<% 'pass = Request.Form("pass") IF ((Request.Form("pass") = 1) OR (Session("pass") = "pass")) THEN %> Speculative-Investor.com
   -- Weekly Market Update for the Week Commencing 23rd April 2007

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.

Bonds commenced a secular BEAR market in June of 2003. (Last update: 22 August 2005)

The stock market, as represented by the S&P500 Index, commenced a secular BEAR market during the first quarter of 2000. The rally that began in October of 2002 will end during the first half of 2007. The ultimate bottom of the secular bear market won't occur until the next decade. (Last update: 02 October 2006)

The Dollar commenced a secular BEAR market during the final quarter of 2000. The first major downward leg in this bear market ended during the first quarter of 2005, but a long-term bottom won't occur until 2008-2010. (Last update: 28 March 2005)

Gold commenced a secular bull market relative to all fiat currencies, the CRB Index, bonds and most stock market indices during 1999-2001. The first major upward leg in this secular bull market ended in December of 2003, but a long-term peak won't occur until at least 2008-2010. (Last update: 13 February 2006)

Commodities, as represented by the CRB Index, commenced a secular BULL market in 2001. The first major upward leg in this bull market ended during the second quarter of 2006, but a long-term peak won't occur until at least 2008-2010. (Last update: 08 January 2007)

Copyright Reminder

The commentaries that appear at TSI may not be distributed, in full or in part, without our written permission. In particular, please note that the posting of extracts from TSI commentaries at other web sites or providing links to TSI commentaries at other web sites (for example, at discussion boards) without our written permission is prohibited.

We reserve the right to immediately terminate the subscription of any TSI subscriber who distributes the TSI commentaries without our written permission.

Outlook Summary

Market
Short-Term
(0-3 month)
Intermediate-Term
(3-12 month)
Long-Term
(1-5 Year)
Gold
Neutral
(23-Apr-07)
Neutral
(23-Apr-07)
Bullish

US$ (Dollar Index)
Bullish
(23-Apr-07)
Bullish
(31-May-04)
Bearish

Bonds (US T-Bond)
Neutral
(26-Mar-07)
Bearish
(26-Mar-07)
Bearish

Stock Market (S&P500)
Neutral
(19-Mar-07)
Neutral
(26-Mar-07)
Bearish

Gold Stocks (HUI)
Neutral
(23-Apr-07)
Neutral
(23-Apr-07)
Bullish

OilNeutral
(12-Mar-07)
Neutral
(
25-Sep-06)
Bullish

Industrial Metals (GYX)
Neutral
(15-Jan-07)
Neutral
(26-Mar-07)
Bullish


Notes:

1. In those cases where we have been able to identify the commentary in which the most recent outlook change occurred we've put the date of the commentary below the current outlook.


2. "Neutral", in the above table, means that we either don't have a firm opinion on which way the market will move or that we expect the market to be trendless during the timeframe in question.

3. Long-term views are determined almost completely by fundamentals, intermediate-term views by giving an approximately equal weighting to fundmental and technical factors, and short-term views almost completely by technicals.

The Fed's Dilemma

...a break to new highs by the gold price has the potential to de-rail any realistic possibility of a 2007 rate cut and shift the odds decisively in favour of the next move being a rate hike.

Many analysts fixate on economic problems directly and indirectly related to the downturn in the US housing market, and, as a result, arrive at the conclusion that the Fed's next move will have to be a rate cut. Their assessment of the situation could prove to be right, but only under certain conditions because they are failing to account for the Fed's greatest fear: an out-of-control rise in inflation expectations. This is where gold comes in.

The gold price is steadily approaching its May-2006 peak, and although we do not view a sustained move above this peak to be the most likely short-term outcome there is a significant risk that an upside breakout will soon occur. If it were to occur then the Fed might be forced to commence another rate-HIKING campaign, an eventuality that would obviously come as a big surprise to the financial markets and analysts that expect the Fed to remain on hold over the next few months and to commence a rate-CUTTING campaign well before year-end.

To the extent that gold is viewed as a barometer of inflation expectations, a break to new highs by the gold price could provoke unexpected -- unexpected, that is, from the mainstream financial world's perspective -- actions from the Fed, especially if such a gold market event were to happen while cyclical markets (equities and industrial commodities) remained strong. The important thing to understand is that the Fed has the tools to cope with most threats to the monetary system. It can, for example, always arrange for more money to be created and will therefore always be able to handle any deflation-related threat with ease. It will hit a brick wall, however, at the point where inflation EXPECTATIONS (expectations regarding the currency's future loss of purchasing power) begin to run way ahead of actual monetary inflation. This is the point at which increasing the money supply will become counter-productive because it will result in further outsized gains in inflation expectations, but increase the money supply is what the Fed MUST continue to do to prevent the largest-ever "Ponzi scheme" from unraveling.

In other words, in the current environment a break to new highs by the gold price has the potential to de-rail any realistic possibility of a 2007 rate cut and shift the odds decisively in favour of the next move being a rate hike. However, it seems that some high-profile commentators on the interest rate outlook don't even give the gold market a moment's thought when penning their forecasts.

The Gold Speculator's Dilemma

As a result of the global growth theme's resilience we have downgraded our intermediate-term gold market outlook to "neutral"...

In the 29th January 2007 Weekly Update we described what we perceive to be the two most likely intermediate-term scenarios for gold. Both scenarios entailed gold rising to test its May-2006 peak within the ensuing few months, but after that they took very different paths. The first scenario had gold testing its May-2006 peak and then dropping back to test its June-2006 bottom (around $550) later in the year, while the second scenario was based on the premise that a new multi-year advance began last October. Under this more bullish scenario a test of the May-2006 peak during the first half of the year would be followed by a moderate pullback to around 630-650 and then an upward move that took the gold price well beyond last year's high.

At that time we said we favoured the second (more bullish) scenario because it meshed with our stock market and economic outlooks. Specifically, we expected stock markets and industrial commodities to start weakening by the second quarter of the year in anticipation of a global growth slowdown, leading to wider yield and credit spreads and, ultimately, to interest rate reductions on the part of the central banking community.

Up until now gold's price action has been consistent with both of our scenarios because the monetary metal has gained about $50 during the intervening period and appears to be set for a test of its May-2006 peak in the near future. The challenge is in figuring out what's likely to happen AFTER this test.

Looking at what's going on across the financial world we see a set of circumstances that is slightly LESS bullish for gold -- from an intermediate-term perspective -- than would be the case if our second scenario still had a definitive advantage. In particular, although the US yield-spread has shown signs of reversing upward, gold has recently been under-performing the industrial metals and credit spreads are, on average, narrower than they have ever been. This, along with the performances of most stock markets throughout the world, tells us that investors have not yet begun to discount a global growth slowdown. It is, of course, possible for gold to continue its upward trend under such conditions, but the reason we have headed this section "The Gold Speculator's Dilemma" is that an upside breakout by the gold price in the face of widespread strength in cyclical assets would likely provoke a serious tightening of monetary policy, which would, in turn, have the potential to halt the gold rally in its tracks. Or, to put it another way: in the absence of sufficient weakness in growth-oriented investments to mask an inflation threat and, thus, to prevent the Fed from fighting the breakout, a move to new highs by the gold price would probably contain the seeds of its own quick reversal.

As a result of the global growth theme's resilience we have downgraded our intermediate-term gold market outlook to "neutral", meaning that we now assign approximately equal odds to the two different scenarios outlined in our 29th January commentary.

To avoid being whipsawed -- it's possible that we will be forced to switch back to "bullish" at some point over the coming 6 weeks -- we wrestled with the idea of leaving our intermediate-term bullish view in place while awaiting further developments. However, "neutral" most accurately reflects our assessment of the current situation. We hope (and expect) that the performances of the financial markets between now and the end of May will bring enough clarity to allow us to 'get off the fence', but for now there's too much uncertainty to commit to a more definitive view.

Grain prices in real terms

When looking at the nominal price charts of corn, soybeans and wheat you might get the impression that the grains have become expensive due to the price gains of the past year or so. However, if you look at the following CPI-adjusted charts (courtesy of www.fullermoney.com) you should get a very different impression. These charts show that grain prices would have to approximately quadruple from where they are now just to bring them back to where they were in the 1970s, assuming that changes in the CPI accurately reflect changes in the dollar's purchasing power.

Of course, changes in the CPI do not accurately reflect changes in the dollar's purchasing power. Even an honest attempt to come up with a single number that represents the economy-wide change in the dollar's purchasing power would necessarily fail because there can never be any such thing as the average price within an economy. To paraphrase Einstein: some things that can be measured aren't worth measuring, and some things that are worth measuring can't be measured. The economy-wide purchasing power of a currency falls into the latter category. We can observe the effects of a change in purchasing power, but it is not possible to calculate a meaningful number that represents this change.

But the Government's attempts to calculate changes in purchasing power are not honest; rather, they are designed to come up with a number that understates the effects of inflation. Therefore, although we can't accurately measure the change in the 'real' price of anything, we can be sure that in real terms today's grain prices are even lower than suggested by the following charts.






The Stock Market

The US stock market in real terms

...all the price gains achieved since early October have been the result of currency depreciation.

Over the very long-term, changes in the gold price probably do a better job than anything of reflecting changes in the official currency's purchasing power. Therefore, changes in real prices can, over multi-decade periods, be 'seen' by dividing nominal prices by the price of gold.

Over shorter time periods the gold price reflects financial-market mood swings rather than changes in purchasing power, so when we chart gold-denominated prices over periods of a few years or less and refer to the chart as being a reflection of real performance -- as we've done below with the S&P500 -- we are using poetic license (we are deviating from the strictly-correct definition of the word "real"). What we are endeavouring to show, with such charts, is the financial markets' PERCEPTION of whether price increases are real or inflation-induced.

The message of the following S&P500/gold chart is that the US stock market experienced a good rally during June-September of last year, but despite the reams of bullish commentary to the contrary the market's perception is that all the price gains achieved since early October have been the result of currency depreciation.


It's worth pointing out, though, that while the people who have been 'long' the S&P500 Index since early October haven't really achieved anything, the people who have been 'short' have suffered real losses. In a high-inflation world the odds are stacked heavily against anyone who attempts to profit from a fall in nominal prices.

Current Market Situation

We doubt that the ultimate highs are in place, but the market is very 'overbought' and desperately needs a pullback to restore balance. When some Asian markets dropped sharply last Thursday it momentarily looked like such a pullback was about to begin, but this was not the case as the S&P500 closed only two points lower that day and then surged to new multi-year highs on Friday. There have now been 14 trading days since the beginning of this month and the S&P500 has risen on 12 of them.

The Yen carry trade continues to be a very important driver of stock markets throughout the world. Over the past month the US$ has been very weak relative to most major currencies, but relative to the Yen it has strengthened as speculators have continued to take advantage of the almost-free money being made readily available to the world by the Bank of Japan (BOJ). With official overnight interest rates throughout the non-Japanese developed world ranging from the ECB's 3.75% to the Bank of New Zealand's 7.5%, there is an enormous incentive to borrow Yen at less than 1% to finance investments almost anywhere else.

The central bankers of Europe, the US, Australia, New Zealand and Canada must be getting extremely frustrated because their attempts to reduce the global liquidity deluge are being rendered futile by the idiocy of Japan's monetary policy. The Japanese are blowing bubbles everywhere...except Japan.

The Yen carry trade has become a drug and global stock markets appear to be hopelessly addicted. This sets the stage for substantial stock market declines and a simultaneous Yen rally at some point in the future. The risk is high, but the timing is unknowable.

This week's important US economic events

Date Description
Monday Apr 23
No important events scheduled
Tuesday Apr 24
Consumer Confidence
Existing Home Sales
Wednesday Apr 25 Durable Goods Orders
New Home Sales
Fed's Beige Book
Thursday Apr 26 No important events scheduled
Friday Apr 27 GDP
Employment Cost Index

Gold and the Dollar

Currency Market Update

It would be an understatement to say that the currency market is extended at this time. For example:

a) Before experiencing a small bounce on Friday, the Dollar Index had fallen for 8 days in succession.

b) The euro has risen for 6 weeks in a row and 11 of the past 12 weeks.

c) Last week, Market Vane's bullish consensus for the euro and the British Pound hit 2-year highs of 81% and 89%, respectively, while the Dollar Index's bullish consensus dropped to 28% (within 2% of a 2-year low).

d) The following chart shows that the Dollar Index touched the bottom of what COULD be a large declining wedge pattern late last week in parallel with a POTENTIAL positive divergence of momentum indicators.


There is not yet any evidence that the US$ has bottomed, but we think the dollar's short-term risk/reward is now skewed toward the reward side of the equation. We have therefore upgraded our short-term US$ outlook to "bullish", although if we were short-term traders of currencies (we aren't) we would wait for an upward reversal before making a leveraged bet on a US$ rally.

Note that while there appears to be excessive bullishness toward some US$ alternatives -- the euro, the Pound and the Australian Dollar, in particular -- universal bullishness toward US$ alternatives is not apparent. The latest Commitments of Traders data, for instance, show that speculators are bearish on the Yen and the Swiss Franc and neutral on the Canadian Dollar.

The euro appears to be the US$ alternative most vulnerable to a downward reversal.

Gold

Below is a weekly chart of gold futures.

The May-2006 peak was the end result of 9 up-weeks in a row. The current sequence of up-weeks is 7, although the most recent rise has been a lot weaker than the rise that resulted in the May-2006 intermediate-term peak. Whereas the relentless surge during March-May of last year was clearly a blow-off move, gold has not made substantial progress despite having risen for the past 7 weeks in succession and 14 of the past 15 weeks. In fact, it has just taken gold 7 weeks to recover the ground it lost during a single week in the February-March correction.


Since early October of last year we've had the range between the May-2006 and July-2006 peaks in mind as a short-term upside target. The bottom end of this target range has just been reached near a time when cycle analysis projects a turning point. We've therefore downgraded our short-term outlook from "bullish" to "neutral".

Ideally, gold will make some additional gains over the coming 1-3 weeks (based on cycles, the 'ideal' time for a peak is the first half of May), but the risk/reward no longer justifies a short-term bullish view. In downgrading our gold market outlook we are also taking into account the likelihood of an upward reversal in the US$ at some point over the next few weeks.

Gold Stocks

We have been short-term bullish on the gold sector since 4th October of last year in anticipation of the AMEX Gold BUGS Index (HUI) rising to 370-400 during the first half of 2007. The bottom of this target range was touched over the past week, so our short-term price objective has essentially been achieved. Also, we've been expecting that a short- or intermediate-term peak would be in place by mid May, so our time objective is close to being achieved. As a result, we have downgraded our short-term outlook on the HUI from "bullish" to "neutral".

A confusing aspect of the current market environment is the investing public's lack of enthusiasm for the major gold stocks. Given that gold has been rising in parallel with a strong stock market we would have expected the gold stock indices to be livelier than they have been over the past few months. In particular, we would have expected to see significant strength in the major gold stocks relative to gold bullion. However, the following chart shows that the HUI/gold ratio ended last week not far above its lows of the past 18 months. Additionally, the amount of cash invested in the Rydex Precious Metals fund (RydexPM) dropped to a new 3-year low last Friday. RydexPM could well be in a terminal decline due to competition from various ETFs, but it has continued to work as a sentiment indicator provided the downward trend in its size is taken into account. Its current message is that sentiment is more consistent with a short-term bottom than a short-term peak.


The sentiment backdrop makes further gains likely over the coming 2-3 weeks. We don't, however, think there is sufficient additional upside potential relative to the downside risk to warrant maintaining a short-term bullish outlook.

How each person approaches the market will always depend on individual circumstances. For example, it could be appropriate for someone with heavy exposure to a long-term bull market to be clipping profits and, at the same time, be appropriate for someone with minimal exposure to be doing some buying.

