-- Weekly Market Update for the Week Commencing 6th January 2020

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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

There were no blog posts last week.

Summary of current thinking/positioning

1) The Dollar Index (DX) remains range-bound, needing a weekly close below 96.5 to signal an intermediate-term reversal to the downside or a weekly close above 99.5 to signal an intermediate-term rally.

2) For gold, silver and the gold-mining indices/ETFs, we expect a multi-month top in January.

3) The senior US stock indices probably will make multi-month tops during the first half of January. Sentiment indicators are flashing warning signs, but breadth indicators are saying that the coming decline will be limited to around 10%.

4) The T-Bond is at risk of downward acceleration over the coming month or two, but regardless of what happens in the short-term there's a good chance that major price weakness will be seen in 2020. In other words, it looks like higher interest rates are on the way.

5) We expect the oil price to trend upward over the next 12 months, but the stage is now set for a multi-month price high in January.

6) We are holding a cash reserve of 25%-30% and are looking for opportunities to increase this reserve.

TSI Schedule Reminder

This is the third week in a row that we will not be doing an Interim Update, but thereafter we will be back to our usual two reports per week format.

Revisiting the Fed's potential game-changer

Over the past four months the Fed has added about $400B to its balance sheet. To put this into perspective, since early September the Fed has expanded its balance sheet at an annualised rate of around 30%. According to the Fed, the purpose of this dramatic monetary expansion was to address a temporary liquidity issue in the "repo" market. The question is: If the Fed is dealing with only a temporary shortage of liquidity in the market for short-term money, why did it introduce a program in mid-October to supplement the temporary injections of "repo" money with $60B/month of permanent money?

The answer is that the Fed is dealing with something more than a temporary shortage of liquidity in the market for short-term money. The fact that the Fed sees the need to remove $60B/month of Treasury supply from the market in addition to the Treasury supply that is being removed on a temporary basis via "repo" operations implies that the overall demand for Treasury debt is falling short of Treasury supply at the Fed's targeted interest rates. Looking from a different angle, it is clear that at current interest rates the global financial system wants more dollars and less Treasury debt. The Fed is accommodating this desire by increasing the supply of dollars to the market and reducing the supply of government debt that must be absorbed by the market.

The key phrase in the above paragraph is "at current interest rates". If the supply of and the demand for money and credit were permitted to balance naturally then interest rates would now be much higher. However, the Fed doesn't want supply and demand to strike a natural balance; the Fed has decided that it wants the price of credit at a certain level and that it will use its power to create and destroy money to override natural market forces. In this regard the current situation is unusual only in degree, because the Fed has been attempting to override market forces for more than 100 years.

The US Federal government is not about to slow the pace at which it emits new debt. On the contrary, the rate of growth in government debt supply looks set to rise. Therefore, one of two things will have to happen if interest rates are to stay near current low levels: The Fed will have to keep absorbing Treasury supply at a rapid pace or the market's desire to hold Treasury debt will have to increase substantially. The latter could occur in response to a sizable decline in the US stock market or a crisis outside the US.

Within a week of its mid-October announcement we wrote that the Fed's promise to inject $60B/month of new 'permanent' money was a potential game-changer, in that it could extend the current cycle (prolong the equity bull market) and lead to more "price inflation" than earlier programs. We continue to think that a cycle extension could be on the cards, but if so the recession warnings that were generated by leading indicators during the second half of last year must disappear within the next couple of months.

US Recession Watch

Our favourite leading indicators of US recession are the ISM New Orders Index (NOI), Real Gross Private Domestic Investment (RGPDI) and the yield curve. Subsequent to our last discussion of US recession risk the only new information worth mentioning is an updated NOI (the latest ISM Report was published last Friday).

As mentioned previously, the NOI occasionally generates a false recession warning. When the signal proved to be false in the past, for example, in March-April of 2003, the move below the recession line (the red line on the following monthly chart) was marginal and quickly reversed. By the same token, when the signal proved to be correct the initial break below the recession line was followed by a significant extension to the downside.

Since issuing a recession warning the NOI has chopped around near the red line, meaning that the signal is intact. In this respect nothing has changed over the past month. However, time is running out for the NOI to invalidate its recession warning.



The situation now is similar to what it was a month ago, in that all three of our favourite leading indicators are warning of recession.

Based on the latest data, our rough estimates of recession start-time probabilities are:

  - H1-2020: 60% (unchanged from a month ago)
  - H2-2020: 20% (unchanged from a month ago)
  - Later than 2020: 20% (up from 10% a month ago).

