<% 'pass = Request.Form("pass") IF ((Request.Form("pass") = 1) OR (Session("pass") = "pass")) THEN %> Speculative-Investor.com
   -- Weekly Market Update for the Week Commencing 16th June 2008

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)

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.

Outlook Summary

Market
Short-Term
(0-3 month)
Intermediate-Term
(3-12 month)
Long-Term
(1-5 Year)
Gold
Neutral
(02-Jun-08)
Bullish
(12-May-08)
Bullish

US$ (Dollar Index)
Bullish
(16-Jun-08)
Bullish
(31-May-04)
Neutral
(19-Sep-07)

Bonds (US T-Bond)
Neutral
(03-Mar-08)
Neutral
(19-May-08)
Bearish
Stock Market (S&P500)
Neutral
(02-Jun-08)
Bearish
(12-May-08)
Bearish

Gold Stocks (HUI)
Neutral
(02-Jun-08)
Bullish
(12-May-08)
Bullish

OilNeutral
(09-Jun-08)
Bearish
(22-Oct-07)
Bullish

Industrial Metals (GYX)
Bearish
(05-May-08)
Bearish
(09-Jul-07)
Bullish


Notes:

1. In those cases where we have been able to identify the commentary in which the most recent outlook change occurred we've put the date of the commentary below the current outlook.


2. "Neutral", in the above table, means that we either don't have a firm opinion or that we think risk and reward are roughly in balance with respect to the timeframe in question.

3. Long-term views are determined almost completely by fundamentals, intermediate-term views by giving an approximately equal weighting to fundmental and technical factors, and short-term views almost completely by technicals.

Returning to gold as money

...if left to its own devices the market will choose gold, or the combination of gold and silver, as money... ...Apart from the government/bank alliance's desire to maintain control of the money supply, ignorance is the biggest obstacle facing the return of gold to its traditional monetary role.

A lot of the world's problems stem from the abilities of the government and the banking system (the central bank and the private banks) to inflate the supply of money. This is because the inflation: a) distorts price signals, leading to the misdirection of valuable resources and slower economic growth, b) supports the expansion of government power and thus leads to a less-free society, c) benefits leveraged speculators and the asset-rich at the expense of conservative savers and the asset-poor, leading to greater wealth disparities than would otherwise exist and to resentment amongst those who are on fixed incomes or at the bottom half of the economic ladder, and d) supports the militaristic objectives of governments. The problem of inflation would not occur, however, if gold were the general medium of exchange because governments and banks cannot create gold. This prompts the following questions:

1. How can we get from where we are now to the point where gold is money?

2. Will gold return to its historical role as the general medium of exchange within the foreseeable future?

The first question is easy to answer. Most serious advocates of returning gold to its position as the official currency of the realm concoct detailed plans as to how a gold-based monetary system should be structured and implemented, but if gold truly is the best money then such plans are neither required nor desirable. All that would have to happen is the abolition of the central bank and legal tender laws, thus leaving the market free to choose the general medium of exchange. If gold is, as we believe, ideally suited to perform the monetary role, then market forces would inevitably cause it to recapture this role if such forces were allowed to operate.

Gresham's Law states that bad money chases out good money, but Gresham's Law only applies when legal tender laws force people to accept the bad money at face value. In the absence of legal tender laws the good money will chase out the bad because people will refuse to accept the bad money in exchange for their valuable goods, services and assets.

In other words, if gold is the best form of money then returning gold to its monetary role will not require any additional laws or institutions. It will, instead, simply require the removal of some existing laws and institutions. In particular, there should be nothing in a country's constitution that specifies what the general medium of exchange should be, and the government should certainly NOT be granted the power to coin or print money or to otherwise exert influence over the supply of money. For example, the writers of the US Constitution committed a grave error when they stipulated what the money should be (gold and silver coin) and granted Congress the monopolistic right to coin new money, because in doing so they unwittingly opened the door to the monetary mischief that has since occurred. If the US Constitution had said anything at all about money it should have said something along the lines of: "The government shall stay completely out of the money business".

The bottom line is that there should not be any "official" money. Based on thousands of years of history we can be very confident that if left to its own devices the market will choose gold, or the combination of gold and silver, as money, but the main point is that the market must be left to its own devices.

By the way, we don't mean to imply that the transition from the current government-managed monetary system to a new system based solely on market forces would be simple, smooth and painless. Mountains of debt and derivatives have been amassed on the premise that there will always be plenty of monetary inflation, so it might be necessary to phase the central bank out over 5-10 years rather than eliminate it in one fell swoop.

