-- Weekly Market Update for the Week Commencing 14th May 2018

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 mid-2016, but there will be many years of topping action in bond prices and bottoming action in bond yields before major new trends get underway. A major decline in government bond prices will unfold during the 2020s. (Last update: 11 September 2017)

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.), gold-denominated prices and inflation-adjusted prices. This secular trend will bottom in 2020 or later. (Last update: 11 September 2017)

A cyclical BEAR market in the US Dollar began in 2016-2017. (Last update: 11 September 2017)

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 in 2020 or later. (Last update: 11 September 2017)

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 2020 or later. (Last update: 11 September 2017)

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

US Recession Watch

Summary of current thinking/positioning

1) The Dollar Index probably made a multi-week top last week, but it is set to make additional gains prior to its counter-trend rally coming to an end.

2) By reversing upward following a brief drop below its $1309-$1363 trading range during the week before last, the gold market has signaled that a short-term bottom may be in place. However, more strength is required to confirm the reversal.

3) The SPX has confirmed an end to its correction and likely will make a new all-time high before the end of next month. The risk/reward is not bullish, though, because a move to well above the January high is unlikely.

4) The multi-year upward trend in commodity prices that got underway in early-2016 appears to have resumed. If so, the Australian and Canadian dollars should be relatively strong over the next few months.

5) The price of West Texas Intermediate Crude oil probably made a 1-2 month top on 10th May (when it touched US$72) or will do so this week.

6) There is no evidence that the Swiss Franc has bottomed, but taking a 3-6 month view this currency's risk/reward looks very attractive.

7) The bond market is probably close to a multi-month bottom, but new lows in bond prices (new highs in bond yields) are likely during the second half of this year.

8) Holding a cash reserve of around 30%.

The Stock Market

Current Market Situation

The probability that the US stock indices would break below their February lows has been steadily decreasing. Of particular relevance, market internals have indicated underlying strength since February, there was a rare buy signal from the TSI Put/Call Indicator (TPCI) during the week before last and, as noted in last week's Interim Update, the Russell2000 SmallCap Index had been relatively strong and had broken upward from a contracting triangle.

Here is an update of the Russell2000 chart included in our mid-week report. This chart shows that the index built on its breakout over the final two days of last week.



The SPX had to close above 2718 to complete its own upside breakout, which it now has done. The following daily chart shows last week's breakout by the SPX and also shows that the NYSE Common-Stocks-Only Advance-Decline Line ended last week at a new 12-month high.



There is now little room for doubt that a) the decline from the late-January top was a short-term bull-market correction, albeit a steep one, and b) the correction is over.

While there is a very good chance that most US stock indices will test or exceed their January highs before the middle of this year, there is unlikely to be a strong upward trend in equity prices over the next few months. The main reason is that government bond prices will keep falling (interest rates will keep rising) until the stock market suffers a large-enough decline to precipitate a deflation scare.

The bond market looks set to rebound over the coming 1-2 months in response to the anti-bond trade having become far too popular within the speculating community, but after that the bond bear market should resume. When the T-Bond resumes its long-term bearish trend and breaks decisively below its February-2018 low, a new round of downside volatility should commence in the stock market.

We suspect that a stock market decline that is larger and longer than the Q1-2018 episode will happen, or at least get underway, in the second half of this year. However, it's too soon to begin preparing for that.

Tesla Update

In addition to financial problems, production problems, accounting issues that have drawn the attention of regulators and burgeoning competition in the electric vehicle market, over the past year Tesla (TSLA) has suffered from an exodus of top executives. The latest to go is the company's head of engineering and production. Officially he is taking a leave of absence to spend more time with his family, but given that the ramp-up of Model 3 production is at a critical stage it's a very strange time for someone in this position to be taking time off.

Despite Tesla's obvious problems and absurdly high market valuation, the stock price continues to hold up well. This undoubtedly is due in part to TSLA being one of the most shorted stocks in the US market. With so many shares having been sold short already there is regular support from short covering and no room for new shorts to get involved in a big way (you can't sell short if you can't borrow the stock).

Due to the stock's recent resilience, the late-March plunge looks like an overshoot and the decline from the 2017 top looks no worse than the intermediate-term correction that occurred in 2016. Also, $275-$280 has become a critical support area. The stock price must break through this support to confirm that we are dealing with a major bearish trend as opposed to a severe bull-market correction.



We continue to believe that Tesla is on its way to bankruptcy, but the short-term risk/reward no longer favours the bears. We think it is now neutral, with the probability of a $50-$100 rise being roughly the same as the probability of a $50-$100 fall.

In our opinion it doesn't make sense to be short the stock at this time, although it could make sense to establish (or re-establish) a short position if there is a daily close below $275 within the coming few weeks.

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 relationship between reported bullion inventory and the gold price

Most people who comment on the relationship between gold ETFs such as GLD (SPDR Gold Shares) and the gold price don't understand how ETFs work. This leads to wrongheaded comments along the lines of "gold flowing into and out of bullion ETFs is an important driver of the gold price" and "gold flowing into GLD's inventory indicates increased demand for gold" and "the ETF managers adjust the amount of gold in the inventory to keep the net asset value (NAV) the same as the market price".

For gold to be added to a bullion ETF's inventory it must be removed from somewhere else. That is, for an ETF to be a buyer of physical gold, someone else must be a seller of the same quantity of physical gold. The result is no change in overall gold demand, just a change in the location and/or ownership of a certain quantity of gold.

Also worth mentioning, in case it isn't obvious, is that no gold has to be added to or removed from the inventory of a gold ETF in order for the ETF to track the gold price. The ETF automatically tracks the gold price by virtue of the fact that it owns nothing except gold.

Why, then, does the amount of gold held by ETFs change over time?

The addition of physical gold to the inventory of a bullion ETF results from ETF buyers paying a premium over the ETF's NAV, in the process creating a risk-free arbitrage opportunity for the ETF's Authorised Participants (APs). In simple terms, the arbitrage opportunity involves an AP providing physical gold to the ETF in exchange for new ETF shares that are immediately sold in the stock market. The AP pockets a profit equal to the temporary NAV premium and the act of doing this trade puts downward pressure on the ETF's share price relative to the gold price. The ETF's market value is thus brought back into line with its NAV.

In other words, when gold flows into an ETF it indicates a general willingness of speculators to pay over-the-top for ETF shares. By the same token, the removal of gold from an ETF's inventory indicates a general willingness on the part of speculators to sell their shares at a discount.

Now, when will speculators in gold ETFs tend pay a premium to get their hands on ETF shares and when will these same speculators tend to sell ETF shares at a discount to NAV?

The answer is that they are more likely to pay-up AFTER evidence emerges that the price is in an upward trend and they are more likely to sell at a discount to the underlying asset value AFTER evidence emerges that the price is in a downward trend.

An implication is that most of the time the amount of gold held by a large and liquid gold ETF such as GLD will FOLLOW the gold price. Upward price trends will tend to go with rising inventory levels due to increasing optimism on the part of trend-following ETF speculators and downward price trends will tend to go with falling inventory levels due to decreasing optimism on the part of trend-following ETF speculators, with turning points in the bullion price happening before turning points in the ETF inventory.

Another implication is that changes in price can be used to predict near-term changes in ETF inventory, but changes in ETF inventory can't be used with any reliability to predict changes in price.

The tendency of gold ETF inventory levels to follow the price can be demonstrated with the help of the two charts from www.goldchartsrus.com that are displayed below. The top section of the first chart compares the US$ gold price with the GLD inventory level (in tonnes). The strong positive correlation is obvious and if you look closely you'll see that the price normally leads the inventory at turning points. The areas enclosed in the blue rectangles are examples.

The second chart is more general in that it compares the gold price with the total of all reported gold inventories (Comex warehouses and other futures market repositories, ETFs, mutual funds, and e-funds such as Bullionvault and Goldmoney). However, the same relationship can be observed -- changes in the reported inventory follow changes in the bullion price.

Current Market Situation

The fundamental backdrop, as indicated by our Gold True Fundamentals Model (GTFM), turned gold-bearish during the first half of January and has remained so ever since. Refer to the following chart for details. However, we expect that two of the GTFM's seven components will switch from bearish to bullish during the early part of a 1-2 month (or longer) T-Bond rebound and that such a rebound in the T-Bond should begin soon if it hasn't begun already. This will shift the GTFM into bullish territory if other components remain the same. Therefore, the fundamental backdrop could soon become supportive.



Turning to the price action, after 5 tests of the 200-day MA in 7 trading days the US$ gold price bounced to its 20-day MA over the final two days of last week. The bounce from the 200-day MA is not yet large enough to be significant, but a daily close above the 50-day MA (near $1330) would make it significant.



A rise in the US$ gold price to new multi-year highs is coming, but it is probably still more than a month away.

Silver

Apart from a short-lived upward spike last month, the US$ silver price has spent the past three months oscillating between $16.10 and $16.90. During the week before last it tested the bottom and on Friday 11th May it tested the top of this range. The top of the range roughly coincides with the 200-day MA, so the price is currently butting up against significant resistance. Furthermore, there is additional resistance defined by the channel top a little higher -- at $17.20-$17.40. Consequently, silver has some work to do to signal an upward trend reversal.

Sentiment is not yet a tail-wind for the silver price. This is because although the total speculative net position reveals minimal bullish enthusiasm, the 'dumb money' (the group defined as "NonReportable" in the COT reports) continues to bet aggressively on a rally.

Now, it's possible that a substantial rally will begin without the sentiment situation first becoming supportive, but the odds are against it. We therefore expect the US$ silver price to spend at least a few more weeks within its downward-sloping price channel and won't be surprised if it spikes below the bottom of its 3-month range before a substantial rally gets underway.



Gold Stocks

Current Market Situation

The following daily chart shows that the Gold Miners Index (GDX) has been moving back and forth between $21.00 and $24.50-$25.00 since early last year. This is a long time to spend in a narrow (by the standards of an historically volatile equity sector) horizontal range.



It would be normal for such a long period of dull price action to result in a general lack of optimism, but that doesn't appear to be the case here. We are referring to the fact that every time the gold-mining sector shows any sign of life, many articles are published proclaiming: "This is it! A big rally has begun!"

We expect that a big rally (a rally lasting more than 6 months and taking the gold-mining indices/ETFs above their 2016 highs) will begin in the not-too-distant future. Furthermore, this month (May-2018) was previously considered to be a likely time for such a rally to begin. However, there is no evidence that it has already begun.

The situation could change, but at this stage the upward move that got underway in March has the hallmarks of a counter-trend rebound. To bring itself into line with the other counter-trend rebounds of the past 16 months it could push the GDX price up to $24.50-$25.00, but as things stand right now there isn't a good reason to expect it to do significantly better than that.

Tanzania, Zambia, Ghana, DRC and now Mauritania

After the close of trading last Tuesday (8th May), Kinross Gold (KGC) reported its Q1 results. The company's production and financial performances were fine, but when the stock opened for trading on Wednesday the price plunged. Bearing in mind that KGC's largest mining operation is the Tasiast project in the West African country of Mauritania (the Islamic Republic of Mauritania, to be precise), here's why:

KGC's Q1 report mentioned that the Mauritanian government had recently rejected an important permit application for the Tasiast project. This would be bad enough on its own, but KGC's report also stated:

"...[the government of Mauritania has expressed] a desire to enter into mutually beneficial discussions with respect to all of the company's activities in Mauritania. The company understands the government's position to be that any discussions are to be initiated by a proposal from Kinross that would provide greater overall economic benefits to the country."

That is, it seems that the Mauritanian government is intent upon changing the rules (reneging on past agreements) in an effort to extract more money from KGC and is using an important permit application as leverage. By going down this road it is following in the recent footsteps of other African governments, including the governments of Tanzania, Zambia, Ghana and the DRC.

For foreign mining companies, country risk is ramping up in Africa.



The Currency Market

The Dollar Index (DX)

We thought that if the DX didn't make a multi-week high on Friday 4th May then it would do so during the past week. At this stage it looks like the expected high was put in place on Wednesday 9th May.

We expect the DX to make new highs for the year following a 1-3 week correction. However, the on-going failure of the US$ gold price to confirm the DX's upside breakout indicates that the bulk of the dollar's rally may be in the books already. This would be consistent with the signs that some other currencies are close to short-term bottoms.



The Swiss Franc (SF)

Over the past two weeks there was a dramatic change in the SF's Commitments of Traders (COT) situation. As illustrated by the following chart, the total speculative net-short position in SF futures (the inverse of the blue bars in the middle section of the chart) surged to a 9-year high. This sets the stage for a tradable rally.

The previous six times that the COT situation was near a similar extreme are indicated by arrows in the top section of the chart. In all except one of these cases, the COT extreme coincided with a multi-month low and the start of an 8-point or larger rally. The exception was in 2012, when an extreme in the total speculative net-short position was followed by a 2-3 week 'head fake' to the upside and then a decline to a new low. However, even in 2012 a long position in the SF purchased at the time of the COT extreme yielded a profit of up to 5 points within 4 months.



Below is a daily chart of FXF, a US$-denominated ETF that holds Swiss Francs and therefore tracks the SF/US$ exchange rate. The tracking is not perfect (FXF marginally underperforms the SF over time due to fees and, more recently, the cost of negative interest rates), but it is good enough for short or intermediate-term trades.

FXF bounced from an 'oversold' extreme over the final two days of last week but must close above the 20-day MA (the black line on the chart) to provide preliminary evidence that a short-term bottom is in place.



The sort of downward momentum extreme achieved by the SF (and FXF) last week often precedes a price low, so something along the lines of what happened when the SF was in a similar situation in 2012 (a bounce and then a decline to a new low prior to the start of a meaningful rally) is a distinct possibility over the next few weeks. However, we think it makes sense to at least take an initial position in FXF now.

We have decided to add some short-term SF exposure to the TSI List via an FXF call option. Specifically, we are adding the FXF September-2018 $96 call at US$1.05 (the mid-point of Friday's closing bid-offer spread). Note that we would be more comfortable with a December-2018 expiry date, but at this time there is no liquidity in the FXF December options.

The Australian Dollar (A$)

By dropping below an obvious lateral support level and then recovering to end the week above the support, last week the A$ generated a bullish signal in the form of a failed downside breakout. It's the same type of signal generated by the US$ gold price during the week before last.

This is preliminary evidence that a short-term bottom is in place for the A$. A daily close above the 50-day MA would be more conclusive.



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 May 2018:

[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%, NSR = Net Smelter Return, P&P = Proven and Probable, PEA = Preliminary Economic Assessment, PFS = Pre-Feasibility Study]

  *Almaden Minerals (AAU) published its financial statements for the March-2018 quarter, revealing that the company had C$12M of working capital at 31st March (about C$4M less than at the end of last year).

The aforementioned working capital amount should be enough to fund AAU through environmental permitting and FS completion (due by year-end) for the company's flagship Ixtaca gold-silver project in Puebla State, Mexico. Furthermore, the MD&A published with the financial statements contained the following: "The Company expects its current capital resources will be sufficient to carry out its exploration plans and operations for the foreseeable future." However, within hours of publishing the MD&A the company advised that it was raising C$7M by issuing new shares at C$1.00. So, a company that doesn't need the money has decided to issue new shares at a time when the share price is near a 2-year low. It's a great deal for the participants in the financing (insiders and a small number of favoured investors), but a bad deal for all other AAU shareholders.

It's likely that AAU will receive a takeover bid soon after completion of the FS and environmental permitting.

  *Alio Gold (ALO) published its financial results for the March-2018 quarter.

The plan at the start of this year was for Q1 production from the company's San Francisco gold mine (Mexico) to be much lower than the average run rate for the year. It did turn out to be a sub-par production performance from the mine during Q1, and as a result of this and expenditure on the exploration-stage Ana Paula project the company's balance sheet experienced a US$4M cash reduction during the quarter. However, the balance sheet remains strong, with no long-term debt and US$58M of working capital.

Right now we aren't concerned about the San Francisco project, because its production and cash generation should be much better over the remainder of the year. We are, however, concerned about the changes that have occurred at the Ana Paula project. In particular, the proposed mine plan for Ana Paula has become a lot more complex than originally envisaged, resulting in the completion of the FS being delayed from Q2-2018 to sometime next year. This could mean that the economics of the original plan were not as attractive as indicated in the PFS.

We are also concerned about ALO's takeover bid for Rye Patch Gold (RPM.V). This bid makes no sense whatsoever at the agreed price UNLESS it has become apparent to ALO's management that the Ana Paula project is worth a lot less than suggested by the PFS.

Due to the above concerns, we will be looking for a good opportunity to exit ALO before year-end. Hopefully, a gold-sector rally will provide the aforementioned opportunity.

  *Africa Oil (AOI.TO) published its financial results for the March-2018 quarter.

At 31st March the company had no long-term liabilities to speak of, US$409M of working capital and US$42M of equity investments (stakes in Africa Energy Corp, Eco (Atlantic) Oil and Gas, and Impact Oil and Gas), that is, the company had US$451M of working capital plus equity investments (WC+EI). This compares to US$453M of WC+EI at the end of last year.

At the current exchange rate and total share count, US$451M equates to C$1.23/share. This means that if you buy AOI shares at C$1.23 or less you are, in effect, getting 25% of the large development-stage South Lokichar Basin (the company's flagship asset) for free. It is expected that over the next few years South Lokichar will be developed into a producing oil field with output of around 100K barrels of oil per day (bopd).

  *Blackham Resources (BLK.AX) advised that recent drilling had identified extensions to shallow oxide and transitional mineralisation that suggests the potential for new open pits close to the Wiluna plant. The quantity of gold that will be added to the mine plan probably isn't substantial, but because the additional resource could be mined via existing infrastructure it could have a significant positive effect on project economics.

  *Continental Gold (CNL.TO) published its financial results for the March-2018 quarter.

At 31st March the company had working capital of US$45M (down from $69M at 31st December), long-term debt of US$73M (up from $48M at 31st December) and undrawn credit of US$200M.

The company has available financing (working capital plus undrawn credit) of $245M. Although this should be enough to cover the remaining mine capex and working capital requirements, we continue to expect that for risk management purposes a US$20M-$40M equity financing will be done within the next 9 months.

Our CNL valuation is unchanged at C$5.30/share based on US$1300/oz for gold.

  *Petrus Resources (PRQ.TO) reported its operating and financial results for the March-2018 quarter.

During the quarter the company's net debt (long-term debt minus working capital) dropped from C$146M to C$144M, meaning that the company added about C$2M of cash to its balance sheet. Quarterly production averaged about 10,600 boe/day, which was similar to the preceding two quarters.

Considering the extremely low price of natural gas in Canada, this was a satisfactory result.

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) ALK.AX (last Friday's closing price: A$0.31)

2) AOI (last Friday's closing price: C$1.27)

3) CNL.TO in the C$3.40s (last Friday's closing price: C$3.66)

4) EGD.V (last Friday's closing price: C$0.40)

5) GRG.V (last Friday's closing price: C$0.49)

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
http://www.goldchartsrus.com/