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   -- Weekly Market Update for the Week Commencing 22nd December 2014

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 ended in 2012. In real (gold) terms, bonds commenced a secular BEAR market in 2001 that will continue until 2018-2020. (Last update: 20 January 2014)

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

Market
Short-Term
(1-3 month)
Intermediate-Term
(6-18 month)
Long-Term
(2-5 Year)
Gold N/A Bullish
(26-Mar-12)
Bullish
US$ (Dollar Index) N/A Neutral
(29-Sep-14)
Neutral
(19-Sep-07)
US Treasury Bonds (TLT) N/A Neutral
(18-Jan-12)
Bearish
Stock Market (DJW) N/A Bearish
(28-Nov-11)
Bearish
Gold Stocks (HUI) N/A Bullish
(23-Jun-10)
Bullish
Oil N/A Bullish
(17-Dec-14)
Bullish
Industrial Metals (GYX) N/A Neutral
(15-Sep-14)
Bullish
(28-Apr-14)

Notes:

1. Our short-term expectations are discussed in the commentaries, but except in special circumstances we won't attempt to assign a "bullish", "bearish" or "neutral" label to these expectations.

2. The date shown below the current outlook is when the most recent outlook change occurred.


3. "Neutral" means that we think risk and reward are roughly in balance with respect to the timeframe in question.

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

Schedule reminder and best wishes

As advised in the last Interim Update, we are taking a break and therefore won't be publishing any regular commentaries until the Interim Update scheduled for 8th January. As also advised, during the intervening period there will be one or two brief updates via email and there will probably be a couple of posts at the TSI Blog.

By the way, less than one-third of TSI subscribers have signed up to receive email notification whenever there's a new blog post. This is fine, but if you are interested in the blog posts and don't want to waste time checking the site to see if anything has changed then it makes sense to submit your email address via the box at the right hand side of the page at http://tsi-blog.com/.

Our very best wishes for Hannukah, the Northern Hemisphere Winter Solstice, the Southern Hemisphere Summer Solstice, Christmas, and (according to the Gregorian calendar) the start of a new year!

Real Performance

Rapid economic growth is never the primary driver of the long-term bull markets in commodities that are often referred to as "commodity supercycles". There is actually no such thing as a "commodity supercycle". Instead, there are periods when commodity prices are among the main beneficiaries of inflation, where inflation is defined as an expansion of the money supply. One of the consequences of inflation is a reduction in the value of money relative to some of the things that money can buy, with different goods, services and assets benefiting to different extents at different times. Another and more important consequence of inflation is the slowing of economic progress (the rate of improvement in the general standard of living) that stems from the distortion of the relative price signals upon which markets rely.

Due to the effects of inflation on nominal prices, to determine which assets are 'really' in long-term bull markets we must first adjust nominal prices in a way that accounts for the inflation. As advised in many previous commentaries, we use a method of adjusting for the effects of US$ inflation that was first described in a 2010 article. This method isn't reliable over periods of two years or less, but it should come close to reflecting reality over the long term.

Using this method, here are monthly charts showing the inflation-adjusted (IA) performances of some important commodities and indices. In these charts the last point is the closing price on 18th December, with all historical prices being shown in current dollar terms.

1) Gold

The performance of IA Gold during 2001-2014 looks like an elongated version of its performance during 1971-1976. As previously explained, this makes sense on the basis that gold's official link to the US$ prior to 1971 caused the compression of what would have been a much longer cycle.

One of the most interesting aspects of the long-term chart of IA Gold is that it suggests a multi-generational upward trend in real terms. This is very significant, given that commodity prices, in general, still appear to be in ultra-long-term downward trends. Moreover, it is exactly what would be expected if, as is our firm belief, the increasingly frequent and aggressive interventions of the Fed since its ability to meddle was unshackled from gold are generally leading to greater uncertainty and slowing the long-term rate of real economic growth. The less productive the economy becomes and the more uncertain the future seems, the greater will be the demand for safe havens.



2) Silver

Unlike the IA gold price, the IA silver price shows no signs of being in a multi-generational upward trend. However, it now looks cheap (it's back to 1973 levels) and poised to outperform gold over the coming three years.



3) Oil

The IA oil price has essentially oscillated within a wide horizontal range since the 1973-1974 surge.

Interestingly, in IA terms the 1980 and 2008 tops were roughly the same. Also, the decline in the IA oil price from its 2008 top to its recent bottom now looks similar to the decline in the IA oil price from its 1980 top to its 1986 bottom, although to match its 1986 bottom in IA terms the nominal oil price will have to drop to the high-$30s over the next few months.

We think that the high-$30s defines oil's maximum downside potential. We can envisage a scenario under which it would drop that far, but it's a low-probability scenario involving a major deflation scare. A far more likely scenario involves the oil price bottoming at around $50 during the first half of next year.



4) Copper

Over the past 60 years the IA copper price has oscillated within a very wide range. The range appears to have a slight downward bias, in that the 2008 peak was a little lower than the 1974 peak and the 2002 low was below the mid-1980s low, which, in turn, was below the mid-1960s low.

In IA terms that current copper price is close to the long-term average, but previous cyclical bear markets haven't ended until after IA Copper moved well below its long-term average. Unlike oil and silver and the grains and many other commodities, which have already collapsed to levels where the remaining downside risk is low, a collapse in copper could still lie ahead.



5) Platinum

The IA platinum price's 2008 peak was below its 1980 peak, but it has made progressively higher lows over the past 60 years. This means that, like gold, there is some evidence that platinum is in a multi-generational upward trend in IA terms. If this is the case it is because at those times when the industrial demand for platinum is weak, the platinum price gets supported by safe-haven-related strength in the gold price.



6) Continuous Commodity Index (CCI)

As noted in the above discussion of the IA gold price, commodity prices, in general, still appear to be in ultra-long-term downward trends. This is evidenced by the following chart of the IA CCI. Notice that the IA CCI's 2008 peak was a long way below its 1980 peak and that the IA CCI's 2001 bottom was a long way below its 1971 bottom. While this implies that the CCI will eventually make a new all-time low in real terms, it doesn't imply that commodity prices have much further to fall between now and the start of their next multi-year advance.

Commodity prices are generally now very cheap in real terms. In fact, apart from 2001-2003, they have never been cheaper. This means that they are positioned to be among the main beneficiaries of future monetary inflation.



7) The Dow Industrials Index

The main reason we believe that the US stock market remains in the secular bear market that commenced in 2000 is that the average valuation at the 2009 bottom was nowhere near as low as it was at previous secular bottoms. The following chart of the IA Dow is consistent with this belief, because it shows that in real terms the Dow has been making lower lows and lower highs since 2000.

The Stock Market

Long-Term Sell Signal

Two months ago we pointed out that the SPX/USB ratio (the S&P500 Index divided by the price of the 30-year T-Bond) had signaled a major top by doing what it did at the major tops of 1999-2000 and 2007: rising above 14 and then breaking below its 50-week moving average. Nothing has since happened to negate the signal.

The signal would be negated by a rise in the ratio to above its mid-2014 peak, while a decline by the ratio to below its October low would be additional evidence of a major top.



Current Market Situation

As it had done on seven previous occasions over the past two years, the SPX pulled back to its 120-day MA (the blue line on the following chart) over the past two weeks and then quickly moved back to the vicinity of its 12-month (and all-time) high. Only in October of 2014 did a pullback extend beyond the 120-day MA.



Many bearish divergences continue to point to a far more substantial decline, chief among them being the divergence between credit spreads, which have been in a widening trend since the middle of this year, and the SPX. Under normal circumstances credit spreads contract when the SPX is trending upward.

Considering the seasonal tail-wind it isn't surprising that there wasn't any significant follow-through to the downside last week. However, we doubt that the seasonal tail-wind is capable of generating much additional upward progress.

Our best guess is that there will be choppy price action over the next 2 weeks, with a marginal new high during the week ahead and then another marginal new high in early January followed by a decline of greater magnitude than any of the declines that occurred over the past two years. The most likely alternative is that the aforementioned decline of greater magnitude gets underway during the coming week.

This week's significant US economic events (The most important events are shown in bold)

Date Description
Monday Dec 22 Existing Home Sales
Tuesday Dec 23 Durable Goods Orders
Q3 GDP (revised)
Personal Income and Spending
New Home Sales
Consumer Sentiment
Wednesday Dec 24 No important events scheduled
Thursday Dec 25

Markets closed for Xmas

Friday Dec 26 No important events scheduled

Gold and the Dollar

Gold

Fundamentals

At this time gold's fundamental drivers could either be described as mixed or slightly bearish, depending on how much weight is placed on each driver. We think that 'mixed' is the most appropriate term.

With the Dollar Index having made another multi-year high last week, the US dollar's exchange rate is clearly in gold-bearish territory. However, the US dollar's exchange rate is just one of several fundamental drivers of the US$ gold price. Of the other drivers, the real US interest rate, the US yield-spread (or yield curve) and the average US credit spread are three of the most important.

Inflation expectations are important for gold, but only to the extent that they affect real interest rates (the real interest rate being the nominal interest rate minus the EXPECTED rate of currency depreciation). The real interest rate is bullish for gold if it is trending lower and bearish for gold if it is trending higher.

As illustrated by the following chart, the 10-year TIPS yield, an indicator of the real US 10-year interest rate, trended upward from late-2012 until mid-2013 and was therefore gold-bearish during this period. It then began to work its way downward and made a multi-month bottom in early-August of this year. During this period (mid-2013 through to early-August of this year) it was therefore gold-bullish. In early-August it stopped being a supportive influence on the gold price, but the overall downward trend that began in mid-2013 could still be intact. We therefore currently rate the real interest rate as neutral for gold.



The biggest fundamental negative for gold right now isn't the upward trend in the Dollar Index, it's the downward trend in the US yield-spread (the flattening of the US yield curve). The following chart shows our preferred indicator of the US yield-spread (the 10-year T-Note yield minus the 2-year T-Note yield).

The yield-spread started to turn gold-bearish at the beginning of 2014 and turned definitively bearish in May. From May until early-August its effect on the gold market was offset by the decline in the real interest rate, but once the real interest rate stopped declining the effect of the contracting yield-spread was felt.

We expect that the yield-spread will turn higher and start becoming supportive for gold at around the same time as the US stock market makes an intermediate-term peak.



The main reason that the gold price has held up quite well over the past few months despite getting pressured lower by the contracting yield-spread and the rallying Dollar Index is illustrated by the following chart. The chart shows that there has been a very significant widening of US credit spreads over the past 6 months. The trend in credit spreads is gold-bullish and incongruous with the persistent upward trend in the S&P500 Index.



Price Action

The gold price pulled back sharply on Monday of last week, but there was no follow-through to the downside. Instead, the price chopped back and forth around a horizontal line during the rest of the week.

The 20-day and 50-day MAs are at $1202-$1203, so a daily close above $1203 would be the first sign that the recent consolidation is over.



With regard to gold's short-term prospects, the most important resistance lies at $1240-$1250. Our view has been that this resistance would probably cap gold's upside during December and be breached during January. That's still the case.

Gold Stocks

Current Market Situation

For a change, today we'll review a couple of XAU charts.

Like the HUI, at the close of trading on Tuesday 16th December the XAU had fallen for five days in a row and was near its early-November crash low. Wednesday's rise then suggested that a successful test of the crash low had been completed. Another rise on Thursday provided additional evidence that a successful test had occurred and that an intermediate-term rally had begun. A third consecutive up-day on Friday would have virtually 'sealed the deal' (left little room for doubt that the bottom was in), but the following daily chart shows that the XAU reversed lower from its 20-day MA on Friday and ended the day with a small loss. This keeps alive the possibility that some additional testing of the low will precede the start of a meaningful rally.

If a successful test of the early-November crash low did, indeed, occur last week then there shouldn't be more than one additional down-day prior to a resumption of the rally.



On a daily closing basis the XAU's most important nearby resistance is at 76. A daily close above this level would leave no room for doubt that the early-November low had been successfully tested. However, on a longer-term, monthly-closing basis the most important nearby resistance levels are at 80 and the 20-month MA.

The following monthly chart shows that 80 was the lowest monthly close during the 2008 financial crisis and coincides with intermediate-term lows in 2005 and 2013. Also, the chart shows that the 20-month MA acted as intermediate-term support during 2010-2011 and limited the multi-month counter-trend rebounds of 2012 and 2013-2014.



Unlike the HUI and the XAU, GDXJ broke below its early-November crash low during the first half of last week. However, it quickly reversed upward and negated the downside breakout. Consequently, GDXJ appears to have also completed a successful test of its low.



Crazy volumes and price changes due to GDXJ's quarterly rebalancing

Changes to GDXJ components and component weightings took effect at the close of trading last Friday. Furthermore, whereas GDXJ's buying and selling associated with the September quarterly balancing happened over the space of a week, it looks like all trading required to implement the changes associated with the December quarterly rebalancing took place on a single day (Friday). That's why there were many big price moves on massive volumes within the ranks of the junior gold miners last Friday.

Most of GDXJ's existing components were negatively affected by the December rebalancing. This is because:

1) There were 14 additions and only 6 deletions from GDXJ, meaning that the total number of GDXJ components increased by 8.

2) 11 of GDXJ's 13 highest-weighted components were not part of this ETF prior to 19th December.

3) To make way for many additions with relatively high weightings, the weightings of most of the existing components had to be reduced. In some cases this required GDXJ to sell tens of millions of shares, almost all of which, it seems, were dumped onto the market on Friday 19th December.

Of the TSI stocks, the most obvious negative effects of GDXJ's rebalancing were evident in EDV.TO, GSS, SBB.TO and TGD (TMM.TO). Other stocks on our radar that were negatively affected include BCM.V, LSG.TO, LYD.TO, MDW, TGZ.TO, and TRX. PVG was the only TSI stock to be helped by the GDXJ rebalancing, as it was one of the additions.

Strangely, due to the changes implemented on Friday several of the top holdings of GDXJ, an ETF that is supposed to be focused on juniors, are now mid-tier miners. For example, GDXJ's ten largest holdings now include IAMGold (IAG), Hecla Mining (HL), AuRico Gold (AUQ), Alamos Gold (AGI) and Harmony Gold (HMY).

The Currency Market

During the week just past the Dollar Index invalidated the short-term reversal signal generated at the end of the preceding week. It did this by closing at a new high for the move.

As has been the case for all the new highs achieved by the Dollar Index since early October, the latest one was not confirmed by the daily RSI shown at the base of the following chart. It was also not confirmed by gold. However, it was confirmed by the relative strength of the S&P500 Index.



Both the Dollar Index and the S&P500 remain extremely extended to the upside by multiple measures, although whereas the S&P500 is probably close to a high of at least intermediate-term importance the Dollar Index is probably only close to a high that will hold for a few months.

85 remains a reasonable target for the coming downward correction in the Dollar Index, but as at the end of last Friday a downward correction had not begun.

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 ended Friday 19th December 2014:

[Note: AISC = All-In Sustaining Cost, FS = Feasibility Study, 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]

  *Almaden Minerals (AAU) announced that it is deferring shareholder approval of the spinout of its early stage exploration projects and royalty interests (everything except the Tuligtic project), which was originally expected to happen in December-2014, to the company's 2015 annual general meeting in June-2015. This is being done to avoid the expense of an additional shareholders' meeting and to allow more time for an internal restructuring of the assets to be spun out.

This schedule change isn't a big deal, but despite the additional expense we would prefer that the company had gone ahead and held a special shareholders meeting in December as originally planned. The spinout is important for shareholders as it will force the stock market to value assets that are currently being assigned no value as part of AAU.

  *Evolution Mining (EVN.AX) advised that it has rolled over its existing A$200M credit facility into a new, lower-cost revolving credit facility of the same amount. $127M had been drawn on the previous facility and has now been drawn on the new facility.

EVN also announced that it has increased its gold hedging by 225K ounces. The company now has forward sales over the next three years of 347K ounces of gold at an average price of A$1541/oz. This represents less than 25% of expected gold production over the period, so EVN retains plenty of exposure to the spot gold price.

  *Timmins Gold (TGD) announced that it has purchased the Caballo Blanco exploration-stage gold project from Goldgroup Mining (GGA.TO).

When we saw the press-release headline that TGD had purchased Caballo Blanco, we cringed. The reason is that we are well aware of the permitting obstacles facing this project. When we read the press release and saw the price tag (US$10M plus 16M TGD shares, or US$25M at TGD's current stock price), we cringed again.

Caballo Blanco is a small (around 1M-oz total resource), low-grade deposit that could potentially be developed into a profitable, 90K-oz/yr open-pit heap-leach gold mine at the current gold price IF it were possible to get all the necessary approvals to construct a mine. And there's the rub, because the project effectively came to a standstill about two years ago due to Goldgroup's inability to get the necessary approvals from the relevant authorities. Furthermore, according to the most recent information from Goldgroup (in the MD&A published last month), nothing has changed.

It's quite possible that TGD's managers know something about Caballo Blanco's permitting issues that we don't. We certainly hope that's the case. At this stage, however, it looks like they've agreed to pay $26M for a liability.

As an aside, Caballo Blanco was originally discovered by Almaden Minerals (AAU) and Almaden retains a 1.5% NSR royalty on the project. This is one of the assets that will end up in the AAU spin-out. Therefore, AAU shareholders stand to benefit if, by some remote chance, TGD is able to build a mine at Caballo Blanco.

    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$0.96).

2) AKG (last Friday's closing price: US$1.58).

3) EDV.TO (last Friday's closing price: C$0.41).

4) EVN.AX (last Friday's closing price: A$0.57).

5) TGD (last Friday's closing price: US$0.92). (Due to its price and its profitable current production, TGD has an attractive short-term risk/reward despite what appears, on the surface, to be a hare-brained asset purchase by its management.)

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.

    Update on our Japanese pair trade

In the 5th November Interim Update we added a "Japanese pair trade" to the TSI Stocks List. The 'pair' is a long position in the Yen via the January-2016 $90 FXY call options and a long position in the Japanese stock market via January-2016 EWJ (Japan iShares) $12 call options. These positions, together, create a higher probability of success than would be obtained by either position alone.

As explained at the time, there is a realistic possibility that we will make a profit on both of these option positions. However, there is a much higher probability that only one of them will be profitable, with the gains on the winner potentially dwarfing the losses on the loser. The reason is that Yen strength over the coming 6-12 months will likely go with a downward-trending Japanese stock market and Yen weakness over the coming 6-12 months will likely go with an upward-trending Japanese stock market.

The basis for the pair trade is illustrated by the following chart. The chart shows that there has been a strong positive correlation over the past three years between the Yen and the inverse of the Nikkei. To put it another way, the chart shows that there has been a strong inverse relationship between the Yen and the Nikkei.

We continue to like this trade.

Chart Sources

Charts appearing in today's commentary are courtesy of:

http://stockcharts.com/index.html
http://research.stlouisfed.org/



 
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