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

Inflation: A deliberate policy, not the natural way

The US Federal Reserve ("the Fed") was created in 1913. All the shares of the Fed are owned by private banks (every bank operating within the Federal Reserve system must have equity in the Fed), so it can be said that the Fed is privately owned. However, the shares held by the private banks confer almost none of the normal ownership privileges, and control of the Fed is almost completely within the hands of the US Government. It is therefore more accurate to consider the Fed a government agency -- an agency that operates for the benefit of the government and the banks.

The Fed's main achievement during its existence has been massive inflation of the US dollar supply, the bulk of which occurred after the loosening of the 'gold shackles' in 1934. And one of the most obvious effects of this monetary inflation has been a 95% decline in the dollar's purchasing power (one dollar today buys roughly what 5c bought in 1913). Furthermore, the loss of purchasing power has transpired in such a relentless fashion that almost everyone now perceives rising prices to be the natural way of things. Few people realise that during the 100-year period prior to the Fed's creation -- a period during which the US economy made exceptional progress -- the dollar lost none of its purchasing power.

The reality is that a long-term DOWNWARD trend in prices is the natural way of things in a FREE economy. In the absence of government manipulation of the money supply, prices will naturally fall over the long-term due to increasing productivity. This means that in the absence of government manipulation of the money supply there would be no need for a person to speculate in order to secure his/her financial future. A person could simply save cash, safe in the knowledge that the cash will buy at least as much in the future as it does in the present. In other words, monetary inflation forces everyone to become a speculator, an endeavour at which some will succeed and most will fail.

A few smart people are presently anticipating deflation. We certainly see the appeal of the deflation view given the present economy-wide debt burden, but, unfortunately, such a view flies in the face of both logic and history (the history of the past 75 years and the history of the past 15 months). We say "unfortunately" because a period of deflation is needed to establish the foundation for a sustainable economic expansion, whereas more inflation will only make a terrible situation even worse.

Rather than deflation, chances are that the US government, via its tool known as "the Fed", will continue to borrow and spend enough new money into existence to more than offset the private sector's desperate attempts to repair its collective balance sheet. In the process they will probably end up eradicating much of the remaining 5% of the dollar's purchasing power.

Money Supply Variations

Oil and Gas Updates

The Stock Market

The US stock market is 'overbought' and could experience a sharp pullback at any time, but the bearish divergences that were evident during September-November of last year have mostly evaporated. In particular, we note that the S&P500's recent move to a new 52-week high has been confirmed by new 52-week highs in the Russell 2000 Small Cap Index, the NYSE Advance-Decline Line and the NDX/Dow ratio, as well as by new lows in credit spreads. The NASDAQ's Advance-Decline Line remains below its September-2009 peak, but has been moving upward since mid December. All of which suggests that the post-crash rebound has still not reached its ultimate top.

The Shanghai Stock Exchange Composite Index (SSEC) is presently in an interesting position. As illustrated below, this index has worked itself into a corner such that within the next couple of weeks it will have to either break out to the upside or break out to the downside. The direction of the breakout will likely have significance outside China because the 'China growth story' has been an important part of the worldwide rebound in economic confidence. 

This week's important US economic events

Gold and the Dollar

Gold

Current Market Situation

In the 25th November 2009 Interim Update we wrote:

"Gold/euro [gold in euro terms] is testing its February-2009 peak. It is 'overbought' on a short-term basis -- as evidenced by the large gap between the current level and the 50-day moving average -- but is not yet 'overbought' on an intermediate-term basis. We doubt that gold/euro is close to an intermediate-term peak, but the risk of a short-term correction is high."

The euro-denominated gold price reached a short-term peak a few days later and then dropped back to the vicinity of its 50-day moving average, thus eliminating the 'overbought' condition. The current situation is shown below.

We suspect that gold/euro's short-term correction bottomed at around 760 in late December and that new highs will be seen during the first quarter of this year.

