<% 'pass = Request.Form("pass") IF ((Request.Form("pass") = 1) OR (Session("pass") = "pass")) THEN %> Speculative-Investor.com
   -- Weekly Market Update for the Week Commencing 21st April 2008

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.

Bonds commenced a secular BEAR market in June of 2003. (Last update: 22 August 2005)

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)

The Dollar commenced a secular BEAR market during the final quarter of 2000. The first major downward leg in this bear market ended during the first quarter of 2005, but a long-term bottom won't occur until 2008-2010. (Last update: 28 March 2005)

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 CRB Index, commenced a secular BULL market in 2001. The first major upward leg in this bull market ended during the second quarter of 2006, but a long-term peak won't occur until at least 2008-2010. (Last update: 08 January 2007)

Copyright Reminder

The commentaries that appear at TSI may not be distributed, in full or in part, without our written permission. In particular, please note that the posting of extracts from TSI commentaries at other web sites or providing links to TSI commentaries at other web sites (for example, at discussion boards) without our written permission is prohibited.

We reserve the right to immediately terminate the subscription of any TSI subscriber who distributes the TSI commentaries without our written permission.

Outlook Summary

Market
Short-Term
(0-3 month)
Intermediate-Term
(3-12 month)
Long-Term
(1-5 Year)
Gold
Bearish
(21-Apr-08)
Neutral
(21-Apr-08)
Bullish

US$ (Dollar Index)
Bullish
(10-Mar-08)
Bullish
(31-May-04)
Neutral
(19-Sep-07)

Bonds (US T-Bond)
Neutral
(03-Mar-08)
Bearish
(23-Jan-08)
Bearish
Stock Market (S&P500)
Bullish
(18-Mar-08)
Neutral
(26-Mar-07)
Bearish

Gold Stocks (HUI)
Bearish
(21-Apr-08)
Neutral
(21-Apr-08)
Bullish

OilBearish
(14-Jan-08)
Bearish
(22-Oct-07)
Bullish

Industrial Metals (GYX)
Neutral
(28-Nov-07)
Bearish
(09-Jul-07)
Bullish


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 giving an approximately equal weighting to fundmental and technical factors, and short-term views almost completely by technicals.

Measuring the money supply

...monetary inflation has moderated considerably since 2001-2003. Inflation is still occurring, but hyperinflation certainly doesn't look like a near-term threat.

In our 9th April commentary we attempted to answer the question: "What is the best measure of money supply?" In the process of doing so we:

a) Noted that there was considerable disagreement, even amongst good economists from the "Austrian School", regarding what constitutes money nowadays.

b) Explained that both M1 and the Monetary Base are poor indicators of monetary conditions.

c) Referred to Murray Rothbard's 1978 article on money supply to make the point that it is the SUBJECTIVE assessment of people that determines whether something should, or should not, be counted as money (savings deposits are credit transactions, but the fact that people generally believe savings deposits to be redeemable in standard money on demand, and therefore treat them as equivalent to cash, means that these deposits SHOULD be included in the money supply).

d) Said that a reasonable argument could be made for including retail Money Market Mutual Funds (MMMFs) in the money supply based on the subjective nature of money as outlined in the above-linked Rothbard article (if almost every individual that holds a money market deposit BELIEVES the deposit to be a cash surrogate -- always convertible on demand into cash at par -- then it can reasonably be argued that these deposits form part of the money supply).

We concluded that the answer to the money supply question is not 'cut and dried', and that there may not be a single right answer. We therefore suggested paying attention to three different monetary measures: TMS (True Money Supply -- the money supply measure calculated at the Mises.org web site), MZM (Money with Zero Maturity), and M2. These three measures will often move together, but will occasionally diverge quite markedly.

We've since given the issue of money supply measurement more thought and, as a result, have greater conviction with respect to two issues. First, we are now convinced that retail MMMFs should be counted as part of the money supply as long as the vast majority of people who hold these deposits believe them to be redeemable at par on demand. In other words, if almost every individual with a MMMF deposit thinks of this deposit as part of his/her readily available money supply, then the sum of these deposits should be considered part of the economy's total money supply (even though doing so will result in some double-counting of money). The key question, then, is: does almost everyone consider their MMMF deposits to be part of their readily available money supplies? At some future time the answer to this question might be no, but right now we think the answer is yes.

Second, we are convinced that time deposits should NOT be counted as part of the money supply -- despite Rothbard's assertion to the contrary -- because when an individual places money into such an account he/she consciously trades the convenience of having money available on demand for the benefit of a higher interest rate. Putting it another way, when people open time deposits they usually understand that they are entering into credit transactions and that their money will not be available to them until after a pre-determined amount of time has passed.

