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.

Bonds commenced a secular BEAR market in June of 2003. (Last update: 22 August 2005)

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)

The Dollar commenced a secular BEAR market during the final quarter of 2000. The first major downward leg in this bear market ended during the first quarter of 2005, but a long-term bottom won't occur until 2008-2010. (Last update: 28 March 2005)

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 CRB Index, commenced a secular BULL market in 2001. 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. (Last update: 03 November 2008)

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Outlook Summary

Inflation Watch

Last week was more of the same on the monetary inflation front, with another large increase in reserve bank credit and little change in broader measures of money supply such as TMS and M2.

Currently, the US Treasury has $621B on deposit at the Fed and the commercial banks have a combined total of $364B of excess reserves on deposit at the Fed. This means that there is now close to 1 trillion dollars of money at the Fed that should eventually work its way into the economy and into the broader measures of money supply. The big question is: how long will it take for this to happen?

We don't know, although we suspect that the current administration will want to allocate a large chunk of the Treasury's $621B over the coming two months, because after that it will no longer by the current administration and will lose the ability to control who gets what.

Commodities

The bull market in acronyms

The Stock Market

To confirm that it has bottomed the S&P500 Index will have to break decisively above resistance at 1000, but as each week goes by we continue to see more evidence that the stock market is forming a base. For example, we mentioned in last week's Interim Update that each subsequent return by the senior stock indices to the vicinity of their 10th October lows had been accompanied by a reduced quantity of new individual stock lows. This positive divergence became more pronounced last Thursday when spikes by the indices to well below their 10th October intra-day lows were accompanied by a relatively small number -- small, that is, relative to what happened on 10th and 24th October -- of NYSE stocks making new 52-week lows. Almost no stocks are currently making new 52-week highs, but this is to be expected following such a large decline in the broad market. The number of new 52-week highs won't likely rise by much until the senior indices are at least a few weeks into a rally.

Other signs of base formation to emerge last week include Thursday's key price reversal and the positive divergence illustrated by the following chart. The chart shows that declining lows in the NASDAQ Composite Index over the past 5 weeks have been accompanied by rising lows in the NASDAQ's McClellan Oscillator.

This week's important US economic events

Gold and the Dollar

Gold

The December gold contract's short-term support and resistance levels at $700 and $770, respectively, are drawn on the following daily chart, as are intermediate-term resistance at $920 and the channel that has defined gold's progress since its March-2008 peak.

Gold dropped to short-term support last Thursday and then rebounded, but needs to close above $770 to signal a short-term bottom and project a rise to the channel top. A daily close above $920 would suggest that the overall correction had ended and that gold's next multi-year advance had begun.

A bottom hasn't yet been signaled, but the short-term downside risk appears to be low. A final downward spike will remain a possibility until a daily close above $770, but given the bullish structure of the market -- the Commitments of Traders situation is more bullish than it has been in over three years, which suggests that the de-leveraging of gold speculators has run its course -- a substantial extension of the downward trend is unlikely.

The following chart shows that the gold/oil ratio tested its 2005 major low a few months ago and has since rocketed up to its highest level since late-2003. You would never know it from the performances of gold-mining shares, but gold's recent strength relative to oil represents a substantial improvement in gold-mining profit margins that should start becoming evident in this quarter's financial results.

In our opinion, the world has entered an extended period in which the rate of economic growth will be unusually slow. The mismatch between consumption and production caused by the massive global credit bubble necessitates a painful period of realignment, but governments are desperately trying to prevent this realignment from occurring by applying counter-cyclical fiscal and monetary policies. These policies are all but guaranteed to prolong the agony, transforming what would potentially have been a sharp 1-2 year downturn into a 5-10 year depression. Such an economic environment greatly favours gold over oil, so we expect that the recent sharp rally in the gold/oil ratio will prove to be just the first leg of a major multi-year advance. It is quite likely, however, that there will be a counter-trend move over the next few months, with gold/oil retracing some of its post-July-2008 gains before returning to its upward path.

