-- Weekly Market Update for the Week Commencing 17th August 2015

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.

The BULL market in US Treasury Bonds that began in the early 1980s ended in early-2015, but there will be many years of topping action in bond prices and bottoming action in bond yields before major new trends get underway. (Last update: 29 June 2015)

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 2018 and 2020. (Last update: 29 June 2015)

A secular BEAR market in the US 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 2018 and 2020. (Last update: 29 June 2015)

Commodities, as represented by the CRB Index, 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 2018-2020. (Last update: 29 June 2015)

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Outlook Summary

4. Long-term views are determined almost completely by fundamentals and intermediate-term views are determined by a combination of fundamentals, sentiment and technicals.

Last week's posts at the TSI Blog

Bearish divergences at gold-mining bottoms

Facts, Opinions, and Risk Management

Gold's safe-haven status is not in doubt

Gold is very different from all other commodities. This is due to physical characteristics that caused it to be money for thousands of years and led to its aboveground supply becoming orders of magnitude greater than its annual production*. However, despite the huge size of its existing aboveground supply relative to the rate at which new supply is created, that is, despite its massive stocks-to-flow ratio, gold is still a commodity and its US$ price is still affected by the overall trend in commodity prices. In particular, a major decline in commodity prices will naturally put downward pressure on the gold price and a major advance in commodity prices will naturally put upward pressure on the gold price. That's why gold's performance can be most clearly 'seen' by comparing it to the performances of other commodities, with the most appropriate comparison being with 'non-monetary' metals**. Such a comparison reveals that gold has performed exactly as a safe haven should have performed given the economic and financial-market backdrops.

In particular and with reference to the following chart, we point out that the gold/GYX ratio (the gold price relative to the price of a basket of industrial metals) rocketed upward from mid-2007 through to early-2009 in response to the global financial crisis and severe economic recession of the period. The early-2009 high was an all-time high, which was a reflection of an extremely low level of general confidence in economic prospects and the abilities of central banks. The gold/GYX ratio then pulled back sharply as the crisis abated and an economic recovery got underway, but it stopped declining in the first half of 2010. Since then it has been making lower highs and higher lows, with a euro-zone (EZ) crisis causing a rise to just below the all-time high in 2011-2012, the semblance of economic stability in both the EZ and the US causing a steady slide from late-2012 through to late-2014, and the re-emergence of fears regarding EZ stability causing a couple of bounces over the past 9 months.

At the end of last week the gold/GYX ratio was near a 2-year high and close to the middle of the wide range that was established during 2009-2010. Note that by historical standards this wide range is at an elevated level.



There is currently a higher-than-average amount of confidence in the Fed, the US stock market and the US economy, which suggests to us that the gold/GYX ratio is now as high as it should be. However, we strongly believe that this confidence is misplaced and will erode over time, causing the gold/GYX ratio to break above its 2009 peak.

Unfortunately, we can't predict when it will happen. We thought that it would have happened by now, but, despite a lot of evidence to the contrary, a critical mass of people remains convinced that better economic times lie around the next corner.

    *Gold's aboveground supply is so large relative to annual mine production that changes in the latter can safely be ignored when looking for price clues.

    **Gold is no longer money in the true meaning of the word, but it still trades as if it were.

The Stock Market

The US

It was more of the same in the US stock market last week. The price action has been tedious for many months and last week continued the pattern.

In one respect the lack of S&P500 (SPX) movement over many months is interesting. We are referring to the fact that it is rare for the SPX to trade sideways for so long and it is unprecedented with regard to the past 15 years. The following monthly chart helps to illustrate what we mean.



Short-term indicators of market sentiment are presently as neutral as the S&P500's price action. Some reveal optimism, but others reveal sufficient fear/pessimism to suggest the potential for a significant multi-week rally.

The put/call situation is an example of the latter. The 10-day MA of the equity put/call ratio (a short-term indicator of 'dumb money' sentiment) has just risen to a 3-year high at the same time as the 10-day MA of the OEX put/call ratio (a short-term indicator of 'smart money' sentiment) is not far from a 3-year low. This is bullish because it suggests that the 'dumb money' has become very concerned about short-term downside risk at the same time as the 'smart money' is less concerned than usual. The 'dumb money' has undoubtedly been influenced by the proliferation of crash forecasts over the past couple of months.



