-- Weekly Market Update for the Week Commencing 18th June 2018

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 mid-2016, but there will be many years of topping action in bond prices and bottoming action in bond yields before major new trends get underway. A major decline in government bond prices will unfold during the 2020s. (Last update: 11 September 2017)

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.), gold-denominated prices and inflation-adjusted prices. This secular trend will bottom in 2020 or later. (Last update: 11 September 2017)

A cyclical BEAR market in the US Dollar began in 2016-2017. (Last update: 11 September 2017)

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 in 2020 or later. (Last update: 11 September 2017)

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 2020 or later. (Last update: 11 September 2017)

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True Fundamentals Summary [Notes: 1) The date shown next to the current True Fundamentals Model (TFM) signal is when the most recent change occurred. 2) Charts of the Gold and Equity TFMs are included in the "Charts and Indicators" section of the TSI web site]

Last week's posts at the TSI Blog

What is fiat currency?

Summary of current thinking/positioning

1) The euro's rebound from its late-May low came to a premature end last Thursday. The euro and the Dollar Index now appear to be headed for new 2018 extremes (a new low for the euro, a new high for the DX), but a lot hinges on whether critical levels (1.156 for the euro, 95 for the DX) are breached on a weekly closing basis.

2) Last week's price action suggests that the gold price is on its way to the mid-$1200s.

3) The SPX likely will make a new all-time high by July. The risk/reward is not bullish, though, because a move to well above the January high is unlikely and because there is a realistic chance of a large decline during the second half of 2018.

4) Bearish signs emerged last week for commodities and commodity-related currencies.

5) The T-Bond price should have an upward bias over the coming 2-3 months.

6) Holding a cash reserve of around 30%.

No Weekly Update next week

The next Interim Update will be posted at around the usual time on Thursday 21st June, but please note that due to our travel schedule there will be no Weekly Update next Sunday.

Commodities

Copper refuses to follow the bullish script

A week ago we wrote that copper's price action suggested the potential for move up to $3.80-$4.00 by September. We also wrote:

"... the current COT situation constitutes a yellow warning flag. As illustrated by the following chart, the total speculative net-long position in Comex copper futures is almost as big as it was when the price was hitting a short-term top last September. If the total speculative net-long position gains another 10K contracts or so then the COT situation will constitute a red warning flag."

And:

"...a daily close below $3.20 would call into question the validity of last week's breakout, whereas 1-2 weeks of consolidation in the $3.20-$3.30 range would reduce the downside risk and potentially set the stage for another sharp rise."

The latest COT report was published Friday (based on data as of Tuesday 12th June) and it constitutes a red warning flag. It shows that since the previous report the total speculative net-long position in Comex copper futures surged by 24K contracts to an all-time high. Here's the relevant chart:



Furthermore, the following chart shows that the copper price broke below $3.20 on Friday.



This means that the copper market hasn't followed our bullish script. The sharp pullback in the price over the final two days of last week still could be viewed as a test of the preceding week's upside breakout, but the extremely aggressive speculative positioning indicated by the latest COT report combined with Friday's decisive breach of $3.20 suggests that we are dealing with something more bearish than a routine 1-2 week correction. It suggests that either the previous week's move up to around $3.30 created an intermediate-term double top, in which case a decline to as low as the $2.50s could precede the next substantial rally, or the price will chop around between $2.95 and $3.30 for a few more months before resuming its multi-year upward trend.

Oil resumes its correction

The oil price was expected to rebound by a few dollars before resuming its downward trend, which it has done. It looks like the downward trend resumed on Friday 15th June in parallel with broad-based weakness in the commodity markets.

Lateral support near $58 remains the most plausible target for a correction low.



Global Debt

The following chart from the Institute of International Finance (IIF) is provided mainly for the sake of interest. It shows the change in worldwide indebtedness of non-financial corporations, government, households and financial corporations from 1997 to 2017.

For us, the main takeaways from this chart are:

1) The incredible increase in total debt from 1997 to 2017. Total global debt went from US$74 trillion in 1997 to US$238 trillion in 2017. This is primarily the result of central banks attempting to mitigate the short-term effects of one bursting credit bubble by fomenting a new credit bubble.

2) The fact that since 2007 the growth rates of household and financial-sector indebtedness have slowed substantially whereas government and non-financial corporate indebtedness have continued to grow at the same frenetic pace.

The second of the above points suggests to us that whereas the last major crisis revolved around household and financial sector debt, the next major crisis will be linked to excessive corporate and government debt.



The Stock Market

The Fundamentals

The stock-market fundamentals that matter (the monetary inflation rate, credit spreads, the real interest rate, the yield curve and confidence in the banking sector) are incorporated into our Equity True Fundamentals Model (ETFM) to generate a score from 0 (max bearish) to 100 (max bullish). The ETFM's current value is 50, which is the upper end of bearish territory. A reading of 50 constitutes a warning of intermediate-term downside risk, but it does not constitute a warning that a bear market will soon begin.

Referring to the following chart of the ETFM (in blue) and the SPX, notice that the ETFM broke well below 50 in mid-2007 -- a few months prior to the start of the 2007-2009 equity bear market. Also notice that the ETFM remained well below 50 until late-2008.



Current Market Situation

We recently mentioned signs that downside risk is beginning to rise in the US stock market. These signs are the TSI Put/Call Indicator getting close to a sell signal and the Bitcoin price getting close to a breakdown. Also, the escalating trade war between the US and China governments could soon start taking a toll, as the Trump decision on Friday 15th June to plough ahead with $50B of tariffs on Chinese exports to the US prompted China's government to announce the next day that it would impose 25% tariffs on $34B of US commodity exports to China.

However, there are not yet any danger signs in market internals or the SPX's price action.

In nominal terms the SPX is still trading within the range established during the first 6 weeks of the year. It looks like a drawn-out consolidation pattern.



However, the SPX's performance in nominal dollar terms understates its strength. For example, in gold terms the SPX just made a new high for the year. In fact, it just made a new 10-year high. This is important because the SPX tends to peak in gold terms before it peaks in dollar terms.



For another example, in euro terms the SPX has moved well into new all-time high territory over the past three weeks.



The odds favour the market maintaining an upward bias into July.

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:

"Gold price volatility has reduced to almost nothing, with the daily closes staying within a $2 range over the past four days. This has undoubtedly added to the general lack of interest in gold discussed in the Adrian Ash article linked above.

Sentiment is supportive, but not in a decisive way, and the fundamental backdrop remains bearish, but likely to shift in gold's favour within the next two months if there is a sizable rebound in the T-Bond market. That leaves us with very little to go on aside from the price action.

The gold price must get back above its 200-day MA [$1309] on a daily closing basis to warn that a short-term rally has begun, whereas a daily close below $1280 would warn of a decline to the $1240s or lower."

The sentiment and fundamental backdrops were unchanged last week, although the next COT report could reveal substantial liquidation on the part of speculators. If so, the sentiment situation would be far more supportive.

There was a change in the price action, though, in that during the final two days of the week there was a sudden increase in volatility beginning with an attempt to break out to the upside. The gold price briefly traded above its 200-day MA and lateral resistance at $1309 on Thursday, but failed to close above this resistance. The next day the gold price plunged through support to a new low for the year.

It's unlikely that the break below $1280 is heralding the start of a large decline. Considering the current sentiment and fundamental backdrops a drop to test the December-2017 low near $1240 has a decent chance of happening prior to the next short-term bottom. However, with the fundamental backdrop likely to become more gold-bullish within the next several weeks and with the sentiment backdrop likely to become more supportive very quickly in response to additional price weakness, we doubt that it will do any worse than that.



Silver

When we posted last week's Interim Update the silver price had just broken above the top of its $16.10-$16.90 range and moved up to within a few cents of its intermediate-term channel top at $17.20-$17.30. Breaking above the channel top would suggest that a quick rally to around $18.50 had begun.

An upside breakout from the intermediate-term channel looked likely last Wednesday-Thursday, but it wasn't to be. Just as it did in April, soon after reaching its channel top last week the silver price reversed course and plunged.

