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   -- Weekly Market Update for the Week Commencing 5th May 2008

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.

Bonds commenced a secular BEAR market in June of 2003. (Last update: 22 August 2005)

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)

The Dollar commenced a secular BEAR market during the final quarter of 2000. The first major downward leg in this bear market ended during the first quarter of 2005, but a long-term bottom won't occur until 2008-2010. (Last update: 28 March 2005)

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 CRB Index, commenced a secular BULL market in 2001. The first major upward leg in this bull market ended during the second quarter of 2006, but a long-term peak won't occur until at least 2008-2010. (Last update: 08 January 2007)

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Outlook Summary

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

US$ (Dollar Index)
Bullish
(10-Mar-08)
Bullish
(31-May-04)
Neutral
(19-Sep-07)

Bonds (US T-Bond)
Neutral
(03-Mar-08)
Bearish
(23-Jan-08)
Bearish
Stock Market (S&P500)
Neutral
(05-May-08)
Neutral
(26-Mar-07)
Bearish

Gold Stocks (HUI)
Neutral
(05-May-08)
Neutral
(21-Apr-08)
Bullish

OilBearish
(14-Jan-08)
Bearish
(22-Oct-07)
Bullish

Industrial Metals (GYX)
Bearish
(05-May-08)
Bearish
(09-Jul-07)
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.

Changes to short-term views

We expect that gold bullion and the HUI will break below last week's lows before the gold correction comes to an end. However, the views shown in the Outlook Summary Table included at the top of every Weekly Market Update are not based on what we think will PROBABLY happen; they are based on our assessment of risk versus reward. For example, if we think a market has an 80% chance of rising 5% and a 20% chance of falling 30% then we will either be bearish or neutral on the market with respect to the timeframe in question even though we expect the market to rise. The reason is that in this hypothetical case the greater magnitude of the downside risk outweighs the higher probability of an upward move.

We will give our reasons later in this report, but we think the decline of the past two weeks has mitigated downside risk by enough to warrant upgrading our short-term views on gold and gold stocks from "bearish" to "neutral". If things go according to plan then we will further upgrade our short-term views on these markets -- to "bullish" -- later this month, but we will cross that bridge when we come to it.

We turned short-term bullish on the broad US stock market on 18th March in anticipation of a rebound lasting at least 2 months. The rebound is probably not over, but we are now downgrading our short-term stock market outlook to "neutral" on the basis that the rally of the past several weeks has substantially reduced the upside potential. If things go according to plan then we will further downgrade our short-term view on this market -- to "bearish" -- at some point over the next few weeks, but, again, we will cross that bridge when we come to it.

The final change is the downgrading of our short-term view on industrial metals from "neutral" to "bearish". This is due to our perception that downside risk is increasing within this sector.

In summary: our perception is that the short-term risk/reward for cyclical (growth-oriented) markets has deteriorated while the short-term risk/reward for gold, the primary counter-cyclical market, has improved.

Commodities

The CRB Index

With reference to the following daily chart, the CRB Index rocketed upward between late February and mid March, pulled back sharply, rebounded to test its March peak, and now appears to be rolling over into the next phase of its intermediate-term correction. This downward correction in the commodity world is linked to the upward correction in the US$.



Industrial Metals

Over the past two months the one thing that has prevented us from downgrading our short-term view on industrial metals to "bearish" has been the bullish price action in the copper market. However, we made the following comment in last week's Interim Update:

"A daily close below $3.80 [by May copper] would be a clear sign that copper's short-term supply problems were close to being resolved or about to be trumped by falling demand. Such an outcome would immediately cause us to downgrade our short-term outlook for the industrial metals sector from "neutral" to "bearish"."

The copper price plunged below $3.80 last Thursday, but then 'muddied the waters' by closing back above $3.80 on Friday. The reversal is therefore not as definitive as we'd like, but a short-term bearish outlook is appropriate given the downside risk to global economic growth and the upside risk to the US dollar's exchange value.

As noted on the following chart, our expectation is that the Industrial Metals Index (GYX) will drop back to near the bottom of its 2-year range.


The Stock Market

Following the selling climax of 22-23 January our view was that the US stock market had set its low for the first half of the year, regardless of whether or not a bear market was in progress. Our reasoning was that the sort of selling climax seen in January had ALWAYS resulted in a low that had held for at least 5 months irrespective of whether the longer-term trend was up or down.

Some people claimed that the stock market's performance would be different this time round because the US was experiencing the worst financial crisis ever, but in real time the latest crisis will usually feel like the worst crisis ever. The current crisis could well prove to be the worst ever as far as the banking industry is concerned, but it's not close to being the worst ever for the majority of US corporations. For example, with some notable exceptions such as the banking and homebuilding sectors, corporate America is in much better shape today than it was during 2000-2002. Furthermore, valuations, while still high by historical standards, are a lot lower today than they were at the beginning of the last recession.

Our view is that the stock market's current rebound is the bear market variety and will be followed by a decline to new multi-year lows. However, we don't expect the rebound to end until sentiment has moved back to 'optimistic territory'. Two indicators that we will be using to identify when that happens are the TSI Index of Bullish Sentiment (TIBS -- a weighted average of six different sentiment indicators) and the 10-day moving average of the put/call ratio. Charts of these indicators are displayed below.

Near the end of the stock market's rebound we expect that:

a) TIBS will be 25 or above. (Note - we picked 25 because this is roughly where the multi-month counter-trend rebounds ended during the 2000-2002 bear market.)

b) The 10-day moving average of the equity put/call ratio (the blue line on the second chart) will be 0.60 or lower -- indicating complacency on the part of the 'dumb money' -- AND the 10-day moving average of the OEX put/call ratio (the green line on the second chart) will be above 1.60 -- indicating concern on the part of the 'smart money'. (Note - the scales are inverted on the put/call chart, so peaks on this chart correspond with put/call lows.) 




This week's important US economic events

Date Description
Monday May 05ISM Services
Tuesday May 06No important events scheduled
Wednesday May 07 Consumer Credit
Pending Home Sales
Q1 Productivity
Thursday May 08 No important events scheduled
Friday May 09 Trade Balance

Gold and the Dollar

Gold

The case for additional near-term weakness

Indicators of gold market sentiment, such as the Commitments of Traders (COT) data and the results of Market Vane's daily survey of gold traders, show that there has been a sufficient reduction in optimism to set the stage for the next multi-month rally. However, for the reasons outlined below we doubt that a sustainable price low is already in place.

We expect the gold price to bottom during May or June, but it's unlikely to bottom until the stock market's rebound has run out of steam; and as things currently stand, the stock market is poised to continue its short-term upward trend.

From our perspective, the likelihood of the US$ making significant additional gains also points to new correction lows for gold over the weeks ahead. It is reasonable to expect that gold will bottom against the US$ well before the US$ peaks against the euro, but we don't think it's reasonable to expect gold to bottom at such an early stage of the US dollar's recovery. Our thinking is that gold's correction low will roughly coincide with the end of the dollar's INITIAL rally (the end of the first wave of a multi-wave rebound).

The third reason we expect some additional price weakness in gold relates to our general commodity outlook. Specifically, we think the world of commodities has successfully tested its March peak and has begun to roll over into a downtrend that will probably last at least a few months. Gold's fundamentals are very different to those of any other commodity, but if non-monetary commodities begin to accelerate to the downside then the monetary commodity (gold) will, at least initially, get dragged along for the ride. But like the case with the US$-gold relationship, gold should only have a problem during the first phase of the commodity decline because some of the expected drivers of weakness in industrial commodities, such as slowing economic growth and the resumption of the debt crisis, are positives for gold.

Current Market Situation

Since the beginning of gold's correction we've had $800 in mind as a worst-case target. This remains so. As illustrated by the following daily chart of June gold futures, $800 coincides with intermediate-term support and is just below the 200-day moving average (bull-market corrections often bottom just below the 200-DMA).

If we are right to assume that gold will do no worse than drop to around $800 before resuming its long-term advance then the current downside risk is only about 7%; hence, the upgrade to our short-term outlook.

By the way, we think the downside risk in silver is approximately double the downside risk in gold (we expect that a 5-7% decline in the gold price would be accompanied by a 10-15% decline in the silver price).


Any near-term rebound in the gold market will probably be limited by former support (now resistance) in the low-$880s and should definitely be limited by the top of the downward-sloping channel drawn on the above chart. By the same token, a solid daily close above the channel top would be a clear sign that the correction low was already in place.

Intermediate-term Outlook

Yield spreads (differences between the yields on long-term and short-term Treasury debt) and credit spreads (differences between the yields on high-risk and low-risk debt securities of the same duration) are two of the most important drivers of the gold price. In particular, gold tends to fare well when yield spreads and credit spreads are rising, that is, when long-term interest rates are rising relative to short-term interest rates and when the yields on high-risk debt securities are rising relative to the yields on investment-grade securities.

The first of the following charts shows that a measure of the US yield-spread -- in this case, the TYX/FVX ratio (the yield on the 30-year T-Bond divided by the yield on the 5-year T-Note) -- trended higher from June of 2007 through to mid March of 2008, while the second of the following charts shows that a measure of credit spreads -- in this case, the JP Morgan EMBI Global Spread (the difference between the yield on a basket of emerging market debt and US Treasury debt of comparable duration) did something similar. The charts make the point that the financial crisis peaked in mid March, which, not coincidentally, was also the peak for the gold price.




We are operating under the reasonable assumption that the financial crisis has not ended. At least, it seems like a reasonable assumption to us given that you can't expect to wring-out all, or even most, of the adverse ramifications of a decade of credit-related excesses within the space of only 9 months, especially when the central bank and the government are trying to 'help' (read: delay the healing process). Therefore, a resumption of the crisis is likely within the next few months.

A resumption of the crisis will almost certainly be signaled by upward reversals in yield and credit spreads, which will, in turn, be evidence that gold's intermediate-term trend had again turned up or was about to do so. Gold should be a major beneficiary of both the realisation that the crisis is not over and the attempts that officialdom will undoubtedly make to inflate-away the consequences of earlier mistakes.

In other words, the beginning of gold's next intermediate-term advance should coincide with, or be led by, upward reversals in yield and credit spreads.

Gold Stocks

Current Market Situation

Based on a simplistic chart-based measurement, the HUI's recent breakdown from a "head and shoulders" top created a downside target of 320. We do not believe the actual downside risk to be that great, but due to the factors mentioned in our gold discussion under "The case for additional near-term weakness" there is a good chance that last week's low will be breached before the correction comes to an end.

One reason we view a drop to 320 (20% below Friday's closing price) as highly improbable is that gold stocks are already very cheap relative to gold bullion and, as discussed above, we think gold's additional downside potential is only about 7%. Another reason is illustrated by the following chart.

The chart shows the performance of the HUI over the past 6 years relative to a Moving-Average (MA) envelope. The lines of the MA envelope are determined by the 50-DMA +/- 15%, so the HUI will touch the lower green line when it is 15% below its 50-DMA and the upper green line when its is 15% above its 50-DMA. Moves to the upper edge of the MA envelope have not been reliable signals of intermediate-term highs, but moves to the lower edge have done an extremely good job of pinpointing intermediate-term lows. In fact, prior to last week the HUI had dropped to the lower edge of its MA envelope on eight separate occasions over the past six years, and each time it did so the gold sector was within three weeks of an intermediate-term bottom. On five of these occasions the touch of the envelope's bottom edge set the price low for the correction, whereas on three occasions -- July of 2002, April-May of 2004 and June of 2006 -- the HUI ended up spiking 10-15% below the bottom of its MA envelope before the final correction low was in place.

The 'envelope-based' analysis therefore suggests that at last week's low the HUI was within three weeks and 10-15% of its ultimate correction low.

Considering the message of the 'envelope' alongside the relative valuations of gold bullion and gold stocks we come to the conclusion that the HUI's downside potential is limited to the mid-300s and that a bottom will be in place by the end of the third week of May.


The following daily chart shows a close-up view of the HUI relative to its MA envelope, and also includes the HUI's MACD at the bottom of the chart. When the HUI becomes as oversold as it is right now an upturn in the MACD -- indicated by the black line crossing above the red line -- is a reliable signal that a correction low is in place.


Further to the above, we will upgrade our short-term view on gold stocks to "bullish" when the HUI drops to the 350s or when the HUI's MACD turns higher, whichever happens first.

By the way, confirmation of a bottom in the gold sector would be a bearish omen for the broad stock market.

Bullion versus Stocks

There's no good reason to own any gold stock unless you are confident that the stock will out-perform gold bullion by a wide margin. However, such confidence has generally been misplaced over the past year in that most gold stocks have not only failed to out-perform gold bullion by a healthy margin, they have actually UNDER-performed gold bullion. A lot of investors in gold stocks are therefore wondering why they should bother.

The increasing popularity of bullion ETFs is widely considered to be at least partly responsible for the lacklustre performance of the average gold share, but we disagree with this view. We see the advent of bullion ETFs as a net positive for the gold-mining sector because the additional investment demand for bullion created by the ETFs helps boost the bullion price, which, in turn, increases the value of the average gold-mining company.

Our thinking with regard to the gold-mining sector's relatively poor performance has been covered in earlier TSI commentaries, but here's a very quick recap:

1. Gold mining shares haven't done a good job of leveraging gains in the gold price because gold-mining companies haven't done a good job of leveraging gains in the gold price. In other words, the cost of mining gold has risen almost as fast as the gold price.

2. Share inflation (the supply of gold mining shares has been growing rapidly due to equity financings, employee option plans, and the floating of new companies)

3. Political risk (a.k.a. government stupidity)

Share inflation and concerns about political risk will continue to dog the sector, but Newmont Mining's recent financial results suggest that the gains in the gold price are finally beginning to generate serious profits for the mining companies. Also, the risks posed by share inflation and government stupidity can be mitigated to a significant extent via prudent stock selection.

We are going to maintain a strong focus on the junior end of the gold/silver sector, despite its lousy performance over the past 9 months, because we don't think the recent trend should be extrapolated. There are legitimate concerns, but these concerns can be managed and are more than fully discounted in current prices. Rather than give up on the sector that served us so well prior to the past year, we find ourselves becoming increasingly bullish. 

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)

As promised in last week's Interim Update, we present, below, an alphabetically-sorted shortlist of current TSI gold/silver stocks that may be suitable for new buying immediately or following some additional near-term weakness. With two exceptions, the stocks we've chosen to highlight are either in production or close to production. In some cases these stocks don't have as much upside potential as the earlier-stage exploration plays in the TSI Stock Selections List, but we expect them to be amongst the first movers during the next gold rally.

The two exceptions mentioned above are Andina Minerals (TSXV: ADM) and Keegan Resources (TSXV: KGN), both of which are years away from production. We've singled out these two explorers due to the high quality, large scale and relatively secure location of their respective gold deposits.

1. Andina Minerals (TSXV: ADM). Shares: 64M issued, 81M fully diluted. Recent price: C$3.59

ADM gained 15% on higher-than-average volume on Friday, breaking its downward trend and leaving little doubt that it bottomed at just below C$3 during the week before last. Friday's surge was in response to good drilling results announced after the close of trading on Thursday. More good drilling-related news and an upgraded resource estimate are likely over the next two months.

Buy at around C$3.50.

2. First Majestic Silver (TSX: FR). Shares: 63M issued, 77M fully diluted. Recent price: C$4.03

FR continues to make steady progress with regard to increasing the silver production and resources at its Mexican mines. This year's silver production is expected to be around 5M ounces.

Buy following a pullback to the mid-C$3 area or a daily close above C$4.20.

3. Great Basin Gold (AMEX: GBN, TSX: GBG). Shares: 203M issued, 245M fully diluted. Recent price: US$2.95

An emerging gold producer with development-stage projects in South Africa and the US. It offers substantial leverage to gold due to the relatively low valuation of its in-ground resources.

Buy the stock at US$2.55-2.75 and/or buy the warrants (TSX: GBG.WT) below C$0.40. Note that the warrants are much riskier than the stock.

4. Keegan Resources (TSXV: KGN, AMEX: KGN). Shares: 26M issued, 35M fully diluted. Recent price: C$4.34

KGN was hit hard over the past couple of weeks due to political-risk-related concerns -- Ghana's Mining Minister made some comments implying that the government would attempt to obtain a higher return for itself from its mining industry -- and the resultant sell recommendation of another newsletter. Given what has recently transpired in Ecuador and Venezuela it is both natural and appropriate to pay more attention than ever to political risk, but we don't think Ghana's government will do anything to seriously degrade the economics of mining in that country. We therefore think that the recent fears were overblown and created a terrific buying opportunity.

We highlighted KGN in last Wednesday's email alert when it was trading at C$3.45 and in last week's Interim Update when it was trading at C$3.72. It has since rebounded to the C$4.30s, but may pull back to the mid-C$3 area if the gold-stock indices break to new lows over the coming weeks. If such a pullback occurs it would be another buying opportunity.

5. Minefinders Corp. (AMEX: MFN). Shares: 48M issued, 60M fully diluted. Recent price: US$10.46

A sizeable short position has built up in MFN, most likely in anticipation of the company experiencing similar start-up problems at its Dolores gold/silver mine over the remainder of this year to those experienced by Gammon Gold over the past year. This means that MFN will be given a hefty boost by a bout of short covering IF the mine start-up goes relatively smoothly.

Buy at around US$9.50.

6. Metallica Resources (AMEX: MRB, TSX: MR). Shares: 93M issued, 119M fully diluted. Recent price: US$6.45

In our opinion: a 'must-own' gold stock. It hasn't pulled back very far up until now, but a break to new lows by the HUI would probably result in MRB dropping to US$5.75-6.00. If this happened it would constitute a buying opportunity.

7. Northgate Minerals (AMEX: NXG, TSX: NGX). Shares: 255M. Recent price: US$2.94

On a cash flow and earnings basis, NXG is the most under-valued gold stock we know of.

Buy below US$3.00.

8. Resolute Mining (ASX: RSG). Shares: 278M issued, 280M fully diluted. Recent price: A$1.97

2008 should be a good year for RSG as the company brings its Syama gold project into production and transitions from a junior to a mid-tier miner.

Buy below A$2.00

    As also promised in last week's Interim Update, here is a shortlist of potential future TSI gold/silver stock selections and the prices at which we would, or might, be interested in adding them. It's unlikely that these prices will be attained over the next few weeks unless the HUI drops to at least the mid-300s.

Symbol Market Company Name Current Price
Comment
ATW TSXV ATW Ventures C$0.83
Would probably add at C$0.75
EDV TSX Endeavour Mining Capital
C$6.95 
Would probably add at C$6.35
FVI TSXV Fortuna Silver
C$1.97
Would definitely add at C$1.60
GSS AMEX Golden Star Resources US$3.30 Would consider adding at US$3.00
HL NYSE Hecla Mining US$10.29
Would consider adding at around US$9.00
RGLD NYSE Royal Gold 
US$27.33 Would definitely add at US$24.00
TGB* AMEX Taseko Mines
US$5.17 Would definitely add at US$3.50
WGW AMEX Western Goldfields US$2.82 Would probably add at US$2.25

     *TGB is a copper producer

    Tax consequences

When we present investing/trading ideas at TSI we never take income-tax consequences into account, for these two main reasons: First, taxation-related implications/issues are outside TSI's scope and outside our area of knowledge. Second, our subscribers are spread over more than 30 tax jurisdictions, so we couldn't possibly provide relevant tax-related information that catered for all, or even most, of our subscribers even if we wanted to. The bottom line is that subscribers must do their own research as far as personal income tax issues are concerned.

Personal tax-related matters could be important considerations when it comes to investments such as the Canadian energy trusts and Exchange Traded Notes (ETNs). As far as we tell from reading the info at http://www.ipathetn.com/Exchange-Traded-Notes-taxation.jsp#q1, the livestock ETN (COW) that was added to the TSI Stocks List a couple of weeks ago should be treated like a common stock for tax purposes; but because they are debt securities ETNs can sometimes have unexpected tax consequences.

Chart Sources

Charts appearing in today's commentary are courtesy of:

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



 
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