The second question is impossible to answer. Governments and banks will never willingly give up the right to create new money, so the only way that gold could ever again become the general medium of exchange is following the total collapse of the current system. In other words, it is very unlikely that the control of money could ever be wrested from the government and returned to the free market in the absence of a total monetary breakdown. And even then, there is no guarantee that a gold-based system would rise from the ashes of our current system.

Apart from the government/bank alliance's desire to maintain control of the money supply, ignorance is the biggest obstacle facing the return of gold to its traditional monetary role. The vast majority of people, including some intelligent and thoughtful people, believe the dual fallacies that the supply of money must grow at a certain rate to support economic growth and that in times of stress the government can help the economy by increasing its borrowing/spending (financed by increasing the money supply). Also, very few people understand the link between the rising prices that they complain about and the increase in the supply of money, a lack of understanding that the representatives of governments and central banks take every opportunity to nurture. For example, the statements emanating from this weekend's meeting of G8 finance ministers were worded as if rising commodity prices were the CAUSE of the problem rather than a SYMPTOM of what was happening to money (as far as we can tell, the increase in the supply of money was not even mentioned). For another example, at this same meeting US Treasury Secretary Henry Paulson should have 'brought the house down' when, according to this article, he "urged countries to let markets work, not rely on subsidies". This really was a funny thing for him to say given that the subsidies and tariffs put in place to protect the US ethanol and sugar-growing industries are probably the second most important cause of rising grain prices. The image of a pot pointing at a kettle and yelling "You're black!" springs to mind, and yet most people take such statements at face value.

For some strange reason, despite the continual flood of lies spewing forth from the halls of government and the mountain of evidence that economic well-being and freedom from government meddling are positively correlated, there is a general distrust of the free market.

Inflation-Adjusted Prices

The data for most so-called "inflation-adjusted" charts are prepared by dividing the nominal price by either the CPI or the PPI. However, this is not a good way to determine the real performance of any market because the CPI and the PPI are bogus numbers. A better way is to adjust nominal prices such that changes in the money supply are taken into account; that is, by dividing the nominal price by the total quantity of money.

The inflation-adjusted charts we've shown in the past have used either M3 or M2 to represent the total quantity of money, but as discussed in a number of commentaries over the past several months TMS is a much more appropriate way of measuring money supply. The long-term inflation-adjusted charts displayed below are therefore based on the assumption that the inflation rate equals the increase in TMS.

The first of our charts shows the inflation-adjusted performance of the oil price from 1959 through to the present. Notice that despite the huge gain in the nominal price of oil over the past 18 months, the inflation-adjusted oil price is still a long way below its 1980 peak. In other words, in US$ terms oil is not yet over-priced on a long-term basis. It is, however, very over-priced relative to many other commodities. Rather than saying the oil price is too high it is therefore more apt to say that the prices of many other things are too low relative to oil.



The second of our charts shows the long-term inflation-adjusted performance of the gold price. Gold has clearly got a very long way to go before it becomes expensive in US$ terms. In fact, even if its nominal price quadrupled from here gold would still be cheaper, in real terms, than it was in January of 1980.



Our third and final inflation-adjusted chart shows the Dow Industrials Index. When the effects of money-supply growth are removed from the picture it becomes obvious that the Dow entered a primary bear market in 2000.


Bonds

The following chart shows that there has been a strong inverse relationship between the US stock and T-Bond markets over the past 9 months (highs in one market have corresponded with lows in the other). This relationship is probably a consequence of the credit crisis in that during periods when credit-related problems have shifted to centre stage the investment demand for equities has fallen and the investment demand for the perceived safety of T-Bonds has risen, whereas the opposite has occurred during periods when credit-related problems have appeared to dissipate. Notice, though, that since the middle of May the stock and bond markets have both trended lower. This, we suspect, is because growing evidence of an inflation problem, as opposed to the surfacing of more credit-related problems, has been the primary cause of the most recent stock market swoon.



If the outward signs of inflation become increasingly blatant over the coming weeks then stocks and bonds will probably keep moving lower together. We see this as the worst-case outcome, but not the most likely outcome. Rather, with more evidence of a US$ bottom having just emerged it is more likely that both the stock and bond markets will reach short-term bottoms over the coming fortnight. As noted in previous commentaries, a bond market bottom prior to the end of this month would also be consistent with this market's tendency to reach an extreme (an intermediate-term high or low) during the May-June time window.

While the US T-Bond market gets most of the attention, most of the action is happening in the German and Japanese government bond markets. For example, the following weekly chart shows that the market for German Bunds has just experienced a veritable collapse and ended last week at critical support defined by its 2007 low. Moreover, the 2007 low was the lowest level since August of 2002, so additional weakness from here would take the Bund to a new 5-year low. Needless to say, prices generally don't make new 5-year lows during long-term BULL markets.

This is clearly a dicey situation for the Bund, but note that it is testing important support after having fallen on 11 of the past 13 weeks. In other words, the market is now very oversold. This means that a break below support at this time probably won't be sustained.



There's a good chance that a global bond market rebound will get underway within the next couple of weeks. And even though this rebound would probably be the counter-trend variety (a rebound within a bear market), it could last a few months if credit-related problems return to centre stage.

The Stock Market

The main driver of the US stock market's decline from last year's peak was the debt crisis that originated in the realm of sub-prime mortgage debt and spread to many other types of debt and derivatives. When fear associated with the debt crisis reached panic proportions in mid March the stage was set for a multi-month stock market rebound because such extremes of emotion cannot be sustained for long. This rebound seemed to run out of steam during the first half of May, but despite the heavy price action since that time and the decisive break to new lows by the Bank Index the credit markets have not yet signaled the resumption of the crisis. For example, the following chart shows that the HYG/LQD ratio, a measure of the demand for high-yield/high-risk corporate debt relative to the demand for investment-grade corporate debt, has just returned to its September-2007 peak. This suggests that 'investors' have been bidding up high-yield (relatively high risk) debt securities over the past few weeks even as the stock market has been declining, which is certainly not what we'd expect to be happening IF the stock market had embarked on its next major downward leg.


The credit-market situation suggests that the stock market's rebound from its mid-March low is not over. Also, the sentiment backdrop, while not yet close to the extreme reached in mid March, has again become supportive of the stock market. The biggest negative is the high oil price. It's difficult to imagine the stock market returning to its recent highs unless the oil market establishes a downward trend.

Weighing all the evidence, we suspect that if the stock market hasn't already reached a short-term bottom it will do so within the next two weeks.

This week's important US economic events

Date Description
Monday Jun 16
Net foreign purchases of US securities
Tuesday Jun 17
PPI
Housing Starts
Capacity Utilisation
Industrial Production
Wednesday Jun 18 No important events scheduled
Thursday Jun 19 Leading Economic Indicators
Friday Jun 20 No important events scheduled

Gold and the Dollar

Currency Market Update

The US$ was quite strong last week in response to Bernanke's 'jawboning', although the euro still hasn't broken below the bottom of its 3-month trading range. Also, the following daily chart shows that the September A$ has not yet confirmed a top.


While last week's US$ rally was insufficient to cause downside breakouts in either the euro or the A$, the following weekly chart shows that it was strong enough to take the Dollar Index above resistance at 74. Moreover, it resulted in the Dollar Index's first weekly close above its 20-week moving average (the blue line on following chart) in almost 18 months. This is evidence that the current rebound will have more staying power than the other rebounds that have been attempted over the past year.


Also of potential significance at this time is the performance of the Baltic Dry Index. As we said in the 8th June Weekly Update:

"In addition to the price action in the currency and various other financial markets, our US$ outlook is influenced by the performance of the Baltic Dry Index (BDI). The performance of the BDI, an index of international ocean-going freight rates, is relevant because intermediate-term turning points in the BDI usually coincide with intermediate-term turning points in the currency market. Specifically, BDI highs generally coincide with US$ lows and BDI lows generally coincide with US$ highs.

The following Bloomberg.com chart shows that the BDI plunged between early November of last year and late January of this year. We took this as a signal that an intermediate-term US$ bottom was put in place last November, which proved to be the case relative to the Canadian Dollar and British Pound but not relative to other major currencies. The BDI has since moved back to and slightly beyond its November-2007 peak, perhaps driven by the demand for oil tankers. However, if it turns down from near its current level then the BDI's recent performance will look very similar to its performance last October-November."

An updated version of the above-mentioned Bloomberg.com chart is included herewith and shows that the BDI has just reversed downward in impressive fashion. This, taken along with the weekly Dollar Index chart presented above, suggests that the US$ has FINALLY commenced an intermediate-term rally worthy of the name.


The Dollar Index could continue to rally over the coming 1-2 weeks or it could consolidate last week's gains, but if an intermediate-term rally actually is underway then it should remain above its 20-week moving average on a weekly closing basis.