The silver price ended the week in the middle of its $16.10-$16.90 range. This means that it has gone back to "square one".



Despite all the commentary claiming otherwise, at no time over the past three months has the sentiment situation been any better than neutral for silver. Large speculators became net-flat for the first time in a very long time, but this bullish factor was offset by the high open interest (OI) and the fact that small traders were aggressively net-long.

Right now the sentiment situation is slightly bearish for silver. This is because the latest COT report revealed a surge in the total speculative net-long silver position to its highest level of the year and a surge in OI to near the highs of the past few years. Refer to the following chart for the details. In both the silver market and the gold market, important price lows tend to coincide with relatively low levels of OI and important price highs tend to coincide with relatively high levels of OI.

That being said, last Friday's price plunge would have been associated with substantial liquidation on the part of speculative 'longs'. Therefore, the COT situation will now look quite different. The next COT report will be interesting.



As mentioned above, last week's downward reversal in the silver looks similar to the reversal that occurred in April. In April the price found support at the bottom of the $16.10-$16.90 range, which it may well do again. However, the ideal set-up for an intermediate-term rally would involve a spike below the bottom of this range.

Gold Stocks

In last week's Interim Update, we wrote:

"On a daily closing basis, the HUI has now spent 37 trading days between 176.9 and 182.4. A daily close above 182.5 would break the HUI out of this range and above the top of the channel drawn on the following daily chart. This, in turn, would indicate that a rally was underway.

There is a potential channel top at 195-200 that will be a reasonable 2-4 week upside target following a daily close above 182.5."

Despite last Thursday's currency-market turmoil and last Friday's breakdown in the US$ gold price, the HUI did not manage to break out of the above-mentioned narrow range. On a daily closing basis it has now spent 39 trading days between 176.9 and 182.4.

Today we'll take a look at a daily chart of the Gold Miners ETF (GDX). GDX made a multi-week high last Thursday and a multi-week low last Friday, but because the recent trading range has been so narrow it was able to accomplish this feat without much movement.

GDX's chart pattern is essentially the same now as it was a week ago. Since mid-April this ETF has been confined to a narrow channel with a slight downward slope. It ended last week near the mid-point of this channel.



The gold-mining sector is trading as if it is 'sold out' and therefore has some immunity to bullion-market weakness. However, if the gold price builds on last week's downside breakout then GDX will stand a good chance of re-testing support near $21.00.

The Currency Market

The euro and the Dollar Index (DX)

There was minimal reaction to last Wednesday's rate-hike announcement from the Fed, because the announcement contained no new information of significance. However, Thursday was a very volatile day in the currency market as traders reacted to the outcome of the ECB's latest meeting. As fully expected the ECB left its interest rate targets unchanged, but as discussed below its announcement contained significant new information.

In response to the new information the euro/US$ rate, which earlier in the day had made a new one-month high, plunged to a two-week low. The day's trading range was a remarkable 2.7 points. This transformed what had appeared to be a minor 1-2 week correction (down in the euro, up in the DX) into something more substantial.

On Friday the euro briefly traded below 1.156, but then recovered to again avoid a weekly close below this critical support level.



The speed at which the euro dropped and the DX rose last Thursday suggests that the late-May extremes will be breached. The key regarding what the future holds in store will be whether critical support/resistance levels (1.156 for the euro, 95 for the DX) are breached on a weekly closing basis. Spikes below/above the recent extremes that aren't confirmed by weekly closes would set the stage for a larger euro rebound (to 1.20 or higher) and DX decline.

So, what was the new information that got traders excited last Thursday?

Prior to last Thursday most traders expected that the ECB would taper its bond monetisation during the fourth quarter of this year, but the details weren't known and there was a difference of opinion within the currency-trading community as to when the details would be announced (many traders weren't expecting an announcement until next month). Also, prior to last Thursday the market had priced in the ECB's first rate hike for June-2019. Thanks to last Thursday's ECB announcement, we now know that:

1) The ECB plans to reduce the pace of its bond purchases during the final quarter of this year from the current 30B euros/month to 15B euros/month and to complete its purchases in December. In other words, euro-zone QE will end in December.

2) The ECB will continue to reinvest the proceeds of maturing bonds for "an extended period of time". This means that the ECB's balance sheet will remain at its bloated end-2018 level for the foreseeable future.

3) The interest rates directly controlled by the ECB will "remain at their present levels at least through the summer of 2019".

The ECB's new information does not constitute a meaningful change, but it highlights the 'dovishness' of the euro-zone central bank relative to the US central bank. First, by stating that it won't even begin the move away from its Negative Interest Rate Policy (NIRP) before the end of next summer the ECB effectively is stating that the euro-zone won't have a positive official interest rate until at least early-2020. By that time the Fed Funds Rate could be above 3%. Second, it appears that the Fed will be at least two years into its quantitative tightening program before the ECB even starts thinking about 'normalising' its balance sheet.

We've said in the past that Mario Draghi may well be the worst head of a major central bank in history. He has distorted trillions of euros worth of bond prices beyond recognition, he has created giant funding gaps in pension schemes, and he has crucified savers and anyone who relies on interest income. Why? For the sake of boosting "inflation", that's why. His term as ECB chief ends in October-2019, but by then it will be too late. By then the economic damage to the euro-zone will be irreparable.

The Swiss Franc (SF)

In commentaries last month we wrote about the SF's downward momentum and COT extremes. These extremes suggested two equally-plausible short-term outcomes. The first was that a tradable multi-month rally was about to begin. The second was that there would be a multi-week bounce followed by a decline to a new low prior to the start of a tradable multi-month rally.

For example, in the 14th May Weekly Update we wrote:

"The previous six times that the [SF's] COT situation was near a similar extreme are indicated by arrows in the top section of the chart. In all except one of these cases, the COT extreme coincided with a multi-month low and the start of an 8-point or larger rally. The exception was in 2012, when an extreme in the total speculative net-short position was followed by a 2-3 week 'head fake' to the upside and then a decline to a new low. However, even in 2012 a long position in the SF purchased at the time of the COT extreme yielded a profit of up to 5 points within 4 months."

And:

"The sort of downward momentum extreme achieved by the SF (and FXF) last week often precedes a price low, so something along the lines of what happened when the SF was in a similar situation in 2012 (a bounce and then a decline to a new low prior to the start of a meaningful rally) is a distinct possibility over the next few weeks. However, we think it makes sense to at least take an initial position in FXF now."

Last week most currencies reversed downward in sympathy with the euro. The SF was no exception. As a result, something along the lines of what happened in 2012 now appears to be the most likely scenario.

Here are two daily charts that hopefully make the situation clearer. The first chart shows the SF's performance in 2012 and the second chart shows the SF's performance since the beginning of this year. If the current situation is similar to 2012 (as appears to be the case) then the most likely outcome is that a tradable rally will begin in July -- after the SF makes a new low for the year.

Anyone who wants to 'go long' the SF or who took a position (via FXF or FXF call options) near the May low should plan to wait at least a few weeks before buying or adding. Also bear in mind that a daily close above the early-June high would leave almost no doubt that the anticipated multi-month rally was underway.

The Commodity Currencies

In response to the broad-based weakness in the commodity markets over the final two days of last week, the two senior commodity currencies (the A$ and the C$) 'took it on the chin'. Both ended the week near support levels, though. In the A$'s case the support being tested is the early-May low. In the C$'s case the support being tested is the bottom of the channel that began to form last September. Here are the relevant charts:

The A$ is our primary focus at this time. It achieved a marginal upside breakout during the week before last and needed to stay above the 50-day MA during a near-term correction, which it failed to do. Also, it needed to stay above 75 to keep alive the bullish signal generated by last month's upward reversal from slightly below this level, which it failed to do.

The A$ could bounce from near its current level, but given the bearish signs that emerged in the commodity world last week it now looks like this currency is going to drop at least as far as its May-2017 bottom (73.5) before the rally we've been expecting gets underway.

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 15th June 2018:

[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%, NSR = Net Smelter Return, P&P = Proven and Probable, PEA = Preliminary Economic Assessment, PFS = Pre-Feasibility Study]

  *Blackham Resources (BLK.AX) provided some new information regarding its Golden Age Underground gold mine. Golden Age is a relatively small part of the company's Matilda-Wiluna operation in Western Australia, but its production has an outsized effect on overall profitability due to the mine's high grade and associated low costs.

In the 26th March Weekly Update, we wrote: "Mining studies have extended the Golden Age Underground mine plan from Jun-18 to Dec-18. This involves about 5K ounces of additional production. Also, there's a good chance that an underground drilling program will further extend the life of this mine."

Last week's news is that recent drilling has confirmed the potential to further extend the underground mine. Also, surface drilling at Golden Age North has identified shallower mineralisation that could be amenable to both open pit and underground mining. This is obviously good news.

As previously mentioned, our BLK valuation will increase from A$0.11 to A$0.13 if/when it becomes highly probable that the company will meet or exceed its CY2018 production target. Note that the company's production guidance is for 40K-45K ounces during the first half of CY2018, so we are assuming this means 80K-90K ounces for the full calendar year.

  *Cobalt 27 Capital (KBLT.V) issued a press release after the close of trading on Monday 11th June that contained good news, neutral news and bad news.

The good news is that the company has purchased from Vale, at a cost of US$300M, a "stream" that entitles it to cobalt production from the Voisey's Bay (VB) nickel mine in Canada beginning on 1st January 2021. KBLT will be entitled to 32.6% of the cobalt production from VB until 23.8M pounds have been delivered and 16.3% thereafter.

In addition to the up-front payment of US$300M, KBLT will pay an amount equal to 18% of the cobalt market price upon delivery of the metal. This effectively means that once metal deliveries commence in 2021, KBLT will generate a gross profit from the VB stream equal to the number of delivered pounds multiplied by 82% of the cobalt market price.

Once Vale's production ramp-up is complete, the stream is expected to provide KBLT with 1.9M pounds/year of cobalt. Assuming US$40/pound for cobalt, this implies annual gross profit US$62M. Applying a multiple of 15 to this figure gives us an indicative value of US$930M for the stream. Obviously, the stream could end up being worth a lot more or a lot less than that depending on what happens to the cobalt price. We expect the cobalt price to be much higher when metal deliveries begin in 2021, so from our perspective KBLT has done a good deal.

The neutral news is that KBLT is issuing new shares to raise C$345M to fund the purchase of the stream.

The bad news (for existing shareholders) is that the new shares are being sold at a large discount to the market price prior to the announcement. Specifically, the share price closed at C$11.62 on the day prior to the announcement and the new shares are being issued at C$9.75. This means that the new shares are being issued at a 16% discount to what was, in our opinion, already a fairly low price considering the per-share net asset value (NAV). That's why the share price was down sharply on the news.

Despite the share dilution caused by the equity financing, with the share count rising from 52M to 88M, we reckon that the deal announced last week is strongly accretive to KBLT's NAV. With this deal, our estimated NAV rises from around C$14.50/share to C$17.80/share.

If we are right to be long-term bullish on cobalt then as a result of last week's price action KBLT is now one of the best buys in the stock market on a risk/reward basis.

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 (last Friday's closing price: US$0.74)

2) CGT.TO (last Friday's closing price: C$0.28)

3) EGD.V (last Friday's closing price: C$0.39)

4) KBLT.V (last Friday's closing price: C$9.61)

5) PRQ.TO (last Friday's closing price: C$1.14)

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.

Summary of potential additions to the TSI List

Here is an updated version of the table originally included in the 12th March Weekly Update showing potential additions to the TSI Stocks List. The table mentions the price at which each stock would be automatically added (unless advised otherwise) and whether the stock would be a long-term position or a shorter-term trade.

The table originally contained 5 stocks, but two stocks (CGT.TO and ORA.TO) subsequently hit their buy prices and were added to the List. Also, the buy price of SBB.TO has been raised from C$1.45 to C$1.53.



Chart Sources

Charts appearing in today's commentary are courtesy of:

http://stockcharts.com/index.html
http://www.goldchartsrus.com/