-- Weekly Market Update for the Week Commencing 14th March 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

Bad logic on trade

Brazil Boom and Bust

This week's FOMC meeting

In the FOMC statement scheduled for this Wednesday the Fed will likely say that it is taking no immediate action and that it remains data dependent. Furthermore, the statement will likely be worded in such a way as to leave open the possibility of a second rate hike as soon as June.

It is not reasonable to expect the Fed to do/say anything other than what we've outlined above, but many traders could still have different expectations. How the markets react to the Fed's announcement will be determined by what most traders are expecting.

Note that what the Fed says it plans to do over the months ahead and what the Fed actually ends up doing are unrelated. What the Fed does over the next few months will mostly be determined by the performance of the stock market.

More leeches!

The euro-zone wrecking-ball known as Mario Draghi did what he seems to enjoy doing last Thursday and created a brief period of chaos in the financial markets. In terms of additional 'unconventional'* monetary measures, the ECB did everything that most currency traders were expecting and then some. The result was a huge intra-day swing in the euro.

The additional/ramped-up measures comprise a further push into negative-interest-rate territory (the rate on deposits at the ECB has been reduced from minus 0.30% to minus 0.40%), an expansion of the asset monetisation (QE) program from 60B to 80B euros/month, the inclusion of corporate bonds in the assets to be monetised, and the re-introduction of long-term (4-year) repurchase operations (LTROs) beginning in June. The rate on the new LTROs can be as low as the deposit rate (minus 0.40%), which means that the ECB will simultaneously be charging banks to lend money to the ECB (via deposits, which are loans) and paying banks to borrow money from the ECB (via LTROs).

Why is the ECB charging banks to deposit money on the one hand and paying banks to borrow money on the other? That is, why is the ECB transferring money from one pocket to the other?

The explanation is convoluted. One reason is that the negative interest rate on deposits imposes a cost on the euro-zone banking system that, as we discussed in a recent commentary in relation to US bank reserves, cannot be avoided. An individual bank could avoid or minimise the cost by transferring deposits to another bank, but the cost cannot be avoided or reduced on an industry-wide basis. By paying banks to borrow money at the same time as it is charging banks to deposit money, the ECB is allowing banks to offset the cost of NIRP (negative interest rate policy).

But why have the NIRP in the first place? What good can possibly come of it?

The answer is that no good can possibly come of it. It is damaging to both the economy and the financial system. However, this is an example of one ill-conceived intervention by central planners creating a problem that necessitates another ill-conceived intervention.

In this case, aggressive central-bank support of government bonds led to many of these bonds having negative yields, which would have prevented the bonds from being purchased as part of QE operations. This is due to a guideline that only bonds that yield at least as much as the deposit rate can be monetised by the ECB. In other words, earlier ECB actions led to a situation (negative yields on bonds) that would have greatly limited the ECB's future actions unless the official deposit rate was set below zero.

As we said, the explanation is convoluted.

The initial reaction of currency speculators to the ECB's new tactics was to aggressively sell the euro, causing it to plunge 1.6% (an unusually-large intra-day move by the world's second most important currency). But that was nothing. The next reaction of currency speculators was to aggressively buy the euro, causing it to surge by 3.6% from its low. All of this happened within the space of four hours in the aftermath of the ECB announcement.

Why the sudden turnaround in the euro's exchange rate?

It's likely that speculators first sold the euro on the belief that the accelerated pace of money-pumping would result in more "inflation" and that the monetary stupidity was destined to continue unabated, but then bought on the belief -- based on comments made by Draghi at a press conference -- that the ECB had effectively gone 'all in' for the time being and would now be on hold for an extended period.

It seems to us that the 'market' misinterpreted Draghi's press-conference remarks to mean that the ECB would take no further actions to promote "inflation", whereas all he actually said was that a further reduction in interest rates was probably not on the cards. He did not imply that other pro-inflation measures would not be taken.

In last week's Interim Update we said that the ECB's senior policy-makers, in looking at the world through a Keynesian lens, were like astronomers trying to understand the paths of the planets based on the theory that the Earth is the centre of the universe. Another appropriate analogy is the medical profession's ancient theory that all manner of illness could be alleviated by applying leeches to the patient's body. In this case the body is the euro-zone economy and the leeches are interest-rate suppression and "quantitative easing".

The ECB has been applying the monetary equivalent of leeches in an effort to cure an illness it does not understand. When the economy fails to respond positively to the application of leeches, the solution is always: "More leeches!"

Unless Draghi and his crew of monetary quacks are stopped, eventually there will be no blood left to suck.

    *We placed inverted commas around the word unconventional because in the realm of monetary policy what used to be called unconventional has transmogrified into the norm.

The Stock Market

The US

The S&P500 Index (SPX) reached its 200-day MA on Friday 11th March. For the past few weeks we've viewed the vicinity of the SPX's 200-day MA as the most likely place for the rally from the January-February double bottom to end, so the fact that it has moved this high is certainly not unexpected. The challenge is in figuring out the most probable path from here on.

We'd like to be able to unequivocally state that the stage is now set for the next bear-market downward leg to begin, but we can't. We can't because although the market is now 'overbought' on a short-term basis, there isn't yet any evidence that something more than a routine consolidation lies in the near future. In particular, market internals and sentiment indicators are currently not flashing warning signs.



To give you an idea of where we think the market is now positioned, here is a chart of the NYSE Composite Index (NYA) covering the past 17 years. The red line on the chart is the 200-day MA and the green arrows mark the tops of the bear-market rebounds to near the 200-day MA in 2001 and 2008.

The chart shows that, based on the historical record, it was reasonable to expect a rebound to near (slightly above) the 200-day MA from the January-February 'oversold' extreme. Also, the chart suggests that if a bear market is in progress then prices should soon begin rolling over to the downside without making much additional headway.



Considering the current lack of bearish warning signs in measures of market breadth and sentiment and the fact that the NYA hasn't quite reached its 200-day MA, it's unlikely that a strong downward trend will begin immediately. Instead, the most likely near-term outcome is a form of topping pattern involving a pullback followed by a marginal new rebound high, with acceleration to the downside not happening until April or May.

We stress, however, that the short-term risk/reward is now decisively skewed towards risk and that it is reasonable to view the current strength as an opportunity to scale into bearish speculations. For one thing, although the stock indices are probably going to make new rebound highs within the next few weeks, they probably aren't going to move a lot higher. For another thing, although the odds favour a topping process over the next few weeks, there is definitely a risk that the next downward leg begins as soon as this week.

The World

The Dow Jones Global Index (DJW) has almost reached the top of a well-defined intermediate-term price channel. This means that it isn't just the US stock market that is probably close to a rebound peak.



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

The Missing Link

The most important fundamental driver of the gold market that hasn't yet begun to move in a gold-bullish direction is the US yield curve, represented on the following chart by the 10yr-2yr yield spread. The yield curve is bullish for gold when it is getting steeper, as indicated by a rising 10yr-2yr yield spread (a rising line on the following chart). With the 10yr-2yr yield spread having recently made a new 8-year low and not yet shown any sign of reversing upward, the yield curve remains unequivocally gold-bearish.



The yield curve is also one of the most important economic indicators to not yet warn of a US recession. As pointed out in a recent TSI commentary, it isn't an inversion of the yield curve (the 10yr-2yr yield spread dropping below zero) that warns of a recession, it's a trend reversal from flattening to steepening after the yield-spread has fallen to a multi-year low.

Based on what happened over the past 50 years, a trend reversal in the yield spread is not a prerequisite for a gold bull market. As long as sufficient other fundamental drivers (e.g. credit spreads and the real interest rate) are gold-bullish it is possible for gold to commence a bull market in the absence of a supportive yield curve. This is exemplified by the bull market that began during 1976-1977. However, it would be unprecedented for a US recession to begin in the absence of an upward reversal in the 10-yr-2yr yield spread.

The COT situation is now sounding a loud warning bell

The following chart shows that the total speculative net-long position in COMEX gold futures moved to near a 3-year high last week. This increases the short-term downside risk because it means that there is now more scope for long liquidation by speculators in reaction to a declining price.



As mentioned many times in the past, a drawback of sentiment indicators such as the COT report is that there are no absolute benchmarks. For example, if a gold bull market has begun then the speculative net-long position in gold futures will tend to make progressively higher highs over the coming 1-2 years along with the price. However, it is still prudent to view a rise in the speculative net-long position to near the high of the preceding three years as a signal to be cautious.

Current Market Situation

From last week's Interim Update:

"...a short-term top has still not been signaled. This means that a rise to $1300-$1308 remains a realistic possibility prior to such a top (a price peak that holds for 1-3 months).

As noted in earlier TSI commentaries, the first clear sign that a short-term top was in place would be a daily close below the 20-day MA. This MA is now at $1235 and should be above $1240 by the end of the week.

In addition, the $1240 level is now shaping up to be significant lateral support, given that the gold price reversed upward on Wednesday following a decline to slightly above this level. Therefore, over the next few days gold's position relative to $1240 could also be used to confirm/deny a short-term top. Specifically, it would now be reasonable to interpret a daily close below $1240 as evidence that the US$ gold price had made a top that will hold for at least a month."

The price action is becoming increasingly choppy, with a move below $1240 being quickly reversed on Thursday 10th March and then a move to a new high for the year being quickly reversed on Friday 11th March. Friday's price action was obviously a little bearish, but a short-term top still hasn't been signaled. Until it is there will be a realistic chance of a final surge to resistance at $1300-$1308, but the probability of this resistance being tested in the near future diminished last week.



It would be normal for the coming correction to retrace at least half of the preceding advance, which suggests that there will be a decline to the $1160s or lower over the weeks ahead IF it turns out that last Friday's intra-day high was the rally top. However, it will be important to take the evidence as it comes. In particular, the pace at which speculators liquidate their long positions in the futures market will provide useful clues regarding the length and magnitude of whatever correction follows a short-term top.

Gold Stocks

Current Market Situation

Although Friday's new high for the year in the US$ gold price wasn't accompanied by a new high for the year in the HUI, the gold-mining stocks generally shrugged-off Friday's downward reversal in the gold price and the HUI/gold ratio ended the week near a 9-month high. This means that the HUI is still outperforming gold.

As discussed in last week's Interim Update:

1) A daily close below 160 would indicate that a short-term price top was in place.

2) Until a short-term top is signaled there will remain a realistic chance of a surge to a new high for the year, with round-number resistance at 200 probably defining the maximum upside following a break above the recent high in the 180s.



The HUI's rally from its January-2016 bottom fell behind the pace of the rally from the Q4-2008 bottom last week, but it is still the second-strongest rally ever from a multi-year low. This augurs well for the coming 1-2 years, since it is clear-cut evidence that we have witnessed the start of a bull market rather than just another bear-market rebound. However, significant corrections occur within bull markets.

Our concern over the past few weeks was that the HUI had become very stretched to the upside on a short-term basis. As indicated by the RSI shown at the bottom of the following weekly chart, it is now also stretched to the upside on an intermediate-term basis (the weekly RSI just hit its highest level since 2010). This is a normal occurrence in the early part of a bull market, but it is a further warning to be prepared for a multi-week correction/decline.



Quarterly Index Changes

The quarterly changes to gold-mining indexes and the associated ETFs become effective at the end of this week.

Evolution Mining (EVN.AX) is the TSI stock that will probably be influenced to the greatest extent by these changes, because it is going from 3.93% to 0% of GDXJ (it is being removed from GDXJ due to the fact that it is no longer a junior). Consequently, GDXJ will have to sell about 50M EVN shares, which equates to about 8 days of average trading volume, by the end of the week. This will naturally put downward pressure on EVN's stock price, although the effect of GDXJ selling could be partially offset by GDX buying. Unfortunately, we haven't been able to find out what changes are being made to GDX component weightings.

Other TSI stocks that could be affected by changes to GDXJ weightings are AKG, PG, PVG and RSG. In each of these cases the stock price will be helped by GDXJ buying, but the effect is unlikely to be significant.

The Currency Market

Thursday's dramatic intra-day upward reversal in the euro was driven by hints that the ECB would not apply additional monetary leeches for at least the next several months. If you conclude that this is not a solid foundation for a euro rally, you are right.

The euro's upward reversal from support at 108 last Thursday is short-term bullish, but the euro's intermediate-term outlook remains bearish due to the relative weakness over the past 6 months in euro-denominated equities.



Zooming out, 12 months ago the Dollar Index was as 'overbought' as it ever gets. This created the potential for a major US$ top, but the subsequent sideways move has fully corrected the 'overbought' condition without doing any technical damage.

The extent to which the Dollar Index's situation has shifted over the past 12 months is illustrated by the Rate of Change indicator at the bottom of the following chart. This indicator shows that at around this time last year the Dollar Index was 25% above its level of 250 days earlier, whereas it is now 3.8% lower than it was 250 trading days ago. This effectively means that it is down on a year-over-year basis.

Think back on the extreme US$ bullishness that prevailed 12 months ago. Almost everyone was convinced that the US$ would continue to rise over the coming 12 months. Instead, it fell. The sentiment extreme has been corrected along with the momentum extreme, although it is fair to say that there are still a lot more US$ bulls than US$ bears.

A full correction of last year's US$ sentiment extreme is not going to happen this year unless there is a decline in the Dollar Index to well below the lows of the past 12 months, which is very unlikely. More likely is that the range-trading continues for at least another month, after which the Dollar Index embarks on its next -- and probably final -- upward leg.



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 11th March 2016:

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

  *Energy Fuels (EFR.TO, UUUU) made three notable announcements last week.

First, it announced that it plans to produce 950K pounds of uranium and to sell 550K pounds of uranium this year. Most of the sales will be into long-term contracts priced in the high-$50s (the current spot price is below $30) and will be profitable.

Second, it announced that it sold about 4.4M new shares at US$2.40 (C$3.25) per share to raise US$10.5M. The news of this low-priced equity financing caused the stock price to plunge by around 15% last Thursday.

Third, it announced that it is buying Mestena Uranium LLC, a privately held uranium producer that operates the Alta Mesa ISR (In Situ Recovery) project in Texas, at a cost of 4.5M EFR shares. Alta Mesa is a fully-permitted production facility capable of producing 1.5M pounds of uranium per year. It is currently on standby pending a higher uranium price.

With its White Mesa mill, its Nichols Ranch ISR project and the newly-acquired Alta Mesa project, EFR will have the ability to ramp up uranium production to more than 10M-pounds/year once the uranium price moves high enough. Consequently, it is positioned to be one of the 'go to' uranium stocks during the next multi-year upward trend in the uranium price. However, it probably won't be a strong candidate for new buying until there are signs that the uranium price has turned upward. Given that the uranium price made a new 18-month low last week (see chart below) we are obviously not at that point.



  *Energold Drilling (EGD.V) announced an interesting acquisition. It has agreed to purchase Cros-Man Direct Underground, a small company that provides horizontal directional drilling services for the telecommunications, water, sewage, hydro and oil and gas markets in central Canada. According to EGD's press release: "Cros-Man's primary business involves the trenchless method of installing cable and piping systems underground in a shallow arc along a predetermined path, by the use of highly specialised drilling equipment. Over the past eleven years, Cros-Man has generated an increasing portion of its revenue from engineering and telecommunications drilling services and also maintains an ongoing presence in the oil and gas pipeline market in Central Canada."

Cros-Man is a debt-free growing company that generated $4.7M of revenue in 2015. The purchase price of $3.5M up front plus about $800K/year for the next three years therefore looks like a reasonable deal for EGD. The acquisition appears to be accretive and has the benefit of diversifying EGD's overall business by adding a segment that doesn't rely on commodity prices.

Despite the long-term upside potential stemming from its low valuation, we view EGD as more of a hold than a buy at this time.

  *Pretium Resources (PVG) reported the sixth set of results from its infill and stope-definition drilling program. The latest batch of results included four intersections of greater than 1,000-g/t gold over narrow (0.5m) widths.

This program, which is scheduled to be completed in Q2-2016, has thus far generated results from 186 holes with 29 intersections grading more than 1,000-g/t gold. According to PVG's management, it is achieving its intended purpose of increasing confidence in the resource model and assisting with planning the first three years of production.

With the completion of the recent $133M equity financing (the initial $120M financing plus the exercising of the underwriters' $10M over-allotment option plus the exercising by Orion Mine Finance of its proportionate ownership entitlement), PVG is fully funded through to production in late-2017. Unfortunately, there will continue to be uncertainty regarding the validity of the resource estimate and the mining plan until after the project goes into production.

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) FCG, with a sell stop at $4.06 if buying for a short-term trade (last Friday's closing price: US$4.39)

2) PRQ.TO (last Friday's closing price: C$2.80)

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.

The FCG (Natural-Gas Equity ETF) Trade

FCG was extremely volatile over the first two days of last week, first surging to a new high for the year and then plunging to support in the low-$4 area. At this stage the sharp decline on Tuesday 8th March looks like a routine pullback within a short-term upward trend, but a decline to below the 8th March low would suggest that a short-term top was in place.

Consequently, the FCG trading position will be removed from the TSI List if FCG trades below last Tuesday's low of 4.07 within the next two weeks. In setting this 'stop' we are ensuring that the worst-case result for this trade will be a profit of 15%.

The trading position will also be removed from the TSI List if FCG moves up to $5.60 within the next two weeks, because at that price the short-term risk/reward would no longer justify the position.



XME put-option suggestion

XME, an ETF that tracks the S&P Metals and Mining Index, has rocketed upward since bottoming in January. According to its daily RSI(14), which is shown at the bottom of the following chart, it recently reached its most 'overbought' level of the past few years. It is also close to important lateral resistance at $20.

The price action suggests the potential for a rise to a new high for the year this week, but the short-term risk/reward is now decisively skewed towards risk. Even if a bull market has begun it would be normal for this ETF to retrace at least half of its January-March rally before resuming its advance.



Our intention at this time is that for TSI record purposes, QID July call options will be the exclusive focus of a short-term stock market bearish speculation. However, we wanted to point out that XME put options now look interesting, either as a hedge for anyone with long positions in commodity-related equities or as an outright bearish bet.

We bought a small position in XME June-2016 $16 put options for our own account last Friday and will possibly add to the position if XME becomes even more extended to the upside over the days/weeks ahead.

Chart Sources

Charts appearing in today's commentary are courtesy of:

http://stockcharts.com/index.html
http://www.sharelynx.com/
http://www.barchart.com/