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 mid-2010. In real (gold) terms, bonds commenced a secular BEAR market in 2001 that will continue until 2014-2020. (Last update: 09 February 2009)

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

Recap

There were a number of interesting developments in the financial world over the past fortnight. Most notably:

1. The debt-related problems of Greece's government continued to grow, as did the risk that Greece's debt crisis would quickly evolve into a broader euro-zone debt crisis. This caused interest rates and insurance costs on "PIIGS" debt to rise sharply.

2. The increasingly precarious financial position of Europe's most debt-stricken governments put additional downward pressure on the euro and was the catalyst for a rapid global stock market decline that led to a decisive break below support by an 'overbought' US stock market.

3. The euro's unrelenting weakness combined with plunging equity prices and surging PIIGS-related interest rates caused policy-makers to panic.

4. Panic on the part of policy-makers manifested itself on 9th May in the form of a trillion dollar support package for troubled euro-zone governments, involving a) the replacement of bank debt by EU debt, b) debt monetisation by the ECB, c) the provision of funds by the IMF, and d) a promise by the US Federal Reserve to make an unlimited quantity of US dollars available to the ECB -- as part of a new currency swap programme -- to ensure sufficient "liquidity".

5. Prior to the announcement of the trillion-dollar support package the stage was already set for a sharp rebound in the stock market (by virtue of how 'oversold' it had become), so it is debatable as to whether policy-makers' efforts had a significant effect on the stock market. What isn't debatable is that these efforts had the intended effect of suppressing the interest rates on PIIGS government debt and other low-quality/high-risk debt.

6. As has happened numerous times over the past 12 years, resources were consumed and prices were distorted in a counter-productive effort to avoid short-term pain.

7. The gold market broke to new highs as speculators discounted the inflation and economic weakness that will inevitably result from the latest -- but undoubtedly not the last -- in a long line of 'rescues'.

An excellent synopsis from a non-Austrian

The Australian government takes aim at its foot

Treasury Bond Update

The Stock Market

Emerging-market and commodity-related equities

Over the past few years, investing in ETFs that track high profile emerging markets such as China and Brazil has effectively been the same as investing in the stocks of large industrial-metal producers.

The close ties between emerging market and commodity-related equities are illustrated by the following two charts, the first of which compares the performances of FXI (an ETF that tracks an index of large-cap Chinese stocks) and BHP (the world's largest diversified mining company). Notice that FXI and BHP have generally moved together over the past four years, although FXI peaked well in advance of BHP in both 2007-2008 and 2009-2010.

The second chart compares the performances of EWZ (an ETF that tracks the Brazilian stock market) and FCX (the world's largest listed copper producer). The performances are almost identical, with not a single meaningful divergence over the past four years.

For both fundamental and technical reasons, we think the emerging markets and the large-cap industrial-metal miners will be amongst the best candidates for BEARISH speculations over the months ahead. The fundamental reason is that global economic growth is likely to be much weaker over the next 12 months than most people expect. The technical reason is that FXI, EWZ and FCX failed to make new 52-week highs over the past three months and thus demonstrated weakness relative to the S&P500 Index.

Current Market Situation

As discussed in the 24th February Interim Update and the 29th March Weekly Update, the intermediate-term consolidations in the S&P500/gold ratio over the past several years have encompassed an initial sharp rally followed by a lengthy period of oscillating within a horizontal range, with the boundaries of the horizontal range being defined by the peak of the initial rally (point A) and the bottom of the first pullback following the initial rally (point B).

The chart displayed below shows that SPX/gold tested the top of its horizontal range in March and is currently testing the bottom of the range. A decisive break below the bottom of this range would be a clear signal that the US stock market was on its way to a new multi-decade low in gold terms.

Turning to the nominal (US$-denominated) S&P500 Index, the following chart shows that the early-May downward spike ended just above support defined by the February low. This support is now very important, particularly since many people believe that the market's steep decline was primarily the result of a trading or computer error. Taking out the February low would validate the early-May decline in the minds of many traders and leave little room for doubt that the post-crash recovery -- which some analysts have labeled as a cyclical bull market -- ended in April.

In our opinion, the most likely outcome is that support defined by the February and early-May lows will hold for 1-2 months before being breached.

Lastly, it is worth noting that the stock market's recent plunge was confirmed by a material widening of credit spreads, as indicated by a quick drop to a new low for the year by the HYG/TLT ratio. HYG/TLT appears to have topped over the past 4-5 months in similar fashion to the way it bottomed between December of 2008 and March of 2009.

We are hoping that the markets will provide us with good opportunities to accumulate new hedges -- in the form of put options and/or inverse index funds -- during June-July, but as usual our primary method of hedging will be via a large 'cash cushion'.

