<% 'pass = Request.Form("pass") IF ((Request.Form("pass") = 1) OR (Session("pass") = "pass")) THEN %> Speculative-Investor.com
   -- Weekly Market Update for the Week Commencing 6th February 2006

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. The rally that began in October of 2002 will end by the first quarter of 2006 and will be followed by a substantial decline to a higher low (above the Oct-2002 bottom) during the second half of 2006. The ultimate bottom of the secular bear market won't occur until the next decade. (Last update: 12 December 2005)

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 during 1999-2001. The first major upward leg in this bull market ended in December of 2004, but a long-term peak won't occur until 2008-2010. (Last update: 28 March 2005)

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 first quarter of 2005, but a long-term peak won't occur until 2008-2010. (Last update: 28 March 2005)

Copyright Reminder

The commentaries that appear at TSI may not be distributed, in full or in part, without our written permission. In particular, please note that the posting of extracts from TSI commentaries at other web sites or providing links to TSI commentaries at other web sites (for example, at discussion boards) without our written permission is prohibited.

We reserve the right to immediately terminate the subscription of any TSI subscriber who distributes the TSI commentaries without our written permission.

Outlook Summary

Market
Short-Term
(0-3 month)
Intermediate-Term
(3-12 month)
Long-Term
(1-5 Year)
Gold
Neutral
(5-Dec-05)
Bearish
(06-Feb-06)
Bullish

US$ (Dollar Index)
Neutral
(12-Dec-05)
Bullish
(31-May-04)
Bearish

Bonds (US T-Bond)
Bearish
(11-Jan-06)
Bearish
(02-Jan-06)
Bearish

Stock Market (S&P500)
Neutral
(10-Jan-06)
Bearish
(05-Jan-05)
Bearish

Gold Stocks (HUI)
Neutral
(30-Nov-05)
Bearish
(06-Feb-06)
Bullish

General Commodities (CRB)
Neutral
(14-Nov-05)

Bearish
(23-Mar-05)

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 on which way the market will move or that we expect the market to be trendless during 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.

While we were away...

Fortunately, nothing earth-shattering happened in the financial world while we were AWOL. Stocks, bonds, commodities, gold and the major currencies either consolidated or continued to move in the directions they had been moving prior to our 2-week absence.

It didn't provoke much of a market reaction at the time, but something happened while we were away that will potentially have a big effect on all the markets over the coming months/years. We are referring to Hamas becoming the elected government of the Palestinian people. This marks the first time that a terrorist organisation has been democratically elected to power and, assuming there is no change to Hamas's platform, means that there are now two governments in the Middle East -- the governments of Iran and the Palestinian Authority -- openly calling for the destruction of Israel.  

The Middle East 'pot' therefore continues to heat up and we think it's only a matter of time before it boils over. As a result we would definitely not want to be short oil, even though we think the oil price has a greater chance of falling than rising over the next six months. 

Something else worth commenting on that happened over the past fortnight was the meeting, on the 31st of January, of the US Federal Open Market Committee (FOMC). The outcome of this meeting -- another 0.25% hike in the Fed Funds rate and an announcement suggesting at least one more rate hike -- was neither surprising nor noteworthy, but the 31st January meeting was Greenspan's finale and therefore marked the end of an era. Greenspan did an enormous amount of damage during his 18-year stint as Fed Chairman, but if his performance is measured against the objectives of the job it is clear that he was a star performer. The Fed's raison d'être is to inflate (expand the money supply) whilst keeping inflation expectations in check, and during Greenspan's term there was a lot of inflation in parallel with generally low/falling inflation expectations.

Greenspan was, of course, given a huge amount of help by the secular trends that were already underway when he took the reins at the Fed, but he certainly made the most of a fortuitous set of circumstances.

The new Fed chairman -- Ben Bernanke -- is unlikely to be anywhere near as successful as Alan Greenspan, regardless of how adept he is at keeping the inflation going whilst managing inflation expectations. This is because the secular trends are not in his favour. Bernanke is taking over at a time when long-term bull markets in gold and commodities and a long-term bear market in US equities are still quite young.

Questions to ponder

Why do people who know that socialism has never worked and understand why it can never work believe that central planning is effective/feasible when it comes to money and interest rates?

Why do people who can readily explain why it makes no sense for the government to dictate the price of tomatoes believe that it is reasonable for the government to dictate the price of short-term money?

Why is it widely accepted without question that the Fed is needed to control inflation, maintain financial stability and promote employment growth when the historical record clearly shows that there was generally less inflation, greater financial stability and lower unemployment BEFORE the establishment of the Fed?

The Stock Market

Current Market Situation

The following chart suggests that an important piece of the bearish stock market puzzle is falling into place. Specifically, the weekly Price Momentum Oscillator (PMO) for the NDX/Dow ratio has just moved below its 10-week moving average, which, in turn, means that the intermediate-term trend for the NDX/Dow ratio -- one of the most reliable leading indicators of the US stock market -- is probably in the process of reversing from up to down. We say "probably" because at this stage the PMO's cross from above to below its 10-week moving average is difficult to see without the aid of a magnifying glass, but any further weakness from here in the NDX relative to the Dow will confirm the downward reversal.


In previous commentaries we've noted that the ideal topping formation for the US stock market would entail the NASDAQ100 Index (NDX) making a peak in January and the S&P500 and Dow Industrials indices making their ultimate highs about two months later. A downward reversal in the NDX/Dow's weekly trend at this time would be consistent with such an outcome.

The following chart shows that the NDX has important lateral support at around 1630 and trend-line support at around 1600. A solid close below 1630 would be a clear sign that an intermediate-term peak was put in place during the first half of January.


This week's important US economic events

Date Description
Monday Feb 06
Leading Economic Indicators
Tuesday Feb 07 No important events scheduled
Wednesday Feb 08 Existing Home Sales
Thursday Feb 09 Durable Goods
Friday Feb 10 Q4 GDP (Prelim)
New Home Sales

Gold and the Dollar

The Yen and the Gold Sector

...the strong positive correlation between the HUI and the Japanese Yen that had been in place for years suddenly became a strong INVERSE correlation at the beginning of September last year...

The rally in the gold sector that began in May of last year was/is the first intermediate-term rally in this market that has exceeded our expectations, the previous intermediate-term rallies during gold's secular bull market having either just met, or fallen short of, our expectations. Our view, up to the point where the AMEX Gold BUGS Index (HUI) broke decisively above its 2003-2004 highs, was that we were seeing a counter-trend advance within the context of an on-going correction.

One of our mistakes last year was to focus too much on what the Fed was doing and not enough on a) the inflation stemming from the monetary policies of other central banks, and b) the inflation being caused by an acceleration in US Government borrowing. These other factors began to dominate the financial landscape at the beginning of September and, as a result, there were some rather dramatic changes in inter-market relationships at that time. For example, the following chart shows that the strong positive correlation between the HUI and the Japanese Yen that had been in place for years suddenly became a strong INVERSE correlation at the beginning of September last year (the Yen is represented by the blue line on the chart). Since then the gold sector of the stock market has benefited from Yen weakness (US$ strength relative to the Yen).


The Yen is being driven lower by the carry trade (borrowing at the near-zero interest rates available in Japan in order to purchase higher-yielding US$-denominated debt). When the carry trade starts to unwind there will be a vicious rally in the Yen, but neither we nor anyone else knows when this unwinding will begin. In the mean time, the large and still-expanding interest rate gap between the US and Japan will cause the Yen carry trade to remain popular.

When the Yen carry trade eventually loses its appeal it will probably be because of an emerging perception that a material narrowing of the interest rate gap was about to occur OR because there is sufficient strength in the Yen -- due to non-interest-rate-related factors -- to convince carry trade participants that the Yen's intermediate-term trend has turned up.

We think it is reasonable to average into a position in the Yen at current levels or lower based on the likelihood that at some point over the next 18 months there will be an explosive rally in this currency due to the unwinding of carry trades. Furthermore, with Yen futures having fallen on 8 of the past 9 trading days some sort of rebound should begin very soon, although we don't have a strong opinion on whether this next rebound will take the Yen to new highs for the year.

Taking a 3-5 year view the Yen remains our favourite fiat currency due to the support that we expect the currency's exchange value to receive from the combination of Japan's trade surplus and the secular bull market in Japanese equities. However, if we are right to be long-term bulls on the Yen then at some point the relationship between gold stocks and the Yen will have to return to being positive because we are also long-term bulls on gold stocks.

Gold Stocks

...gold stocks won't provide indefinite leverage to increases in the gold price... ...an intermediate-term peak is close at hand.

When gold stocks are trending higher relative to gold bullion it is bullish for both gold stocks and gold bullion. However, during a time when most prices are being pushed higher by inflation and a long-term downward trend in stock market valuations (price/earnings ratios, etc.) is in force there will be a limit to how high gold stock prices can become relative to the gold price. In other words, when the costs of producing gold are increasing and the amount that investors are willing to pay for a dollar of earnings/cash-flow is falling, gold stocks won't provide indefinite leverage to increases in the gold price and there will be a ceiling over the HUI/gold ratio.

With the HUI/gold ratio nearing its December-2003 peak (see chart below) it's quite possible that we are now close to the aforementioned ceiling and that some of the major/mid-tier gold stocks are almost as high as they are ever going to get RELATIVE TO the gold price. Further down the food chain there are, however, plenty of stocks that should continue to provide substantial leverage to gains in the gold price.


There is scant evidence that the gold stock rally has ended. There are, however, many signs that an intermediate-term peak is close at hand. For example:

a) The gold stock rally that began in May of 2005 is now as long as the longest of the intermediate-term rallies that occurred during the first major upward leg (the one that ended in December-2003), although the gain achieved since the May-2005 bottom is still about 10% shy of the gain achieved during the first major upward leg's weakest rally.

b) As mentioned above, the HUI/gold ratio is getting close to its December-2003 peak.

c) Market Vane's bullish percentage is above 90 for both gold and silver.

d) The Central Fund of Canada -- a mutual fund that holds gold and silver bullion -- is trading at a 10% premium to its net asset value.

e) NovaGold Resources (TSX and AMEX: NG), a stock that tends to be one of the best performers during the late stages of intermediate-term rallies in the gold sector, has just hit the top of its long-term channel (refer to the chart included in the "Updates on Stock Selections" section).

f) The palladium market is hot and over the past few years the palladium market has only ever become hot near the ends of metal rallies.

g) Prior to pulling back on Thursday and Friday of last week the HUI had risen for 6 trading days in a row. When a lengthy sequence of 'up days' occurs after a market has already been trending higher for several months the resultant peak can be important.

As far as the next two months are concerned, one probable outcome is that there's a pullback followed by another rally with new highs in the metals (gold and silver bullion) NOT being confirmed by new highs in the stocks of the major metal producers. This would be a significant bearish divergence that would pave the way for a substantial correction (a correction lasting at least 6 months and resulting in a peak-to-trough decline of at least 25% for the HUI).

We are switching our intermediate-term outlook for the HUI to "bearish" based on the expectation that the aforementioned correction will begin within the coming two months.

There is some talk of the current rally evolving into a "runaway bull market". Such an outcome would surprise us greatly because bull markets only become "runaway bull markets" in their final stages. For example, it was only during the final 18 months of its 18-year bull market that the NASDAQ became a "runaway bull".

Our view is that the bull markets in gold and gold stocks will continue for an absolute minimum of three more years and will potentially continue for as many as 14 more years, so we think the "runaway" stage of the bull market lies well into the future. If we are wrong about this we will still participate in the surge because we maintain a substantial core position in line with the long-term trend, we'd just participate to a lesser extent than would be the case if we thought that large additional gains were probable over the coming months.

Gold

Gold versus Other Metals

...what we've actually seen over the past several months is a general metal rally with gold being one of the worst performers. ...the fact that the Fed has not been openly promoting inflation the way it was during 2001-2003 has probably caused gold to lag the industrial metals.

Over the past five months gold has surprised us with its strength relative to the US$, but relative to the most other metals gold has been surprisingly weak. In particular, the following chart shows that the gold price has just reached a new 4-year LOW relative to the Industrial Metals Index (GYX). The gains made by the gold price have been grabbing a lot of headlines because gold has such a high profile due to its history as a form of money, but what we've actually seen over the past several months is a general metal rally with gold being one of the worst performers.


We think gold's relative weakness can be explained by the on-going contraction of the US yield-spread as illustrated by the following chart of the TYX/IRX ratio (the yield on the 30-year T-Bond divided by the yield on the 13-week T-Bill). This chart indicates that the Fed is telling the truth when it says, in the monetary policy statement issued after every FOMC Meeting, that "longer-term inflation expectations remain contained". (The Fed is, of course, lying when it goes on to say that "possible increases in resource utilization as well as elevated energy prices have the potential to add to inflation pressures" because money-supply growth is the ONLY thing that can add to inflation pressures).

Although the Fed's efforts to make monetary conditions less accommodative have been countermanded to a large extent by the US Government's borrowing binge and the inflationary practices of other central banks, the fact that the Fed has not been openly promoting inflation the way it was during 2001-2003 has probably caused gold to lag the industrial metals. The situation should reverse, however, once there's enough weakness in the economy and the stock market to prompt the Fed to begin its next rate-cutting campaign. At that point the yield-spread will begin to widen and we will probably be at the start of a 2-3 year period characterised by strength in gold relative to the industrial metals. This relative strength might initially be due to gold falling by less than the other metals during a general downturn, but should eventually involve all metals rising with gold rising the fastest.


Current Market Situation

Our short- and intermediate-term outlooks for gold are the same as they are for gold stocks, for the same reasons.

Silver

Below is a daily chart of March silver futures. We continue to expect a move to above $10 before a substantial correction gets underway.


Currency Market Update

The consolidation in the currency market over the past 2.5 months has resulted in speculators in currency futures becoming net-flat the US$ relative to the Swiss Franc. Ideally there will be enough additional weakness in the dollar over the coming month or so to prompt speculators to build-up a significant net-short position in the US currency, but the fact that a large speculative net-long position in the dollar has been eliminated without the need for anything more serious than a routine pullback is a good sign as far our intermediate-term bullish view on the dollar is concerned.

As things currently stand, the Dollar Index is mid-way between intermediate-term resistance at 92.5 and intermediate-term support at 86. A drop to test this support will remain a likely short-term prospect as long as the 50-day MA is not exceeded. However, if the Dollar Index achieves consecutive daily closes above its 50-day MA then we will conclude that a correction low is already in place.


Below is a daily chart of the Canadian Dollar.

The Canadian Dollar has moved up and down in synch with the gold price over the past year, although this relationship has broken down to some extent over the past 6 weeks in that the C$ has failed to match gold's strength. In particular, when gold was surging to new multi-year highs during the first half of January the C$ was threatening to break below intermediate-term support at 85.

The C$ finally traded at a new multi-year high during the first half of last week, but its upward progress has been laboured and the path of least resistance for this currency appears to be down.

We expect to see a sharp decline in the C$ once an intermediate-term top is in place in the gold market.


Update on Stock Selections

NovaGold Resources (TSX and AMEX: NG) is our favourite gold stock investment for the long haul, but every stock we own is for sale at the right price and NG has just reached a price at which some profit taking would be appropriate. Specifically, the stock has just hit the top of its long-term channel (see chart below) and now looks fully valued with respect to our intermediate-term outlook for metal prices. In our opinion it would make sense to sell 30%-50% of your position in NG near the current price, but it would NOT make sense to completely exit the stock.

We are going to keep NG in the Stocks List, but will exit the NovaGold warrants (TSX: NG.WT) to reflect our view that some profit taking is appropriate at this time. The realised gain on the warrants is 572% based on our Oct-2003 entry price of C$1.25 and Friday's closing price of C$8.40.


Fears that the development of European Minerals' (TSX: EPM) Varvarinskoye gold/copper project would be delayed by the financial problems being experienced by its contractor (MDM Ferroman) created an opportunity to buy the stock in the low-to-mid C0.80s during the first half of January. The stock price subsequently rocketed up to the C1.40s on the back of increasing enthusiasm for gold stocks and the realisation that MDM's troubles didn't materially alter the investment case for EPM. It therefore almost reached our intermediate-term target of C$1.50 before pulling back over the past two trading days.

EPM has now terminated MDM's turnkey mine construction contract, an outcome that could be a blessing in disguise because other gold mining companies that have employed MDM over the past two years have experienced cost overruns and delays. Fortunately, MDM's contract at Varvarinskoye was ended before it had really begun, that is, before there was an opportunity for the contractor to cause any major delays or cost overruns. However, there is now some additional uncertainty for the stock market to deal with because EPM no longer has a fixed price mine-construction contract.

As a result of the recent price action and further consideration of the effects that higher metal price assumptions will have on the reported gold/copper reserves at Varvarinskoye, we are increasing our intermediate-term target for EPM to C$1.80-C$2.00. A pullback to near the support shown on the following chart would create a short-term buying opportunity.


    In the 9th January Weekly Update we wrote:

"The biggest short- and intermediate-term risk with Metallica (the stock and the warrants) is the risk that the company will not be able to obtain the explosives permit needed to progress the construction of its Cerro San Pedro gold/silver mine in Mexico. There's a high probability that the required permit will be obtained, but until it is in hand the risk will remain. A confirmed failure to get the permit would hit the stock hard, whereas news that the permit had been received would likely push the stock price up to and through our short-term price target [US$2.50]."

There was good news regarding the explosives permit while we were away and this news did, in fact, push the stock price well above our short-term target. We think MRB is still significantly under-valued at Friday's closing price of US$3.05, but the stock is extended from a technical perspective. In our opinion, it makes sense to take some money off the table now whilst maintaining a core position.

    In addition to the ones mentioned above, gold/silver stocks that have reached or exceeded our short-term targets (levels at which some profit taking might be appropriate) are First Majestic Resource (TSXV: FR) and Western Silver (AMEX: WTZ). Non-gold/silver stocks that have reached levels at which it would be reasonable to make a PARTIAL exit are Broadwing Corp. (NASDAQ: BWNG) and Taseko Mines (TSXV: TKO).

    In the 23rd January Weekly Update we said that we would add the QQQQ Jan-07 $42 put options (VCQMP) to the Stocks List if they dropped to US$2.30 (they were trading at $2.70 at the time). Our buy price was reached on 27th January, so VCQMP has been added to the List at US$2.30.

Chart Sources

Charts appearing in today's commentary are courtesy of:

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



 
Copyright 2000-2005 speculative-investor.com
<% Session("pass") = "pass" Session.Timeout = 480 ELSE Response.Redirect "market_logon.asp" END IF %>