If gold/euro invalidates our short-term outlook by breaking decisively below its late-December low then it will mean that the early-December peak was probably the intermediate-term, rather than just the short-term, variety.

Gold versus the Industrial Metals

Gold tends to weaken relative to industrial metals when economic confidence is on the rise and strengthen relative to industrial metals during periods when confidence is falling.

At the beginning of 2009 we thought that there would be rebounds in economic confidence and the broad stock market during the first half of the year, paving the way for gold to retrace some of the gains it had made during 2007-2008 relative to the industrial metals. This, we believed, would be followed by a second-half resumption of gold's relative strength due to the emerging realisation that a sustainable economic recovery would not begin anytime soon. We seemed to be 'on track' when the gold/GYX ratio (gold relative to a basket of industrial metals) reversed upward in August of 2009, but the following chart shows that the August-November gains made by gold/GYX have since been given back. This tells us that despite the absence of supporting evidence, investors, as a group, still have moderately optimistic expectations about economic growth.

We view the on-going strength in the industrial metals in both dollar and gold terms as the triumph of hope over logic. It is indicative of a general perception that the world is entering a period characterised by robust growth and minimal inflation risk. This, in our opinion, is not only unlikely, it is one of the lowest-probability outcomes we can imagine.

As long as the broad stock market holds together there probably won't be large price declines in most industrial metals, but at their current prices the downside risk certainly appears to be high relative to the upside potential. This is particularly the case for copper, a metal that has now recouped the bulk of its 2008 losses despite burgeoning inventory levels.

We were long-term bullish on the industrial metals complex throughout the past decade, but even with the strong likelihood of a lot more monetary inflation over the next several years the risk/reward no longer justifies such a view.

Gold Stocks

We are operating under the assumptions that a) gold-stock indices such as the HUI and the XAU made intermediate-term peaks on 2nd December of last year, and b) many small-cap gold stocks will make new 52-week highs during the first half of this year (note: six of our junior gold/silver stocks have already made new 52-week highs in 2010).

We can't yet rule out the possibility that the gold-stock indices will rise to new highs within the next few months, but what we can say is that if 2nd December of 2009 did not yield the ultimate high for the intermediate-term advance that began back in October of 2008 then it almost certainly yielded the penultimate high (meaning that the next surge to a new high would create THE top). Putting it another way, we see little chance that a break above the 2nd December highs would usher-in a major extension of the intermediate-term advance.

The following weekly DecisionPoint.com chart of the XAU supports our view. The chart shows that the XAU's weekly Price Momentum Oscillator (PMO) has turned down from a high level in the same way as it did in early 2006 and late 2007. In each of these prior cases, a final 1-2 month surge to a new high followed the PMO's initial downward reversal from its high.

A broad-based stock market decline represents a significant threat to the gold sector, particularly since the next meaningful decline in the overall stock market will likely be accompanied by US$ strength. The stock market PROBABLY won't experience anything more serious than a routine pullback over the next three months, but, given that it is being held up by something as insubstantial as misplaced optimism about the economy, there is a risk that it will begin its next major downward leg earlier than currently expected.

The best way to manage the risk of a market decline is to build up cash, and the best way to build up cash is to take some money off the table in response to price surges in your investments/speculations. For example, we are maintaining plenty of exposure to the junior end of the gold sector in our own accounts while methodically adding to our cash reserve as short-term selling opportunities arise in individual stocks. We are now 45% cash and will probably go to 50% cash if prices continue to escalate over the next two weeks.

Currency Market Update

When we look at charts of the euro and the Swiss Franc we see evidence that intermediate-term peaks were put in place in late-November of last year. These currencies have rallied following their sharp December declines, but the rallies look like counter-trend rebounds rather than new upward trends.

Charts of the senior commodity currencies (the A$ and the C$) look different in that there is no visible evidence, yet, that intermediate-term peaks are in place. The A$, for example, moved lower from mid November through to late December, but has since recouped all of its losses. For its part, the C$ has now recouped most of the losses sustained during the pullback from its October peak. Daily charts of the March A$ and the March C$ are displayed below.

The A$ and the C$ need to drop below 0.86 and 0.92, respectively, to signal intermediate-term peaks.

We suspect that the commodity currencies will remain comparatively firm until after the broad stock market peaks, at which point they will become good short-sale or put-option candidates.

There is an unusually large "commercial" net-short position in the Dollar Index futures market right now. Some analysts have cited this as an important dollar-bearish factor, and, by extension, an important gold-bullish factor, but the "commercials" also have an unusually large net-short position in gold futures. Is it reasonable to argue that the commercials are smart to be short the dollar and, at the same time, dumb to be short gold? Or is it more reasonable to take the Commitments of Traders (COT) data with the proverbial 'grain of salt'? We think the latter. The COT report is just one small piece of a very large puzzle.

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)

Clifton Star Resources (TSXV: CFO). Shares: 25M issued, 38M fully diluted. Recent price: C$4.82

The interview with Paul Zweng at http://www.kereport.com/dailyshow/daily-jan0710-seg1.html contains a good overview of the Clifton Star story. Mr. Zweng discusses the potentially important similarities between CFO's gold deposit and the nearby Malartic deposit owned by Osisko, and towards the end of the interview explains why he has a 1-2 year price target of C$12-C$17 for CFO.

    New Gold (AMEX: NGD, TSX: NGD). Shares: 387M issued, 471M fully diluted. Recent price: US$4.72

We have previously noted the potential for positive market-moving NGD news in the form of a deal relating to the company's 30% stake in the exploration-stage El Morro copper/gold project. What we had in mind was the sale of the El Morro stake or the swapping of it for a gold-producing asset, but the deal that was announced prior to the start of trading last Thursday involves NGD retaining its interest in El Morro on more favourable terms. The more favourable terms include an immediate payment of US$50M from the new owner of the remaining 70% (Goldcorp) and a commitment by Goldcorp to arrange all mine-construction financing at a relatively low cost to NGD.

The market liked this deal enough to propel NGD's stock price 21% higher over the final two days of last week. Our view is that the deal adds significant (at least US$0.30/share) value to NGD, although we would have preferred that it had sold El Morro and used the proceeds to purchase a gold or gold/silver asset (El Morro will be a copper mine with a substantial gold byproduct). This is because we perceive a lot of downside risk in the copper market, and NGD already has sizeable exposure to copper via the New Afton and Peak projects.

The copper exposure probably won't hurt over the next few months, but it could become a problem further down the track.

The following chart shows that last week's surge took NGD to a new 52-week high. This has, we think, created another short-term selling opportunity. If you failed to make a PARTIAL exit when the stock rose to the mid-US$4 area last October then you now have another chance to do so.

There is some resistance at US$5.00, but more important resistance lies at US$6-US$7. At this stage our plan is to make a complete exit from NGD if it rises to around US$6.00 during the first half of this year.

    Sabina Gold and Silver (TSX: SBB). Shares: 108M issued, 124M fully diluted. Recent price: C$1.31

Based on conservative assumptions (relatively low metal prices and a discount rate of 10%), SBB's Hackett River project in northern Canada is estimated to have a net present value of C$523M. To this we will add C$72M for the 2.4M-ounce gold resource at SBB's Back River project on the basis that this resource is worth C$30/oz. This results in a very rough and fairly conservative estimate of C$595M, or C$4.80 per fully-diluted share, for SBB's total value. SBB therefore has a lot of valuation-related upside potential.

The following chart shows that the stock has resistance at C$1.50 and then at C$2.25-C$2.50. We view the $2.25-$2.50 range as a reasonable intermediate-term target.

Chart Sources

Charts appearing in today's commentary are courtesy of: