-- Weekly Market Update for the Week Commencing 19th February 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

For gold and bitcoin, the cost of mining follows the price

Summary of current thinking/positioning

1) Thinking that the US$ gold price will work its way downward over the next few weeks but will go on to make new highs for the year during the second quarter. However, acknowledging the possibility that a downside breakout in the Dollar Index will cause an earlier-than-anticipated upside breakout in the US$ gold price.

2) Expecting 1-2 more weeks of consolidation in the stock market followed by another fast decline that tests or breaches the early-February low. Although not the most likely outcome, there is a realistic chance that the SPX will trade as low as 2200 before the end of Q1.

3) Thinking that industrial commodities such as oil and copper are in downward trends that will end in March.

4) Expecting the Dollar Index (DX) to rebound for a few weeks before resuming its longer-term downward trend, but acknowledging that a break below the recent lows could set in motion a wave of speculative selling that drives the DX sharply lower. Consequently, not interested in betting on short-term US$ strength even though it is the most likely outcome.

5) Thinking that the T-Bond's short-term risk and reward are now in balance, meaning that the best place for short-term traders to be is on the sidelines.

6) Holding a cash reserve of 25%-30% and looking for opportunities to increase it.

Inflation expectations peaked with the stock market

The recent rise in long-term US interest rates does not appear to be related to concerns about increasing "price inflation". We say this because the 10-year Expected CPI (the difference between the yields on the 10-year T-Note and the 10-year TIPS) peaked with the stock market about three weeks ago. The Expected CPI rose last week, but it remains below its recent high and was declining while bond yields were rising during the first half of February.

Here is a chart of the 10-year Expected CPI covering the past 12 months.



Rising inflation expectations will be the primary driver of rising interest rates over the years ahead, but the recent increase in long-term interest rates appears to have been driven more by fear of rising bond supply than fear of currency depreciation.

It seems to have dawned on bond traders that if there's one thing that the US Republicans and Democrats agree on it's that government spending should be ramped up. The only political disagreement is on how the higher rate of spending should be paid for. The Democrats want to pay for bigger government by trying to extract more money from 'the rich', whereas the Republicans like to pretend that no payment is required.

T-Bond Update

The Big Picture

The evidence continues to build that the T-Bond made a secular top in July-2016, but the evidence is not yet conclusive.

Unless the T-Bond gains more than 3.5 points over the next 7 trading days, more evidence of a secular top will arrive at the end of February in the form of a monthly close below the 84-month moving average (MA). This is something that hasn't happened in more than 18 years and has happened only twice since 1990. Refer to the following monthly T-Bond chart for details.



Actually, more evidence of a secular top could arrive as soon as this coming Friday. This is because the T-Bond ended last week at the bottom of a 10-year price channel, meaning that a net decline over the course of the week ahead would break the T-Bond below the bottom of its 10-year channel. Refer to the following weekly T-Bond chart for details.



But even if the T-Bond breaks below its channel bottom this week and ends February below its 84-month MA, the evidence of a secular reversal won't be conclusive. That's because the situation could then be similar to late-1994 or late-1999.

In late-1994 the T-Bond achieved a single monthly close below its 84-month MA, but then reversed upward on an intermediate-term basis. And in late-1999 the T-Bond achieved consecutive monthly closes below its 84-month MA before reversing upward on an intermediate-term basis.

There's no magical level that the T-Bond would have to break below to remove all doubt that the secular trend has changed from up to down, but if such a change has occurred then what should happen over the months/years ahead is that the former limits on intermediate-term declines become limits on intermediate-term rallies. An example would be the 84-month MA becoming resistance.

Current Market Situation

For two main reasons we think it makes sense to take profits on bearish T-Bond speculations now.

The first reason is sentiment as indicated by the COT data. Specifically, the sum of the speculative net-short positions in T-Bond futures and 10-year T-Note futures is now large enough to fuel something more than a routine counter-trend bounce.

The COT situation for 10-year T-Note futures is illustrated by the following weekly chart. Notice that the total speculative net-short position in this market is now almost as extreme as it was at the Q1-2017 price bottom.



The second reason is that a further significant decline in the T-Bond price over the weeks ahead would be the catalyst for a much larger decline in the stock market. This means that if you are short-term bearish on the bond market it would make more sense for you to have a bearish stock market position than a bearish bond market position.

Therefore, TBT (our current vehicle for betting against the Treasury market) has been removed from the TSI List. The result of this short-term trade was a gain of about 12%.

