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   -- Weekly Market Update for the Week Commencing 23rd March 2015

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 Bearish
(26-Jan-15)
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.

Last week's posts at the TSI Blog

Ignore per-ounce valuations for gold deposits

Interesting US oil-production and price-inflation charts

Commodities

The commodity bear market is (probably) winding to a close

The length and severity of the commodity bear market are such that it is probably almost over. Here are some examples that illustrate the bear market's extent:

First, the CRB Index at its lowest level since March-2009 and within 5% of a 13-year low. It's also worth noting that although a lot of commodities didn't peak until 2011, the CRB Index peaked in 2008 and has therefore been in a bearish trend for almost 7 years.



Second, the PowerShares DB Agriculture Fund (DBA), a proxy for agricultural commodities such as cattle, cocoa, coffee, hogs and various grains, came within spitting distance of its 2008 Global Financial Crisis bottom last week.



Third, the inflation-adjusted oil price is now within $10 of its 1986 bottom.



Fourth, silver's bear market is 5 weeks away from being 4 years old, which is long in the tooth, and has reduced the price by 70%.



Given the across-the-board magnitudes and durations of the declines in commodity prices and the likelihood that monetary conditions will remain very inflationary for the foreseeable future (in 2015 there will not be anything resembling deflation in the US, the euro-zone, Japan, China, or anywhere else we can think of), there's a good chance that a commodity turnaround will happen this year. For a clue as to whether the turnaround will happen during the first or the second half of the year, we shift our attention to gold.

Gold is expensive relative to silver, platinum, oil, agriculture, and commodities in general. For example, the following chart shows that gold is near a multi-decade high relative to the CRB Index and oil. Why? Is it being manipulated upward?

We doubt it. There is manipulation in both directions in every market, but for gold and any other scarce commodity a long-term price suppression scheme is impossible and a long-term price elevation scheme is extremely unlikely. It's far more likely that gold is being supported relative to other commodities because there are plenty of well-heeled people in the world who are aware of the eventual consequences of the current monetary experiments. Gold, we suspect, is being steadily accumulated as insurance.



With regard to commodities in general, a concern we have is that gold's current fundamentals and recent price action point to the US$ gold price breaking below last year's low before making a long-term reversal to the upside. Since gold tends to lead most other commodities at major bottoms, this indicates that a long-term reversal to the upside for commodities in general (as represented by the CRB Index) might not happen until the second half of this year.

We'll see. On the question of the commodity-turnaround's exact timing we don't have any preconceived opinions. It could be that gold remains above last year's low, which would suggest a first-half bottom for many other commodities including oil and the industrial metals.

Copper Bottom

The first of the following charts shows that the copper price moved sharply higher over the final two days of last week and made a 2-month high on Friday.

Last week's strength was at least partly due to the temporary production halt at Freeport's huge Grasberg mine in Indonesia. Given that the mine re-started on Saturday, it's reasonable to assume that some of the recent price gain will be given back this week.

The $2.90-$3.00 range that acted as support for years will now be formidable resistance for the copper market. It would take a weekly close above this resistance to confirm that the copper price made an intermediate-term, rather than just a short-term, bottom in late-January.

The second of the following charts shows that the Industrial Metals Index (GYX) also moved sharply higher over the final two days of last week. Although GYX hasn't been as strong as the copper price over the past 2 months, GYX has the more bullish chart pattern. The reason is that GYX broke out to the downside and dropped to its January low before rebounding by enough to negate the breakdown and indicate that a successful test of the multi-year low had taken place.

Before drawing any conclusions we'll need to see how the copper price and GYX respond to the news that the Grasberg mine is back on-line.

Trade gaps and currency exchange rates revisited

We take our publishing deadlines seriously. As a consequence, there are times when we end up publishing something that we aren't satisfied with. Occasionally we read what we've written and realise that we weren't clear enough or made less sense than we'd hoped, but with the publishing deadline approaching there isn't time for a re-write. This happened with the discussion on trade gaps and currency exchange rates in last week's Interim Update. We tried to make a complex subject simple by staying away from theory and presenting a numbers-based hypothetical example. In doing so we succeeded in making the subject more confusing.

In the hypothetical 'all else remaining equal' example presented in the Interim Update, we gave some benefit of the doubt to the devaluation proponents by assuming that a 10% reduction in the exchange rate would lead to a 10% increase in export VOLUMES and a 10% rise in import COSTS. However, it would more likely result in no change in trade volumes and a 10% rise in import costs. The reason is that prior to the exchange-rate change the economy would be structured to produce certain things and to import certain things. Devaluing the currency by 10% would not magically realign the economy such that some of the things that were being imported would now be produced locally. All it would do is force people to pay more for the imported things. On the export side the devaluation would temporarily enable exporters to make more profit in terms of the devalued currency, but it would not magically change the production structure on both the domestic front and the international front such that the exporting industries in the country with the devalued currency would suddenly be able to sell more things.

That's what could -- and probably would -- happen in the short-term in response to currency devaluation. By the same token, a likely short-term result of an upward revaluation of the currency would be 1) a reduction in the total cost of imported goods, 2) no change in export or import volumes, and 3) lower profits for unhedged exporters in terms of the upwardly-revalued currency.

This means that exporters would generally be the short-term beneficiaries of a downward currency revaluation and the rest of the economy would generally be the short-term beneficiary of an upward currency revaluation. That's why exporters often lobby hard for policies designed to reduce the currency's value on the FX market. In the short-term, these policies effectively siphon money from the rest of the economy into their pockets.

The long-term results of currency devaluation and revaluation are more difficult to appreciate, because they can't be understood without some knowledge of good economic theory. This means that it is not possible to 'see' the long-term effects of currency changes through a Keynesian lens.

Over the long-term, neither producers nor consumers can benefit from currency devaluation. The reason is that a large and sustained reduction in a currency's value on the FX market requires monetary policies that a) raise domestic prices by enough to counteract any benefit that exporters would achieve from currency devaluation, and b) distort relative prices in a way that makes the economy less efficient. That's why countries with strong manufacturing sectors tend to have strong currencies and why countries with weak manufacturing sectors tend to have weak currencies. It's also why a weak manufacturing sector cannot be made sustainably strong by devaluing the currency.

Wrapping up, there's an inter-relationship between the currency, including the currency's relative value on the FX market, and the economy, such that the policies that lead to a persistently strong currency also promote greater efficiency and a stronger economy, and a stronger economy will tend to result in a stronger currency. Therefore, as well as often being a reflection of a strong economy, long-term currency strength is a necessary precondition for long-term economic strength.

The Stock Market

An update on the strange bedfellows

As we noted in a post last month at the TSI Blog, over the past few years every short-term trend in Japan iShares (EWJ) has been mimicked by London’s FTSE Index. In other words, there has been a strong positive correlation between the Japanese stock market’s performance in US$ terms and the UK stock market’s performance in Pound terms. We don't know why.

Based on the aforementioned relationship, it was reasonable to expect that if EWJ was able to sustain its February upside breakout then London's FTSE would do the same. The chart displayed below shows that EWJ clearly did sustain its breakout and that the FTSE, after making one failed attempt to break out, is now following suit.



We don't have any opinion about the FTSE, except that its breakout shouldn't be ignored. Breakouts following long-term consolidations can lead to substantial moves in the direction of the breakout.

Regarding EWJ, $14-$15 is a plausible 2-3 month target.

For both the FTSE and EWJ, a sizable downturn in the US stock market represents the biggest potential short-term obstacle. As a result of the downward pull from a declining US market, one possibility is that EWJ and the FTSE will pull back to test their breakouts before returning to their upward paths.

We continue to like our Japan pair trade, which involves being long EWJ and long the Yen. There's a high probability that at least one side of this trade will work very well and a realistic possibility that both sides will work well. The EWJ side is working well at the moment, but the Yen side will probably come to life after the US stock market starts showing clear-cut signs of weakness.

The US

It's possible that the S&P500 Index (SPX) peaked in late-February, suffered an initial decline, and is now testing its peak prior to suffering a much larger decline. This is the short-term scenario that we favour, but there are obviously other possibilities. The good news is that we should find out this week if our favoured scenario is valid, because this scenario will be rendered invalid unless the SPX reverses lower within the coming few days without making significant additional headway. That makes risk management straightforward for any bearish speculations.



Making the situation even more straightforward is the fact that the NYSE Composite Index (NYA) has just moved up to resistance defined by multiple highs over the past 9 months. It would clearly take only a small amount of additional strength from here to effect a breach of this resistance.



A move to a new high within the coming week wouldn't necessarily mean that another bull-market leg was underway. It could, instead, be the type of break above obvious resistance or below obvious support that often occurs near the end of a major trend. However, traders shouldn't automatically assume that breakouts in the SPX and the NYA will fail. It would be more prudent to give the benefit of the doubt to the breakout until subsequent price action created evidence of a failure.

On the positive side of the ledger, the Russell2000 SmallCap Index (RUT), which was a laggard last year, has definitively broken out to the upside.



Europe

Accelerating monetary inflation in the euro-zone is continuing to levitate the prices of financial assets in the region. Last week Spain's stock market, which is represented on the following chart by the IBEX Index, joined the stock markets of Germany, France and Italy by moving to a new multi-year high.

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

Date Description
Monday Mar 23 Existing Home Sales
Tuesday Mar 24 CPI
New Home Sales
Wednesday Mar 25 Durable Goods Orders
Thursday Mar 26

No important events scheduled

Friday Mar 27 Q4-2014 GDP (second revision)
Consumer Sentiment

Gold and the Dollar

Gold and Silver

The speculative net-long position in COMEX gold futures reached a 2-year high in late-January and has since fallen back to near the 12-month low reached last November. That's not surprising, given that the US$ gold price tested its November low last week.

At this stage it looks like the test of the low was successful and that a multi-week rebound has begun, with upside potential to the vicinity of the 200-day MA (currently at $1240).



Silver was strong relative to gold last week. Whereas gold only rose to its 20-day MA in the low-$1180s, silver managed to rise to its 50-day MA (equivalent to a gold price of $1223). This relative strength pushed the silver/gold ratio up to near its highest level in more than 5 months.

Silver has strong resistance at $18-$19, which we expect to be re-tested as part of a multi-week rebound.



Gold Stocks

For the second week in a row there was no immediate follow-through in the gold-mining indices after a Wednesday reversal to the upside. As it turned out, the HUI was flat on Thursday and gained 2.7% on Friday. This was not enough strength to signal a short-term trend reversal, especially considering that Friday's rise was limited by the 20-day MA.

With last week's rebound and the late-February rebound both being limited by the 20-day MA, a daily close above this MA could reasonably be viewed as a confirming signal of a short-term trend reversal.



Although it hasn't yet been confirmed by the price action, we guess that the HUI made a multi-week bottom last week. If so, a rebound over the next few weeks could take the price as high as, but probably no higher than, the 200-day MA.

The Currency Market

Why have 'the Commercials' been so wrong about the euro?

The following chart shows that Commercial traders have, as a group, been heavily net-long euro futures almost all of the way down (the blue bars indicate the net-position of the Commercials). Since the Commercials are reputedly the "smart money", how could they have been so wrong?



The answer is that they haven't been wrong. Here's why.

First, if we lump large speculators and small traders together under a category labeled "speculators", then the commercial net-position is simply the mathematical offset of the speculative net-position. If speculators, as a group, are net long to the tune of X contracts, then commercials, as a group, will be net short to the tune of X contracts. Second, in the currency market and especially in the gold market (gold trades like a currency), speculators drive short-term price moves. This is evidenced by the fact that speculators (as a group) become increasingly 'long' as the price rises and then become increasingly less long, or short, as the price declines.

Due to the fact that every long position in the futures market must be associated with a short position (it's a zero-sum game), speculators cannot increase their long exposure in the futures market unless commercials increase their short exposure by exactly the same amount. To put it another way, it would not be possible for speculators to drive the price upward by going 'long' if there weren't commercials prepared to take the other side of the trade and 'go short', and it would not be possible for speculators to go short or liquidate their long positions unless commercials were prepared to go long or exit their short positions.

Looking at it from a different perspective, it would not be possible for commercials to hedge their long exposure in the cash market by going short in the futures market unless speculators were prepared to do the opposite (go long) in the futures market, and it would not be possible for commercials to hedge their short exposure in the cash market by going long in the futures market unless speculators were prepared to do the opposite.

Both commercials and speculators are needed to establish a liquid futures market. The speculators create the opportunity for commercials to hedge by selling into strength and buying into weakness, and commercials create the opportunity for speculators to do what they do -- speculate on price direction.

That's why the relentless complaining in some quarters about commercial short selling of gold futures and other precious-metals futures is so silly. Complaining about a large commercial net-short position is the same as complaining about a large speculative net-long position, because they are two sides of the same coin -- you can't have one without the other. Limit the extent to which the commercials can go short and you also limit the extent to which speculators can go long.

Getting back to the euro futures market, it's not correct to say that the commercials have been wrong, because a substantial commercial net-long position in the futures market does not imply that the commercials are betting on a rising euro. In general, the commercials don't bet on price direction; that's what speculators do.

In the euro futures market the commercials haven't been wrong, but it's fair to say that speculators, as a group, have been very right all the way down. That's unusual. The Commitments of Traders (COT) situation is nothing more than a sentiment indicator, and it's rare for speculative sentiment to reach either a bullish or a bearish extreme and for the price to continue in the direction expected by speculators with almost no interruption for many months thereafter. So rare, in fact, that we can't recall ever seeing it before.

Current Market Situation

Volatility in the currency market has become extreme, with the Dollar Index having its biggest intra-day trading range in many years last Wednesday in reaction to a few words from the Fed.

We suspect that a top that holds for at least a few months is now in place, but the price action hasn't yet confirmed this suspicion. Also, part of the topping process could involve a test of last week's peak within the coming week or so.

If a multi-month peak has finally been put in place, then, based on what happened following similar previous extremes, a decline to near the 200-day MA is likely within the next 2 months.



The Canadian Dollar (C$) reversed upward last week after testing its January low. A daily close above 81 would now confirm that the C$ had 'double-bottomed' at 78 and project an initial upside target of 84.

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 March 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]

  *Asanko Gold (AKG) published its financial reports for the quarter and year ending 31st December 2014.

Based on the balance sheet at 31st December and accounting for the equity financing completed in February, we estimate that AKG currently has about US$190M of net cash and $70M of undrawn credit. We also estimate that it will need to spend about $180M to complete the construction of Phase 1 of its Asanko gold mine in Ghana by the scheduled time of Q1-2016. Allowing $20M for the costs of running the business and completing the engineering work associated with Phase 2 of the project, this should mean that AKG will have about US$60M of cash plus long-term debt of $130M when the 190K-oz/yr Phase 1 operation comes on line in early 2016.

Completion of the PFS for Phase 2 was previously scheduled for Q1-2015, but is now scheduled for Q2-2015. This is the next big milestone for AKG. It will, we think, shine a spotlight on AKG's value.

We are comfortable with the way AKG is progressing. By this time next year it should be a low-cost gold producer (the Phase 1 AISC is expected to be about US$780/oz) with a solid balance sheet and substantial organic growth potential.

  *Energy Fuels (EFR.TO, UUUU) published its financial reports for the quarter and year ending 31st December 2014. The reports show that EFR's balance sheet remains healthy, with $39M of working capital and only $16M of long-term debt.

EFR is biding its time until the uranium price moves higher. The company limited its production to 900K pounds of uranium in 2014 and plans to limit its production to only a few hundred thousand pounds in 2015. At the same time it is working down its inventory and delivering into long-term contracts at $57/pound, thus generating positive operating cash flow despite the low uranium price.

It maintains the flexibility to quickly and substantially increase production when the uranium price recovers (the company's White Mesa mill has the capacity to process 8M pounds per year). We suspect that a spot price above $50/pound would prompt the company to start ramping up its production. The current spot price is around $39/pound.

The uranium market began to strengthen during the second half of last year, but the crash in the oil price prevented the spot uranium price from making a sustained break above $40. There's a realistic chance that the uranium price will be at $50/pound or higher by year-end, but for that to happen there will probably have to be an upward reversal in the oil price by mid-year and additional progress on the restart of nuclear reactors in Japan.

Note that an upward reversal in the oil market and continuing progress on re-starting Japan's reactors are not totally independent events. This is because the longer the oil price stays in the $40s or lower, the lesser the economic fallout from the disastrous set of policies known as "Abenomics" and the lesser the financial incentive to restart nuclear reactors.

  *Pilot Gold (PLG.TO) announced that it has completed its 60% earn-in at the TV Tower project in Turkey. There was never any doubt that this would happen, but it's a significant milestone because it means that PLG's joint venture partner (Teck) must fund 40% of all future exploration work. In other words, reaching this milestone means that PLG will now be able to carry out a larger amount of exploration at a lower cost to itself.

  *Sabina Gold and Silver (SBB.TO) published its financial reports for the quarter and year ending 31st December 2014. The company ended 2014 with about C$32M of working capital, which should be more than enough to fund the business for the next 12 months.

SBB plans to publish the results of the Back River FS during the second quarter of this year. This will be a very important milestone for the company. It will determine whether Back River has real value at current metal prices or is purely an option on an eventual metal-price recovery.

  *UEX Corp. (UEX.TO), an exploration-stage uranium miner, reported that it had about C$8M of working capital at 31st December. Its exploration budget for 2015 is $4.6M, which means it should have enough money to make it through this year. However, the company will no doubt want to maintain a significant cash reserve, so we expect that it will do a small equity financing during the second half of the year.

Along with the shares of most other uranium-mining companies, the shares of UEX will probably be 'dead money' until signs emerge of a sustained turnaround in the uranium price.

    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) AKG (last Friday's closing price: US$1.51).

2) EDV.TO (last Friday's closing price: C$0.54).

3) EVN.AX (last Friday's closing price: A$0.76).

4) RMS.AX (last Friday's closing price: A$0.10).

5) TGD (last Friday's closing price: US$0.69).

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
http://www.sharelynx.com/



 
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