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.

In nominal dollar terms, the BULL market in US Treasury Bonds that began in the early 1980s ended in 2012. In real (gold) terms, bonds commenced a secular BEAR market in 2001 that will continue until 2018-2020. (Last update: 20 January 2014)

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)

A secular BEAR market in the Dollar began during the final quarter of 2000 and ended in July of 2008. This secular bear market will be followed by a multi-year period of range trading. (Last update: 09 February 2009)

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 Continuous Commodity Index (CCI), 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 2014-2020. In real (gold) terms, commodities commenced a secular BEAR market in 2001 that will continue until 2014-2020. (Last update: 09 February 2009)

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Outlook Summary

Why the US$ is rallying

As long as a market is in a strong rising trend almost any bullish argument could appear to have a ring of truth about it, even a completely baseless one. A case in point is the deluge of baseless, bullish-slanted US$ analyses prompted by the strong rise of the past few months in the Dollar Index.

Many of the fundamental reasons put forward for the US dollar's strength could seem valid at first glance simply because they match the price action, but many of these reasons are irrelevant or wrong. For example, considering its financial effect relative to the volumes of foreign exchange trading and international investment flows, there is no way that the US "shale revolution" and the associated move towards energy independence* could be a primary reason for a US$ bull market. For another example, the belief in some quarters that the US$ has been manipulated higher by the Fed is ridiculous, because the Fed wants a stable or a moderately weak dollar; it absolutely does not want a strong dollar. The reality is that speculators have ramped the US dollar's exchange rate upward contrary to the wishes and best efforts of the Fed. For a third example, the popular notion that the euro is being pushed downward against the US$ due to the potential for much greater monetary stimulus in the euro-zone is not just off the mark, it is diametrically opposite to what's actually going on. We'll now explain why.

To understand why the anticipation of greater monetary stimulus in the euro-zone could not have been the driving force behind the euro's recent sharp decline (and the resultant sharp rise in the Dollar Index**), the following points must first be understood:

1) As long as inflation expectations are low and stable, the stock market will usually be one of the earliest and greatest beneficiaries of monetary stimulus. Belief that the ECB was going to crank-up the money pumps would therefore almost certainly lead to substantial strength in European equities, especially with European equities not being particularly expensive. Furthermore, given that the Fed is known to be nearing the completion of its money-pumping, widespread anticipation of greater monetary accommodation from the ECB would almost certainly cause European equities to become strong relative to US equities.

2) The performance of European equities relative to US equities explains every important euro/US$ trend over the past 10 years. As evidence we have included, below, a chart comparing the VGK/SPX ratio (the blue line) with the euro (the green line). VGK is an ETF that provides broad exposure to European equities.

On a side note, we have previously used the STOX5E/SPX ratio as a measure of how European equities were performing relative to US equities, but this was a mistake because it involved putting a euro-denominated index up against a US$-denominated index. For such a ratio to be valid, both parts of the ratio must be denominated in the same currency. Otherwise, changes in currency exchange rate will distort the signal we are trying to obtain.



The point we've been working around to is that IF the financial markets really had been anticipating greater monetary stimulus from the ECB, then European equities would have been strengthening relative to US equities over the past few months and the euro would NOT have declined. Instead, European equities have fallen sharply relative to US equities over the past few months, pushing the euro downward. This means that rather than the main cause of the euro's recent weakness -- and the Dollar Index's associated recent strength -- being the fear that the ECB is going to stimulate (meaning: inflate the money supply) more aggressively, the main cause has been the fear that the ECB will be unable to stimulate aggressively enough.

In conclusion, we aren't arguing that the perceptions and realities of the ECB's performance are the only causes of the euro's plunge and the related rally in the Dollar Index. There have been other contributing factors, one being the US-initiated economic sanctions against Russia that the EU stupidly went along with. These sanctions have prompted Russia's government and private sector to establish closer trade ties with South America and China, which means that the sanctions could lead to the permanent loss of business for some EU industries. We are, however, arguing that the perceptions and realities of the ECB's performance are by far the most important causes. In particular, from mid-2012 through to mid-2014 the markets were comfortable that the ECB would make good on Mario Draghi's promise to "do whatever it takes", but about three months ago the markets started to doubt the ECB's ability to follow through. The ECB is now being asked to deliver more than words, and the response, to date, has been two programs that aren't expected to provide the desired inflationary impetus.