Gold Stocks

In last week's Interim Update we wrote:

"...17th November (next Monday) is an important anniversary date for the gold sector. Specifically, 17th November-2000 was the date on which a 20-year bear market ended and a new long-term bull market began. Furthermore, 4 years to the day after the November-2000 major turning point the gold sector, as represented by the AMEX Gold BUGS Index (HUI), hit an intermediate-term high (the peak on 17th November of 2004 was followed by a large 6-month decline). We are therefore now approaching the 8-year anniversary of the November-2000 major low and the 4-year anniversary of the November-2004 intermediate-term high.

Will 17th November of 2008 prove to be another important turning point? If it does it will obviously have to be a turn from down to up."

The HUI dropped back to near its October low on Thursday 13th November before reversing upward, so it could be that there was an important turning point two trading days prior to the 17th November anniversary. However, Friday's poor performance partly negated Thursday's bullish action, and in any case another test of the October low will remain a possibility worth considering until the HUI has broken above resistance at 225.

Interestingly, there was a very important low for the gold-stock indices on 19th November of 2001, meaning that the anniversaries of three important turning points occur during the first three trading days of this week. These anniversaries would add to the significance of an upward reversal that occurred within the next few days.

Currency Market Update

The G-20 Meeting

In last week's Interim Update we wrote the following regarding the likely outcome of the 15th November G-20 Heads of State Meeting in Washington:

"We will be surprised if anything earth-shattering comes out of this meeting. We certainly don't expect a new monetary system to be one of the outcomes. Our guess is that the heads of state will encourage each other to spend more (and thus inflate more) and create more regulations, as if the inflation that has already occurred and the regulations that are already in place haven't caused enough problems."

Unfortunately, we were close to the mark. According to the Associated Press article posted at http://biz.yahoo.com/ap/081115/meltdown_summit.html:

""We must lay the foundation for reform to help ensure that a global crisis, such as this one, does not happen again," the leaders said in lengthy statement after the emergency summit.

The plan endorses an early warning system for problems such as the speculation frenzy that fed the U.S. housing bubble. It also calls for the creation of "supervisory colleges" of financial regulators from many nations to better detect risky investing and other potential problems."

And:

"Leaders backed efforts to improve international monitoring of markets and bolstering rules about how companies value their assets, a weakness seen as partly responsible for the crisis at hand. Those steps are aimed at making the global financial system more accountable to investors and more transparent to regulators."

And:

"A thorny issue was whether all nations should pledge to enact government spending plans to stimulate their economies. The leaders supported the benefits of that approach, but stopped short of a commitment for all to act at the same time, as some Europeans had favored.

The leaders pledged to "use fiscal measures" to energize individual countries' economies "as appropriate." They recognized the importance of the Federal Reserve and other central banks to order interest rate reductions to help cushion the economic fallout."

In other words, governments have placed the blame for the crisis on greed and frenzied speculation within the private sector. Furthermore, they have decided to expand their own power with the aim of preventing a similar crisis from occurring in the future, and generally support the idea that an increase in the rate at which they spend taxpayers' money will help stimulate economic growth.

Not unexpectedly, the heads of state have chosen to ignore the root causes of the crisis. Chief among these root causes are central bank manipulation of the price of credit, government intervention in the economy (regulations designed to promote sub-prime lending, for example), and a debt-based monetary system under which new money is created 'out of thin air'.

The responses of policy-makers are usually predictable, at least in general terms. However, it is far more difficult to predict the short-term responses of financial markets to the actions of policy-makers, because a lot depends on what the markets had discounted prior to the actions. For example, the outcome of the G-20 Meeting was really just more of the same, but we don't know how the markets will react because we don't know what other traders/investors were expecting.

Current Market Situation

It looks like the Dollar Index successfully tested its October high last week in parallel with the stock market's test of its October low. However, a downward reversal hasn't yet been signaled.