We expect to re-enter TBT within the coming two months.

The Stock Market

Differentiating a bull-market correction from the start of a bear market

We think that the current stock market (basis the S&P500 Index) correction will run its course over the coming month or so and be followed by a move to a new high during the second quarter. The stage could then be set for a larger/longer correction or a bear market to begin during the second half of the year.

However, there can be a big difference between what we think the markets are going to do and what they actually do. We must therefore regularly compare the price action with our expectations to identify, as soon as practicable, the times when our expectations aren't in line with reality.

In determining if our broad-brush expectations of what the stock market will do this year remain in line with market reality, the monthly performance of the S&P500/euro ratio should be useful. The reason is that the long-term upward trend in this ratio has been so consistent that a loss of consistency would be a 'red flag'.

The consistency we are referring to is performance in relation to the 24-month moving average (MA). As illustrated by the following monthly chart, with the exception of the final stage of the drawn-out correction of 2010-2011 the SPX/euro ratio has not ended a month below its 24-month MA since 2009. It traded below this MA during the 2015-2016 correction and again during the week before last, but in each case it managed to avoid a monthly-closing breach of the MA.

The consistency of SPX/euro's long-term upward trend was also present during the 2004-2007 cyclical bull market. SPX/euro tested its 24-month MA many times during this earlier bullish period but didn't end a month below it until November-2007 -- the month after the nominal SPX made its bull-market top.



Further to the above, we would view a monthly close by SPX/euro below its 24-month MA as a sign that the bull market was over. According to our current view, this won't happen during the first quarter but potentially will happen during the second half of the year. In other words, if SPX/euro were to end February or March below its 24-month MA it would suggest that the decline from the January-2018 peak was the start of a major bearish trend as opposed to just a steep short-term correction.

The warning shots of 2007

For a market analyst there is an irresistible temptation to seek out one or more historical parallels to the current situation. The idea is that clues about what's going to happen in the future can be found by looking at what happened following similar price action in the past. Sometimes this method works, sometimes it doesn't.

Assuming that the decline from the January-2018 peak is a short-term correction that will run its course before the end March, we think the recent price action is akin to what happened in February-March of 2007. In late-February of 2007 the SPX had been grinding its way upward in relentless fashion for many months. The VIX was near an all-time low and there was no sign in the price action that anything untoward was about to happen, even though some cracks had begun to appear in the mortgage-financing and real-estate bubbles. Then, out of the blue, there was a 5% plunge in the SPX. On the following daily chart this plunge is labeled "Warning shot 1".

After the February-March 'hiccup' the SPX resumed its bull market. Both the stock market and the economy were believed to be in good shape, with the problems that had emerged in the realm of sub-prime mortgage lending generally considered to be contained to that relatively-unimportant part of the economy. No less of an authority than Ben Bernanke assured us that the sub-prime lending problems were, indeed, contained.

The upward trend continued until mid-July, at which point another 'out of the blue' plunge began. This time the decline lasted 5 weeks and wiped 11% off the SPX. On the following daily chart it is labeled "Warning shot 2".

The July-August decline was taken more seriously by almost everyone, including the Fed's senior management. It was taken seriously enough, in fact, to prompt a reversal in the Fed's monetary policy. The Fed entered rate-cutting mode.

During the weeks following the August-2007 low there was still widespread optimism. The overall economy was supposedly still strong, the Fed was being supportive and, as everyone knows, you should never fight the Fed.

The SPX went on to make a marginal new high in October-2007 and then commenced a bear market that over the ensuing 17 months would result in a loss of almost 60%.



The SPX was more stretched to the upside last month than it was in late-February of 2007 and the plunge was twice as big, but we could be dealing with Warning Shot 1. Also, this time around there may not be a second warning shot.

Current Market Situation

The SPX closed higher every day last week. It has now reached its 50-day MA and recouped slightly more than half of the loss from its January peak.

If the rebound of the past six trading days is destined to be followed by another fast decline that tests or breaches the 9th February intra-day low of 2532 then the area near the 50-day MA is the most likely place for the rebound to end. In other words, if our favoured scenario is roughly correct then the rebound probably topped on Friday 16th February. Consequently, this is a good time to hedge or establish a short-term bearish speculation or add to existing positions that are designed to profit from or hedge against substantial stock market weakness.



Note that due to the speed of the rebound to the 50-ay MA, even if we are right to anticipate a second downward leg the SPX could spend 1-2 weeks chopping around in the 2650-2750 range before starting its next serious decline.

