-- Weekly Market Update for the Week Commencing 12th December 2016

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.

The BULL market in US Treasury Bonds that began in the early 1980s ended in early-2015, but there will be many years of topping action in bond prices and bottoming action in bond yields before major new trends get underway. (Last update: 29 June 2015)

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 2018 and 2020. (Last update: 29 June 2015)

A secular BEAR market in the US 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 2018 and 2020. (Last update: 29 June 2015)

Commodities, as represented by the CRB Index, 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 2018-2020. (Last update: 29 June 2015)

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Outlook Summary

4. Long-term views are determined almost completely by fundamentals and intermediate-term views are determined by a combination of fundamentals, sentiment and technicals.

Last week's posts at the TSI Blog

The problem is a single central bank, not a single currency

An Australian gold producer sells high and buys low

Summary of current thinking/positioning

1) Continuing to expect that the overall corrections/downturns for gold and the associated mining indices will extend into Q1-2017, but anticipating an intervening rebound. Unsure if the rebound will get underway this week or be delayed until early-January.

2) Expecting that 2017 will be a bullish year for commodities. Maintaining long-term exposure to non-gold commodities while acknowledging that the early-2016 lows could be tested in Q1-2017 prior to the start of the aforementioned bullish period.

3) Expecting a decline in the oil price to a January-February bottom and positioned for this outcome via USO put options expiring in February. In addition to being a speculation, these options have been purchased as a hedge against short-term weakness in commodity-related equities.

4) Thinking that government bonds have commenced a long-term bear market, but that the US Treasury Bond is close to a short-term price bottom.

5) Expecting a 6-12 month extension of the equity bull market and looking for opportunities to add to general non-US equity exposure, but maintaining a very small short-term bearish speculation via QID (leveraged NDX bear fund) call options expiring in January-2017.

6) Thinking that the Dollar Index is close to a 1-2 month top, but that it will move to new multi-year highs during the first quarter of 2017 and won't reach a major top before the second quarter of 2017.

7) Maintaining a large cash reserve in recognition of the short-term downside risk in almost all equities (current cash percentage is about 40%).

Remembering the Plaza Accord

The Plaza Accord was an agreement between the governments of France, West Germany, Japan, the United States and the United Kingdom to depreciate the US dollar in relation to the Japanese Yen and German Deutsche Mark. The Accord was signed on 22nd September, 1985, at the Plaza Hotel in New York City and had some major effects. As is typically the case with large-scale financial-market interventions by governments and central banks, some of the biggest effects were both unintended and harmful.

The Plaza Accord was a reaction to the strength of the US$ during the first half of the 1980s, especially during the 2-year period from early-1983 to early-1985. Rapid strengthening of the dollar relative to other major currencies made life more difficult for some US-based manufacturers. (As an aside, it also made life easier for almost everyone else, but most of the economy isn't represented by high-paid lobbyists.) These manufacturers banded together to put pressure on the US government to implement protectionist measures, and coordinated intervention to weaken the dollar was the settled-upon solution.

The US$ weakened considerably on the foreign exchange (FX) market during the 2-year period following the September-1985 signing of the Plaza Accord (PA), so on the surface the international agreement achieved its intended purpose. However, there is no way of determining how much of the dollar's weakness was due to the FX interventions of the PA's signatories and how much was part of a natural corrective process.

What we do know is that the dollar's relative value was in a downward trend prior to the PA coming into effect. Specifically, the following chart shows that when the PA was signed the Dollar Index had been trending downward for 7 months and had already fallen by 18% from its peak.



Considering the dollar's trend prior to the signing of the PA it's a good bet that less than half of the Dollar Index's 1985-1987 decline was due to the FX interventions stemming from the PA. In other words, it's a good bet that the bulk of the dollar's decline was due to corrective market forces stemming from the US currency's over-valuation. However, regardless of their direct effects on currency exchange rates, the actions taken by central banks in response to changes in FX rates during the mid-to-late 1980s had far-reaching consequences.

For example, the dollar's strength put downward pressure on prices in the US economy, which prompted loose monetary policy from the Fed. This enabled rapid money-supply growth (the year-over-year TMS growth rate was continuously above 10% from mid-1985 to mid-1987 and got as high as 17% in early-1987), which, in turn, fueled a rapid expansion of credit and a stock-market bubble that burst in spectacular fashion in October-1987.

Japan provides us with an even better example. The Yen had begun to strengthen prior to the Plaza Accord, but, as illustrated below, when the agreed FX interventions got underway its rate of increase accelerated in dramatic fashion.



The accelerated strengthening of the Yen beginning in September-1985 led to aggressive monetary easing from Japan's central bank in an effort to counteract the effect on domestic prices of the rising currency (as is the case today, central bankers in the 1980s were dumb enough to believe that falling goods-and-services prices are bad). This resulted in booming asset markets in Japan, with both the property market and the stock market soaring to absurd valuation levels (the following chart shows the performance of the Nikkei225 stock index). Furthermore, the booming asset markets attracted foreign investment, which reinforced the Yen's upward trend.



The gigantic boom stemming from the interventions of Japan's policy-makers during the mid-to-late 1980s naturally transmogrified into a gigantic bust during the 1990s.

It could be argued that Japan is still suffering from the effects of the policy errors of the 1980s, including the policy error known as the Plaza Accord. This argument is not valid, however, because if Japan's policy-makers had sworn-off their interventionist ways following the 1985-1989 disaster then the economy would likely have been positioned for a strong and sustainable recovery by 1993. Instead, they learnt nothing and ramped-up their meddling. In the process they proved that if Keynesian 'remedies' are applied with sufficient consistency and vigour in the aftermath of credit bubble, then a genuine recovery can be postponed indefinitely.

Summing up, in one important respect the Plaza Accord was similar to all other grand schemes to manipulate markets and economies. It was the equivalent of a giant spanner being thrown into the economic works.

Commodities

Oil and Gas

Below are daily price charts of oil, a commodity on which we are short-term bearish and intermediate-term neutral, and natural gas (NG), a commodity on which we are short-term neutral* and intermediate-term bullish.

The oil price has moved up to near the top of its 6-month range. There remains a bearish divergence between oil and the C$ that points to a sizable decline in the oil price within the next two months, but if the oil price breaks out to the upside in the near future (a solid daily close above $52.50 would do it) then this short-term bearish potential will be postponed. In this case, there could be a rise to the vicinity of last year's high in the low-$60s before the start of a meaningful decline.

If the oil price does manage to break out to the upside in the near future it will probably be because of a further increase in the speculative enthusiasm for growth-oriented 'plays'.



The NG price took off like a scared rabbit after successfully testing support in the $2.50s a few weeks ago. We suspect that a several-week consolidation will soon begin, but much higher price levels will probably be reached within the next 6 months.

One reason to anticipate a much higher NG price within the coming 6 months is the evidence that, unlike the oil market, the supply situation in the NG market is 'tight'. We are referring to the spread between different contract months in the NG futures market, which shows that the market is in backwardation (prices are higher in the nearer months than in the further-out months).



    *We were short-term bullish on NG when its price was near support in the $2.50s a few weeks ago, but the subsequent near-vertical rise has significantly increased the risk and reduced the potential reward.

Commodity-Related Equities

Non-gold commodity stocks have done very well of late, with even the uranium-mining stocks catching a bid over the past fortnight. Charts showing two examples from the TSI Stocks List (a copper producer and a natural gas producer) are displayed below.

If we are looking at a 6-12 month extension of the general equity bull market, which seems likely, then non-gold commodity stocks should continue to be strong for another 6-12 months. However, on a short-term basis the risk is becoming uncomfortably high due to the impetuousness of some of the recent buying.

Evidence of the impetuous buying is in the performance of Northern Dynasty (NAK), a miner with a massive undeveloped copper project in Alaska. This project will never get developed into a mine and therefore offers no leverage to copper, but it is being promoted and bought as if it offered huge leverage.



Evidence of the impetuous nature of the buying is also in the infrastructure-spending story that is being touted to justify the rising prices. The story that Trump's infrastructure spending plans will result in large increases in the consumption of metals is nonsense. First, due to budgetary constraints it's unlikely that these plans will ever come to fruition. Second, even if the plans do come to fruition they won't make a significant difference to the global consumption of metals such as copper.

Now, it's perfectly fine to profit from uninformed buying (profiting from uninformed buying and uninformed selling is how we make a living), but in such cases it's important to understand that the price gains you are profiting from will ultimately prove to be unsustainable. The best way to manage the risk while not taking too much money off the table too quickly is to gradually scale out of positions when prices are rising along steep trajectories. Positions can then be rebuilt during the ensuing steep corrections if it is appropriate to do so based on longer-term considerations.

We've left our industrial-commodity exposure roughly unchanged in response to the recent price run-ups, with profit-taking in some stocks mostly offset by purchases of other stocks. However, it's likely that we will reduce our exposure if prices continue to rise over the coming few weeks.