The following daily chart shows that the December euro has short-term support at 1.24 and resistance at 1.30. A downward reversal in the US$ would be signaled by a daily close above 1.30 by December euro futures. Also, a daily close above $770 by December gold would be a reliable indication that the US$ had made a peak of at least short-term significance.

As things currently stand a currency market reversal has not been signaled, leaving open the possibility that the Dollar Index will spike up to around 90 within the coming 1-2 weeks. However, we think that the dollar's short-term downside risk now exceeds its upside potential and have therefore downgraded our short-term dollar view from "neutral" to "bearish". 

Update on Stock Selections

(Note: 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)

International Royalty Corp. (TSX: IRC, AMEX: ROY). Shares: 78M issued, 84M fully diluted. Recent price: C$1.49

IRC is a small royalty company that currently generates most of its income from base-metal royalties (mainly nickel) but will have increasing exposure to gold as development-stage projects come on line over the next few years. As a royalty company almost all of its expenses are discretionary, giving it considerable financial flexibility. Moreover, it is subject to almost none of the risks associated with mining.

According to the latest quarterly results issued last Friday, despite the large decline in the nickel price the company remains cash-flow positive and financially solid. Of particular note, it has only used US$5M of a US$40M revolving credit facility, which means that it has the ability to take advantage of today's depressed market environment.

The biggest negative that we perceive continues to be the delays to Barrick Gold's Pascua-Lama project (a huge gold project on the border of Chile and Argentina) relating to permits and tax agreements. As noted in the 12th May 2008 Weekly Update: "The Pascua-Lama royalty owned by IRC is by far the company's most important gold royalty, so the delays to the start of mine construction at this project have had a negative impact on IRC's stock price. Due to the importance of this project to Barrick Gold and to the two countries involved, we expect that the issues delaying the start of construction will be resolved in the not-too-distant future."

IRC is presently trading at around one-third of its book value and is, we think, a good candidate for new buying at this level despite its current substantial exposure to base-metal projects. The base metal exposure probably won't hurt over the next 3-6 months because the prices of these metals should rebound in parallel with a stock market rebound.

    Gassy Trusts

Penn West (TSX: PWT.UN, NYSE: PWE) and Advantage (TSX: AVN.UN, NYSE: AAV), two of the five Canadian energy trusts that comprise the TSI Energy Trust Index (TETI), released their latest quarterly reports last week. As was the case with the three trusts that reported earlier, PWT's and AVN's results revealed that there would be no danger of cuts in monthly distributions as long as there wasn't a large additional decline in the natural gas price. Of particular interest, payout ratios for PWT and AVN during the recently completed quarter were 59% and 54%, respectively.

At Friday's closing prices, PWT yields 21.0% and AVN yields 22.7%. Both are suitable for new buying near current levels.

    Orsu Metals (TSX: OSU) (Formerly European Minerals). Shares: 457M issued, 621M fully diluted. Recent price: C$0.045

Commenting on OSU in the 5th November Interim Update, we wrote: "The question is: will the Varvarinskoye gold/copper mine achieve its design parameters over the coming 2 quarters without the need for additional financing? The next set of financial results will hopefully get us closer to answering the above question."

The "next set of financial results" was released last Thursday, and based on these results the answer to the above question is: no, OSU will either need to arrange additional financing or negotiate a change in the repayment schedule for its current debt. The company has sufficient cash on hand to make the $17M debt payment due at the end of December, but if it made this payment it would not have enough cash to pay its other expenses.

The ramp-up to full production appears to be progressing well under the supervision/control of the company's new management, so if the short-term 'cash crunch' can be resolved the stock price should rebound strongly. We suspect that it will be resolved, but there's obviously a lot of risk. This risk is why the stock is trading at such a low level.

Chart Sources

Charts appearing in today's commentary are courtesy of: