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   -- Weekly Market Update for the Week Commencing 16th September 2013

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 will end by 2013. In real (gold) terms, bonds commenced a secular BEAR market in 2001 that will continue until 2014-2020. (Last update: 23 January 2012)

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

Market
Short-Term
(1-3 month)
Intermediate-Term
(6-12 month)
Long-Term
(2-5 Year)
Gold Neutral
(10-Sep-13)
Bullish
(26-Mar-12)
Bullish

US$ (Dollar Index) Neutral
(24-Dec-12)
Bullish
(01-May-13)
 
Neutral
(19-Sep-07)

Bonds (US T-Bond) Bullish
(24-Jun-13)
Neutral
(18-Jan-12)
Bearish
Stock Market (DJW) Bearish
(15-Jul-13)
Bearish
(28-Nov-11)
Bearish

Gold Stocks (HUI) Neutral
(10-Sep-13)
Bullish
(23-Jun-10)
Bullish

Oil Neutral
(30-Jul-12)
Neutral
(31-Jan-11)
Bullish

Industrial Metals (GYX) Neutral
(30-Jul-12)
Neutral
(29-Aug-11)
Neutral
(11-Jan-10)


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 fundamentals, sentiment and technicals, and short-term views by sentiment and technicals.

The start of the dreaded "taper"

It is widely expected that the Fed will announce the first step in the reduction of its monetary accommodation in the policy statement issued at the completion of the FOMC Meeting on Wednesday 18th September. As far as we can tell, most Fed watchers expect the pace of asset monetisation to be scaled back from the current $85B/month to somewhere in the $60B-$75B/month range.

It's noteworthy that the Fed began to tighten its monetary policy in 'baby steps' starting about one year into the 2003-2007 monetary-inflation-fueled boom, but here we are, four years into the next monetary-inflation-fueled boom, and the Fed is a long way from embarking on any sort of genuine tightening. Instead, the Fed is gingerly planning to reduce the extent of its monetary easing in 'baby steps'. The obvious conclusion is that the US economy is becoming increasingly dependent on money-pumping, with stimulus and price-support programs first preventing existing mal-investments from being liquidated and then adding new mal-investments into the mix.

To get an inkling of the absurdity of the current US monetary situation, assume that the Fed does the maximum it is expected to do this week and reduces its monthly asset monetisation from $85B to $60B. $60B/month of asset monetisation would still constitute the most aggressive monetary easing in US history apart from the past 8 months, the 7-month "QE2" period from late-2010 through to mid-2011, and the period from late-2008 through to mid-2009 during which "QE1" was in progress. In fact, a Federal Reserve program that involved the creation of $60B of new money every month would have been unthinkable prior to late-2008. But now, four years into a so-called economic recovery, many market participants and commentators are worried that it won't be enough!

The "taper" has been so widely telegraphed that Wednesday's official announcement shouldn't have a big effect on the financial markets. However, this week is still likely to be more volatile than usual as short-term traders first make their bets about what the Fed is going to say/do and how other traders are going to react, and then reposition in the aftermath of the news. 

Fed expansion plus commercial bank contraction

Although the year-over-year rate of growth in US True Money Supply (TMS) is still high by historical standards, the following chart shows that it has just dropped to its lowest level since late-2008.



However, it is more likely to rise than fall over the next few months. The reason is illustrated by the following chart of the annualised 3-month TMS growth rate. The annualised 3-month rate of US monetary inflation bottomed at just below 4% in March of this year and has since rebounded to 9.5%.



There are some interesting details behind this year's US TMS statistics. First, since January of this year there has been almost no net change in US commercial bank credit and yet the US money supply has risen by about $400B. This tells us that the rise in the money supply since January of this year was driven almost totally by the Fed. Second, since the end of April this year there has been a net contraction of almost $100B in US commercial bank credit while the US money supply has risen by about $250B. This tells us that the Fed has been responsible for more than 100% of US money-supply growth over the past four months.

The Fed has directly injected enough new money into the US economy over the past four months to cause the short-term rate of TMS growth to accelerate upward despite a credit contraction in the private banking sector, which confirms some things we already knew. Most notably, it confirms that a) the Fed's QE not only boosts bank reserves, but also boosts the quantity of money circulating within the economy (bank reserves are not included in TMS), and b) the Fed is capable of expanding the US money supply without any help from the commercial banks.

We think there are two main reasons why US commercial banks, as a group, are not expanding their balance sheets, the first being that the pool of willing and qualified borrowers has shrunk due to the lacklustre economy and existing high debt levels.

The second and probably the more important reason for the reticence of commercial banks to expand credit is that the banks are now far more risk averse due to having very weak balance sheets. The balance sheets that are made public generally look fine, but this could be mainly because banks are no longer required to mark their assets to market in the reports that are made public. We suspect that a proper marking to market of all bank assets would in many cases reveal a precarious financial position.

There's no way for us to know for sure, but balance-sheet weakness would go a long way towards explaining the recent behaviour of the commercial banking industry. It would explain why banks seem to be wary about monetising assets such as T-Notes in addition to being wary about making new loans.

The Stock Market

Our stock market outlook is global, not US-centric. However, our short-term bearish outlook now hinges on the failure of the US S&P500 Index to confirm the new high for the year recently achieved by the US NASDAQ100 Index. The relevant charts are displayed below. Consequently, if the S&P500 removes this non-confirmation by closing above its early-August high, our short-term stock market outlook will automatically shift to "neutral".

Note that a break to a new high by the S&P500 wouldn't suggest that significant additional upside was in store. It would just 'muddy the waters'.

This week's important US economic events

Date Description
Monday Sep 16 Empire State Mfg Survey
Industrial Production
Tuesday Sep 17 CPI
TIC Report
Wednesday Sep 18 FOMC Announcement and Bernanke Press Conference
Housing Starts
Thursday Sep 19

Current Account Balance
Existing Home Sales
Philadelphia Fed Survey
Leading Economic Indicators

Friday Sep 20 No important events scheduled

Gold and the Dollar

Gold

A good example of bad analysis

The article posted HERE summarises the latest gold-related forecasts of Gold Fields Mineral Services (GFMS) and contains good examples of what's wrong with the typical gold-market analysis put out by GFMS and the World Gold Council (WGC). In brief, here's why.

First, GFMS is forecasting a decline in gold demand and a rise in the gold price (to the low-$1500/oz area) over the next several months. However, such an outcome is impossible. As we've explained in the past, the change in the gold price over a period is the ONLY reliable measure of the change in gold demand over the same period, with a higher price necessarily implying increased demand and a falling price necessarily implying reduced demand. In other words, in order for the price to rise to the low-$1500s, demand will have to rise. Alternatively, if demand falls then the price will fall. In the gold market it is simply not possible to have a rising price in parallel with falling demand or a falling price in parallel with rising demand.

Second, GFMS and many other gold-market analysts continue to begin their analyses with the ridiculous premise that total gold supply is roughly equal to annual mine supply plus scrap supply, despite the fact that the sum of annual mine and scrap supply is no more than 2% of the existing aboveground gold inventory. They then attempt to determine a demand number that is consistent with this bogus supply number by adding up the amount of gold flowing to different sectors of the overall market, as if: 1) volume is an indicator of demand (it isn't; an increase in volume could be associated with a rise or a fall in demand), 2) demand can be calculated independently of price (it can't be), and 3) the 150,000 tonnes or so of aboveground gold can be safely ignored. As a colleague of ours likes to put it, the analysis is so off-track it's not even wrong.

Gold and the Fed's "tapering"

In previous commentaries we've covered our reasons for believing that not only would a "tapering" of the Fed's current QE program not be bearish for the gold market beyond short-lived psychological effects, but also that additional QE will not be required for gold to embark on the next upward leg of its long-term bull market. In summary, our reasoning is:

1) Gold is propelled upward by the negative effects of monetary inflation, not the monetary inflation itself.

2) The superficial effects of monetary inflation will usually be positive for a while. That's why the policy is popular. Gold will tend to go out of favour as long as the superficial positive effects are dominant. There is no way of knowing, ahead of time, how long this will be.

3) The negative effects of monetary inflation include "price inflation", excessive risk-taking, reduced saving, and economic weakness stemming from misdirected investment and reduced saving.

4) Almost regardless of what the Fed does from now on, there has already been more than enough monetary inflation to ensure that there will be blatant negative effects in the future. As far as the next year is concerned, negative effects in the form of economic weakness are likely to become sufficiently obvious to foster the general belief that the inflation policy has failed.

5) The loss of confidence in the Fed caused by the obvious failure of QE to bring about genuine economic progress will, in our opinion, be one of the two driving forces behind the next major advance in the US$ gold price. We expect the other driving force to be the resumption of the euro-zone debt/banking crisis.

Current Market Situation

Gold support at $1350 gave way late last week. This increases the probability that the June low ($1150-$1200) will be tested before the long-term bull market's next upward leg begins.

We do not think that there is a realistic chance of gold falling further than the $1150-$1200 range. Sentiment is already 'in the toilet', having not recovered by much during the July-August price rebound.



Former support in the $1350s will now act as resistance during rally attempts, but the most important resistance is clearly the Syria-inspired late-August price high. A daily close above this level would definitively signal that the bull market's next upward leg had begun.

Silver

The following weekly silver chart shows the moving-average envelope that usually limits rallies and declines in the silver market. The silver price only ever makes a sustained break above this envelope when a major upside blow-off is in progress, and the silver price only ever trades well below the bottom of this envelope during a crash. It therefore isn't surprising that the silver price has reversed lower after trading slightly above the top of its MA envelope during the second half of August.



The silver/gold ratio moved sharply higher during July-August and had become very 'overbought' by late-August. It is no longer 'overbought', but has not yet 'corrected' enough to suggest that a new low-risk silver buying opportunity is at hand.



We will continually re-assess as new information becomes available, but we would probably be buyers of silver at around $20.

Gold Stocks

In the 11th September Interim Update we wrote:

"GDX, a proxy for the stocks of large and mid-size gold miners, has dropped to its 50-day MA and lateral support. This is as low as it can go without eliminating the second of our two short-term scenarios (a rally to new multi-month highs in September followed by two months of choppy sideways trading, as per the 1968-1970 Model). But although the second scenario can't yet be ruled out, the first scenario (a downward trend to final low during October or November) is now the favourite."

The following daily chart shows that GDX fell far enough over the final two days of last week to clearly break below lateral support and its 50-day MA. The second of our two short-term scenarios can therefore now be ruled out.



The scenario that has just been eliminated from contention involved the gold sector continuing to follow the 1968-1970 Model. The next chart shows that until two weeks ago the HUI appeared to be bottoming in a very similar fashion to the way the Barrons Gold Mining Index (BGMI) bottomed at the end of the 1968-1970 major correction. The chart also illustrates the divergence that has since occurred.



In any financial market there will always be a myriad of short-term possibilities. This is true for the gold sector right now, but the clear-cut favourite among these possibilities is a major low during October-November (most likely October). The major October-November low could turn out to be a successful test of the June low or a new low for the year.

Note that if the gold sector is headed for an October or November low, it is almost certainly not going to get there in a straight line. Along the way there will be rebounds lasting at least a few days, one of which is likely to begin soon.

Unfortunately, of the two short-term scenarios we had identified, the one that appears to be playing out is the more difficult to trade. It would have made life easier if the market had given us a better short-term selling opportunity before providing us with the next general short-term buying opportunity, but, to use a well-worn analogy, we have to play the hands we are dealt.

We don't like to give pep talks or try to convince anyone to buy/hold any particular investment. We simply present our analyses and opinions as objectively as we can. However, if you have stuck with the gold sector through the major correction of the past two years it seems to us that it would make sense to stick with it a while longer, because there's a high probability that this year's low will be followed by a very strong upward trend. If we are right that gold is still in a bull market then the upward trend should last 3-5 years (as per 1970-1974 or 1976-1980), but even if our long-term bullish view is wrong (extremely unlikely, but not impossible) the upward trend should last 6-18 months (as per 1986-1987 or 1993-1994).

Currency Market Update

The two senior currencies still aren't doing much relative to each other. We think that the US$ is more likely to fall than to rise against the euro over the coming 1-2 months, but not by much.

The following chart shows a strong inverse relationship over the past year between the Yen and the Dow Jones World Stock Index (DJW). This means that despite "Abenomics", the Yen is still behaving like a safe-haven currency. It also means that the next significant Yen rally will likely coincide with the next significant stock market decline. We expect that both will soon begin.

Update 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 September 2013:

[Note: 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) reported drilling results from its Tuligtic gold-silver project in Mexico. The 2013 drill program is focused on expanding the known resource (3.6M gold-equivalent ounces) adjacent to the current resource shell and within what is considered a potential pit shell.

The reported results were good and will almost certainly contribute to a positive resource update in the future. The best result came from Hole TU-13-295, which intersected 98 metres of 1.1 g/t gold-equivalent and 33.78 metres of 4.4 g/t gold-equivalent.

  *Pilot Gold (PLG.TO) reported another set of drilling results from the KCD target at its TV Tower project in Turkey. The KCD target contains a near-surface silver zone and a deeper/higher-grade gold zone.

Of the latest batch of drilling results, the most significant was a step-out hole that extended the silver zone. This hole intersected 90.2 g/t silver over 91.5 metres.

This year's drilling of the KCD target is almost complete, but there will be plenty of news from PLG over the months ahead due to a) the drilling of other targets at TV Tower, b) the new drilling program underway at the Kinsley Mountain project in Nevada, and c) an initial resource estimate for the KCD target.

  *Pretium Resources (PVG) issued drilling results and an update on the progress of its Bulk Sample Program (BSP). As usual for this company, some spectacular gold intercepts were announced. For example, results from recent underground drilling associated with the BSP included 1,622 grams of gold over 6.25 metres and 9,900 grams of gold over 0.50 metres.

The excavation of material for the 10,000-tonne bulk sample is complete and drilling related to the BSP (a total of 202 holes for 16,500m) will be complete by mid-September. The bulk sample material will be transported to Montana for milling over the next two months, after which Strathcona (PVG's consultant) will analyse all the results and compile its report. Strathcona's report on the BSP is now expected early next year, or 1-2 months later than previously envisaged. Between now and when Strathcona's BSP report is published, we think that PVG will trade like a leveraged play on the overall gold sector.

  *Ramelius Resources (RMS.AX) had three pieces of significant news.

First, the company updated the market on its progress. In particular, it announced that a) gold production at its Mt Magnet mine is expected to be 18,000 ounces during the current (September) quarter and 21,000-23,000 ounces during the December quarter, and b) initial gold production from the new Coogee mine is expected to be 5,000 ounces during the December quarter. RMS is therefore forecasting gold production of around 45K ounces during the second half of this year. If this forecast is achieved it will be a good result.

Second, RMS advised that it was raising up to A$16M via a pro-rata (1-for-4) rights issue. Shareholders with registered addresses in Australia or New Zealand will be eligible to purchase one new share at A$0.18 for every four existing shares.

It will probably make sense for RMS shareholders with Australia/NZ addresses to take advantage of this rights issue IF the stock price is at or above A$0.18 near the scheduled closing date of the issue, but since the scheduled closing date is about 5 weeks away (21st October) there is no need to make an immediate decision. Looking at the situation from a different angle, if you are an eligible shareholder with a desire to add to your exposure then you now know that you will be able to do so at no higher than A$0.18/share up until 21st October. Therefore, you could reasonably decide to hold off on any new buying unless the shares become available on the market at well below A$0.18.

Note: A pro-rata below-the-market rights issue is the fairest way for a company such as RMS to raise money, because it enables existing shareholders to avoid having their stakes diluted.

Third, RMS issued its annual Resources and Reserves Statement. The company's total gold resource is now 2.55M ounces (1.65M ounces M&I plus 0.9M ounces Inferred), which represents a small decline over the past 12 months.

Candidates for new buying

As a result of last week's price action many TSI gold stocks are now at levels at which some buying could make sense. However, due to increased probability that the gold sector is headed for an October low, we have narrowed-down our list of the best candidates for new buying to only three stocks.

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

1) EDV.TO at around C$0.70 (last Friday's closing price: C$0.73)

2) PVG below US$7.50 (last Friday's closing price: US$7.45)

3) RIO.TO/RIOM (last Friday's closing price: C$2.16/US$2.07)

TSI stocks affected by upcoming changes to indexes and ETF holdings

A quarterly index and ETF re-balancing is scheduled to take effect after the close of trading on Friday 20th September. As far as we can tell, this will affect TSI stock selections as follows:

1) Almaden (AMM.TO) and Golden Star (GSC.TO) will be deleted from the S&P/TSX Small Cap Index. This will result in some additional selling pressure in these stocks on 20th September.

2) Rio Alto (RIO.TO) will be added to the S&P/TSX Small Cap Index. This will result in some additional buying pressure in this stock on 20th September.

3) We haven't been able to confirm that this change will definitely happen, but new rules put in place by the index that the Gold Miners ETF (GDX) attempts to track could result in Golden Star (GSS/GSC) being fully or partially removed from GDX at the end of this week. If this change does happen it will result in significant additional selling pressure in Golden Star shares.

The above-mentioned changes could lead to good buying opportunities in AAU/AMM.TO and GSS/GSC.TO near the end of trading on Friday 20th September.

Chart Sources

Charts appearing in today's commentary are courtesy of:

http://stockcharts.com/index.html



 
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