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

A massive mortgage bailout coming soon?

Posted by James Pethokaukis (the Money & Politics columnist for Reuters Breakingviews) at his blog on 5th August:

"Main Street may be about to get its own gigantic bailout. Rumors are running wild from Washington to Wall Street that the Obama administration is about to order government-controlled lenders Fannie Mae and Freddie Mac to forgive a portion of the mortgage debt of millions of Americans who owe more than what their homes are worth. An estimated 15 million U.S. mortgages -- one in five -- are underwater with negative equity of some $800 billion. Recall that on Christmas Eve 2009, the Treasury Department waived a $400 billion limit on financial assistance to Fannie and Freddie, pledging unlimited help. The actual vehicle for the bailout could be the Bush-era Home Affordable Refinance Program, or HARP, a sister program to Obamaís loan modification effort. HARP was just extended through June 30, 2011.

The move, if it happens, would be a stunning political and economic bombshell less than 100 days before a midterm election in which Democrats are currently expected to suffer massive, if not historic losses. The key date to watch is August 17 when the Treasury Department holds a much-hyped meeting on the future of Fannie and Freddie."

The rumoured mortgage bailout mentioned above has already been officially denied once. If it gets denied two more times then it is probably going to happen.

We have no idea whether the Obama Administration is about to effect the transfer of hundreds of billions of dollars to homeowners with negative equity, but if the employment situation fails to improve (a virtual certainty), the housing market continues to deteriorate (another virtual certainty) and the stock market resumes its long-term decline (very likely) then it's a good bet that within the next 12 months something along these lines will be tried. If/when it happens it will prevent prices from falling to their correct levels and further distort the price signals that the market uses to allocate resources. It will therefore place another large obstacle in front of a genuine recovery, but this won't be a concern for senior policy-makers because the overarching goal of such schemes is always to rob Peter to pay Paul and thus obtain the support of Paul. If there are more 'Pauls' than 'Peters', or if the 'Peters' don't realise they are being robbed (as is often the case when wealth 'redistribution' is effected via monetary inflation), then the scheme could simultaneously be an economic disaster and a political success.

If a massive mortgage bailout were put into effect within the next few weeks it could cause the stock market to deviate from the Presidential Cycle Model we've been using. Specifically, it could cause the stock market to be a lot stronger from mid August through to mid October than we are currently expecting. It could also have short-term bullish implications for most commodities (including gold) and short-term bearish implications for the US$. Having said that, we note that the September-2008 decision to use hundreds of billions of taxpayer dollars to shore-up the balance sheets of commercial banks (the Troubled Asset Relief program, or TARP for short) and the unprecedented explosion in the Fed's balance sheet during September-October of 2008 caused only a momentary interruption to the stock market's downward trend. In 2008, the attempts to support prices seemed to increase the stock market's volatility without altering its ultimate short-term destination.

It's all just rumour at this stage and may not happen this year. Actually, we will be surprised if another large bailout of any description happens this year due to the risk of it backfiring in spectacular fashion at the November elections (it could backfire because it would so obviously be a pre-election political stunt and because it would be viewed with disgust by every person who continues to take responsibility for his own financial situation). But the fact that this rumour has been floated at all and has an air of credibility about it suggests that in the realm of policy-making there remains a strong desire to seek an inflationary 'solution'. Was there ever any doubt?

Interesting quote or fact of the week

The Stock Market

The most important chart in the financial world, updated

We show the following chart once or twice per year, every year. We don't show it more often than that because it presents a very long-term picture that doesn't usually change significantly from month to month or even from year to year, but we like to show it at least once per year because it is, in our opinion, the most important chart in the world for long-term equity investors. The importance of this chart is that it takes currency fluctuations out of the equation and reveals the US stock market's REAL long-term trend.

As explained in the 16th February 2009 Weekly Update: "The stock market's real long-term trend can be defined by its performance in gold terms or, just as appropriately, by the trend in its average valuation (price/earnings ratio, dividend yield, etc.). It doesn't matter which of these two measures is used because, as evidenced by our chart, the long-term trends in the stock market's performance relative to gold (as measured by the Dow/Gold ratio) and the S&P500's valuation (as measured by the price/peak-earnings ratio developed by John Hussman) are always in synch with each other."

Based on the "Hussman P/E" (the top section of our chart), the S&P500 Index briefly dipped into under-valued territory in early 2009. However, John Hussman has pointed out in his commentaries that the low level of the price/peak-earnings ratio in early 2009 was partly due to the extraordinarily high profit margins of 2007, and that the S&P500's early-2009 valuation looks much less attractive if earnings are normalised to account for 2007's extremely elevated profit margins. To put it another way, the "peak earnings" that go into the calculation of the P/E ratio used in the above chart have been inflated by 'bubble' profit margins that may never be seen again, causing the valuation to appear lower than is really the case.

Notice that in the previous two secular bears, the market spent years in 'under-valued territory' before the long-term trend turned upward.

Current Market Situation

Is the US stock market now 'overbought'?

The answer depends on whether we are correct to assume that an intermediate-term downward trend is still in progress. By way of explanation, we include, below, a chart showing the percentage of S&P500 stocks trading above their respective 50-day moving averages. During an intermediate-term upward trend this indicator will often move above 90 before a downward correction gets underway, but upward corrections within intermediate-term downward trends typically end after the indicator moves into the 70-80 range. The indicator briefly moved into the 70-80 range last week, so if we are correct to assume that an intermediate-term downward trend is still in progress then the market is now sufficiently 'overbought' for the next meaningful decline to begin.

Below is another look at the S&P500's "rising wedge". Friday's price action further defined the bottom of this wedge.

A daily close below 1100 would be a definitive downside breakout from the wedge pattern and suggest that the S&P500 was on its way to new lows for the year, while the S&P500 could move up to the 1140s over the coming 1-2 weeks and still remain within its potentially bearish wedge pattern.

The US stock market is entering a critical two-week period. The rebound from the early-July low is consistent with the Presidential Cycle Model that the market has been tracking since the beginning of the year, but in order to avoid a significant deviation from the Model the market must reach a short-term peak by the third week of August at the latest. In other words, a new multi-month high after the end of next week (20th August) would be a clear sign that the market was no longer following the Presidential Cycle Model.

The "jobless recovery"

We just wanted to point out that there cannot be any such thing as a "jobless recovery". In a genuine recovery a lot more private-sector jobs will be created than lost, while a failure to make a sizeable dent in the overall level of joblessness will mean that no genuine recovery is occurring.

This week's important US economic events

Gold and the Dollar

Gold and Silver

The gold price has just risen for 8 days in succession, which is an unusually long winning streak. It is potentially significant that it has managed to string together such a large number of consecutive up-days without rising above its 50-day moving average or lateral resistance at $1220-$1230.

We continue to anticipate an October-November correction low at somewhere between the mid-$1000s and the mid-$1100s. We therefore aren't anticipating a lot of weakness, although there could be sufficient weakness to test the bulls' resolve.

As has been the case throughout much of the past two years, silver's price chart (see below) looks more precarious than gold's. The recent rebound has taken the September silver futures contract back to resistance, but note that resistance extends from the current price up to $20. In other words, even if silver were to show some 'surprising' strength over the next couple of weeks and break above resistance at $18.50-$18.75, it wouldn't be 'out of the woods'.

Due to silver's greater downside risk we continue to believe that it is reasonable to use silver put options as a partial hedge for gold-heavy portfolios.

By the way, there's a big difference between hedging against a potential decline and speculating on a potential decline. The difference can be explained using a housing insurance analogy. You don't buy fire insurance because you want or expect your house to burn down; you buy it just in case it burns down.

Gold Stocks

Current Market Situation

In last week's Interim Update we noted that the XAU had closed Wednesday's trading session at its 50-day moving average, and that the preceding two rebounds had ended shortly after reaching this moving average. The following chart shows that by moving sideways on Thursday and rallying on Friday the XAU has managed to break above its 50-day moving average and rise to lateral resistance at 177.5.

Although the break above the moving average is a minor sign of strength, the price action in both the gold bullion market and the gold mining sector of the stock market continues to look very much like the counter-trend-rebound variety. In particular, we note that gold and the gold-stock indices have recently strung together a lot of up-days, but that the overall upside progress has not been substantial and gold bullion has yet to even test lateral resistance at $1220. We therefore view the recent strength as another opportunity to build up cash or do some hedging, as opposed to evidence that a correction low is in place.

Friday's intra-day high in the XAU was within 7% of its May high. Realistically, if the XAU continues to move upward from here it will take a decisive close above the May high to convince us that a new intermediate-term advance has begun. A more likely outcome involves a downward reversal within the next few days followed by a multi-week decline to a correction low in the vicinity of the February low (150 for the XAU, 370 for the HUI).

It isn't only governments that attempt to re-write history

We don't want to comment on Ron Rosen's article at http://www.kitco.com/ind/rosen/aug032010.html, but we feel that we really must. The article contains a forecast that the HUI is about to embark on a decline that will take it back to its October-2008 bottom of 150.

At any given time there will be a huge range of opinions about the likely future performance of any market. In fact, differences in opinion are what make a market. Right now, for example, some people are expecting a deflationary collapse or deflation scare that will cause the prices of gold and gold mining stocks to crash (as per 2008); some people (us, for example) are expecting relatively minor declines or rises within the contexts of on-going cyclical bull markets; and some people believe that gold and gold stocks are about to 'go parabolic' in response to a hyper-inflationary blow-off.

We think the first and the last of the aforementioned short-to-intermediate-term outcomes are the outliers (the outcomes that have the lowest probabilities). Mr. Rosen's opinion obviously falls into the first category, and while we strongly disagree with it -- as far as we can tell, there is NO historical precedent for the broad stock market or the gold sector of the stock market experiencing two massive crashes within the space of two years -- we certainly don't hold it against him. There is a small chance that he could be right, which is a reason why the hedges we've previously suggested should remain in place. What we have a problem with is the following paragraph:

"There is one chart in the precious metals complex that has been true, honest, and faithful right from the beginning of its bull market. You will see a white square on this chart that says DEC 2007 DANGER!!! This was a magnificent and totally up front and obvious clue that the tide was about to turn bearish for the HUI. Between November 2000 and December 2007 the HUI did not at any time retreat below a previous monthly high. Horizontal lines have been drawn to show you this continuously bullish pattern. For the first time in seven years the HUI closed below a previous monthly peak in December 2007. I wrote about this in several REPORTS and told subscribers to sell. The HUI continued moving up for three months and then began a Flat Correction. The HUI has not exceeded the March 2008 high of 519.68 for the last 29 months."

Someone reading the above would get the impression that Mr. Rosen turned bearish near the HUI's 2007-2008 peak (thanks to "a magnificent and totally up front and obvious clue" in the HUI's monthly chart) and then stayed bearish, thus helping his subscribers avoid the H2-2008 crash. What he fails to mention is that some time before the 2008 crash he returned to the bullish side. As evidence we cite the article at http://www.gold-eagle.com/editorials_08/rosen071908.html, which was published on 19th July 2008 (just prior to the start of a massive decline in the gold sector). The article includes the following comments:

"The monthly chart of the HUI is a thing of beauty. It continues to climb ever higher with a few patience-trying corrections. It is close in time to beginning an explosive move up."

"...you are close to entering a rip roaring bull move in the precious metals complex."

We have certainly made our share of bad forecasts, and, as we said above, we have no problem with Mr. Rosen's current ultra-bearish opinion. What we have a problem with is his brazen attempt to re-write history. He doesn't appear to have said anything in his recent article that isn't true, but by leaving out some relevant information he has attempted to paint an unreasonably positive impression of his own performance.

Currency Market Update

The two charts displayed below explain a lot. The first chart shows that the Australian Dollar (A$) has a strong positive correlation to global equities (as represented in this instance by Hong Kong's Hang Seng Index), which suggests that the A$ will be a relatively strong currency as long as the global stock market rebound is intact and will become relatively weak during the next meaningful stock market decline. The second chart shows that there is a strong positive correlation between the C$/A$ ratio and the Dollar Index, meaning that the C$ usually trends higher relative to the A$ when the Dollar Index is strengthening and lower relative to the A$ when the Dollar Index is weakening. This chart explains why the C$ has weakened considerably against the A$ over the past two months and why it should begin to outperform the A$ once the broad stock market resumes its downward trend (since the Dollar Index is trending inversely to the stock market).

The following chart shows that the September euro has risen to resistance at 1.33-1.34. This is a likely range for a reversal, but only if there's a corresponding reversal in the stock market. Alternatively, some additional upside in the stock market over the coming 1-2 weeks could push the euro up to its 200-day moving average (presently at 1.355).

Update 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)

Agriculture ETF (NYSE: DBA). Recent price: US$25.68

Over the past few weeks there has been an interesting up-move in the grains, with wheat leading the way. The recent sharp rise in the wheat price was a response to drought-related damage to wheat crops in Russia and Central Asia, and the related decision by the Russian government to suspend wheat exports.

The wheat 'supply shock' and resultant sharp rise in its price have implications for the two other major grain markets (corn and soybeans). For example, if wheat prices rally further and it becomes apparent that they are going to remain relatively high for some time, then farmers in, say, the US will have a strong incentive to plant more wheat and less corn in the future. This will result in a higher corn price than would otherwise have been the case. Also, substantially lower-than-forecast production in one of the world's important grain-growing regions makes the global grain market more vulnerable to future weather-related problems.

The wheat price was "limit down" on Friday, so the upward pressure on prices appears to have momentarily abated. It's a good bet, though, that the recent market action will prove to be more than just a short-lived spike, because considering the extent of the reduction in the wheat crop it is very unlikely that a one-month bounce in price could bring supply and demand back into balance on a sustained basis. Accumulating exposure to the grains -- preferably on weakness -- therefore makes even more sense to us today than it did a few weeks ago.

Unfortunately, there is no ideal vehicle for the aforementioned grain exposure. We have chosen to go with DBA, but DBA has the disadvantage (from our perspective) of holding sugar futures in addition to wheat, corn and soybean futures. We would much prefer a pure play on the trio of wheat, corn and soybeans. JJG is such a play, but it is an ETN rather than an ETF. This means that JJG is a credit instrument issued by a financial institution (Barclays), and, therefore, that the buyers of JJG are taking credit risk.

    Andina Minerals (TSXV: ADM). Shares: 108M issued, 129M fully diluted. Recent price: C$1.23

Buyers of ADM at the current price get Measured-and-Indicated (M&I) gold resources for less than US$20/ounce, which is extremely cheap considering the size (7M ounces) and location (Chile) of the deposit. The main reason it's so cheap is the risk that it will not be possible to economically mine the deposit at the current gold price. The extent of the risk won't be known until the company completes its re-engineering and the associated Preliminary Economic Assessment (PEA), which probably won't be until early next year.

If the PEA reveals favourable economics at a gold price of $1000/oz or lower then ADM should recoup all the ground it lost earlier this year and make a sustained break above C$2.00, but if the PEA indicates that a much higher gold price will be needed to make the project viable then ADM will probably remain a lowly-valued option on the gold price.

Turning to the price chart (see below), ADM has been 'chopping' back and forth between C$1.05 and C$1.25 since we last mentioned it on 26th April. It appears to be building a base, with the top of the base being defined by resistance at C$1.40. A break above C$1.40 would probably be followed by a rise to C$1.70-$1.80, where a lot of supply would undoubtedly 'come out of the woodwork'. Good news relating to the PEA will probably be needed to get the stock above C$1.80.

Risk-tolerant speculators who currently have no exposure to ADM should consider building a position below C$1.20. The company has a strong balance sheet (almost $40M in cash) and the stock could be viewed as an option on a higher gold price and/or successful re-working of the mine plan.

Chart Sources

Charts appearing in today's commentary are courtesy of: