-- Weekly Market Update for the Week Commencing 15th January 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)

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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

Monetary Policy Madness?

A reality check regarding China purchases of US debt

Summary of current thinking/positioning

1) Expecting that gold will test its 2016 high of US$1377 during the first half of 2018 (possibly as soon as next month).

2) Expecting a tradable US stock-market correction to begin soon and planning to add a bearish position in the form of QID and/or QQQ puts to the TSI List after a downward reversal in the market.

3) Thinking that industrial commodities such as oil and copper will make short-term price highs during the first two months of 2018.

4) Thinking that the Dollar Index (DX) has resumed its longer-term downward trend and that there is a risk of downward acceleration over the coming three weeks. At the same time, recognising that currency-market trends are already stretched on a short-term basis and at risk of sharp reversals.

5) Thinking that the T-Bond has almost completed an intermediate-term topping pattern within the context of a long-term topping pattern.

6) Holding a cash reserve of about 25% and looking for opportunities to boost this reserve to 30%-35%.

Commodities

EV Metals

We found the following chart in a presentation by Alkane Resources (ALK.AX). It shows estimates of the percentage increase in production of various commodities that would be required if all vehicles were electric.

There are good reasons to expect that all new motor vehicles will be electric by the middle of the next decade, so in this respect the chart doesn't assume something outlandish. The estimates are unrealistic, though, firstly because battery technology* will change dramatically over the next several years and secondly because it's likely that the intersection of EV advancement, self-driving technology and ride sharing** will result in there being a lot less cars on the road. The details are inestimable at this time, but the chart is still interesting and useful because it provides a very rough idea of the scale of the production increases that may be needed to satisfy future demand.

It will not be possible to get production increases even remotely as large as those that could be required for lithium, cobalt and the REEs (rare earth elements) without the incentive of much higher prices. That's why there's a good chance that the prices of these metals will remain in or enter powerful upward trends over the next few years.



  *To get an idea of what may be possible within the next several years, watch the short interview linked HERE. Apparently, the technology already exists to develop a high-performance EV that can go for 700 miles on a 1 minute charge.

  **It's likely that major car manufacturers will be partnering with companies such as Uber, Google and Amazon to make this happen. An example is the new strategy recently announced by Toyota.

Getting exposure to cobalt

The following chart shows that the price of cobalt has more than doubled over the past 12 months to US$75,000/tonne (US$34/pound). We normally wouldn't be interested in purchasing exposure to a commodity after it has just doubled within a year, but, due to the EV trend and the fact that cobalt supply is largely price-insensitive (thanks to almost all cobalt supply being a byproduct of copper and nickel mines), it's likely that a much higher price will be attained within the next two years.



Investors can participate in the cobalt bull market without taking exploration or country risk (almost all of the world's high-margin cobalt deposits are in the DRC) by purchasing the shares of Cobalt 27 Capital Corp. (TSXV: KBLT). KBLT currently owns 2,983 tonnes of physical cobalt stored in LME warehouses and some royalties on early-stage cobalt projects. It also plans to do cobalt streaming deals at mines where the cobalt byproduct is small relative to the mine's total revenue.

KBLT has only existed for about 7 months. It has 34M shares outstanding and ended Friday's session at C$12.45/share.



Based solely on its cash and physical cobalt, that is, assigning no value to its royalties, we estimate that KBLT's current net asset value (NAV) is about C$9.00/share. This means that KBLT is trading at about a 38% premium to NAV.

Taking into account the paucity of choices when it comes to cobalt-focused investments and KBLT's plan to do streaming deals, this is not an unreasonable premium. It could therefore make sense to take an initial position near the current price, although we are hoping that a better buying opportunity will arrive within the next couple of months.

A much better buying opportunity is not likely, because a stock such as this usually will trade at a significant premium to NAV and there probably won't be a large decline in the cobalt price. Consequently, we think that the current NAV defines the downside risk.

KBLT will be added to the TSI Stocks List if it trades at C$11.00.

2018 Commodity Forecast

Our 2017 commodity forecast was for a Q1-2017 top, an important bottom around mid-year and general commodity-price strength during the second half of the year. The following chart shows that this turned out to be exactly right, although some of our reasoning was wrong.



So, what's on the cards for 2018?

To use a cliche, 2018 will be a year of two halves for the commodity markets and many other markets. To begin with, here are some of our commodity-related expectations for the first half.

If we had written this forecast five weeks ago we would have stated that the basket of commodity prices that constitutes the GSCI Spot Commodity Index (GNX) was set to trend upward during the first half of 2018. That's still our prediction, but due to the intervening price action there's now a higher risk of it being wrong.

Risk has increased due to the recent sharp advances in the prices of some commodities, most notably oil and copper. In particular, the approximately $9 rise in the price of oil (West Texas Intermediate Crude) from around $56/barrel in early-December to a high last week of almost $65 has substantially reduced the intermediate-term upside potential of what is still the world's most important commodity.

Oil and some metals, including copper, now look set to make multi-month price highs within the first two months of 2018.

In oil's case, counter-balancing the extent to which price and speculative sentiment are stretched into 'overbought' territory is the fact that the fundamental backdrop remains bullish. As long as the supply-demand situation in the physical market remains bullish, as evidenced by significant backwardation in the futures market, it will be reasonable to assume that nothing more bearish than a run-of-the-mill 1-2 month correction is in store. We therefore expect that oil will exceed its Q1 price high during Q2.

In copper's case the fundamental backdrop is now neutral at best. This may mean that whatever high is made by the copper price during the first two months of the year will be the high for the first half of the year.

If the first half pans out roughly as expected then the second half should contain a lot more downside volatility. In particular, we expect that a substantial decline in the broad stock market during the second half will lead to pronounced weakness in the prices of industrial commodities as the dominant concern temporarily shifts from "inflation" to "deflation".

In the above discussion we singled out oil and copper, because these are two of the small number of commodities that we follow closely. For most commodities we have no opinion regarding likely price performance in 2018. For example, we have no idea what will happen over the year ahead to the prices of wheat, corn, cattle, hogs, cotton, sugar, lumber and coffee. However, here are some additional brief thoughts on what we expect from specific commodity markets:

We think that uranium made a long-term price bottom near $18/pound in late-2016, but that a new bull market will not begin in the foreseeable future. Uranium-mining stocks should, however, continue to be good for the occasional short-term trade.

Due to a physical supply-demand situation that remains very supportive, we think that zinc's bull market has a long way to go.

When platinum began trading at a discount to gold in 2015 we thought it was a temporary state of affairs, but we now view it as a more-or-less permanent shift. Rather than spikes below 1 in the platinum/gold ratio signaling that platinum offers excellent value relative to gold it may now be the case that spikes above 1 in this ratio signal that platinum is expensive relative to gold. Long-term fundamental changes support this conclusion, with gold benefiting from the increasingly manipulative/counter-productive efforts of central banks and platinum being hurt by the trend towards an all-EV world. That being said, we think that there will be an opportunity to sell platinum in the $1200s (more than 20% above the current price) during the first half of 2018.

We guess that natural gas will trade above US$4.00 within the first half of 2018.

2018 T-Bond Forecast

Here's how we summarised our annual T-Bond forecast at this time last year:

"We expect that it will be another losing year for the T-Bond due primarily to rising fear of inflation during the second half of the year, but that a major T-Bond decline won't happen. Preventing a major decline will be price-support from central banks and periodic flights to safety, with the flights to safety being caused by stock market volatility in the US and political drama in Europe.

The current price for the T-Bond is 151. We expect the price to trade near 140 before year-end, but not below 130. This expectation is based on the strong tendency for intermediate-term declines in the T-Bond to bottom at or slightly below the 84-month moving average...".

This forecast proved to be too bearish. 2017 turned out to be a flat year for the T-Bond as what we interpret as a long-term topping pattern continued to develop. The long-term topping pattern is evident on the following monthly chart.



The above chart shows that the T-Bond has major support at 146 defined by its lows of the past three years and its 84-month MA. A monthly close below this support would confirm that the multi-decade bond bull market had ended.

We expect that the aforementioned major support will hold if tested during the first quarter but will be breached during the second quarter in response to rising fear of "inflation".

In the second half of the year we expect to encounter substantial 2-way bond-market volatility, with a strong 2-3 month rally at some point in reaction to falling equity and commodity prices.

Overall, we are anticipating a down year for the T-Bond (an up year for long-term interest rates), but not a large decline. We expect that major weakness in 'risk free' government bonds will be one of the next decade's big stories.

The Stock Market

The first of the following daily charts shows that the nominal (US$-denominated) S&P500 Index (SPX) was in a consistent upward trend throughout 2017 and accelerated upward during the first two weeks of 2018. Referring to the bottom section of the chart, notice that the upward acceleration has pushed the SPX's daily RSI(14) to a very high level. It is actually the highest level achieved by this momentum indicator in decades, suggesting that on a short-term basis the SPX is as 'overbought' as it ever gets. What does this mean?

It probably means that the SPX is close to a short-term top, but not a long-term or even an intermediate-term top. This is because longer-term SPX tops rarely -- we are tempted to say never, but there could be exceptions we aren't aware of -- coincide with short-term RSI extremes. Instead, they tend to be associated with waning short-term momentum and/or a bearish momentum divergence (a higher-high for the price in parallel with a lower-high for momentum).

Also worth mentioning is that the bearish divergence of market internals that was evident for about two months beginning in late-October has disappeared. That is, the price surge of the past two weeks was broad-based.

The second of the following charts shows the performance of the SPX in euro terms (SPX/euro).

The difference between the two charts is stark. Whereas the nominal SPX was in a strong and consistent upward trend over the past 12 months, SPX/euro is no higher today than it was in early-March of last year.

The implication is that what we've witnessed since early-March of 2017 is primarily a reaction to US$ weakness. This is the case for most of the major asset markets, not just the US stock market.

We are expecting a significant (>5%) short-term correction to occur during the first quarter of this year, but the correction obviously hasn't begun yet.

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

We were anticipating a modest 1-2 week correction prior to the resumption of the short-term upward trend, but all we got was a 2-day pullback. The gold-market correction that appeared to get underway during the first half of last week was cut short by Friday's downside breakout in the Dollar Index.

This means that the gold market has stayed short-term 'overbought' and is still vulnerable, but what happens to gold over the next couple of weeks will be mostly determined by what happens in the currency market. In particular, we think that if the Dollar Index follows through on last Friday's downside breakout then the US$ gold price will move quickly up to the vicinity of the 2016 high.

Further to comments in the last two TSI reports, gold's 20-day MA, which will move into the low-$1300s this week, can now be used for risk management purposes. Specifically, it will be reasonable to assume that the upward trend is intact until there is a daily close below the 20-day MA.



The fundamental backdrop (as indicated by our Gold True Fundamentals Model - GTFM) shifted from slightly gold-bullish to slightly gold-bearish last week. It remains delicately balanced, though, and vulnerable to being 'whipsawed' in response to minor shifts in interest rates.

However, that the GTFM has not moved decisively into bullish territory over the past several weeks is consistent with the price action. The US$ gold price is in a strong short-term upward trend, but taking a broader view of gold's performance leads to the conclusion that what we have seen to date is mostly the offsetting of US$ weakness as opposed to genuine gold strength. This is evidenced by the following two charts, the first of which shows the gold price in euro terms and the second of which shows the gold/SPX ratio.

Platinum

Platinum has channel resistance and 'round number' resistance at $1000. Above that there is important lateral resistance at $1025-$1050.

It is currently short-term 'overbought' and testing the lower of the aforementioned resistance areas. We expect a multi-week price peak at around this level or following a near-term spike to $1025-$1050.



Gold Stocks

Current Market Situation

A week ago we wrote to expect a 1-2 week correction in the gold-mining sector that would take the HUI down to the vicinity of its 50-day MA. Then, in last week's Interim Update we wrote that a correction may have already come and gone, with Tuesday's touch of lateral support at 191 marking the end. However, at that time there was still a chance of some additional corrective activity incorporating a test of the 50-day MA.

Due to Friday's rise to a new 2-month high we now know that a minor correction did, indeed, end last Tuesday.

With regard to the coming week we have no expectations other than we don't expect the HUI to trade below last week's low. With regard to the next month or so, a test of resistance at 220 is likely. The 220 level acted as a ceiling throughout last year, so how the HUI performs when it reaches 220 will be informative.



The First Majestic Silver takeover of Primero Mining

Primero Mining (P.TO) encountered major problems at its flagship San Dimas gold-silver mine (Mexico) over the past couple of years, leading to desperate sales of some non-core assets and a near-death experience over the past 6 months. However, the company has been rescued via an agreed takeover bid by First Majestic (FR.TO). The announcement of this bid on Friday resulted in a 125% increase in the price of P shares, although the following chart makes it clear that only recent buyers of the shares could have profited.



Given that San Dimas had gold-equivalent production of about 85K ounces over the past 12 months and that P's post-bid market cap is only C$52M, on the surface it seems that FR is getting the San Dimas mine at a bargain price. However, taking into account P's net debt and the amount that FR will pay to Wheaton Precious Metals to restructure the San Dimas streaming deal, the total cost of the purchase will be about $320M. This seems like a very high price to pay for a troubled 85K-oz/yr mine that will be subject to a streaming arrangement that limits the gold sale price to $600/oz on 25% of production.

Prior to this deal FR was a leveraged play on silver that was only good for the occasional short-term or intermediate-term trade. That's still the case, although the risk is now higher.

The Currency Market

Last week, the intensity of speculative betting on a rising euro continued to ramp up. The result was a large rise in the total speculative net-long position in euro futures to another new all-time high and a new high for the open interest in euro futures. Refer to the following long-term weekly chart for additional details.



The rapidly-increasing speculative enthusiasm for the euro and the rising price are self-reinforcing, in that trend-following speculators are ramping up their bullish exposure in reaction to higher prices and the speculative buying is fueling the price rise. We know how this ends, but don't know when.

The speculator-driven rise in the euro to a new multi-year high broke the Dollar Index (DX) below support defined by its September-2017 low (refer to the chart below). Unless this breakdown is painted as false by a reversal within the next few days then a 2-3 week steep additional decline in the DX may be in store.

We don't have an opinion on whether it's more likely that last week's breakout will be quickly reversed or lead to significant additional movement in the direction of the breakout (down for the DX, up for the euro). However, it makes sense to assume that the breakout is genuine/sustainable until proved otherwise.



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 12th January 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%, P&P = Proven and Probable, PEA = Preliminary Economic Assessment, PFS = Pre-Feasibility Study]

  *Alio Gold (ALO) reported December-quarter gold production of 16K ounces from its San Francisco mine in Mexico. This was a poor result, but it was in line with the guidance provided by the company about two months ago.

We expect that ALO will have positive news-flow during the first half of this year. In particular, the company should be able to report a much improved production performance from the San Francisco mine in each of the first two quarters and good news in the form of the FS for the Ana Paula project in the second quarter.

Completion of the Ana Paula FS could turn ALO into a takeover target.

  *Premier Gold (PG.TO) announced positive news that the stock market ignored. The news is that PG has done a deal with Barrick Gold (ABX) that entails the major gold producer spending US$22.5M by June-2022 to earn a 60% interest in the exploration portion of PG's McCoy-Cove gold project in Nevada. PG will retain 100% ownership of the deposits hosting the project's existing high-grade resource.

This deal suggests that ABX's management sees a lot more value in McCoy-Cove than the stock market is presently giving PG credit for.

The first look at the economics of McCoy-Cove will come via a PEA that was originally scheduled to be complete by the end of last year and is now expected by the end of this year's first quarter. After that, PG will extract a bulk sample of up to 120K tonnes from its 100%-owned portion of the project that will be processed by ABX for an agreed price.

  *Ramelius Resources (RMS.AX) reported an above-plan production result for the December quarter. The company produced a record-high 58K ounces during the quarter from its operations in Western Australia, or about 3K ounces more than the top end of its guidance range. The newly-acquired Edna May mine contributed 21K ounces, which was roughly as expected, while the Mt Magnet operations delivered better-than-expected output.

Production costs and most other financial details won't be known until the half-yearly report is published in February, but the press release issued last week noted that the company had A$61.8M cash on hand after paying $38M for Edna May and spending $13.2M on capital development during the quarter.

This is good news. It confirms that RMS has substantial valuation-related upside potential.

We think that RMS is worth at least A$0.80/share at the current gold price.

  *US Gold (USAU) announced the results of an updated PEA for its Copper King gold-copper project in Wyoming. Here are the salient numbers:

  - Average annual production of 41K ounces of gold plus 11M pounds of copper over a 17-year mine life

  - Pre-production capex of US$114M

  - M&I resource comprising 966K ounces of gold plus 235M pounds of copper

  - After tax NPV(5%) and IRR of US$162M and 29.7%, resp., at a gold price of $1275/oz and a copper price of $2.80/pound

The above numbers suggest that the Copper King project would be economically robust at today's metal prices. Copper King underpins USAU's market cap, but it isn't the main source of the stock's upside potential.

The bulk of USAU's reward potential is associated with the Keystone project in Nevada. This project is at a very early stage of exploration, with only scout drilling having been done to date. The results of the first few scout holes are expected during the second half of this month.

USAU has rebounded strongly from its November low near US$1.00. This is not surprising, because as we mentioned at the time the plunge to the low-US$1 area on no news was another in a long line of examples of the stock market being wrong.

Despite the strong rebound, the stock is still not expensive. With only 14.3M shares outstanding the market cap is about US$40M, which is more than fully justified by the Copper King project. This suggests that buyers near the current price aren't paying anything for the upside potential associated with Keystone.



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$0.335)

2) ALO (last Friday's closing price: US$3.64)

3) EGD.V (last Friday's closing price: C$0.36)

4) NSU (last Friday's closing price: US$2.39)

5) PG.TO (last Friday's closing price: C$3.53)

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/
http://www.lme.com/