-- Weekly Market Update for the Week Commencing 11th November 2019

Copyright Reminder

The commentaries that appear at TSI may not be distributed, in full or in part, without our written permission. In particular, please note that the posting of extracts from TSI commentaries at other web sites or providing links to TSI commentaries at other web sites (for example, at discussion boards) without our written permission is prohibited.

We reserve the right to immediately terminate the subscription of any TSI subscriber who distributes the TSI commentaries without our written permission.

True Fundamentals Summary [Notes: 1) The date shown next to the current True Fundamentals Model (TFM) signal is when the most recent change occurred. 2) Charts of the Gold and Equity TFMs are included in the "Charts and Indicators" section of the TSI web site]

Last week's posts at the TSI Blog

Banks versus Gold, Part 2

Summary of current thinking/positioning

1) The Dollar Index (DX) remains range-bound, needing a weekly close below 96 to signal an intermediate-term reversal to the downside or a weekly close above 99.5 to signal an intermediate-term rally. We are anticipating the former, but we are uncertain as to whether it will happen in the near future or during the first half of next year.

2) Gold, silver and the associated mining indices/ETFs resumed their corrections last week. Correction lows could occur soon, but this is not a short-term buying opportunity due to the risk of downward acceleration.

3) The Fed's new asset monetisation program has increased the risk for bearish stock-market speculators and clear signs of equity strength have appeared outside the US. However, we suspect that the senior US stock indices are close to short-term tops.

4) The T-Bond has dropped below its September low and could be near a short-term bottom, but there is risk of downward acceleration over the coming month or two. Whether or not a short-term bottom is close at hand, there's a good chance that major price weakness will be seen within the next 12 months. In other words, it looks like higher interest rates are on the way.

5) Industrial commodities such as oil and copper appear to be in the process of bottoming, with intermediate-term price lows either already in place or likely to be in place by early next year.

6) We are holding a cash reserve of 25%-30%.

Close to a short-term bottom for the T-Bond?

About a month ago we noted on a chart that the $130-$135 range was a realistic target for a short-term bottom in the iShares 20+ Year Treasury ETF (TLT). The following daily chart shows that TLT made it to the top of the aforementioned target range late last week.



TLT, and therefore the T-Bond, could be close to a short-term bottom in terms of both price and time, but the risk/reward does not favour a long-side trade. The reason is that last week's break below the September low creates the risk of downward acceleration over the next few weeks.

Cannabis Crash Update

In the 14th October Weekly Update we wrote about the crash in cannabis-related stocks and ETFs. Due to the extreme selling pressure witnessed over the preceding several weeks, we concluded that the cannabis sector was probably within a few weeks of an intermediate-term bottom and that it would be reasonable to take an initial position in HMLSF, MJ or CRON with the aim of averaging in on further weakness or following evidence of a reversal. To reflect this assessment we added the CRON January-2021 US$10.00 call option to the TSI List at US$1.50.

The sector subsequently bounced and then dropped to test the October low before reversing upward on Friday 8th November. As illustrated by the following daily charts, HMLSF made a slightly lower low whereas CRON made a slightly higher low last Thursday before rallying on Friday.

We continue to like the cannabis sector for an intermediate-term trade.

Oil's next turning point

There's a strong tendency for the oil price to make a multi-month high or low during the December-February period, with the type of extreme (high or low) determined by the price trend going into the period.

The current chart pattern (see below) is noncommittal with regard to the coming December-February turning-point window. One possibility is that the oil price reverses downward without making significant additional headway and spikes below support in the low-$50s within the next couple of months, in the process setting an important low. Another possibility is that the oil price soon breaks above resistance at $57-$58 and surges to the mid-$60s or higher during December-January, in the process setting a high that holds for at least a few months.

At this time we favour the first possibility because it meshes with our current stock market outlook, but the second possibility will become more likely if it turns out that we have underestimated the bullish contingent's ability to extend the stock market's short-term upward trend.



The Stock Market

Extraordinary Trade Deal Mileage

We are impressed, nay stunned, at the amount of mileage that US equity bulls have managed to get from the US-China trade negotiations. If a trade deal had been struck between the US and China governments 15-16 months ago, that is, shortly after the 'war' began, the US economy would now be stronger but the stock market probably would be lower. Instead, the tariffs and counter-tariffs, the threats, the disruptions, the on-again/off-again negotiations, the uncertainty and the relentless headlines have stymied economic progress while creating a sentiment and monetary backdrop that perpetuated upward trends in the senior stock indices.

The pattern over the past 16 months has involved the following:

1) Negative news on the trade front.

2) A stock market sell-off due to concerns about the effects of tariffs on the economy.

3) A turn for the better in trade-related news.

4) A stock market rally driven by optimism regarding what will happen to the economy after the trade dispute is put to bed.

This pattern has repeated several times and has, we suspect, given the S&P500 Index a substantial net boost even though the deal that possibly will be done within the next month will leave the US economy in a much weaker state than it was prior to the start of the trade war.

The above describes the sentiment-related stock-market fuel provided by the trade war, but on its own this would have been insufficient to sustain the bullish trend. There also had to be monetary assistance from the Fed.

Partly due to the economic weakness caused by the trade war, the Fed shifted in record time from tightening to neutral to easing to aggressive easing. The 'coup de grace' was the Fed's reintroduction of QE (but don't you dare call it QE!) in early October, just 12 months after the Fed Chairman intimated that the Fed's monetary tightening had a long way to go.

In essence, the topsy-turvy US-China trade situation created periodic sharp equity sell-offs that established sentiment platforms capable of supporting subsequent multi-month rallies, and also helped to transform the Fed from market head-wind to market tail-wind. The net effect is an S&P500 Index that is probably higher than it would be if the 'trade war' had never happened.

A Bank Speculation

The following chart shows the recent upside breakout in the US Bank Index (BKX) and the surge in the BKX/SPX ratio. The banking sector is now short-term overbought in both absolute and relative terms, but if long-term interest rates and the spread between long-term and short-term interest rates have commenced cyclical upswings, which we suspect is the case, then the banking sector's recent strength is the start of a trend that should last at least 12 months.



The US banking industry doesn't operate in isolation. Instead, banks around the world are interconnected. A consequence is that general strength in US bank stocks should go with general strength in European bank stocks.

We are interested in speculating on an intermediate-term global rebound in the banking sector via call options on one of the world's worst-performing major banks: Deutsche Bank (NYSE: DB). Specifically, we have added the DB January-2021 US$10.00 Call Option to the TSI List. The option ended last Friday's trading session with a bid-ask spread of US$0.50-US$0.59, so we have used US$0.55 (roughly the mid-point of the bid-ask spread) as the starting price for record purposes.

DB's problems are well known, which is why the stock has made only minor gains since hitting an all-time low in August. However, the price action since June of this year has the look of a basing pattern.

Note that a daily close above US$8.00 would warn that the base was nearing completion and that a meaningful rally was about to begin, whereas a daily close below US$7.20 would warn that the stock was on its way to new lows.



Usually when we suggest buying call options on a stock or an ETF the trade also could be done by purchasing the underlying stock/ETF. For example, our cannabis trade is reflected in the TSI List by a long-dated call option on CRON, but for most of our readers it would make more sense to buy CRON shares than to buy CRON call options. That's not the case with the DB speculation, though. The reason is the uncomfortably high risk of out-of-the-blue news that craters the stock.

Our thinking is that over the next 12 months DB shares will either more than double in response to a sector-wide rally or collapse to near zero due to bankruptcy. This suggests that the stock itself does not have an attractive risk/reward (100% potential reward versus 100% downside risk), but that the call options mentioned above have reward potential of at least 1,000% versus downside risk of 100%.

Current Market Situation

S&P500 earnings fell during each of the first three quarters of this year and another decline is likely during the final quarter. Furthermore, total US corporate profit peaked way back in 2014. 100% of the US stock market's gain since then is due to multiple expansion and share buybacks.

Shares are bought today based on what the underlying company is expected to earn in the future, not what the company earned in the past. Consequently, by enlisting the appropriate optimistic forecasts of future earnings it is always possible to justify current valuations. That these forecasts never pan out is a minor issue.

Turning to the charts, we find a market that by some measures has broken out to the upside and by other measures has reached critical resistance. The weekly SPX chart displayed below is an example of the former.



The following two daily charts are examples of the latter. They show that the Dow Transportation Average (TRAN) and the Russell2000 ETF (IWM) tested, but failed to close above, intermediate-term lateral resistance last week.

We also find a market that can now be described as 'overbullish', meaning that indicators of sentiment are stretched far enough into optimistic territory to warn of short-term downside risk. Of particular relevance, the bottom section of the following chart shows that the 10-day MA of the equity put/call ratio has just hit a 12-month low and is where it was when the SPX was peaking in September-October of last year.



We think that a multi-week correction will begin soon, with the scale of the downturn being determined by what happens with the international trade negotiations. A trade deal that removes existing tariffs could ensure that the decline is limited to 3%-5%, while an obvious failure to reach agreement probably would be the catalyst for an the SPX decline of around 10%.

This week's significant US economic events [Notes: 1) The most important events (to the markets) are shown in bold. 2) A list of global economic events can be found HERE]

Gold and the Dollar

Gold

Clearly, the strength in the gold market during the week before last was misleading. Last week the 'risk on' trade accelerated and the most popular safe havens were dumped. The result was that late last week the US$ gold price made a marginal new correction low.



Due to the widespread embracing of risk, last week our Gold True Fundamentals Model (GTFM) turned bearish. This is indicated on the following chart by the plunge in the blue line.



The fundamental backdrop should begin to shift back in gold's favour and the gold price probably will begin to rebound after the SPX enters correction mode, which could happen as soon as this week. However, unless the trade negotiations collapse there probably won't be a sufficient improvement in the fundamentals to counteract a sentiment situation that now constitutes a major obstacle.

The sentiment 'problem' relates to speculative positioning in the gold futures market.

The first part of the problem is that the futures open interest (OI), which tends to peak near important price highs and trough near important price lows, made a new all-time high last week. This is illustrated by the green bars in the bottom section of the following chart.

The second part of the problem involves the total speculative net-long position, which is the inverse of the Commercial net-short position (indicated by the blue bars in the middle section of the following chart). The recent surge in OI didn't cause the total speculative net-long position to exceed its September-2019 all-time high, but it is not far from an all-time high despite the fact that gold has been in correction mode for more than two months.

The third part of the problem is that the net-long position of small (Non-Reportable) traders hit a 6-year high last week. This tells us that the proverbial 'dumb money' is very optimistic about gold's prospects.



The gold price could have sustained its upward trend in the face of problematic sentiment if the fundamentals had remained supportive, but that didn't happen and so the sentiment-related risk has moved to centre-stage. Unfortunately, it probably will take either a lot more price weakness or a lot more time to eliminate this risk.

Our intermediate-term outlook hasn't changed, in that we expect gold to perform well over the coming year (albeit not as well as industrial metals such as copper). However, a short-term decline in the gold price to test major support in the mid-$1300s looks far more likely now than it did a week ago.

Silver

The US$ silver price tested its September low last Thursday and on Friday made a new 2-month low. It appears to be on its way to major support at around $16.20, which is the lower of the two downside targets that we first mentioned at the very beginning of the September-November correction.

At the same time the market is now 'oversold' on a short-term basis, so a rebound should begin soon. A counter-trend rebound could go as high as $17.50.

Silver could be bought for an intermediate-term trade in the $16.00-$16.50 range, but be aware that it will take time to establish a new base.



Gold Stocks

Current Market Situation

As mentioned above in the Gold discussion, the price strength that emerged during the week before last turned out to be a misleading signal. Clearly, the corrections in gold, silver and the gold-mining sector did not end in October.

Although the corrections resumed last week, unlike gold bullion the gold-mining indices/ETFs have not made new correction lows. Instead and as illustrated by the daily charts displayed below, late last week GDX tested its October low and the HUI stayed comfortably above its October low.

Furthermore, the HUI/gold ratio held up fairly well last week. It dropped below its 40-day MA on Friday, but only by the smallest of margins.



Our 1980s model projects an October-November correction low followed by a rapid advance to new multi-year highs. A bottom this week would be consistent with this model, but note that if the HUI makes new correction lows after mid-November then we would view it as a critical deviation.

The gold-mining charts look fine on their own, in that the price action of the past 2.5 months still has the look of a routine short-term correction. However, gold-market sentiment and fundamentals suggest the possibility that something more serious than a routine short-term correction is underway.

What to do?

Short-term traders who bought the HUI and GDX pullbacks to 20-day MAs on Tuesday 5th November should have been stopped out on 7th November with small losses and should now be on the sidelines. New long positions will not be advisable until there is evidence that a short-term bottom is in place.

It would be reasonable for intermediate-term and long-term traders to do some buying if/when the gold-mining ETFs drop to near their 200-day MAs, but caution will be warranted until there are significant improvements in gold-market sentiment and/or fundamentals.

The Currency Market

Like it did in mid-October, last week the Dollar Index (DX) rebounded from slightly below its 200-day MA. The current rebound is stronger, but this really just prolongs the agony.

DX sentiment, fundamentals and price action are all neutral. In other words, there's very little to go on.



Last week the CurrencyShares Japanese Yen Trust (FXY) pulled back to the bottom of the wedge pattern drawn on the following daily chart. FXY is a reasonable speculation on a short-term shift away from risk associated with a stock market correction, provided that a tight stop is used.

Bear in mind that the Yen probably will remain under pressure if the stock market extends its short-term upward trend into year-end, that is, if the 'risk on' theme dominates for several more weeks.



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 ending Friday 8th November 2019:

[Note: AISC = All-In Sustaining Cost, EBITDA = Earnings Before Interest, Tax, Depreciation and Amortisation (a measure of cash flow), EV = Enterprise Value or Electric Vehicle, FS = Feasibility Study, FY = Financial Year, IRR = Internal Rate of Return, ISR = In-Situ Recovery, JV = Joint Venture, 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%, NSR = Net Smelter Return or Net Smelter Royalty, P&P = Proven and Probable, PEA = Preliminary Economic Assessment, PFS = Pre-Feasibility Study]

  *Alkane Resources (ALK.AX) reported the third set of results from a 60,000m resource definition drilling program undertaken at the San Antonio and Roswell targets. The latest results included 13 metres grading 9.74g/t Au at San Antonio and 15 metres grading 6.22g/t Au at Roswell.

The next significant news is expected to be an initial resource estimate for the Roswell prospect early next month.

The combination of San Antonio and Roswell could enable a multi-year extension to the TGO's life. If so, substantial value will be added to the company.

  *Peyto Exploration and Development (PEY.TO) published its results for the quarter ending 30th September 2019.

PEY, a mid-tier Canadian natural gas (NG) producer, has just achieved its 59th consecutive quarter of profitability, despite the NG price in Canada reaching historically-low levels during the quarter.

Regarding the past quarter's extremely low NG price and the improving price outlook, this is what PEY had to say:

"Natural gas prices in Alberta plunged in the quarter to some of the lowest prices in the past 30 years as restricted access to storage prevented supplies from finding a market. Despite the Company's market diversification efforts this still resulted in some of the lowest realized natural gas prices in Peyto's 20 year history. Late in the quarter, however, and with the help of the Alberta government, an industry agreement to revise NGTL [Nova Gas Transmission Ltd.] service priorities during future summer periods was successfully negotiated. This had an immediate impact on AECO natural gas prices and should help prevent the recurrence of such a disconnected Alberta gas market over the next few years while NGTL continues to build out its capacity to handle basin growth."

Here's a chart showing the low average Canadian NG price during the third quarter and the rapid rebound over the past 1-2 months from near zero to about C$3/GJ.



Despite the NG price weakness, during the September quarter PEY achieved a 64% Operating Margin, a 6% Profit Margin, and generated C$68 million (C$0.41/share) in Funds from Operations (FFO).

PEY's management anticipated the NG price weakness of 2019 and now anticipates a sustained recovery. According to the company's press release, the Canadian natural gas market has changed throughout 2019 from one of over-supply and lack of take-away capacity to one of under-supply and increasing take-away capacity. Based on industry projections for reduced drilling activity, this trend is expected to continue in 2020.

In its history, PEY has never incurred a write down nor recorded an impairment of its assets. Therefore, it's reasonable to assume that its assets are valued realistically and that the stated book value shown on the balance sheet included with its September-quarter results is an accurate reflection of what the company is worth at this time. The stated book value is about C$10.40/share, which is more than three times the current stock price.

PEY is a strong intermediate-term buy in the low-C$3 area for anyone looking for capital appreciation potential and/or dividend yield in a natural resource stock.

List of candidates for new buying

From within the ranks of TSI stock selections the best candidates for new buying at this time, listed in alphabetical order, are:

1) CRON (last Friday's closing price: US$8.52)

2) PEY.TO (last Friday's closing price: C$3.08)

3) SBB.TO (last Friday's closing price: C$1.56)

4) TGB (last Friday's closing price: US$0.45)

The above list is limited to five stocks. It sometimes will contain less than five, but it never will contain more than five regardless of how many stocks are attractively priced for new buying.

Canadian natural gas speculation

As mentioned above in the discussion of Peyto's latest quarterly results, there are tentative signs that a sustainable recovery is underway in the Canadian natural gas (NG) market. Owning PEY shares is a good way to profit from this recovery, because the stock has large upside potential but the company will remain viable if the recent NG price rebound proves to be a false start.

Another way to profit would be to own the shares of Petrus Resources (PRQ.TO), a former member of the TSI Stocks List. In terms of current production, PRQ is about one-tenth the size of PEY. Also, PRQ has a higher production-cost structure and a weaker balance sheet than PEY. These attributes make it a lot riskier, but they also mean that the stock price could achieve a much greater percentage gain IF the recent NG price rebound proves to be the start of an upward trend.

Further to the above, we have added a PRQ trading position to the TSI List at Friday's closing price of C$0.17. This is a trade with an expected duration of 6-12 months.

Note that due to the effects of tax-loss selling and weakness in the oil price the stock could remain under pressure until early next year, but we like the current risk/reward.



Chart Sources

Charts appearing in today's commentary are courtesy of:

https://stockcharts.com/
http://www.goldchartsrus.com/