-- Weekly Market Update for the Week Commencing 21st May 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

Incomplete silver COT analysis

Summary of current thinking/positioning

1) The Dollar Index is set to make additional gains prior to its counter-trend rally coming to an end.

2) The US$ gold price has broken out to the downside, but a short-term bottom could be put in place as soon as this week.

3) The SPX has confirmed an end to its correction and likely will make a new all-time high by the end of next month. The risk/reward is not bullish, though, because a move to well above the January high is unlikely.

4) The multi-year upward trend in commodity prices that got underway in early-2016 appears to have resumed. If so, the Australian and Canadian dollars should be relatively strong over the next few months.

5) The price of West Texas Intermediate Crude oil is close to a 1-2 month top.

6) There is no evidence that the Swiss Franc has bottomed, but taking a 3-6 month view this currency's risk/reward looks very attractive.

7) The T-Bond is close (in terms of time) to a multi-month bottom, but new lows in bond prices (new highs in bond yields) are likely during the second half of this year.

8) Holding a cash reserve of around 35%.

Revisiting the global US$ short position

Major currency-market trends are caused by differences in stock-market performance, real interest rates and monetary inflation rates. When these factors conspire to create a downward trend in the US dollar's foreign exchange value it becomes increasingly attractive for people outside the US to borrow dollars. And when these factors subsequently conspire to create an upward trend in the US dollar's foreign exchange value, debt repayment becomes more costly for anyone with US$-denominated debt outside the US and taking-on new US$ debt becomes less appealing.

A lot more dollars get borrowed during US$ weakening trends than get repaid during US$ strengthening trends, so the net effect of the cycle outlined above is the accumulation of US$-denominated debt outside the US. The total quantity of this debt now amounts to many trillions of dollars and is often referred to as the "global US$ short position", because when you borrow in terms of a currency you are, for all intents and purposes, short that currency.

It's important to understand that this global US$ short position is an effect, not a cause, of US$ upward trends. The US$ doesn't rally because of this short position, but the short position can become problematic because of a US$ rally. The short position can become problematic due to the collective financial position of foreign US$ borrowers deteriorating as the US$ strengthens.

Further to the above, a substantial extension of the Dollar Index's upward trend could bring on a global financial crisis. The crisis likely would begin in the emerging markets, because that's where many of the most vulnerable US$ borrowers are based. Therefore, if the US$ rally continues we will pay closer-than-usual attention to indicators of emerging-market financial stress, such as the TLT/EMB ratio (T-Bonds relative to emerging-market bonds). A rising TLT/EMB ratio points to increasing stress.

We don't expect substantial strength in the US$ over the remainder of this year, but with the fundamental backdrop favouring the US$ over the euro we can't rule it out.

A copper top or bull market correction?

We've drawn lines on the following daily chart to make the point that the decline in the copper price from its December-2017 peak looks similar to the correction that occurred during February-June of last year. If this is the right way to interpret the chart pattern then the copper price will resume its multi-year upward trend within the next month or two.

Alternatively, everything since early-September of last year could be interpreted as part of a major top.

We have favoured and continue to favour the first of the above interpretations, mainly because it meshes with our expectations for other markets. However, it won't be long before we know for sure which interpretation is correct. A weekly close above $3.20 would validate the first interpretation and signal that a move to well above the December-2017 peak (potentially to US$4.00 or higher) was underway, whereas a weekly close below $2.95 would validate the second interpretation and signal that a move to $2.50 or lower was underway.



The more bullish interpretation of the above copper price chart is supported by the chart of the Global X Copper ETF (COPX) displayed below. COPX's price action since its January-2018 peak looks a lot more like a mid-trend consolidation than a top.



Our final copper-related chart shows that the oil/copper ratio has risen to near the top of the moving-average envelope that has often limited its upward trends in the past, implying that the oil price is now stretched to the upside relative to the copper price. This chart suggests that copper will outperform oil over the next 6 months.



The Stock Market

The US Stock Indices

We are impressed by the recent ability of the stock market to ignore the rising interest-rate trend. Even last week's decisive break in the 10-year T-Note yield to above 3.0% didn't spook the stock market.

The dilemma for intermediate- and long-term stock market bulls is that interest rates are bound to continue rising until rising interest rates are generally perceived as a major problem by the stock market, that is, until the stock market tanks. To put it another way, the longer the stock market ignores the rising interest-rate trend, the higher interest rates will go before reaching intermediate-term tops.

We think that interest rates will make short-term tops within the next couple of weeks and then consolidate for 1-2 months. If so, that will help the stock market and could (probably will) enable the SPX to make a new high by the end of June. There is not yet any evidence, though, that interest rates have topped on even a short-term basis.

With the stock market showing internal strength, as evidenced by new highs last week in the Russell2000 Index and the NYSE Advance-Decline Line, it's very unlikely that a large stock-market decline will soon begin. However, if interest rates continue to rise over the coming fortnight then the senior stock indices will struggle to build on their recent gains.

Tesla (TSLA) Update

As illustrated below, last week's closing price for TSLA was slightly below the bottom of its 2.5-year channel and right at the bottom of its shorter-term channel. Consequently, if the stock closes just a few dollars lower on any day this week, it will have broken out to the downside.

This is a risky time for both TSLA bulls and TSLA bears. If it looks like the stock is breaking downward then some of the heretofore resilient bulls may finally throw in the towel, causing the decline to accelerate. However, due to the massive outstanding short position there could be a vicious rally fueled by short covering if it starts to look like support will hold.

We remain very bearish on TSLA's intermediate-term and long-term prospects (actually, we don't think it has any long-term prospects), but we have no opinion on what will happen to the stock over the coming 1-2 months. Neither a $50-$100 decline nor a $50-$100 advance would surprise us.



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

Last week the US$ gold price broke below important lateral support at $1309. It also broke below its 200-day MA, thus creating a divergence from the 1985-1987 Model.

In the email sent to subscribers after last Tuesday's downside breakout and in last week's Interim Update, we wrote that based on what happened last year following breaks below the 200-day MA the price likely will bottom at $1250-$1280 during the next week (that is, this coming week).

We also wrote that there is more to be lost than gained by trading in anticipation of a near-term bottom, because there is no guarantee that the latest break below the 200-day MA will follow the pattern of previous breaks. Instead of 'going long' in anticipation of an upward reversal it would be prudent for gold traders seeking a buying opportunity to wait for evidence of a reversal before acting.

That prompts the question: What would constitute evidence of an upward reversal?

Preliminary evidence would be a daily close above the 200-day MA and decisive evidence would be a weekly close above the 200-day MA. To move back into line with the 1985-1987 Model, the upward reversal must be confirmed within the next three weeks.



The fundamental backdrop (as measured by our GTFM) is presently almost as bearish for gold as it ever gets. This could soon change, but for there to be a meaningful short-term shift in gold's favour there will have to be a significant rebound in the T-Bond. The T-Bond is very 'oversold' and primed for a counter-trend move to the upside, but at this time there is no evidence that a short-term bottom is in place.

Now, a tradable rally in the gold price could get underway in the face of a gold-bearish fundamental backdrop if the sentiment situation was very supportive. However, the latest COT data indicate that the sentiment situation is only mildly supportive.

To help explain the above comment we present the following chart. Notice that the total speculative net-long position in Comex gold futures (the inverse of the blue bars in the middle section of the chart) has been in a steady decline since reaching a short-term peak in the second half of January. The good news is that its level is now similar to what it was when the price was bottoming in December-2016, but the bad news is that the open interest (the green bars in the bottom section of the chart) is now much higher than it was at the December-2016 price low. As is also the case the silver market, important price lows in the gold market tend to coincide with low futures open interest.



The COT data suggest that additional near-term price weakness will be required to create the sort of speculative disinterest or pessimism that normally precedes a strong rally.

Silver

The sentiment situation in the silver market has been neutral over the past two months, with the bullish implications of the shrinkage to almost nothing in the total speculative net-long position in Comex silver futures being counteracted by the bearish implications of the large net-long position of small traders in Comex silver futures. The collective net position of the small traders is shown in the middle section of the following chart.

In late-March the collective net-long position of small traders hit a 9-year high. It has since dropped a little, but it remains near the top of its 10-year range. On the whole, therefore, market sentiment is still not bullish for the silver price.



Last week the US$ silver price remained within its narrow ($16.10-$16.90) range. This was a relatively good performance considering that the US$ gold price broke out to the downside.

We expect that silver will trade above $20 before year-end, but there's an uncomfortably-high risk that it will drop well below the bottom of its 3-4 month range -- to $15.60 or perhaps even as low as $15.00 -- before the start of a meaningful rally.



Gold Stocks

The gold-mining indices and ETFs are holding up well relative to gold bullion and a positive divergence between the gold-mining sector and the bullion market is in place. At the same time, the HUI's rebound from its March low continues to look a lot more like a counter-trend move than the start of a major rally. In fact, the rebound from the March low has, to date, been weaker than any of the counter-trend moves of the past 18 months.



Ideally, there will be wash-out declines over the coming 1-2 weeks in the bullion market and the associated mining stocks, as that appears to be what's required to set the stage for a substantial rally. Another realistic possibility, however, is that the gold price will do no better than recover to its breakdown level (around $1309) over the coming fortnight and that this will extend the gold-mining sector's counter-trend upswing. In this case, the HUI could rise to 190-200 before heading back down. From our perspective this would be non-ideal because it would further prolong the tedious pattern that began early last year.

In the financial markets you never have to position yourself as if there is only one possible outcome. At the moment, for example, we don't think it makes sense to speculate on a bearish short-term outcome for the gold-mining sector, because the downside potential does not appear to be large enough to justify such a position. However, if you have substantial exposure to gold-mining stocks then it could make sense to buy some insurance just in case.

One way to insure against short-term weakness in a gold-mining portfolio is buy GDX put options, but you have to be able to judge when to add the insurance and when to remove it. In our own money management we generally add and remove insurance in the same way that we add and remove long positions in stocks -- by scaling in and scaling out. For put-option insurance we would plan to scale in during price strength in the underlying security (when the options are relatively cheap) and scale out during price weakness in the underlying security (when the options are relatively expensive). For example, we purchased an initial insurance position in GDX September $20 put options on Friday and plan to add to this position if the gold-mining sector strengthens over the coming 1-2 weeks.

The Currency Market

Conflicting COT Signals

The first of the following charts shows that the total speculative net-SHORT position in Swiss Franc (SF) futures hit a new 10-year high last week, indicating that speculators, as a group, are more bearish on the SF than they have been at any time over the past 10 years. Given that speculative sentiment is a contrary indicator when it reaches extremes, this is very bullish for the SF. At the same time, the second of the following charts shows that speculators, as a group, are maintaining an unusually-large net-LONG position in euro futures. This indicates that the euro remains vulnerable to speculative long liquidation and is clearly bearish.

The next chart shows that speculators have accumulated their largest net-SHORT position in A$ futures since early-2016. We view this as moderately bullish for the A$. The qualifier "moderately" has been inserted because the speculative net-short position in A$ futures became much bigger than it is today prior to multi-month price bottoms during 2013-2015.



In summary, based solely on speculative sentiment the risk/reward looks bearish for the euro and bullish for both the SF and the A$. This is a conflict, because it's hard to imagine the euro trending downward while both the SF and the A$ trend upward.

Price Action

A week ago we thought that the Dollar Index (DX) had commenced a 1-3 week correction, but this was not so. The DX resumed its short-term upward trend last Monday (14th May) and on Friday 18th May achieved its highest daily close of the year. Furthermore, last week the US dollar's April breakout to the upside was finally confirmed by a breakdown in the US$ gold price.

The fundamental backdrop remains very supportive of the DX, with both the interest-rate differential and the relative equity-market strength putting upward pressure on the US$/euro exchange rate. At the same time, the recent pullback was not long enough or deep enough to alleviate the DX's short-term 'overbought' condition, so the 1-3 week correction that we thought had begun during the week before last could begin soon.



The SF has rebounded by a small amount from its 'oversold' extreme. A daily close above the 20-day MA (the black line on the following daily chart) would be preliminary evidence that it has bottomed on at least a short-term basis.

Keep in mind that the SF's recent downward momentum extreme suggests the potential for a bounce followed by a decline to a new low prior to the start of a sizable multi-month rally.



Before leaving the SF it's worth mentioning that the SF/euro ratio has just rebounded to the top of an 18-month channel (see chart below). If this ratio closes above last Friday's intra-day high it will be evidence of an intermediate-term reversal in relative strength.



Finally, tentative signs of an A$ bottom continue to emerge, with "tentative" being the operative word.

As previously noted, it's possible that the early-May drop below the December-2017 low was the sort of false breakout that quickly leads to a trend reversal. At this stage, however, there hasn't been enough strength to confirm the reversal.



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 18th May 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%, NSR = Net Smelter Return, P&P = Proven and Probable, PEA = Preliminary Economic Assessment, PFS = Pre-Feasibility Study]

  *Alio Gold (ALO) advised that its takeover of Rye Patch Gold (RPM.V) has been approved by the shareholders of both companies. We view this as bad news, because ALO is massively overpaying for RPM's assets. However, the news was fully expected and fully discounted in ALO's stock price.

The combination of the two companies is scheduled to be completed on 25th May, at which time ALO will take ownership of the 50K-oz/year Florida Canyon gold mine in Nevada.

  *Aura Minerals (ORA.TO) published its financial statements and MD&A for the March-2018 quarter. The financial statements showed that ORA had US$27M of working capital and US$7M of long-term debt at 31st March, which means that its financial position is healthy enough.

The company's latest quarterly profit and loss figures were distorted by deals that were consummated during the quarter and therefore are not representative of what can be expected in the future.

ORA has an extremely low market value for a profitable 140K-oz/year gold producer (at Friday's closing price of C$2.29 it had an enterprise value of only C$73M). This will change. Also, note that ORA benefits from weakness in the Brazilian Real, so the 11% year-to-date loss in this currency should be giving a boost to ORA's profitability.

  *Cobalt 27 Capital Corp. (KBLT.V) has established a US$80M credit facility. As a result of this and the C$200M equity financing completed in March, we estimate that the company now has access to about C$330M of liquidity with which it can do deals.

KBLT probably is close to completing its first cobalt streaming deal. Unfortunately, due to the high cobalt price this is far from an ideal time to be purchasing cobalt streams. The company must close some deals soon, though, to create the leverage to the cobalt price that it currently lacks.

  *Euro Sun Mining (ESM) published its financial statements and MD&A for the March-2018 quarter.

The financial statements indicate that the company had working capital of US$1.5M at 31st March-2018, down from US$5.5M at 31st December-2017. US$4M is a large quarterly cash draw-down for a junior exploration-stage miner that did not conduct a drilling program during the quarter. The main reason for the large draw-down is that directors and officers of the company awarded themselves an additional US$2.2M of compensation in the form of "deferred share units". Nice work if you can get it.

Due to the substantial Q1 cash drain, ESM will have to do an equity financing soon.

Regarding the ratification of the mining licence for ESM's Rovina Valley gold-copper project in Romania, on 7th February the company advised:

"The remaining signatures are expected imminently after which the company will be able to announce the full ratification of the mining licence. This is expected to occur some time before the end of the month."

Then, on 7th March the company advised:

"In continuation of the public transparency legislation in Romania, the endorsement procedure outlined was initiated on March 6, 2018. Ratification by the Ministry of Economy, Ministry of Environment, and Ministry of Water and Forests is to be concluded no later than March 9, 2018.

Further reanalysis and ratification will occur by the Ministry of Public Finance no later than March 16, 2018, and March 23, 2018, by the Ministry of Justice."

And finally, from the MD&A issued last Monday (14th May):

"Solid progress continues towards ratification of the Company's Romanian mining licence continued in Q1 2018. On March 6, 2018, the Ministry of Economy, Ministry of Environment and Ministry of Water and Forests initiated their endorsement procedures for the ratification of the Company’s mining license in Romania."

Interesting definition of "solid progress", when something that was going to "be concluded no later than March 9, 2018" is on-going.

The mining licence eventually will be ratified, but the long delays involved in achieving this permitting milestone highlight the difficulty of dealing with the Romanian government and developing a mine in Romania.

  *Petrus Resources (PRQ.TO) advised that its credit facilities had been extended by 12 months.

Oil and gas drilling is a capital intensive business. As a result, companies involved in O&G production tend to have high debt relative to working capital. In this regard PRQ is no exception.

PRQ relies on two credit facilities: A C$35M term loan and a C$120M revolving credit facility (RCF). The company advised last week that the maturity date of its term loan had been extended to October-2019 and that its RCF had been extended to May-2019. However, at 30th June this year the total amount available under the RCF will reduce from C$120M to C$110M.

With the reduction in the total amount of the RCF, PRQ will have access to C$145M of credit. At 31st March it had used C$136M of this credit.

Due to the fully-expected extensions of the company's credit facilities, PRQ's liquidity situation remains satisfactory. Furthermore, the company's 2018 plan involves a shift from capital investment to debt reduction, so the liquidity situation should improve over the coming quarters.

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$0.28)

2) AOI.TO (last Friday's closing price: C$1.29)

3) EGD.V (last Friday's closing price: C$0.40)

4) GRG.V (last Friday's closing price: C$0.48)

5) PG.TO (last Friday's closing price: C$2.71)

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.

Exiting Euro Sun Mining (ESM.TO). Recent price: C$1.20

We expect that ESM's mining licence will get ratified at some point over the next few months and that when this happens there will be a substantial bounce in the stock price, but due to three other issues that have recently cropped up we are not willing to wait any longer and have removed ESM from the TSI Stocks List. The stock is flat year-to-date and up by 10% since its September-2016 inclusion in the List.

The three other issues are:

1) The large cash payments to officers and directors of the company during the latest quarter.

2) The need to top up the treasury via an equity financing in the near future.

3) ESM's surprising involvement in a takeover bid for Nevsun Resources (NSU). In our opinion, the bid that was made public about two weeks ago has no chance of success. This creates the risk that ESM and its partner (Lundin) will make a higher offer. Also, due to issues raised by NSU in its rejection of the bid, chief among them being the potential tax liability stemming from the transfer of NSU's Timok project to Lundin, we are not comfortable with ESM's involvement in the takeover as presently structured.

Chart Sources

Charts appearing in today's commentary are courtesy of:

http://stockcharts.com/index.html
http://www.goldchartsrus.com/