-- Weekly Market Update for the Week Commencing 22nd February 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

There is nothing inherently wrong with market manipulation

Changes in gold location say nothing about the gold price

Can a US recession occur without an inverted yield curve?

Long-term price targets are meaningless

Bullish pundits routinely tout very high long-term price forecasts. Although less common, there are also bearish pundits who regularly tout very low long-term price forecasts. Furthermore, the touting of extremely high or extremely low price targets seems to be more common with gold and silver than with any other market. For example, even during the precious-metals depression of the past year it wasn't difficult to find predictions that the gold price will reach $5000/oz or more within the next few years. Such predictions are always meaningless, although they are a tried and true method of generating subscription revenue.

There are always a myriad of factors affecting price. Since it is impossible to not only take all of these factors into account but also to predict how each factor will change in the future, nobody has a clue what the gold price or the price of anything else will be in a few years' time. Of course, the long-term price predictions of some people will end up being correct for the same reason that completely random predictions will sometimes be correct.

One of the unpredictable factors is the changing value of the money in which prices are expressed. What use, for example, is a forecast that gold is going to US$5000/oz in a certain number of years unless there is a way of knowing what the purchasing power of a dollar will be at that future time. To explain what we mean we point out that a rise in the nominal gold price to $5000/oz by some future time will represent a DECLINE in the real worth of gold if the price of a loaf of bread rises to $30 over the same period.

So, whenever you see/hear a prediction that the gold price is going to be 'X' thousand dollars an ounce within 'Y' years, just laugh and move on.

The Fed is now expected to do nothing

A report put out by the Fed a couple of months ago predicted that there would be four 0.25% hikes in the Fed Funds Rate (FFR) in 2016, but traders operating in the interest-rate futures market never bought into that forecast. According to the price of the December-2016 Fed Funds Futures (FFF) contract, at the point of maximum interest-rate bullishness late last year 'the market' was expecting 2-3 Fed rate hikes in 2016. In other words, two months ago there was a significant gap between what the Fed was expecting to do and what 'the market' was expecting the Fed to do. The gap is now much wider.

The Fed has not yet officially backed away from its 'four rate hikes' forecast, but according to the current price of the December-2016 FFF contract (see chart below) 'the market' now expects the number of 2016 rate hikes to be zero or one, with the odds slightly favouring the former. In other words, traders operating in the interest-rate-futures market are now collectively of the opinion that there will be NO Fed rate hikes this year.

This is a remarkable change in interest-rate expectations, and all it took to bring about the change was an 8% drop in the stock market and a decision by the Bank of Japan to set a negative interest rate on a small portion of the reserves held by Japanese banks.



It doesn't take much imagination to figure out what will happen to the Fed's interest-rate plans and market expectations regarding the Fed's likely actions if the S&P500 Index breaks solidly below its January low and the economic data start pointing more definitively towards recession. It doesn't take much imagination because to become a central banker you must believe that the key to a stronger economy is more borrowing and spending. What will happen is that negative interest rate policy (NIRP) will be 'on the table' in the US, although we doubt that it will ever actually be implemented.

The world's most powerful central bankers have dug themselves into a giant hole and they strongly believe -- because this is what their models and Keynesian theories tell them -- that the solution is to keep digging.

The Stock Market

The US

The S&P500 Index (SPX) pulled back a little over the final two days of last week. This didn't change anything.

There is short-term lateral resistance at 1950 that in a couple of days will coincide with the falling 50-day MA. It's a good bet that this resistance will soon be tested. More important resistance lies at 1990-2000. What's the probability of this higher resistance being tested prior to the resumption of the longer-term bearish trend?



We don't know the probability, but clues regarding the possible extent of a continuing SPX rebound from the February low can be found in the two measures of sentiment discussed below.

The following chart shows the S&P100 Index (OEX), the 10-day MA of the equity put/call ratio and the 10-day MA of the OEX put/call ratio. The equity put/call ratio indicates the public's (the dumb money's) concern about downside risk and the OEX put/call ratio indicates the professionals' (the smart money's) concern about downside risk, with a high put/call ratio implying high concern and a low put/call ratio implying low concern.

The chart tells us that during November-December the smart money was worried about downside risk while the dumb money was complacent. AFTER the market tanked, the dumb money became very worried about downside risk and the smart money became less concerned than usual.

At the end of last week the dumb money was still very worried and the smart money was relatively unconcerned. The put/call situation therefore points to higher prices over the weeks ahead.



The other measure of sentiment we'll deal with is the weekly Investors Intelligence survey.

The following chart from Yardeni.com shows that the Investors Intelligence Bull/Bear ratio recently reached an unusually low level. In fact, during the week before last the Bull/Bear ratio reached a level that over the past 20 years was only exceeded near the crescendo of the 2008 crash.



The sentiment situation suggests that we should be open to the possibility of a meaningful rally over the coming 2 months. For instance, although we don't expect the rally to go this far it is not inconceivable that the SPX will move all the way back to the vicinity of its December high before the next short-term downward trend gets underway.

The sentiment situation also suggests that there is very little chance of the SPX dropping well below its January-February double bottom within the next few weeks. The double bottom could be briefly undercut, but it would probably require bearish sentiment to break all records for the market to drop more than a few percent below this level in the near future.

The one thing that could possibly cause bearish sentiment to break all records and lead to a sharp decline to well below the January-February double bottom is a dramatic escalation in the war raging in and around Syria. In particular, if Turkey and Saudi Arabia invade Syria then those two countries will find themselves at war with Russia and all bets will be off.

For safety reasons (to partially hedge the long exposure to non-gold commodity stocks that we've begun to build) we purchased about 25% of what we would consider to be a full position in EEM put options shortly after the start of trading last Thursday, but we probably won't add to this position anytime soon. For now, it makes sense to give the benefit of the doubt to the bullish side.

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 gold price plunged to the low-$1190s last Tuesday and then rebounded. The price pattern didn't change over the final two days of last week, so the following comment from the 17th February Interim Update remains applicable:

"There is currently no way of telling whether this sharp decline [to around $1190] was a routine pullback to 'test' the preceding upside breakout prior to the resumption of the rally or the start of a correction that will run for at least a few weeks. A daily close below $1190 would point to the latter."



According to the latest data, gold's Commitments of Traders (COT) situation remains neutral (it was bullish until two weeks ago and has since been neutral). What we mean is that the speculative net-long position has risen to the point where the COT situation is no longer a tail-wind for the US$ gold price, but it hasn't yet risen far enough to become a head-wind.

Although it is not something we would bet on, with support at $1190 having passed its first test and with the COT situation not yet bearish a quick move to a new high for the year is a realistic possibility. Round-number resistance at $1300 and the January-2015 peak at $1308 will be obvious near-term targets if the February high of $1264 is breached.

Silver

The optimism about silver's price prospects is nothing if not stubborn and the breathlessly-bullish commentary on the silver market is nothing if not persistent.

Every year, without fail, stories get circulated about a looming global silver shortage. These stories seem to start when someone walks into a coin shop in a town somewhere (usually in the US) and discovers that the shop is temporarily out of silver coins. This information is then passed onto someone else who writes an article claiming that the world is running short of silver, which leads to widespread speculation that a silver-price moon-shot is about to happen. The problem is that if the speculation is not supported by the underlying supply-demand situation for physical silver, a situation that absolutely cannot be understood by visiting coin shops, it will not lead to a sustained price advance.

Over the past three weeks the bullish speculation about silver's prospects has ramped up, as it almost always does whenever the gold price rallies, but as has consistently been the case over the past couple of years the speculation has not been supported by the underlying supply-demand situation for physical silver. We know that this is the case because the increase in the speculative net-long position in silver futures was large in comparison with the increase in price. To put it another way, it took a disproportionately large increase in speculative buying in the futures market to lift the price.

As illustrated by the red and blue bars moving beyond the edges of the box drawn on the following chart, silver's short-term COT situation is now clearly bearish. This should be viewed as a red flag, but it doesn't guarantee significant price weakness in the near future. It's possible, for example, that a rise to a new high for the year in the gold price will prompt an additional surge in silver-related speculation.


                                                   Chart source: www.sharelynx.com

In silver's favour is the evidence that gold has commenced a bull market and the fact that the silver/gold ratio is very low by historical standards. The silver/gold ratio will probably extend its multi-year downward trend over the months ahead, but it probably won't get a lot lower.

Platinum

Apart from gold, which always warrants special treatment, platinum was the only commodity we singled out for discussion in our 2016 Yearly Forecast. Here's how we concluded the discussion: "We expect platinum to make a major bottom in US$ terms, inflation-adjusted terms and gold terms during the first quarter of 2016."

The first evidence that a major bottom is in place for platinum came a couple of weeks ago when the price broke above the top of a well-defined 18-month channel. More evidence of a major bottom will be in place if the platinum price holds at or above $900 during a correction and then moves decisively above its 200-day MA.



Gold Stocks

Current Market Situation

In the email sent to subscribers following Thursday's US trading session, we wrote:

"In situations such as this it's best to take the evidence and review the situation day by day. No short-term forecasting (that is, guessing) is necessary. For example, if the HUI simply closes higher on Friday it will open up the possibility of next week being similar to each of the past two weeks, with a sharp 1-2 day pullback early in the trading week followed by a quick move back to or above the year's high. Alternatively, a lower close on Friday followed by a second lower close next Monday would indicate that a short-term top was probably in place."

There was a small decline in the HUI on Friday. This tells us nothing in isolation, but if it is followed by a significantly larger decline on Monday then we will have evidence of a short-term top.

With regard to price levels that would have to be breached to confirm a short-term top, for the HUI it's 140 (see chart below). This is more than 10% below the current price and is therefore too low for practical purposes.



However, the XAU, by virtue of its relative weakness over the past several months, is closer to important support and would therefore have to fall by a lesser amount to confirm a short-term reversal.

In the XAU's case (see chart below), critical daily-closing support lies at 57-58. The lower end of this support range is only about 5% below the current price, which means that it is high enough to act as a timely indicator of a downward reversal. That is, it would be reasonable to interpret a daily XAU close below 57 as confirmation that a short-term top is in place.



The gold-mining indices remain very 'overbought' on a short-term basis, but the evidence of a long-term bullish reversal is continuing to build-up. For one example, the HUI has just achieved a second weekly close above its 80-week MA. For another example, at the same time as it points to near-term downside risk, the unusual extent to which the HUI has become stretched to the upside on a short-term basis is longer-term bullish. The explanation was outlined as follows in last week's Interim Update:

"Although the above chart indicates an 'overbought' extreme and suggests that a correction will soon begin (if it hasn't already), it also supports the view that a cyclical bull market has started. The reason is that the only times in the past that the HUI got close to being as stretched to the upside on a short-term basis as it was last Friday was during the first 6 months of the multi-year rally that began in November-2000 and the first few months of the multi-year rally that began in October-2008."

It will probably take a decline to the vicinity of the HUI's 50-day MA to create the next sector-wide short-term buying opportunity, but in the meantime there will be opportunities to buy individual gold stocks.

What to do?

The primary focus at this time should be on raising cash by gradually scaling out of stocks that have moved rapidly upward over the past several weeks, while maintaining 'core' exposure to the gold sector. Unless you sell into the periodic surges you won't be in a position to buy during the subsequent purges.

At this stage, however, we can't rule out the possibility of an over-stretched market becoming even more so or the possibility that the overbought condition will be worked off via a choppy sideways consolidation. In either of these cases, the gold stocks that are likely to outperform are the ones that offer substantial leverage to changes in the gold price and are still at depressed levels. Three examples are Orvana Minerals (ORV.TO), Resolute Mining (RSG.AX) and Timmins Gold (TGD). RSG and TGD are members of the TSI List. ORV is not a TSI stock selection, but it has been discussed at TSI over the past few months (refer to the 21st December Weekly Update for the most recent note).

The above-mentioned stocks are current producers that transition from being loss-making or marginal at $1150-$1200/oz to being profitable at $1250-$1300/oz. This transition dramatically changes the value of the company.

Of course, if it starts to look like gold's rally is over then these stocks will quickly give up their gains.

The Currency Market

The chart displayed below compares the SPX/MSWORLD ratio with the Dollar Index over the past 15 years. MSWORLD is a proxy for global equity performance excluding the US, so the SPX/MSWORLD ratio is an indicator of US equity performance relative to the performance of equities in the rest of the world.

It is clear from the chart that on an intermediate-term basis the Dollar Index usually trends in the same direction as the SPX/MSWORLD ratio. Moreover, the chart also shows that the SPX/MSWORLD ratio tends to lead the Dollar Index at important turning points. In other words, it shows that relative strength in US equities tends to be followed by strength in the Dollar Index and relative weakness in US equities tends to be followed by weakness in the Dollar Index.

A downward correction in the SPX/MSWORLD ratio during the first quarter of last year has been followed by a strong rally to new highs. The following chart's overarching message is therefore that the Dollar Index will break decisively above its March-2015 peak sometime this year.



There's a good chance that the Dollar Index will trade at least a few points above its March-2015 peak before this year is over. The main question is: will the start of a rally to new multi-year highs be preceded by a decline to near the bottom of the 12-month range (the low-90s)?

Based on the recent price action the answer to the above question is: yes, it probably will be. However, all it would take to negate the recent short-term bearish evidence is a weekly close above 97.5.



Unless the facts change in the meantime, our intermediate-term outlook for the Dollar Index will shift from "neutral" to "bullish" following either a decline to the low-90s or a weekly close above 97.5.

By the way, the Dollar Index is dominated by the USD/EUR exchange rate. A bullish view on the Dollar Index therefore implies a bearish view on the euro, but it doesn't necessarily imply a bearish view on other currencies. In particular, we wrote in our 2016 forecast that we expected the Yen to be this year's strongest major currency. That expectation is intact.

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 19th February 2016:

[Note: AISC = All-In Sustaining Cost, FS = Feasibility Study, FY = Financial Year, IRR = Internal Rate of Return, 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]

  *Dalradian Resources (DNA.TO) reported the results from the fourth batch of holes from a 50,000m infill drilling program at its Curraghinalt gold project in Northern Ireland. The purpose of this drilling program is to convert Inferred resources to Indicated resources in support of a Feasibility Study scheduled for completion in Q3-2016. As was the case with earlier results, the latest drilling results included some good intercepts and appear to be consistent with the resource estimate.

To date, the results associated with about 40,000m of the 50,000m program have been released. The program's remaining holes are almost complete and will probably be reported in a single batch within the coming 2 months.

If the figures in DNA's Oct-2014 PEA are in the right ballpark then DNA offers very good value near its current share price assuming a gold price of $1200. In fact, based on the PEA figures we can easily justify a C$2/share valuation for DNA at the current gold price. However, the 'P' is in PEA for a good reason. The economic analysis is Preliminary and might not be substantiated by the far more rigorous Feasibility-level analysis. That, of course, is why you can currently buy DNA shares in the C$0.80s.

  *Evolution Mining (EVN.AX) published its half-year report for the 2016 Financial Year.

The company made what it refers to as an "underlying net profit" (the net profit excluding acquisition-related charges) of A$108M. If we annualise this figure and divide the result by the total share count (1463M) we get A$0.15/share. Applying a 10-15 multiple to this net earnings figure gives us a fair value for EVN of A$1.50-$2.25 per share.

This is consistent with our previously-expressed view that EVN is worth around A$2.00/share at the current gold price.

The balance sheet included with the half-year report shows that EVN had A$25M of working capital and long-term debt of A$409M at 31st December, for net debt of A$374M. This is a comfortable amount of debt for a profitable 800K-oz/year gold producer with a market cap of around A$2.6B (at A$1.80/share).

  *Pretium Resources (PVG) advised that construction at the Brucejack gold mine remains on track for commissioning in Q3-2017. PVG also published its updated capital cost estimate for the mine. This is important new information that was originally scheduled (by the company) to be provided in Q4-2015.

The estimated capital cost has fallen by US$106M from US$747M to US$641M. Looking at the details we see that the updated capex estimate includes a $145M exchange-rate benefit and the transfer of $23M of cost from initial capital to sustaining capital. It could therefore be said that the capital cost has increased by $62M, but the increase has been more than offset by a fortuitous movement in the C$/US$ exchange rate and the shifting of some cost from pre- to post-production.

In any case, it's good news that the mine is now expected to cost significantly less than originally estimated.

The lower capex and other changes have improved the economics of the Brucejack project. Assuming a gold price of $1100/oz and a silver price of $14/oz, the project is now estimated to have an NPV(5%) of US$1.55B. This compares to the NPV of $1.45B estimated in the June-2014 FS assuming the same gold price and a $3/oz higher silver price.

Taking into account the revised capex estimate and the amount of working capital that will be needed between now and when the mine is expected to become cash-flow positive, PVG will need to raise about US$100M. This will most likely happen via an equity financing. Furthermore, although PVG probably won't need to raise the additional money until next year, it's possible that the recent relative sluggishness of PVG's share price is at least partly due to anticipation of a sizable equity financing happening in the near future. The recent relative weakness in PVG's share price could also be related to the on-going concern regarding the validity of the Brucejack resource estimate.

Assuming that PVG has to issue 20M new shares, the Brucejack economics presented in last week's press release suggest a valuation of about US$9.40/share at a gold price of $1100/oz, about US$11.30/share at a gold price of $1200/oz, and about US$14.30/share at a gold price of $1400/oz. Given the uncertainty about the resource estimate and therefore the published economics, it is not unreasonable to apply a 50% discount to these figures. Doing so gives us a fair value estimate for PVG of US$5.50-$6.00 (C$7.50-$8.20) at the current gold price. PVG ended last week at US$5.13 (C$7.05).

  *Ramelius Resources (RMS.AX) published its half-year report for the 2016 Financial Year.

The 6-month after-tax profit was A$21.9M, which was slightly higher than we estimated last week. Annualising the 6-month profit and dividing the result by the total share count of 470M gives us an earnings-per-share estimate of A$0.092 for the current financial year. If we then assume that the company is worth 5-10 times its current annual earnings we arrive at a back-of-the-envelope valuation range of A$0.46-A$0.92.

As stated last week, we think it makes sense to use the low (5X) earnings multiple and, therefore, the lower end of the aforementioned valuation range. The reason is that RMS's profitability currently depends on adding high-grade ore from small satellite deposits to the ore obtained from its Mt Magnet mine. As also stated last week, if we became confident that the company was going to at least maintain its current level of production for several more years then we would use a higher earnings multiple.

RMS has a strong balance sheet, with A$31.5M of working capital and no long-term debt.

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) DNA.TO in the low-C$0.80s (last Friday's closing price: C$0.88)

2) FCG (last Friday's closing price: US$3.36)

3) IVN.TO (last Friday's closing price: C$0.66)

4) PRQ.TO (last Friday's closing price: C$3.00)

5) TGD at around US$0.20 (last Friday's closing price: US$0.22)

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.

Second RGLD call option exited

From the email sent to subscribers after Thursday's US trading session:

"...for TSI record purposes we are going to exit the remaining Royal Gold (RGLD) Jan-2017 $40 call option position at Thursday's closing price of US$11.00. Based on our December entry at $4.90, the result was a profit of 125%. Traders who scaled into the options during the weeks following our original buy suggestion should have achieved a much higher profit result."

We will consider new long-dated gold-stock call options following a significant correction.

Chart Sources

Charts appearing in today's commentary are courtesy of:

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