This week's important US economic events

Gold and the Dollar

Gold

A point we've made numerous times over the years is that gold is not primarily a play on a decline in the US dollar's foreign exchange value; it is a play on a general decline in monetary confidence.

Evidence in support of this view is the fact that the spectacular advance in the gold price that began during the second half of 1978 and ended in January of 1980 was accompanied by stability in the US dollar's value against most other major fiat currencies. The recent market action constitutes additional evidence.

The increase in the US$ gold price from its early-February correction low in the mid-$1000s to last week's high of $1250 has clearly been driven by plunging confidence in the euro, not the US$. The following chart comparison of the US$ gold price and the euro confirms that this is the case (the chart shows the US$ gold price gathering strength over the past few months as the euro accelerated downward against the US$).

As investors with substantial exposure to gold, one concern we have right now is that the surge in the US$ gold price and the accompanying plunge in the euro/US$ exchange rate has pushed the euro-denominated gold price (gold/euro) 16% above its 50-day moving average. Consequently, in euro terms gold is now more 'overbought' than it was at the intermediate-term peak of May-2006 and almost as 'overbought' as it was at the intermediate-term peak of February-2009. The situation is depicted below.

During the final 18 months of gold's long-term bull market the technical indicators we use to help us weigh risk against reward will stop working, because during this period gold will probably become extremely 'overbought' and then quickly double in price. Our opinion is that the end of the bull market is still a few years away and, therefore, that the traditional indicators should continue to be useful for a while, but there is a small -- although not insignificant -- possibility that a complete breakdown in the euro could send gold into 'blow-off' mode earlier than expected. This is why it is very important to maintain a sizeable 'core' gold position, despite the elevated level of gold/euro.

In US$ terms, gold would need to rise to at least 1300 to be at risk of experiencing something more serious than a routine short-term correction.

Silver

At this time gold is the only pure monetary commodity, which is why it has been the only major commodity to make new price highs in response to the burgeoning debt crisis. Silver, on the other hand, is part monetary commodity and part industrial commodity. This has meant that since late 2007 it has been subject to powerful countermanding forces. Specifically, it has been pushed upward by falling confidence in the official monetary system and pulled downward by the global economic downturn. The end result is the following chart, which shows that over the past two years silver has gone nowhere in a very interesting way.

At some point the rise in the monetary component of silver's overall demand should overwhelm the industrial component, propelling silver sharply higher in both gold and US$ terms. However, as things currently stand we think silver's position is more precarious than gold's. This is because it is butting up against considerable chart-based resistance (gold has no overhead resistance) and because the broad stock market has probably embarked on an intermediate-term decline (silver tends to weaken relative to gold when the stock market trends downward). Experienced options traders could therefore use SLV (silver ETF) January-2011 put options to partially hedge their exposure to gold- and silver-related investments.

Gold Stocks

Our favoured scenario is that the gold sector, as represented by the HUI, will peak this month and then decline to an October low. Assuming that the intermediate-term correction that began in early December of 2009 is still in progress, the October low should be close to the February low (around 370). We therefore think that investors should be looking for opportunities to scale back to their 'core' exposure.

The following chart is consistent with the idea that a short-term peak will soon be put in place, because it shows that the HUI is 'overbought'. We cannot, however, rule out the possibility that the intermediate-term correction that began last December is over and that a major advance has begun.

Novices often think they KNOW what's going to happen and bet everything on one particular scenario, whereas seasoned speculators generally understand -- and take into account -- that there are always many possible outcomes.

In our opinion, the most bullish thing that the HUI could do from here would be to consolidate for a few weeks between 460 and 500, and then break out to a new high. The consolidation would eliminate the short-term 'overbought' condition and the subsequent break to a new high would confirm that a new intermediate-term advance had begun.

Currency Market Update

Over the past few weeks it has almost seemed as if the euro zone's political leaders were TRYING to make as many wrong moves as possible in the shortest possible timeframe. Let's put it this way: it is difficult to imagine how they could possibly have done more harm in such a short time if they were trying. For example, the bailouts that have been cobbled together in an effort to prevent the holders of government debt from suffering losses on their bad investments are completely counter-productive, and now we have Portugal's government deciding to introduce a "crisis tax" involving increases income, corporate and value-added tax rates. Increasing taxes at this time is so illogical it boggles the mind.

We again ask the question: why can't bondholders be allowed to suffer losses on their investments? Or, putting it another way: why should wealth be forcibly transferred from individuals and corporations that did not make bad investments to support banks and other corporations that did?

Angela Merkel, Germany's Chancellor, has characterised the current predicament as "us against them", with "us" being the government and the people and "them" being the evil speculators that supposedly dominate 'the market'. In reality, it's the government and the banking industry versus individual freedom and the real economy.

As mentioned in an earlier update, the government debt crisis is beginning in Europe because the structure of Europe's monetary union prevents technically insolvent governments from making full use of monetary inflation to maintain the illusion of solvency. The crisis will eventually spread to the US, but before it does there will probably be more problems in Europe and weakness in the euro.

There are, however, three points in the euro's favour. The first is the RSI (Relative Strength Index) included at the bottom of the following weekly chart, which indicates that the euro is now more oversold than it has been at any time over the past decade. The second is the general awareness of the euro's inherent problems, meaning that the current exchange rate at least partially discounts the problems. These two points suggest the potential for a 1-3 month rebound fueled by short covering. The third point is the US Federal Reserve, in that the Fed has the power to support the euro by devaluing the US$ and will likely make use of this power if the euro continues to slide. Due largely to the presence of the Fed, we suspect that the euro will drop no lower than 1.15 over the remainder of this year.

If the euro had commenced a counter-trend rebound from the low-1.30s, as we thought it might last month, then it would have had the potential to move up to around 1.42 before resuming its bear market. It wasn't to be, though, and the currency has fallen all the way to a new 4-year low.

A rebound that begins from near the current level could make it up to around 1.35, but probably no higher than that.

As noted above, the euro is dramatically 'oversold' and its problems are now well known (read: the problems are at least partially reflected in the market). This is not the case when it comes to the senior commodity currencies (the A$ and the C$). Consequently, there is a good chance that the commodity currencies will be weaker than the euro over the next 6 months.

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)

Northgate Minerals (AMEX: NXG, TSX: NGX). Shares: 290M issued, 297M fully diluted. Recent price: US$3.16

NXG reported its Q1 financial results and updated 2010 production guidance last Tuesday. The bad news is that the company is going to produce less gold in 2010 than we were expecting.

The good news is that NXG is attempting to revive the Kemess North gold/copper project. The multi-million-ounce Kemess North project had to be shelved a few years ago due to permitting issues associated with the planned open-pit operation, but it seems that the potential may exist to mine part of the project (1.4M ounces of gold and 500M pounds of copper) using an underground block caving method. An international engineering firm has been commissioned to assess this potential.

If the block caving method is determined to be economically viable then our NXG valuation would probably rise by US$0.30-$0.60 per share.

NXG has resistance at US$3.50 and strong support at US$2.50-$3.00. We think it is a good candidate for new buying below US$3.00.

    Franco Nevada March-2012 C$32.00 Warrants (TSX: FNV.WT). Recent price: C$5.55

Franco Nevada (TSX: FNV), a gold royalty company, appears to be breaking out to the upside from a 14-month-long consolidation.

The stock is 'overbought' on a short-term basis and could soon pull back, but if last week's breakout is genuine then any downward correction over the weeks ahead should hold at around C$29.

Our interest is in the FNV March-2012 warrants, rather than the stock itself. If the breakout is genuine then the stock price is probably on its way to C$40, and if the stock price rises to $40 then the warrant price should rise to at least $10. This is our current intermediate-term target for the warrants.

The warrants are significantly under-priced relative to the stock and could therefore be purchased near Friday's closing price, but a better opportunity to buy the warrants would almost certainly arise if the stock were to pull back to around C$29.

    US Silver (TSXV: USA). Shares: 251M issued, 289M fully diluted. Recent price: C$0.225

On a market-cap-per-ounce-of-production basis, USA.V is the cheapest silver producer we know of. There's a good reason for this relative cheapness, however, which is that its per-ounce production cost is high. For example, USA just reported Q1 results that indicated a cash cost per silver ounce produced of $12.59. And the cost would have been even higher if not for the effects of copper and lead byproducts.

Due to its relatively high cost structure, USA should be an extremely good performer when the silver price breaks above its high of the past few years. The other side of the coin is that if silver and base-metal prices experience significant declines over the months ahead then USA could begin to lose money on every ounce it produces.

The chart (see below) shows that USA has built a substantial base over the past 20 months with resistance at C$0.25. This resistance was tested last week.

If we were confident that silver was about to make a sustained break above resistance at $19.50 then we would view USA.V as a clear-cut 'buy' near its current price, but we aren't confident that this is about to happen. For new buying at this time we would therefore be more inclined to focus on silver stocks that don't NEED short-term strength in the silver price. Sabina Silver (TSX: SBB) is one example.

Chart Sources

Charts appearing in today's commentary are courtesy of: