-- Weekly Market Update for the Week Commencing 10th November 2008
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.
Bonds commenced a secular BEAR market in
June of 2003. (Last
update: 22 August 2005)
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)
The Dollar commenced a secular BEAR market during the final quarter of 2000. The
first major downward leg in this bear market ended during the first
quarter of 2005, but a long-term bottom won't occur until 2008-2010. (Last update: 28 March 2005)
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 CRB Index, commenced a secular BULL market in 2001. 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. (Last update: 03 November 2008)
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Outlook Summary
Market
|
Short-Term
(0-3 month)
|
Intermediate-Term
(3-12 month)
|
Long-Term
(1-5 Year)
|
Gold
|
Bullish
(30-Jun-08)
|
Bullish
(12-May-08)
|
Bullish
|
US$ (Dollar Index)
|
Neutral
(10-Sep-08)
| Neutral
(22-Sep-08)
|
Neutral
(19-Sep-07)
|
Bonds (US T-Bond)
|
Neutral
(14-Jul-08)
|
Bearish
(22-Sep-08)
|
Bearish
|
Stock Market (S&P500)
|
Bullish
(16-Oct-08)
|
Bullish
(08-Oct-08)
|
Bearish
|
Gold Stocks (HUI)
|
Bullish
(30-Jun-08)
|
Bullish
(12-May-08)
|
Bullish
|
Oil | Neutral
(03-Sep-08)
| Neutral
(22-Sep-08)
| Bullish
|
Industrial Metals (GYX)
| Neutral
(18-Jun-08)
| Neutral
(22-Sep-08)
| Bullish
|
Notes:
1. In those cases where we have been able to identify the commentary in
which the most recent outlook change occurred we've put the date of the
commentary below the current outlook.
2. "Neutral", in the above table, means that we either don't have a
firm opinion or that we think risk and reward are roughly in balance with respect to the timeframe in question.
3. Long-term views are determined almost completely by fundamentals,
intermediate-term views by giving an approximately equal weighting to
fundmental and technical factors, and short-term views almost
completely by technicals.
Inflation Watch
Deja-vu
During 2001-2002 we regularly argued that the money supply's rapid
growth would eventually lead to large price increases SOMEWHERE in the
economy -- it was just a matter of figuring out which prices and which
investments were likely to be boosted the most by the monetary
inflation. At the same time, the deflation forecasters would regularly
point out why we were wrong. They claimed that the deflationary tide
would prove to be unstoppable because the Fed's efforts to inflate
would be overwhelmed by falling asset prices and the contraction of
credit.
We are currently reminded of the 2001-2002 deflation scare because,
again, we are arguing that rapid growth in the money supply WILL lead
to large price increases somewhere in the economy while the deflation
forecasters are saying "no; the Fed may well boost the money supply but
this money-supply increase will be overwhelmed by falling asset prices
and the contraction of credit". We admit, though, to being slightly
less confident about the outcome now than we were at the peak of the
2001-2002 deflation scare. The reason is that when we were arguing in
favour of an inflationary outcome in the midst of the 2001-2002
deflation scare the total money supply's growth rate had already moved
into double digits, whereas the Fed's yeoman-like money-pumping over
the past two months has only moved the year-over-year TMS (True Money
Supply) growth rate up to around 6%.
But the fact that there has not yet been dramatic acceleration in the
total money supply's growth rate is not a reason for us to doubt our
inflation hypothesis, because we are, after all, only two months into a
new central-bank-sponsored inflation cycle. What we mean is that prior
to September the Fed was trying to mitigate the financial crisis and
economic downturn in ways that did not involve pumping more money into
the system. It was only during the first half of September, when the
stock market went into crash mode and the inter-bank lending market
froze up, that the Fed began to inflate aggressively. Although we
expect it to happen much sooner, it could be a few months before the
full effects of the Fed's actions begin to appear in the broader
monetary aggregates.
Secondary effects of credit contraction
Credit contraction is not deflation, but it can lead to deflation. To
be more specific, a large-scale contraction of credit could lead to the
situation whereby the amount of new money being borrowed into existence
is less than the amount of old money being eliminated via the repayment
of loans (note: loan repayments eliminate money, loan defaults do not).
In other words, a credit contraction can lead to a contraction in the
supply of money (deflation). Monetary deflation can therefore be a
secondary effect of credit contraction.
It's very difficult, if not impossible, to measure changes in the total
supply of credit, but it is reasonable to assume that the supply of
credit has contracted to some extent over the past several months. The
fact that the supply of money has grown during this period and has
recently begun to grow at an accelerated pace tells us that the
above-mentioned secondary effect of credit contraction has, up until
now, been more than offset by the money-creating activities of
governments and central banks.
How long does it take for monetary inflation to affect prices?
We attempted to answer the above question in prior commentaries over
the past two months. For example, in the 6th October Weekly Update we
wrote:
"A pronounced and
sustained increase in the rate of money-supply growth ALWAYS leads to
substantially higher prices somewhere in the economy, but due to the
time-lags involved it will often be difficult to see the link between
money-supply changes and price changes. For example, the rapid rises in
the prices of many everyday items over the past three years occurred
while the money supply was growing slowly. These price-rises were an
effect of the rapid money-supply growth that occurred during the first
few years of the decade. Also, the quickening in the rate of
money-supply growth that has just begun and looks set to continue over
the coming year will probably be accompanied by a slowing rate of
increase in the general price level, thus setting the scene for a
"deflation scare". The reason is that the prices of everyday items have
yet to react to the slower money-supply growth of 2005-2007."
And, later in the same report:
"It could be 1-2 years
before the new upward trend in money-supply growth begins to have a
meaningful effect on commodities in general and 3-4 years before it
begins to boost the prices of everyday items, but gold's reaction is
likely to occur much sooner due to the anticipatory gold-buying of
large speculators (some large speculators will appreciate the
inevitable/eventual effects of the monetary inflation and take
positions in gold in anticipation of these effects)."
In other words: if we are right to assume that a new inflation cycle
has begun then the gold market, and only the gold market, stands a good
chance of embarking on a major rally in the near future. A surge in the
TMS growth rate could be the spark that ignites such a rally.
Industrial commodities could be close to their ultimate price lows and
are likely to rebound over the next 3-6 months in parallel with a stock
market rebound, but it will probably be at least another year before
they begin to react to the new monetary trend.
Current Monetary Situation
The Fed added another $183B to its balance sheet during the latest
week, taking the cumulative addition to more than $1 trillion over just
the past four weeks. The recent frenetic expansion of reserve bank
credit hasn't yet filtered through to the M2 and TMS aggregates,
although we expect to see a significant boost when the next set of
broad money-supply numbers are released at the end of this week. The
reason is that the broad money-supply data trail about 2 weeks behind
the Fed's balance sheet data, so this week will be the first time that
the effects of the Commercial Paper Funding Facility (CPFF) appear in
the broad money-supply numbers. During its first two weeks of operation
the CPFF purchased $243B of commercial paper from non-financial
corporations.
Another quick comment on the so-called "paradox of thrift"
In order for a baker to increase his spending he must either bake more
bread or dip into his savings. If he has no savings and no capacity to
increase his production of bread then he cannot increase his spending,
unless he borrows the savings of others. But he may not be willing or
able to borrow the savings of others, and in any case most of the
'others' may be in a similar situation. That, in essence, describes the
current ECONOMY-WIDE problem, and this problem can only be solved via
the accumulation of REAL savings. It most definitely cannot be solved
by introducing more money into the economy or by diverting scarce
resources to the government.
Increasing the money supply will, at best, lead to a fall in the value
of money. We say "at best" because a fall in the value of money is the
LEAST damaging effect of monetary inflation. In fact, if the only
effect of monetary inflation were an evenly-dispersed fall in the value
of money (higher prices throughout the economy) then people could
easily take this effect into account when making investment decisions,
and inflation wouldn't be a major problem for the economy. The main
issue is that it is often impossible in real time to distinguish
between price rises driven by sustainable changes in supply/demand
fundamentals and those that are primarily the result of inflation (and
are thus unsustainable). Consequently, increasing the money supply
leads to mal-investment, which, in turn, depletes the pool of real
savings and reduces the economy's long-term growth potential. This is
why the fiscal and monetary policies that have been put in place to
'help' the economy get past the financial crisis are almost guaranteed
to produce a WEAKER economy over the years ahead.
Potential "head and shoulders" bottoms
We present, herewith,
daily charts of the S&P500 Index, the Australian Dollar and the
AMEX Gold BUGS Index (HUI) to make the point that each of these very
different markets is potentially close to completing the "right
shoulder" of a "head and shoulders" bottom formation.
There has been a lot of excitement in the markets over the past 2
months, and for better or worse the excitement looks set to continue
over the next two weeks. The reason is that the markets charted below
are about to either complete their bottom formations and begin
accelerating upward or begin moving quickly back to their October lows.
In the very short-term these markets are likely to move as one, meaning
that they will all either breakout to the upside or drop back to test
their October lows.
Bonds
We remain intermediate-
and long-term bearish on bonds primarily because current yields do not
come close to factoring in the inflation risk. Even if the current
deflation scare were to last another 6-12 months and prompt some
additional demand for government bonds there is a reasonable chance
that this increase in demand would be swamped by the $2 trillion (or
so) of new supply that's likely to hit the market over the coming year.
As far as the short-term risk/reward balance is concerned, we don't
have a strong view. Sentiment indicators are marginally bullish, but
the price action has been slightly bearish. As evidenced by the
following daily chart, the December T-Bond futures have been
oscillating within a downward-sloping channel over the past seven weeks
and are currently near their channel top. A daily close above 118 would
be a breakout that would project a rise to new highs.
The Stock
Market
The big 6-day rally in the US
stock market from its 24th October low to its 4th November high
occurred after it became obvious that Barack Obama would be the next
president, so it is ridiculous to assert that the sharp stock-market
decline on the two days following the election was due to concerns
about an Obama presidency. The main concern is that the downward trend
in corporate earnings is not close to an end. Also, de-leveraging is
still going on.
The market could be headed for a full re-test of the October low, but
in our opinion it is very unlikely that the October low will be
breached. Our view is that the current action is part of a
base-building process that will lead to significantly higher prices
over the coming few months.
This week's
important US economic events
Date |
Description |
Monday Nov 10
| No important events scheduled
| Tuesday Nov 11 | No important events scheduled
| Wednesday Nov 12
| No important events scheduled
| Thursday Nov 13
| Trade Balance
| Friday Nov 14
| Import and Export Prices
Retail Sales
|
Gold and
the Dollar
Gold Stocks
The Big Picture
Below is a weekly log-scaled chart of the Barrons Gold Mining Index
(BGMI) covering the period from 1960 through to the present. The red
line on the chart is the BGMI's 200-week moving average.
Notice that:
1. The BGMI trended higher within a channel from the early-1960s
through to 1968, at which point it commenced a correction that would
ultimately result in a peak-to-trough decline of 61%. This correction
broke the BGMI well below the channel that had defined its progress
prior to 1968 and well below its 200-week MA.
2. The 1968-1969 collapse was followed by a new bull market lasting 4-5 years.
3. After topping in 1974, the BGMI lost 68% of its value during the
ensuing correction. Again, at the end of the correction the BGMI was
well below its 200-week MA.
4. The 1974-1976 collapse was followed by a new bull market lasting 4-5 years.
5. The largest decline in the BGMI's history occurred between late-1980
and mid-1982. This decline resulted in a 72% peak-to-trough decline.
6. The 1980-1982 downturn was followed by the largest 7-month advance
in the BGMI's history (the BGMI almost tripled between July of 1982 and
February of 1983). However, this advance proved to be a counter-trend
rebound within a new long-term bear market.
7. The BGMI trended higher within a channel from the early-2000s
through to 2008, at which point it commenced a correction that has, to
date, resulted in a peak-to-trough decline of 69%. Like the correction
of the late-1960s, the recent correction pushed the BGMI well below the
long-term channel that previously defined its progress and well below
its 200-week MA.
The first point we
are attempting to make is that this year's spectacular decline in the
gold sector is similar to the declines that occurred during the
long-term bull market of the 1960s and 1970s. We didn't expect such a
large correction to happen when it did, but it was always likely that
one or two 60-70% corrections would occur during the current bull
market.
The second point we wanted to make is that even in the highly unlikely
case that the gold sector's bull market has ended, we should still get
a huge rally over the next 6 months.
Current Market Situation
With reference to the chart included earlier in today's report, the HUI
has resistance at 225. A break above this resistance would not only
confirm that a bottom was put in place last month and create a
short-term objective of around 300, it would be a sign that a new 4-5
year bull market was underway.
We would hold off on any new buying until the HUI closes above 225 or
it becomes clear that a close above 225 is going to occur. The reason
is that the action in the gold, currency and stock markets last
Thursday and Friday was not particularly encouraging for gold-sector
bulls. The markets are set up in a way that suggests the potential for
final trend-ending spikes (down for gold stocks, up for the US$) over
the coming 5-7 trading days, so anyone planning to do additional buying
should wait until this potential is either eliminated (via a HUI close
above 225) or realised.
A plunge back to the October low is not the most likely outcome, but
the probability is high enough to make it worth mentioning. If it is
going to happen at all it will most likely happen over the coming week
or so and will not have bearish implications beyond the immediate-term.
Gold
The Commitments of Traders (COT) data remain gold-bullish, but this
doesn't preclude the possibility of a spike to new correction lows over
the coming 1-2 weeks. As noted in the latest Interim Update, a daily
close above $770 by December gold would confirm that a short-term
bottom was in place and project further gains to the mid $800s.
Currency Market Update
International reserves and fiscal deficits
Hugo Salinas Price posted an article at http://news.goldseek.com/GoldSeek/1225998768.php
late last week about the recent decline in global currency reserves and
commented that if central banks continue to reduce their US$ reserves
then the US will have trouble funding its massive fiscal deficit. As
noted in our bond market discussion earlier in today's report, we
suspect that the coming year's deficit will be in the vicinity of $2
trillion.
In our opinion, if the current set of circumstances were to persist for
another year then the US Government would have little difficulty
selling a large quantity of bonds to foreign investors. The reason is
that the decline in official currency reserves reflects a large
INCREASE in non-government demand for the US$. To be more specific,
some central banks have recently decided to sell US$ reserves in order
to prop-up their own currencies, which have tanked relative to the US$.
For example, Russia has reduced its currency reserve by about $70B over
the past three months in an effort to stabilise the rouble.
The current set of circumstances probably won't persist for much
longer, though, because there are clear signs that credit markets are
'loosening up' and that the de-leveraging process is becoming less
frantic. Therefore, the upward pressure on the US$ and the downward
pressure on the more junior currencies associated with global
de-leveraging should soon begin to abate, obviating the need for
central banks to prop-up their currencies via the sale of foreign
exchange reserves.
If we assume that the de-leveraging-related surge in the demand for US
dollars will soon abate then the question of how the US will fund its
massive fiscal deficit is a good one. This is particularly so because
while the US government runs an astronomical deficit over the next 12
months in a misguided effort to stimulate its economy, some of the
largest holders of US$ reserves -- China and Russia, for instance --
will likely be running economic stimulus operations of their own and
partially funding these operations via the sale of US$ reserves. Now,
US$ reserves generally aren't held in the form of cash US dollars; they
are held in the form of debt securities such as Treasury Bonds.
Therefore, it is quite possible that at the same time as the US
Treasury is issuing trillions of dollars of new bonds, governments
around the world will be selling US Treasury bonds. As we said, we
remain intermediate-term bearish on T-Bonds.
It looks, to us, like a large chunk of the new debt issued by the US
government over the coming year will have to be monetised by the Fed
(purchased by the Fed using newly created dollars). If this occurs it
will put considerable downward pressure on the US dollar relative to
gold, but whether it causes the US$ to decline relative to the euro
will be determined by the monetary and fiscal policies of the euro
zone. The euro remains over-valued relative to the US$, so if European
policy-makers inflate just as aggressively as their US counterparts
then the USD/EUR exchange rate could make additional gains.
Current Market Situation
The following chart comparison of the Dollar Index and the S&P500
Index (SPX) suggests that the sharp rise in the US$ since early August
is linked to the concurrent sharp decline in the stock market.
The late-October peak for the Dollar Index coincided with the bottom
for the SPX, but the price action since that time is inconclusive in
that it could be interpreted as a continuation pattern or a topping
pattern. We expect the US$ to work its way back to the low-80s over the
coming 1-2 months, but the prospect of the dollar spiking to a new high
will continue to exist until the SPX has provided definitive evidence
of a bottom by making a solid break above 1000.
One indication that
the level of stress in the financial world is a lot lower now than it
was in late October is the recent sharp pullback in the Yen (refer to
the daily chart of December Yen futures presented below). We suspect
that the August-October rally in the Yen will prove to be the first leg
of a new bull market, but some additional consolidation is likely
before the next upward leg gets underway. Support at 97-98 is a
reasonable target for a correction low.
Note that if the stock market were to drop back to its October low then
the Yen could test its October high before resuming its downward
correction.
Quick note on copper
The following monthly copper chart shows the former long-term resistance at around $1.50 that should now act as support.
The long-term chart
suggests that the copper price is probably close to a low. However,
there is not yet any evidence that a price low is in place.
The copper market has recently moved into contango (the spot price has
fallen below the nearest futures price), which indicates that there is
ample supply relative to short-term demand. A return to backwardation
would be a reliable signal that a price low was in place.
