-- Weekly Market Update for the Week Commencing 17th October 2016

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

Most people want price controls

The gold manipulation silliness continues

Summary of current thinking/positioning

1) No longer hedged via put options against short-term downside in gold and the associated mining stocks (due to options having been exited in response to the recent price plunge), but still hedged via a substantial cash reserve. Expecting large gains in gold-related investments over the next two years, but not expecting much with regard to the next 6 months.

2) Gradually increasing exposure to non-gold commodity-related stocks during periods of price weakness in anticipation of 2017-2018 being a very bullish period for commodities. Thinking that the early-2016 lows could be tested prior to the start of the aforementioned bullish period.

3) Thinking that the US stock market has commenced a meaningful 1-2 month decline. Positioned via QID call options and EEM (Emerging Markets ETF) put options.

4) Due mainly to the divergence between the currency and oil markets discussed in the 12th October Interim Update, expecting the oil price to soon commence a tradable decline and positioned for such an outcome via USO put options.

5) Thinking that the Yen is about to break out to the downside, that the commodity currencies are still in consolidation mode with a risk of testing their early-2016 lows, and that within the next few months the British Pound will make a low of similar magnitude to the major bottom of early-1985.

6) Maintaining a large cash reserve in recognition of the downside risk in almost all equities (current cash percentage is around 50%), but looking for opportunities to reduce cash and add to gold plus commodity exposure.

The US Treasury has been tightening monetary conditions

Since last October the year-over-year rate of growth in US True Money Supply (TMS) has risen from about 6.8% to about 9.6%. Putting this into perspective, 9.6% is the fastest rate of US monetary inflation since April-2013. The acceleration in the US money-supply growth rate has, however, partly been offset by the US Treasury's removal of money from the economy. Curiously, while 'everyone' has been agonising over when the Fed will take its next baby step along the tightening path, the US Treasury has been stealthily tightening US monetary conditions.

The stealth tightening by the Treasury was broached in a 14th September post at the TSI Blog. The crux of the matter is that there has been a large increase since early-November of last year in the amount of money held by the Treasury in its account at the Fed. This money forms part of the US money supply and is therefore included in the TMS calculation, but for all intents and purposes it has been temporarily removed from the economy.

The following chart illustrates what we mentioned in the preceding paragraph (the chart indicates the amount of money in billions of dollars that the US federal government has on deposit at the Fed). It shows that:

1. Prior to 2008 the Treasury's account at the Fed was usually almost empty.

2. From late-2008 through to late last year the amount held in the Treasury's account at the Fed usually fluctuated between $20B and $120B, and that in early-November of last year it was around $30B.

3. This year the amount held in the Treasury's account at the Fed has fluctuated in a much higher range and is currently at an all-time high of almost $360B.



In effect, the US Treasury has removed -- by not spending all the taxes it collects or the money it borrows -- about $330B from the US economy since early-November of last year. This is sufficient to have caused a slowing of economic activity.

Just to be clear, creating money out of nothing can only get in the way of real economic progress, but it often causes a burst of activity and temporarily makes the economy seem more vibrant. It can be likened to throwing a party in which the seed corn is consumed. The party-goers feel great for a while...and then they starve. By the same token, while slowing the pace at which money is created out of nothing (that is, slowing the pace at which the seed corn is consumed) will ultimately be helpful, in the short-term it will make the economy seem less vibrant. In terms of short-term economic effect, the actions taken by the US Treasury since last November are similar to slowing the pace at which new money is created.

Conspiracy theorists would be having a field day if the opposite had happened, that is, if the amount of money in the Treasury's account at the Fed had fallen by $330B over the past 11 months. They would be shouting that the account had been drained in an effort to give the economy an artificial boost in the lead-up to the Presidential election, thus improving the chances of a Democrat victory. But with the incumbents having taken money OUT of the economy in the lead-up to the election this particular theory never got off the ground.

So what, then, is the reason for the stealth monetary tightening conducted by the US Treasury via its account at the Fed?

We can only guess, but it's reasonable to assume that the slight tightening of monetary conditions was NOT an intended consequence of the Treasury's actions. In other words, it's implausible that during the year leading up to an election the Treasury knowingly took a course of action that would be a short-term economic depressant.

A far more reasonable explanation is that the action was taken for risk management purposes. The Treasury has always lived from hand to mouth, with almost no emergency cash. Having run out of money a couple of times over the past few years due to inter-party haggling over the "debt ceiling", it has probably been decided that a lot more cash should be kept in reserve.

The bond market breaks support

The iShares 20+ Year Treasury ETF broke below support at $133 on Friday. This breakdown suggests short-term downside potential to $127-$128 and -- dare we say it -- is possibly an early warning that the secular bull market in US government bonds has ended.



The market for government bonds has been steadily weakening since early-July. The weakening could be a routine intermediate-term correction within an on-going bull market, but there are signs that it is something more serious. Specifically, there are signs that it is due to a spreading realisation that central-bank programs designed to push bond prices to absurdly-high levels are counter-productive, and that a further doubling-down on these programs could wreak both economic and political havoc.

Last Friday's reaction to a Janet Yellen speech was one such sign that the bond market is becoming increasingly wary of central-bank promises to do more of the same. We are referring to the fact that when Yellen speculated on Friday that the Fed might have to do more (meaning: monetise more assets and hold interest rates lower for longer), the T-Bond sold off and broke below support.

The T-bond price is not going to suddenly collapse in a heap, because the Treasury market is still widely considered to be a safe haven in times of trouble and there will be no shortage of trouble in the future. A realistic possibility, however, is a downward trend that gradually picks up steam over the coming 12 months.

The Stock Market

The US

The S&P500 Index (SPX) opened sharply lower last Thursday and briefly traded below support at 2120 (the 'cliff edge') before reversing course. It ended the day with a trivial loss and handily above the aforementioned support. Optimism inspired by Thursday's turnaround then prompted some follow-through to the upside during the first couple of hours of Friday's trading session, but the gains were given back and the market ended flat on the day.

Despite the downside breakout from a 'contracting triangle' early in the week and significant intra-day volatility during the final two days of the week, the SPX got through last week's challenges without suffering much technical damage. So, what's likely to happen from here?



One possibility is that a routine 2-month correction ended with last Thursday's short-lived breach of support. If so, a rally to a new all-time high is just getting underway.

It's more likely, however, that there will soon be another test of support at 2120 with a very different result. As previously advised, we are expecting that a breach of support at 2120 will be followed by a quick decline to near the "Brexit" sell-off low in the 1990s.

For anyone interested in taking a short-term bearish position, one advantage of the current situation is that it wouldn't take much movement in the wrong direction (upward) to show that the position was wrong. As mentioned in last week's Interim Update, all it would take is a daily SPX close above 2170. This makes risk management relatively straightforward.

Emerging Market Equities

We use the Emerging Markets Equity ETF (EEM) as a commodity-market indicator. It is useful in this regard because periods during which EEM is strong relative to the SPX almost always coincide with periods of broad-based strength in commodity prices. Moreover, the EEM/SPX ratio either leads the commodity world at major turning points or can be used to confirm a major trend reversal in commodities.

There was enough strength in the EEM/SPX ratio during the first 8 months of this year to signal a major reversal from down to up in the commodity world. However, no major trend evolves in a straight line and there are signs, including the recent divergence between the Canadian dollar and the oil price, that at least a 1-2 month period of commodity-price weakness has begun or will soon begin.

If we get concurrent downturns in the commodity markets and the SPX over the weeks ahead then EEM is likely to fall in both nominal dollar terms and relative to the SPX.

With reference to the following chart, EEM has more-or-less traded sideways since topping in August. It appears to have broken below the bottom of a channel that dates back to the January low, but the important support lies at $36.00. EEM support at $36 is equivalent to SPX support at 2120, with a decisive breach projecting a decline to the June low ($32 for EEM).



We are planning to substantially increase our exposure to non-gold commodity stocks over the months ahead, but we already have enough exposure to this group of stocks to be concerned about the effects on our portfolio of concurrent commodity and equity sell-offs. We therefore purchased some December-2016 EEM put options last week as both a hedge and a speculation.

Those who are interested in a way of trading a short-term stock market decline and who aren't interested in trading options could consider buying the ProShares UltraShort Emerging Markets ETF (EEV) near Friday's closing price of US$15.52. A decline in EEM to around $32 would likely result in a gain of around 25% in EEV's price.

A daily close above $38.50 by EEM could be used as a stop for an emerging-markets-related bearish speculation.

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

A week ago we wrote:

"Our view is that the gold price either made a short-term bottom at $1243 on Friday or will make a short-term bottom somewhere in the $1200-$1243 range within the next two weeks. A 1-2 month rebound will probably then get underway, but we expect that the overall correction will extend into the first quarter of next year."

Last week's small fluctuations near the 200-day MA didn't change anything. It's still possible that a short-term bottom was put in place at $1243 on Friday 7th October, but it's also still possible that there will soon be a quick decline to support in the low-$1200s prior to a short-term bottom. The latter possibility is the more likely, but it shouldn't make a difference unless you are a very short-term trader trying to scalp a few percent here or there.



Although the gold price did almost nothing last week, there was a significant improvement in the Commitments of Traders (COT) situation. As indicated by the blue bars in the middle section of the chart displayed below, the Commercial net-short position (the mathematical inverse of the total speculative net-long position) in Comex gold futures shrank by about 50K contracts during the latest week. At 221K contracts it is now about 120K contracts below its July-2016 peak.

We suspect that the total speculative net-long position in Comex gold futures will fall to around 150K contracts prior to the end of the overall correction, but when it comes to sentiment indicators such as the COT data there are no absolute benchmarks. All we can say is that the COT situation poses much less of a risk now than it did as recently as two weeks ago.

As an aside, you should ask the people who claim that the Commercial traders engineered the gold-price decline to explain exactly how a group of traders that was a net BUYER during the period of weakness could possibly have caused the price to fall. The explanation they come up with is likely to be funny to anyone who understands how markets work.


                                                 Chart source: www.goldchartsrus.com

Gold Stocks

With the gold price trading sideways within a narrow range last week it is not surprising that the HUI did very little. In fact, it ended the week almost exactly where it began the week.

As illustrated below, the HUI remains at support defined by its May-2016 low. This support was our downside target over the past two months and the fact that it has been reached means that most (not all) of the short-term risk has been eliminated.



As is the case with gold bullion, the HUI's next intermediate-term rally is probably not going to begin before the first quarter of 2017. This is based on the historical record of gold-mining corrections during bull markets as well as fundamentals and sentiment. However, as is also the case with gold bullion a tradable 1-2 month rebound will probably soon get underway in the gold-mining sector -- from near the current price level or following a spike to a new correction low within the next several days.

Here, again, is our weekly chart comparing the HUI from its January-2016 bottom (the blue line) with the Barrons Gold Mining Index (BGMI) from its 1982 bottom. We will continue to track this comparison as long as it continues to work.

If the timing suggested by the 1982-1983 comparison is as accurate at the bottom as it was at the top then the HUI will achieve its lowest weekly close this week.



As far as how we are trading the gold-mining sector's on-going correction, the following is a repeat of what we wrote a week ago:

We are hoping for some additional near-term weakness in the gold-mining sector. The reason is that we had several under-the-market buy orders in place for gold-mining stocks last week and only one of these orders was filled. However, we have no intention of being aggressive in our efforts to boost our gold-mining exposure, because if the prices at which we want to buy aren't reached over the coming 1-2 weeks then they will probably be reached when the October low is tested late this year or early next. Furthermore, we have our 'core' exposure to cover us in the unlikely event that an intermediate-term rally begins without the expected additional corrective activity.

The Currency Market

The Dollar Index broke above minor resistance a couple of weeks ago and last week broke above the more important resistance defined by its July peak. The obvious short-term target is now major resistance near 100.

It's not evident from the following chart, but 100.0-100.5 is the top of a 20-month horizontal trading range. If the Dollar breaks out to the upside from this lengthy trading range then it will probably continue to trend upward to a long-term peak during the first half of 2017, but while an eventual upside breakout from the 20-month range is the most probable outcome it is far from a certainty.



On a short-term basis the Dollar Index is now 'overbought'. This could mean that there will be a pullback over the next few trading days even if a test of major resistance near 100 is destined to happen in the near future.

As noted above, an eventual upside breakout from the Dollar Index's lengthy trading range is a reasonable bet. After all and as we've explained in many previous commentaries, the intermediate-term fundamentals that matter the most (relative equity market and banking sector performance) have been relentlessly US$-bullish throughout this year. However, with the Dollar Index already short-term 'overbought' it is unlikely to do any more over the coming month than test the top of its range. This should mean that even if a major upside breakout in the Dollar Index is on the cards there will be time for a rebound in the gold market before it happens.

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 ending Friday 14th October 2016:

[Note: AISC = All-In Sustaining Cost, FS = Feasibility Study, FY = Financial Year, IRR = Internal Rate of Return, ISR = In-Situ Recovery, 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 the discovery of a new zone of relatively-high-grade mineralisation within the planned pit at its Tuligtic gold-silver project in Mexico. The important drill hole returned a 14.4m intercept grading 3.57 g/t gold and 146.9 g/t silver.

The next milestone -- and probably the next market-moving event -- for AAU will be completion of the Tuligtic project's PFS. This will probably happen early next year.

  *Ivanhoe Mines (IVN.TO) published the initial resource estimate for the Kakula discovery at its Kamoa copper project in the DRC (Democratic Republic of the Congo).

The initial resource estimate is staggeringly-large and probably exceeded most analysts' expectations, although based on the performance of the stock price during the weeks prior to the news it is clear that impressive numbers were anticipated.

Cutting to the chase, Kakula has an Indicated copper resource of 14.6B pounds at an extraordinary average grade of about 3.5% plus an Inferred copper resource of 6.1B pounds at an average grade of about 2.7%. This takes the overall project's Indicated resource up to 58.9B pounds at an average grade of 2.83%.

Putting the above numbers into perspective, Kamoa is now one of the 10 largest copper deposits ever discovered. However, what really stands out is the deposit's grade. This is clearly illustrated by the following comparison of the world's 10 largest copper deposits. Note Kamoa-Kakula's grade relative to the grades of the other 9 projects.



The next chart shows that in a comparison of high-grade copper projects, only the Tenke Fungurume (TF) project in the DRC is remotely comparable to Kamoa.



Freeport McMoran (FCX) recently sold its 56% stake in the TF project to a Chinese company (China Molybdenum Co.) for US$2.65B. A Chinese company (Zijin Mining) is also involved in Kamoa as IVN's JV partner. It therefore seems that there is much less concern in China than there is in the West about the risk of investing in the DRC.

We are more concerned about IVN's country risk now than when we added the stock to the TSI List in February of this year. This is because the stock's market value is now a lot higher. When we added the stock to the TSI List there was very little risk because it was trading well below the value of the company's cash, meaning that the stock market was valuing the company's mining assets at less than zero. Even if the mining assets were located on Mars there would have been minimal risk in buying at C$0.60/share when the company had C$0.85/share of cash.

At Friday's closing price of around C$2.30/share we estimate that the company's mining assets are being valued by the stock market at around C$1.4B (C$2.30 per share minus C$0.70/share of cash multiplied by a total share count of 780M). Considering what the company owns, this is arguably still quite low. This is because IVN's 47% stake in the Kamoa project could easily be worth C$2B by itself, and then there is the Kipushi zinc project and the Platreef PGM project to consider. However, the risk is much greater now than it was in February by virtue of the 275% increase in the stock price during the intervening 8 months.

If the DRC remains stable then IVN is likely to become a much more valuable company over the coming two years, but that, of course, is a big 'if'. For risk management purposes it could therefore now be appropriate -- depending on position size -- to take some money off the table.

  *Ramelius Resources (RMS.AX) reported a very good production result for the September quarter. The company produced 36K ounces of gold during the quarter, which is 1K ounces above the top of its guidance range.

Importantly, it was another quarter of strong cash generation. Despite spending almost A$12M on capital investment, RMS's operations added about A$14M of cash to the balance sheet. Consequently, the balance sheet now contains no debt and about A$89M of cash.

With 525M shares outstanding and net cash of $89M, at Friday's closing price of A$0.46 RMS's enterprise value is A$153M (US$115M). This is extremely low in the current market environment for a profitable 100K-oz/year gold producer.

We think that RMS's stock price stands a good chance of working its way up to around A$1.00 over the coming 12 months assuming no change in the gold price. In other words, we think that RMS has intermediate-term upside potential of 100% even assuming no help from the gold price.

  *Timmins Gold (TGD) reported Q3 gold production of 24K ounces. This is a good result and keeps the company on track to achieve its upwardly-revised 2016 guidance of 90K-100K ounces.

The company also reported that it achieved an average sales price of $1330/oz for its gold during Q3. This should mean that it was strongly cash-flow positive during the quarter, although we won't know for sure until its quarterly financial statements are published early next month.

TGD will probably be a good candidate for new buying after there is evidence that the gold-market downturn is complete.

  *UEX Corp. (UEX.TO) appears to have discovered a new sub-zone of high-grade uranium mineralisation within the Paul Bay deposit at the company's Christie Lake project. Christie Lake is located approximately 9km from Cameco's McArthur River Mine in Canada's Athabasca Basin.

This is obviously a positive development, but from our perspective it's way too soon to estimate the value of Christie Lake.

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) AAU near US$1.00 (last Friday's closing price: US$1.22)

2) EVN.AX near A$2.00 (last Friday's closing price: A$2.17)

3) PG.TO (last Friday's closing price: C$3.37)

4) PRQ.TO (last Friday's closing price: C$2.00)

5) RMS.AX near A$0.40 (last Friday's closing price: A$0.46)

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
http://research.stlouisfed.org/