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.

Bonds commenced a secular BEAR market in June of 2003. (Last update: 22 August 2005)

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 2014 and 2020. (Last update: 22 October 2007)

The Dollar commenced a secular BEAR market during the final quarter of 2000. The first major downward leg in this bear market ended during the first quarter of 2005, but a long-term bottom won't occur until 2008-2010. (Last update: 28 March 2005)

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 2014 and 2020. (Last update: 22 October 2007)

Commodities, as represented by the CRB Index, commenced a secular BULL market in 2001. The first major upward leg in this bull market ended during the second quarter of 2006, but a long-term peak won't occur until at least 2008-2010. (Last update: 08 January 2007)

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Outlook Summary

Burst Bubble Comparison

The chart comparison displayed below includes, from top to bottom, a chart of the NASDAQ100 Index (NDX) covering the period from 12 months prior to its March-2000 bubble peak to 31 months after its bubble peak, a chart of the Dow Jones US Home Building Index (DJUSHB) covering the period from 12 months prior to its August-2005 bubble peak to 31 months after its bubble peak, a chart of the Shanghai Stock Exchange Composite Index (SSEC), and a chart of oil. The four charts have been positioned such that their peaks are aligned, with projections being drawn on the SSEC and oil charts to very roughly show the future trends of these markets assuming that the 31-month periods beginning with the bursting of their respective bubbles continue to follow the examples set by the NDX and the DJUSHB.

It could be argued that the oil market never moved into 'bubble territory' because the rise in the oil price was supported by supply/demand fundamentals, in which case there is no reason to expect oil to go the way of the other burst bubbles. However, all investment bubbles are supported by supply/demand fundamentals. What differentiates a bubble from something more sustainable is the role played by inflation (growth in the supply of money) on the demand side of the equation, but it's often difficult in real time to tell the difference between inflation-fueled demand (demand that will evaporate sometime after the rate of monetary inflation begins to slow) and a sustainable increase in demand. The relevant question, then, is: how much of oil's price rise was due to inflation? Before attempting to answer this question we will make some general comments about inflation-fueled booms.

Most people, including almost all central bankers and politicians, dwell under the misapprehension that inflation isn't a problem unless the prices of everyday items are rising sharply. However, inflation is actually far more destructive when it causes an investment bubble to develop than when it boosts the cost of living, the reason being that investment bubbles lead to the misallocation of resources on a grand scale.

Resources get misallocated because it is often not possible to distinguish between inflation-fueled price gains and price gains resulting from sustainable changes in supply/demand fundamentals. For example, the CEOs of the major US homebuilding companies are not stupid. They know their industry well and during the first half of this decade responded to what they perceived to be genuine/sustainable increases in the demand for housing relative to the supply of housing, and yet their companies ended up in dire straits because they created way too much supply relative to real underlying demand.

Like all great booms, the real estate boom in the US was fueled by the rampant creation of money "out of thin air". To most of the people involved in the industry the price gains seemed to be supported by sustainable supply/demand trends, but after the rate of monetary expansion began to slow the actual basis for the boom became apparent. Also like all great booms, the US real estate boom did substantial damage to the overall economy because it sucked real savings/resources away from other -- potentially more productive -- uses and thus depleted what Frank Shostak refers to as the "pool of real savings". The depletion of real savings, not the cost-of-living increases that the average central banker tends to fret over, is the main problem caused by inflation.

Shifting back to oil, a popular view is that oil's price rise was underpinned by "Hubbert's Peak". It seems to us that Hubbert's theory is valid, but it was just as valid in January of 2007 with oil at $50/barrel as it was in July of 2008 with oil at $145/barrel. This theory does not come remotely close to explaining the 200% rise in the oil price over the 18-month period leading up to the July-2008 top.

In our opinion, bubble-like behaviour commenced in the oil market in August of 2007 when the price was about $70/barrel. During the 11-month period between mid-August of 2007 and mid-July of 2008 the underlying demand appeared to be tapering off in response, firstly, to slowing growth in the US and later to slowing growth in other major oil-consuming economies. Over the same period OPEC increased the rate at which it was supplying oil to the market, and yet the price kept powering upward. The price action indicated that additional demand was coming from somewhere, but this additional demand could not be adequately explained by non-monetary factors.

As we stated a number of times in TSI commentaries during the course of the incredible 11-month oil-price surge that culminated in July of this year, the primary driver of the price action appeared to be US$ weakness against the euro, which was, in turn, driven by the anticipation of massive additional money-supply growth courtesy of "Helicopter Ben". Throughout this spectacular upward trend in the oil price almost nothing seemed to matter except the currency market. As long as the US$ kept to its downward path the oil market was prepared to ignore significant bearish developments, including OPEC supply hikes and plummeting US gasoline usage, and to latch onto the most trivial bullish developments. But as soon as the US$ reversed upward the oil game changed completely. We are now two months into a US$ recovery and the oil market seems to need a barrage of good news just to prevent the price from falling.

Further to the above, we think a good case can be made that the oil market was in 'bubble territory' at its July top. In particular, at its price top oil was very expensive relative to just about everything and it is clear that monetary factors had been the primary propellants of the rise to such an over-valued level. Having said that, the oil bubble of 2007-2008 was nowhere near as big as the preceding real estate or NASDAQ bubbles, so its unraveling could take less time and should result in a much smaller peak-to-trough price decline (our guess is that the ultimate price low will be in the $70s). In other words, we view the projection drawn on the above oil chart as the worst case rather than the most likely case.

Commodities

The Stock Market

It would be farcical if it weren't so serious

As we write, US Treasury and Federal Reserve officials are apparently working with large Wall Street firms to cobble together some sort of rescue package for Lehman Brothers. If this latest operation to save the world follows the pattern of earlier operations (Bear Stearns, Fannie and Freddie), bondholders will be bailed out and equity holders will be left with almost nothing.

These bailouts are being sold to the public as necessary evils to avert a total financial and economic collapse, but since when did socialising bad investment decisions and preventing insolvent companies from going bust ever do anything except weaken the economy? Furthermore, why would the broad economy be damaged by the collapse of highly leveraged financial firms that have no business being in business? Would Microsoft stop selling software if Lehman collapsed? Would Intel stop selling computer chips? Would Exxon Mobil stop selling oil? Would people stop shopping at Walmart? Would farmers stop buying fertiliser from Potash Corp. and tractors from John Deere?

The main point to understand is that the damage has already been done. Creating even more inflation and leverage in an effort to paper over the problems caused by previous inflation and leverage is only going to push an even bigger problem into the future.

But creating more inflation in an effort to 'fix' the problems caused by prior inflation is exactly what's happening and what will almost certainly keep happening regardless of who wins the US Presidential election. It's a totally nonsensical strategy, but one that almost everyone, regardless of where they happen to reside along the political spectrum, has bought into.

Current Market Situation

The Dow Industrials Index is sill a few hundred points above its 15th July low, but, as evidenced by the top section of the following chart, the NASDAQ100 Index (NDX) broke below its July low last week. This caused the NDX/Dow ratio, depicted by the middle section of the following chart, to hit its lowest level in more than three months.

Prior to the past 12 months we would have viewed the sort of weakness in the NDX relative to the Dow that has occurred over the past few weeks as an important bearish divergence, but since the beginning of the credit crisis the relative strength of the Bank Index (BKX) has been far more important than the relative strength of the NDX. And the bottom section of the following chart shows that the BKX/Dow ratio broke out to the UPSIDE during the first half of this month.

The BKX's recent relative strength suggests that there is little chance of a major decline over the coming weeks, as does the 10-day moving average of the OEX (S&P100) put/call ratio charted below. Unlike the equity put/call ratio, the OEX put/call ratio is not a contrary indicator. Whereas the trading of equity options is dominated by the general public, OEX options are most often used by professional money managers for hedging purposes. Therefore, relatively low levels for the OEX put/call ratio suggest a relatively low level of concern about downside risk on the part of the smart money, whereas relatively high levels for the OEX put/call ratio suggest the opposite.

The following chart shows that over the past 18 months OEX option traders have generally been worried about downside risk when the S&P100 Index has been above 675 and relatively unconcerned about downside risk when the S&P100 Index has been below 600 (note that the put/call chart's scale is inverted, meaning that the line on the chart rises as the put/call ratio falls). As at the end of last week the 10-day moving average of the OEX put/call ratio was near its lowest levels of the year, indicating minimal worry on the part of the smart money.

We continue to anticipate a stock market rebound to an October or November high, but we don't think the upside potential is particularly interesting.

Assuming it occurs as anticipated, the above-mentioned stock market rebound will probably be accompanied by a pullback in the bond market.

This week's important US economic events

Gold and the Dollar

Gold Stocks

Following last Thursday's US trading session we issued our third market alert email within the space of four days. In this email we said:

"...we doubt that any professional investor would be CHOOSING to sell [gold and silver stocks] at current levels. Rather, the selling pressure that continues to be evident is most likely stemming from the FORCED liquidation of positions in response to margin calls or, more generally, a need to raise cash at any cost. However, the market for gold shares finally appears to have reached the point where the forced selling of some investors is being offset by the new buying of bargain-hunters.
 
On Thursday the gold-stock indices dropped back to Wednesday's intra-day lows and then rebounded. They ended the day with losses, but the net result of the past two days is small gains in the gold-stock indices combined with a $35 fall in the spot gold price. This is a positive divergence. For its part, gold is testing important support at $725-$735.
 
For those with the financial capacity to do so this is a very good time to be buying gold bullion and gold stocks, either as trades or for long-term investment purposes. As noted in Thursday's Interim Update, traders taking positions in gold-stock ETFs or highly liquid major/mid-tier gold stocks (the only ones suitable for short-term trading) should place protective stops just below this week's lows."

The trading strategy mentioned above remains applicable. In fact, risk management is now more straightforward because Friday's rise in the gold sector puts significant space between current prices and Wednesday's lows, thus reducing the risk of being 'whipsawed' by normal intra-day fluctuations. In other words, there is now a large-enough gap between the lows reached earlier in the week and current prices that protective stops placed just below the lows will not be hit in response to normal intra-day volatility.

As discussed in last week's Interim Update, the bear market signal generated by the HUI's break below support at 275-285 could have occurred at the END of the bear market and almost certainly occurred just prior to the start of a multi-month rebound. That is, a multi-month rally has probably begun regardless of whether or not the bear market is over. A reasonable expectation is that the first leg of this rally will take the HUI up to near its 50-day moving average (currently at 367 and falling).

Gold

Intermediate-term Outlook

As a result of the past two weeks' action, some of our intermediate-term gold market indicators have turned negative. In particular:

1. Gold made a marginal new 8-month low last week relative to the S&P500 Index

2. Gold dropped to its lowest level in more than 2 months relative to the Industrial Metals Index (GYX)

3. After looking like it was beginning to strengthen against the euro prior to last week, the good work was quickly undone thanks to a drop to a new multi-month low in the euro-denominated gold price. The following chart depicts the current situation. Note, though, that it's still possible -- and likely, in our opinion -- that gold/euro is experiencing a routine correction similar to the one that occurred during 2006.

4. Bank stocks have extended their recovery relative to the broad stock market, showing that confidence in the financial system is 'on the mend'.

However, like the HUI's plunge below support at 275-285 the deterioration that has just occurred amongst our intermediate-term bullion indicators could prove to be an overshoot resulting from the forced unwinding of leveraged trades, and could mark the END of the downturn. Moreover, last week's low or whatever new low is made this week will likely be followed by a tradable rebound regardless of whether or not the longer-term outlook has just turned bearish.

Our intention is to monitor the performances of all our intermediate-term indicators during the coming rebound to ascertain if the intermediate-term outlook has actually turned negative, or if, as we currently suspect, the action of the past 1-2 weeks was an overshoot. If we are correct to maintain our intermediate-term bullish stance then this rebound should be accompanied by a 'steepening' of the US yield curve and by significant strength in gold relative to the broad stock market, industrial metals, oil, and the euro.

Current Market Situation

Unlike the gold-stock indices, gold bullion has not yet done enough to confirm that a low is in place. Also, last week's price decline stopped slightly short of a full test of intermediate-term support at $725-$735 (spot gold reversed upward from near the top of this range). Traders should therefore allow for the possibility that gold bullion will spike down to a new low this week before beginning to trend upward, but under no circumstances should such a spike to a new low in the bullion market be accompanied by a new low in the gold sector of the stock market.

Below is a daily chart of December gold. There is some resistance at $780 and more important resistance at $860. Resistance at $860 is, we think, a reasonable target as far as the coming 1-2 months are concerned.

Currency Market Update

Below is a monthly Decisionpoint.com chart of the Dollar Index. The bottom section of this chart shows the monthly Price Momentum Oscillator (PMO).

The monthly PMO has just crossed from below to above its 10-month moving average (the blue line on the chart has moved above the green line). This isn't a buy signal; it's belated confirmation that an intermediate-term trend reversal has occurred.

The previous monthly PMO crossovers that have occurred from oversold levels are identified on the chart with vertical green lines. These crossovers have generally happened near the halfway point of an intermediate-term US$ rally, although the 1995-1996 crossover happened during the early stage of a major US$ bull market.

If we make the reasonable assumption that a major US$ bull market has not begun then the PMO's recent crossover suggests that the dollar is immersed in an intermediate-term rally that's now about half complete. This is consistent with our currency market outlook.

In last Thursday's Interim Update we downgraded our short-term US$ view from "bullish" to "neutral" because the risk of a multi-week counter-trend move (down in the US$, up in the euro) had become high. Last Friday's market action indicates that counter-trend moves have begun.

With reference to the following daily chart, the euro has resistance at 1.45-1.46 and then at 1.52. At a minimum we expect that the first of these resistance levels will be tested over the coming weeks.

Update on Stock Selections

(Note: 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)

New Gold (AMEX: NGD, TSX: NGD) Shares: 235M issued, 313M fully diluted. Recent price: US$4.00

Due to its asset portfolio, growth potential, management team and balance sheet, we think NGD deserves to be a core holding. Near the current price it also has an attractive short-term risk/reward ratio because its recent sell-off has been so severe that even a routine 50% retracing of the decline -- a fairly typical counter-trend move -- would lead to a large percentage gain in the stock price (a 50% retracing of the recent decline would take the stock price back to the US$6.50-$7.00 area). In other words, regardless of whether or not NGD's overall decline has bottomed (we suspect that it has), the potential exists for the stock to make sizeable gains over the coming months.

Also of note is that Seymour Schulich, a savvy investor and the co-founder of the former Franco Nevada, purchased 5M shares of NGD in August at well above the current price, bringing his total investment in the company to 25M shares. Pierre Lassonde, the other co-founder of the former Franco Nevada and the chairman of the current Franco Nevada, also has a substantial personal stake in NGD.

    Energy Fuels Inc. (TSX: EFR). Shares: 52M issued, 63M fully diluted. Recent price: C$0.61

In Friday's email alert (Market Alert #186) we mentioned that uranium junior EFR had announced very positive news on Thursday. There was no market reaction to the news on Thursday, but the stock bounced on good volume on Friday.

We commented on Friday that EFR "now has two fully-permitted uranium mines in the US and is poised to move into production." Our understanding is that EFR will begin producing ore at its Whirlwind Mine within the next couple of months and will begin producing ore at its Energy Queen mine next year. Most of the infrastructure to enable this production to commence is already in place and we don't expect that any additional financing will be needed to make it happen. Note, though, that unless EFR can negotiate a toll milling arrangement with another uranium miner it will not be able to generate any cash flow from its mines over the next two years; rather, it will stockpile ore in readiness for the company's own uranium mill (the Pinon Ridge mill), which is currently scheduled to be complete in early 2011. We expect that the construction of this mill will be debt-financed.

In other words, if EFR can negotiate a toll milling agreement then it could begin generating cash flow from its Whirlwind mine in the near future, but otherwise it should become a profitable uranium miner by 2011. As far as we know, this puts it way ahead of any other exploration/development-stage uranium junior.

Chart Sources

Charts appearing in today's commentary are courtesy of: