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 will end by mid-2010. In real (gold) terms, bonds commenced a secular BEAR market in 2001 that will continue until 2014-2020. (Last update: 09 February 2009)

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

Sentiment Overview

Gold Market Sentiment

When the gold price rose to $1000 in late February there was naturally a lot of enthusiasm about this market's prospects, which, combined with the almost uninterrupted $200 rise over the preceding five weeks, paved the way for a downward correction. The gold price then fell for eight trading days in a row, with the eighth down day being last Wednesday. The stage was thus set for a rebound, but as noted in last week's Interim Update the fact that the 8-day decline had barely put a dent in bullish sentiment suggested that the overall correction from the February high had not yet run its course.

Interestingly, while the 8-day decline generated very little concern amongst gold bulls, Thursday's rebound from support near $900 was greeted with unrestrained exuberance. For example and as illustrated by the following chart, the premium to net asset value of the Central Gold Trust (GTU), a closed-end fund that invests in gold bullion, surged from an already-high 20% on Wednesday to a new all-time high of 33% in response to Thursday's technical rebound. Buyers of GTU near the close of trading on Thursday were, in effect, paying about $1250/ounce for gold while the spot gold price was in the $930s. No well-informed investor would do this.

If the pullback that culminated last Wednesday had been accompanied by significant concern and the subsequent rebound had been accompanied by scepticism then the gold market would be well positioned to resume its intermediate-term upward trend. However, this is clearly not the situation.

Stock Market Sentiment

Extreme short-term optimism in the gold market is occurring alongside extreme short-term pessimism in the stock market. For example, the following chart of the weekly AAII Sentiment Survey indicates that 70% of survey respondents were bearish as of last week, versus only 19% that describe themselves as bullish. This happens to be the highest bearish percentage in the survey's history. 

We won't argue that the incredibly high bearish percentage isn't justified by both the price action and the fundamentals. We also won't claim that total capitulation has occurred. However, if the current long-term equity bear evolves in similar fashion to previous examples then total capitulation lies at least a year, and potentially as many as 5 years, into the future. In the mean time there is a sentiment platform in place capable of supporting a strong counter-trend rebound.

Industrial Commodities

With the exception of those who remain in a blissful state of denial, observers of the economy and the financial markets realise that the global boom has ended and that a new boom is not going to begin anytime soon. Many people are therefore extrapolating today's bearish industrial-commodity supply/demand trends (falling demand relative to supply) well into the future. In other words, there is a great deal of pessimism built into the current prices of most industrial commodities.

A good example of the current stark difference between gold sentiment and industrial-commodity sentiment is the relative performances of the Central Gold Trust (GTU) and the Uranium Participation Corp. (TSX: U). GTU, as noted above, holds gold bullion and currently trades at a huge premium to its net asset value (NAV). U, on the other hand, holds an industrial commodity (uranium) and is currently priced at a substantial DISCOUNT to its NAV (by our calculations, Friday's closing price of C$5.95 for U represented a discount of about 16% to the market value of its uranium).

Cramer

Jim Cramer, a very high-profile and outspoken commentator on the financial markets, has recently had a lot to say about gold, almost all of it positive. At the same time he has apparently been saying bearish things about natural gas.

Cramer is a good indicator of public sentiment, meaning that when he is very bullish it generally means that most people are bullish and when he is very bearish it generally means that most people are bearish. Cramer's current outlook therefore confirms that there is considerable optimism built into gold's current price and considerable pessimism built into the current prices of natural gas and other industrial commodities.

By the way, we understand that Cramer has been advising people to scale into gold on weakness, which is actually very good advice. Our point is that his current strong focus on gold adds weight to the view that sentiment represents a barrier to significant additional SHORT-TERM gains in the gold price.

Conclusion

Sentiment suggests that there will soon be a temporary shift away from the premier counter-cyclical investment (gold) to cyclical investments such as general equities and industrial commodities. Silver is part monetary (counter-cyclical) and part industrial (cyclical), so if/when this shift takes place it will probably build on its recent strength relative to gold. 

Oil and Gas

The Stock Market

There is no question that the US economy is in bad shape and is still deteriorating. For example, the latest Purchasing Managers' Index (PMI) confirms the continuation of a strong downward trend in manufacturing, the unemployment rate has risen to around 15% (based on correct measurement, not the headline number), and one in eight US homeowners are now delinquent on their mortgages. This, however, is well known. It is a large part of the reason why the stock market has been incredibly weak and why sentiment surveys reveal extreme negativity. 

Because it is well known, today's miserable economic backdrop won't prevent the stock market from rebounding, or, for that matter, from embarking on a new long-term upward trend. Note, though, that we don't think there's a realistic chance of a new equity bull market starting anytime soon. This is partly because valuations are still much higher than they usually get near the ends of major bear markets and partly because the actions being taken by policymakers to "stimulate" the economy will prolong and deepen the downturn. Note, as well, that the capitulation we expect to see towards the end of the equity bear will probably encompass the gold price rising to some unbelievable price as well as widespread acknowledgement that the interventionist economic theories of Keynes et al are wrong. The current situation is that gold is yet to exceed its March-2008 high, and most people still seem to believe, or have not yet completely rejected, the idea that the government can help by creating money out of nothing and by stealing from Peter to pay Paul.

A new bull market appears to be out of the question, but we continue to anticipate a tradable multi-month rebound. After a promising start the anticipated rebound failed to materialise during the first quarter, but we are now entering a 2-week time window when intermediate-term equity market turning points have regularly occurred over the past 9 years.

Once a rebound begins it will probably NOT take the form of a consistent upward trend, at least not initially. The most likely pattern following a low will be a sharp 1-3 week bounce and then a pullback to test the low prior to the start of a consistent upward trend.

This week's important US economic events

Gold and the Dollar

Gold

The following daily chart of April gold futures shows that the gold price bottomed at its 50-day moving average last week. At this stage, therefore, the current correction looks similar to the one that ended during the first half of January. However, due primarily to the sentiment situation discussed earlier in today's report we suspect that the current correction is not complete.

With the economic and monetary backdrops the way they are there is a significant risk that the gold price will soon blow through $1000/ounce and begin heading rapidly to much higher levels. As a result, you would have to be either crazy or oblivious to risk to be short gold right now. However, a far more likely short-term outcome is that the rebound from last week's low will end below the February high and be followed by a decline to a new low for the move.

We have no particular target in mind for a correction low. All we can say is that we would not be surprised if gold dropped to the mid-$800s prior to the end of this correction, but would be surprised if it fell below $800.

Rather than thinking in terms of a downside price target it makes more sense to expect the correction to continue until the 'froth' has been taken out of the market. Likely signs that the froth has been removed include a peak-to-trough decline of more than 50K contracts in the speculative net-long position in COMEX gold futures and substantially reduced NAV premiums for CEF and GTU (premiums of 5% or lower would be ideal).

Gold Stocks

The continuation of gold's correction would put downward pressure on gold stocks. However, if a stock-market rally were to commence in the near future then the downward pressure exerted by a consolidating gold price would be at least partially offset by the upward pressure exerted by a rising stock market. Furthermore, the average gold stock has not yet come close to fully discounting the positive effects on the gold mining business of the large rise in the real gold price that has occurred over the past 6 months. As a result, the HUI has a much better chance than gold of making a sustained move above its February high within the next two months.

The following chart shows that the HUI plunged below its 50-day moving average at the beginning of last week. It then rebounded to slightly above this moving average on Friday before reversing lower and ending the week below it.

We don't know if the HUI's correction is over. As noted in last week's Interim Update, it is certainly possible that it ended when the HUI dropped to 260 on Tuesday 3rd March. At the same time, it wouldn't surprise us if there were some additional downside prior to a sustainable low being reached. A daily close above last Friday's intra-day high of 295 would be a clear indication that the correction was over.

There is probably now greater short-term upside potential in non-gold stocks than in gold stocks, but there is also greater downside risk. Moreover, investors should ensure that their primary focus remains on the gold sector because in our opinion it is the only equity sector that happens to be a long-term bull market.

Currency Market Update

A potentially significant divergence

Important turning points in the Dollar Index tend to coincide with important turning points in the Baltic Dry Index (BDI), with US$ highs associated with BDI lows and US$ lows associated with BDI highs. For example, the following chart shows a BDI low and a US$ high in Q2-2004, a BDI high and a US$ low near the end of 2004, a BDI low and a US$ high between July and November of 2005, and a BDI high combined with a US$ low in mid-2008.

A divergence between the BDI and the Dollar Index has recently developed. Specifically, the BDI bottomed in November of last year and has just made a new multi-month high, but after declining sharply in the weeks following its November high the Dollar Index resumed its advance and has also just risen to a new multi-month high (actually, a multi-year high).

Based on the historical record we should expect that either the BDI will soon begin heading back towards last year's low or the Dollar's trend will reverse downward. If the stock market soon begins to rally then it is likely that the BDI will maintain its upward bias and the recent BDI-US$ divergence will be resolved via a downward reversal in the US$.

Current Market Situation

Weakness in the Yen has created the impression that the US$ has recently been very strong, but the following daily chart shows that the March euro has spent the past month drifting between 1.25 and 1.30. Apart from a quick 10% decline in the Yen, very little has happened in the currency market over the past few weeks.

The euro has made numerous attempts to rally since the beginning of this year, but each attempt has failed at, or below, the 18-day moving average (the green line on the following chart). A decisive daily close above this moving average should therefore be taken as an early warning of a short-term trend change.

Update on Stock Selections

(Note: 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)

More comments on the NGD-WGW Merger

The merged company is expected to have:
  - 348M shares outstanding, 436M on a fully diluted basis
  - 12.2M ounces of gold in the measured-and-indicated resource category, including 7.6M ounces of reserves, all within politically secure jurisdictions
  - 340K ounces/year of current production rising to 420K ounces/year in 2012 (assuming no contribution from Amapari and no further acquisitions)
  - Sufficient cash and cash flow to bring New Afton into production in 2012 at the rate of 80K ounces/year of gold and 75M pounds/year of copper without issuing more equity or debt

Go to http://www.bnn.ca/news/7668.html to view an interview with the CEOs of the two companies regarding the merger's rationale.

The more we think about this deal the more it seems like a good move from NGD's perspective. In a nutshell, it answers the financing question for the New Afton project in a cost-effective way, thus eliminating one of the issues that had been weighing on NGD's stock price. However, we still don't see that the deal makes a lot of sense from WGW's perspective. It provides a growth path that didn't previously exist, but with development-stage gold projects currently having such low valuations there were, in our opinion, much better ways in which WGW could have grown.

Here are some back-of-the-envelope calculations of the combined company's value:

340K ounces/year at US$2500 per ounce of production implies a valuation of US$850M, or US$2.44/share assuming 348M shares (note that we are not using the fully diluted share count because almost all the warrants are a very long way out of the money). 420K ounces/year at US$3000/ounce (a $3000/oz figure will be more appropriate once New Afton comes on line and costs decline) implies a valuation of US$1260M, or US$3.62/share. Adding US$150M for the company's 30% stake in the undeveloped El Morro copper/gold project increases these valuations to US$2.87 and US$4.05/share, respectively. These valuations assume that Amapari is worthless, that the company's $170M of ABCP has no value, and that gold and copper remain below US$1000 and US$2 respectively.

By the way, when we come up with a rough valuation by assuming that production is worth $2500/ounce (or some other figure) we are not saying that one ounce of gold is worth $2500; we are saying that an ounce of gold per year for the next 10 (or so) years can be assumed to have a present value of around $2500. Apart from the price of gold, the value assigned to gold production will be determined by production cost and risk. For example, production from higher-cost mines should be assigned lower valuations, as should production from higher-risk locations. Currently, the 37 gold producers followed by John Doody at www.goldstockanalyst.com have a weighted average market-cap-per-ounce of forecast 2009 production of around $4200. Furthermore, Gammon Gold, which has about 15% lower gold production and higher risk than the NGD-WGW combination, is presently being valued by the market at around $3000 per ounce of forecast 2009 gold production. In other words, the figures used in our NGD valuation are fairly conservative.

Finally, as happens from time to time on the AMEX stock exchange (now called the NYSE Alternext), there was strange action at the end of Friday's session in that WGW suddenly dropped from the mid-US$160s to US$1.51 due to a single trade done just after the close. This sharp drop was not reflected in WGW's Canadian-traded shares (TSX: WGI) or in NGD shares and will probably be 'corrected' as soon as trading commences on Monday. WGW should trade at a slight discount to NGD, which closed at US$1.71 on Friday.

    Great Basin Gold (AMEX and TSX: GBG). Shares: 315M issued, 403M fully diluted (including the latest financing). Recent price: US$0.99

After GBG announced an equity financing on 23rd February we said: "...this financing has been poorly timed and is very much in the bad news category. Furthermore, the company has proceeded with the equity offering without first locking in a price for the new shares. This, in our opinion, was a stupid thing to do. The financing news pushed GBG down to support at US$1.40, which would ordinarily constitute an opportunity for new buying. In this case, however, we would wait until the financing price has been determined and the market has had time to fully digest the effects of the share dilution before doing any new buying."

The financing price was announced last Wednesday, and it was LOW: C$1.30 (US$1.00) with a half warrant at C$1.60. GBG's management pretty much guaranteed that the financing would be done at the lowest possible price, thus wiping out the maximum possible amount of shareholder value, by announcing the financing without first locking in a price.

GBG is developing two gold mines -- the Hollister mine in Nevada and the Burnstone mine in South Africa. Hollister is expected to produce 138K ounces/year at a cash cost of US$384/ounce and is estimated to have a net present value of US$100M using a discount rate of 10%. Burnstone is expected to produce 275K ounces/year at a cash cost of $303/ounce and is estimated to have a net present value of US$611M at a discount rate of 5%. These figures are taken from GBG's web site. The combined NPV of the two projects is therefore estimated to be US$711M. Subtracting US$60M of debt yields an estimated market value for the company of US$651M, or US$1.86/share assuming 350M shares. Taking a different approach and valuing the 413K ounces of forecast annual production at US$2500/ounce yields an estimated market value of US$2.78/share.

The poorly handled financing has hurt our GBG stock position and has all but guaranteed that our April-2009 GBG warrants will expire worthless. However, the company should now be fully financed through to production and at the current price or lower the stock offers interesting upside potential, especially considering that we have not allowed anything in the above valuations for Burnstone's excellent expansion potential. The increase in supply will probably keep a lid on the share price for a while, but we think the shares have a good risk/reward at US$1.00 or lower.

Chart Sources

Charts appearing in today's commentary are courtesy of: