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   -- Weekly Market Update for the Week Commencing 16th December 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
(04-Nov-13)
Bullish
(26-Mar-12)
Bullish
US$ (Dollar Index) Bullish
(11-Dec-13)
Neutral
(18-Sep-13)
Neutral
(19-Sep-07)
Bonds (US T-Bond) Bullish
(11-Dec-13)
Neutral
(18-Jan-12)
Bearish
Stock Market (DJW) Bearish
(11-Dec-13)
Bearish
(28-Nov-11)
Bearish
Gold Stocks (HUI) Neutral
(04-Nov-13)
Bullish
(23-Jun-10)
Bullish
Oil Neutral
(30-Jul-12)
Neutral
(31-Jan-11)
Bullish
Industrial Metals (GYX) Bearish
(06-Nov-13)
Bearish
(13-Nov-13)
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.

Monetary Inflation Update

The US

Despite the Fed's efforts, the year-over-year (YOY) rate of growth in US True Money Supply (TMS) has just dipped below 8% for the first time since November-2008. The situation is illustrated below.



Why is the Fed's creation of around $85B of new money every month being accompanied by a decline in the US monetary inflation rate?

Although we can't be certain of the reason, we can come up with a plausible answer to the above question. The answer begins with the recognition that the growth in the US money supply over any period will roughly equal the net quantity of dollars added by the Fed plus the net quantity of dollars added by the private banks minus the net quantity of dollars flowing out of the US.

Over the past 12 months, the Fed has added about $1T of new money via its debt monetisation and the US True Money Supply has increased by about $700B. As per the formula mentioned in the above paragraph, this means that about $300B must have been subtracted from the US money supply by the combination of deposit-reduction on the part of US-based private banks and money flowing out of the US.

The private banking industry has done very little deposit-creation over the past 12 months, but we doubt that it has taken steps to reduce its collective deposit base. Therefore, the most likely reason for the TMS increase of the past 12 months being about $300B less than the amount of new money created by the Fed is the transfer of a few hundred billion dollars from the US to other countries. Considering the performances of stocks, bonds and currencies around the world, most of the money probably ended up in Europe (the euro-zone, the UK and Switzerland).

The approximately 8% rate of US monetary inflation of the past 12 months is still on a high side by long-term historical standards, but the US bubble economy of the present day probably can't tolerate a more normal rate of money-supply growth. As a consequence, some sort of economic unravelling is a distinct possibility for 2014. Also as a consequence, the Fed's next move might be to ramp up, rather than to "taper", its 'monetary accommodation'.

Japan

As explained in previous TSI commentaries, the 'great Yen inflation' instigated by the Bank of Japan (BOJ) earlier this year has actually been far from great and hasn't, up until now, altered the strong seasonal tendencies of Japan's money supply.

As illustrated by the first of the following charts, the annualised 3-month rate of change in Japan's M2 money supply rose to a May peak and then fell to a September-October trough, as it almost always does. This year's main differences in the behaviour of the annualised 3-month M2 growth rate are that the May peak was a little higher than average and the September-October trough was just above zero rather than just below zero.

As illustrated by the second of the following charts, the aforementioned differences have resulted in the 12-month rate of change in Japan's M2 money supply reaching its highest level in at least 14 years. Note, though, that what constitutes a 14-year high for Japan's monetary inflation rate would be in the bottom quartile of the US monetary inflation rate's 14-year range.



The gap is narrowing, but the monetary inflation differential, the most important long-term exchange-rate influence, remains decisively bullish for the Yen relative to the US$.

Various

Here's what's happening on the monetary inflation front in some other countries:

1) Australia's YOY TMS growth rate has flatlined at around 10% over the past 7 months, which is close to the mid-point of the 14-year range and about 2% above the current US monetary inflation rate.

The fact that Australia's monetary inflation rate has oscillated around an average of 10% over the past 14 years explains why Australia has an obvious inflation problem, with prices having risen rapidly throughout the economy for many years. The fact that the monetary inflation rate remains near 10% tells us that the inflation problem is going to get worse, and the fact that the A$'s rapid loss of domestic purchasing power has not yet been reflected in the foreign exchange rate suggests that the decline in the A$/US$ rate has a long way to go.



2) The YOY growth rate of Canada's M1+ money supply (the M1+ aggregate reported by the Bank of Canada is a reasonable proxy for TMS) peaked at just above 14% in early 2010. Over the past three years it has oscillated within the 6%-10% range and was 8.7% at the end of October-2013 (the latest month for which data are available).

As is the case with Australia and many other countries, Canada's money supply has grown fast enough over many years to create an inflation problem (most obvious in the real estate market). Considering the recent money-supply data, the problem looks set to get worse.



3) Brazil's central bank has been hiking interest rates over the past two years in an effort to reduce the country's inflation problem. The interest rate hikes have put irresistible downward pressure on Brazil's stock market, but with the following chart showing that Brazil's TMS grew by more than 15% over the past 12 months they clearly haven't been effective in dealing with the root cause of the inflation problem. The problem is therefore destined to get worse, leading to additional currency and economic weakness.



4) Hong Kong probably has the most blatant inflation problem in the developed world, but the Hong Kong monetary authority continues to add fuel to the inflation fire by maintaining a near-zero official interest rate and double-digit money-supply growth. This policy-stupidity is necessitated by the desire to maintain the HK dollar's totally inappropriate peg to the US$.

We are amazed by how long it is taking for Hong Kong's policy-makers to come to their senses. The US$ peg must either go or be changed in a way that results in a large increase in the HK dollar's exchange rate.

 

Copper Update

The copper price broke out to the downside in November, but there was very little follow-through and the price has since moved back up to near the top of its 6-month range. Copper's resilience is surprising.



There's a good chance that prior to the completion of its cyclical bear market the copper price will break below long-term support at $3.00 and drop to the mid-$2 area or lower. However, one realistic possibility, given the recent price action, is that there will be a rally to as high as $3.80 prior to the start of the market's final downward leg. A solid break above $3.35 would suggest that such a rally was underway.

Our short-term outlook for industrial metals will shift from "bearish" to "neutral" if copper achieves a daily close above $3.35.

The Stock Market

The US Market

The S&P500 Index (SPX)

By the thinnest of margins, the SPX managed to hold support at 1775 last week. It therefore hasn't yet signaled that a short-term top is in place.



Due to sentiment (the Investors Intelligence Bull/Bear ratio made a new 25-year high last week) and the cyclical bull market's advanced age (the bull is now three months shy of its 5th birthday), there's a high risk that a short-term top will evolve into a long-term top. However, before we start getting enthused about the possibility that a long-term top is in place, we need to get evidence that a short-term top is in place. A daily close below 1775 would be the first sign, while a weekly close below 1775 would be a more definitive sign.

As discussed in last week's Interim Update, the level at which the SPX ends this month could be telling. The reason is that it is rare for the US stock market to not achieve a net gain during the month of December, especially when the market has been strong over the course of the year.

We point out that over the past 10 years the only 'down' December occurred in 2007. It was only a small decline, but it was a warning of the much greater decline to come. We also point out that seasonal forces are decisively bullish over the next 2-3 weeks, which is another reason that even a small amount of weakness at this time could be significant.

A failure by the SPX to end this year at 1806 (its November close) or higher could therefore be ominous, whereas closing out the month of December below 1775 would almost certainly be ominous.

Sector ETFs that are in interesting positions

ITB, the iShares Home Construction ETF, made an intermediate-term top in May and has consolidated since making a short-term bottom in August. As illustrated below, the consolidation range is narrowing. We are therefore likely to get a breakout, one way or the other, within the next three weeks.

A break above $24 would indicate that the May-December price action was a routine intermediate-term correction for the US home construction sector, while a break below $21.50 would suggest that a major decline began last May.



XLE, the Energy ETF, is a proxy for the only commodity-related stocks that had satisfactory performance over the past two years (the oil and gas stocks).

A daily close below $84 would be an early warning that XLE's intermediate-term upward trend had ended. Consecutive daily closes below the 200-day MA (currently at $81.56) would be a more conclusive warning of an intermediate-term trend reversal.



A few months ago we mentioned that the coal sector of the stock market, as represented by KOL, would be a reasonable long-side speculation due to how depressed this sector had become in dollar terms and relative to the oil-and-gas sector. KOL subsequently gained about 10%, but didn't show enough strength to suggest that its major trend had reversed upward and now appears to be resuming its long-term decline.

A daily close above the high of the past two months would be an early warning of an important trend reversal (from down to up), while a solid break above intermediate-term resistance at $21.50 would be a more definitive reversal signal.



Bear Funds

The Prudent Bear Fund (BEARX) is a conservative way to bet against the US stock market. This actively-managed bear fund tends not to move by much from day to day, but based on its long-term history (see chart below) is likely to rise by at least 100% from its bull-market low point to its bear-market high point.

BEARX was recently added to the TSI Stocks List and will remain there as long as the SPX ends the year below 1806.

This week's important US economic events

Date Description
Monday Dec 16 Empire State Mfg Survey
Q3 Productivity and Costs (revised)
TIC Report
Industrial Production
Tuesday Dec 17 CPI
Q3 Current Account
Housing Market Index
Wednesday Dec 18 FOMC Meeting Announcement, FOMC Forecasts, Bernanke press conference
Housing Starts
Thursday Dec 19

Philadelphia Fed Survey
Existing Home Sales
Leading Economic Indicators

Friday Dec 20 Expiry of December futures and options

Gold and the Dollar

Gold

Nothing has changed in the gold market since we wrote the following in last week's Interim Update:

"Getting above resistance in the $1320s would provide conclusive evidence of a trend reversal, but considering the extent to which the gold market is 'oversold', the extremely depressed sentiment, the length of the preceding decline and the time of the year, we would interpret consecutive daily closes above $1280 as confirmation that a sustainable upward reversal had occurred.

Our short-term gold market outlook will automatically shift to "bullish" following consecutive daily closes above $1280 or following a shift to "bullish" in our short-term gold-stock outlook (as discussed below).
"

The daily chart displayed below shows the positive correlation between gold and the Yen over the past three years. We don't think that there has been a direct causal relationship between these two markets, meaning it's unlikely that gold has driven the Yen or that the Yen has driven gold. Instead, we think that both the Yen and gold have reacted in the same way to changes in the common belief regarding the benefits of monetary inflation. In particular, both gold and the Yen began their respective large declines during the final quarter of 2012 when the belief began to take hold that monetary inflation would generate real/sustainable economic progress in both the US and Japan. Although the belief is false, it has undoubtedly played a big role in the financial markets over the past 14 months.

Chances are that gold and the Yen will reach major lows at around the same time, with this month being the most likely time for such lows. That being said, our confidence that gold is very close to a major low is greater than our confidence that the Yen is very close to a major low. The reason is that gold's supply is essentially fixed, whereas it is technically possible for the Bank of Japan to substantially increase the Yen supply.



Gold Stocks

On a daily closing basis both the HUI and the XAU held above their 6th December lows last week, keeping alive the possibility that the bear-market bottom coincided with the 3-year anniversary of the XAU's bull-market top. However, there is no evidence in the price action that a reversal has occurred. This means that although a major low is probably very close in terms of both price and time, it is probably not in place yet.

The following excerpt from last week's Interim Update remains applicable:

"Considering the price action, the time of the year and our belief that the ultimate low is close at hand if not already in place, our short-term gold-stock outlook will automatically shift to "bullish" if both the HUI and the XAU achieve daily closes above their 11th December intra-day highs (207 and 86.6). This would constitute enough additional strength to suggest that an important upward reversal had, indeed, coincided with the 3-year anniversary of the XAU's major high."



Currency Market Update

The Australian Dollar (A$) is testing intermediate-term support defined by its August low. There is a risk that a near-term break below this support will generate another wave of speculative selling, quickly resulting in a few points of additional downside. However, it's more likely that the support will hold for now.

Our expectation is that the A$ will work its way down to the 70s in fits and starts over the coming two years.



The A$ is testing its low for the year at the same time as the euro is testing its high for the year.

The euro has been boosted since mid-2013 by the increasing popularity within the financial world of all things European. We don't know if the shift towards Europe has run its course, but with European equities having recently begun to trend downward relative to US equities and with the euro having just turned lower from near its 52-week high after becoming slightly overbought and moderately over-valued, it may well have done so.

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 December 2013:

[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]

  *Dragon Mining (DRA.AX) advised that it is reviewing its operations with the aim of bringing about further reductions in costs and that the Environmental Impact Assessment Report for its exploration-stage Kuusamo gold project (Finland) has been released for public comment.

The company also advised that Eurogold, the owner of 24% of DRA, has requested a shareholders meeting to consider the removal of DRA's chairman, managing director and two other directors. It therefore seems that a top-level shakeup is in the works at DRA, which, given the company's performance, would be appropriate.

  *In a press release last Friday, Pretium Resources (PVG) reported additional results from the milling of its 10,000-tonne (10,302-tonne, actually) bulk sample. The as-good-as-final result was gold production of 5,865 ounces, versus the 4,000 ounces that were predicted by the Snowden resource model. This is an excellent result, but the information included in last Friday's press release doesn't address the issues raised by Strathcona. For example, it doesn't indicate how well the production from each section of the bulk sample matched up with the resource model. That is, it doesn't answer the first question mentioned in the following excerpt from our 9th December commentary:

"The final bulk-sample milling results are going to show that a lot more gold was recovered than originally expected, meaning that the average grade of the 10,000-tonne sample is a lot higher than the average grade predicted by the Snowden resource model. This is obviously a plus, but the issues raised by Strathcona will not be resolved by the total gold recovery from the bulk sample regardless of how high it ends up being. The salient questions revolve around whether the gold was dispersed within the 10,000-tonne sample in accordance with the resource model, and whether the sample itself was representative (the 10,000-tonne sample is about 0.06% of the currently-defined deposit). The second of these questions won't be answered in the near future, but if the first question is answered in the affirmative it will be a big step in the right direction."

According to last Friday's press release, the answer to first question will be available within the next few weeks. Specifically, it was stated in the press release that the total number of ounces processed on an individual cross-cut basis will be reconciled against the local resource model and documented as part of an updated NI 43-101-compliant Valley of the Kings Mineral Resource estimate to be completed by Snowden. The updated Mineral Resource estimate for the Valley of the Kings is expected later this month, with the NI 43-101-compliant Technical Report to follow.

Although last Friday's news didn't provide much in the way of relevant new information, it wouldn't have surprised us if the stock price had risen by more in reaction to the news. The reason the stock price didn't rise by much on Friday can probably be explained by the following chart. The top half of the chart shows that substantial resistance exists in the US$6-US$7 range. It will be difficult for PVG to overcome this resistance in the absence of sector-wide strength, especially given the message of the bottom half of the chart. The bottom half of the chart shows that relative to its peer group (represented here by GLDX) PVG had already recouped all of its Strathcona-related losses prior to last Friday's news. On a side note, the July-2013 high for the PVG/GLDX ratio was an all-time high.



We remain bullish on PVG's intermediate-term prospects. At the same time we are concerned about a) the uncertainty that persists regarding the most appropriate mining method for the Valley of the Kings deposit, b) PVG's high valuation relative to many other beaten-down gold-mining stocks, and c) the likelihood that PVG's management will take advantage of the stock's recent strong rebound by arranging another equity financing. Our conclusion is that at current prices there are better candidates for new buying within the gold sector.

  *Ramelius Resources (RMS.AX) was halted over the final two days of the week before last, pending an announcement from the company regarding a pit-wall failure at its Western Queen South mine. The announcement came on Monday 9th December.

The effect of the pit-wall failure is not as bad as feared. In fact, it isn't significant. The company expects that it will only take about 14 days to repair the damage and that due to having 4 months of stockpiled ore there will be no effect on gold production.

The same announcement contained updated production guidance resulting from the ball-mill motor failure that happened in November. In this case the effect was significant, with this quarter's production forecast falling from 27K ounces to 21K ounces. This bad news had previously been discounted by the stock market and therefore didn't cause additional price weakness.

However, the stock price fell sharply the day after the bad news regarding the reduced production guidance. This could have been because some traders were aware of the news that would arrive later in the week. We are referring to Friday's announcement of details regarding the "Gold Pre-Pay Finance Facility" arranged early last month.

What was previously known was that RMS had effectively forward-sold A$16M of gold, in that it would receive a $16M cash advance to be repaid via the delivery of gold from January through to August of 2014. What wasn't known was the price of the forward gold sale.

As a result of last Friday's announcement we now know that RMS has, for all intents and purposes, agreed to sell 1492 ounces of gold per month over the first 8 months of next year at a price of A$1340/oz (about US$1200/oz at the current exchange rate). This is obviously a bad deal, because a) gold for delivery during January-August of next year could be sold in the futures market right now for around US$1235/oz, and b) the gold price is probably near a major low.

Fortunately, during the period covered by the credit facility RMS should still be able to sell about 6000 ounces of gold per month at the spot price.

List of candidates for new buying

From within the ranks of TSI stock selections, below is a list of the best candidates for new buying at this time.

1) AAU (last Friday's closing price: US$1.07)

2) EDV.TO/EVR.AX (last Friday's closing price: C$0.56)

3) PG.TO (last Friday's closing price: C$1.46)

4) PLG.TO (last Friday's closing price: C$0.86)

5) RIO.TO/RIOM (last Friday's closing price: C$1.47/US$1.38). Last week's price action suggests that RIO has finally bottomed. We expect that it will rebound quickly to $2.00 after the overall sector reverses upward.

Potential future TSI stock selections

Here are some of the stocks on our radar screen with the potential to be future additions to the TSI Stocks List, including brief notes on why the stock has speculative merit and our main reason(s) for not 'pulling the trigger' at this time.

1) Golden Queen Mining (GQM.TO)

GQM has 111M shares (fully diluted) and ended last week at C$0.63. It is developing the Soledad gold-silver project in California.

The reason to like GQM is that at last Friday's closing price it offers huge upside leverage to gold. Specifically, using figures from the September-2012 FS we estimate that GQM would be worth about C$3.50/share (almost 6-times the current price) at a gold price of $1415/oz.

Our main concern is that the company is entering the construction phase with very little cash in the bank, meaning that a substantial financing will soon have to be done to enable progress to continue. GQM will need to raise at least $120M to build the proposed Soledad mine, which is a lot for a company with a market cap of around $70M.

2) Minera IRL (IRL.TO)

IRL has 182M shares outstanding and ended last week at C$0.17. Its two most important assets are the Don Nicolas gold project in Argentina and the Ollachea gold project in Peru. Both projects are fully permitted and ready to enter the mine construction phase. Also, in both cases the planned mine would likely be profitable at $1250/oz for gold.

IRL's market cap is very low relative to the value of its mining assets. Financing is the problem. Financing is in place for the Don Nicolas mine construction, but the company has negative working capital and therefore urgently needs to raise more money to continue progressing its Ollachea project and just stay in business.

Despite the fact that IRL is very much on sale, it will probably make sense to steer clear for now and revisit the stock after the required financing is in place. Also, at this time the stock is not liquid enough for our liking.

3) Midway Gold (MDW)

MDW has 128M shares outstanding and ended last week at US$0.84. It is in the process of building an 80K-oz/year gold mine at the Pan project in Nevada and has two other interesting assets at earlier stages of development. It is well financed, with about $50M of working capital, but will need to raise an additional $50M or more within the next several months in order to complete the mine construction at the Pan project.

MDW's current enterprise value is about $130M, which we consider to be a bit high in the context of today's depressed market for gold mining shares. Also of concern is the uncertainty regarding how the company will raise the additional $50M it needs to complete the Pan construction.

4) Papillon Resources (PIR.AX)

PIR has 340M shares outstanding and ended last week at A$1.00. It owns the 5M-oz Fekolo gold project in Mali and is well funded with about $45M of cash.

Using the figures in the June-2013 PFS and assuming a 25% tax rate, we calculate Fekolo's post-tax NPV(5%) and IRR to be $717M and 47%, resp., at a gold price of $1300/oz. This suggests that Fekolo is an exploration-stage project that would 'work' and be attractive to larger mining companies near the current gold price.

PIR offers good value near its current price, but due to the country risk it would have to become significantly cheaper before we would buy it.

5) Roxgold (ROG.V)

ROG has 184M shares outstanding and ended last week at C$0.44. It owns the very high-grade (17-g/t average) 1M-oz Yaramoko gold project in Burkina Faso and has been written-up in previous TSI commentaries.

Our only concerns with ROG are that its price isn't quite low enough (the stock would be very interesting near C$0.35) and it is too thinly traded.

Chart Sources

Charts appearing in today's commentary are courtesy of:

http://stockcharts.com/index.html



 
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