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   -- Weekly Market Update for the Week Commencing 18th November 2013

Big Picture View

Here is a summary of our big picture view of the markets. Note that our short-term views may differ from our big picture view.

In nominal dollar terms, the BULL market in US Treasury Bonds that began in the early 1980s will end by 2013. In real (gold) terms, bonds commenced a secular BEAR market in 2001 that will continue until 2014-2020. (Last update: 23 January 2012)

The stock market, as represented by the S&P500 Index, commenced a secular BEAR market during the first quarter of 2000, where "secular bear market" is defined as a long-term downward trend in valuations (P/E ratios, etc.) and gold-denominated prices. This secular trend will bottom sometime between 2014 and 2020. (Last update: 22 October 2007)

A secular BEAR market in the Dollar began during the final quarter of 2000 and ended in July of 2008. This secular bear market will be followed by a multi-year period of range trading. (Last update: 09 February 2009)

Gold commenced a secular bull market relative to all fiat currencies, the CRB Index, bonds and most stock market indices during 1999-2001. This secular trend will peak sometime between 2014 and 2020. (Last update: 22 October 2007)

Commodities, as represented by the Continuous Commodity Index (CCI), commenced a secular BULL market in 2001 in nominal dollar terms. The first major upward leg in this bull market ended during the first half of 2008, but a long-term peak won't occur until 2014-2020. In real (gold) terms, commodities commenced a secular BEAR market in 2001 that will continue until 2014-2020. (Last update: 09 February 2009)

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Outlook Summary

Market
Short-Term
(1-3 month)
Intermediate-Term
(6-12 month)
Long-Term
(2-5 Year)
Gold Neutral
(04-Nov-13)
Bullish
(26-Mar-12)
Bullish

US$ (Dollar Index) Neutral
(24-Dec-12)
Neutral
(18-Sep-13)
 
Neutral
(19-Sep-07)

Bonds (US T-Bond) Neutral
(11-Nov-13)
Neutral
(18-Jan-12)
Bearish
Stock Market (DJW) Neutral
(18-Nov-13)
Bearish
(28-Nov-11)
Bearish

Gold Stocks (HUI) Neutral
(04-Nov-13)
Bullish
(23-Jun-10)
Bullish

Oil Neutral
(30-Jul-12)
Neutral
(31-Jan-11)
Bullish

Industrial Metals (GYX) Bearish
(06-Nov-13)
Bearish
(13-Nov-13)
Neutral
(11-Jan-10)


Notes:

1. In those cases where we have been able to identify the commentary in which the most recent outlook change occurred we've put the date of the commentary below the current outlook.


2. "Neutral", in the above table, means that we either don't have a firm opinion or that we think risk and reward are roughly in balance with respect to the timeframe in question.

3. Long-term views are determined almost completely by fundamentals, intermediate-term views by fundamentals, sentiment and technicals, and short-term views by sentiment and technicals.

US Monetary Inflation Update

Total US commercial bank credit has shrunk by about $50B over the past 6 months. Fortunately, from the perspective of those who believe that the economy is helped by monetary inflation, the Fed is picking up the slack.

Despite getting no assistance from the private banking industry, the following chart shows that the Fed has managed to boost the annualised 3-month rate of growth in the True Money Supply (TMS) from a low of just below 4% at the end of March to around 11% at the end of October. That's the result of monetising $85B/month in debt securities.



The next chart shows that the year-over-year rate of growth in US TMS has been trending downward since the third quarter of 2011. However, the recent acceleration in the shorter-term (3-month) monetary inflation rate has at least temporarily arrested the decline in the year-over-year rate. This is evidenced by the uptick in the year-over-year rate from about 8.2% in September to about 8.6% in October.



As we've said in the past, it's possible that the next financial/economic crisis will begin with the monetary inflation rate at a higher level than it was prior to the starts of previous crises (the 2000-2002 and 2007-2009 crises began after the monetary inflation rate dropped below 5%). As we've also said in the past, it isn't possible for the Fed to put off a crisis indefinitely by maintaining a high rate of money-supply growth. The reason is that each new round of money pumping causes distortions that inevitably result in some form of economic bust. Trying to put off the bust indefinitely via increasingly large monetary injections will only add to the risk that the next bust will occur in parallel with a rapidly-rising cost of living rather than a falling cost of living. 

The Stock Market

Stock markets around the world are at different degrees of 'overbought'. Here's what we mean:

The Dow Jones World Stock Index (DJW) ended last week just below the top of an upward-sloping channel that has defined its extremes over the past two years. In particular, every rise by this index to the top of its 2-year price channel has been followed by a decline to the bottom quartile of the channel.

The DJW is 'overbought', but no more 'overbought' than it was prior to the May-June 10% pullback.



What is the chance that the DJW will make a solid break above the top of its intermediate-term upward-sloping channel?

Ordinarily the chance would be very slim, but the following chart shows that the US S&P500 Index has just broken above the top of a similar upward-sloping channel. This means that the S&P500 has just joined the NASDAQ100 in upside blow-off mode and that these are not ordinary times.



A lot of commentators are expecting the upside blow-off to continue and there is breathless talk of the S&P500 zooming directly to 2000. Even some well-known bears are acknowledging the possibly that prices could quickly move higher from here.

Will the stock market accommodate the "melt up" forecasts of the overwhelming bullish majority?

The odds are against it, but we won't be able to rule out the possibility until there is clear evidence of a trend reversal. Preliminary evidence of a breakout failure and a trend reversal would be a daily close below the low of the past two weeks (1746 for the S&P500).

In recognition of the possibility that the upside blow-off in the US stock market will continue and take other markets along for the ride, our short-term stock market outlook, which shifted to "bearish" just two weeks ago, has shifted back to "neutral".

Before we leave the stock market, there's one more chart we want to show.

The following chart illustrates that large-cap European stocks, as represented by the EURO STOXX50 Index (STOX5E), are short-term 'overbought' and at resistance. However, on an intermediate-term basis and a long-term basis the STOX5E is not close to being 'overbought'. In fact, it could be in the process of completing a multi-year base.

This week's important US economic events

Date Description
Monday Nov 18 TIC Report
Housing Market Index
Tuesday Nov 19 Employment Cost Index
Wednesday Nov 20 CPI
Retail Sales
Business Inventories
FOMC Minutes
Existing Home Sales
Thursday Nov 21

PPI
Philadelphia Fed Survey

Friday Nov 22 No important events scheduled

Gold and the Dollar

Gold

The COMEX Stockpile Controversy

We've dealt with this issue before, but based on comments received from our readers it is worth revisiting. The question is: Does this year's large decline in the COMEX gold inventory provide any clues about gold's likely future performance or anything else of importance for those invested in gold? The short answer is no.

As evidence we present the following long-term chart from the excellent Sharelynx.com site. The chart is split into four sections, which, from top to bottom, show the gold price, the COMEX futures open interest expressed in terms of millions of ounces, COMEX gold stocks (the total amount of physical gold stored in COMEX-approved warehouses) expressed in terms of millions of ounces, and the ratio of open interest to gold stocks. The larger the open-interest/gold-stocks ratio, the smaller the quantity of physical gold that 'backs' the open futures contracts.

If you compare the first and third sections of the chart you should notice that major trends in the COMEX stockpile FOLLOW major trends in the gold price, and that this year's sharp decline in the COMEX inventory is consistent with the performance of the gold price. The fact is that based on the record of the past 40 years, a major decline in the COMEX inventory should be expected to accompany a major decline in the gold price.

Our point, in a nutshell, is that large moves in the COMEX inventory are effects, not causes, of large changes in the gold price. At least, that's the way the inventory-price relationship has worked up until now. Consequently, it would have been very strange if this year's price action had NOT gone hand-in-hand with a substantial decline in the COMEX stockpile.



The bottom section of the chart shows that there is presently about 1 ounce of physical gold in COMEX warehouses for every 5.5 ounces covered by open futures contracts. This is close to the average for the past 10 years.

Some commentators have pointed out that while the total amount of gold in COMEX warehouses is at an average level relative to the open interest in gold futures, the amount of "registered" gold in COMEX warehouses is abnormally low. This is supposed to be important because only "registered" gold can be delivered against a futures contract.

We don't have long-term data on "registered" gold inventory, so we don't know how the quantity of "registered" gold reacted to large price movements prior to 2003. However, we have no reason to believe that this is an important fundamental development. First, under normal conditions very few 'longs' in the gold futures market request delivery of the physical, and the speculative 'longs', as a group, would be even less inclined to take delivery when the gold price is trending downward. Second, there was no consistent correlation between changes in "registered" gold stocks and the gold price over the 11-year period for which we do have data. Third, the peak-to-trough change in the "registered" gold stockpile over the past few years is only about 2.5M ounces, which is a trivial amount relative to the overall market.

Before leaving this topic it is worth taking a quick look at the behaviour of the COMEX silver stockpile.
The chart below (also courtesy of Sharelynx.com) is the same as the chart above, except that it deals with silver instead of gold. Interestingly, unlike the gold market, where major trends in the COMEX inventory follow major price trends, in the silver market there has been no consistent historical relationship between major changes in the COMEX stockpile and major price changes. Just as interestingly, the COMEX silver stockpile is presently near a 15-year HIGH and the ratio of silver ounces in COMEX inventory to COMEX open interest is also near a 15-year high. If, as some commentators claim, the relatively low COMEX gold inventory is a reason to be bullish on gold, then why isn't the relatively high silver inventory a reason to be bearish on silver?

Our view is that a relatively low COMEX inventory level is not a good reason to be bullish on gold or silver and a relatively high COMEX inventory level is not a good reason to be bearish on gold or silver. The COMEX inventory level is simply not important.



Current Market Situation

Gold held support at $1270 'by the skin of its teeth' last week.

The short-term parameters are clear. A daily close below $1270 would indicate that gold was very likely going to drop back to the vicinity of its June low ($1150-$1200) before completing its bear market, whereas a daily close above the late-October high ($1362) would leave little room for doubt that the bear market was over.



Gold Stocks

The XAU's price action over the past 6 months can be interpreted as either a major bottoming pattern or a flat consolidation within a continuing bear market. Given the length and magnitude of the preceding decline, it's far more likely to be the former. However, even if we are dealing with the major-bottoming-pattern interpretation there could still be a final short-lived spike to a new multi-year low between now and year-end.

Last week's price action was non-committal, but within the coming fortnight we should have a clear picture as to whether or not the gold-mining bulls will be forced to endure a spike to a final low. We would now consider a daily close above the late-October high (an XAU level of just above 100) as persuasive evidence that THE bottom is in, whereas a daily close below the mid-October low would tell us that the ultimate bear-market low was not yet in place.



Below is an update of our comparison between the Barrons Gold Mining Index (BGMI) from its 1974 peak and the HUI from its 2011 peak. Up until early September the HUI's performance was a better fit with the 1968-1970 major correction than with the 1974-1976 major correction, but over the past 2.5 months it has more closely matched the price action of 1976.

For the HUI to continue to closely follow the path of the mid-1970s BGMI, a rally will have to begin this week.



The lower gold price has forced gold producers to operate smarter, leading to lower production costs. This will pay dividends during the first two years of the next cyclical advance in the gold price, just as a similar situation paid dividends for gold-mining investors during 2001-2003.

Currency Market Update

The following chart shows the tight inverse relationship between the Yen and the Japanese stock market (represented by the Nikkei 225 Index) over the past two years. Last week the Nikkei broke out to the upside from a 5-month consolidation. The Nikkei's upside breakout naturally -- considering the historical relationship -- coincided was a downside breakout in the Yen. Neither breakout is supported by valuation, but price is capable of making a large move counter to valuation.

There is no telling if there will be much follow-through in the directions of the recent Yen and Nikkei breakouts, although, at a minimum, tests of the May-2013 extremes are likely.



Considering that Yen bounces over the past six weeks ended at or just below the 200-day MA, it would now be reasonable to view a daily close above this MA as a signal that the Yen's intermediate-term trend had reversed.

We have some long-term exposure to the Yen, in that about 10% of our cash reserve is Yen-denominated. This is due to our assessment that the Yen will continue to do a relatively good job of maintaining its purchasing power. We are retaining this long-term exposure, but have no immediate intention of adding to it.

The next chart shows the general tendency of the Dollar Index to track the SPX/STOX5E ratio (large-cap US equities relative to large-cap European equities). The Dollar Index tends to strengthen when US equities are outperforming (rising faster than or falling slower than) European equities and to weaken when US equities are underperforming. Notice that the recent rebound in the Dollar Index coincided with relative strength in US equities.



Considering only the price action, the recent rebound in the Dollar Index looks like it could be the start of an intermediate-term rally. However, US equities are on average far more expensive than their European counterparts, so for the US$ rally to be sustained beyond the short-term the US stock market will have to overcome a strong valuation-related headwind. Also, the recent US$ bottom did not coincide with an anti-US$ sentiment extreme, and despite the fact that the price bottom was only two weeks ago speculators, as a group, have already become optimistic about the dollar's prospects. This matters because intermediate-term rallies usually begin at sentiment extremes and are initially greeted with skepticism.

Update on Stock Selections

Notes: 1) To review the complete list of current TSI stock selections, logon at http://www.speculative-investor.com/new/market_logon.asp and then click on "Stock Selections" in the menu. When at the Stock Selections page, click on a stock's symbol to bring-up an archive of our comments on the stock in question. 2) The Small Stock Watch List is located at http://www.speculative-investor.com/new/smallstockwatch.html

Company news/developments for the week ended Friday 15th November 2013:

[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) issued its quarterly reports for the September quarter. The financial statements showed that the company had $16.8M of working capital at 30th September. This means that AAU should be fully funded for at least the next 12 months.

  *Endeavour Mining (EDV.TO, EVR.AX) published its results for the September quarter.

Production during the quarter was 88K ounces (a record-high) at an AISC of $1,057/oz. This means that EDV is now producing gold at the rate of about 350K ounces/year, which is at the upper end of the company's guidance. The production rate is expected to increase to more than 400K ounces/year in Q1-2014 due to the start-up of the Agbaou mine.

The financial statements showed that working capital was ample at $164M and that net debt (long-term debt plus long-term derivative liabilities minus working capital) increased from $118M at the end of June to $144M at the end of September, or by $26M. The increase in net debt was more than fully explained by the $43M that was spent on growth-related projects (primarily: the new Agbaou mine).

EDV's cash-flow performance was markedly better than its earnings performance during the latest quarter. This was mainly due to the fact that there was an amount of about $22M for "depreciation and depletion" charged against earnings, but the company only spent about $5M on sustaining capital. This continues a pattern seen over the past few quarters. For example, over the first 9 months of this year the company's earnings were reduced by about $70M due to accounting entries for "depreciation and depletion", but only about $11M was spent on sustaining capital over the same 9-month period. This bears watching closely, as it could mean that EDV will have to ramp-up capital and exploration spending at its existing operations over the next couple of years.

All in all, it was an OK quarterly performance by EDV.

EDV has the lowest stock market valuation that we know of among the financially-strong 100K-500K oz/year gold producers.

  *Energy Fuels (EFR.TO) published its results for the September quarter. Production at the company's White Mesa mill totaled 180,000 pounds of uranium during the quarter, bringing 2013 uranium production up to around 1M pounds.

At 30th September 2013 the company had $32.5M of working capital, which is down from $33.8M at 30th June 2013. Subsequent to the end of the quarter the company added $5M to its working capital via an equity financing.

EFR has long-term uranium contracts with a floor price of about $58/pound. At the current spot uranium price of around $35/pound it makes more sense for EFR to purchase uranium on the spot market and deliver it into the long-term contracts, thus earning a risk-free profit of about $23/pound, than to produce uranium, especially considering that its production cost is about $40/pound. Buying on the spot market for delivery into long-term contracts is exactly what EFR's management plans to do over the next 12 months. Specifically, the company is obligated under existing contracts to supply 800K pounds of uranium to its customers next year at a floor price of $58/pound. It plans to obtain 300K pounds of this contracted supply by purchasing uranium on the spot market and to reduce its production to around 500K pounds.

With at least $35M of working capital at the moment and the ability to generate significant cash-flow via the spot-contract arbitrage mentioned above, EFR should be able to weather the storm. However, it will need a new bull market in the uranium price to start providing good returns to shareholders.

We continue to anticipate a new uranium bull market, but it is obviously taking a lot longer than expected to get underway. Fundamental drivers of the new bull market include the recent end of the "Megatons to Megawatts" program, reduced mine supply stemming from the low price, and the re-starting of most of Japan's nuclear reactors.

  *Lydian International (LYD.TO) published its results for the September quarter.

LYD's working capital was $12.4M at the end of September, which means that about $6.5M was spent during the quarter. The rate of spending should be lower during the next 2-3 quarters, so LYD probably has enough money to complete the revised FS for the Amulsar gold project (the revised FS is scheduled to be complete in Q2-2014). However, another financing is likely during the first half of next year.

  *Pilot Gold (PLG.TO) published its results for the September quarter.

For a mining-exploration company such as PLG, the only useful new information in the quarterly reports will usually be the working capital position. The reason is that all other pertinent developments will usually have been covered in earlier press releases.

PLG's working capital was $23.6M at the end of September, which means that about $6M was spent during the quarter. At its current rate of spending PLG is funded through to around September of next year.

With its highly regarded management and its high-potential projects, PLG is unlikely to have trouble getting additional funding as needed.

  *Premier Gold (PG.TO) published its results for the September quarter. PG's quarterly financial statements showed that working capital was about $70M at the end of September, down from $82M at the end of June. PG appears to be fully funded for the next two years.

  *Rio Alto (RIOM, RIO.TO) published its results for the September quarter.

Production during the quarter was 59K ounces at an AISC of only $808/oz. With such a low production cost you'd expect that RIO would be profitable, which it certainly is. During the latest quarter the company had net income of $15.9M, or $0.09/share. If we annualise this quarterly result we find if RIO's price doubled from here it would still be trading at only 10-times earnings.

It was a good quarter for RIO, but if we were intent on nitpicking we would point out that the company's free cash-flow was a lot less than its earnings. By comparing the balance sheet at 30th September with the balance sheet at 30th June, we calculate that RIO generated about $8M of cash during the latest quarter. The difference between earnings and free cash flow is primarily due to the company's spending on property, plant and equipment being about $8M higher than its amortisation/depreciation charge.

RIO is on track to achieve even better results in the December quarter, with higher production and even lower costs.

The fact that RIO's stock price continues to languish near multi-year lows despite its good operational performance is mostly indicative of the current lousy market for gold mining shares. However, companies such as RIO and EDV that are performing well on the ground should be among the first gold miners to recoup their stock-market losses of the past 2 years.

  *Ramelius Resources (RMS.AX) announced bad news and good news last Wednesday. The good news was obviously announced in an effort to offset the effect of the bad news. Unfortunately, the bad news was a lot more significant than the good news.

The bad news is that the electric motor that drives the ball mill at RMS's Mt Magnet processing plant failed on 9th November and will take 6-8 weeks to repair. During this period the plant capacity will be reduced by about 50%, which will naturally cause the December-quarter production to be materially lower than previously forecast. According to the company, updated production guidance will be provided in early December.

The good news relates to some narrow, high-grade gold intercepts from initial drilling at the newly-acquired Vivien gold project. This news is not significant.

  *Sabina Gold and Silver (SBB.TO) published its results for the September quarter. SBB's quarterly financial statements showed that working capital was about $65M at the end of September, which means that about $25M was spent during the quarter.

The second and third quarters of the year are when SBB does the bulk of its spending, because this is the only part of the year when the weather in Canada's far north enables drilling to be carried out. The rate of spending should be a lot lower over the next two quarters.

SBB appears to be fully funded until at least the third quarter of next year.

  *Sprott Inc. (SII.TO) reported its results for the September quarter. EBITDA was $6M and the bottom-line profit result was $13M ($0.06/share). In the June quarter the company made a bottom-line loss of $6.7M. Assets under management rose marginally from $7.1B at the end of June-2013 to $7.3B at the end of September-2013. The company maintained its quarterly dividend at $0.03/share.

In the 12th August Weekly Update we wrote that SII's profitability would probably hit its low for the cycle in either the just-completed June quarter or the current (September) quarter, and that the stock price possibly made its cyclical low in July. The return to profitability during the September quarter is evidence that the June quarter was the low for the underlying business, and the recent upside breakout in the stock price (see chart below) is evidence that the stock did, indeed, make its bottom for the cycle during July.

Candidates for new buying

From within the ranks of TSI stock selections, below is a list of the best candidates for new buying at this time. Note that for this list of 'best buys' to be useful we must limit it to 5 stocks or less. This could involve not mentioning stocks that offer excellent value and are good -- but not among the best few -- candidates for new buying. Note as well that the stocks included in this list of 'best buys' do not necessarily offer the best value. In the current market environment we are placing more emphasis than usual on risk, meaning that we could view a more expensive stock as a better candidate for new buying due to its lower risk.

Due to our focus on risk, this week's list contains only three stocks. As well as being very 'oversold' and offering excellent value, these companies have relatively low risk by virtue of being very profitable at the current gold price (in the case of EDV and RIO) or being valued by the market at less than cash in the bank (in the case of AKG).

1) AKG (last Friday's closing price: US$2.09)

2) EDV.TO/EVR.AX (last Friday's closing price: C$0.61)

3) RIO.TO/RIOM (last Friday's closing price: C$1.78/US$1.72)

Chart Sources

Charts appearing in today's commentary are courtesy of:

http://stockcharts.com/index.html



 
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