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.

In nominal dollar terms, the BULL market in US Treasury Bonds that began in the early 1980s ended in 2012. In real (gold) terms, bonds commenced a secular BEAR market in 2001 that will continue until 2018-2020. (Last update: 20 January 2014)

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)

A secular BEAR market in the 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 2014 and 2020. (Last update: 22 October 2007)

Commodities, as represented by the Continuous Commodity Index (CCI), 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 2014-2020. In real (gold) terms, commodities commenced a secular BEAR market in 2001 that will continue until 2014-2020. (Last update: 09 February 2009)

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Outlook Summary

No Interim Update this week

Please note that there will be no Interim Update this week and that we will be incommunicado (on a remote island with no internet access) during Tuesday-Wednesday.

Last week's posts at the TSI Blog

What does the copper inventory tell us about the copper price?

The short answer is: nothing. Here comes a longer answer.

We used to keep a close eye on changes in the reported copper inventory, especially the LME (London Metal Exchange) inventory, based on the belief that changes in the reported inventory contained information about the likely future direction of the copper price. After a while, however, it became clear to us that there was no consistent relationship between the reported inventory level and the recent or future price performance. Consequently, although we continued to occasionally check what was happening to inventory levels, we stopped factoring the information into our price outlook.

But why doesn't the reported copper inventory typically provide useful information about the copper price? After all, shouldn't a large decline in the reported inventory be indicative of substantially reduced supply, which would have bullish price implications, and shouldn't a large rise in the reported inventory be indicative of substantially increased supply, which would have bearish price implications?

The answer is that the reported inventory is generally NOT indicative of the overall supply situation in the market.

The reasons that there is no consistent relationship between the reported inventory and the market's overall supply situation are covered in a recent article by Andy Home. A key point is that a large increase or decrease in the reported inventory position could reflect the movement of metal into or out of the LME system with no change in total supply or even in the physical location of the metal. For example, the afore-linked article notes that on Thursday 5th February there was a sudden large increase in the reported LME inventory as the result of someone "warranting" (in effect: registering for sale via the LME) metal that was already in the warehouse, which in this day and age is something that can be done with the stroke of a keyboard. Why did this happen? The most likely reason is to make a physical delivery against a short position on the LME.

The Andy Home article goes on to explain that when the market is in "backwardation", as is currently the case, there is a financial incentive for short positions to be closed by making physical delivery. This is because any short-seller who rolls his position forward will have to pay the "backwardation". When this happens there is no change in overall supply, but the reported LME inventory increases.

The lack of a consistent relationship between the LME copper inventory and the copper price is evident on the following chart. The sharp price decline of the past few months has gone with a rising inventory, but note that the inventory level had plunged over the preceding 12 months and was at a 5-year low prior to the start of the sharp price decline. Anyone who took the unusually low level of the reported inventory in mid-2014 as a reason to make a bullish bet on the copper price would have been as wrong as they could be.



The bottom line is that you won't get any reliable insight into the likely future performance of the copper price by tracking the reported copper inventory.

The Stock Market

The US

Current Market Situation

Although the breakout hasn't been confirmed by all of the important US stock indices, it is fair to say that the US stock market broke out to the upside last week and in doing so marked the choppy December-January price action as a consolidation within an upward trend. Of particular significance, the following chart shows that the NASDAQ100 Index (NDX), the index that has often led to the upside over the past several years, clearly broke out to a new multi-year high during the final two days of last week.



The next chart reveals that the NYSE Composite (NYA) is one of the indices that haven't yet confirmed the break to new highs. However, there's a good chance that it will make its own way to new highs within the weeks immediately ahead.



In last week's Interim Update we wrote that given on our longer-term bearish outlook, two short-term scenarios were equally plausible. One was that the market had already made a major top and would soon begin to trend downward. This scenario was subsequently ruled out. The other was that the market would make a new high within the next few weeks before reversing lower and commencing a 1-2 year bearish trend. This scenario, which is still very much in play, would be similar to how the NYA peaked during 2000 and how several indices peaked during 2007.

Here's a chart showing the NYA's major top in 2000. Notice the upside breakout above obvious resistance in August of 2000. The NYA sustained the breakout for about two weeks and then rolled over into a downward trend that would last about two years and reduce the price by almost 40%.



An upside breakout that fails within a few weeks is, we think, the most probable scenario, but there is more to be lost than gained by betting on a potential breakout failure at this time. It makes more sense to wait for evidence of failure before taking any new bearish positions, because the evidence will emerge while the price is still close to its high.

The best thing that the US stock market currently has going for it is the evolving stock-market situation outside the US. Here's what we are referring to:

1. The strongest euro-zone stock markets clearly broke out to the upside last month and have sustained their breakouts.

2. The weakest euro-zone stock markets appear to be following suit.

3. The Japanese stock market looks set to break out to new multi-year highs in the near future.

4. There are signs that a multi-month bottom is in place for EEM, a proxy for emerging-market equities.

A coal speculation worth considering

The most unloved sector of the US stock market isn't the gold sector, it's the coal sector. The coal sector was very much out of favour and cheap prior to the collapse in the oil price, but this didn't prevent it from taking a big hit when other energy-related equities plunged in reaction to oil's steep price decline. Furthermore, whereas the Energy Sector ETF (XLE) has rebounded by about 15% from its January low, the Market Vectors Coal ETF has gained only 5% from its low. This is despite the fact that KOL is down by about 70% from its 2011 peak.

The world will continue to rely heavily on coal for large-scale power generation for a long time to come, so although it is unfashionable the coal-mining industry will survive and will have to generate sufficient returns to attract new investment. This tells us that at some point KOL will bottom out and commence a major upward trend.

We suspect that the bottom for KOL is either already in place or will be put in place during the first half of this year at not far below the January low, and that KOL's price will be much higher a year from now.



Europe

A little more than two weeks ago (in the 28th January Interim Update) we said that it could make sense to buy the Global X Greece ETF (GREK) for an intermediate-term trade. Our reasoning was that given the steep price decline of the preceding 10 months and the fact that Greece's stock market had the world's lowest Cyclically-Adjusted P/E ratio (CAPE) prior to the start of this steep decline, the market appeared to have factored in the worst-case scenario and then some. Driven by a sharp rebound in the Athens General Share Index (ATG) and stabilisation of the euro, GREK has since gained 28%.

The following daily chart shows that ATG broke above short-term resistance last Friday and ended the week at a 2-month high. This price action suggests that January's downside breakout was a 'fakeout'. It also suggests that Greece will remain in the euro-zone and the ECB will have some success in its new efforts to 'kick the can down the road' by generating "inflation".



The rise by Spain's IBEX 35 Index to its channel top is another sign that the ECB will have some success in its attempts to generate "inflation". If the IBEX makes additional upward progress from here, which it looks set to do, it will mark the choppy price action of the past 7 months as a consolidation within a multi-year upward trend.

This week's significant US economic events (The most important events are shown in bold)

Gold and the Dollar

Gold

The Fundamentals

The popular claim that deflation is currently a big threat is unadulterated hogwash. Europe, apparently, is the focal point of the deflation threat, but the rate of growth in euro supply was more than 9% last year and will probably move into double digits after the ECB's new inflation program kicks off. Furthermore, European stock indices are starting to become very strong, which is something that would definitely not be happening if deflation were a probable outcome.

The view that there is a high risk of deflation is a mistake, but it's a forgivable mistake. It is based on either the misinterpretation of evidence or looking at the wrong evidence. What's not forgivable is claiming that central banks should be ramping up the money supply to prevent deflation, because even if there were a decent chance of deflation actually happening it would be counter-productive to create large amounts of new money out of nothing. The reason is that the creation of money out of nothing falsifies price signals on a grand scale, leading to investing errors throughout the economy. Regardless of the circumstances, an economy can never be helped via policies that make the economy less efficient.

In any case, there are signs in the financial markets that inflation expectations have begun to increase from low levels. All else remaining the same, rising inflation expectations are bullish for gold. However, all else never remains the same. The fact is that rising inflation expectations are only bullish for gold to the extent that they rise relative to nominal interest rates. Putting it another way, rising inflation expectations are only bullish for gold to the extent that they result in a lower real interest rate, the real interest rate being the nominal interest rate minus the EXPECTED rate of currency depreciation.

Over the past four weeks there was an up-tick in US inflation expectations, but this up-tick was less than the increase in nominal interest rates over the same period. The net effect was a small rise in the real US interest rate (as indicated on the following chart by the 10-year TIPS yield) and some downward pressure on the gold price from this particular fundamental driver. However, taking a wider-angle view there has been a slight downward bias in the real US interest rate since Q3-2013, so this fundamental factor is still a neutral-to-bullish influence on gold's intermediate-term price trend.



Widening credit spreads indicate declining economic confidence and are therefore bullish for gold. As illustrated by the following chart, the trend in credit spreads was bearish for gold from late-2011 through to around June of 2014, at which point it turned gold-bullish. Trends don't move in straight lines and there has been a narrowing of credit spreads over the past two months, but we still view this fundamental driver as bullish for gold.



Talking about trends not moving in straight lines, the BKX/SPX ratio has rebounded strongly over the past four weeks within the context of a longer-term declining trend. The overall trend (weakness in bank stocks relative to the broad market) remains gold-bullish, but the recent sharp rebound in the banking sector's relative performance has no doubt contributed to gold's downward correction.



The US dollar's performance on the foreign exchange market has clearly been gold-bearish over the past 6 months, but the most important fundamental driver of the gold market that remains definitively bearish is the US yield curve, as represented on the following chart by the yield spread between 10-year and 2-year Treasury Notes. A rising yield-spread (long-term interest rates rising relative to short-term interest rates) is bullish for gold because it is the result of either rising inflation expectations or declining financial-market liquidity, whereas a falling yield-spread is bearish for gold because it is the result of either declining inflation expectations or aggressive boom-time speculation.

It's possible that the US yield curve is just beginning to move in gold's favour, but it has certainly been a bearish influence over the past 12 months.



Overall, the fundamental backdrop can still be aptly described as neutral or slightly bullish for the US$ gold price, depending on how much weight is assigned to each driver. However, due to the large gains made by gold relative to oil and in terms of currencies other than the US$, the fundamental backdrop for gold mining is very bullish. That's especially the case for gold miners operating outside the US.

The Price Action

The US$ gold price did very little last week. The net change over the course of the week was a decline of only $6 and the daily oscillations were small.

The corrective process should continue for at least a few more weeks, but within this process there will be rebounds. Resistance at $1250 and the 20-day MA (the mid-$1260s) are likely targets for a rebound over the coming fortnight.



Gold Stocks

Current Market Situation

Last week's performance by the HUI was similar to last week's performance by the US$ gold price, meaning that the HUI didn't move by much in either direction and ended the week with a small loss. Support at around 180 remains a likely target for a correction low in the HUI.



We suspect that the correction in the gold-mining sector will end sooner than the correction in the bullion market. It won't surprise us, for example, if a rally to a lower high in the gold price (within the context of an on-going correction) is accompanied by a rally to a new high for the year in the HUI. Be aware, though, that the HUI must hold support at 180 to maintain its bullish posture. A daily close below 180 would open up the possibility that a re-test of the November-2014 low is on the cards.

GFI versus KGC

On a few occasions last year we mentioned that Gold Fields Ltd. (GFI) and Kinross Gold (KGC) offered the best value among the senior gold-mining stocks. We have generally preferred GFI due to its lower country risk, although KGC was one of the most obvious buys in the stock market when it dropped to US$2.00 last November. We suggested a short-term trade in KGC at that time in anticipation of a quick rebound to US$3.00. Also, the TSI Stocks List has some exposure to both stocks via January-2016 call options.

GFI and KGC rebounded strongly from their November-2014 bottoms, with GFI doing well enough to reach a 16-month high in January and KGC fully retracing its September-November-2014 crash. However, they both plunged last week after announcing their Q4-2014 results and 2015 guidance, despite reporting year-over-year cost declines of around 15% and decent cash flows. It's therefore an opportune time to briefly review our assessments.

GFI achieved good production and cost results for the final quarter of last year and forecast similar production for 2015, but announced further delays to the ramping up of its South Deep mine in South Africa. This was the main reason for the sharp decline in its stock price. The South Deep mine is GFI's only remaining South African operation and has been a thorn in the company's side for years.

Also, GFI advised the market that due largely to oil-price hedging it would not achieve a significant benefit during 2015 from last year's decline in the oil price. This was a negative surprise.

Regarding price action and current valuation, a normal correction would have taken GFI from the January high of around US$6.00 to the 50-day MA and lateral support at around US$5.00. However, the reaction to last week's news has led to a greater-than-normal correction. GFI ended the week at US$4.83, which is roughly in line with its book value. A decline to the vicinity of the 200-day MA (the $4.20s) now looks possible.



Like GFI, KGC achieved good production and cost results for the final quarter of last year. However, this good news was overshadowed by a few negative surprises.

One of the negative surprises was that 2015 production is forecast to be about 200K ounces less than 2014 production, but the main one was another large ($1B) non-cash asset writedown. KGC appeared to have thrown out everything except the kitchen sink when writing down the accounting values of its assets in 2013, so another large writedown was not expected by us or by the market. It seems that the kitchen sink is now gone as well, so the asset writedown phase must surely now be over.

Despite having a much stronger balance sheet than GFI (zero net debt for KGC versus $1.5B of net debt for GFI), KGC has a much lower valuation. By a number of measures including book value, we estimate that KGC's current valuation is at least 35% lower than GFI's current valuation. The discount is justified in part by KGC's much greater country risk (KGC's most profitable mine is in Russia, whereas almost half of GFI's production comes from Australia), but it looks excessive to us.

KGC has strong chart-based support at US$2.50-$2.60. We will be interested in adding exposure to this stock at around US$2.60.



The Currency Market

The Dollar Index

Many analysts continue to cite anticipation of Fed rate hikes as the main reason for the US dollar's surge from its June-2014 low to its January-2015 high. However, while there were almost certainly multiple reasons for the US dollar's strong rise, we can be sure that anticipation of Fed rate hikes wasn't one of them. The following chart of the December-2015 Fed Funds Futures explains why. It shows that at the start of the dollar's big rally the market was expecting the Fed Funds Rate (FFR) to be 0.8% (100 - 99.2) in December-2015 and that at the end of the dollar's big rally the market was expecting the FFR to be 0.4% (100 - 99.6) in December-2015. In other words, the market's expectations of what the Fed's targeted interest rate would be in December of 2015 fell by 0.4% over the course of the dollar's big rally.



As pointed out in previous commentaries, we think the main reason for the US$ rally was strength in US equities relative to European equities. However, declines in European interest rates relative to US interest rates could have also played a part, as could positive feedback whereby a rise in the US$ causes a sell-off in commodity prices, which reinforces the upward trend in the US$, and so on. The positive feedback will work the other way when the US$ begins to trend downward and commodity prices turn upward.

A multi-month US$ downward trend driven primarily by relative strength in European equities could be underway, but more evidence is required.

The C$

The Canadian Dollar (C$) is showing early signs of having bottomed. A daily close above 0.81 would be a clearer sign that a bottom is in place.

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 ended Friday 13th February 2015:

[Note: AISC = All-In Sustaining Cost, FS = Feasibility Study, 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]

  *Almaden Minerals (AAU) announced that it has raised C$5.5M by issuing new shares at C$1.25/share. By our calculations this means that AAU now has about C$15M in its treasury, which should be enough to fund the company's exploration and engineering work for at least 12 months.

  *Asanko Gold (AKG) has completed its previously announced bought deal financing by issuing 22.8M shares at C$2.02/share to raise a total of C$46M. Interestingly, the full overallotment option was exercised by the underwriters despite the stock price at the time of closing being about 10% below the financing price.

  *Premier Gold (PG.TO) announced that it has swapped early-stage exploration projects with Goldcorp, with PG ending up with 100% of the Hasaga gold project in Red Lake, Ontario. This news is not significant, at least not at this time. Of course, if future exploration reveals an economic gold deposit at Hasaga then the news was significant.

  *Timmins Gold (TGD) reported drilling results that indicated the potential to grow production at its San Francisco gold mine (Mexico) by widening the existing pit and via underground development from the existing open pit. This is good news.

  *True Gold Mining (TGM.V): On-market buying of TGM shares by the company's most important insider (Mark O'Dea) continued last week. The total number of shares bought by the company's CEO from 28th January through to 12th February is 555K.

    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) AAU (last Friday's closing price: US$1.10).

2) AKG (last Friday's closing price: US$1.55).

3) EDV.TO (last Friday's closing price: C$0.60).

4) PG.TO following a pullback to C$2.10-$2.20 (last Friday's closing price: C$2.45).

5) TGD (last Friday's closing price: US$1.01).

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

Chart Sources

Charts appearing in today's commentary are courtesy of:

http://stockcharts.com/index.html
http://www.barchart.com/
http://www.kitco.com/
http://research.stlouisfed.org/