The following chart supports the notion that time deposits are yield-based investments, rather than money. The chart shows that the year-over-year (YOY) percentage change in small time deposits consistently tracks the 3-month T-Bill yield (it shows that the demand for time deposits rises and falls with short-term interest rates). In fact, it is the strong tendency of the total time-deposit amount to move up and down with interest rates that caused M2 and M3 -- monetary aggregates that include time deposits -- to generate 'major league' false signals during 1991-1993. During this period the amount of money invested in time deposits plunged as the Fed slashed short-term interest rates in an effort to drag the banking system out of a hole (the sort of hole it seems to dig itself into every 8-10 years). This, in turn, caused sharp declines in the growth rates of M2 and M3, making it appear as if deflation was a clear and present danger. However, at the same time that the growth rates of M2 and M3 were sinking like stones, the growth rates of TMS and MZM -- neither of which includes time deposits -- were shooting upwards. Based on the performance of the stock market at the time we can be quite sure that the monetary signals generated by TMS and MZM were the accurate ones.


As far as monetary indicators go, TMS and MZM appear to be superior to M2 and M3. However, from our perspective TMS is flawed because it doesn't include retail MMMFs, while MZM is flawed because it includes both retail and institutional MMMFs. We've therefore come up with a new monetary aggregate that we will call TMS+, which is calculated by adding retail MMMFs to TMS.

The following chart compares the YOY percentage changes of TMS (shown in blue) and TMS+ (shown in red). Interestingly, there has been almost no difference between these two measures in the past. A difference could occur in the future, though.


The message of both TMS and TMS+ is that monetary inflation has moderated considerably since 2001-2003. Inflation is still occurring, but hyperinflation certainly doesn't look like a near-term threat. This is consistent with our 'big picture' view in that we expect hyperinflation to occur eventually, but not this decade.

The inflationary effects that are readily apparent almost everywhere are mostly due to the rampant inflation that occurred during 1998-2003, whereas the impact of the much slower monetary growth of 2004-2007 is yet to be seen outside the real estate and financial sectors. This is because the effects of inflation on currency purchasing power can, and often do, lag actual inflation by several years.

Quick update on bonds

One of the most reliable cycles in the financial world over the past 6 years has been the yearly cycle in the bond market that results in an intermediate-term extreme (a high or a low) during the May-June time window. To be specific, there were important highs in the bond market during May-June of 2003 and 2005, and important lows during May-June of 2004, 2006 and 2007.

If the bond market's reliable May-June cycle is going to 'work' this year then we think the odds are slightly in favour of it providing an important low. The idea that there will be a sharp bond-market decline over the next several weeks, leading up to a May-June low, meshes with our bullish stock market outlook; however, we don't think bonds should be sold short at this time because the Commitments of Traders data for this market has become quite bullish (the "Commercials" have built up a sizeable net-long position in T-Bond/T-Note futures). It would make more sense, we think, to wait to see what bonds do over the coming month or so before taking a position. For example, a sharp bond-market decline over the next several weeks would likely create a very bullish set-up, whereas a move to new highs for the year in May or June would probably set the scene for many months of bond market weakness.

The Stock Market

Current Market Situation

The S&P500 Index ended last week just below important resistance at 1400. However, the Dow Industrial Index and the NASDAQ100 Index (NDX) broke decisively above similar resistance levels on Friday. The top section of the following chart shows the NDX's upside breakout, while the bottom section of the chart makes the point that the NDX has begun to trend higher relative to the Dow.


Better-than-expected earnings from the large-cap tech stocks are driving the nascent upward trend in the NDX/Dow ratio. There has been an overwhelming focus on the massive write-offs occurring within the financial sector, but it is becoming clear that there has not yet been a significant slowing in the growth of the tech sector. Furthermore, many large US tech companies generate a lot of their sales outside the US and are therefore immediate beneficiaries when the US$ weakens.

Microsoft (MSFT), a large-cap tech stock in which we have an interest, reports its latest quarterly earnings results after the close of trading on Thursday 24th April.

Sentiment indicators suggest that the broad US stock market will achieve significant additional gains before an important top is in place. In particular, we note that the 10-day moving average of the equity put/call ratio is still very high (>0.80), and that both the Investors Intelligence and AAII sentiment surveys still show more bears than bulls.

The Airlines

Most sectors of corporate America appear to be in reasonable shape, with the standout exceptions being the sectors involved with homebuilding, financial services, and air travel. Of these, only the last one has speculative appeal for us at this time.

The airline sector has been battered and bruised by the relentless rise in the oil price. It will continue to languish until the oil price begins to trend lower, but once oil establishes a downward trend the airline stocks are likely to make huge gains.

As far as the next few months are concerned, we think the airline sector has more upside potential than any other sector of the US stock market. This doesn't, however, mean that we think the airline sector offers the best investment opportunity. This is a situation where the upside potential is very high AND the risk is high given that the oil price could -- we don't think it will, but it COULD -- move a lot higher before it moves lower. The airline stocks should therefore be looked at as short- or intermediate-term speculations, not investments.

The following weekly chart of Continental Airlines (CAL) gives an indication of the airline sector's upside potential. CAL dropped to its long-term channel bottom in January and again in March, and might now be in the very early part of a rally that ultimately takes the stock back to its channel top. CAL's extremely low valuation is consistent with the idea that a major upward trend is about to begin, but a bullish outcome obviously hinges on the oil market soon commencing a multi-month correction. And, as discussed in previous commentaries, a downward correction in oil probably depends upon an upward correction in USD/EUR.

A weekly close by CAL above its 40-week moving average (the blue line on the following chart) would be a clear sign that a large rally had begun, so one strategy would be to wait for a break above this moving average before establishing a new position or adding to an existing position in the stock. However, our preference would be to buy while the stock is in the vicinity of its long-term channel bottom.


CAL is one component of the "Airline Trade" in the TSI Stocks List. The other component of this trade is COPA Holdings (CPA), Panama's national airline. CPA's business has been so strong that it has been able to achieve good earnings growth despite the high cost of fuel.

The following chart shows that CPA is presently testing resistance at around $40. A break above this resistance would create a short-term objective of $50.


This week's important US economic events

Date Description
Monday Apr 21
No important events scheduled
Tuesday Apr 22
No important events scheduled
Wednesday Apr 23 Existing Home Sales
Thursday Apr 24 Durable Goods Orders
New Home Sales
Friday Apr 25 No important events scheduled

Gold and the Dollar

Gold

The following daily chart shows that the June gold futures contract broke below its channel bottom about three weeks ago and found support at $880. It then rebounded to resistance defined by its late-March peak, its 50-day moving average, and the bottom of its former up-channel. Friday's action suggests that this resistance has held and that a decline to a new correction low is underway.

Friday's action has increased the probability that the $800-$850 target range mentioned in earlier TSI commentaries will be achieved within the next couple of months, so we have downgraded our short-term outlook for gold from "neutral" to "bearish". Note that a daily close above $960 (basis the June contract) would indicate that this short-term bearish outlook was wrong and that gold was, instead, on its way to a new all-time high.


In the 14th April Weekly Update we noted that the factors we take into account when assessing gold's real intermediate-term trend had deteriorated to the point where it wouldn't take much to drop the score from the "bullish" to the "neutral" range. Due to some further narrowing of credit/yield spreads and some additional strength in the broad US stock market relative to gold, we would now place gold's real intermediate-term trend in the "neutral" category. This, combined with Friday's sharp reversal in the nominal gold price, has prompted us to downgrade our intermediate-term outlooks for gold and gold stocks -- from "bullish" to "neutral".

If things go roughly according to plan then our intermediate-term outlooks for gold and gold stocks will return to "bullish" during May or June, but we will cross that bridge when we come to it.

Gold Stocks

Re-visiting the "1973 Model"

...there's a good chance that the gold sector's downward correction and the stock market's upward correction will end at roughly the same time.

Over the past few months we've been comparing the recent and expected future performances of the US stock market, the US dollar and the gold sector with their performances during 1973. The reason, of course, is that we perceive many similarities between the situations these markets find themselves in today and their situations during 1973.

For the broad US stock market, 1973 was the first year of a devastating 2-year bear market, but the market's price action was not consistently bearish; rather, it was a 'choppy' year that had a slight downward bias and included one strong multi-month rebound. For the gold sector, as represented by the Barrons Gold Mining Index (BGMI), 1973 was a very good year. It did, however, include a sizeable multi-month decline -- a decline that coincided with the aforementioned stock market rebound (as is the case today, the gold sector and the broad stock market were inversely correlated during much of 1973). For the US$, 1973 started badly but ended well.

The chart displayed below, which was originally included in our 30th January commentary, shows how the BGMI performed in relation to the Dow Industrials Index during 1973. Notice that there was a stock market selling climax in May (>1100 new lows on the NYSE), followed by a 3-month bottoming process and then the strong rebound mentioned above. Notice, as well, that the BGMI trended upward from the May selling climax until just before the Dow had completed its bottoming process, after which it commenced a decline that ended up lasting about 2 months.


Our view has been that the January-2008 selling climax (there were more than 1100 new lows on the NYSE on 22nd January) was akin to the selling climax that occurred in May of 1973, in which case it was reasonable to expect that the January climax would usher-in a 2-3 month bottoming process followed by a tradable rally lasting at least 2 months. This rally began on 18th March. The parallel with 1973 also suggested that the gold sector would remain firm until around the time that the broad stock market's bottoming process was complete, after which a downward correction would occur. This downward correction commenced on 17th March.

Based on the "1973 Model" and the fact that the gold sector and the broad stock market have been inversely correlated for much of the past year, there's a good chance that the gold sector's downward correction and the stock market's upward correction will end at roughly the same time.

Current Market Situation

Our expectations have not changed, but Friday's upside breakouts by a number of stock indices have greatly increased the probability that the gold sector is immersed in a downward correction that won't end for at least another month. Also, when the correction began in mid March we thought that the HUI would do no worse than drop to the low-400s, but the recent rebound from 420 to the mid 470s has increased the downside risk. In particular, if the HUI were to break below support at 420 in the near future then the decline would probably continue to well below 400 before a correction low was in place. We have therefore downgraded our short-term outlook from "neutral" to "bearish".

The following chart shows GDX (the Gold Mining ETF) and the GDX/gold ratio. Support at 420 for the HUI is equivalent to support at $46 for GDX.

According to the GDX chart, a clear break below $46 could bring the $42 and $36 support levels into play. However, when we take into account the low current value of the GDX/gold ratio and our expectation that gold's ultimate correction low will be in the $800-$850 range it becomes difficult for us to imagine that GDX will trade below $40. For example, a gold price of $800 and a GDX/gold ratio of 0.052 (near the multi-year low) would imply a price of $41.60 for GDX. We therefore suspect that GDX will bottom in the low $40s if support at $46 is breached.


In last week's Interim Update, with the HUI in the mid-470s, we said that we had begun to average into GDX and PAAS June-July put options for hedging purposes. We would look at a HUI rebound to 465-475 over the coming week as an opportunity to add to this hedge position.

The problems with using put options to hedge are: a) the options will quickly become worthless if the market does not decline in the expected timeframe, and b) for the options to really pay off it is necessary to time both the entry and the exit, which is difficult to do. Rather than using put options to hedge, the average investor will therefore usually be better served by raising cash that can subsequently be put to work if a sharp pullback materialises.

Currency Market Update

The following chart shows that the June Swiss Franc futures contract is close to signaling an intermediate-term top. To confirm such a top it needs to close below 0.9750.


Intermediate-term tops are in place for the Canadian Dollar, the British Pound and, quite likely, the Yen. The Australian Dollar hasn't confirmed a peak, but neither has it broken decisively above last November's high. It may be forming a double top. As noted above, the Swiss Franc is close to signaling a top.

The one major currency that hasn't yet shown any sign of weakness relative to the US$ is the euro. As mentioned in previous commentaries, the June euro needs to close below its 18-day moving average to generate an early-warning signal of a top. 

Update on Stock Selections

(Note: 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)

European Minerals (TSX: EPM). Shares: 304M issued, 457M fully diluted. Recent price: C$0.91

In last week's Interim Update we wrote:

"...EPM will have to come to an agreement with its lenders to re-schedule loan repayments and deliveries into forward sales contracts so that they line up with the revised production schedule, or arrange additional financing of at least $30M.

We think that EPM will get through this rough period mostly intact, although there is a good chance that the share count will rise by another 10-15% between now and when the company becomes cash flow positive. In any case, we would not do any new buying of the stock until a solution to the immediate financial issues is in place."

In a press release on Friday it was announced that EPM has arranged to get the money it needs to solve its immediate financial problems. The way the money is being obtained is quite strange, however, because instead of doing its own equity financing EPM has agreed to buy a small exploration-stage miner by the name of Lero Gold (TSXV: LER) via a share exchange (one new EPM share for each LER share). Prior to the takeover being effected LER will do a private placement of new shares at C$0.85/share to raise at least $40M ($66M maximum), $25M of which will immediately be lent to EPM.

We don't know anything about Lero, except that it owns some exploration-stage projects in Kazakhstan and Kyrgyzstan. These projects currently don't have any NI-43-101 compliant resources, but initial resource estimates are due to be published before the end of this month. EPM is also expected to issue a revised (upgraded) resource for its Varvarinskoye gold/copper project in the near future.

Given that LER's large equity financing is being fully underwritten by Canaccord, it seems that there is considerable demand for EPM/LER shares at C$0.85. This suggests to us that EPM's news flow is about to take a turn for the better.

We now consider EPM to be a speculative buy at around C$0.85.

Chart Sources

Charts appearing in today's commentary are courtesy of:

http://stockcharts.com/index.html
http://www.futuresource.com/
http://bigcharts.marketwatch.com/



 
Copyright 2000-2008 speculative-investor.com
<% Session("pass") = "pass" Session.Timeout = 480 ELSE Response.Redirect "market_logon.asp" END IF %>