We are also open to making new purchases if the right opportunities present themselves. For example, we'd be buyers of Sprott Resource Corp. (SCP.TO) or Adriana Resources (ADI.V) shares if we didn't already have sufficient exposure to this pair of merging natural-resource companies, and we are looking for an opportunity to add to our position in mid-tier copper producer Oz Minerals (OZL.AX).

The T-Bond is stretched to the downside, but will make new lows next year

The following weekly chart shows that the US T-Bond price has just dropped to its 200-week MA (the red line on the chart) and that the T-Bond's weekly RSI (shown at the bottom of the chart) is as low as it has been at any time over the past 15 years.



Our expectation has been, and still is, that the overall downward trend will extend at least as far as the channel bottom near 140, regardless of whether we are dealing with a new bear market or a bull-market correction. However, the magnitude of the short-term decline has exceeded our expectations.

With the decline having gone as far as the 200-week MA without a significant counter-trend move, the historical record now suggests two possible short-term paths. One is that a multi-week and possibly even a multi-month rebound will get underway this week as part of a "sell the rumour buy the news" reaction to the Fed's announcement of a rate hike on Wednesday 14th December. The other is that the price will continue to slide for a few more weeks, perhaps bottoming (on a short-term basis) during the first half of January at around 145.

The Stock Market

The US

The fundamental reason for last week's stock-market strength

There doesn't have to be a fundamental explanation for a single week's rise or fall in the stock market, as most weekly fluctuations result from changes in sentiment. However, one particular 'fundamental' stood out last week and possibly explains why an upward trend that was looking tired suddenly became energetic.

The explanation revolves around the US government's account at the Fed, called the US Treasury General Account. When money goes into this account (due to tax receipts and borrowing), the money is temporarily removed from the economy. The money is then returned to the economy when it is spent by the government.

As discussed in two blog posts (HERE and HERE) over the past few months and in the 17th October Weekly Update, the government has been holding an unusually-large amount of money in its Fed account and therefore causing monetary conditions to be a little tighter than would otherwise be the case. Specifically, from November of 2015 through to November of this year the US government effectively removed almost $400B from the US economy.

During the week ending Wednesday 7th December they 'returned' $66B to the economy. It's possible that this sudden monetary injection had a positive effect on the stock market.

Current Market Situation

With everything that has happened it is remarkable that the NASDAQ100 Index (NDX) has still not broken above its September-October highs. However, it would be 'grasping at straws' to view the NDX's inability to confirm the new 2016 highs achieved by almost all other important US stock indices as anything more than a short-term issue.



Of greater significance is the recent quick rise by the NYSE Composite Index (NYA) to slightly below its 2015 all-time high. Refer to the top section of the following chart for details. There's a chance that this will turn out to be a long-term 'double top' for the NYA, but the probability of such an outcome is low. There's a much higher probability that the NYA's overall upward trend will extend well into next year, although there is likely to be a sizable correction within the next two months and if the correction begins within the next three weeks it could create the false impression that a long-term double top has occurred.

The bottom section of the following chart illustrates the main reason that the NYA's overall upward trend will probably extend well into next year. It shows that the number of individual NYSE common stocks making new 52-week highs reached its highest level since Q2-2010 last Thursday. Even more impressively, a greater number of NASDAQ stocks made new 52-week highs last Thursday than on any other day over the past 20 years.

The implication is that the current rally in the US stock market is extremely broad.



Broad stock-market rallies do not end in long-term tops or even intermediate-term tops. Instead, long-term and intermediate-term tops are generally (we'd say always, but there may be an exception or two somewhere in the historical record) preceded by at least a few months during which the rally becomes narrower, that is, at least a few months during which the senior indices remain in a rising trend while the number of individual stocks making new highs is in a falling trend. Examples that can be seen on the above chart are the months leading up to the 2007, 2011 and 2015 peaks.

Broad stock-market rallies can, however, be interrupted by steep short-term corrections. For example, the only time over the past 10 years when the number of NYSE common stocks making new 52-week highs was greater than it was last Thursday was about a week before the beginning of a steep correction in April-2010.

We expect that a steep short-term correction will begin by early-January. We also expect that if the stock market's overall upward trend continues for another 6-12 months, as seems likely, then non-gold commodity stocks will be leaders to the upside.

Europe

Just a quick note to point out that the EURO STOXX50 Index (STOX5E), the European equivalent of the Dow Industrials Index, completed a major basing pattern -- composed of a double bottom during February and June -- last week by closing above its April high. We expected this to happen, but we were uncertain as to when it would happen.



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

How the fundamental backdrop could turn gold-bullish

A cottage industry has developed around manipulation-focused gold commentary. In this industry, gold's price changes are portrayed as the outcome of a never-ending battle between the forces of good and evil, with the evil side constantly trying to beat the price down and the good side constantly buying or holding. Also, in the world imagined by this industry the fundamental backdrop is always gold-bullish. The implication is that all price rises are in accordance with the fundamentals and all price declines are contrary to the fundamentals and likely the result of manipulation by the forces of evil.

In the real world, however, the fundamentals are always in a state of flux -- sometimes bullish, sometimes bearish, and sometimes mixed/neutral. Furthermore, our experience has been that gold tracks fundamental developments more closely/accurately than any other market.

When the gold price was topping in July-August of this year, the fundamental backdrop wasn't gold-bearish; it was neutral. The 'fundamentals' therefore didn't signal a top, but they did indicate that additional gains in the gold price would not have been fundamentally-supported and would therefore have required a further ramp-up in speculative buying.

From early-July through to early-November the 'true fundamentals' shifted between being neutral to being slightly-bearish for gold and then back again (we thought they were slightly bearish from mid-September through to mid-October and otherwise neutral). They turned bearish, however, a couple of days after the US Presidential Election and since around mid-November have been their most bearish in at least three years.

The fundamental backdrop is now definitively gold-bearish because we have a) real interest rates in an upward trend and at a 6-month high in the US, b) US credit spreads immersed in a major contraction (indicating rising economic confidence), c) dramatic relative strength in bank stocks (indicating sharply-rising confidence in the banking/financial system), and d) the Dollar Index in a strong upward trend and near a multi-year high. Given these conditions, any analyst/commentator who is now claiming that the 'fundamentals' are bullish for gold is either clueless about gold's true fundamentals or is trying to promote an agenda.

That's the situation today, but the situation will change. In broad-brushed terms, here are the two most likely ways that the situation could change to become supportive of an intermediate-term gold rally:

1) Rising inflation expectations

US inflation expectations have been rising since 11th February and have been rising at a quickened pace since late-September, but since Trump's election victory the rate of increase in nominal interest rates has exceeded the rate of increase in inflation expectations. This has brought about a rise in REAL interest rates.

In effect, over the past month economic growth expectations have risen faster than inflation expectations. This doesn't make a lot of sense considering the plans of the Trump Administration, but when speculating in the financial markets we must deal with 'what is' rather than 'what should be'.

It's certainly possible that at some point over the next few months the markets will figure out that the combined plans of the US government and the Fed will lead to more "price inflation" than economic growth, resulting in a relatively fast increase in inflation expectations. As well as causing real interest rates to fall, this would result in a weaker US$ and a further steepening of the yield curve. All told, it would result in the fundamental backdrop becoming gold-bullish.

2) A banking crisis in Europe

The major banks around the world are intimately and intricately connected via their massive derivative books, so a banking crisis that began in Europe would not remain confined to Europe. It would lead to concerns about the profitability of US banks, which, in turn, would lead to relative weakness in bank stocks and a general shift towards safety. Interest rates on Treasury debt would fall faster than inflation expectations, resulting in a lower real interest rate in the US. Also, short-term interest rates would fall relative to long-term interest rates due to a flight to liquidity and the market beginning to anticipate a shift in the Fed's stance, resulting in a steepening of the yield curve. The overall effect would be a fundamental backdrop that was gold-bullish.

Either of the above could happen within the next few months, but neither is happening now.

Current Market Situation

The Commitments of Traders (COT) situation is becoming more supportive as continuing price weakness causes speculators to 'throw in the towel'.

The total speculative net-long position in gold futures was 155K contracts last Tuesday (the date of the latest available information), which is roughly the level we thought it would reach prior to a correction low. The problem, as discussed last week, is that we might not be dealing with a bull market correction. In fact, fundamental factors indicate that a new cyclical bull market for gold has not yet begun.

If a new gold bull market has not yet begun then the speculative net-long position in Comex gold futures has not yet reached price-bottoming territory, although the sentiment backdrop is conducive to a short-term rebound.

Even though the overall correction/downturn was always likely to extend into 2017, we thought that there would be a significant intervening rebound from a November low. The rebound obviously hasn't eventuated. Instead, the US$ gold price has slowly-but-surely weakened and made a marginal new low for the move on Friday 9th December.

As is the case with the T-Bond, there is a realistic chance of a meaningful gold-price rebound beginning within two days of the Fed's rate-hike announcement on Wednesday 14th December. This is what happened last year. Bear in mind, though, that at this time last year the fundamental backdrop was neutral for gold and the total speculative net-long position in Comex gold futures was close to zero. In other words, there was a much better setup for a gold rally in mid-December of last year than there is today.

On the plus side of the ledger we have the on-going divergence between the bullion market and the gold-mining indices. As illustrated below, the HUI/gold ratio has risen since mid-November while the gold price has made progressively lower lows. In fact, the gold-mining indices have essentially ignored the entire decline in the gold price from the $1210s to the $1150s.



So, what do we think is going to happen over the weeks ahead?

We expect that there will be at least a 3-6 week rebound prior to the decline that takes the gold price to its ultimate low. We won't be surprised if the rebound begins this week, but with the downward trend having extended to mid-December we also won't be surprised if its start is postponed to the first half of January. Much will depend on the Treasury market, as the start of a gold-price rebound will probably be linked to the start of a T-Bond rebound.

Gold Stocks

The resilience of the gold mining indices in the face of a $50+ decline in the gold price over the past few weeks probably stems from the strength in non-gold mining stocks. Just as a steep decline in non-gold mining stocks dragged the HUI to new multi-year lows in January-2016 despite the gold price having bottomed in December-2015, a strong rally in non-gold mining stocks is now holding the HUI above its mid-November low despite the on-going slide in the gold price.

It's important to note that although the HUI has held up remarkably well of late, it still hasn't signaled a short-term bottom. This means that a plunge to new lows could still be in store prior to a short-term bottom.

If the HUI were to break below its recent lows in the 170s then the likely target would be the channel bottom near 160, whereas a short-term bottom would be signaled by a daily close above 200 (falling to 195 by the end of this week).



The Currency Market

The Euro

ECB went out of its way to generate currency-market volatility last Thursday.

The euro initially rallied on Thursday when the 'ship of fools' known as the ECB advised that it was going to reduce the rate of its monthly bond purchases from 80B euros to 60B euros beginning in April, but then tanked when Mario Draghi, the chief fool, held a press conference and emphasised the ECB's unswerving commitment to counter-productive monetary 'accommodation'.

The net effect was that two weeks of gains were quickly retraced over the final two days of last week, with the euro ending the week near the major 105 support level.



The euro's plunge over the final two days of last week could turn out to be another successful test of the 105 support level, but we wouldn't bet on it. There remains the near-term potential for a rebound to as high as 109.5 (reduced from 110 due to last week's price action), but there is now a higher risk than a week ago of a near-term break below 105 followed by a quick multi-point drop.

The Yen

Based on what happened in the past following strong rallies from multi-year lows, our expectation was that the Yen would make an intermediate-term bottom near its 70-week MA (the blue line on the chart displayed below) in the 89-90 range and then embark on an advance that would take it above its 2016 peak. A brief spike below the 89-90 range would have been within the bounds of normal, but what we now have is a solid break below the expected bottoming area. This is a significant deviation from the historical pattern.



The Yen is now very 'oversold' and should rebound with the T-Bond and gold, with the rebound beginning either this week or, failing that, in early-January. However, the currency's intermediate-term prospects are now uncertain.

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 9th December 2016:

[Note: AISC = All-In Sustaining Cost, FS = Feasibility Study, FY = Financial Year, IRR = Internal Rate of Return, ISR = In-Situ Recovery, 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]

  *Blackham Resources (BLK.AX) reported that it had generated a trading profit of A$6.3M by closing out some of the gold hedges put in place a few months ago when the gold price was much higher. This news was discussed in a post at the TSI Blog.

  *Petrus Resources (PRQ.TO) continues to be the recipient of significant insider buying, even though the stock price has risen sharply over the past few weeks. Last week the company's chairman was a buyer at C$2.89.

We have C$6 in mind as a 12-month target for PRQ. This target assumes that the stock price will work its way up to near the company's book value.

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) BLK.AX in the low-A$0.50s (last Friday's closing price: A$0.56)

2) EVN.AX (last Friday's closing price: A$1.87)

3) PG.TO (last Friday's closing price: C$2.19)

4) PRQ.TO if there's a pullback to the C$2.60s (last Friday's closing price: C$2.98)

5) SCP.TO (last Friday's closing price: C$0.53)

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

Chart Sources

Charts appearing in today's commentary are courtesy of:

http://stockcharts.com/index.html