With respect to the gold sector's current situation, we think people who are substantially overweight the sector should be looking for opportunities to scale back to their "core" position whereas people who are yet to build a core position should be looking for opportunities to scale-in. A core position should be small enough that a 20-30% decline would not be unduly stressful and large enough that you would welcome 20-30% of additional upside. It is, in effect, the psychological break-even point between hoping for a large correction so that you can put some cash reserves to work at lower prices and hoping for a large rally so that you can take profits at higher prices.

During the course of a long-term bull market there will invariably be some big upside surprises, so those who attempt to avoid the corrections altogether by getting completely out of the market will eventually come unstuck. In our opinion, you position yourself to get the most from a long-term bull market by maintaining core exposure at all times.

Non-Gold Mining Stocks

Below is a chart comparing junior copper/gold producer Northgate Minerals (AMEX: NXG), a stock that was added to the TSI List as a short-term trade about two weeks ago, with Peabody Energy (NYSE: BTU), a major coal producer. We don't have an interest in Peabody -- our only coal play is Red Hill Energy (TSXV: RH), a stock that has recently begun to perk-up due to the growing interest in its Mongolia-based coal deposit -- but thought the similarities between Peabody's chart and that of NXG were worth highlighting.


Patterns similar to the ones revealed in the charts of NXG and BTU keep popping up throughout the non-gold mining world. The pattern entails a spectacular upside blow-off followed by a sharp decline and then an extended period of base building. In the cases of NXG and BTU, a break above the top of the base has not yet occurred but appears to be close-at-hand. In the cases of some other stocks, such as the two TSI stock selections charted below (Taseko Mines and Northern Orion Resources), a break above the top of the base has already occurred.

The short-term outlook for non-gold mining stocks remains bullish.


Update on Stock Selections

(Note: 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)

International Barytex Resources (TSXV: IBX). Shares: 36M issued, 53M fully diluted. Recent price: C$1.98

IBX is a very speculative stock -- the company is exploring a copper project in the Democratic Republic of Congo and hasn't yet released an initial estimate of the in-ground resource -- and is too illiquid to be purchased as a short-term trade. However, a speculator who buys with the aim of holding for up to 2 years if need be will potentially be rewarded with a good short-term gain. This is because a break above the resistance at C$2.20 would create a short-term technical objective of C$2.70-$3.00.

The initial resource estimate due next month could be the catalyst for such a move.


    Hecla Mining (NYSE: HL). Shares: 119M issued, 120M fully diluted. Recent price: US$9.69

Since adding HL to the Stocks List last October we've had US$9-$10 in mind as a profit-taking range. With the stock now in the upper half of this range and with the gold sector probably within three weeks of a peak, we've decided to make our exit. The profit on the trade, based on our original price of US$5.48 and Friday's closing price of US$9.69, was 77%.

    Metallica Resources (AMEX: MRB, TSX: MR). Shares: 92M issued, 118M fully diluted. Recent price: US$5.36

We currently have Metallica Resources stock and warrant positions in the TSI Stocks List.

The warrants were added in November-2005 to provide leveraged exposure to a deeply under-valued gold stock. We think that now is an opportune time to exit these warrants -- firstly because the stock is no longer deeply under-valued; secondly because the sector-wide risk/reward has deteriorated; and thirdly because we can (the TSI Stocks List is not run like a portfolio so in most cases we can't use it to demonstrate good money-management practice, but in this case we effectively have two positions in the one stock and therefore have the ability to make a partial exit in response to increasing market risk).

The profit on the warrants, based on our original price of C$0.37 and Friday's closing price of C$3.00, was 711%.

We still consider MR to be one of the best long-term speculations in the gold sector and would maintain significant exposure to this company via the stock and/or the warrants. This is just an opportunity to take partial profits -- something we are able to do in this case by virtue of having two entries in our Stocks List for the one stock.

Chart Sources

Charts appearing in today's commentary are courtesy of:

http://stockcharts.com/index.html
http://www.futuresource.com/
http://www.fullermoney.com/



 
Copyright 2000-2007 speculative-investor.com
<% Session("pass") = "pass" Session.Timeout = 480 ELSE Response.Redirect "market_logon.asp" END IF %>