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

Fighting Deflation

The ECB is taking additional steps to fight deflation. At least, that's how the outcome of last week's ECB meeting is being portrayed by the mainstream media, most 'economists' (we use the term loosely) and the ECB itself. However, this portrayal is wrong. The ECB is actually doing nothing other than distorting prices.

The new measures to be taken by the ECB entail interest-rate reductions, because, for example, the previous deposit rate of zero was obviously too high and was therefore getting in the way of economic growth, as well as incentives for banks to make more loans, because economies that are burdened by excessive debt would obviously benefit from more debt.

These new measures leave no doubt that the ECB is every bit as misguided and destructive as the US Fed. The ECB hasn't yet resorted to QE, but that's only because of political obstacles (a.k.a. Germany). There's a high probability that when the 'unconventional' measures introduced last week fail to have a sustained positive effect, the political obstacles that have prevented euro-zone QE up until now will be overcome and an asset monetisation program will be introduced. We suspect that this will happen by the first quarter of next year.

Getting back to the "fighting deflation" propaganda, if, for the sake of argument, we go with the flow and define deflation as a decline in the general price level, then there are only two ways that deflation can occur. The first way is via economic progress. Contrary to the popular view that economic growth causes prices to rise and that rising prices are needed for economic growth, per-capita economic growth is only possible via increased productivity. Increased productivity will, all else remaining the same, lead to LOWER prices (the same amount of money will be 'chasing' a larger quantity of goods and services). Some analysts refer to this as "good deflation". The computer industry is an excellent example. If the entire economy were able to achieve the same productivity growth as the computer industry, then most prices would be in steep downward trends and the average living standard would be in a steep upward trend.

If the euro-zone is currently heading towards deflation it clearly isn't because of real economic progress. However, the ECB's attempts to distort the price signals upon which the productive sector relies will certainly get in the way of economic progress (by curtailing production) and thus make falling prices ("good deflation") less likely. In this respect the ECB is not really "fighting" deflation, it is robbing the average euro-zone consumer of the deflation from which he/she would otherwise benefit.

The other way that deflation can occur is via a contraction in the supply of money and/or credit (a contraction in the supply of credit will typically provoke an increase in the demand for money that has the knock-on effect of lowering prices). This is sometimes called "bad deflation". In this case, the deflationary force is caused by the prior inflations of money and credit stemming from the artificially-low interest rates brought about by the central bank.

See the problem? In its attempts to "fight deflation" the ECB is not only reducing the chances of "good deflation", it is also doing more of what created the potential for "bad deflation". Nobody wants "bad deflation", but after a period of rapid money/credit inflation there is no rational way to avoid it. The central bank can only postpone the inevitable by taking actions that will lead to a more painful future denouement in the form of a deflationary great depression (the best case) or a hyper-inflationary great depression (the worst case). 

Commodities

The Continuous Commodity Index (CCI) appears to be close to completing a normal correction to the intermediate-term advance that got underway late last year. In particular, after becoming very 'overbought' -- based on the daily RSI(14) shown at the bottom of the following chart -- in early March, it recently became as 'oversold' as it was just prior to the start of its upward trend last November.



While the CCI's correction has been routine in nominal currency terms, it has experienced a more serious decline relative to the US stock market. As illustrated by the following weekly chart, the CCI/SPX ratio gained enough ground during the first quarter of this year to trade above its 50-week moving average for the first time since the third quarter of 2011, but almost all of this ground has since been given back.

Our view is that the CCI/SPX ratio is in the process of successfully testing its January-2014 bear-market low as part of a gradual transition from relative strength in equities to relative strength in commodities. A gradual transition from relative weakness to relative strength in emerging-market equities in general and Russian equities in particular is part of the same theme.

The Stock Market

Periods like the last few weeks make us wish we were believers in the idea that direct manipulation of prices by a cartel comprising the government, the central banks and the largest commercial banks was the primary driving force in the markets. Then when the markets moved counter to our expectations we could say something along the lines of "our analysis was spot on and would have been proven right if not for the manipulators". Unfortunately, we could never make such a claim in good faith.

We are surprised that the stock market's upward trend has extended into June. This opens up the possibility that the overall topping process could continue into the final quarter of this year, with a significant decline during the next couple of months followed by a rally to test the high later in the year.

On a short-term basis, however, the recent price action has only increased the downside risk, in that the strength that has enabled the NASDAQ100 Index (NDX) to confirm the new highs in the S&P500 Index (SPX) has led to the senior stock indices becoming very 'overbought'. As an example, the Dow Jones World Stock Index (DJW) has risen on 10 of the past 12 trading days. The daily advances have all been small, but, as illustrated by the following daily chart, the result is that DJW is now at the top of its intermediate-term price channel and DJW's daily RSI(14) is now at a 2-year high.



Also worth noting is that a put/call sell signal was generated at the end of last week in the US stock market. We define a put/call sell signal as the 10-day moving average of the equity put/call ratio moving to the vicinity of its 3-year low concurrently with the 10-day MA of the OEX (S&P100 Index) put/call ratio moving to the vicinity of its 3-year high. Such signals usually occur no more than twice per year and are short-term bearish omens because they indicate a lack of concern about downside risk on the part of the 'dumb money' (the dominant influence on equity option volumes) combined with a heightened level of concern about downside risk on the part of the 'smart money' (the dominant influence on OEX option volumes).



Therefore, although the stock market has defied our expectations over the past few weeks, this is not a good time to become more short-term bullish.

This week's important US economic events

Gold and the Dollar

Gold

GLD's Gold Inventory

It has been several months since we last discussed the changes in the amount of gold bullion held by the SPDR Gold Trust (GLD), the largest gold bullion ETF. This is because there has been nothing to discuss, in that the changes to GLD's gold inventory have been small and, given the price action, there has been no reason to expect anything different. However, it's time for an update, if only to counter the misinformation that regularly gets bandied about on this topic.

The concept that must always be kept in mind when analysing changes in GLD's inventory is that these changes can only happen as a result of arbitrage. More specifically, the Authorised Participants (APs) in the ETF will only add gold to the inventory when the price of a GLD share moves above the net asset value (NAV) of a GLD share. The addition of the gold involves multiple steps (the short-selling of GLD shares, the purchase of gold bullion, the delivering of gold bullion to the ETF and the creation of new GLD shares that are used to cover the aforementioned short position) that occur almost simultaneously, but the key is that it is a mechanistic process that a) gets initiated by GLD's market price moving above its NAV and b) serves the purpose of closing the price-NAV gap. Similarly, the APs will only ever remove gold from the GLD inventory when the price of a GLD share moves below the NAV of a GLD share. Again, there are multiple virtually-simultaneous steps involved (the buying of GLD shares, the short-selling of gold bullion, the redeeming of GLD shares for gold bullion from GLD's inventory, and the use of the bullion obtained from the inventory to cover the aforementioned gold short position). And again, it is a mechanistic process that a) gets initiated by GLD's market price moving below its NAV and b) serves the purpose of closing the price-NAV gap.

In the hope of adding clarity we'll mention two related points. First, it is not possible for GLD's gold inventory to be used to cover short positions elsewhere in the gold market except as part of the arbitrage described above. Second, because GLD holds gold bullion, a change in the price of gold will not necessitate a change in GLD's inventory. GLD's shares will naturally track the price of gold without the need to do anything, regardless of how far or how fast the price of gold moves. However, there are times when the buyers of GLD shares become over-eager, causing the market price of GLD to rise relative to the price of gold, and there are times when the sellers of GLD shares become over-eager, causing the market price of GLD to fall relative to the price of gold. This sets in motion the arbitrage described above.

Now, buyers are most likely to become over-eager after the price has been trending higher for a while and sellers are most likely to become over-eager after the price has been trending lower for a while. That's why the chart presented below shows that major trends in the GLD inventory FOLLOW major trends in the gold price, and why it makes more sense to view last year's decline in GLD's gold inventory as an effect, not a cause, of the decline in the gold price.

With the gold price having stopped falling last December but not yet having done enough to suggest to most people that there has been a sustained turn to the upside, it is not surprising that the GLD inventory has essentially flat-lined since the beginning of this year. After the gold price starts trending upward with conviction we should start to see a steady build-up in the GLD inventory.



Current Market Situation

Despite some potentially market-moving news in the form of the ECB's new counter-productive actions and the US monthly employment report, the financial markets did very little last week. In this respect the gold market was no exception. The "death cross" that occurred during the week before last appears to have marked some sort of price bottom for gold, but gold hasn't done anywhere near enough to confirm that the bottom will hold beyond the very short-term.



It seems that almost every 'technical analyst' on the planet is calling for gold and the gold-mining indices to make new lows within the next few months. The long-term bulls expect a final decline to marginal new lows prior to the start of a multi-year upward trend, whereas the long-term bears expect a decline to well below last year's lows as part of a continuing bear market. Enough strength over the weeks ahead to confirm that the March-June decline was a correction to a new upward trend rather than the continuation of the 2011-2013 downward trend would therefore catch the maximum number of chart-huggers and price-followers off guard. This doesn't mean that gold is about to reverse course and prove the majority wrong, but it does mean that there is plenty of sentiment-related fuel to propel the price upward. As discussed in previous commentaries, there is also now plenty of fundamentals-related fuel for a gold rally, although we are getting the impression that the inverse relationship between the gold and stock markets is the only fundamental that matters at this moment.

Getting back above $1280 on a daily closing basis would be a clear sign that the trend had reversed, while $1230 +/- a few dollars remains a realistic target for a near-term downward spike.

Gold Stocks

The price action of the past three weeks has invalidated our 1970s model, at least temporarily. It looks like the initial rebound from the 2013 bottom is going to be more drawn-out than the initial rebounds from the 1970 and 1976 bottoms, undoubtedly as a result of the extension of the US stock market's topping process.

Below is another view of the loose inverse relationship between the HUI and the SPX. Although the HUI made a new low in December-2013, it essentially stopped trending downward in June of 2013. It broke out to the upside in January of this year, but the SPX's continuing advance has restrained the enthusiasm for gold-related investments.

The SPX is now as stretched to the upside as it was when the HUI reversed higher in late-December.



The following chart shows that while the HUI did very little last week, the GDXJ/GDX ratio ended the week at a 2-month high. As a consequence, the current bullish divergence between the HUI and the GDXJ/GDX ratio is far more pronounced than the one that occurred last December. The stage therefore remains set for a new short-term upward trend, but the HUI has not yet done anything to signal the start of such a trend.

Critical short-term resistance lies at 220. A daily close above this resistance would confirm a reversal.



The Currency Market

After all was said and the ECB had done its worst, the euro managed to end last week at roughly where it began the week. In holding its ground it also managed to hold its 200-day MA after spiking below it in the immediate aftermath of the ECB's irresponsible promises to 'do more'.

The modest recovery following the ECB news was predictable given that the euro had lost almost four points and become quite 'oversold' in anticipation of the news.

With the euro still 'oversold' and with the speculative net-short position in euro futures having just reached its highest level since last July, the euro is poised to rally. A counter-trend rally within a downward trend would take it up to around 138, but we are expecting more than a counter-trend rally. Unless the market proves otherwise, we will work under the assumption that the euro's intermediate-term trend is to the upside.

A daily close below 135 would prove otherwise.

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 6th June 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]

  *Batero Gold (BAT.V) confirmed that it is in cash-preservation mode and will therefore be doing little to advance its Batero-Quinchia gold project in Colombia over the months ahead. It will, however, be on the lookout for acquisitions with near-term production potential. The company has about $13M (C$0.15/share) of cash.

  *Clifton Star Resources (CFO.V) advised that it is suing Osisko over the failure of that company to provide a $22.5M loan in accordance with a joint-venture agreement. This is consistent with the following excerpt from our 2nd June report:

"We expect that CFO will conserve its cash over the next couple of quarters by doing very little to advance its gold project and devoting the small financial resources at its disposal to the legal pursuit of the $22.5M loan that -- according to CFO -- should have been provided by Osisko 18 months ago. This loan will soon be the obligation of the Agnico Eagle (AEM) -Yamana Gold (AUY) joint venture, which is in the process of buying Osisko.

Taking legal action to obtain the above-mentioned $22.5M loan is currently the best way for the company to use its limited resources, because doing so could prompt the AEM-AUY joint venture to settle the matter by purchasing CFO or doing some other deal that would benefit CFO shareholders."

  *Pilot Gold (PLG.TO) announced more drilling results from the Kinsley Mountain gold project in Nevada. These latest results show that about 1km from the deep, high-grade zone that delivered spectacular gold intercepts over the past several months, there is a potentially-economic deposit of shallow, oxidised gold. Kinsley Mountain keeps getting better.

The Kinsley Mountain project is 79% owned by PLG and 21% owned by Nevada Sunrise Gold (NEV.V). Up until now NEV shares have benefited to a far greater extent than PLG shares from the Kinsley exploration success, with NEV now up by 560% since we brought the stock to the attention of our readers in early February and PLG 'only' up by around 40% over the same period. This is due to the fact that NEV is a tiny company that holds nothing of real value aside from its 21% stake in Kinsley Mountain (NEV is nothing other than a leveraged play on Kinsley), whereas PLG is a much larger company with a lot of cash and two potentially-valuable projects in addition to Kinsley Mountain.

Although the depressed market for gold-mining stocks has thus far prevented PLG's stock price from responding vigorously to the Kinsley Mountain exploration success, the stock appears to be close to ending a correction that looks similar to the multi-month correction that occurred during the second half of last year.



  *Pretium Resources (PVG) reported the results of the first hole from a 3-hole surface drilling program in the Valley of the Kings deposit at the Brucejack project. The main purpose of the drilling is to test for gold mineralization at depth. To our non-geologist eyes, the results of the first hole were not significant.

The next important market-moving event for PVG is expected to be the publishing of the amended Brucejack FS, which is scheduled to happen later this month.

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) EDV.TO (last Friday's closing price: C$0.75).

2) EVN.AX (last Friday's closing price: A$0.79).

3) PLG.TO (last Friday's closing price: C$1.39).

4) TGM.V (last Friday's closing price: C$0.38).

Chart Sources

Charts appearing in today's commentary are courtesy of:

http://stockcharts.com/index.html