping line drawn on the daily chart displayed below. It initially has followed the pattern of the past year and rebounded from support.



Many individual gold-mining stocks have already suffered capitulations. They appear to be 'sold out'. It's a different story for the HUI, though. Every time it moves to a marginal new multi-month low and looks set to commence a trend-ending plunge, buyers step in and 'save the day'. Unfortunately, this eagerness to buy every dip to a marginal new multi-month low is prolonging the downward drift.

As mentioned in recent commentaries, we think that to get an intermediate-term rally it will be necessary to break the pattern of the past year. To be more specific, to get a much stronger rally than the 1-2 month counter-trend rebounds of the past 12 months there probably will have to be a sharp decline to below the HUI's December-2016 low of 160.

We are hoping that the aforementioned trend-ending plunge will happen during the first half of this month.

The Currency Market

The following weekly chart shows that the euro's recent peak was close to the top of the channel that limited ALL of its intermediate-term trends over the past 10 years. In other words, the euro recently turned down from near a very important psychological resistance level.

If we are dealing with a euro bull market (our working assumption despite the euro's bearish fundamentals), as opposed to an intermediate-term rally within a bear market, then at some point over the next few months there should be a break above the top of the long-term channel.

Also, if we are dealing with a euro bull market then corrections over the remainder of this year should be limited by the 50-week MA (the blue line on the following chart). The 50-week MA is presently at around 1.16 and rising, so this gives us a rough idea of the short-term downside potential.



The following daily chart shows that the euro has done little more than consolidate since hitting a peak during the first half of February. Ideally, the recent consolidation will evolve into a meaningful correction that results in a decline to either the 200-day MA near 1.18 or lateral support near 1.16. A decline of this magnitude would substantially reduce the speculative net-long position in euro futures and improve the currency's risk/reward. However, until a meaningful correction is signaled by a daily close below 1.22 there will be a realistic chance of a near-term surge to a new multi-year high.

The latter outcome would be difficult to trade or even analyse, because it would involve the euro breaking above the top of its long-term channel at a time when speculators, as a group, were massively long in anticipation of additional gains. That is, the upside breakout would be occurring in parallel with a sentiment backdrop that indicated large short-term downside risk.



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 March 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%, NSR = Net Smelter Return, P&P = Proven and Probable, PEA = Preliminary Economic Assessment, PFS = Pre-Feasibility Study]

  *Alkane Resources (ALK.AX) issued its half-year financial report. The balance sheet included in this report showed that ALK had no debt and A$45M of working capital at 31st December 2017, which is up from A$35M six months earlier. This means that ALK remains in a strong financial position.

ALK has two projects -- the Tomingley Gold Operation (TGO), a gold mine with expected production of 70K-80K ounces during the current FY, and the Dubbo Project (DP), which is construction-ready and slated to produce zirconium, hafnium, niobium and REEs.

For the TGO, an underground mining study is scheduled to be complete this quarter. For the DP, a project execution and financial model incorporating the results of a modularised build study is also scheduled to be complete this quarter. That is, ALK should have two pieces of important news within the next four weeks.

  *Africa Oil Corp. (AOI.TO) published its financial report for the quarter and the year ending 31st December 2017. The report highlights how cheap this stock has become.

There was only a minor change in the company's balance sheet during the final quarter of 2017. In particular, working capital was US$443M at 30th September and US$436M at 31st December, with the US$7M drop offset by a small increase in long-term assets. The company has no long-term liabilities.

The working capital is equivalent to C$1.22/share, which effectively means that AOI is currently trading at only about 10% above its net cash. The implication is that the market is valuing AOI's 25% stake in the South Lokichar Basin (Kenya), a large development-stage oil project that could be in production as soon as 2021, at almost zero.

This makes AOI a very cheap oil stock.

  *Blackham Resources (BLK.AX) issued its half-year financial report.

The report shows the company's financial position at 31st December 2017, but the situation is now very different due to the recapitalisation that happened during January-February. In particular, the company's net debt has since dropped from A$59M to about A$20M.

Contrary to a comment we made in the 19th February Weekly Update, for a company of BLK's size and operating history a net debt position of A$20M should not be described as healthy. If the operational improvements reported for December-January are sustained and the company achieves its production guidance for the first half of the 2018 calendar year then by the third quarter of 2018 the financial position should be healthy or at least comfortable. However, that's a big if.

On a positive note, the downward pressure on the stock price stemming from selling by participants in the recent entitlement issue appears to have abated.

  *Cobalt 27 (KBLT.V) announced that it is raising up to C$130M by issuing new shares at C$11.40/share.

On the surface this looks like a bad deal for existing shareholders, at least for the ones who are not participating in the financing. This is because the new shares are priced at a discount of more than 15% to the market price at the time of the announcement. However, it all depends on how the company uses the cash.

The cash will be used to purchase cobalt royalties and do cobalt streaming deals. The right deals would add a lot more than $130M of value to KBLT.

  *Nevsun Resources (NSU) is expected to have important news this month in the form of the PFS for its Timok Upper-Zone copper project in Serbia.

  *Premier Gold (PG.TO) announced updated estimates of resources and reserves for its 40%-owned South Arturo project in Nevada. Barrick Gold owns the other 60% and is the operator of the project.

South Arturo has four phases: the Phase 1 Open Pit, the Phase 2 Open Pit, the Phase 3 Open Pit and the El Nino Underground (located below the Phase 2 Open Pit). The Phase 2 Open Pit was mined over the past 2 years, yielding substantial profits for the PG-ABX joint venture, but is now depleted. The Phase 1 Open Pit and the El Nino Underground will begin being developed during the third quarter of this year and should be in production in 2019. A schedule for development of the Phase 3 Open Pit is yet to be determined.

The highlights of the reserve/resource update were:

1) An increase of 333% in mineral reserves (Phase 1 plus El Nino) to 270K ounces of gold at 3.18 g/t.

2) Initial Phase 3 Open Pit M&I mineral resources of 275K ounces of gold (exclusive of reserves).

The above figures are the portions of the total project reserve and resource attributable to PG.

This is good news. The total quantity of ounces included in the new estimate is not large, but if the Phase 2 experience is anything to go by the mining of the other phases will generate a lot of cash for PG.

  *Ramelius Resources (RMS.AX) issued its half-year financial report.

The only new information of significance in this report was the updated balance sheet. We had previously estimated that the company's working capital position was A$55M-A$60M at 31st December. The balance sheet included in the half-year report showed that it was A$57M, so no surprise there.

Our RMS valuation is unchanged at around A$0.80/share.

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) ALK.AX (last Friday's closing price: A$0.28)

2) ALO (last Friday's closing price: US$2.51)

3) AOI.TO (last Friday's closing price: C$1.33)

4) EGD.V (last Friday's closing price: C$0.38)

5) PG.TO (last Friday's closing price: C$3.15)

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.goldchartsrus.com/
http://www.barchart.com/