We currently put the probability of a crash during this year's September-October 'crash season' at only slightly more than zero, although there is still time for a crash setup to develop.

Australia

Commodity production is a big part of the Australian economy, but while the large across-the-board decline in commodity prices has been the catalyst for a large decline in the Australian Dollar it hasn't yet had a big effect on the Australian stock market. The Australian stock market, as represented by the All Ordinaries Index (AORD), has declined over the past few months, but only by enough to take AORD to the bottom of the narrow upward-sloped channel that has defined its progress over the past 2.5 years.

As far as we can tell (we closely follow some Australian stocks, but not the broad market), the rally of the past few years has been led by the financial sector.



It would be normal for AORD to rebound from its channel bottom over the days ahead, but as is the case with the US market the Australian market appears to have short-term downside potential of at least 10%.

A recovery in the commodity world could end up supporting the Australian stock market, but, as happened in 2011 when there was a shift in upside leadership from commodity to non-commodity stocks, a return to upside leadership by commodity-related equities would probably be associated with a substantial correction in the broad market.

This week's significant US economic events [Notes: 1) The most important events (to the markets) are shown in bold. 2) A list of global economic events can be found HERE]

Gold and the Dollar

Gold

Gold's "commercial" traders are different because gold is different

In a typical commodity market the traders known as "commercials" are usually hedging their exposure to the physical commodity when they buy or sell futures contracts. For example, in the oil market the most important "commercials" include oil producers, who are naturally 'long' the physical commodity and often sell futures contracts to hedge this exposure, and manufacturers of oil-based products, who are effectively 'short' the physical commodity (by virtue of the fact that oil is one of their biggest costs) and often buy futures contracts to hedge this exposure. However, the gold market is different.

Some of the commercial traders operating in the gold market are traditional hedgers. Mining companies and jewellery manufacturers, for example. But given that the existing aboveground stock of gold dwarfs the annual supply of new gold and that the amount of gold that changes hands for store-of-value, investment and speculative purposes dwarfs the amount of gold bought/sold for more traditional commercial uses such as fashion jewellery and electronics, a reasonable and knowledgeable person would expect that traditional commercial traders would play a relatively small role in the gold market. A reasonable and knowledgeable person would be right.

In the gold market the dominant commercials are not traditional hedgers. They are also not speculators, in that they rarely take positions that rely on the gold price moving in a particular direction. They are spread traders, meaning that they make their profits by trading the differences in price between the physical and futures markets.

For example, if speculative buying of gold futures causes the futures price to rise relative to the spot price by a sufficient amount it will create an essentially risk-free arbitrage opportunity for a commercial to sell the futures and buy the physical, and if speculative selling of gold futures causes the futures price to fall relative to the spot price by a sufficient amount it will create an essentially risk-free arbitrage opportunity for a commercial to buy the futures and sell the physical. For another example, if gold buying by hoarders of physical gold causes the cash (physical) price to rise relative to the futures price by a sufficient amount it will create an essentially risk-free arbitrage opportunity for a commercial to sell the physical and buy the futures, and if the 'dishoarding' of physical gold causes the cash (physical) price to fall relative to the futures price by a sufficient amount it will create an essentially risk-free arbitrage opportunity for a commercial to buy the physical and sell the futures. In other words, commercial trading in the gold market is mostly about arbitrage.

The difference between commercial trading in the gold market and commercial trading in all other commodity markets is tied to gold's long history as money. Strangely, many gold 'experts' assert that gold is different due to its dominant monetary and store-of-value roles, but then insist on applying a traditional commodity-style method of supply-demand analysis. Unsurprisingly, the result is a pile of hogwash*.

    *No offence meant to the pig farmers in our readership.

The Fundamentals

To paraphrase Jim Grant, gold's perceived value in US$ terms is the reciprocal of confidence in the Fed and/or the US economy. That's why the things we refer to as gold's true fundamentals are measures of confidence in the Fed and/or the US economy. We've been covering these fundamental drivers of the gold price in TSI commentaries for about 15 years.

In no particular order, the gold market's five most important fundamental drivers are the real interest rate, the yield curve, credit spreads, the relative strength on the banking sector, and the US dollar's exchange rate.

Over the past 2 years gold's true fundamentals have usually been mixed, meaning neither clearly bullish nor clearly bearish. What has tended to happen during this period is that when one of the fundamentals has moved decisively in one direction it has been counteracted by a move in the opposite direction by one of the others. For example, when credit spreads began to widen (gold-bullish) in mid-2014, the flattening of the yield curve (gold-bearish) accelerated. For another example, when the yield curve reversed direction and began to steepen (gold-bullish) in January of this year, the real interest rate turned upward (gold-bearish) and the banking sector began to strengthen relative to the broad stock market (gold-bearish).

Charts illustrating the performances over the past 5 years of the first four of the above-mentioned fundamental drivers of the gold market are displayed below. The first chart shows that the 10-year TIPS yield, our proxy for the real US interest rate, has moved into the top half of its 2-year range after making a 2-year low in April. This is neutral-to-bearish for gold. The second chart shows that our proxy for credit spreads has been working its way upward since mid-2014 and has just broken to a new 2-year high. This is bullish for gold. (It is also a bearish omen for the broad US stock market.) The third chart shows that the yield curve began to steepen in January, which is bullish for gold, although the performance over the past two months creates some doubt as to whether this driver is still gold-bullish. And the fourth chart shows that after being relatively weak from July-2013 through to January-2015, the bank sector suddenly became relatively strong early this year. This driver has therefore shifted from gold-bullish to gold-bearish.

The overall picture painted by these charts is that gold's fundamentals are still mixed.

The Price Action

The US$ gold price rose for 5 trading days in a row ending last Wednesday and then pulled back over the final 2 days of the week. The pullback was neither surprising nor significant.

Gold's Commitments of Traders (COT) situation remains bullish and the upside breakout during the first half of last week from a narrow 2-3 week sideways trading range was confirmed by the gold-mining sector. This means that additional gains are likely over the weeks ahead.

As previously advised, former support (now resistance) at $1135-$1140 is the most realistic initial upside target. We will take the rally one step at a time and consider higher upside targets if/when this resistance is tested.



Gold Stocks

Strong and sudden multi-day price rebounds can mark the beginnings of new bull markets, but they can also occur within powerful downward trends. For example, there were a few short and sharp rebounds during the 2008 stock-market collapse. At this early stage we therefore can't rule out the possibility that the gold-mining sector's sharp rebound during the first three days of last week is just a counter-trend bounce. However, due to the magnitude and duration of the preceding decline it makes sense to give the benefit of the doubt to the possibility that an intermediate-term reversal has just happened.

Following the 3-day surge during Monday-Wednesday of last week there could have been an extension of the rally, but a pullback was equally likely. A pullback occurred over the final two days of the week.



The most likely near-term outcome is that the rally resumes during the first half of this week. As mentioned in last week's Interim Update, the initial upside target for the HUI is former support (now resistance) at 145.

The junior end of the gold-mining sector, which is represented on the following daily chart by GDXJ, has been relatively strong. For example, whereas the HUI made a new low in early-August, GDXJ bottomed in July, and whereas last week's HUI high was well below its 50-day MA, GDXJ reached its 50-day MA before pulling back.



For both GDXJ and the HUI, closing above last Wednesday's high would be an important additional piece of evidence that an intermediate-term bottom was in place.

The Currency Market

The Dollar Index wasn't able to sustain last Wednesday's marginal breach of support at 96.3, but the short-term bias still appears to be to the downside. There was certainly nothing bullish about last week's performance.

We suspect that the Dollar Index is on its way back to the low-90s.



The Yen's performance over the past several months has been almost as dull as the S&P500's. The only significant difference is that whereas the S&P500 has traded sideways, the Yen has had a slight downward bias.

If the Yen can close a week above its early-July rebound peak (around 83) it would not only confirm that a short-term bottom was in place, it would also be a clear sign that this currency's multi-year decline was over. That, of course, is a big 'if'. Getting above 83 would require a gain of only 3.5% from here, but over the past three weeks the Yen has been unable to move by more than 1% in either direction.



Last week, the change in the China government's exchange-rate policy garnered a massive amount of media attention and roiled the financial world for 1-2 days. The policy change is significant, but nowhere near as significant as it was made out to be. Like many events in the financial markets, it was overhyped in order to attract readers/viewers and sell subscriptions.

Contrary to popular opinion, the 2% Yuan devaluation implemented by China's government probably had nothing to do with trying to stimulate exports. This is because even a 10% devaluation would have minimal effect on export volume and because senior Chinese policymakers would not want to encourage additional capital outflows (a likely consequence of expected devaluation). As explained in last week's Interim Update, it was probably about trying to avoid the tightening of monetary conditions that would be required to keep the Yuan at an artificially high level.

Lost in much of the hyperbolic commentary provoked by last week's policy change was the fact that, due to the actions taken in China to create the impression of stability, the Yuan had held its ground against the US$ since the middle of last year while almost every other currency in the world tanked. This left the Yuan at an unrealistically-high level, especially relative to the currencies of other "emerging-market" economies. For example, here are charts showing the large reductions in the values of the Brazilian Real and the Malaysian Ringgit relative to the US$ (a rising line on these charts indicates devaluation). Since the middle of last year the Real has lost 37% of its value relative to the US$ and the Ringgit has lost 23% of its value relative to the US$.

As a result of last week's 'dramatic' devaluation and market reaction the Yuan is now down by about 3% relative to the US$ since the middle of last year.



The Yuan is very over-valued and has a long way to fall, but the fall will probably happen in slow motion.

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 14th August 2015:

[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]

  *Almaden Minerals (AAU) published its financial statements for the June quarter. The Almadex spinout happened subsequent to the quarter-end, so the current balance sheet will be materially different from the published balance sheet.

Taking into account the effects of the spinout, we estimate that AAU presently has a bit less than C$6M of working capital. This is probably only enough to fund the company for another 6-9 months, so it is reasonable to expect that AAU will raise additional money before year-end. We suspect that it will do a $3M-$5M equity financing, but there are other possibilities.

  *Almadex Minerals (AMZ.V), the recent spinout from AAU, began trading on the TSXV on Friday 14th August.

AMZ currently holds the following assets:

- A 100-per-cent interest in the El Cobre project in Mexico.
- A portfolio of 21 other exploration projects.
- A 2-per-cent net-smelter-return (NSR) royalty on the Tuligtic property in Mexico.
- A portfolio of 21 additional NSR royalties on exploration projects in Mexico, Canada and United States, identified through Almaden's past prospect generator activities.
- Equity holdings in several publicly listed companies.
- 1,597 ounces of gold bullion.
- C$3-million in cash.

What's all this worth?

Valuation of the cash plus bullion is straightforward. At the current gold price it is about C$5.3M. With 44M shares on issue, this amounts to about C$0.12/share.

The 2% NSR royalty on the Tuligtic project is the asset with the highest potential value. For example, if Tuligtic were put into production at the planned 260K-oz/year rate then at a gold price of $1300/oz the 2% NSR would generate about US$6.8M/year of cash. A cash-flow-producing royalty such as this on a mine with a life of at least 12 years would probably be worth about US$50M, or C$1.47 per share. However, in the current market with the project still at least a few years from production and taking into account the risk that the project will never go into production, the royalty is worth very little. We assign a nominal value of C$2M.

In the current market all of the remaining assets combined would be worth no more than the C$2M nominal value assigned to the Tuligtic royalty.

We therefore come up with a very rough estimate of C$9.3M for AMZ's current value. This equates to C$0.20/share. Note that if we use the accounting values in AAU's financial statements rather than our own assumptions, AMZ's estimated value comes to C$10.9M. This equates to about C$0.25/share.

There was almost no trading in AMZ shares on Friday, but the small amount of trading that happened was at C$0.19-C$0.20 and the stock closed at C$0.20. The current market price is therefore at what we perceive to be fair value. At this price AMZ is neither a sell nor a buy.

We think that AMZ would be a reasonable -- albeit very speculative -- buy near the value of its cash-plus-bullion, which is currently C$0.12. And although it has huge long-term upside potential linked to the possibility that the Tuligtic project will be put into production, at this time we would view it as a short-term sell above C$0.30.

For TSI record purposes we are going to consider the Almadex spinout as a capital return for Almaden shareholders. At Friday's closing price of C$0.20/share for AMZ, the per-share return to AAU shareholders amounts to C$0.12 (US$0.09). Also, due to its huge long-term upside potential and well-regarded management, we have put AMZ into the TSI Small Stocks Watch List.

  *Asanko Gold (AKG) published its financial results for the June quarter. According to these results the company had US$204M of working capital and US$124M of long-term debt at 30th June. This compares with US$208M of working capital and US$59M of long-term debt at 31st March, which indicates that the company spent about US$69M during the latest quarter.

The rapid pace of spending is not a surprise, because AKG is rapidly advancing Phase 1 of the Asanko Gold Mine (AGM) into production. Commercial production at the design rate of 190K ounces/year is on track to be achieved early next year.

AKG remains fully-funded through to production.

We continue to like AKG because it offers substantial leverage to the gold price (our estimate of fair value rises from US$1.50/share to US$3.00/share with an increase in the gold price to $1300/oz) but doesn't need a higher gold price to ensure its survival or justify its current stock price.

  *Dalradian Resources (DNA.TO) issued its financial report for the quarter ending 30th June 2015. The report showed that the company had C$33.5M of working capital at 30th June, which is down from C$44M at 31st March. This is enough to fully fund the company's aggressive work program for at least the next 12 months.

The next important milestone for DNA is the completion of a PFS at its Curraghinalt gold project in Northern Ireland. The PFS milestone is expected to be achieved late this year.

  *Endeavour Mining (EDV.TO, EVR.AX) reported drilling results from its Agbaou gold project in Ivory Coast, West Africa. Numerous significant intercepts were reported, including 16.47 g/t over 8.3 metres and 12.15 g/t over 9.4 metres.

The results suggest that the project's reserves are going to expand and that the mine-life is going to be extended. This is very good news, because Agbaou is EDV's highest-margin operation.

  *Premier Gold (PG.TO) published its financial results for the June quarter. According to these results the company had about C$90M of working capital and no long-term debt at 30th June. Obviously, a very strong financial position.

PG had previously advised that it expected to end this year with C$75M of working capital and to end next year with about C$100M of working capital assuming an average gold price of US$1200/oz in 2016. Next year's expected working-capital increase is due to PG becoming a gold producer courtesy of its 40% stake in the South Arturo project.

  *Pilot Gold (PLG.TO) published its financial statements for the June quarter. The most important number for an exploration-stage mining company is the working capital, which in PLG's case was about US$12.7M at 30th June. At the current rate of spending this would be enough to fund the company for about 12 months, although we suspect that PLG's management will look for an opportunity to top-up the treasury before year-end.

  *Pretium Resources (PVG) has optioned some properties from Teuton Resources. The properties adjoin PVG's Brucejack project.

At $1.8M to be paid over four years, the cost of optioning these properties is financially insignificant to PVG. However, the deal could have significant long-term value in that exploration work carried out to date suggests geological similarities between these properties and the Brucejack project.

  *Sabina Gold and Silver (SBB.TO) published its financial statements for the June quarter. Based on these statements and taking into account the spending that would have happened since the end of June, the company probably now has about C$21M of working capital. This should be enough to fully fund the business for at least one more year or until a decision is made to commence mine construction.

The next important milestone for SBB is the completion of a Feasibility Study for a smaller-scale mining operation at the Back River project, which is targeted for next month.

List of candidates for new buying

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

1) EDV.TO in the mid-C$0.50s (last Friday's closing price: C$0.59)

2) EVN.AX (last Friday's closing price: A$1.00)

3) PLG.TO (last Friday's closing price: C$0.40)

4) SBB.TO (last Friday's closing price: C$0.38)

5) TGD (last Friday's closing price: US$0.27)

Note that the above list is limited to five stocks. It will sometimes contain less than five, but it will never contain more than five regardless of how many stocks are attractively priced for new buying.

Chart Sources

Charts appearing in today's commentary are courtesy of:

http://stockcharts.com/index.html
Pacific Exchange Rate Service
http://research.stlouisfed.org/