-- Weekly Market Update for the Week Commencing 8th August 2016

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.

The BULL market in US Treasury Bonds that began in the early 1980s ended in early-2015, but there will be many years of topping action in bond prices and bottoming action in bond yields before major new trends get underway. (Last update: 29 June 2015)

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 2018 and 2020. (Last update: 29 June 2015)

A secular BEAR market in the US 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 2018 and 2020. (Last update: 29 June 2015)

Commodities, as represented by the CRB Index, 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 2018-2020. (Last update: 29 June 2015)

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Outlook Summary

4. Long-term views are determined almost completely by fundamentals and intermediate-term views are determined by a combination of fundamentals, sentiment and technicals.

Last week's posts at the TSI Blog

There will never be a "commercial signal failure" in the gold market

Does the Fed support the stock market?

Summary of current thinking/positioning

1) Concerned about short-term downside risk in gold, silver and the associated mining stocks, but comfortable maintaining 'core' exposure in anticipation of large additional gains over the next two years. Also, still looking for opportunities to buy into 'special situations' -- small/illiquid gold stocks that could generate large gains independently of sector-wide performance.

2) Planning to increase exposure to non-gold commodity-related stocks (primarily base-metals producers/explorers, but also energy and agriculture companies) during periods of price weakness over the next four months in anticipation of 2017-2018 being a very bullish period for commodities.

3) Thinking that the time has arrived to start preparing for the possibility/risk of significant downside in the stock market during September-October. The stronger the market during August the more likely a large decline during September-October.

5) Speculating on short-term downside in the 'safe haven' government bonds.

6) Starting to suspect that the commodity currencies have completed the downward corrections that began in late-April, but awaiting more evidence to confirm or deny.

7) Maintaining a large cash reserve in recognition of the downside risk in almost all equities, although the cash percentage has been slightly reduced over the past month via the accumulation of non-gold commodity stocks. Current cash percentage is around 50%.

Commodities

A possible bottom for the oil price

The crude oil price has been following the currency market. Oil's strongest positive correlation is with the Canadian dollar (C$), but it also has an interesting relationship with the Chinese Yuan.

Based on historical lead-lags, after both the C$ and the Yuan reversed downward in April it became very likely that a significant downward correction in the oil market would begin by early June. The correction occurred and may or may not be complete. Whether or not it is complete will be influenced to a large extent by whether the recent upturns in the C$ and the Yuan prove to be sustainable.

The following chart compares the oil price with CYB, a Yuan proxy. Notice that since the beginning of this year CYB (the green line) has led the oil price (the black line) by a few weeks at turning points. The periods from a turning point in CYB to an equivalent turning point in the oil price are indicated by blue boxes on the chart.



Copper warning signal still in place

The warning about short-term weakness in the copper price that was generated by the COT (Commitments of Traders) data a little more than a fortnight ago remains in place, as copper's COT situation hasn't changed.

We are not forecasting it, but we won't be surprised if the copper price pulls back to around US$2.00 within the next few weeks.



The Stock Market

The US

A valuation and recession indicator

The Wilshire 5000 Index is the broadest of the popular US stock indices. It pretty much covers the entire US stock market. The Wilshire5000/GDP ratio therefore indicates overall stock-market capitalisation relative to the size of the economy, which is a measure of the extent to which the stock market is over/under-valued since the stock market's total capitalisation should be proportional to the size of the economy.

The chart shows that with the exception of the 1999-2000 bubble peak, since 1970 the US stock market has never been more expensive than it has been over the past 2 years. Furthermore, despite having pulled back from its Q2-2015 top, by this measure the US stock market is currently about 10% more expensive than it was at the major high of 2007. Remarkably, an unusually-high valuation has been sustained over the past couple of years despite a complete absence of earnings growth.

The overarching message is that there is a lot of valuation-related downside risk in the US stock market.



Interestingly, in addition to being a long-term measure of the stock market's valuation the Wilshire/GDP ratio works rather well as a leading indicator of economic recession. Periods of official recession are the shaded areas on the above chart.

Notice that with the exception of the 1980 episode, the Wilshire/GDP ratio turned down in advance of every recession since 1970. The reason it probably didn't turn down ahead of the 1980 recession was that the stock market was very under-valued at the time. In other words, it seems that prior to the 1980 recession the stock market was already discounting the worst-case scenario. That's obviously not the case today.

The decline in the Wilshire/GDP ratio from its Q2-2015 peak is large enough to be interpreted as a recession warning. It is similar to the warning generated by Real Gross Private Domestic Investment, which was discussed at TSI last week, in that it points to a recession beginning within the next few quarters but not necessarily within the next few months.

Current Market Situation

Last week's price action was bullish. Of particular note, the NYSE Composite Index (NYA) reversed upward during the second half of the week after testing support at 10600 during the first half of the week.