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)
Hecla Mining (NYSE: HL). Shares: 170M. Recent price: US$1.68
On 14th March 2008, with the stock trading at around US$12, RBC Capital
Markets upgraded HL. On 7th November 2008, with the stock trading at
around $2, RBC Capital Markets downgraded HL. Hopefully, last Friday's
downgrade will prove to be just as 'prescient' as the preceding
upgrade.
We added HL to the TSI Stocks List in June as a trade and made the
mistake of not setting a protective stop. We don't think it makes sense
to use stops to manage the risk in long-term valued-based investments,
but stops should almost always be used to manage risk in trading
positions. With the stock price having plunged it is way too late to
sell, so we find ourselves in the bad situation where a short-term
trade has become an unwanted longer-term holding.
In addition to the huge sector-wide correction, HL has come under pressure for a few company specific reasons, most notably:
a) A large equity financing in September
b) The issuing of 7M new shares last week due to the acquisition of Independent Lead Mines (ILM)
c) Challenges associated with debt refinancing in the current difficult environment
On the plus side of the ledger, HL is a low-cost producer and even at
today's relatively low metal prices is generating substantial cash
flow. Also, all of its assets are in politically secure regions.
HL currently has huge upside potential, although the same thing can be
said about most gold and silver stocks. It will, we think, be a good
candidate for new buying once the HUI breaks above 225.
The 'Gassy' Trusts
The five Canadian energy trusts that make up the TSI Energy Trust Index
(TETI) are Advantage (AVN.UN), Daylight (DAY.UN), Peyto (PEY.UN), Penn
West (PWT.UN), and Trilogy (TET.UN). Of these, three have already
announced their third-quarter results and the results were generally
encouraging. In particular, distribution payout ratios (the proportion
of cash flow paid to unit holders) for the most recent quarter were 43%
for DAY.UN, 64% for PEY.UN and 55% for TET.UN. These payout ratios
suggest that there will be no danger of distribution cuts as long as
the natural gas price holds above its recent low. In other words, they
suggest that the current high distribution yields reflect unfounded
fear rather than legitimate risk.
With a current payout ratio of only 43%, DAY, which already yields 20%
at Friday's closing price of C$7.80, appears to have the capacity to
INCREASE its monthly distribution. We aren't expecting a distribution
increase in the near future, though, because DAY's management is using
its spare financial capacity to grow the business.
DAY, PEY and TET are good candidates for new buying near current
prices. We think that DAY and TET have the greatest short-term upside
potential and that PEY remains a good long-term holding due to its high
reserve life index.
We remain intermediate-term bullish on natural gas.
For some time we have been suggesting that people take advantage of the
indiscriminate nature of the gold/silver stock sell-off by switching
from relatively high-risk to relatively low-risk stocks. Up until now
we haven't removed any of the highest-risk stocks from the TSI List,
but we are now going to do so. Specifically, we have decided to realise
large (>90%) losses on two of our most speculative junior resource
stocks -- Apogee Minerals (TSXV: APE) and International Barytex
Resources (TSXV: IBX).
We are very reluctant to exit APE at its current ultra-depressed price
of C$0.065 because the company has been making good progress with its
exploration-stage Paca-Pulacayo project in Bolivia. However, even
though this high-potential project is being valued at almost zero,
there are, at this time, other projects with just as much upside
potential and a lot less risk that are being valued equally lowly by
the stock market. For example, US Silver's (TSXV: USA) stock price and
enterprise value (market capitalisation plus debt minus cash) are just
as low as APE's, but USA.V has more than 2M ounces/year of current
silver production and no political risk. For another example, two
week's ago the stock market became so irrational that it was assigning
New Gold (NGD) a lower enterprise value than APE (as we noted at the
time, when NGD traded below US$1 in late October its 250K ounces/year
of current profitable gold production was being valued by the stock
market at less than zero).
We aren't planning to exit any of our other gold/silver stock
selections in the near future, but we continue to advocate switching
from higher risk to relatively low-risk stocks whenever opportunities
to do so present themselves. Also, we will probably add one more
cashed-up gold/silver junior to the List before year-end.
We are exiting IBX, an exploration-stage copper miner, because the main
reason we persevered with the company prior to now was the value
inherent in its high-grade Shituru copper project, but the difficult
financial environment has forced IBX to sell this project at a very low
price. As a result of the deal, IBX will become a 'shell' with about
C$0.16/share of cash and nothing else.
Chart Sources
Charts appearing in today's commentary
are courtesy of:
http://stockcharts.com/index.html
http://www.futuresource.com/
http://www.mrci.com/
|