Gold

The following daily chart of August gold futures shows that the gold market ended last week at its 200-day moving average and marginally above its early-May low. This suggests that gold has either just completed a successful test of its May low and is about to rally or that it is about to plunge to new correction lows (with support at around $800 being a likely near-term target).

We think the latter outcome is the more likely, but we do not in this case, and nor do we ever, rely on short-term predictions. Rather, we prepare ourselves for various possible outcomes. For example, we cannot confidently predict that gold will drop to around $800 in the near future, but we can unequivocally state that we will be buyers of gold bullion IF the price drops to the low-$800s.


The potential for Fed rate hikes in response to the increasingly obvious inflation problem is not a serious threat to gold because the Fed cannot afford to implement genuinely tight monetary policy. We don't think that rising unemployment or other overt signs of economic weakness will prevent the Fed from hiking if the evidence of an inflation problem continues to mount, but the emergence of more problems within the banking system almost certainly would rule out anything more than a token rate hike. Keep in mind that the Fed exists to support the government and the banks, not to maintain the integrity of the currency or to promote economic growth.

Our thinking has been that gold would be weak during the first few months of an intermediate-term US$ rally, but that once the euro bulls had been chased out of the gold futures market the gold price would be able to rally in US$ terms even while the US$ rallied against the euro. To put it another way: we haven't been, and still aren't, anticipating US$ strength; what we are anticipating is euro weakness.

Despite last week's market action there is still plenty of uncertainty as to whether the euro is preparing to break out to the downside from its 3-month trading range. If it does break downward then the initial reaction of speculators will be to sell gold, but a sharp decline by the euro would be bullish for gold beyond the very short-term, especially if it is accompanied by a sharp decline in the oil price. The reason is that sharp declines in EUR/USD and the oil price would eliminate the perceived need for tighter monetary policy on the parts of both the ECB and the Fed.

Lastly, note that a USD/EUR rally over the coming 3-6 months would be consistent with the "1973 Model" that we've been following since early this year. During 1973-1974, the best gains in gold and gold stocks occurred while the US dollar's exchange rate was trending upward.

Gold Stocks

The AMEX Gold BUGS Index (HUI), a daily chart of which is displayed below, is probably very close to a bottom in terms of time. One reason is that the gold price will probably reach its correction low during the INITIAL phase of the US dollar's recovery against the euro. A second reason is that gold and gold stocks have been discounting a US$ recovery for the past three months, meaning that current prices are already factoring-in a material amount of US$ strength. And a third reason is that the HUI's 50-day moving average will soon move below its 200-day moving average. As discussed in previous commentaries (most recently, the 7th May 2008 Interim Update), downward corrections in bull markets often end at around the time the 50-day MA drops below the 200-day MA.

However, there remains a significant risk of a final plunge to end the correction. Our guess is that such a plunge would take the HUI down to near the bottom of the channel drawn on the following chart (the mid-300s).


We aren't betting on a final plunge in that our own portfolio has close to maximum exposure to gold stocks in line with our long-term and intermediate-term views, but as previously advised we haven't yet established any short-term trading positions. Our plan is to purchase some January-2009 (or later) GDX call options IF the HUI drops to the 350s.

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)

Minefinders Corp. (AMEX: MFN). Shares: 48M issued, 60M fully diluted. Recent price: US$9.56

In the 5th May Weekly Update we wrote:

"A sizeable short position has built up in MFN, most likely in anticipation of the company experiencing similar start-up problems at its Dolores gold/silver mine over the remainder of this year to those experienced by Gammon Gold over the past year. This means that MFN will be given a hefty boost by a bout of short covering IF the mine start-up goes relatively smoothly.

Buy at around US$9.50."

The following chart shows that MFN has dropped back to near support at US$9.50 (our suggested buy zone). Furthermore, the short position is still large.

MFN's stock price has undoubtedly been hurt by the problems experienced over the past year by Gammon Gold (GRS) during the ramping-up of production at a similar mining operation in the same part of the world. Importantly, though, GRS's operation has been turned around by its new management, which indicates that the problems previously experienced by this company were primarily management-related rather than geological. This suggests that MFN will not experience anywhere near the same level of difficulty as GRS during its first year as a producer as long as MFN's mine construction/commissioning has been better managed.

MFN is a buy near Friday's closing price of US$9.56.


Chart Sources

Charts appearing in today's commentary are courtesy of:

http://stockcharts.com/index.html
http://www.futuresource.com/



 
Copyright 2000-2008 speculative-investor.com
<% Session("pass") = "pass" Session.Timeout = 480 ELSE Response.Redirect "market_logon.asp" END IF %>