    *Note that energy independence is not, in and of itself, a worthwhile goal. It is also not necessarily an economic plus. It only makes sense to produce energy locally, rather than import it, if the risk-adjusted cost of local production is lower than the risk-adjusted cost of importation.

    **The USD/EUR exchange rate is about 60% of the Dollar Index, so the Dollar Index almost always trends in the opposite direction to the euro.

T-Bonds are following the traditional long-term topping pattern

In our 2013 Yearly Forecast and again in our 2014 Yearly Forecast we wrote that the performance of the US Treasury market during the 1940s-1950s and the performance of the Japanese Government Bond (JGB) market since 2003 suggested that the end of the 1980s-2000s secular bull market in US government bonds would be followed by several years of horizontal range-trading. The following paragraphs essentially repeat what we wrote back in January of 2013.

The JGB yield made its ultimate low in mid-2003 and has since been bouncing along near its long-term bottom. The basing pattern is now into its 12th year, with the yield roughly the same today as it was at the mid-2003 trough. Furthermore, this is similar to how the secular US interest-rate decline of the 1920s-1940s came to an end. Yields on low-risk bonds reached their ultimate bottom in the early-1940s, but a major upward trend didn't get underway until the late-1940s. That is, the historical record suggests that secular bond bull markets tend to end with a whimper rather than a bang.

That long-term bond bull markets have tended to end gradually rather than with spectacular reversals is probably related to the nature of the market. Government bonds are subject to speculative buying and selling like any other investment, but first and foremost they are purchased with the aim of earning interest income. As the price of a bond advances its yield-to-maturity declines, and if the price of a bond rises far enough then its yield-to-maturity will fall to zero. This places a virtual lid on the price of a bond that doesn't exist for commodities, equities or real estate. This virtual lid limits the speed at which a long-in-the-tooth bond bull market can rise and the magnitude by which it can rise, so rather than the bull market ending with a huge upside blow-off followed by a definitive downward reversal (as per a long-term gold bull market), it just peters out over a decade or even longer.

The upshot is that although a secular price peak (yield bottom) was probably put in place during 2012, a very gradual rolling over of long-dated Treasury prices (a gradual turning up of yields on long-dated Treasury notes and bonds) lasting many years is the most likely outcome. More specifically, it's likely that the 2012 bottom (1.5%) and the 2013 top (3.0%) for the 10-year T-Note yield established the extremes of a range that will remain intact for many more years (refer to the chart displayed below). Therefore, a major rise in US government bond yields could be NEXT decade's big story.

The Stock Market

Traders of S&P500 (SPX) futures have been well trained over the past two years to buy every dip of a few percent. This training came to the fore during the second half of last week, when a decline to the SPX's channel bottom was treated as a buying opportunity.

It's possible that the SPX is in the process of rolling over into a major decline, but if this is the case then something different from the many other routine 'corrections' of the past two years will have to happen over the weeks ahead. Specifically, the SPX will have to close below its channel bottom and lateral support at 1900.



The Bank Index (BKX) has provided more evidence that, similar to what happened in March, it reached a multi-month peak in September soon after breaking out to the upside.



A relatively low-risk way betting on a major decline in the US stock market is to accumulate shares of BEARX and/or HDGE during market rallies. These are unleveraged, actively-managed bear funds.

This week's significant US economic events (The most important events are shown in bold)

Gold and the Dollar

Gold

Gold to $660?

A few days ago we saw a headline predicting a decline in the gold price to $660/oz. This prediction was based on gold experiencing the same decline from its 2011 peak as it experienced from its 1980 peak.

It's all well and good to claim that IF gold matches its decline from the 1980 peak it will eventually trade at $660/oz. The problem with this line of thinking is that a comparison with the early-1980s has no basis in reality. At that time the T-Bond yield had just begun to fall from a secular peak of around 18%, the S&P500 Index was just about to commence a secular bull market from a single digit P/E, government and private-sector debt levels were much lower, and there was a lot less buffoonery at the Fed.

We are having trouble finding relevant historical parallels for the current market situation. As a result of the US dollar's recent surge and the US stock market's extremely high valuation, in some respects the present looks similar to the late-1990s. However, there are enough differences between now and then to invalidate such a comparison.

Current Market Situation

At each step along the way over the past two months, the most bearish but still-plausible short-term scenarios that we could come up with for gold and gold-mining stocks have happened. For example, a week ago we wrote:

"If gold does the unexpected and closes below $1206 after 30th September it will suggest that last year's low of around $1180 is going to be tested. Considering that the $1180 level has already been probed twice, another test would probably fail and lead to a quick spike down to the mid-$1100s."

And:

"If we are wrong to interpret the GDXJ/GDX ratio's recent performance as a bullish omen then there could be a quick GDXJ price decline of around 10% to a traditional October low."

Gold finally buckled under the pressure last Friday and broke below $1206, ending the week in the low-$1190s. This caused gold-mining stocks to plunge and eliminated the GDXJ/GDX bullish divergence that had, until then, been pointing to an upward reversal.

There will probably be some follow-through to the downside early this week due to margin-related selling, so a quick decline in the gold price to the mid-$1100s is certainly possible. This would potentially be the final shakeout/capitulation. However, considering the extent to which the gold market and many related markets are now stretched, it's also possible that support defined by last year's low will hold for now. In this case a break below the aforementioned support would likely be delayed until the first half of next year, with a strong intervening rebound. Either way, triple bottoms are rare, so it now looks like last year's lows will have to be taken out prior to a final low.



By the way, Friday's US employment numbers weren't significant. Stronger numbers earlier this year didn't provoke significant strength in the US$ or weakness in gold. It's just that speculators are currently milking the US dollar's upward trend for all it's worth and are latching onto any positives, even minor ones, as reasons to buy.

Checking the boom/bust indicator

Some analysts use the gold/silver ratio as an indicator of the general perception of risk or as an economic confidence indicator. For the past 15 years we have also used the gold/silver ratio in this way, although we think that the gold/GYX ratio (gold relative to the Industrial Metals Index) is more reliable.

The message of the gold/silver ratio can be either diluted or distorted by the fact that silver and gold are often bought and sold for the same reasons and by the fact that the silver price sometimes changes rapidly for reasons that are unrelated to economic confidence and general risk aversion. The gold/GYX ratio, on the other hand, considers gold relative to a basket of metals that, as a group, can be relied upon to trend higher relative to gold during periods of rising confidence and lower relative to gold during periods of falling confidence.

The following chart shows that the gold/GYX ratio turned higher from the vicinity of a multi-year low last month, but the upturn is not yet big enough to signal a transition from boom to bust.



Platinum

Although we don't have any exposure to platinum, this is the third commentary in a row in which we've discussed it. The reason for our recent interest is that platinum has become the 'poster child' for what's going on in the commodity world.

The top section of the following daily chart shows that the platinum price fell by almost 20% over the past three months and ended last week at its lowest level in more than 5 years. The bottom section of the chart shows that the platinum/gold ratio ended last week at its lowest level since the first half of 2013.



There will almost certainly be a sharp bounce in the platinum price from whatever low is made during the first half of October, but at this time we aren't tempted to buy. This is because platinum is currently not cheap enough relative to gold. We will probably be interested in adding some exposure to platinum (the metal, not the mining stocks) if it drops to a 5%-10% discount to gold.

Gold Stocks

Last Friday's break below $1200 in the gold market pushed the HUI down to support defined by its December-2013 bottom and eliminated the bullish divergence between the HUI and the GDXJ/GDX ratio that began to develop a month ago (the GDXJ/GDX ratio closed below its September low on Friday).



The HUI is in the same position as gold bullion. Margin-related selling will probably result in some follow-through to the downside early this week, pushing the price below last year's low. This could create a traditional intermediate-term October turning point for the gold-mining sector.

The price action over the next two trading days will be informative.

The Currency Market

Overview

We began the year with an expectation that the Dollar Index would work its way down to the low-70s over the ensuing year or so to complete its long-term basing pattern. This expectation was primarily based on the associated expectation that European equities would strengthen relative to US equities, due to their more attractive valuations and the likelihood that the ECB would conduct easier monetary policy than the Fed. Also, it was consistent with, and lent support to, our related view that gold's cyclical bear market had ended and that the cyclical decline in commodities was close to an end.

These expectations received plenty of corroboration during the first half of this year, in that although the Dollar Index essentially traded sideways within a narrow range, European stocks were gradually gaining relative strength, gold looked like it was completing its basing pattern, the commodity currencies reversed upward and the commodity markets began to rally. Additionally, emerging-market equities showed relative strength from late in the first quarter, which was consistent with the commodity-recovery theme. Even the T-Bond was cooperating, in that its predictable rebound from the oversold extreme reached in December of 2013 led to a downward trend in real US interest rates. This is why we were slow to adjust when the Dollar Index suddenly 'took off' during July-August.

Although the overall financial-market situation began to deviate from our global view in July, it wasn't until August that the deviation became pronounced. Since then, we've been as far out-of-synch with the markets as we've ever been. This is due primarily to the near-vertical rally in the Dollar Index, which, as discussed earlier in today's report, has been driven by a plunge in European equities relative to US equities. As also discussed earlier in today's report, this plunge in European equities relative to US equities appears to be an effect of general concern that the ECB won't be able to inflate enough to sustain bull markets in stocks and bonds.

Current Market Situation

Having come this far, the Dollar Index appears to be set for a test of its 2008, 2009 and 2010 highs, which are clustered a little more than one point above last Friday's close. This resistance is drawn on the first of the following weekly charts.

The second of the following weekly charts shows that the Dollar Index rocketed up to just below a similar resistance level in early-1997. It then quickly dropped to its 20-week MA (the blue line on the chart).

Note: We do not believe that the Dollar Index's performance during the late-1990s is the right model for the next few years. However, it has worked over the past few months and stands a reasonable chance of working over the next few months. It suggests a near-term peak at 87.5-88.0 followed by a pullback to 84-85.

Thoughts on the euro's Commitments of Traders (COT) data

In June of 2012, when there appeared to be a serious threat that Europe's monetary union would unravel, the Speculative net-short position and the offsetting Commercial net-long position in euro futures reached an all-time high. The following chart from Sharelynx.com shows that over the past two months the Speculative net-short and Commercial net-long positions got almost as high as their 2012 extremes, despite the absence of an existential threat to the euro.

The COT situation tells us that euro-related sentiment is 'in the toilet' and that there is a lot of speculative-short-covering fuel to power a euro rally. However, the main reason for including this chart is to show that the Speculative net-short and the Commercial net-long positions had already reached unusually high levels in August when the euro was trading at 1.34. This means that the bulk of the euro's decline occurred AFTER the Commercials became massively net-long in the futures market. The question is: How could the Commercials be so dumb in the currency market and at the same time be so smart in the gold market?



The answer is that the Commercials are neither dumb in the currency market nor smart in the gold market. As we've explained in the past, the Commercial net-position in the futures market is simply a mathematical offset of the Speculative net-position, with Speculators being the driving force behind short-term price trends. The Commercials only appear to have been wrong based on their recent positioning in euro futures and right based on their recent positioning in gold futures because euro speculators (as a group) have recently been right and gold speculators (as a group) have recently been wrong.

It is also worth reiterating that the Commercial position in the futures market does not generally reflect the overall Commercial position. For example, a Commercial that is net-short in the futures market could be either flat or net-long when all positions are taken into account. In fact, a Commercial that establishes a large net-short position in the futures market is probably doing so BECAUSE it has a large net-long position to hedge in the cash market.

When the euro's short-term trend reverses upward, the Speculators will be on the wrong side of the market and the Commercials will start to look right.

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 ended Friday 3rd October 2014:

[Note: AISC = All-In Sustaining Cost, FS = Feasibility Study, IRR = Internal Rate of Return, MD&A = Management Discussion and Analysis, M&I = Measured and Indicated, NAV = Net Asset Value, NPV(X%) = Net Present Value using a discount rate of X%, P&P = Proven and Probable, PEA = Preliminary Economic Assessment, PFS = Pre-Feasibility Study]

  *Ramelius Resources (RMS.AX) announced that it produced 22.3K ounces of gold during the quarter ended 30th September. This was slightly above the midpoint of its guidance range.

RMS's main problem is that it's a relatively high-cost producer. The full quarterly results that are scheduled to be released later this month should show that its costs were lower during the September quarter than during the June quarter, but at the average gold price of the past three months it would almost certainly have been cashflow negative.

Fortunately for RMS and other gold producers operating in Australia, the recent sharp decline in the A$ has counteracted the decline in the gold price.

    List of candidates for new buying

From within the ranks of TSI stock selections, the best candidates for new buying at this time are:

1) AAU (last Friday's closing price: US$1.25).

2) EDV.TO (last Friday's closing price: C$0.59).

3) PVG (last Friday's closing price: US$4.98).

4) TGD (last Friday's closing price: US$1.19).

Chart Sources

Charts appearing in today's commentary are courtesy of:

http://stockcharts.com/index.html