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

The Stock Market

The stock market is not a zero-sum game

One of the common complaints about High-Frequency Trading (HFT) goes something like this: trading is a zero-sum game, so the profits stemming from HFT must be associated with losses sustained by other market participants, including moms, pops, widows and orphans. For example, in a recent article John Mauldin wrote: "High-frequency trading is a zero-sum game. It takes money from "us" and gives it to funds with instant access to the exchanges." For another example, in a recent blog post Barry Ritholtz wrote: "The math on trading is simple: It is a zero-sum game. One trader's gain is another trader's loss. Only in the case of HFT, the losers are the investors -- by way of their pension funds, retirement accounts and institutional funds. The HFT's take -- the "skim" -- comes out of these large institution's trade executions". Putting aside the fact that traders who use limit orders won't be adversely affected by HFT and that traders who hold stocks for months or years with the aim of making double-digit or triple-digit percentage gains won't be adversely affected by traders who hold for no more than a few seconds with the aim of making a small fraction of one percent, the main point we want to make now is that the stock market is NOT a zero-sum game.

The futures market is a zero-sum game. In the futures market the result on one side of a trade will always be the opposite of the result on the other side of a trade, and the sum of all profits and losses will always be zero. This is because every long position is exactly offset by a short position. The stock market is different, however, because the quantity and dollar value of shares bought/held is always vastly greater than the quantity and dollar value of shares sold short. In the stock market, the buyer and the seller can both make a profit or the buyer and the seller can both make a loss. Trader A can sell shares to Trader B for a profit, Trader B can then sell the same shares to Trader C for a profit, Trader C can then sell the same shares to Trader D for a profit, and so on.

It therefore doesn't follow that the profits made by HF Traders operating in the stock market must come at the expense of other traders/investors.

Although it is clear that the stock market is not a zero-sum game and, therefore, that the profits made by HF Traders do not have to come out of the pockets of other traders and investors, let's assume, for argument sake, that Barry Ritholtz is right and that everyone else suffers worse performance as a result of HFT. What would this worse performance look like?

To answer the question we note that the total of all profits generated by HFT in the US stock market is currently estimated to be in the $1B-$2B/year range and falling. This compares to the current total market capitalisation of around $20 trillion, which means that total HFT profits amount to less than one-hundredth of one percent of stock market capitalisation.

Surely there are more important things to worry about?

Current Market Situation

Below is a 3-year weekly chart comparing the NASDAQ100 Index (NDX) with the NDX/SPX ratio. The recent pullback in the NDX from a multi-year high has been minor, but the decline in this index's relative strength -- as indicated by the plunge in the NDX/SPX ratio -- has been substantial.

The past year's upward surge in the US stock market was characterised by relative strength in the NDX, so the recent dramatic shift in relative strength could be an early warning of a major market-wide trend change. However, even if it is only due to sector rotation within the context of an on-going bull market it is likely a warning of additional weakness over the next two months. As evidence we point out that a similar downward reversal in the NDX/SPX ratio during September-October of 2012 signaled a decline in the NDX to below its 50-week MA (the blue line on the following chart). A similar outcome this time around would result in the NDX trading about 10% below its current price within the next two months.



In addition to being a warning that significantly lower prices could be in store, the recent relative weakness in the NDX increases the probability that if there is a move to a new high in the SPX later this month (in line with the Presidential Cycle Model) it will not be confirmed by the NDX. As mentioned in last week's Interim Update, such divergences inevitably occur at major market tops.

Due to the rising downside risk and the comparatively small (as far as we can tell) additional upside potential, our short-term stock market outlook has shifted back to "bearish".

Moving on, one of our expectations is that relative strength in most things commodity-related (commodities, commodity currencies and the stocks of commodity producers) will be a general theme in 2014. During the year to date the markets have mostly been in synch with this theme, although it is obviously still early days and the evidence isn't yet conclusive.

The coal sector of the stock market, represented by the Market Vectors Coal ETF (KOL), is close to providing another piece of evidence in support of the aforementioned theme. As illustrated by the top half of the following weekly chart, KOL has just moved up to its 50-week MA. If it manages to achieve a weekly close above this MA it will have done something it hasn't been able to do since mid-2011, thus suggesting that an important transition (from cyclical bear to cyclical bull) is underway. As illustrated by the bottom half of the chart, the KOL/SPX ratio (coal stocks relative to the broad market) lost downward momentum in mid-2013 and is now showing signs of turning higher.



While we are confident that commodity-related equities will be relatively strong in 2014, we are well aware of the fact that only the gold-mining sector would stand a good chance of rising in nominal dollar terms in the face of a broad-based equity bear market.

This week's important US economic events

Gold and the Dollar

Gold

Confusing trading volume with demand

The vast majority of the gold-market supply/demand analysis that gets published is completely off-track and irrelevant. One reason is that most analysts confuse trading volume with demand.

The mixing-up of trading volume and demand explains why the increase in China's gold imports over the past three years was wrongly viewed by many analysts as a major bullish influence on the gold market. It also goes part of the way to explaining why so many bullish-leaning gold analysts complain about price manipulation. After all, if you are certain that the fundamentals are bullish and becoming increasingly so, and yet the price is mired in a large multi-year decline, you will be inclined to conclude that the price is being manipulated downward. The alternative would be to discard your dearly-held premise (that the fundamentals are bullish), which is psychologically difficult to do.

The reality is that the increasing quantity of gold imports by China is neither inherently bullish nor inherently bearish. It is simply a measure of trading volume that says nothing about past or likely-future price movement. To understand why this is the case, think of the global gold market as containing only two traders: China and World Excluding China (WEC). If one of these traders wants to reduce the amount of gold it holds it can only do so if the other trader agrees to increase the amount of gold it holds. In other words, for WEC to reduce its gold holdings it is mathematically necessary for China to increase its gold holdings. Furthermore, if the amount of gold that WEC wants to sell is more than the amount of gold that China wants to buy at the current price, the price will fall to the point where a balance is achieved.

Supply and demand must always be equal, with the price continually adjusting to maintain the equivalence. As a consequence, the change in price is the only reliable measure of whether demand is trying to rise relative to supply or supply is trying to rise relative to demand. The amount of trading generally doesn't indicate anything useful about price, because a rise in trading volume could go with a rising or a falling price, as could a fall in trading volume. In fact, it's conceivable that at some point over the next few years the volume of gold being traded, including the volume of gold being imported by China, will plunge in parallel with a large and rapid increase in price due to most existing holders of gold refusing to sell at any price.

To further explain why most analyses of gold supply/demand are completely off track, we'll revisit an analogy we've used in the past: we'll liken the gold market to a publicly-traded company.

Our hypothetical company (stock symbol ABC) currently has 100M shares outstanding and is guaranteed to increase its total share count by about 1% this year and every year thereafter, meaning that at the end of this year it will have 101M shares. Now assume that Fred Smith, an investor, buys 500K shares of ABC. Will any financial journalist or analyst reporting on this event compare the amount of shares bought by Fred Smith with the amount of new shares due to be issued by ABC during the current year and say something along the lines of "Fred Smith has just bought 50% of ABC's shares!"? Of course not. Any analyst or journalist with at least half a brain will realise that Fred Smith's purchase represents only 0.5% of the outstanding shares. And if Fred Smith subsequently sells his shares to Bill Jones, will any rational observer exclaim that Bill Jones' purchase constitutes a 500K-share increase in demand? Again, of course not; the transfer of shares from Smith to Jones obviously doesn't say anything about overall demand for the shares.

As is the case with our hypothetical company and its total share count, the gold-mining industry adds a tiny percentage (about 1.5%) to the total supply of gold every year. Therefore, comparing the quantity of ABC shares purchased by Fred Smith with the quantity of new shares issued during the year and concluding that Smith's purchase represents 50% of the company is effectively what gold-market analysts do when they compare the amount of gold purchased by some traders or regions (e.g. China) with the gold-mining industry's annual production. Such comparisons are worse than meaningless, they are misleading. Also, concluding that Bill Jones' purchase of Fred Smith's shares represents an increase in the overall demand for the shares is effectively what gold-market analysts do when they assume that the gold flowing into China represents an increase in the overall demand for gold.

The bottom line is that any gold-market analysis will be fatally flawed if it is based on the premise that demand and supply can be determined by looking at the amounts of gold being traded between different parts of the overall market. It will be fatally flawed because the underlying premise is wrong.

Current Market Situation

The low of what we think will turn out to be the initial leg of gold's correction was put in place last Tuesday (1st April). That this low would soon be in place was signaled during the week before last by strength in gold-mining stocks relative to gold bullion.

With the initial decline having gone a little further than expected, the final decline (the decline that follows the current rebound) probably won't do significantly worse than test last week's low.



We don't have an opinion regarding the extent of the current rebound. A fairly normal 50% retracing of the initial decline would take the price up to the $1330s, but the rebound could end anywhere from the low$1300s to the $1350s.

The Commitments of Traders (COT) data, a short-term sentiment indicator, is slightly bearish for gold in that the recent $100 price decline led to a relatively minor reduction in the speculative net-long position. Small traders actually increased their long exposure to gold futures during the price decline. This is consistent with our view that the overall correction is not over.

However, long-term sentiment indicators remain supportive of the view that a major bottom was put in place late last year. For example, the bottom half of the following chart shows that the premium to net asset value of the Central Fund of Canada (CEF), a closed-end fund that holds gold and silver bullion, reached its lowest level since 2001 last year and remains near this 12-year low despite this year's price recovery.

By the way, the large downward spike in the CEF premium in early-May of 2011 was due to extreme intra-day price volatility, not pessimistic sentiment. The calculation of the CEF premium is based on the "London Fix" price for bullion and the closing price of CEF on the NYSE, which means that it is based on a comparison of price snapshots taken at different times. If the price of gold and/or silver makes a big move between the "London Fix" time and the close of trading on the NYSE, the calculated CEF premium will be artificially high or low.



Gold Stocks

The HUI made some sort of bottom 7 trading days ago (on 27th March) when it traded at 216.7. This bottom either marked the end of the correction or the end of the first leg of the correction (the end of the 'A' wave in an A-B-C decline). At this stage we favour the latter. Also, we suspect that the correction's final decline (the 'C' wave that follows a 'B' wave rebound) will do no worse than test the low of the initial decline.

A weekly HUI close above 250 would indicate that our favoured scenario is wrong and that the correction ended on 27th March.



The Currency Market

The Dollar Index broke above resistance at 80.5 last week. This is of only slight interest to us, because the critical resistance as far as the intermediate-term trend is concerned is a point higher at 81.5. A solid weekly close above 81.5 would certainly cause us to seriously question and would probably cause us to change our intermediate-term bearish view of the Dollar Index.

The top section of the following daily chart shows the performance of the Dollar Index, with lines drawn to indicate the resistance at 80.5 that was overcome last week and the more important resistance at 81.5. The bottom section of the chart shows the SPX/STOX5E ratio, a measure of how large-cap US stocks are performing relative to their European counterparts.

The recent performance of the SPX/STOX5E ratio relative to the Dollar Index is a lot more interesting than the recent performance of the Dollar Index in isolation. This is because the inter-market relationship has become counterintuitive. Prior to last December, strength in the Dollar Index was generally accompanied by strength in US stocks relative to European stocks. This makes intuitive sense. However, since December of last year and especially since mid-February of this year, the Dollar Index has generally strengthened when US stocks were relatively weak and weakened when US stocks were relatively strong. In other words, over the past few months the correlation between the Dollar Index and SPX/STOX5E has shifted from strongly positive to strongly negative.

At this time we aren't going to use up much commentary space trying to explain the change in the relationship between the currency market and relative equity-market strength, because the change could turn out to be nothing more than a short-lived anomaly. Suffice to say for now that fears about euro-zone deflation could be evolving into the primary driver of the US$/euro exchange rate. For example, rising fear that the euro-zone was moving towards deflation would tend to simultaneously put upward pressure on the euro/US$ rate and downward pressure on European equity prices.

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 4th April 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]

  *Almaden Minerals (AAU) provided a summary of its 2014 work plans for its 100%-owned Tuligtic gold-silver project (Mexico). The company plans to complete a PEA for the project's Ixtaca zone within the next few months. The Ixtaca zone is presently estimated to contain a total gold-equivalent resource of 4.2M ounces (3.5M M&I plus 0.7M inferred). The company also plans to drill high-priority epithermal targets outside of the Ixtaca Zone but within the project's claim boundaries.

  *Asanko Gold (AKG) announced that it has received the environmental invoice and water use permits for the Esaase deposit, part of the Asanko gold mine project, from the relevant Ghanaian regulatory authorities. This is the penultimate stage of the environmental approval process and gives the company the option to immediately apply for a temporary mining permit and commence earthworks for the Esaase deposit. This is obviously good news, although it isn't significant as far as AKG's 2014 work plans are concerned. The reason is that AKG's current plan is to bring the Nkran deposit into production (Phase 1 of the overall development) before building a mine at the Esaase deposit.

AKG also announced that it has appointed DRA, a company based in South Africa, as the engineering, procurement, construction and management (EPCM) contractor for Phase 1 of the Asanko Gold Mine development. DRA has a lot of experience building mines in West Africa.

The completion of Phase 1 is expected to result in gold production of 220K ounces per year beginning in Q1-2016. The cost estimates for this phase are based on the FS completed by PMI Gold in September-2012 and are in the process of being updated. Phase 2 will likely involve developing the Esaase deposit to bring the company's total production up to around 400K ounces/year. Phase 2 will be planned in detail during the Phase 1 construction period.

  *Energy Fuels (EFR.TO, UUUU) provided its guidance for 2014.

First, EFR forecasts 2014 sales to be approximately 800K pounds of U3O8, all of which will be sold into long-term contracts at a price of around $58/pound (65% above the current spot price). 300K pounds of the 800K total will be purchased in the spot market for sale into one contract. That is, if there is no change in the spot price then EFR will buy 300K pounds at around $35/pound for delivery into a long-term contract at $58/pound, resulting in a zero-risk profit of about $7M.

Second, the company expects to produce about 500K pounds of U3O8 during 2014. However, mining and milling operations (aside from some toll milling) will be placed on standby in August 2014 unless there is a significant increase in the spot uranium price in the meantime.

Third, at the end of last year the company had about 450K pounds of U3O8 in inventory. This inventory could be used to fulfill long-term contract obligations in the event that there wasn't a sufficient improvement in the uranium market to warrant the resumption of production during the final few months of this year.

Fourth, EFR will have considerable flexibility to adjust production in response to changes in the uranium market. For example, mines put on standby will kept ready for a quick restart.

Fifth, EFR has a number of development-stage projects that will be advanced towards production in response to a large and sustained increase in the uranium price. We think that a long-term uranium price of at least $65/pound would be needed to justify bringing these projects into production.

  *Golden Star Resources (GSS) announced drilling results that establish the continuity of, and will likely increase the size of, a high-grade resource below its Wassa open-pit gold mine (Ghana). This resource has the potential to be developed into a profitable underground mine.

The first look at the economics of an underground mine at Wassa will come via a PEA currently being prepared by SRK Consulting and scheduled to be complete this quarter.

  *Premier Gold (PG.TO) issued its financial statements and MD&A for the year ended 31st December 2013.

At the end of last year PG's working capital was about $58M, including 3.7M shares of Sandstorm Gold (SSL.TO) that are held for sale. Due to the subsequent increase in the market price of SSL.TO, PG's current working capital is probably still around $58M (the increase in the value of the SSL shares probably offset spending over the past three months). This should be enough to fully fund the company for the next 18 months.

  *Ramelius Resources (RMS.AX) announced a small (16%) increase in the estimated resource at its exploration-stage Vivien gold project. The new resource is estimated to contain 185K ounces at an average grade of 7.1-g/t.

RMS plans to commence the development of an underground mining operation at Vivien during the second half of this year.

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) PG.TO below $2.00 (last Friday's closing price: C$2.05).

2) PLG.TO in the low-C$1.30s (last Friday's closing price: C$1.44).

3) RIOM (last Friday's closing price: US$2.03). The following chart shows that RIOM has lateral resistance at US$2.10. The 50-day MA in the $2.15-$2.20 range is also likely to offer some resistance. A daily close above $2.20 would therefore leave little room for doubt that a correction low is in place, but we think it makes more sense to buy at $2.00 or lower than to buy above $2.20.

Chart Sources

Charts appearing in today's commentary are courtesy of:

http://stockcharts.com/index.html