Note that even if the US economy doesn't slide into recession anytime soon, the weakness over the past several months in the ISM NOI suggests that some coincident economic statistics will continue to deteriorate during the first few months of 2020. Industrial production is an example.

Also note that the Fed's recent actions are why 2020 recession risk is skewed towards the first half of the year. If the Fed's actions are too little too late to prolong the monetary-inflation-fueled boom, then a recession should get underway before the middle of this year. Alternatively, if the Fed has done enough to prolong the boom then a recession probably won't get underway until 2021.

The Monthly (and Yearly) Closing Prices

At around this time every month we review some of the most important (from our perspective) monthly charts. We do this because monthly closing prices can confirm or deny intermediate-term trend changes. For December-2019 we'll review the monthly closes for gold, GDX, the HUI, the S&P500 Index (SPX) and the T-Bond.

As stated in earlier commentaries, critical monthly-closing support for gold's intermediate-term upward trend is defined by the 8-month MA. That is, a monthly close below the 8-month MA would confirm that an intermediate-term top (a top that holds for 6-12 months or longer) is in place. The following monthly chart shows that this MA was tested in each of the past two months and has risen to $1460.

We expect that there will be another test of the 8-month MA during the first quarter of this year, most likely following a January spike to a new multi-year high.

Note that a monthly close above resistance at $1570 would point to a test of the 2011 major peak.



GDX and the HUI completed 2-3 month corrections in November and then resumed their upward trends. They are in different positions on the monthly chart, though, because the HUI made a new multi-year high in December whereas GDX has stayed well below its August-2019 high.

Although the chart patterns suggest that the 2016 highs will be tested prior to an intermediate-term peak, there are reasons to be cautious about the gold sector's 2-4 month prospects. One reason is the 1980s comparison, which projects a substantial decline from a January top.

The SPX's price action during the period since September-2018 still looks similar to the price action that followed the intermediate-term top in 2011. The similar periods are indicated by the red boxes drawn on the following monthly chart.

For the post-2011 similarity to be maintained, the 12-month MA should not be breached on a monthly closing basis for a long time to come. This is not what we expect, but clearly the long-term US equity bull market was intact at the end of December-2019. That's despite the complete lack of earnings growth over the past year and the high risk that the US economy will slump into recession in 2020.

A monthly close below the 12-month MA (currently at 2938 and rising) would be the first clear sign on the monthly chart that the bull market is over.



The T-Bond rocketed up to a top in August-2019 and then fell during each of the ensuing four months. It is tracing out a long-term top.



The Stock Market

On 27th December a US contractor was killed in Iraq by a rocket attack that the US blamed on an Iran-backed Iraqi militia called Kataeb Hezbollah (KH). In retaliation, on 29th December the US launched airstrikes in Iraq that killed 25 KH fighters. In retaliation, on 31st December the US embassy in Iraq was attacked by KH supporters. In retaliation, on 2nd January the US launched a drone attack in Iraq that killed a high-profile Iranian general, prompting the threat of harsh retaliation from the Iranian government.

There is a risk that the sequence of retaliatory actions will spiral out of control and lead to outright war, but according to the stock market it is a low-probability risk. We know that's the stock market's assessment because on 3rd January, in response to the news of the US attack that killed the Iranian general and the Iranian government's promise to seek a "forceful revenge", the SPX didn't even fully retrace the preceding day's advance.

The reaction to last week's bearish news was remarkably mild considering that the market is both 'overbought' in momentum terms and 'overbullish' in sentiment terms (the dangerous sentiment situation was discussed in our previous two Weekly Updates). In fact, Friday's pullback is barely noticeable on the 1-year daily SPX chart displayed below. This implies that a short-term top has not been signaled yet.



The lower section of the above chart shows the NYSE Advance-Decline Line (ADL). The ADL made a new all-time high last Thursday and then dropped a little on Friday.

The US stock market has never commenced a bear market with the ADL at/near an all-time high, but the ADL's strength does not preclude a correction of up to 10%. We are anticipating a correction of up to 10% from a January high.

It's still the case that the obvious lack of strength in the Dow Transportation Average (TRAN) is the only noteworthy bearish divergence or non-confirmation. As illustrated below, the TRAN remains below its early-November high and continues to trade in a lacklustre manner.



The concluding comment from the Stock Market discussion in the previous Weekly Update remains applicable. Here it is again:

"It would be reasonable to accumulate new or add to existing bearish speculations over the coming fortnight. These speculations could take the form of put options with expiry dates of March-2020 or later that are 5%-10% out of the money, or bear funds such as QID."

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

Many fundamental developments could affect the gold market in 2020, but the most important ones should be picked up by our Gold True Fundamentals Model (GTFM). The GTFM takes guesswork and our opinions out of the equation.

Over the past several weeks the fundamental situation has been finely balanced, with four of the GTFM's seven inputs being close to their tipping points. Therefore, although the GTFM currently is in bullish territory (see chart below) we consider the current fundamental backdrop to be neutral for gold.



When we have substantial 'long-side' exposure to a market we are always more interested in what could go wrong than what could go right for the market. With regard to the gold market at this time, a rise in the T-Bond yield (a fall in the T-Bond price) is the most likely thing that could go wrong.

At some point we will see the gold price rocketing upward in parallel with a rapidly-rising T-Bond yield due to plunging confidence in the Fed and the currency it tries to manage, but it's likely that in the short-term a significant additional rise in the gold price would be accompanied by a falling T-Bond yield and a significant decline in the gold price would be accompanied by (and partly driven by) a rising T-Bond yield. Consequently, in the short-term the biggest fundamental risk facing the gold market is the possibility that the T-Bond will break below its Q4-2019 price low and accelerate downward.

At the moment, however, the biggest overall risk facing the gold market is related to sentiment, not fundamentals. Due to the public holiday there was no new COT report last week, but the rise in futures open interest (OI) over the course of the week suggests that the total speculator net-long position in Comex gold futures is at an all-time high.

Sentiment is never a sufficient condition for a trend reversal. To be more specific, no upward price trend ever ended simply because speculators became very optimistic and no downward price trend ever ended simply because speculators became very pessimistic. Therefore, today's extreme speculator optimism in the gold market won't CAUSE a downward reversal in the gold price. The issue is that the speculating community is betting so heavily on additional gains in the gold price that even a relatively minor negative development (for example, a downside breakout in the T-Bond price) could lead to an avalanche of speculator long liquidation.

Turning to the short-term price action, the following daily chart shows that the US$ gold price broke out to the upside during the week before last and moved steadily higher until Friday 3rd January, when there was upward acceleration. Friday's 1.6% gain was a reaction to the ramping-up of the US-Iran conflict mentioned in the Stock Market section of today's report.

The Iranian government has threatened to retaliate against the killing late last week of one of its generals, so this particular phase of the US-Iran conflict probably hasn't run its course and there could be more news within the next couple of weeks that prompts another wave of speculative gold buying.



A week ago we wrote: "... [gold's] chart pattern suggests that a test of the 2019 high probably will happen in the near future and that a spike to as high as $1600 is possible." Last week's price action is consistent with this expectation, but the US-Iran situation has introduced a wildcard. If there is a major escalation of hostilities there could be a vicious near-term spike in the gold price to well above $1600.

Keep in mind, though, that the gold market has NEVER sustained price gains that occurred in reaction to military conflict or the threat of military conflict. Therefore, it's a very good bet that any price gains made by gold in response to the heightened tensions in the Middle East will be relinquished in full.

Silver

Regarding silver, a week ago we wrote:

"There is some resistance in the low-$18 area that could limit the rally temporarily, but a near-term rise to the $19.00-$19.50 area looks likely.

Note that silver has a smaller chance than gold of exceeding its 2019 high prior to the next multi-month price top."

Despite gold's return to the vicinity of its 2019 high, silver is still struggling with resistance in the low-$18 area. The potential for a near-term rise to the $19.00-$19.50 area remains, but we doubt that silver will exceed its 2019 high in the short-term.



The Other White Metal

The platinum market has a strong tendency to make a multi-month price low in the December-January timeframe. As indicated by the arrows on the following monthly chart, there was an important low during seven of the past eight December-January periods, with six of those lows occurring in December.

If the platinum price had traded below its November-2019 low of $867 in December the stage would have been set for a bullish platinum market during H1-2020. However, that didn't happen. Instead, the cycle appears to have inverted and platinum now looks set to make a December-January high. This means that platinum could be topping on a multi-month basis in synch with gold, silver, the mining indices, oil and the S&P500.



The rise in the platinum price into a reliable turning-point window isn't the only reason to be cautious about this market's short-term prospects. Sentiment is also a concern. Specifically, the following weekly chart shows that the total speculator net-long position in platinum futures recently hit a 9-year high (the total speculator net position is the inverse of the commercial net position, which is indicated by the blue bars in the middle section of the chart).



We have had US$1200 (the 2016 high) in mind as an intermediate-term target for the platinum price. Although this target still looks achievable in 2020, we have removed the Physical Platinum (PPLT) trading position from the TSI List. The result of this 7-month trade was a profit of 17%.

Gold Stocks

Despite very different economic, financial-market and monetary backdrops, the gold mining sector continues to follow its 1980s path with remarkable precision. Here's the updated chart comparison of today's HUI (the blue line) and the Barrons Gold Mining Index (BGMI) of the 1980s (the green line).

The 1980s comparison projects a top for the gold-mining sector during the first three weeks of January followed by a large decline to a March low.



At some point the current market will stop tracking the 1980s model, but we will pay attention to the model as long as it continues to be applicable. The model's current message is that there is substantial short-term downside risk in the gold mining sector. This is consistent with the message from gold's COT data, so it shouldn't be ignored.

Turning to the short-term price action, the gold sector was noticeably weak relative to the bullion market on Friday 3rd January. However, this is not significant because the gold-mining indices/ETFs have been trending upward relative to gold since October and Friday's weakness did not signal a trend reversal. In fact, the following daily chart shows that Friday's decline in the HUI was nothing more than a test of the preceding upside breakout.

Keeping it simple, the first sign that a multi-month top is in place would be a daily close by the HUI below its 20-day MA. This MA ended last week at 228 and is rising, so it won't take much weakness from here to signal a reversal. By the same token, until a reversal is signaled there will be scope for additional near-term upside.



In recognition of the increasing short-term downside risk, last week we began to buy GDXJ put options expiring in May. Our plan is to buy more of these puts to hedge our gold stock exposure if there is additional strength in the gold-mining sector over the next couple of weeks.

The Currency Market

The Dollar Index (DX) broke below support at 96.5 early last week and then rebounded to test its breakout. It is yet to achieve a weekly close below support, so there is some question as to whether the downside breakout was genuine. We think it was and that there will be significant additional downside in the DX, perhaps not immediately but within the next few months.



A week ago we wrote:

"A daily close above 92 would break the Yen out of its wedge and suggest that the gold-Yen divergence...was going to be resolved via a surge in the Yen."

Last week the Yen broke out to the upside.



The potential exists for a large and fast rally in the Yen. To be more specific, there is a decent chance of the Yen surging to 95-96 during the first quarter of this year. Unfortunately, the strength might not occur quickly enough to rescue the FXY January-2020 call options in the TSI List.

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 3rd January 2020:

[Note: AISC = All-In Sustaining Cost, EBITDA = Earnings Before Interest, Tax, Depreciation and Amortisation (a measure of cash flow), EV = Enterprise Value or Electric Vehicle, FS = Feasibility Study, FY = Financial Year, IRR = Internal Rate of Return, ISR = In-Situ Recovery, JV = Joint Venture, 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 or Net Smelter Royalty, P&P = Proven and Probable, PEA = Preliminary Economic Assessment, PFS = Pre-Feasibility Study]

There was no company-specific news worth mentioning last week.

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) AOI.TO (last Friday's closing price: C$1.22)

2) GXY.AX (last Friday's closing price: A$1.02)

3) PEY.TO (last Friday's closing price: C$3.66)

4) TK.V (last Friday's closing price: C$0.18)

The above list is limited to five stocks. It sometimes will contain less than five, but it never will contain more than five regardless of how many stocks are attractively priced for new buying.

Tax Trade Update

Four weeks ago we mentioned five candidates for a tax-loss trade that we planned to track as a group, with each stock being added to the group if/when it became available at a targeted entry price. Two of the stocks didn't quite make it to the targeted buy price before rallying, so our tax trade group ended up with only three stocks: AAL.V, TGB and TK.V.

A week ago we wrote that any member of the group would be automatically exited if it traded at least 100% above its entry price, which AAL.V (Advantage Lithium) subsequently did. In fact, AAL traded more than 200% above its entry price last week, showing what's possible with these microcaps after they become extremely depressed and market conditions change.

Here is a table showing the performance to date of our tax trade group, using last week's lowest price for AAL and Friday's closing prices for TGB and TK.V. For TSI record purposes we are going to assume that the trade is now closed. The average profit across the three stocks was 61.5%.



Deutsche Bank (DB) and Cronos Group (CRON) Trade Updates

We are speculating, via call and put options expiring in January-2021, that DB will either recover or collapse during 2020. Either of these outcomes would yield a substantial profit, whereas 12 months of 'chopping around' in the US$6-$9 range would lead to a substantial loss.

DB has shown signs of strength over the past couple of weeks, but there hasn't been a significant move yet.



We are speculating, via CRON call options expiring in January-2021, that the cannabis sector will rebound strongly from its Q4-2019 bottom. CRON was chosen because of its strong balance sheet and its relationship with Altria.

A daily close above US$8.00 would be the first clear sign that CRON has bottomed. Our target for profit taking is the 200-day MA.



Chart Sources

Charts appearing in today's commentary are courtesy of:

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