-- Weekly Market Update for the Week Commencing 21st November 2016

Big Picture View

Here is a summary of our big picture view of the markets. Note that our short-term views may differ from our big picture view.

The BULL market in US Treasury Bonds that began in the early 1980s ended in early-2015, but there will be many years of topping action in bond prices and bottoming action in bond yields before major new trends get underway. (Last update: 29 June 2015)

The stock market, as represented by the S&P500 Index, commenced a secular BEAR market during the first quarter of 2000, where "secular bear market" is defined as a long-term downward trend in valuations (P/E ratios, etc.) and gold-denominated prices. This secular trend will bottom sometime between 2018 and 2020. (Last update: 29 June 2015)

A secular BEAR market in the US Dollar began during the final quarter of 2000 and ended in July of 2008. This secular bear market will be followed by a multi-year period of range trading. (Last update: 09 February 2009)

Gold commenced a secular bull market relative to all fiat currencies, the CRB Index, bonds and most stock market indices during 1999-2001. This secular trend will peak sometime between 2018 and 2020. (Last update: 29 June 2015)

Commodities, as represented by the CRB Index, commenced a secular BULL market in 2001 in nominal dollar terms. The first major upward leg in this bull market ended during the first half of 2008, but a long-term peak won't occur until 2018-2020. (Last update: 29 June 2015)

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Outlook Summary

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

Last week's posts at the TSI Blog

Gold and the Real Interest Rate

Summary of current thinking/positioning

1) Thinking that new rebounds for gold and the associated mining indices will soon begin, but continuing to expect that the overall corrections will extend into Q1-2017.

2) Expecting that 2017-2018 will be a very bullish period for commodities. Gradually building up long-term exposure to non-gold commodities while acknowledging that the early-2016 lows could be tested prior to the start of the aforementioned bullish period. Looking for opportunities to establish hedges due to concern about short-term downside risk.

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

4) Positioned for short-term downside in the US stock market via QID (leveraged NDX bear fund) call options expiring in January, but this speculation is currently not working.

5) Thinking that the Dollar Index is close to a 1-2 month top, but that it will move to new multi-year highs during the first quarter of 2017 and won't reach a major top before the second quarter of 2017.

6) Maintaining a large cash reserve in recognition of the downside risk in almost all equities (current cash percentage is 40%-45%).

The Extremes

A remarkable number of market prices and indexes reached some type of extreme over the past two weeks. Perhaps this is what we should expect as the financial/monetary system becomes increasingly unstable due to the increasingly-aggressive interventions of central banks. Anyhow, here are some of the recent extremes:

1) The Copper Market

During the week before last the copper price completed an extraordinary run of 14 consecutive up-days, culminating in the daily RSI (a short-term momentum indicator) hitting its highest level in more than 20 years. Also, the speculative net-long position in Comex copper futures hit a 12-year high.

2) The Treasury Market

The daily RSI for the 20+ Year Treasury Fund (TLT) hit a 9-year low and the daily RSI for the 10-year T-Note yield hit a 9-year high.

3) The NASDAQ

The daily number of NASDAQ stocks making new 52-week highs was greater than at any time since early-2004.

4) The relative strength of the banking sector

Both the daily and the weekly RSI for the BKX/SPX ratio hit 20-year highs, as 'investors' firstly bid up bank stocks on the belief that bank profit margins will widen in response to rising interest rates and then bid them up some more on the belief that Trump will repeal "Dodd-Frank".

5) The Transportation Sector

The daily RSI for the Dow Transportation Average hit a 20-year high.

6) The Coal Sector

The weekly RSI for the VanEck Vectors Coal ETF (KOL) reached by far the highest level in the fund's 8-year history. Note that almost all of the gain happened prior to Trump's election.

7) The Currency Market

First, the Mexican Peso made an all-time low relative to the US$. Second, the Dollar Index has just risen for a very rare 10 trading days in a row (and counting).

The Long Term Dollar Bear

The US dollar's multi-decade downward trend relative to the Swiss Franc (SF) and the euro is a topic we've been covering 'forever' and last re-visited in the 6th June Weekly Update. Considering the recent price action, this is a good time for an update.

Just to recap, relative to the SF (and more recently the euro) the dollar has made a succession of lower highs and lower lows since 1970. However, there has never been a runaway bull or bear market. Rather, steady declines lasting 8-10 years have been punctuated by steady advances lasting 6 years.

Here's the updated chart showing the long-term decline described above. Note that the chart shows the US dollar's performance relative to the SF prior to February-2005 and relative to the euro from February-2005 onwards. Also note that we've drawn a vertical line in 2011 to mark the end of the dollar's most recent down-cycle, even though the US$ bottomed against the euro during the first half of 2008. This was done because the US$ bottomed relative to both gold and the SF during the third quarter of 2011.



When viewed on such a broad timescale the dollar's cyclical performance looks straightforward and predictable, but in real time it can be difficult to figure out the current position in the cycle. For example, if we measure from the early-2008 low then the dollar's latest 6-year up-cycle should have ended by mid-2014. Instead, mid-2014 was the start of a rapid 9-month advance. This is another reason that it makes sense to consider Q3-2011 to be the starting point of the latest up-cycle.

In our most recent previous update on this long-term cycle (in June of this year), we wrote:

"Price (position relative to the long-term channel) and sentiment point to the dollar's latest up-cycle having ended in March-2015, but based on time the up-cycle could extend well into next year [2017]. A break above or below the relatively narrow range of the past 15 months (92.5 to 101) will indicate whether we are dealing with a continuing up-cycle with as much as a year to go or a new down-cycle that will probably extend well into the next decade."

The subsequent price action strongly suggests that we are dealing with a continuing up-cycle. If so, then May-August of 2017 is a reasonable guess as to the timing of the next long-term US$ peak. The reason is that July-August of 2011 appears to have marked the beginning of the current 6-year up-cycle and the month of May marked important turning points in 2014 and 2016.

The T-Bond's intermediate-term risk/reward is no longer bearish

There's a decent chance that the secular bull market in US government bonds is over. Furthermore, even if the secular upward trend in T-Bond prices and the associated secular downward trend in interest rates are not over, there's a good chance that the T-Bond price will decisively breach its 2016 low before bottoming some time during 2017. However, it is time to temporarily step away from our bearish intermediate-term outlook for the T-Bond.

The reason is the extent to which the price has fallen over the past few months and especially over the past two weeks. As illustrated by the following weekly chart, the 20+ Year Treasury ETF (TLT) has reached its 200-week MA (the red line on our chart) and has registered a weekly RSI (shown at the bottom of the chart) that's equivalent to the lows of the past 10 years.

There is a risk that the short-term decline will extend to important lateral support defined by last year's low (115), but even if the intermediate-term downward trend is set to continue there is a good chance of a rebound to the 50-week MA (the blue line on our chart) within the coming two months.



The differences between 1981 and now

Parallels have been drawn in some quarters between the upcoming start of the Trump presidency and the start of Reagan's first presidential term in 1981. However, the economic and financial-market backdrops could hardly be more different, so a very different outcome is all but guaranteed.

Here is a good summary of the differences written by fund manager Kevin Duffy of Bearing Asset Management:

"Reagan inherited a 14 year bear market in stocks and 34 year bear market in bonds. Government debt/GDP had continually fallen since WWII. The baby boomers were moving into their productive years. The IBM PC was just launched. The Soviet empire was on the verge of collapsing. Trump is inheriting asset bubbles in stocks, bonds, and commercial real estate. Total debt/GDP is at record highs, rates at all-time lows (with much of the world's sovereign debt actually dipping into negative yields not long ago). Boomers are just moving into retirement which will swamp an entitlement system that was never reined in. Bonds are probably on the verge of a multi-decade bear market. The government's interest costs will explode as the political class structured its debt on the short end of the curve, assuming rates would stay low forever. Why anyone in his right mind would want to put his name on this Hindenburg is beyond me. But, heck, the Trump brand has been immune to economic forces in the past, so why not?"

The Stock Market

A Fourth Reason

Last week we listed three reasons that, despite the high average valuation and the absence of earnings growth, there could be a 6-12 month extension of the US stock market's long-term upward trend. There is also a fourth reason, which is the performance of stock markets in other parts of the world.

A few times over the past 6 months we wrote that the best thing going for the US stock market was that while the senior US stock indices appeared to be stretched to the upside and tracing out major topping patterns, important stock indices in other parts of the world offered reasonable value and appeared to be tracing out major basing patterns. The best examples are the EURO STOXX 50 Index (STOX5E) and Japan's Nikkei225 Index, charts of which are displayed below. Both of these indices appear to have completed double bottoms during the first half of this year.

The US stock market could be supported over the coming 12 months by a more bullish global trend for equities. This could help the US stock market make new highs in nominal dollar terms while being weak relative to other stock markets.

Current Market Situation

The S&P500 Index (SPX) tested its August-2016 high (and all-time high) late last week. It is not yet 'overbought' on a short-term basis and is therefore in a good position to break out to the upside.



The NASDAQ100 Index (NDX), however, is in a very different position. It continues to trace out a pattern that has the look of an important top.



The SPX and the NDX will soon have to move into line with each other, via either a downward reversal in the SPX or the NDX strengthening enough to invalidate the 'topping pattern' interpretation of its chart. We are positioned for the former outcome, although we don't have a strong opinion on which way this will go.

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 Fundamentals

Our expectation since early-October has been that the US$ gold price would spend most of its time until year-end in the $1250-$1300 range, with moves outside this range being short-lived and there being a realistic chance that support in the low-$1200s would be tested. Prior to the past 1.5 weeks this expectation probably looked too pessimistic to many of our readers, but it is now starting to look too optimistic.

It is not looking too optimistic simply because the gold price has dropped to support in the low-$1200s and has not immediately bounced, but also because the fundamental backdrop is now as gold-bearish as it has been in years. Specifically, with last week's upside breakout in the Dollar Index we now have four of gold's six true fundamental price drivers in bearish territory, one (the general trend for commodity prices) in neutral territory and only one (the yield curve) in bullish territory.

As previously noted, for practical purposes a chart of the bond/dollar ratio (the T-Bond price divided by the Dollar Index) is a reasonable way to quickly see whether the fundamental backdrop is becoming more or less bullish for gold. As illustrated below, the bond/dollar ratio collapsed over the past two weeks and is now below its 2015 low.

It is not appropriate for us to be intermediate-term bullish on gold under these circumstances.



The good news for gold 'longs' is that both the T-Bond and the Dollar Index are very extended -- to the downside for the T-Bond and to the upside for the Dollar Index -- on a short-term basis, which makes it likely that the bond/dollar ratio will soon begin to rebound. Also and as mentioned earlier in today's report, the relative strength of the banking sector (another of gold's true fundamentals) is stretched to an extreme, which means that it is acutely vulnerable to a multi-week corrective move -- in a direction that would be helpful to gold -- even if it is destined to move higher within the coming several months. This should enable the gold price to rebound, but it will be very interesting to see if such a rebound begins before or after a weekly close below $1200/oz.

Before leaving the fundamental influences on the gold market we wanted to point out that the December meeting of the Fed probably won't be important. Almost everyone knows that the Fed is going to implement its second 0.25% rate hike at this meeting, so a rate hike is fully in the market. If gold is still in a short-term decline when mid-December rolls around then the December Fed meeting could coincide with an upward price reversal as it did last year, but we think there's a better chance of the short-term reversal occurring this month.

The Price Action and Sentiment

In last week's Interim Update we wrote that the rebound following gold's test of support in the low-$1200s had been weak to date, so we wouldn't be surprised if there were additional tests over the days ahead. We also wrote that an intra-day spike below support wouldn't be a problem, but that a weekly close below $1200 would be a problem for the intermediate-term bullish case.

Additional doubt has since been cast upon the intermediate-term bullish case by moves in currencies and interest rates, but despite an obvious upside breakout by the Dollar Index the US$ gold price has managed to hold above trend-defining lateral support in the low-$1200s. Also, there was a minor bullish non-confirmation on Friday due to the gold price making a new multi-month low while the HUI held above its 14th November low.



The latest COT report (a sentiment indicator) revealed that there was a sizable post-election decline in the total speculative net-long position in Comex gold futures, although the decline wasn't as big as it could have been given the price action. We wouldn't have been surprised if the total speculative net-long position had dropped to 150K contracts or less, but as at Tuesday 15th November it was 200K contracts.

This means that gold's COT situation has not significantly changed. It stopped being a threat a few weeks ago, but it hasn't yet become supportive.

Considering the extent to which the gold market is now short-term 'oversold' and the likelihood that some important influences have moved as far as they are going to move in a gold-bearish direction in the short-term, we suspect that this month's low will be followed by a rebound into year-end.

We don't have an opinion on whether this month's low is already in place. It might have been put in place last Friday. Alternatively, there could be a spike below $1200 prior to a turnaround.

Silver

Over the past few months we've had $16.00 in mind as a likely level for a correction low in the silver price. The silver price came within 43c of this targeted level on Friday.

We won't be surprised if the silver price spikes down to $16.00 this week, but a bottom that holds for at least two months is probably not far away. As is the case with gold, however, silver's final price low -- which could turn out to be a test of the November-2016 low -- will probably not occur until the first few months of next year.



Gold Stocks

Current Market Situation

As mentioned above, there was a bullish non-confirmation last week with the HUI failing to confirm Friday's drop to new lows in the bullion market. Actually, although a lower low in the gold price alongside a higher low in the gold-mining sector is generally viewed as a bullish non-confirmation, ANY non-confirmation or divergence following a substantial downward move can be bullish. For example, a huge rally began in January shortly after the HUI made a new bear-market low and the gold price made a higher low.

Whether or not last week's non-confirmation signaled an imminent turn to the upside is unknowable at this time.



If a turn to the upside doesn't happen immediately it will probably do so before the end of November. This is not only because the gold-mining indices are 'oversold', but also because the short-term blow-off moves in T-Bonds and the US$ (the source of the current downward pressure on gold-related investments) will soon exhaust themselves.

The rebound that follows the coming short-term reversal could last a few weeks and could be strong enough to create the impression that a new intermediate-term upward trend has begun, but the price action of the past two weeks has increased our conviction that the overall correction/decline won't end before the first quarter of next year.

By the way, the price action of the past two weeks has caused the HUI to deviate in a big way from the 1982-1983 model we've been tracking. The updated chart is shown below. Although the HUI has deviated by falling sharply, this could be viewed as a longer-term positive development in that the 1982-1983 rally was the bear-market variety.



What to do?

Last week we wrote that the best approach for most people and the approach that we were using was to slowly/methodically add to gold-stock exposure on price weakness. There was plenty of price weakness in high-quality gold-mining stocks over the past fortnight and we grabbed the chance to make a few buys, but due to the deteriorating fundamental backdrop for gold we probably won't do any additional buying within this sector unless a spectacular opportunity presents itself. We will also be quicker than usual to take profits during rebounds over the coming two months.

The Currency Market

The Dollar Index has broken above the top of its 20-month horizontal range, but after rising for 10 days in a row it is extended on a short-term basis and probably close to a peak that will hold for at least a few weeks.

The US$/euro exchange rate makes up almost 60% of the Dollar Index. It's therefore interesting that even though the Dollar Index has broken above the top of its 20-month range, the euro hasn't yet broken below the bottom of a similar range. Refer to the following daily chart for details. A sustained downside breakout by the euro is now a high probability, but it might not happen until next year.

We expect that the euro will rebound for at least a few weeks from whatever low is put in place this month.



Our expectation over the past few months has been that the Yen would decline to 89-90 before resuming its long-term advance. The Yen traded as low as 90.1 on Friday and is probably now very close to an intermediate-term bottom in terms of both price and time.

Note that since the Dollar Index's performance is mostly determined by the euro, the Yen will be capable of exceeding its 2016 peak during the first half of 2017 even if the Dollar Index maintains its upward trend.



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 November 2016:

[Note: AISC = All-In Sustaining Cost, FS = Feasibility Study, FY = Financial Year, IRR = Internal Rate of Return, ISR = In-Situ Recovery, MD&A = Management Discussion and Analysis, M&I = Measured and Indicated, NAV = Net Asset Value, NPV(X%) = Net Present Value using a discount rate of X%, P&P = Proven and Probable, PEA = Preliminary Economic Assessment, PFS = Pre-Feasibility Study]

  *Alkane Resources (ALK.AX) had its annual general meetings of shareholders last week. The presentation delivered at the meetings provides a very good overview of the company's progress and potential. It is mandatory reading for anyone who owns or is interested in owning ALK shares.

Although it has a significant gold-production business, the main reason to own ALK is the development-stage Dubbo Zirconia Project (DZP). A Feasibility-level study completed last year estimated that the DZP could be developed into a mining operation with a net present value (NPV), using an 8% discount rate, of US$1.1B (A$1.45B). This equates to A$2.90 per ALK share, or about 5-times the current stock price. Furthermore, an updated engineering/economic analysis using a modular construction process is scheduled to be completed during the first quarter of 2017 and will probably reveal a higher NPV.