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

The US dollar's exchange rate always has an influence on the gold price, but during most periods it has no greater influence than several other fundamental drivers. That's why although the gold price has a general tendency to move in the opposite direction to the Dollar Index (DX), there have been many periods in the past when the two moved in the same direction. When they move in the same direction over a period of weeks or months it means that other influences, such as interest rate spreads, are dominating.

Over the past six months and especially over the past two months the performance of the US dollar's exchange rate has trumped all other influences on the US$ gold price. This is illustrated by the following chart, which reveals a very strong negative correlation. Notice, in particular, that the DX's quick decline to its January low during the first four days of last week was accompanied by a quick rise in the gold price to its January high. This quick rise in the gold price to its January high occurred despite the overall fundamental backdrop being gold-bearish.



It's likely that the DX is in the process of successfully testing its January low -- a process that could involve a brief under-cutting of the low -- and that this test will lead to a few weeks of US$ strength. If so, the gold price probably will give back last week's gain.

Resistance beginning in the low-$1360s and extending up to $1377 remains critical for gold. The bottom of this range was tested last week, but there was no breakout.

We continue to expect that an upside breakout in the gold price will wait until the second quarter, although there is a realistic chance that it will happen sooner -- in reaction to a downside breakout followed by downward acceleration in the Dollar Index.

Gold Stocks

In the TSI commentary posted a week ago we noted the possibility that the HUI's 9th February spike below its December-2017 low and subsequent reversal had set the stage for at least a 1-2 month rally. Last week's price action did not negate this possibility, but we favour a scenario that is more bearish with regard to performance over the next month and more bullish with regard to performance over the next six months.

Here's how we described the more bullish intermediate-term scenario in last week's Interim Update:

"...from a longer-term perspective a more bullish set-up would be created by an extension of the short-term downward trend and an eventual drop below the December-2016 low (160 for the HUI). This would eliminate the tenacious optimism that currently prevails -- as indicated by every upward reversal being heralded as the start of a major advance -- and bolster the current situation's similarity with the lead-up to the huge rally that began in July-August of 1986.

The gold-mining sector will often trend in the opposite direction to the broad stock market, but over the past two months the gold-mining indices have moved up and down with the broad equity indices. For example, the HUI's sharp decline from its late-January high to last Friday's low coincided with a sharp decline in the SPX and the HUI's strong rebound from Friday's low has coincided with a strong rebound in the SPX. ...This suggests that if the HUI resumes its decline and takes out its December-2016 low of 160, the most likely driving force will be another sharp decline in the broad stock market."



A simple, but reasonable, way to look at the gold-mining sector's prospects is that a strong multi-month rally in this sector requires a solid break above the low-$1360s in the gold price. Rallies in the gold-mining sector will be unimpressive until that happens.

The Currency Market

A week ago, we wrote:

"We see two equally-likely paths for the DX over the coming 1-2 months. The first path entails a multi-week top very soon followed by a 1-3 week minor pullback or consolidation and then a move up to the ultimate rebound high in the 91.0-92.5 range. The second path also entails a multi-week top very soon, but with an ensuing pullback that tests or breaches the January low. The stage would then be set for a rally to 92 or above."

By the time we wrote the latest Interim Update it was apparent that the DX was following the second path.

The most likely outcome is that the DX rallies over the next few weeks to above its January high. However, there is a very different lower-probability outcome that we can't rule out, which is that the DX will break below last week's low and accelerate downward in response to another wave of speculative dollar selling.

Turning to the Swiss Franc (SF), the currency that we have been most bullish on over the past three months, there was a break to a new multi-year high last Thursday. The new high was accompanied by a bearish divergence in the daily RSI and was followed by a downward reversal on Friday, so it looks like the SF is about to commence a short-term correction.

The former ceiling at 105-106 should now act as a floor.



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 16th February 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%, P&P = Proven and Probable, PEA = Preliminary Economic Assessment, PFS = Pre-Feasibility Study]

  *Blackham Resources (BLK.AX) has completed its Entitlement Issue (EI) and raised about A$35M. It now has a healthy balance sheet, but it also has a blown-out share count (the company now has 1.26B shares issued and about 1.7B shares fully diluted).

The share price was under pressure last week, probably due to selling by participants in the EI. Given that existing shareholders who took up their full entitlement under the EI now have 2.5-times as many BLK shares as they had two weeks ago, selling by these shareholders could maintain pressure on the stock price for a short while longer.

The free options that were issued as part of the EI are slated to begin trading on the ASX on 20th February (under the symbol BLKO, we guess) and will be added to the TSI List. These options have an exercise price of A$0.08 and an expiry date of 31st January 2019. We estimate that at this time the fair value of the options would be:

A$0.005 (half a cent) with BLK at A$0.05-$0.06
A$0.01 with BLK at A$0.07
A$0.015 with BLK at A$0.08
A$0.022 with BLK at A$0.09

  *Euro Sun Mining (ESM.TO) advised during the week before last that it now expects the long-delayed ratification of the mining licence for its Rovina Valley gold-copper project (Romania) to happen by the end of this month.

The market reaction to the ratification news will be partly determined by what's happening to the gold-mining sector at the time of the news release, but if there's a very strong positive reaction it could be an opportunity to take PARTIAL profits.

  *Evolution Mining (EVN.AX) published its half-yearly accounts for the 2018 Financial Year. The accounts showed that EVN remains very profitable and strongly cash-flow positive.

The best indicator of EVN's performance during the first half of FY2018 is the change in the company's balance sheet over the period. More specifically, the best indicator is the A$191M reduction in net debt, where net debt is defined as long-term debt minus working capital. Net debt was A$285M at 30th June 2017 and only A$95M at 31st December 2017.

EVN is now in a position where it could make sense for the company to take on a significant amount of new debt to fund an acquisition or the construction of a mine, because making the right debt-funded investment would boost the stock's leverage to metal prices without adding much risk.

The owners of EVN shares at the close of trading on 22nd February will be paid a 3.5c/share dividend on 30th March.

  *Solitario Zinc (XPL) announced the 2018 work plan for the Florida Canyon (previously known as Bongara) zinc project in northern Peru. The project is a JV between XPL and Nexa Resources (formerly Milpo), with XPL owning 30% and being carried to production by its senior partner.

The highlight of the planned 2018 work program is the building of an access road into the mineralized portion of the project area. This doesn't sound like much of a highlight, but it is important. Up until now all access supporting surface and underground work has been provided by helicopter, which has greatly limited the scope and speed of the development work.

When complete, the new road will facilitate a) the construction of an underground tunnel into the high-grade zinc zone, b) detailed underground resource/reserve definition drilling, c) surface drilling designed to increase the project resource and d) additional feasibility/infrastructure-related studies.

We estimate that XPL is worth more than US$1.00/share at the current zinc price, but we are concerned that it will remain very under-valued for another 6-12 months due to a lack of market-moving news.

  *US Gold Corp. (USAU) reported the results of the 8 widely-spaced scout holes drilled during the second half of last year at its Keystone project in Nevada. The holes weren't expected to make a discovery, but were expected to provide information that would enable the exploration team to identify parts of the district-scale land package where it would make sense to carry out a more targeted drilling program. In this respect the program was a success. As explained by Dave Mathewson, USAU's Head of Exploration:

"All the Fall 2017 holes intersected thick intervals of anomalous gold mineralization and associated pathfinder elements of arsenic, antimony, mercury and zinc. Arsenic, the element that gold is most strongly associated with is locally visible as arsenopyrite, realgar and orpiment, and is also locally very strongly geochemically present. This information all combines to qualify our assessment that we are in a world-class setting for very large gold deposits."

And:

"With all the new information in hand, the exploration team is now in the process of, and in the position to zero in on the many site-specific target opportunities that have emerged from the drilling that we have conducted to date combined with the recently obtained and assessed geochemical data. The key to ultimate success in the hunt for gold in Nevada is to locate and qualify the gold-bearing fluid conduits that have supplied the gold to the gold-bearing mineral system that is clearly in evidence in the case of Keystone. Once targets are identified and qualified, drilling becomes a vectoring process of drilling holes into these structural gold-bearing conduits and locating more specifically where the conduits cross-cut permissive host rocks."

The information from the scout holes will enable the exploration team's focus to be narrowed down. As Mathewson stated, it will then become a vectoring process -- most likely carried out over multiple drilling programs -- to zero-in on the economic gold mineralisation.

There is, of course, no guarantee that economic gold mineralisation exists within the Keystone land package. All that is known at this time is that large, economic gold deposits have been discovered in geological settings that are similar to Keystone.

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) ALK.AX (last Friday's closing price: A$0.29)

2) KBLT.V (last Friday's closing price: C$11.46)

3) PRQ.TO (last Friday's closing price: C$1.32)

4) QID (last Friday's closing price: US$11.72)

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://www.goldchartsrus.com/
http://research.stlouisfed.org/