-- Weekly Market Update for the Week Commencing 21st October 2019

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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

Monetary Inflation and the Next Crisis

Summary of current thinking/positioning

1) The Dollar Index (DX) confirmed a short-term downward trend reversal during the week before last, but on a longer-term basis it remains in limbo. We expect that the choppy price action of the past several months will be followed by a substantial decline, but there remains a (diminishing) risk that the DX will first move sharply higher for 1-3 months.

2) The US$ gold price, the US$ silver price and the gold-mining indices are still immersed in corrections and are at risk of experiencing sharp price declines within the next couple of weeks, but new upward trends are expected to begin before the end of November.

3) The SPX could be in the process of setting an intermediate-term double top, but even if this is the case it likely will make a marginal new all-time high prior to commencing a sizable decline. At the same time, the Fed's new asset monetisation program has increased the risk for bearish speculators and clear signs of equity strength have started to emerge outside the US.

4) The T-Bond probably has commenced a decline that will take it below its September low within the next few weeks, but major price weakness (yield strength) in the Treasury market could be postponed until next year.

5) We are holding a cash reserve of around 30%.

"Big Picture View" removed from the Weekly Update

We have removed the "Big Picture View" that until now was displayed near the top of every Weekly Market Update. This has been done because the section covered such long time-frames that it added no practical value. Investing and speculating decisions should be based on the current risk/reward and potentially could take into account forecasts of how the financial/economic landscape will change over the coming year or two. Decisions should not be based on vague notions of secular trends.

Yield Curve Reversal

Last week there was a confirmed reversal in the US yield curve from flattening to steepening. This is evidenced in part by the recent up-turn in the 30yr-3mth yield spread illustrated by the following chart. It is the first such signal since Q4-2016 and differs from the previous signal in that it has come after an inversion, which means that it is more significant. Whereas the Q4-2016 signal was part of a counter-trend move within a multi-year 'flattening' trend, it's likely that the current signal is marking the start of a multi-year steepening trend. What are the implications for the financial markets and the economy?



The yield curve reversal increases the risk that a US economic recession will start within the next few months, but it also could be signaling the onset of a 1-2 year period of higher "inflation". The former implies an equity bear market and strength in gold relative to industrial commodities, whereas the latter implies a continuing equity bull market and strength in industrial commodities relative to gold.

More information is required to determine whether the yield curve reversal is a boom-bust transition (recession) warning or an inflation warning, but in either case the curve should continue to steepen over the months/quarters ahead if last week's signal is genuine.

If the yield-curve reversal is signaling higher "inflation" then future steepening will be primarily the result of rising long-term interest rates. This is sometimes referred to as a "bearish steepening" because it is driven by falling bond prices. Alternatively, if the yield-curve reversal is signaling a transition from boom to bust then future steepening will be primarily the result of falling short-term interest rates. This is sometimes referred to as a "bullish steepening" because it is driven by increases in the prices of debt securities.

Do we think it will be a bearish or a bullish steepening?

If not for the Fed's actions over the past few weeks we would favour a bullish steepening, that is, we would assume that the yield curve reversal was signaling a boom-to-bust transition. However, given the Fed's recent reintroduction of QE we are leaning in the other direction. Further to the discussion in the Stock Market section of today's report, the new QE (or whatever the Fed wants to call it) program is a potential game-changer.

Commodities

The palladium bubble continues to inflate

There was a parabolic rise in the palladium price to a peak in mid-March of 2019 and then a sharp 2-week decline. In the 1st April Weekly Update we speculated that the decline from the mid-March peak had marked the start of a multi-month correction, but not the start of a bubble collapse. We followed up with similar assessments in the 6th May and 15th July Weekly Updates, concluding in the 15th July commentary: "Palladium is in a bubble, but the bubble is not yet fully inflated."

The bubble has continued to inflate and now could be in its final blow-off phase.

The last palladium bubble reached its ultimate high in early-2001 and the current bubble appears to be following a similar path. The weekly charts inserted below illustrate this. The first chart covers 1999-2001 and the second chart begins two years ago.

If the rough similarity is maintained then today's market will reach its final top between November of this year and March of next year.

Consolidation in the copper market

In early June the copper price was in the mid-$2.60s. It has since traded as high as $2.80 and as low as $2.48, but has returned to the mid-$2.60s. For all intents and purposes, therefore, it has gone nowhere over the past 4.5 months.

It's possible that an intermediate-term bottom was put in place via the spike down to the $2.40s at the beginning of September, but at this stage there is still a significant risk that a drop to a new multi-year low will precede the start of an intermediate-term rally.

We think that copper will trade a lot higher within the coming 12 months, but the short-term risk/reward looks neutral.



The Stock Market

A potential game-changer

Once an equity bear market is well underway it runs its course, regardless of the Fed's actions. For example, the Fed started cutting interest rates in January of 2001, but the bear market that began in March of 2000 continued until October-2002. For another example, the Fed started cutting interest rates in September-2007, but a bear market commenced in October-2007 and continued until March-2009 despite numerous Fed actions designed to halt the price decline. On this basis it can be argued that the Fed's introduction of a new asset monetisation program roughly one week ago won't prevent the stock market from rolling over into a major bearish trend. However, there is a good reason to think that it could be different this time (dangerous words, we know) and that the Fed's new money-pumping scheme will prove to be game-changer.

The reason to think that it could be different this time is that in one respect it definitely is different. We are referring to the fact that although the Fed started cutting interest rates in the early parts of the last two cyclical bear markets (2000-2002 and 2007-2009), it didn't begin to directly add new money to the financial markets until the S&P500 Index had been trending downward with conviction for about 12 months.

To further explain, when the Fed's targeted interest rates follow market interest rates downward, which is what tends to happen during at least the first half of an economic downturn, the official rate cuts do not add any liquidity to the financial system. It's only after the Fed begins to pump new money into the financial markets that its actions have the potential to support asset prices.

During the last two bear markets, by the time the Fed started to pump money it was too late to avoid a massive price decline. This time around, however, the Fed has introduced a fairly aggressive money-pumping program while the S&P500 is very close to its all-time high and seemingly still in a bullish trend.

The Fed has emphasised that the new asset monetisation program should not be called "QE" because it does not constitute a shift in monetary policy. Technically this is correct, but in a way it's worse than a shift towards easier monetary policy. The Fed's new program is actually a thinly-disguised attempt to help the Primary Dealers absorb an increasing supply of US Treasury debt. To put it another way, the Fed is now monetising assets for the purpose of financing the US federal government, albeit in a surreptitious manner.

This relates to a point we made in a recent blog post. The point is that when the central bank is perceived to be financing the government, as opposed to implementing monetary policy to achieve economic (non-political) objectives such as "price stability", there is a heightened risk that a large decline in monetary confidence will be set in motion. One effect of this would be an increase in what most people think of as "inflation".

Summing up, it's possible that the Fed's new asset monetisation program will extend the current cycle (prolong the equity bull market) and lead to more "price inflation" than earlier programs.

Nearing an upside breakout in the banking sector

With reference to the upper section of the following weekly chart, notice that for the third time since July the US Bank Index (BKX) is threatening to break out to the upside. A weekly close above 103 would do it. Also, the lower section of the chart shows that the BKX/SPX ratio is close to breaking the sequence of declining tops that began early last year. It would do so by ending a week above its July high.



It isn't only the US banking sector that is showing signs of strength. The following daily chart reveals that the Europe STOXX Banks Index (SX7E) has been working its way upward since testing its 10-year low two months ago. A weekly close above the April high would be a definitive reversal signal.



Bank stocks in both the US and Europe have intriguing intermediate-term upside potential. This is linked to the potential for meaningful gains in interest rates and a substantial steepening of the yield curve over the coming year.

Current Market Situation

The S&P500 Index (SPX) has spent the past 2.5 months making lower highs and higher lows. In the process it has formed the contracting triangle drawn on the following daily chart.

It tested the top of its contracting range last week and then pulled back a little. This week it could trade as low as 2890 without altering the short-term pattern.

Given that the NYSE Advance-Decline Line (ADL) made a new all-time high last week, it's likely that over the next few weeks the SPX will do no worse than test the bottom of its contracting range and at some point move into new-high territory.



Interestingly, signs of equity-market strength are becoming apparent outside the US. For example, the following daily chart shows that the EURO STOXX 50 ETF (FEZ) made a new high for the year last week and that European stocks have begun to out-perform US stocks (the FEZ/SPY ratio has been rising since August and moved sharply higher over the past fortnight).



For a second example, it looks like the Emerging Markets Equity ETF (EEM) is about to break upward from the channel in which it has traded since April.



Taken together, the new highs in the NYSE ADL and the recent signs of strength in bank stocks, European stocks and Emerging-Market stocks point to additional gains in equity prices in the short-term.

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

The US$ gold price spent all of last week slightly below its 20-day MA and inside its trading range of Friday 11th October. It's futile, counterproductive even, to try to find meaning in what are essentially meaningless fluctuations.



The US$ silver price was similar, except that it spiked to a new two-week low on Wednesday 16th October.



The fundamental backdrop is neutral-bullish for gold, and based on the most plausible short-term scenarios probably won't change by much over the next couple of months. It could become slightly bearish, but it probably won't become decisively bearish or decisively bullish.

One possibility is that the Fed's new money-pumping scheme gains traction, leading to a significant rise in inflation expectations. While this could support the US$ gold price, it would be more supportive for the prices of many other commodities. The reason is illustrated by the following chart, which compares the commodity/gold ratio (GNX/gold) with the ProShares Inflation Expectations ETF (RINF). The chart makes it clear that there is a strong positive correlation between the commodity/gold ratio and inflation expectations, that is, the chart shows that gold strengthens relative to commodities in general when inflation expectations are falling and weakens relative to commodities in general when inflation expectations are rising.



Anyhow, gold's main problem is sentiment. Over the past three weeks the total speculative net-long position in Comex gold futures has shrunk from an all-time high of 345K contracts to 288K contracts, but that reduction is nowhere near enough to create a relatively low-risk buying opportunity. With the speculating community remaining very optimistic and very 'long', the risk of a quick price decline of up to 10% is uncomfortably high. Also, the risk of a breakout failure would be high if the price were to break above its channel top in the near future.

Therefore, although we continue to expect that the current downturn in the gold market will be followed by a rally to above the early-September short-term top, at this time we would be in no hurry to buy.

Gold Stocks

Last Tuesday the HUI -- along with the other gold mining indices/ETFs -- made a marginal new correction low, but there was no follow-through to the downside. Instead, over the final three days of the week the HUI rebounded to its 20-day MA and in doing so confirmed the wedge pattern drawn on the daily chart displayed below.

The rebound over the past three trading days doesn't provide us with significant new information. In particular, there is still a realistic chance of a quick 10%+ decline to complete the correction.

At this point, a solid daily close above the 50-day MA (currently at 215 for the HUI) would be significant new information. It would suggest that the correction had ended at a higher-than-expected level and that the gold-mining sector's intermediate-term upward trend had resumed.



With regard to the next 6 months we think that the HUI's risk/reward is bullish, with risk of 10%-20% and reward potential of at least 40% (we continue to anticipate a test of the HUI's 2016 high of 280 prior to a longer-term top). However, with regard to the next 4 weeks we think that the HUI's risk/reward is bearish, with risk of 10%-15% and reward potential of less than 10%.

The Currency Market

The Dollar Index (DX) reversed downward from slightly above its channel top at the end of September, confirmed a short-term trend reversal to the downside during the week before last and accelerated downward last week. It now has reached minor support defined by the 200-day MA and is within one point of major support defined by the channel bottom.

If the pattern of the past 14 months continues then the DX will reverse upward from somewhere in the 96-97 range and start working its way back to the channel top. However, this pattern eventually will end. We have thought for the past few months that it would end via a break below the channel bottom. That's still the most likely scenario, but there remains a realistic, albeit diminishing, chance that a US$ surge involving a break above the channel top will precede a lengthy period of US$ weakness.



In the stock market section of today's report we noted the recent strength in European equities relative to US equities. It would take only a small amount of additional relative strength in European equities to shift our US$ True Fundamentals Model (UTFM) from neutral to bearish.

If the UTFM shifts to bearish and the Dollar Index (DX) breaks downward from its 14-month channel (by achieving a weekly close below 96) there will be a high probability that a multi-quarter period of US$ weakness has begun. This would be bullish for the US$ gold price, but it would be even more bullish for the prices of industrial metals because the US$ weakness very likely would be associated with increasing economic activity outside the US.

A week ago we wrote that the Canadian dollar (C$) had been in correction mode since hitting a short-term top in July. We also wrote that an end to the C$'s short-term correction would be signaled by a daily close above 76.

A daily close above 76 was achieved late last week. This is evidence that the C$ has resumed the intermediate-term upward trend that began near the end of last year.



It is hard for us to imagine the C$ making a big move to the upside without considerable strength in oil and oil-related equities. Therefore, if you are 'long' oil stocks then you are, in effect, indirectly 'long' the C$. As explained later in this report, we are adding more exposure to the oil sector via a long-dated OIH call option.

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 October 2019:

[Note: AISC = All-In Sustaining Cost, EBITDA = Earnings Before Interest, Tax, Depreciation and Amortisation (a measure of cash flow), EV = Enterprise Value or Electric Vehicle, FS = Feasibility Study, FY = Financial Year, IRR = Internal Rate of Return, ISR = In-Situ Recovery, JV = Joint Venture, 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 or Net Smelter Royalty, P&P = Proven and Probable, PEA = Preliminary Economic Assessment, PFS = Pre-Feasibility Study]

  *Jervois Mining (JRV.AX, JRV.V) is, via its consultants, updating the FS for the Idaho Cobalt Operation (ICO) acquired in the takeover of eCobalt Solutions. The FS, which is expected to be completed during the first quarter of 2020, considers the production of a cobalt concentrate that would be sent to a refinery outside the US for further processing. In addition, the company advised last week that an engineering firm (Wood) has been appointed to prepare a scoping study into the construction of a refinery at the ICO. The refinery would enable the production of 99.8% grade cobalt metal on site, which could substantially improve the overall economics of the project.

The refinery scoping study is also scheduled to be completed during Q1-2020, so JRV should have major market-moving news early next year.

JRV has no debt and about A$17M in cash, meaning that the company is in a solid financial position and that the above-mentioned engineering studies are fully funded.

  *Peyto (PEY.TO) confirmed its C$0.02/month dividend for October, November and December. At PEY's current stock price of C$2.61, the 0.02/month dividend constitutes an annual dividend yield of 9.2%.

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) AAU (last Friday's closing price: US$0.66)

2) JRV.AX, JRV.V (last Friday's closing price: A$0.22, C$0.20)

3) PEY.TO (last Friday's closing price: C$2.61)

4) OIH (last Friday's closing price: US$11.10)

The above list is limited to five stocks. It sometimes will contain less than five, but it never will contain more than five regardless of how many stocks are attractively priced for new buying.

Exiting KBLT

We have removed the two Cobalt 27 (KBLT.V) positions from the TSI List using last Friday's closing price of C$4.41 for record purposes. The long-term position that was added in February-2018 ended with a loss of about 60% and the trading position that was added in December-2018 ended with a profit of about 34%.

Rather than selling now it would be reasonable to hold until after the takeover is complete, thus receiving the takeover consideration of C$4.00 cash plus one share of Nickel 28 (NKL.V) for each KBLT share. In this case the aim would be to sell the NKL shares soon after they start trading. NKL shares could trade a lot higher than the C$0.41 price implied by KBLT's current price, although in our opinion they are not worth much more than C$0.40.

For our own account, about 40% of the KBLT position was sold last week and we plan to accept the takeover consideration for the balance.

A new idea for an option trade

The all-time low for the Oil Services ETF (OIH)* was US$10.48 in September-2001. Consequently, this year's low-to-date of US$10.76 could be viewed as a test of the all-time low. At the close of trading last Friday the ETF was still within spitting distance of its low.



There's a risk that stock market weakness within the next few months will push the oil price into the $40s and OIH to a new all-time low, but given that the oil services industry is not going away it's a good bet that OIH is not far from 'rock bottom'. Furthermore, if the Fed's new inflation program 'works' and the DX breaks out to the downside then OIH could gain at least 100% over the coming year. On this basis, OIH's intermediate-term risk/reward looks extremely attractive.

As a consequence, we have added the OIH January-2021 US$15.00 call option to the TSI List at Friday's closing price of US$0.62 (Friday's closing bid-ask spread was 0.58-0.62). There is an existing OIH call option with a $17.00 strike price in the TSI List, but this option expires in January of 2020 and probably will run out of time.

Note that when we suggest an option-trading idea related to an ETF or a stock, speculators/investors who like the idea but who don't trade options (most people should avoid options) could participate by taking a position in the underlying ETF/stock. The underlying security will provide less 'bang for the buck', but it also will involve less risk.

    *The ETF was created in 1999.

Chart Sources

Charts appearing in today's commentary are courtesy of:

https://stockcharts.com/
http://bigcharts.marketwatch.com/