The biggest unknowns/risks are the future prices of the specialty metals that the DZP will produce and the details of the construction financing. With regard to the latter, if the modular construction concept is shown to be attractive then ALK will have to raise about US$500M next year in order to bring the project's first phase into production in 2019.

  *Euro Sun Mining (ESM.TO) issued its quarterly report for the September quarter. The report showed that the company had working capital of US$6.7M (C$8.9M) at 30th September, which should mean that ESM is fully funded for at least the next 6 months.

The next significant news for ESM is likely to be the ratification of its mining licence by the Romanian government. We expect this to happen early next year. Also, work on a Feasibility Study for the Rovina Valley gold-copper project is expected to begin early next year.

  *Premier Gold (PG.TO) issued its quarterly report for the September quarter.

The company's balance sheet underwent a dramatic change during the quarter, with working capital rising from C$42M to C$85M, long-term debt rising from C$9M to C$103M, net debt (long-term debt minus working capital) rising by C$51M and non-current assets rising by C$155M. The change was primarily due to the purchase of the Mercedes gold mine (Mexico) for US$123M of cash (funded by a loan and a gold stream) and US$20M of equity.

The balance sheet is likely to undergo another big change during the December quarter due to the completion of PG's transformation from an explorer to a gold producer with two operating mines. Production is expected to be 70K-80K ounces of gold during the quarter, which should enable the company to add a lot of cash and/or gold inventory to its Current Assets.

Of even greater importance, the results of the FS for the Hardrock (Trans-Canada) project in Ontario were published last week. This project is a 50/50 JV between PG and Centerra Gold.

Our initial comments on the FS results were included in last week's Interim Update. We summed them up with the word "lacklustre", because they showed that the economics are not good enough near the current gold price to warrant moving the project into the construction phase. It is worth pointing out, however, that the project is sufficiently close to the money and 'permittable' to suggest that it will eventually be developed into an operating mine. This puts the Hardrock project well ahead of many other undeveloped North American mining projects, including International Tower Hill's Livengood gold project and Northern Dynasty's Pebble copper-gold project. The probability that either of these projects ever gets developed into an operating mine is approximately zero.

The Hardrock FS is based on an open-pit gold mine that produces an average of 288K ounces/year over about 14 years. The estimated AISC is only US$600/oz, which means that the mine would be very profitable at the current gold price if it were in operation today. The problem is that the estimated initial capital cost is almost US$1B (US$962M, to be exact). It's the initial capital cost that weighs down the economics.

At a gold price of US$1250/oz and a USD/CAD exchange rate of 1.3 (implying a local-currency-denominated gold price of C$1625/oz, which is close to the current price), the project's after-tax NPV(5%) and IRR are estimated to C$709M and 14.4%, resp. A 14.4% IRR is not bad, but given the risks involved it is not high enough to justify mine development. At a 15% higher C$-denominated gold price the IRR rises to about 20%, which would almost certainly make the project viable. In other words, we think that the project is currently about 15% out of the money.

Also worth noting is that although the project is a 50/50 JV, PG's 50% stake is worth more than 50% of the total NPV. This is because of PG's tax credits and the greater spending obligations of PG's partner. According to a separate press release, PG's 50% share of the project has an after-tax NPV(5%) of C$414M and an after-tax IRR of 17.5%.

Based on the above, at the project's current stage of development we think it's fair to assign a value of about C$200M (a 50% discount to the NPV) to PG's stake in the Hardrock project. The company has 201M shares, so this equates to C$1.00/share.

After taking into account the effects on PG's two gold-producing assets of the recent decline in the gold price and assigning a value of C$50M to the company's portfolio of exploration-stage assets, we roughly estimate that at the current gold price PG is worth C$4.00/share.

  *UEX Corp. (UEX.TO) published its quarterly report for the September quarter. The report shows that the company had about C$7M of working capital at 30th September, which is down from about C$9M at the end of the preceding quarter. This should be enough to fund the company's uranium exploration business until mid-2017, but it's reasonable to expect that the next equity financing will happen during the first few months of 2017.

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$1.07)

2) BLK.AX (last Friday's closing price: A$0.54)

3) EVN.AX (last Friday's closing price: A$1.96)

4) PG.TO (last Friday's closing price: C$2.28)

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

Chart Sources

Charts appearing in today's commentary are courtesy of:

http://stockcharts.com/index.html