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

Last week's posts at the TSI Blog

Why the next stock market collapse won't be a "black swan"

How the Fed's QE creates money

Revisiting the global boom/bust indicator

Gold tends to fare relatively poorly during the booms, which are periods when confidence in central banks and the economy rises at the same time as mal-investment is setting the stage for a future period of great hardship, and fare relatively well during the busts, which are periods when the investing mistakes of the past come to the fore. Be aware, though, that the word "relatively" is critical to understanding gold's relationship to the boom/bust cycle, because the relationship often doesn't apply to gold's performance in US$ terms.

To show what we mean we'll begin with a chart of the US$ gold price covering the past 20 years. There were booms and busts during this period that are not evident on this chart. In particular, 2001-2011 contained huge booms and busts, and yet the gold price trended steadily upward throughout. How could this be?



Armed with the 20/20 vision called hindsight, analysts who did not expect the large 2001-2011 rise in the US$ gold price and who were completely baffled by it while it was happening eventually came up with explanations/rationalisations for it. Some of the most popular explanations involved identifying other things that trended relentlessly upward during the 2001-2011 period and assuming that the rise in this other 'thing' caused the rise in the gold price.

For one example, prior to the past two years it was possible to create a chart that demonstrated a strong positive correlation between the gold price and the US federal-debt/GDP ratio, provided that you started your chart in the early-2000s (starting the chart much earlier would reveal that there was actually no consistent relationship between gold and the debt-GDP ratio*). For a second example, prior to the past two years it was also possible to create a chart that demonstrated a strong positive correlation between the gold price and the US Monetary Base, again provided that you started your chart in the early-2000s (as is the case with the supposed relationship between the gold price and the debt/GDP ratio, the relationship between gold and the US Monetary Base disappears when a longer-term view is taken**). For a third example, some analysts belatedly linked the 2001-2011 upward trend and subsequent downward reversal in the gold price to the goings-on in the "emerging" economies. This explanation is a top contender for our "grasping at straws" award, since, unlike the linking of gold to the debt/GDP ratio or the Monetary Base, it has absolutely no logical basis. Not only that, but the net buying of gold by India, China and Russia, the three most important "emerging" markets, was greater when the gold price was trending downward during 2012-2014 than when the gold price was trending upward during 2009-2011.

As intimated in our opening paragraph, the overarching driver of the gold price (the boom/bust cycle) only becomes clear when gold's RELATIVE performance is viewed. More specifically, understanding why gold did what it did over a long period requires looking at how it performed relative to industrial metals.

The fact is that the gold market is generally weak relative to the industrial metals markets during the boom phase of the inflation-fueled, central-bank-sponsored boom/bust cycle and strong relative to the industrial metals markets during the bust phase of the cycle. In other words, the gold/GYX ratio (gold relative to the Industrial Metals Index) tends to fall during the booms and rise during the busts. This is due to gold’s historical role as a store of purchasing power and a hedge against uncertainty.

By shading the bust periods in grey, we’ve indicated the global booms and busts on the following chart of the gold/GYX ratio. During the 20-year period covered by this chart there were four busts: the multiple crises of 1997-1998 (the Asian financial crisis, the Russian debt default and the LTCM blowup), the recession of 2001-2002 that followed the bursting of the NASDAQ bubble, the global financial crisis and "great recession" of 2007-2009, and the euro-zone sovereign debt and banking crisis of 2011-2012. On a relative basis gold was clearly very strong during the busts and generally drifted lower during the intervening periods when confidence was rising.

Note that monetary-inflation-fueled booms tend to fall apart more quickly than they build up, which is why the rising trends in the gold/GYX ratio tend to be shorter and steeper than the falling trends.



When gold/GYX made a new multi-year low last October it indicated that the global boom was going to extend into 2015, which it has certainly done. However, gold/GYX's sharp rise from its November-2014 low to its January-2015 high could be an early warning that the boom is on its last legs.

Gold/GYX has pulled back far enough from its January peak that a solid break above that peak would now be a clear signal that the boom has ended or is about to end.

    *Refer to http://tsi-blog.com/2014/09/does-the-debtgdp-ratio-drive-the-gold-price/ for additional information

    **Refer to http://tsi-blog.com/2014/10/does-the-monetary-base-drive-the-gold-price/ for additional information

The Stock Market

The US

Current Market Situation

A week ago we wrote that although the breakout hadn't been confirmed by all of the important US stock indices, it was fair to say that the US stock market had broken out to the upside and in so doing marked the choppy December-January price action as a consolidation within an upward trend. Over the ensuing week the breakout was confirmed by more indices. The following daily charts of the Russell2000 Index and the Dow Industrials Index are examples.

Also, it's worth mentioning that although they haven't exceeded last year's highs, the Dow Jones Basic Materials Index (DJUSBM) and the PowerShares NASDAQ Internet ETF (PNQI) broke upward from triangular price patterns last week.

However, there are still some significant non-confirmations among the indices. For example, the following chart shows that the Dow Transportation Average remains below last year's peak and below a declining short-term trend-line. For what it's worth (not much), the failure of the Dow Transports to confirm last Friday's upside breakout in the Dow Industrials is a bearish non-confirmation under "Dow Theory".



A more interesting example of non-confirmation is provided by the chart of the NYSE Composite Index (NYA) displayed below. The NYA ended last week at lateral resistance defined by 2014's double top.



As stated last week, the most probable scenario involves an upside breakout that fails within a few weeks. This would be similar to how the NYA peaked in 2000 and how several US stock indices peaked in 2007. But as also stated last week, there is more to be lost than gained by 'jumping the gun' and betting on a breakout failure before it happens.

The return to 5000

The top section of the following chart shows that the NASDAQ Composite Index (NAS) has almost made it back to the 'magical' 5000 level, which is where its spectacular blow-off culminated in March of 2000. It's reasonable to expect that 5000 will act as both a magnet and a ceiling over the weeks immediately ahead, meaning that the market will be drawn to 5000 but will probably be unable to make a solid break above it.

The bottom section of the same chart reveals that the NASDAQ's rally has been getting progressively narrower over the past year or so. Whereas a new multi-year high by the NAS in late-2013 coincided with 400 individual NASDAQ stocks making new 12-month highs, last Friday's new multi-year high by the NAS coincided with only 127 individual NASDAQ stocks making new highs. This is a bearish divergence, although it is obviously a divergence that is capable of continuing for a long time.



Japan

EWJ (Japan iShares) has broken out above major resistance at $12.00-$12.20.



A long position in EWJ is half of our 'Japanese pair trade', the other half being a long position in the Yen (FXY). At least one half of this pair trade is likely to work very well, with the profits on the winning half being much greater than the losses on the losing half.

It's not too late to get involved in this trade. The reason is that although EWJ is short-term 'overbought' and therefore vulnerable to consolidation/correction over the weeks immediately ahead, it has the potential to make sizable gains over the next several months. Furthermore, FXY is 'oversold' over all timeframes.

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

Gold and the Dollar

Gold

When gold spiked above US$1300/oz in January we said that it was probably close to a multi-week high in US$ terms and a multi-month high in non-US$ terms. In US$ terms it was sufficiently 'overbought' on a short-term basis to set the stage for a significant correction, with $1250 being a likely initial target for the correction even if the upward spike continued to as high as $1350. In non-US$ terms the gold market was stretched to the upside on an intermediate-term basis, thus paving the way for a lengthy correction. In fact, by one reliable measure (re-visited below) it was as stretched to the upside as it ever gets. The correction of the past 4 weeks has therefore not come as a surprise.

It will never be possible to know, in advance, how far a correction will extend. It will not even be possible to know, in advance, that a pullback or rebound is a correction to an existing trend as opposed to the first leg of a new trend in the opposite direction. We can (and usually do) make guesses regarding the extent of a correction based on support levels and historically-typical retracement amounts, but the reality is that corrections continue until they have done what they need to do. In the case of a downward correction, what they generally need to do is push momentum indicators back to neutral or moderately 'oversold' levels and eradicate speculative enthusiasm. In this way the correction sets the stage for the next leg higher (in the case of an upward trend) or lower (in the case of a downward trend).

With regard to the US$ gold price, the correction of the past 4 weeks has done almost as much as it needed to do. In particular, the RSI (a momentum indicator) included at the bottom of the following daily chart has fallen from above 70 to below 40 and the total speculative net-long position in COMEX gold futures has fallen by 62K contracts from its late-January peak.



In our 2015 Yearly Forecast and again in the 11th February Interim Update we said that the US$ gold price would probably drop to test its November-2014 bottom if the US stock indices broke above last year's highs. Owners of gold-related investments should therefore be prepared for a test of last year's low. That being said, it's unlikely that such a test will happen over the next few weeks. Our expectation, based on current gold-market sentiment and our views on other markets, is that the US$ gold price will make a short-term bottom within the next two weeks (probably early-March) at well above last year's low and then rally for a few weeks. If this multi-week rally happens it will likely result in a lower high for the year in the gold price and higher highs for the year in the gold-mining indices.

Keep in mind that the fundamental backdrop for gold-mining stocks is currently more bullish than the fundamental backdrop for gold bullion.

In the case of the non-US$ gold price, the correction is probably more than half over in terms of price and a lot less than half over in terms of time. We'll try to explain why with the help of the following chart. The chart shows the euro-denominated gold price (gold/euro), the 50-day and 200-day MAs for gold/euro, and a 15% envelope around gold/euro's 50-day MA. This MA envelope has always limited intermediate-term gold/euro rallies in the past, even during the strong bull-market years of 2009-2011.

Based on the historical record, anyone who was expecting gold/euro to make large additional short-term gains after it hit the top of the aforementioned MA envelope in late January was kidding themselves. Unless it was going to be different this time, the rise to the top of the envelope indicated that a correction lasting at least a few months would soon begin.

In the past, the corrections that have followed surges by gold/euro to the top of its 50/15 MA envelope have always continued until the 200-day MA was reached. We don't know of a good reason why it will be different this time, so we expect a return by gold/euro to its 200-day MA prior to the start of a rally to new multi-year highs. The 200-day MA is rising, so the longer it takes for the price to get to the MA the higher the price will be when the intersection occurs. Our guess is that the intersection will occur at least two months from now with the price above 1000 euros.



Gold Stocks

Despite the US$ gold price having fallen by around $100 from its January peak, the HUI has managed to hold above lateral support at 180 and its 50-day MA. To maintain its potential to reach new highs for the year during the next multi-week gold rally, the HUI must continue to hold above 180 on a daily closing basis.



Although it has strengthened a little in relative terms since the beginning of this month, GDXJ, a proxy for the junior end of the gold-mining universe, has continued to trend downward relative to GDX (a proxy for the stocks of larger-scale gold miners) since the November-2014 bottom. Although we didn't anticipate this relative weakness, we can explain it by pointing out that the more speculative stocks will often underperform early and outperform late in an intermediate-term rally.

Unlike the HUI, which held above its 50-day MA last week, GDXJ ended the week below its 50-day MA.



As noted above, whereas the next multi-week rally in gold bullion will probably be within the context of an on-going correction, we expect that the next multi-week rally in the gold-mining sector will result in new highs for the year. If it pans out this way then the 2014-2015 bottoming process will start to look very much like the 2000-2001 bottoming process.

The Currency Market

Greece

Last Friday the Greek government did a deal with the rest of the euro-zone (EZ) that effectively gave the parties an additional 4 months to re-negotiate the terms of the Greek government's on-going 'financial rescue'. In a televised statement on Saturday, Greek Prime Minister Alexis Tsipras essentially declared victory. He said: "Yesterday we took a decisive step, leaving austerity, the bailouts and the troika behind."

This is strange, because from our perspective the new Greek government has not yet won a single concession. Instead, it seems to be going along with the "extend and pretend" strategy that it railed against prior to being elected and during its first couple of weeks in power.

In any case, the financial positions of Greece's government and banking system no longer appear to be urgent issues. The so-called bailout money will continue to flow while negotiations proceed over the coming four months.

Current Market Situation

Last Friday's news about the Greek government's temporary deal doesn't change anything. We can't rule out the possibility that there will be a marginal new low in the euro and high in the Dollar Index within the next couple of weeks, but multi-month moves upward in the euro and downward in the Dollar Index will probably soon begin. These moves will initially be powered by the covering of the massive speculative short position in the euro futures market, but the primary fundamental driver will be strength in European equities relative to US equities.

The Yen is in a similar position to the euro. It hasn't yet done enough to signal an upward trend reversal, which means that we can't rule out the possibility that it will make a marginal new low in the near future, but a tradable rally should soon begin. Due to the fact that the Yen has been trading with the US$ gold price over the past few years (see the chart below for details), there's a good chance that the coming short-term bottom in the gold price will coincide with a turnaround in the Yen.

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 20th February 2015:

[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]

  *Endeavour Mining (EDV.TO, EVR.AX) provided updated information on the economics of the Hounde gold project in Burkina Faso. Based on the FS completed in November of 2013, the Hounde project would be economically viable, but not robust, at a gold price of $1300/oz. However, according to the updated information provided last week, exploration success has resulted in a 34% increase in the project's gold reserves, which, in turn, has greatly improved the economics. The project is now estimated to be more profitable at $1200/oz than it was previously estimated to be at $1300/oz, which is obviously very good news.

At $1200/oz, Hounde is now estimated to have an IRR and NPV(5%) of 28% and US$302M, respectively. The initial capital cost is expected to be US$325M.

Based on the figures reported last week and the earlier receipt of a mining permit, it clearly makes sense for EDV to move the Hounde project into the construction phase if, and only if, it can arrange reasonable-cost financing.

Separately, EDV announced a net increase of 400K ounces in its company-wide reserves over the course of 2014. The net increase stems from 850K ounces of new reserves less 450K ounces of mining depletion.

  *Energy Fuels (EFR.TO, UUUU) advised that it has purchased 50% of the exploration-stage Wate uranium project in northern Arizona. The Wate project's uranium deposit is similar to the deposits at the Pinenut and Canyon mines operated by EFR. It is anticipated that future production from the Wate Project would be processed at EFR's White Mesa uranium mill in Utah, which is currently the only operating uranium mill in the U.S.

The purchase price is $250K to be paid immediately followed by $500K over the next two years. The acquisition is therefore not financially significant for EFR.

  *Evolution Mining (EVN.AX): When EVN issued very good quarterly production results last month, we wrote that we wouldn't know the extent to which these production results had boosted the company's balance sheet until we saw the Half Year report. The Half Year report was published last week.

EVN reported a record net profit of A$43M, or about A$0.06/share, for the half year ended 31st December 2014. Importantly, there was significant free cash-flow generation during the period, with the company's net debt position (long-term debt minus working capital) falling by $23M. Net debt is now only A$93M, which is an easily-manageable amount for a profitable 440K-oz/yr gold producer. Also, a 1c/share dividend will be paid to shareholders registered at 27 February.

Due to the increase in the A$-denominated gold price, EVN's profit during the first half of this year (the second half of the company's financial year) should comfortably exceed the record achieved during the preceding half. Moreover, EVN should generate enough cash over the next few quarters to completely pay off its debt, although we doubt that EVN's management will want or allow the balance sheet to become debt free. It's more likely that with the company now strongly cash-flow positive and its balance sheet in good shape, EVN will go on the acquisition trail. This could be good or bad news for shareholders, depending on the asset purchased and the purchase price. Assuming the price was right, it seems to us that the 260K-oz/yr Cowal gold mine in New South Wales, which has just been put up for sale by Barrick Gold, would be a reasonable addition to EVN's portfolio.

We continue to expect that EVN will trade north of A$1.50/share before this year is over.

  *Golden Star Resources (GSS) published its financial results for Q4-2014 and for the past 12 months.

Despite an improved production performance during the final quarter of last year, the company's balance sheet has continued to deteriorate. There is now a working capital deficit of US$32M and net debt of $148M. The net debt figure includes $78M of convertible debentures* and is up from $126M at 30th September 2014.

GSS does not appear to be in immediate danger of going broke, but the combination of its balance sheet and its cost structure makes it too risky for new buying at the current gold price. New buying probably won't be appropriate until there is a sustained move in the gold price to more than $1300/oz and/or the company receives a large-enough injection of new capital to enable the development of underground operations at Wassa and Prestea. It is estimated that these underground operations could reduce the AISC to around $750/oz, enabling GSS to become cash-flow positive at a much lower gold price.

At current stock and metal prices it makes a lot more sense to own EDV.TO than to own GSS. This is because EDV has just as much upside potential as GSS and a lot less risk. Consequently, if you own GSS and do not own EDV, we think that it would be a good idea to sell GSS and buy EDV.

    *GSS's balance sheet shows a liability of only $47M for the convertible debentures. This is the calculated market value of these debentures, but the full amount of the liability (the amount that will have to be paid when the debentures mature in 2017) is $78M.

  *Ramelius Resources (RMS.AX) published its Half Year report for the period ending 31st December 2014. The report reflected a return to profitability and strengthening of the balance sheet.

Importantly, RMS now has working capital of A$21M and long-term debt of only A$1M. This means that the company is well-positioned to fund the new small-scale mines that it plans to develop over the next several months.

Also, RMS announced that it has forward sold 47K ounces of gold for delivery over the next 2 years at an average price of A$1582/oz. This was a reasonable move, as the hedging only covers about 20% of the company's expected production over the period (meaning: there is still plenty of exposure to future upside in the gold price) and was done with the A$-denominated gold price near a 2-year high. Assuming current cost levels, the hedging locks in a healthy profit margin for 47K ounces of future production.

  *Timmins Gold (TGD) has agreed to buy Newstrike Capital (NES.V) in an all-stock deal in order to obtain NES's exploration-stage Ana Paula gold project in Guerrero, Mexico. Assuming the deal is approved by the shareholders of both companies, each NES share will be exchanged for 0.9 TGD shares. This will result in the combined company being 63%-owned by former TGD shareholders and 37%-owned by former NES shareholders.

We'll state up front that this latest TGD acquisition is more sensible than its December-2014 purchase of the exploration-stage Caballo Blanco gold project in Veracruz, Mexico. How could it not be, given that the Caballo Blanco purchase involved paying $26M for a deposit that has almost zero chance of ever being developed into a mine due to the virtual impossibility of getting all necessary permits and approvals. In other words, the Caballo Blanco purchase involved paying $26M for something with zero value. Although it is in a far-from-ideal location from a political/drug-cartel/security perspective*, the Ana Paula project probably can be permitted and does have significant value.

A PEA completed last September indicates that for a capital cost of US$164M Ana Paula could be developed into an open-pit 116K-oz/yr gold mine with an AISC of only $567/oz. At a gold price of $1300/oz, the after-tax NPV(5%) and the IRR are estimated to be $232M and 32.8%, respectively. Moreover, at a gold price of $1200/oz the figures are $185M and 28.1%, which suggests that the project would be economically viable at the current gold price. The M&I resource is 1.86M ounces.

At US$1.00 per TGD share, which was roughly the price at the time the deal was announced, the acquisition values the Ana Paula project at around US$105M. This is moderately expensive assuming a gold price of $1200/oz, but would be a reasonable price to pay assuming a gold price of $1300/oz. That is, TGD appears to be over-paying considering the current gold price. However, TGD's management believes that the Ana Paula project's economics can be improved.

Associated with the NES acquisition, TGD will raise US$8M by issuing 8M new shares at US$1.00/share to current substantial shareholders in the company and other accredited investors. The price at which these relatively knowledgeable investors are buying shares is almost 20% above the current market price.

    *The risk of living/working in Guerrero state is highlighted by the 2014 mass kidnapping and murder of students and the recent kidnapping of 12 people from near the mine being built by Torex Gold.

    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$1.10).

2) AKG (last Friday's closing price: US$1.55).

3) EDV.TO (last Friday's closing price: C$0.58).

4) EVN.AX following a pullback to the low-A$0.80s (last Friday's closing price: A$0.90).

5) TGD (last Friday's closing price: US$0.84).

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