-- Weekly Market Update for the Week Commencing 19th December 2016

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 early-2015, but there will be many years of topping action in bond prices and bottoming action in bond yields before major new trends get underway. (Last update: 29 June 2015)

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 2018 and 2020. (Last update: 29 June 2015)

A secular BEAR market in the US 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 2018 and 2020. (Last update: 29 June 2015)

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 2018-2020. (Last update: 29 June 2015)

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Outlook Summary

4. Long-term views are determined almost completely by fundamentals and intermediate-term views are determined by a combination of fundamentals, sentiment and technicals.

Last week's posts at the TSI Blog

The second most overbought market since 1980

How the fundamental backdrop could turn bullish for gold

Summary of current thinking/positioning

1) Continuing to expect that the overall corrections/downturns for gold and the associated mining indices will extend into Q1-2017, but anticipating an intervening rebound. The rebound could get underway immediately, but it looks more like being delayed until early-January.

2) Expecting that 2017 will be a bullish year for commodities. Maintaining long-term exposure to non-gold commodities while acknowledging that the early-2016 lows could be tested in Q1-2017 prior to the start of the aforementioned bullish period.

3) Expecting a decline in the oil price to a January-February bottom and positioned for this outcome via USO put options expiring in February. In addition to being a speculation, these options have been purchased as a hedge against short-term weakness in commodity-related equities.

4) Thinking that government bonds have commenced a long-term bear market, but that the US Treasury Bond is close to a short-term price bottom.

5) Expecting a 6-12 month extension of the equity bull market and looking for opportunities to add to general non-US equity exposure.

6) Thinking that the Dollar Index is close to a 1-2 month top, but that it won't reach a major top before the second quarter of 2017.

7) Maintaining a large cash reserve in recognition of the short-term downside risk in most equities (current cash percentage is about 35%), but putting some cash to work in small-cap gold stocks that could rebound strongly within the next 6 weeks.

Reminder about TSI Christmas schedule

As advised last week, there will be no Interim Update this week and no Weekly Update next weekend. However, we will send out a brief market update via email at the end of this week.

What is the US Treasury up to?

A week ago we mentioned that the US Treasury had just 'injected' $66B into the US economy and that this monetary injection could have been partly responsible for the preceding week's stock market surge. For ease of reference, here's what we wrote:

"The explanation [for the surprising recent stock market strength] revolves around the US government's account at the Fed, called the US Treasury General Account. When money goes into this account (due to tax receipts and borrowing), the money is temporarily removed from the economy. The money is then returned to the economy when it is spent by the government.

As discussed in two blog posts (HERE and HERE) over the past few months and in the 17th October Weekly Update, the government has been holding an unusually-large amount of money in its Fed account and therefore causing monetary conditions to be a little tighter than would otherwise be the case. Specifically, from November of 2015 through to November of this year the US government effectively removed almost $400B from the US economy.

During the week ending Wednesday 7th December they 'returned' $66B to the economy. It's possible that this sudden monetary injection had a positive effect on the stock market."

During the latest week the Treasury released another $19B of cash into the economy, bringing the two-week total to $85B.

Before we hazard a guess as to why this happened it's worth taking a step back and quickly reviewing the shifts over the past year in the amount of money held by the Treasury in its account at the Fed. These shifts are illustrated below.

With reference to the following chart, notice that there was a dramatic rise in the amount of money held in the Treasury's account during the 3-month period beginning in early-November of last year. Over this period the government added about $320B to its cash deposit and therefore effectively removed this amount from the economy and the financial markets. It's not a fluke that this withdrawal of money occurred in parallel with a steep stock-market decline.

The amount of money held in the Treasury's account then oscillated within a $100B range for a few months before embarking on another large rise in mid-September. Specifically, from mid-September through to late-October the Treasury removed about $190B from the economy and the financial markets.

The monetary value of the account peaked in late-October at around $430B and has since declined to $325B, with the bulk of the decline happening over the past two weeks.



The swings in the Treasury's account are strange, for two reasons. First, they would have tended to reduce economic activity during the months leading up to the election and boosted economic activity after the election. This is strange because we are taking about an incumbent Democratic administration taking actions that could only have hurt Clinton's chances in the Presidential election and that fueled the financial-market celebrations in the wake of the Trump victory. Second, the main reason for the cash build-up was supposedly to provide a buffer that could be used during the next 'debt ceiling stand-off' (the period of inter- and intra-party haggling that occurs when the current federal debt limit is reached or expires). With the next debt ceiling stand-off due to begin by March-2017, this would seem to be an inopportune time to be reducing the cash buffer.

The explanation for why the Treasury added about 400 hundred billion dollars of cash to its Fed deposit -- and therefore removed the same amount from the economy -- between November of last year and October of this year appears to be relatively straightforward. It was a response to a recommendation by the Treasury Borrowing Advisory Committee (TBAC) to accumulate a $500B emergency cash reserve. That establishing this reserve would dampen economic activity during the 12 months leading up to the Presidential election probably wasn't considered important, because it was probably believed that a Clinton victory was 'a lock'.

The explanation for why the Treasury is now disgorging cash and giving both the stock market and the economy a TEMPORARY boost is less straightforward and relies on guesswork. Our guess is that with a Republican moving into the White House and with the Republican Party in control of both legislative chambers (the Senate and the House of Representatives), the Obama Administration has decided to spend whatever money it can before it departs. Having very little cash in reserve prior to an imminent 'debt ceiling standoff' will potentially create a substantial problem for the Trump Administration to deal with. Also, the superficial impression will be created that the Democrats left the economy in good shape.

The probability that our guess is correct will increase if the Treasury's General Account continues to be drawn down prior to Trump's 20th January Inauguration.

Lastly, we emphasised the word "temporary" above because injecting money into an economy can never cause real progress and because we are talking about a fixed amount of money that will soon be depleted if the injections continue.

Commodities

Copper

The copper price made a double top in the $2.70s during November and has pulled back to the mid-$2.50s. A normal correction could take the price as far down as the low-$2.30s to 'test' the early-November upside breakout.



Despite no longer being 'overbought' in momentum terms there is still significant short-term downside risk in the copper market. The risk stems in part from the recent weakness in the gold price, in that gold could be leading other metals to the downside just as it led to the upside a year ago. It also stems from the fact that the speculative net-long position in Comex copper futures hit an all-time high last week.

With short-term speculators in copper futures now rampantly bullish about copper's prospects there could soon be another surge to a new 12-month high in the copper price, but this would only increase the risk. The problem is that if/when it starts to look like copper's upward trend is over, a lot of long-positioned speculators are bound to rush for the exit at the same time.

Oil

The oil price broke above its June and October highs early last week in response to the re-cycling of the same old (irrelevant) OPEC news. It then reversed course. This price action has altered the chart pattern and has possibly defined a new price channel.



The breakout that happened early last week hasn't yet been negated and suggests the potential for the oil price to rise to the low-$60s before the start of the next tradable decline. However, if the channel we've drawn on the above chart is valid then a) the entire rally from the early-August low is probably a counter-trend move within an intermediate-term correction/consolidation that began in June, and b) a decline to below the August low has probably just begun.

The divergence between the Canadian Dollar (C$) and the oil price was magnified by last week's market action. As illustrated below, the C$ made a clear-cut downward reversal from its channel top and its 200-day MA during the first half of last week.

The divergence will most likely be closed by the oil price making a catch-up move to the downside, although the possibility that it will be closed by the C$ making a catch-up move to the upside cannot be ruled out. In the financial markets there are no guarantees, only probabilities.



The Stock Market

The US

The NASDAQ100 Index (NDX) broke above resistance near 4900 last week and in doing so removed a short-term bearish non-confirmation. The breakout projects a rise to at least 5100 over the weeks ahead.



In the TSI List there is a bearish NDX speculation in the form of QID (a leveraged bear fund) $30 call options expiring in January. The same options are in our own account*. There is still a chance that something will happen to inject significant value into these options prior to their 20th January expiry date (a quick decline of about 15% would do it), but the chance is now so small that we have assumed that they will expire worthless and written them down to zero.

We expect that there will be meaningful (8%-12%) declines in the senior US stock indices from whatever highs are in place by early-January, but at this stage we don't know if it will be appropriate to attempt a new short-term bearish trade given that the market's overall upward trend looks set to extend into the second half of next year.

Before leaving the US stock market we want to point out that the Dow Jones Utility Average (UTIL) has broken upward from the downward-sloping channel that began to develop at this index's early-July peak. The utility sector is primarily a dividend play that is influenced by the bond market and/or expectations regarding future bond yields, so UTIL's up-turn is consistent with our view that the T-Bond will soon begin to rebound.



    *It's worth reiterating that while we will generally have positions in most (not all) of the stocks/warrants/options included in the TSI List, the TSI Stocks List is not a reflection of our portfolio and neither is it supposed to be a recommended or model portfolio. It is a list of speculating/investing ideas that TSI subscribers can draw from.

Europe

Prior to the surge in the US money-supply growth rate over the past two months, the main thing in the US stock market's favour was the major basing patterns evident in European and Japanese stock indices. For example, since July it has looked like the EURO STOXX 50 Index (STOX5E) completed a double bottom during the first half of this year.

The basing-pattern interpretation of the STOX5E's 2016 performance was recently confirmed via a decisive break above resistance at 3150 (the top of the base). There could be a pullback to around 3150 to 'test' the breakout within the next two months, but the price pattern suggests that STOX5E will challenge its 2015 high during 2017.



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

Is there still a realistic chance that a gold bull market is in progress?

The short answer to the above question is no. For the longer answer, read on.

On a few occasions during the 2016 gold rally we asked the question "is it a gold bull market?". On each occasion we answered that it could be, but that neither the true fundamentals nor the price action had confirmed the bull market scenario. Of particular importance, the true fundamentals spent the period from December of 2015 through to October of 2016 oscillating around neutral. They were always either neutral/mixed or slightly bullish or slightly bearish; they were never definitively bullish. In this respect 2016 was very different to 2001-2002 -- the first two years of the last major bullish trend in the gold market, when the fundamental backdrop was consistently and definitively gold-bullish.

With regard to the price action, we pointed out numerous times that this year's rally bore the greatest similarity to the 1982-1983 bear-market rebound.

As recently as late-October we were still prepared to give the bull-market scenario the benefit of the doubt, but in early-November the 'true fundamentals' turned definitively gold bearish. It's simply not possible for the fundamental backdrop to be definitively gold-bearish during the first year of a gold bull market, so a gold bull market is not what we are currently dealing with.

In addition to being eliminated by 'fundamental' factors, the 'gold bull market scenario' (the idea that gold commenced a new cyclical bull market in December-2015) has now been eliminated by the price action.

The main reason we make the above statement is not the large decline in the US$ gold price. After all, if we were looking at nothing other than a chart of the US$ gold price we could make the argument that the decline from the early-July peak is an intermediate-term correction separating the first two legs of a bull market. However, we don't only take into account gold's performance in US$ terms.

Always an important consideration is gold's performance relative to the US stock market, with the S&P500 Index (SPX) being our preferred stock-market proxy. If gold is in a bull market then it WILL trend upward relative to the SPX.

The following weekly chart shows the gold/SPX ratio since 1980. The blue line on the chart is the 150-week MA, which does a good job of differentiating significant (multi-quarter) counter-trend moves from major trend reversals. Of particular relevance, with one exception all significant rebounds during the long-term bearish trend of 1980-2000 and all significant declines during the long-term bullish trend of 2001-2011 ended near the 150-week MA. The one exception occurred in 1987, when a stock-market crash caused a counter-trend rebound in gold/SPX to spike well above the 150-week MA.

Notice that the 2015-2016 rebound in the gold/SPX ratio ended near the 150-week MA and that the ratio has since fallen back to its 2015 bottom. In fact, the ratio made a marginal new 9-year low last week.

If your bull-market definition allows for a new 9-year low to be made one year after the start of a bull market, then there's a problem with your definition.



It's possible that the gold/SPX ratio's recent decline to last year's low will turn out to be a successful test of the low and that another significant counter-trend rally will unfold during 2017. This would result in 2016-2017 looking similar to 1986-1987. It's also possible that the fundamentals will shift decisively in gold's favour during the first half of 2017, leading to a gold bull market getting underway within the next few months. However, it is clear that a gold bull market did not begin in December-2015.

Current Market Situation

Last year, the gold price bottomed on the day after the mid-December Fed meeting, meaning on the day after the announcement of the year's only rate hike. With the gold price having made a 10-month low on the day after this year's mid-December Fed meeting (the day after the announcement of the year's only rate hike), something similar could now be happening. However, for the reasons mentioned in last week's Interim Update the set-up for a strong rally is not as good now as it was a year ago.

What we can reasonably expect is a rebound to as high as the 200-day MA (currently in the $1270s, but beginning to decline) after a short-term bottom is put in place.



Gold Stocks

The HUI was likely to drop to its channel bottom near 160 if support in the low-170s gave way. This happened last week.



As a result of last week's price action there is no longer any divergence or non-confirmation between the bullion market and the gold-mining sector. Specifically, the gold-mining indices have now confirmed gold's drop to new lows for the decline that began during the third quarter.

There is no evidence that a short-term rebound has begun or is about to begin, but the decline to the channel bottom means that for the fourth time since late-August the HUI is stretched to the downside on a short-term basis. On the previous three occasions there was only a small rebound or a sideways consolidation, but at some point a much stronger rebound will get underway regardless of whether or not the fundamental backdrop has turned in gold's favour.

It would take a daily close above 195 to clearly signal a short-term trend reversal, although an early warning of such a reversal would now be provided by a daily close above 185.

Even if the intermediate-term outlook for gold bullion remains uninspiring there could be substantial money to be made in 2017 by trading gold-mining stocks from the 'long' side. It will just be a matter of restricting buying to periods when the sector is depressed (periods like the present) and being quicker-than-usual to start the selling process during rallies. One reason is that after the gold price finds a short-term bottom, the gold-mining sector should benefit from general strength in mining stocks. Another reason is that the gold price is likely to rebound to its 200-day MA within the first half of 2017 even if the overall bearish trend remains intact.

Furthermore, during the first half of 2017 the stocks of junior and mid-tier gold producers based in Australia are likely to perform well (as a group) thanks to their relatively low valuations and relatively high profit margins. Due to the downward trend of the past few months there are also plenty of Canada-based junior gold miners that now offer very good value and have the potential to rally strongly after the sector-wide downward pressure abates.

The Currency Market

The euro broke below major support at 105 during the final two days of last week. The downside breakout was almost inevitable -- the only real question was whether it would happen this month or during Q1-2017.



Despite the breakdown it's still possible that the euro is close to a low that will hold for 1-2 months. However, the break below support should be respected until/unless it is shown to be false via an upward reversal within the next several days.

A daily close above 105.5 would indicate that last week's downside breakout was a false/misleading signal and set the stage for a rebound over the ensuing weeks to as high as 109.5.

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 December 2016:

[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) published a revised resource estimate for the Matilda/Wiluna gold project in Western Australia. The revised estimate is the first step in the Stage 2 expansion study aimed at growing annual gold production to 200K ounces from the current target of 100K ounces.

The combined Matilda/Wiluna Measured, Indicated and Inferred Mineral Resource has grown to 6.0Moz (58Mt @ 3.2g/t) from 5.1Moz. About 2.1M ounces of the new total are open-pit resources.

The additional 900K ounces are mostly the result of resource re-modelling. It is obviously a significant increase, but the real significance won't be known until a detailed economic analysis is done for the expansion project.

Based on the lack of market reaction to BLK's additional 900K ounces of in-ground resources it seems that sentiment has gone full circle. During the second half of 2015 the stock market mostly ignored genuinely good news from gold-mining companies, but by May of this year we were seeing gold-mining stocks rally hard in reaction to irrelevant/neutral news (such as the announcement by a junior gold miner that it planned to do some drilling). Now we are back to the point where genuinely good news is ignored.

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$0.32)

2) BLK.AX (last Friday's closing price: A$0.46)

3) EVN.AX (last Friday's closing price: A$1.61)

4) PG.TO (last Friday's closing price: C$2.07)

5) SCP.TO (last Friday's closing price: C$0.50)

Note that 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://research.stlouisfed.org/