The NYA appears to be on its way to a test of the 2015 peak. A break by the NYA above last year's high would be confirmation of the new high achieved by the SPX, but it wouldn't reduce the probability of a sharp decline during September-October.



We are looking ahead to the possibility of a large decline during September-October, but it should be understood that the set-up for a large decline is currently not in place. To put it another way, certain things will have to happen with the price action, market internals and sentiment over the next few weeks to set the stage for the sort of decline that could be very profitably traded. However, there is no guarantee that these things will happen, and if they don't then any bearish speculations established now or in the near future will end with losses.

Therefore, it is important to only have a small amount of money at risk in bearish speculations at this time and to wait for more signs of weakness/vulnerability before establishing a chunkier position.

Europe

Unlike the senior US stock indices, the EURO STOXX 50 Index (STOX5E) suffered a cyclical decline during 2015-2016. There is currently no decisive evidence that the decline is complete, but it wouldn't take much additional strength from here to generate evidence that a sustainable double-bottom was put in place during the first half of this year.

A weekly close above 3157, which is about 6% above last Friday's close, would do it. This is because such a development would break the STOX5E's sequence of declining tops that dates back to the April-2015 high and also break the index above both its channel top and its 200-day MA.



One of the US stock market's biggest pluses at the moment is the realistic possibility that the senior European stock indices have completed cyclical declines. The reason is that if European equities are in the process of turning upward on a sustained basis then an important source of downward pressure will be removed from the US market.

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

Gold remains hostage to small changes in the expected FFR

The monthly US employment reports have no relevance except for their influence on the Fed and market expectations regarding future Fed actions. The moderately strong employment data reported last Friday, for example, provides no information about the current or likely future performance of the US economy, but was noteworthy because it led to a slight increase in the expected level of the Fed Funds Rate (FFR).

The change in the expected level of the FFR in response to Friday's employment news is illustrated by the following daily chart. The last bar on the chart shows a fall of 0.09 in the price of the January-2018 Fed Funds Futures (FFF) contract, which means that the expected level of the FFR in January-2018 rose by 0.09 (9 basis points) last Friday.



Now, under more normal circumstances a 0.09% change in the expected level of the FFR in 17 months' time would not have a significant effect on the gold market, but these aren't normal circumstances. These are circumstances in which the actions and expected future actions of central banks are dominating all other considerations. Consequently, just as a minor decrease in the expected FFR during the final week of July and the first two trading days of August propelled the gold price from around $1310 to the $1370s, a minor increase in the expected FFR on Friday predictably had the opposite effect.

Does this mean that if the expected FFR builds on Friday's gain over the days/weeks ahead then the gold price will probably trend downward over the same period? Yes, that's exactly what it means. It also means that if something happens in the world to cause the expected FFR to move below the lows of the past few weeks then the gold price will probably move to a new high for the year.

The Price Action

The US$ gold price tested its early-July peak during the first half of last week and then dropped back to its 20-day MA on Friday. Friday's price action hasn't significantly altered the chart pattern and makes a near-term rise to around $1400 only slightly less probable.

Trend-defining support remains at $1308. A daily close below this support would make it very likely that a multi-month top was in place and suggest a short-term target in the low-$1200s.



Gold Stocks

Last Friday's 10-point decline in the HUI doesn't look significant on the following chart, although it could obviously turn out to be the start of a meaningful decline. Some additional weakness over the next two trading days would raise the probability that the incredible rally from the January-2016 bottom was finally over, but in the absence of immediate follow-through to the downside the potential for a near-term surge to around 300 will remain intact.

Trend-defining support for the HUI lies at 235-240, so it will take a solid break below this support to confirm a multi-month top. However, it would now be reasonable to use a daily close below the July low of 247 as an early warning of a trend change from up to down.



Below is our updated comparison between this year's rally in the HUI and the 1982-1983 rally in the Barrons Gold Mining Index (BGMI). If the HUI continues to keep pace with the 82-83 rally then it will surge to around 300 this week and then enter a prolonged decline with an initial low during the second half of October.



As previously advised, from a fundamental-analysis perspective we don't like the comparison with the 1982-1983 rally. This is because the current economic, monetary and financial-market environments have almost nothing in common with the early-1980s. However, there is no other gold-mining rally from a multi-year low that does such a good job of matching this year's price action.

We will continue to view the 1982-1983 price action as a potential roadmap until there is evidence that today's market is taking a different route.

The Currency Market

The Pound

Last Thursday, Bank of England (BOE) chief Mark Carney channeled his ECB counterpart Mario Draghi SCBE (Stupidest Central Banker Ever). About 4 years ago Draghi famously said that the ECB would "do whatever it takes" to maintain Europe's monetary union. Last week Carney said "the BOE stands ready to take whatever action is needed". Of course, neither Draghi nor Carney has any clue about what's actually needed. All they ever do in response to signs of economic weakness is cut interest rates and monetise bonds, as if any economy could ever really be helped by distorting price signals.

True to form, the BOE reacted to the short-term economic weakness and uncertainty stemming from "Brexit" by cutting its targeted interest rate from 0.25% to 0.50%, announcing a plan to monetise 70B pounds worth of bonds (government and corporate), and offering the banking industry 100B pounds of low-interest credit. Additionally, Carney made it clear that more would be done if deemed necessary by the monetary machinators. In other words, the beatings will continue until morale improves!

The BOE actions/plans announced last Thursday were apparently a little more than 'the market' was bargaining on, because the news was followed by a sharp decline in the Pound. However, further to the comment we made in last week's Interim Update it is still possible that the Pound is tracing out a basing pattern.

It is also possible that the Pound is consolidating prior to making a move to new multi-year lows. It needs to break above 134 to confirm the basing-pattern scenario.



We are in the process of building up long-term exposure to the Pound, meaning that we are looking for opportunities to convert part of our US$ cash reserve into Pounds. We took an initial position in the Pound shortly after the Brexit news in late-June and added to the position last Friday.

We currently plan to hold the position for at least a couple of years and to add during times of weakness in GBP/USD over the next several months.

The Dollar Index

The Dollar Index reached its short-term channel bottom during the first half of last week and then rebounded.

The price action contains no clues about what the near future holds in store, but the fundamentals are still bullish for the US$ relative to the euro (USD/EUR is almost 60% of the Dollar Index). We therefore continue to expect an eventual break in the Dollar Index to new multi-year highs, although we won't be surprised if support at 93 is re-tested as part of the on-going intermediate-term consolidation.



The Canadian Dollar (C$)

Last week the C$ failed to follow through on the preceding week's bullish reversal. It is again testing support at 76 and is at risk of breaking out to the downside. A downside breakout would create a measured objective of 72, although there is some support near 75 that could limit the decline.

A close above 78 is needed to confirm a bottom.



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 5th August 2016:

[Note: AISC = All-In Sustaining Cost, FS = Feasibility Study, FY = Financial Year, 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]

  *Energy Fuels (EFR.TO, UUUU) had three pieces of significant news last week.

The first piece of news relates to EFR's agreement in March to buy Mestena Uranium LLC, a privately held uranium miner that operated the Alta Mesa ISR (In Situ Recovery) project in Texas. The purchase price was 4.5M EFR shares. Alta Mesa is a fully-permitted production facility capable of producing 1.5M pounds of uranium per year that is on standby pending a higher uranium price.

Although Alta Mesa was in production for 8 years before being put on standby in 2013, prior to last week the project didn't have a resource estimate. The maiden resource estimate has just been reported by EFR.

The NI-43-101resource estimate is: 3.6M pounds of U3O8 in the M&I category plus 16.8M pounds of U3O8 in the Inferred category. In other words, about 20M pounds in total. This is a very significant quantity and makes the Mestena acquisition look even better than it did in March.

With its White Mesa mill, its Nichols Ranch ISR project and the Alta Mesa project, EFR will have the ability to ramp up uranium production to as much as 11.5M-pounds/year once the uranium price moves high enough. It is therefore positioned to be one of the 'go to' uranium stocks during the next multi-year upward trend in the uranium price. Unfortunately, there is no evidence yet that the next multi-year upward trend in the uranium price has begun.

Second, EFR announced that it has agreed with the holders of $22M of convertible debt to extend the maturity date of the debt from 30 June 2017 to 31 December 2020 and to reduce the conversion price of the debt from C$15.00 to C$4.15. This news is positive, because it gives EFR more financial breathing room.

Third, EFR published its quarterly and half-year financial results. The company's balance sheet remains in reasonable shape, although despite some cash generation resulting from uranium production/sales there was a US$11M reduction in working capital during the first half of the year. This was due to investment in plant/equipment and a decline in the market value of the company's uranium inventory (the uranium price fell from around $35/pound to around $26/pound during the first 6 months of this year).

At this time it is reasonable to have a small position in EFR with the aim of adding to the position following evidence of a uranium turnaround.

  *Premier Gold (PG.TO) announced the details of the package put in place to finance the US$122M cash component of the Mercedes gold mine purchase announced the previous week.

The financing package is being provided by Orion Mine Finance and comprises 1) a loan in the amount of US$42.2M that will be repaid via the delivery of 2,450 ounces of gold per quarter for 15 quarters plus an interest rate of 6.5%, 2) a silver stream with an up-front payment of US$11.5M, 3) an unsecured credit facility in the amount of US$45M, of which $40M remains to be drawn, and 4) new shares in the amount of US$35M.

The press release that provided the details of the financing included the following comment: "This financing arrangement was constructed with a view toward minimizing near-term shareholder dilution."

