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

The misleading nature of GDP

A good article covering some of the problems with the statistic known as Gross Domestic Product (GDP) was posted at Forbes on 8th June. The core problem is that an increase in GDP is supposed to represent economic growth, but it doesn't. GDP is just a measure of some types of monetary spending and does not differentiate between productive and non-productive spending. According to the way GDP is calculated and used, spending that is 100% wasteful, such that for every X$ spent there is a reduction of X$ in real wealth, grows the economy by as much as the same dollar amount of productive spending.

Due to the way GDP is calculated, with counter-productive spending supposedly generating just as much 'growth' as productive spending, it is possible for a country to become poorer while legitimately reporting strong GDP growth. There are many historical examples of this, including the US economy during 1941-1945 (the strongest 'real' GDP growth in US history occurred while wealth was being destroyed at the fastest pace in US history), the US economy during 1976-1979 (the economy was clearly getting weaker while annual 'real' GDP growth averaged around 5%), and the Soviet Union during most of its existence (right up to the point where it collapsed in a pile of economic rubble).

The most important aspect of the core problem mentioned above is that government spending is counted in GDP as if it were just as additive to the economy as private spending. But how can this be, when every dollar spent by the government must first be either borrowed or stolen from the private sector?

Interestingly, statisticians haven't always viewed government spending as an economic plus. Prior to the invention of the GDP statistic in the late-1930s, measures of economic growth showed the economy shrinking if private output declined, even if government spending was expanding output elsewhere in the economy. Although there will always be insurmountable problems with any attempt to reduce an economy to a single number or simple equation, recognition by the calculators of GDP that government spending does not add to the economy and in many cases -- such as the case where the spending is war-related -- subtracts from the economy, would certainly be a step in the right direction.

Today's near-universal belief in the importance and usefulness of the GDP number is one of many indications that the science of economics is unique. It is the one science that has gone backwards over the past 90 years. 

Commodities

Oil

In reaction to developments that could reduce or completely stop oil production in Iraq, the oil price broke above short-term resistance during the second half of last week. This breakout suggests that the more important longer-term resistance at $110-$112 will soon be tested.



We are "neutral" on the oil price. Oil is expensive relative to most other commodities, but its relatively high valuation could continue to be supported by geopolitical events that threaten to curtail supply.

Copper

In the copper market there was a false breakout below major support at $3.00 in March. We suspect that this false downside breakout marked the end of copper's cyclical bear market. The price subsequently rebounded to just below $3.20 in May, before dropping back to re-test major support at $3.00 last week.

Although we expect a successful test of the $2.90-$3.00 support range followed by a multi-month rally to well above the May high, there is sufficient short-term risk of a final decline to new lows to keep our short-term outlook at "neutral". If there is going to be a final decline to new lows it will likely happen within the next two months.

As an aside, the copper and gold markets have been inversely correlated since Q4-2013. For example, gold's year-to-date high in March coincided with copper's year-to-date low, copper's late-May high coincided with a low in the gold market, and over the past two week's there has been a downturn in the copper market in parallel with an upturn in the gold market. This inverse relationship is interesting, but we don't expect it to persist beyond the short-term.



We plan to add some copper exposure to the TSI Stocks List within the next two months, following either a spike to new lows or evidence that the March low has been successfully tested.

The Stock Market

The US stock market's put/call sell signal that we mentioned last week has become more pronounced, with the 10-day MA of the equity put/call ratio remaining near its lows of the past three years (indicating 'dumb money' complacency) and the 10-day MA of the S&P100 Index (OEX) put/call ratio moving well beyond its highs of the past few years (indicating 'smart money' fear). This complacency on the part of the 'dumb money' and fear on the part of the 'smart money' is occurring with the OEX having just reached the top of a channel that dates back to the October-2011 bottom.



While the oil price has just broken above short-term resistance and does not yet look extended to the upside, the following weekly chart of XLE (Energy Sector ETF) indicates that the oil sector of the stock market is in upside blow-off mode. This suggests that there is substantial downside risk in oil-related equities, partly because these equities tend to be influenced just as much by the broad stock market as by the oil price.

On an intermediate-term basis we think that the broad US stock market's risk/reward is worse than the oil sector's risk reward, but the oil sector is now sufficiently 'overbought' that a short-term decline of at least 15% looks likely. Anyone with significant exposure to the oil sector should therefore consider hedging against this possibility via the purchase of XLE put options, especially if the upside blow-off continues over the days ahead in response to additional bad news from Iraq.

This week's important US economic events

Gold and the Dollar

Gold

We've written that gold needs to get back above $1280 on a daily closing basis to confirm that the short-term trend has reversed from down to up, but $1292 is actually a more significant price level. A daily close above $1292 would break gold above its short-term channel top as well as its 50-day, 150-day and 200-day moving averages. This is a feat that has already been accomplished by GDXJ and has almost been accomplished by the HUI. We expect that it will be accomplished by gold bullion within the next three weeks, but hopefully not in response to news from Iraq.



When the gold price rose to around $1350 in late February we thought it was due for a correction that could take it down as far as the $1270s. The Ukraine drama then began, which quickly pushed the gold price up to almost $1400 in early March. We said at the time that as is always the case when gold is bid-up in reaction to international military conflict or the increasing threat of international military conflict, all the price gains achieved by gold on the back of the Ukraine news would be relinquished. This turned out to be so, but with the clarity that only hindsight can provide we now see that the upward price spike in reaction to the Ukraine drama had a much larger effect than originally anticipated. In a financial-market version of Newton's Third Law of Motion (for every action there is an equal and opposite reaction), the surge of uninformed gold-buying prompted by the Ukraine news set the stage for a deeper and longer correction than would otherwise have happened.

Due to the latest developments in Iraq, with Sunni jihadist militants have taken control of the country's second-largest city and a further escalation of violence seemingly on the cards, understanding how gold typically responds to increasing geopolitical instability could be of near-term importance. That's why we just revisited gold's reaction to the Ukraine drama.

The recent upturn in gold-related investments does not appear to be due to the latest developments in Iraq, but if gold spikes upward in the near future in response to a worsening situation in Iraq then the start of the next multi-month advance in the gold price would likely be postponed. This is because any Iraq-related gains would subsequently be given back and because the surge of uninformed buying would weaken the structure of the market.

Now, if the situation in Iraq were to worsen to the point where it provoked another large-scale US military intervention, then the backdrop would become increasingly gold-bullish. This would not be directly due to the military action itself, but due to the damage to the US economy inflicted by the government wasting a lot more resources on another counter-productive escapade. However, history teaches us that even in this case the initial price gains would likely be given back in full.

Gold Stocks

The 216-220 range for the HUI was the scene of a battle between bears and bulls on the way down, with the bears eventually getting the upper hand. Closing back above the top of this range is therefore a clear sign that the trend has changed and that the bulls now have the upper hand.

Last week's breakout by the HUI was marginal and at the end of last week the 200-day MA had not been exceeded, but taken alongside the surge in the GDXJ/GDX ratio there is little remaining doubt that a correction low is in place and that a rally to new highs for the year has begun. If this is the case then the HUI's correction low roughly coincided with a "death cross" (the 50-day MA crossing from above to below the 200-day MA), which is normal. Despite its name, the "death cross" is one of the most reliable short-term BULLISH signals in the realm of technical analysis. Actually, we don't know of a more reliable short-term bullish signal.

Note that a HUI pullback to below 220 over the days ahead wouldn't negate last week's bullish price action, but the HUI must remain above 215 on a daily closing basis to maintain its short-term bullish posture.



The following chart compares the HUI with the GDXJ/GDX ratio (junior gold stocks relative to senior gold stocks) since GDXJ's inception in 2009. Notice that:

a) GDXJ led on the way up and on the way down.

b) There was a multi-month bearish divergence in 2011, with the HUI rising to new highs while GDXJ/GDX trended downward.

c) For the first time in years, the GDXJ/GDX ratio has just made a higher low.

The leadership of GDXJ/GDX at important turning points is somewhat counterintuitive, because a reasonable argument could be made that the higher-risk/more-speculative stocks should outperform near the end of a cyclical bull market and underperform near the beginning of a cyclical bull market. However, the fact that GDXJ/GDX led to the downside during 2011 lends weight to the idea that its relative strength since last December is indicating a major upward trend reversal.



The GDXJ/GDX ratio is likely to 'take a breather' this week. In fact, we would not be surprised to see the overall sector consolidate for at least one week, with or without some follow-through to the upside over the next 1-2 days.

The Currency Market

Revisiting the "Reserve Currency" Myth

The US$ cannot lose its "reserve currency status" because under the current monetary system there is no such thing as "reserve currency status".

The US$ is the most popular "reserve" currency by a huge margin, but this is not because governments choose to hold it in reserve or because it has a certain official status. Instead, governments around the world favour US dollars for their currency reserves because the US$ is by far the most popular currency in the global marketplace. In other words, when governments denominate the bulk of their foreign currency reserves in US dollars they are simply reacting to a marketplace reality.

The reality is that in terms of use in international financial dealings, no other currency comes remotely close to the US$. This is not going to change within the next several years (the euro, the dollar's main competitor, is a very distant second and has lost ground to the US$ over the past couple of years) and it's never going to change due to the government of Russia or China or Iran or any other country deciding that it should change. Political threats to abandon the dollar can be ignored. They are just hot air.

On a related matter, international money flows associated with investing and speculation are about 50-times greater than international money flows associated with trade. Bear this in mind the next time you read a comment along the lines of "the US$ is going to get weaker because Country X is going to stop pricing its oil in dollars". Something else to bear in mind is that China's massive official currency reserve, which was built up over two decades of exchange-rate manipulation and trade surpluses, is equivalent to about one day of current turnover on the foreign exchange market. One day.

The US$ will eventually lose popularity as an international medium of exchange, which will lead to it becoming less popular as an official reserve currency. The point we want to emphasise today is that the loss of popularity as a reserve will be an effect, not a cause, of US$ weakness.

Current Market Situation

We turned intermediate-term bullish on the senior commodity currencies (the A$ and the C$) early this year. Regardless of whether or not their cyclical bear markets were over, these currencies were expected to trend upward through 2014 in parallel with a gradual shift in relative strength towards most things commodity-related.

So far, so good. The A$ moved sharply higher from late-January through to early-April and then commenced what looks very much like a mid-trend consolidation. Based on the lead-lag relationship between gold and the A$ this consolidation could continue for another 2-3 weeks, but in any case we expect the A$ to work its way up to at least the high-90s over the months ahead.



The C$ has been weaker than the A$ this year; however, it is slowly but surely strengthening. The confluence of resistance at 93-94 is a reasonable 2-month target.

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 June 2014:

[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]

  *Lydian International (LYD.TO) had significant insider buying over the past two weeks, with Howard Stevenson, the CEO, picking up 50,000 shares in the public market at around C$1.00.

We should soon get important news from LYD in the form of a revised FS for its Amulsar gold project.

  *Pilot Gold (PLG.TO) reminded the market that it has valuable assets in addition to Kinsley Mountain (Nevada) by reporting a drilling result that constitutes a new discovery at its TV Tower project in Turkey. The result, which came from the first hole drilled into a new gold-copper porphyry target called the Valley Porphyry, was 0.99 grams/tonne gold and 0.39% copper over 153.1 metres starting from near the surface. This is good news as it adds to the TV Tower project's considerable potential.

Also, PLG announced that it was buying Cadillac Resources (TSXV: CQX), a tiny exploration-stage gold miner, for shares and warrants with a current market value of around C$7M. The asset being acquired is the Goldstrike project in Utah. Goldstrike is a past-producing, oxide heap leach project that PLG's top-notch exploration team will now incubate.

Although the CQX acquisition is very small, the announcement put some downward pressure on PLG's stock price last Friday.

  *Ramelius Resources (RMS.AX) has agreed to pay about $4M to acquire the Kathleen Valley gold project, which is located close to RMS's Vivien gold project in Western Australia. This may or may not be a reasonable price to pay for an exploration-stage project with 130K ounces of resources, but either way we think that RMS should be conserving its cash given that its Mt Magnet operation is cash-flow negative at the current gold price.

  *Rio Alto (RIO.TO, RIOM) is no longer part of the TSI List, but we still have a large position in the stock in our own accounts and are therefore still following its progress closely.

A recent note put out by Canaccord included a comment about RIO likely getting a significantly higher weighting in GDXJ due to the SUE takeover. If so it would mean increased demand for RIO shares during the weeks following the completion of the merger (sometime in August?), which could create the selling opportunity we are hoping for.

As we said in our previous discussions of the RIO-SUE merger, the only problem we have with this deal is the price being paid. Our view is that RIO's management is exchanging half the company for an asset that, although a logical fit with RIO's existing business, is not worth more than one quarter of the company. A consequence will be a substantially reduced per-share value for the post-merger RIO.

  *True Gold Mining (TGM.V) announced drilling results that have potentially extended one of the shallow, oxidised gold deposits at its construction-stage Karma project (Burkina Faso) by 50%. The most notable result was 29.5 g/t Au over 6.0 metres.

One of the reasons we like TGM as a longer-term speculation is the high probability that the company's Karma project has a lot more economically-viable gold than the amount included in the FS. If so, the FS substantially understates the project's net asset value.

List of candidates for new buying

From within the ranks of TSI stock selections, the best candidates for new buying at this time are:

1) EDV.TO (last Friday's closing price: C$0.81).

2) EVN.AX (last Friday's closing price: A$0.84).

3) ORE.TO (last Friday's closing price: C$0.68).

4) RSG.AX (last Friday's closing price: A$0.62).

5) TGM.V (last Friday's closing price: C$0.42).

Review of price action for individual stocks

The stocks of companies with economically-viable businesses at the current gold price generally held up well during the recent sector-wide downturn, and three weeks ago it was already apparent that many of these stocks were close to completing routine corrections. Examples from the TSI Stocks List are charted below. Also displayed below is the chart of a TSI stock that doesn't have a viable business at the current gold price, but is showing signs of having reversed upward nonetheless.

1. AAU signaled an end to its correction by breaking above resistance at US$1.40 last week. There is additional resistance at US$1.50 that must now be overcome, after which a rise to around US$2.00 would be on the cards.



2. AKG's recent close above US$2.00 was an early warning that its correction is over. A break above US$2.20 would be more conclusive evidence.



3. EDV.TO has been a relatively strong gold stock since the beginning of this year (actually, EDV's relative strength began almost 12 months ago). It signaled that its correction is probably over when it closed above C$0.80 last Thursday.



4. GSS does not have a viable business at the current gold price (we estimate that GSS would need an average gold price of at least $1350/oz to be profitable), but there are preliminary signs in the price action that it has completed its correction. A daily close above US$0.60 would be a more definitive sign.



5. LYD.TO has been very strong over the past three weeks and is now short-term 'overbought'. We would hold off on new buying pending the results of the Amulsar project's updated FS.



6. ORE.TO completed its correction back in April and is now testing resistance defined by its highs of the year. A break above C$0.70 would create a short-term target of around C$1.00.



7. PG.TO completed its correction back in April and rocketed up to intermediate-term resistance last week. It is now 'overbought' and is no longer a good candidate for new buying, but the stock's intermediate-term risk/reward is still attractive.



8. Last week's break above C$1.50 signaled an end to PLG.TO's correction. C$2.00 looks like a realistic short-term target, but some consolidation around C$1.50 could precede the next meaningful rise.



9. TGM.V signaled an end to its correction a couple of weeks ago, but it has run into a wall of supply in the low-C$0.40s. Our short-term target is C$0.50.

Chart Sources

Charts appearing in today's commentary are courtesy of:

http://stockcharts.com/index.html