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 will end by mid-2010. In real (gold) terms, bonds commenced a secular BEAR market in 2001 that will continue until 2014-2020. (Last update: 09 February 2009)

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

Inflation

Money Supply Update

The best web-based presentation of US money supply data is located at http://trueslant.com/michaelpollaro/austrian-money-supply/. That's where we obtained the following chart, which shows the year-over-year (YOY) percentage changes for TMS1, TMS2 and M2. Note that "TMS2" is what we normally refer to as TMS (True Money Supply), whereas "TMS1" is a narrower definition of money supply that doesn't count savings deposits.

There has been a lot of figurative hair-pulling over the belief that the US money supply is falling, but this is only because the focus has generally been on flawed measures of money supply that include credit instruments in addition to money. When proper measures are used (reasonable arguments could be made in favour of either TMS1 or TMS2 in this regard) it becomes apparent that the US money supply is growing more slowly now than it was six months ago, but is still growing. Not only that, based on TMS2 it is still growing at a double-digit pace.

By the way, even if the US money supply were shrinking it would be a bad idea for the Fed to inject more money into the economy. Creating money out of nothing always causes problems, even if done in an effort to counteract monetary deflation. The reason is that the new money doesn't get spread evenly over the economy; rather, it enters the economy at discreet points, causes some prices to increase relative to other prices, and benefits some individuals and economic sectors (the early receivers of the new money) at the expense of others. It therefore leads to a greater number of ill-conceived investments, more resources being wasted, and the transference of wealth from the later to the earlier users of the new money.

Inflation and Relative Scarcity

Over the long-term almost all parts of the economy are hurt by monetary inflation (creating a lot of money out of nothing), but over timeframes of a few years or less there are winners and losers. It is usually difficult to forecast who will win and who will lose, although one way of identifying the most and least likely beneficiaries is to look at relative scarcity. In particular, all else remaining equal the parts of the economy where there is a lot of excess capacity are less likely to benefit from inflation than are the parts of the economy where supply is constrained or that are operating at close to full capacity. This is a large part of the reason why commodities did not benefit in a big way from the monetary inflation of the 80s and 90s but were amongst the main beneficiaries of the past decade's inflation.

The relationship between relative scarcity and monetary inflation goes a long way towards explaining why counter-cyclical monetary policy creates far more problems than it solves. When boom turns to bust, the central bank invariably slams its foot onto the monetary gas pedal in an effort to support the parts of the economy that are performing the worst, but these are the parts of the economy where there will usually be the greatest amount of excess capacity. In other words, the central bank tries to use inflation to boost the economic sectors that are amongst the LEAST likely beneficiaries of the inflation. This is why efforts to 'pump up' the weakest sectors invariably lead to new bubbles -- and a whole new round of mal-investment -- elsewhere.

In the US economy at this time, excess capacity is most apparent in the labour market (there is a lot of unemployment and under-employment) and the property market (the current and potential future supply of residential and commercial property is weighing heavily on prices). In response to high unemployment and the weak real estate market the Fed seems determined to maintain an exceedingly loose monetary policy. But as discussed above, this cannot possibly help. Take the example of the labour market. The unusually high level of excess capacity in this market ensures that it will not be a beneficiary of inflation. Instead, a likely consequence of the loose monetary policy will be an increase in the cost of living relative to the cost of labour, meaning a general decline in real wages and greater hardship for wage earners.

On a related matter, there can be no such thing as a "wage-price spiral" or any other economy-wide price spiral in the absence of continuing money-supply growth. If there's a large one-off injection of new money then some prices will rise in response to the greater supply of money, and eventually -- probably after a few years -- most prices will move to a higher level than they would have been in the absence of the new money. However, higher prices cannot bring about higher prices in a never-ending loop unless the supply of money continues to ramp up.

We mentioned above that the labour market is more likely to be hurt than helped by the Fed's easy money. What sector of the economy, then, is likely to benefit?

Energy (oil, gas, coal, and fossil-fuel alternatives such as uranium, wind and solar) could benefit, but the only long-term upward trend in which we have a lot of confidence at this time is in the gold market.

Interesting quote or fact of the week

The Stock Market

At the beginning of this year we thought that the most likely scenario entailed the US stock market following the Presidential Cycle model (a model based on the 50-year average for the 2nd year of the Presidential Cycle). The green line on the chart displayed below represents this model.

As evidenced by the following chart of the S&P500 Index: so far, so good.

A literal interpretation of the model would point to a 'choppy' market between now and mid August (encompassing a rebound peak in mid July) and then a very weak market from late August through to early October. However, the model shouldn't be interpreted literally because there are many paths that the market could take over the months ahead and still end up at the expected October low.

Our best guess is that the current rebound will peak sometime between now and mid July at somewhere between 1120 and 1200 (basis the S&P500).

Displayed below is a chart showing the percentage of S&P500 stocks trading above their respective 50-day moving averages. When the percentage dropped below 10 last month it was a sign that the market was sufficiently 'oversold' to enable a strong multi-week rebound. It is now appropriate to consider how far this indicator could rise before a rebound peak is in place.

During the intermediate-term advance of 2009-2010, downward corrections didn't begin until after the S&P500's 50-day MA percentage rose to at least 90. However, during the intermediate-term decline of 2007-2009 the upward corrections ended after the 50-day MA percentage rose to between 65% and 80%.

Based on the assumption that an intermediate-term decline is in progress, we conclude that the current rebound will probably end after the 50-day moving average percentage rises to the 65-80 range.

This week's important US economic events

Gold and the Dollar

Gold and Silver

Current Market Situation

The US$ gold price broke above resistance at $1250 on Friday and is therefore now in new-high territory. There is no overhead resistance, but the chart suggests a short-term target of $1340. Sentiment is strangely quiet, suggesting plenty of scope for additional gains.

If gold's break to a new high is going to fail then it will probably do so within the next two weeks, meaning that we should soon know whether Friday's breakout was the start of something or the end of something. After looking at gold's performance following the other breaks to new multi-year highs that have occurred over the past decade, we think that support at $1220 (basis the nearest futures contract) can now be used as a demarcation level. Specifically, a daily close below $1220 within the next few weeks would signify a breakout failure.

The over-extended level of the euro-denominated gold price remains our biggest concern with regard to gold's short-term outlook.

Silver continues to trade like a large-cap gold stock, meaning that silver's chart continues to look very much like the HUI's chart. If gold maintains its short-term upward trend then silver will almost certainly be dragged behind it to a new multi-year high.

Gold Fund Premiums

When you buy a closed-end gold fund, or any exchange-traded fund for that matter, you should be mindful of the premium/discount to net asset value (NAV) at which the fund is trading. The current NAV premium/discount will generally be reported daily at the fund's web site.

Gold funds such as GTU, CEF and PHYS sometimes trade at ridiculously large premiums to their NAVs. For example, the following chart shows that GTU's premium was above 30% for a while during the first half of 2009. The implication is that someone who bought GTU units in March of 2009 when the fund's premium was above 30% currently has a small LOSS on their investment even though the price of gold bullion is now about 30% higher.

In our opinion, you should never pay a premium of more than 5% for gold funds or any other exchange-traded funds.

Note that GTU's premium is presently around 3%, which is reasonable. It would be OK to buy some GTU near its current premium, either as a long-term investment or as a trade. If buying as a trade you should plan to exit if gold bullion closes below $1220.

Gold and Silver Stocks

Current Market Situation

The gold-stock indices had good upward moves during the second half of last week, but there was surprisingly little excitement evident in the gold sector despite gold bullion's rise to a new all-time high on Friday. For example, trading volumes were generally lower than average. It is also worth noting that the HUI remains below the highs of May-2010, December-2009 and March-2008.

The lack of excitement in the gold sector could be taken as a significant non-confirmation of gold bullion's rise to a new all-time high, or it could be viewed from a contrary perspective as bullish. We don't think the time is right for the gold stock indices to surge to new all-time highs, but that's exactly what they will do if gold bullion continues its short-term upward trend.

Below is a chart of Franco Nevada (TSX: FNV), one of the two senior gold royalty companies. For many years we have used Royal Gold (RGLD), the other senior gold royalty company, as a leading indicator of the gold sector, but if the HUI rises to a new all-time high within the next two months then it will be clear that FNV acted as a leading indicator.

We think that FNV's breakout was the 'real thing', but even so it could be near a short-term peak. A routine 50% pullback would take the price back to around C$30, after which the next upward leg would get underway.

Silver Stocks

A very good report on mid-tier silver producers can be found HERE. "Mid-tier", in this case, is loosely defined as having 3M-25M ounces per year of production. Anyone who invests/speculates in silver mining stocks should go through the entire 18-page report, but here is the conclusion:

"After taking all of the above charts and qualitative factors into account, the three best overall values among mid-tier silver producers presently appear to be Fortuna, Silver Standard and First Majestic. We are currently accumulating a position in Fortuna and will be on the lookout for buying opportunities in Silver Standard and First Majestic should we get a further pullback in the markets. With its huge leverage to higher silver prices, U.S. Silver also offers silver bulls an attractive speculative punt, but we are unlikely to be buyers until cash production costs decline below $10 per silver ounce because in our view the downside risk remains excessive otherwise. Remember, leverage works in both directions. Purists who want primarily precious metal exposure in their portfolios should consider Endeavour Silver with the understanding that purity usually carries a premium. Pan American also deserves consideration as an all-around solid silver producer although it too has a few warts (including a less-than-stellar safety record).

In the grand scheme of things, our report reveals that the mid-tier silver producers are not screaming buys at current prices especially when we consider that they do not offer operating leverage to a 30% rise in metal prices from current levels. Therefore, we believe the key to gains from silver producers in the short to medium term will be value-conscious selectivity and market timing."

The afore-linked report cites Fortuna (TSX: FVI) and First Majestic (TSX: FR) as two of the three best overall values among mid-tier silver producers. We agree, which is why they are the only two mid-tier silver producers currently in the TSI Stocks List. Sabina (TSX: SBB), an exploration-stage miner, is the only other silver stock in the TSI List.

Charts of FVI and FR are displayed below. FVI's chart shows that it broke above the top of a short-term downward-sloping channel last week, a sign that a correction low is in place. We most recently highlighted FVI as a candidate for new buying in late April at C$2.15, at which time we mentioned a valuation-based target of C$3.50. Note that our target probably won't be reached this year unless silver does much better in the short-term than we currently expect. FR's chart shows that it is now testing a confluence of short-term and long-term resistance at C$4.50. A break above C$4.50 would create an initial chart-based target of C$6.00, a level at which FR would be fully valued assuming a silver price in the $18-$21 range.

Silver Standard Resources (NASDAQ: SSRI) is the other stock cited as being among the best overall values in the realm of mid-tier silver producers. Prompted by this report, for the first time in a long time we gave SSRI a close look. Our conclusion: near the current price it is definitely an interesting speculation. Furthermore, it is big enough and liquid enough to be used as a trading vehicle.

SSRI has one project in production and many projects in various stages of development (refer to the map at http://www.silverstandard.com/projects/ for project locations and development stages). The Pirquitas silver project in Argentina is the one that's currently in production. This project is expected to produce 7M ounces of silver in 2010 and 8-10M ounces/year thereafter. Of SSRI's other projects, by far the most important is Snowfield/Brucejack (SB). The SB project has a massive near-surface, low-grade, bulk tonnage gold-copper deposit containing 24M ounces of gold in the M&I category and another 14M ounces of gold in the inferred category. A Preliminary Economic Assessment (PEA) on just the Snowfield part of the overall project suggested reasonable economics near current metal prices. The PEA is currently being updated to incorporate Brucejack and the project's rhenium mineralisation. Due to the SB project, SSRI actually offers greater leverage to the gold price than to the silver price.

A chart of SSRI is shown below. There is major resistance at US$25, and a break above this resistance would project a test of the $40 all-time high reached back in 2007.

SSRI has around 80M shares outstanding, and therefore has a current market capitalisation of around US$1.5B. At 31st March it had working capital of $117M and long-term debt of $112M.

We aren't going to add SSRI to the TSI Stocks List at this time because there will hopefully be a better buying opportunity during October-November. However, we have begun to accumulate the stock in our own account with the aim of averaging into a full position over the next six months.

As an aside, we never cease to be impressed with the way the stock market periodically falls into and out-of love with different stocks. SSRI, for example, went from being a stock market darling during 2005-2007 to being a stock market outcast over the past 12 months. As far as we can tell, the change in sentiment wasn't related to a change in the fundamental value of SSRI's business.

Currency Market Update

A daily chart of September euro futures is displayed below.

We continue to expect that the euro's rebound will take it up to the vicinity of its 50-day moving average, but not much more than that. It could move up to this target over the coming days, or it could pull back to around 1.22 before resuming its rebound.

Note that we plan to exit the euro call options we recently bought for our own account if the euro trades above 1.2550 this week.

Suggested Reading

Over the years we've read many books on investment, but very few of them have had much impact on us. Some of the ones that have had an impact are noted below.

One thing that the following books have in common is that they contain very little specific advice on how to be a better investor. They have, however, helped to shape the way we view the financial markets and the business of investing.

Note that we have never read any books on "technical analysis".

1. "Fooled By Randomness -- The Hidden Role of Chance in the Markets and in Life" by Nassim Taleb

2. "The Black Swan -- The Impact of the Highly Improbable" by Nassim Taleb

3. "The Education of a Speculator" by Victor Niederhoffer

4. "Practical Speculation" by Victor Niederhoffer

5. "Reminiscences of a Stock Operator" by Edwin Lefevre

6. "Against the Gods -- The Remarkable Story of Risk" by Peter Bernstein

7. "Secrets of Professional Turf Betting" by Robert Bacon

For those looking to develop a basic understanding of economics and the interaction between politics and economics, we suggest the following:

1. "Meltdown" by Thomas Woods

2. "The Politically Incorrect Guide to Capitalism" by Robert Murphy

3. "The Politically Incorrect Guide to The Great Depression and The New Deal" by Robert Murphy

4. "Economics In One Lesson" by Henry Hazlitt

5. "The Roosevelt Myth" by John Flynn

Update 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)

Gold-Ore Resources (TSX: GOZ). Shares: 83M issued, 89M fully diluted. Recent price: C$0.51

In early May we wrote:

"Of the gold and silver producers we track, GOZ has by far the lowest market capitalisation per ounce of annual production. In the current market, 200K-500K oz/yr gold producers are typically being valued at $2500-$4000 per ounce of production and sub-200K oz/yr producers are typically being valued at $2000-$3500 per ounce of production. However, at Friday's closing price of C$0.45/share the market was valuing GOZ's production at only $850/oz.

In our opinion, the main reasons for the low valuation are higher-than-expected production costs and lower-than-expected production growth. Due to its high production cost GOZ is only generating a small amount of cash despite the high gold price, while the lack of production growth prevents speculators from becoming enthusiastic about the stock."

The latest quarterly production results announced by GOZ last Thursday indicate that some improvement has occurred, in that Q2-2010 production was about 13% above Q1-2010 production. Full financial results, including production costs, will be announced within the next 30 days, but the higher production rate should translate into lower costs.

There is evidence in GOZ's chart that its downward trend is over, although the big test will be resistance at C$0.58-C$0.60.

The improvement indicated by the latest production results combined with the stock's price action and Friday's upside breakout in the gold price suggests to us that GOZ is now a good candidate for new buying, especially if it pulls back to the high-C$0.40s.

    Clifton Star Resources (TSXV: CFO). Shares: 28M issued, 38M fully diluted. Recent price: C$4.51

In last week's Interim Update, we wrote: "We believe that this is an excellent buying opportunity and that the stock [Clifton Star] is close to its ultimate correction low, but we do have one concern. The concern is the lack of drilling results over the past few months. A massive drilling campaign got underway early this year and we expected that this campaign would yield a steady stream of drilling results throughout the year, but apart from one uninspiring press release in April there has been no drilling news from CFO since February."

A few hours after we wrote about the lack of drilling news, CFO issued a press release containing some recent drilling results. The results were not spectacular, but they were solid. The Mineweb article linked HERE provides some information.

Over the next two months we expect to see more press releases with more drilling results.

    UNG trade update. Recent price: $8.53

For our UNG (United States Natural Gas Fund) trade we are running a 5% trailing stop based on daily closing prices. The highest daily closing price to date is US$8.83, which means that we will automatically exit if UNG closes below $8.39. Obviously, the stop will rise if UNG closes above $8.83.

    Strange discrepancies between closing prices in the US and Canada

On Friday, Minefinders closed at C$9.80 in Canada. This equates to about US$9.55 at the current exchange rate, but the closing price of the stock in the US was US$8.74. We also noticed large discrepancies between the US and Canadian closing prices for Gammon Gold and Fronteer Group, with the US$ closing price being much lower in each case than the US$-equivalent of the closing price in Canada.

We have mentioned at TSI in the past that when these large discrepancies appear the price in Canada is almost always the correct price. It seems that games are sometimes played with the closing prices in the US, with a trade being done at an unrealistically low or high price right at the closing bell in order to 'paint the tape'. When it happens, the 'error' will normally be corrected as soon as the US market re-opens.

Chart Sources

Charts appearing in today's commentary are courtesy of: