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 ended in 2012. In real (gold) terms, bonds commenced a secular BEAR market in 2001 that will continue until 2018-2020. (Last update: 20 January 2014)

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

The "mystery" buyer of T-bonds

A recent article at ZeroHedge notes that "Belgium" is now the third-largest foreign holder of US Treasury paper, with $381B worth at the end of March. The article correctly points out that neither the government nor the country of Belgium owns this US government debt, but otherwise leaves open the question of ownership. We will now tackle the question: Who bought the $381B of Treasury paper that now shows up in official reports as being held by a Belgian entity?

The answer to this question is unknowable. The ZeroHedge article states that the owner is not China (meaning: the government of China), but this is not necessarily true. The reason is that the US Treasury will not always be able to identify the ultimate foreign owner of a T-Bond and will therefore not always be able to accurately report the value of bonds held by various governments. For example, China's government could be buying bonds via an intermediary that uses Euroclear, a Belgium-based financial services company.

The Belgium-based Euroclear specialises in the settlement of securities transactions and the holding of collateral that backs derivatives trades and other types of financial-market trades. It apparently has more than 20 TRILLION dollars of assets on deposit, so it wouldn't exactly be shocking if it now held $381B of the world's most popular collateral.

What we do know for certain is that the $381B of T-bonds that are now reported as having a "Belgium" location are NOT owned by the US Federal Reserve. The Fed cannot secretly create new money to buy bonds, as every dollar created by the Fed shows up as a liability on the Fed's balance sheet and a reserve on the balance sheet of a commercial bank. Anyone who claims that the Fed has been the buyer of all or part of the $381B stack of T-Bonds with the "Belgium" location is either ignorant of how the Fed works or is telling lies in order to promote an agenda.

As an aside, the Fed has overtly done so many counter-productive and unethical things that there is no need for Fed critics to make up silly stories about what is supposedly being done in secret.

It seems to us that some people are coming up with 'kooky' explanations for a T-bond rally that, from their perspective, is inexplicable. After all, with the Fed "tapering" its bond purchases the price should -- according to conventional wisdom -- have been trending downward over the past few months. However, an objective assessment of the facts reveals that there is nothing strange about this year's T-bond rally.

It is important to recognise one's biases. For example, we have a bias against US Treasury debt that causes us to be bearish on this market more often than we should be. But even with our bearish T-bond bias it became clear to us last December that this market's short-term risk/reward was definitively skewed towards reward. Sentiment was 'in the toilet' (evidenced, in part, by a large speculative net-short position) and the market was almost as 'oversold' as it ever gets, thus paving the way for a tradable rebound even if the secular trend was in the process of changing from up to down. Since that time the T-Bond has worked its way higher and has broken out to the upside from an obviously-bullish basing pattern, and yet most speculators remain stubbornly bearish. This has created one of the most blatantly bullish sentiment-price mismatches we have ever seen, suggesting that significant additional price gains are likely over the months ahead.

What about fundamentals? Isn't the T-bond's rally in conflict with its bearish fundamentals?

Well, it is not uncommon for a major financial market to move contrary to its so-called fundamentals for several months, but in the T-bond's case the short- and intermediate-term fundamentals have become increasingly bullish over the past few months. First, inflation expectations are low and the downward reversals in US equity indices that began to appear in March suggest that inflation expectations are going to stay low for at least six more months. Second, long-dated US Treasury securities have become very under-valued relative to investment-grade corporate bonds, junk bonds, European government bonds, Japanese government bonds and emerging-market government bonds. If you must own bonds and you don't mind providing financial support to the world's most destructive organisation, then T-bonds are clearly now the best option.

In summary, the T-bond rally has been driven by sentiment, a reversion to the mean from an 'oversold' extreme, short covering, inflation expectations and relative valuation. These drivers generally remain supportive, and although it is now 'overbought' on a short-term basis the T-bond market is not yet stretched to the upside on an intermediate-term basis. Significant additional gains are therefore a good bet prior to the next multi-month peak.

The bottom line is that no conspiracy/manipulation theories are required to explain the on-going rally. 

Monetary Inflation Update

The year-over-year (YOY) rate of growth in US True Money Supply (TMS) bottomed at around 7.0% in December and has since ticked up to around 8.0%. How could this uptick have occurred in parallel with the Fed's "tapering"?



The answer to the above question is that the US commercial banking industry has recently ramped-up the pace at which it creates credit. US commercial bank credit has risen by only 3.3% over the past 12 months, but since November of last year it has expanded at an annualised rate of around 7%.

Up until now, therefore, a faster rate of money creation on the part of commercial banks has offset the Fed's slower rate of money creation. We doubt that this will continue to be the case over the months ahead, because a) the real-estate financing business has begun to contract, b) the relative weakness of bank stocks suggests that the banking industry is now entering another stressful period, and c) the recent US economic slowdown will probably turn out to be more than a weather-related blip. We therefore expect that the US monetary inflation rate will soon resume its downward trend and that this trend will only end after there is enough weakness in the stock market and the economic data to prompt an about-face by the Fed.

The Stock Market

At the most superficial level, very little has happened in the financial markets since late March. In particular, we note that the S&P500 Index (SPX), the gold price, the gold-stock indices, the Dollar Index and the Continuous Commodity Index are all at roughly the same levels now as they were at the end of March, with minimal intervening volatility. The following chart illustrates the SPX's recent sideways movement near its all-time high. Nothing to see here.



However, if we look just beneath the surface the view gets more interesting. For one example, the first of the following charts reveals what looks like a head-and-shoulders topping pattern in the NASDAQ100 Index (NDX), with the 'right shoulder' having been put in place over the past three weeks. For another example, the second of the following charts shows that the Russell2000 Small-Cap Index (RUT) ended last week at critical support defined by its lows of the past six months.

And if we look further beneath the surface we see two potentially-dramatic developments. First, we see that after peaking in July of last year and making a slightly lower peak in late-March of this year, the BKX/SPX ratio (the banking sector relative to the broad market) fell sharply and broke out to the downside. The BKX/SPX ratio just hit a 52-week low. Second, we see that the HYG/TLT ratio (junk bonds relative to T-bonds) peaked at the beginning of this year and just hit its lowest level since June of last year. The relevant charts are displayed below.

The recent performances of BKX/SPX and HYG/TLT indicate that a headwind is gaining force in the stock market and that a tailwind is gaining force in the gold market.

Well over half of the US stock market has already rolled over to the downside. The S&P500 should soon follow suit.

This week's important US economic events

Gold and the Dollar

Gold

The risk of gold spiking to a new multi-month low before completing its correction was reduced, but not eliminated, by last week's price action. The reason for the lowered risk is that gold failed to make a new correction low despite a marginal new high in the S&P500.

The gold price has essentially gone nowhere for several weeks, which makes gold's recent performance similar to the recent performances of the currency and stock markets. Within its narrow trading range, up-swings over the past couple of weeks have been limited by the 50-day MA. We would therefore view a daily close above this moving average ($1310) as evidence that the correction was over and that a new short-term upward trend had begun.



Gold Stocks

Updated comparisons with the 1970s

Updated charts comparing the BGMI (Barrons Gold Mining Index) from its 1967 and 1974 peaks with the current HUI are displayed below. The current price action continues to be most similar to 1977 (the second of the following charts).

If the current price action continues to follow the 1977 path then an upward reversal will occur this week, perhaps following a spike to a new correction low.

Current Market Situation

Whether or not the HUI broke below short-term support last week depends on how we draw the support line. Last Friday's low was above the intra-day low reached in mid-April, but on a daily closing basis the HUI has just made a new correction low. This suggests that lateral support at 210 will soon come into play. Refer to the top section of the following daily chart for details.

At the risk of disturbing the dour mood we point out that last Friday's decline by the HUI to a new daily-closing low for the correction created a bullish divergence, in that the GDXJ/GDX ratio did not confirm. Refer to the bottom section of the following chart for details. The recent relative performance of the HUI and the GDXJ/GDX ratio is similar to their relative performance during December and suggests that the correction is almost complete.



The stage is set for an upward reversal. However, if you are a short-term trader and were 'long' the gold sector going into last Friday, then for risk management purposes it would have been reasonable to exit when it became clear that the HUI was going to close below 219. You can always re-establish your position after a reversal is signaled.

The Currency Market

The Yen's lack of movement epitomises the general financial-market situation. The Yen and many other markets are 'coiling' in preparation for tradable moves. For the Yen, the move is likely to be to the upside.



The rebound in the Dollar Index that got underway during the week before last has eliminated the 'oversold' condition and made it more likely that a break below support at 79 would have significant follow-through to the downside. Of course, the Dollar Index still has to break below 79.

The Dollar Index has resistance at 80.5 that was almost tested last week and more important resistance at 81.5. The most important support obviously lies at 79.

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 ended Friday 16th May 2014:

[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) published its financial results for the March quarter. The important number is the working capital, which fell by $1.5M during the quarter to around $11M. AAU is fully funded through to at least the end of this year, although we suspect that a small equity financing will be done during the second half of this year to top-up the treasury.

  *Asanko Gold (AKG) published its financial results for the March quarter. The financial reports indicate that AKG had $233.6M of working capital, including $237.7M of cash, at 31st March. It also has a $150M undrawn credit facility and is therefore fully financed through to the completion of Phase 1 of the Asanko mine development.

Although AKG still has a very strong balance sheet, its cash reserve at 31st March was about $17M less than we were expecting. The reason we thought the company had more cash is that a 3rd April AKG press release contains the following quote from CEO Peter Breese: "We are fully funded for phase 1 with $255-million (U.S.) cash...". Shame on us for thinking that the CEO would know how much cash the company had.

  *Dalradian Resources (DNA.TO) published its financial results for the March quarter. The TSI Stocks List has exposure to DNA via the DNA C$0.90 warrants (TSX: DNA.WT) that expire next February. Refer to the 23rd April Interim Update for further information on DNA and its warrants.

The financial reports indicate that DNA has about $17M of working capital, which should be enough to fund the company for another 12 months. Since we expect to exit the warrants within 6 months, it should also be enough to ensure that we will be out of our position by the time the next equity financing is arranged.

Our price target for this intermediate-term warrant trade is C$0.45-C$0.50. For the warrants to trade at this price the shares will probably have to trade above C$1.30. Considering the stock's price chart and valuation, this looks achievable.

At Friday's closing price of C$0.91 for the stock, fair value for the warrants is around C$0.15.

  *Energy Fuels (EFR.TO, UUUU) published its financial results for the March quarter. These results show that the working capital of this junior uranium producer increased from US$33M to US$42M during the quarter. Note that the latest quarter included a restructuring of regulatory bonding that enabled $12M to be transferred from "restricted cash" to working capital, so while the increase in working capital is welcome it was not due to operational profitability.

EFR is a leveraged play on the uranium price that has sufficient balance-sheet strength and operational flexibility to weather the current weakness in the uranium market.

  *Lydian International (LYD.TO) published its financial results for the March quarter. The financial reports indicate that LYD had about $24M of working capital at mid-April, which should be enough to fund the company for another 12 months.

We are expecting LYD to issue an updated FS for its Amulsar gold project within the next month.

  *Premier Gold (PG.TO) reported its financial results for the March quarter. As expected, these results show that the company's working capital was unchanged at around $58M over the course of the quarter, with an increase in the value of investments held for sale (Sandstorm Gold shares) offsetting the quarterly spending. It appears that PG sold most of its remaining investment in Sandstorm Gold during the quarter, as the company's cash increased by about $10M while the "investments held for sale" line on the balance sheet fell to only $8.7M.

We think that PG has enough working capital to fully fund its operations for at least the next 18 months or until it decides to move the Hardrock project into the construction phase.

PG also reported that it has commenced the formal Environmental Assessment (EA) and permitting process at the Hardrock Project, secured a range of consultants necessary for completion of a Feasibility Study expected in the first half of 2015, and retained Mr. Bertho Caron as Engineering & Construction Manager. This means that PG is progressing Hardrock at a brisk pace given that the project's PEA was completed less than 4 months ago.

The next market-moving news from PG is expected to be an updated resource estimate for the Hardrock project within the coming month.

PG is not cheap relative to many other exploration-stage gold mining stocks, but it has relatively low risk. This is due to its strong balance sheet, the politically-secure locations of its projects and the good chance that its largest project will prove to be economically viable.

  *Pretium Resources (PVG) published its financial results for the March quarter and updated the market on its progress. The company had $28M of working capital at 31st March, which should be enough to fund its operations until the final quarter of this year.

The next important milestone for PVG is expected to be the completion of its amended FS. This is due next month. The economics indicated by the amended FS are likely to be just as robust as the economics indicated by the original (June-2013) FS, but the questions raised by Strathcona regarding the resource estimation methodology will remain unanswered.

Judging by PVG's recent price action, the stock market has put aside Strathcona's concerns about the resource. We are referring to the fact that PVG made a new high for the year in dollar terms last week (as illustrated by the top section of the following chart) and is not far from an all-time high relative to its peer group (as illustrated by the bottom section of the following chart).



However, the major mining companies that are the most likely acquirers of PVG probably won't be as quick as the stock market to dismiss Strathcona's concerns. This could mean that PVG will end up having to build the mine itself.

  *Rio Alto (RIOM) reported some drilling results from its 200K-oz/yr La Arena gold mine in Peru. According to the company's press release: "The results of the recent drilling program demonstrate that a large amount of oxide brecciated sandstone mineralization (the main mineral type at La Arena) lies outside the 2014 Reserve Pit. The results are very encouraging and indicate the potential to increase oxide gold resources and reserves and the possibility of extending mine life beyond 2019."

This is good news. Due to its low production costs, every ounce of gold that gets added to RIOM's reserves has significant value. For example, whereas a 100K-ounce reserve addition wouldn't necessarily mean much to an exploration-stage gold miner, based on its current cost structure a 100K-ounce addition to RIOM's reserves would be worth $30M at the current gold price and $50M at a gold price of $1500/oz. To put it another way, at the current gold price and cost structure, every 100K ounces that gets added to the open-pit oxide reserves at RIOM's La Arena project adds about $0.17/share of value to the company.

  *Sabina Gold and Silver (SBB.V) published its financial results for the March quarter. According to these results the company had about $54M of working capital at 31st March. This compares to $59M at the end of last year.

As previously advised, SBB's published work programs and budgets indicate that the company is fully funded through to the end of next year.

Separately, SBB advised that it has finalised the sale of a small non-core project to Laurentian Goldfields (LGF.V) for a 6.3% stake in LGF. This deal was originally announced in January. The financial value of this deal is not significant for SBB (6.3% of LGF is presently worth about C$2M), although thanks to the large increase in the price of LGF shares over the past couple of months the value is much higher now than it was when the deal was first announced.

List of candidates for new buying

From within the ranks of TSI stock selections, the best candidates for new buying at this time are:

1) EDV.TO (last Friday's closing price: C$0.79).

2) EVN.AX at around A$0.80 (last Friday's closing price: A$0.87).

3) PLG.TO (last Friday's closing price: C$1.34).

4) RIOM (last Friday's closing price: US$1.95).

Potential new TSI stock selection: True Gold Mining (TSXV: TGM). Shares: 398M issued, 483M fully diluted. Recent price: C$0.37

A few weeks ago we said that despite the weakness in the gold-mining sector, we were getting frustrated by the resilience of some gold-mining stocks we wanted to buy. There are exceptions, but during the correction of the past two months the stocks of gold-mining companies with high production costs or exploration-stage projects that would need a much higher gold price to become viable have generally been hit hard, while the stocks of gold-mining companies with low production costs or exploration-stage projects that would likely be viable at the current gold price have generally held up well. At this time we are only interested in buying the latter. Hence, our frustration.

Roxgold (ROG.V) is an example of a stock that hasn't pulled back as far as we would have liked. In the 23rd April Interim Update we said that we would add ROG, a company with an economically-robust Feasibility-stage gold project in Burkina Faso, to the TSI List if it traded at C$0.60 (it was trading at C$0.66 at the time). Despite a 4% decline in the XAU between then and now, ROG has since worked its way up to around C$0.70 and no longer has a realistic chance of trading at our suggested buy price. We will therefore file ROG in the "ones that got away" category.

True Gold (TGM.V), a company that also has an economically-robust Feasibility-stage gold project in Burkina Faso, is another example of a stock that interests us but hasn't yet pulled back far enough for our liking. Although we have been tracking TGM since last year, this is the first time we've mentioned it in a TSI commentary. We are mentioning it today because even though it currently isn't quite cheap enough to warrant inclusion in the TSI List, in the near future there could be a final downward spike to end the stock's correction and create the desired buying opportunity.

TGM's Karma gold project has a total resource comprising 2.6M ounces in the M&I category and 2.4M ounces in the Inferred category (including 1.7M Inferred ounces at the North Kao target). However, the only part of the deposit that is economically viable at the current gold price is the leachable oxide portion, which contains 950K ounces in the main resource and 423K ounces at the North Kao target. The aforementioned 950K ounces is the only part of the overall deposit that was considered in the FS completed last December and is the only part of the resource that interests us at this time, although the remainder has option value.

The FS revealed a technically simple project with a manageable initial capex of $131M, a high after-tax IRR of 46.2% at $1300/oz, an after-tax NPV(5%) of $196M at $1300/oz, and average annual production of 97K ounces at an all-in cost of $720/oz over a mine life of 8.5 years. These figures certainly justify the construction of a mine. Furthermore, TGM is almost fully financed through to production (the company has $70M of cash, which is more than enough to cover the equity portion of the project financing, and is close to completing the debt portion of the project financing). Mine construction is expected to begin during the second half of this year.

TGM offers reasonable value at last Friday's closing price of C$0.37, although at this price the reward/risk is not quite good enough for us. The current enterprise value (market cap minus $70M of cash) is only $78M, but we suspect that the short-term upside could be limited by the 65M C$0.47 warrants that expire in mid-August of this year. Our view is that the stock would be an excellent candidate for new buying in the low-C$0.30s and that the reward/risk would also be sufficiently attractive at C$0.35. A spike down to the low-$0.30s is possible within the coming fortnight to complete TGM's multi-month correction, although for TSI record purposes the stock will be bought if it trades at C$0.35.

TGM's management team is highly regarded. Of particular note, Mark O'Dea, the company's executive chairman, is the former CEO of Fronteer Gold and the current non-executive chairman of Pilot Gold.

At this time our 6-month target is C$0.50 and our 12-month target is C$0.70. Many other junior gold stocks have greater upside potential, but a large part of TGM's appeal stems from its relatively low risk.

Chart Sources

Charts appearing in today's commentary are courtesy of:

http://stockcharts.com/index.html