This comment relates to the fact that only $35M of the $122M package involved the issuing of new shares, but by entering into a gold loan and a silver stream the company avoided diluting the stock by diluting the asset. What we mean is that more than 10% of the production has just been lost to loan repayments and "streams". Furthermore, the gold loan creates a significant risk. First, the repayment amounts are reasonable with gold at $1350/oz, but if the gold price rises to $2000/oz within the next couple of years then the cost of the loan becomes exorbitant. Second, if the mine were to stop production for any reason during the next four years then the company would have to buy gold on the market to meet its quarterly repayment obligation.

In general, the ONLY time it makes sense for a gold-mining company to enter into a gold stream or take out a gold loan is when the shares are dirt cheap (meaning: issuing new shares is costly to existing shareholders) and the balance sheet is not strong enough to take-on normal unsecured debt. This is not the case with PG.

So, all things considered we would prefer that PG had done a larger equity financing instead of the gold loan and silver stream. However, at this time the news does not significantly weaken the case for owning PG.

  *Ramelius Resources (RMS.AX) announced two minor financial deals last week.

First, RMS announced that it has sold its Burbanks processing facility, which has been on care-and-maintenance since the Wattle Dam gold mine became depleted in 2014, for A$2.5M in staged payments over 24 months. This is a little disappointing as we expected that RMS would be able to make good use of this facility at some point in the future, but the company's management has obviously decided to direct all of its attention to the Mt Magnet operation.

Second, RMS has sold the mining leases associated with its Kathleen Valley gold project to Liontown Resources (LTR.AX) for 25M LTR shares (current market value: about A$500K). LTR will explore the acquired mining leases for lithium and other rare metals while RMS will retain all gold-related rights and uninhibited access to conduct its gold mining.

  *Taseko Mines (TGB) has received from the Arizona Department of Environmental Quality (ADEQ) the permit to construct and operate a production test facility at its Florence copper project. If all goes well, the test facility will confirm the viability of this project.

The plan is for the Florence project to be developed into an in-situ recovery (ISR) operation. This is a method of mineral extraction that has a very small environmental footprint and is therefore generally easier to permit than either an open-pit or an underground mine. It is common for uranium, but rarely used for copper.

There is apparently one more permit to be obtained before TGB can start building the test facility. This final permit is expected to be granted in the near future.

  *UEX Corp. (UEX.TO) published its quarterly reports for the June quarter. The reports show that UEX had about C$9M of working capital at 30th June, which should be enough to fund the company's uranium exploration business for the next 12 months.

Updates to Small Stocks Watch List (SSWL) and "special situations"

The SSWL contains stocks that are too small and/or too illiquid to be included in the TSI Stocks List, but appear to have substantial upside potential. Although we don't follow these stocks closely via the TSI commentaries, they could be of interest to risk-tolerant speculators capable of doing their own company research.

Here are brief updates on three members of the SSWL and one other "special situation" that was mentioned in a recent TSI commentary.

Since being added to the SSWL about two months ago, junior gold miners Emmerson Resources (ERM.AX) and Sarama Resources (SWA.V) have both gained almost 200%. Over the same period the HUI is up by around 25%. Both ERM and SWA are involved in joint ventures with mid-tier gold-mining companies and will eventually, in our opinion, be purchased by their JV partners. We anticipate large additional price gains, but the short-term risk of new buying is now considerably higher by virtue of the recent stock-price gains.

A sector-wide correction over the next couple of months could create new opportunities to buy ERM and SWA.

A1 Consolidated Gold (AYC.AX) and Carpathian Gold (CPN.CN) have not fared so well. Since being mentioned at TSI a few weeks ago and in AYC's case added to the SSWL, these stocks have dropped a little.

For AYC, the source of the downward pressure is a rights issue to address a cash shortage. The rights issue is on-going and therefore likely to keep a lid on the stock price for a while longer, but this could be viewed as an opportunity for risk-tolerant speculators to pick away at the stock at a price (A$0.027-A$0.03) that could eventually prove to be extremely low.

For CPN, the lacklustre performance could be due to an absence of news/promotion and the fact that it trades on the CSE (Canadian Securities Exchange), a junior exchange that might not be accessible to accounts outside Canada. CPN also trades in the US OTC market under the symbol CPNFF, but a lot of traders (including us) will avoid this market due to its wide buy-sell spreads and market-maker manipulation.

We think the keys to better performance by CPN are news flow, stock promotion (getting the story known), and getting the stock onto either the TSX or the TSXV. The underlying asset (the Rovina Valley gold project in Romania) is superior to many gold-mining assets that are currently being given much higher valuations.

Chart Sources

Charts appearing in today's commentary are courtesy of:

http://stockcharts.com/index.html
http://www.barchart.com/
http://research.stlouisfed.org/