-- Weekly Market Update for the Week Commencing 23rd April 2018

Big Picture View

Here is a summary of our big picture view of the markets. Note that our short-term views may differ from our big picture view.

The BULL market in US Treasury Bonds that began in the early 1980s ended in mid-2016, but there will be many years of topping action in bond prices and bottoming action in bond yields before major new trends get underway. A major decline in government bond prices will unfold during the 2020s. (Last update: 11 September 2017)

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.), gold-denominated prices and inflation-adjusted prices. This secular trend will bottom in 2020 or later. (Last update: 11 September 2017)

A cyclical BEAR market in the US Dollar began in 2016-2017. (Last update: 11 September 2017)

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 in 2020 or later. (Last update: 11 September 2017)

Commodities, as represented by the CRB Index, commenced a secular BULL market in 2001 in nominal dollar terms. The first major upward leg in this bull market ended during the first half of 2008, but a long-term peak won't occur until 2020 or later. (Last update: 11 September 2017)

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True Fundamentals Summary [Notes: 1) The date shown next to the current True Fundamentals Model (TFM) signal is when the most recent change occurred. 2) Charts of the Gold and Equity TFMs are included in the "Charts and Indicators" section of the TSI web site]

Last week's posts at the TSI Blog

Bull market correction or bear market?

A dramatic upward reversal in US monetary inflation

Summary of current thinking/positioning

1) A number of markets are set up for trend reversals or accelerations, with the US$ being the linchpin. If the DX breaks out to the downside from its recent narrow range, rallies should begin or accelerate across the commodity world with silver bullion and gold-mining stocks leading the way higher. However, if the DX breaks out to the upside from its recent range then the commodity world will be pressured downward for at least a few weeks thereafter.

2) The SPX is about to either end its correction or escalate the significance of the January-2018 top by breaking to a new low for the year. The former outcome is the more likely, but mainly due to rising interest rates there remains the threat of a trend-ending plunge to a new low for the year.

3) The multi-year upward trend in commodity prices that got underway in early-2016 appears to have resumed. If so, the Australian and Canadian dollars should be relatively strong over the next few months.

4) We expect the next downward leg in the bond bear market to begin within the next few weeks, but due to the huge speculative net-short position in 10-year T-Note futures we aren't yet interested in placing a new bearish bet.

5) Holding a cash reserve of around 30%.

The burgeoning economic war between governments

The US government has threatened to implement tariffs on $150B of imported goods from China. It isn't yet known what the final tariff tally will be and which products will be affected, because there will be a great deal of lobbying between now and when the threats are transformed into actions. China's government, of course, has threatened to retaliate. The full details of the Chinese retaliation also aren't yet known, but US companies that are heavily reliant on doing business in China should be worried. The war recently moved beyond tariffs, though, when the US government fired a shot against Russia by imposing sanctions on a number of Russian oligarchs and major Russian commodity-producing companies. This led to rapid rises in the prices of aluminium and nickel. Then, over the past week, there was another development in the expanding economic war, with the US government firing potentially the most important shot to date.

Potentially the most important shot to date is the US ban on sales of American components to ZTE Corp, a large Chinese manufacturer of telecommunications equipment. The ban was put in place because ZTE broke a 2017 settlement agreement relating to the sale of equipment to off-limit countries such as Iran.

Regardless of whether or not ZTE's actions justified severe punishment, the US government has inserted itself between international trading partners in a way that not only could destroy a large Chinese company, but also could have negative effects on many US companies and the overall US economy. In the short-term the negative effects will be limited to the US companies that were suppliers to ZTE (e.g. Qualcomm) and the US companies that end up getting targeted for punishment by China's government in retaliation for the heavy-handed treatment of ZTE, but there is a much bigger issue here. The bigger issue is that the US government has, in effect, just made the following announcement to the world: "If at all possible, do not put yourself in the position where you are reliant on US technology".

Many governments and corporations around the world will take notice. Moreover, the US government's ban on the sale of US-made components to ZTE has been a propaganda victory for Xi Jinping, China's dictator. Xi has warned for years that it was dangerous to depend on technology purchased from the US, and he has just been proved right. This will give additional impetus to the "Made In China 2025" program. Refer the article posted HERE for more information on how the ZTE decision is being portrayed in China.

Furthermore, the increasing politicisation of international trade and the retaliations of other governments to the actions of the US government will make US corporations more wary about relying on foreign suppliers, especially foreign suppliers of critical commodities. In an effort to avoid a politically-motivated supply disruption it is therefore conceivable that in the future US manufacturers and utilities will be willing to pay substantially higher prices for locally-sourced commodities and will encourage local supply by making investments in US-based commodity producers.

In summary, economically-important parts of the world are being forced to turn inward.

The economies of all countries will be hurt by this war, with consumers taking the brunt of the punishment. Economic progress will be slowed, many consumer goods will become more expensive and living standards will be lowered. However, there will be winners. For example, gold and gold-mining shares are potential winners from declining confidence associated with the economic war, and some industrial-commodity producers will be able to sell at higher prices due to being 'local'. Also, there will be winners from specific policy missteps, such as the aluminium and nickel producers that benefited from the Russia sanctions and the phone makers that will benefit from the destruction of ZTE's business.

Oil & Gas

Oil versus oil stocks

Last week the oil price made a small gain, thus solidifying the break to a new 3-year high that happened during the preceding week. Speculative sentiment remains riskily stretched into optimistic territory, but the physical supply-demand situation remains bullish. So, there was no change of significance in the oil market last week.

Today we'll take a look at how oil equities trade relative to the commodity, using XLE (the Energy Select Sector SPDR ETF) and XOP (the SPDR S&P Oil and Gas E&P ETF) as proxies for oil equities.

Displayed below are charts that compare the oil price with the XLE/oil ratio and the XOP/oil ratio. These charts show that there is a strong INVERSE correlation between the price of oil and the performances of oil stocks relative to oil. Putting it another way, the charts show that there is a strong tendency for oil stocks to rise by less than the spot price of oil when the oil price is in an upward trend and to fall by less than the spot price of oil when the oil price is in a downward trend.

Oil stocks are generally the opposite of leveraged plays on the oil price because most oil producers do not sell most of their oil in the spot market. Instead, they make extensive use of hedging, so that in a rising oil-price environment they typically will be delivering the bulk of their production into contracts that were entered into at lower prices and in a falling oil-price environment they typically will be delivering most of their production into contracts that were entered into at higher prices. Also of significance is that when oil fundamentals are bullish the spot oil price will tend to be high relative to prices for delivery in 1-2 years' time, which means that new hedging will be undertaken at prices that do not fully reflect the rise in the spot price. The opposite occurs when oil fundamentals are bearish.

This doesn't mean that you shouldn't buy oil stocks if you are bullish on oil. The reality is that unless you have a large oil-storage facility and the financial ability to fill the facility, it will be difficult for you to purchase an investment that tracks or leverages changes in the spot price of oil. You will have to make do with oil futures or ETFs that hold oil futures contracts or the stocks of companies that deliver oil into futures contracts. An alternative would be to buy the stocks of companies that are focused on oil exploration, but these stocks will tend to be driven as much or more by exploration results than by changes in the oil price.

The natgas market is overdue for a rally

The oil-price strength of the past 8 months has done nothing for the natural gas (NG) market. As illustrated by the following chart, the NG price has been working its way downward in 'choppy' fashion since the end of 2016. It made a new 12-month low in February-2018 and remains close to its 12-month low.



The relatively low NG price has affected supply in a predictable way (supply has reduced). This is evidenced by the next chart, which shows that the amount of NG in below-ground storage in the US is 26% below the 5-year average for this time of the year and 38% below the year-ago level.



It's likely that a significant price increase will be required to encourage producers to boost NG supply. At the same time, the market is now acutely vulnerable to a positive shift in demand.

The upshot is that there's a good chance of a tradable rally in the NG price over the coming few months.

One of the simplest and safest ways to participate in the rally would be by purchasing shares of the First Trust Natural Gas ETF (FCG), a chart of which is displayed below. This ETF has languished along with the NG market since late-2016 but is beginning to show signs of life.

A higher-risk/higher-reward alternative to FCG would be a beaten-down junior producer such as Petrus Resources (PRQ.TO).



The Stock Market

Sentiment, the yield curve and credit spreads

Here's how we concluded a post at the TSI blog early last week:

"While sentiment was consistent with a major top and valuations, on average, were definitely high enough to usher in a major top, an end to the long-term upward trend was not signaled by several important indicators. For example, there would normally be a pronounced widening of credit spreads at or before a bull market top, but credit spreads remain near their narrowest levels of the past 10 years. For another example, there is likely to be a reversal in the yield curve from flattening to steepening at or prior to a bull market top, but at the end of last week the US yield curve was at its 'flattest' in more than 10 years. For a third example, there has been more strength in market internals over the past two months than there normally would be if we were dealing with the early stage of a bear market.

So, despite the rampant optimism evident in January-2018, the decline that followed the January peak probably will turn out to be a bull-market correction."

The blog post referred to the absence of reversals in the yield curve and credit spreads, but didn't provide any evidence. The relevant evidence is in the following two charts.

The first chart shows that the 10yr-2yr yield spread, a proxy for the US yield curve, has been in a major downward (flattening) trend since early-2014. This yield spread hit its lowest level in more than 10 years last Tuesday. The second chart shows the spread between an index of non-investment grade publicly-issued corporate debt yields and the 10-year T-Note yield -- a proxy for US credit spreads. This spread did not widen to a significant degree during the January-March stock market turmoil and has since returned to near its narrowest level in many years.

Current Market Situation

In last week's Interim Update we mentioned the sudden and pronounced relative weakness in the banking sector as indicated by a plunge, over the first three days of the week, in the BKX/SPX ratio. We went on to write:

"We can't come up with a good explanation for the sudden bout of relative weakness in the banking sector. It could be argued that the demand for bank stocks is declining due to a rise in the banking industry's interest expense relative to its interest income, but the contraction of bank interest margins is not a new development and therefore cannot be the main reason. Also, the valuations of most US bank stocks are low relative to the S&P500's valuation, so the problem isn't that bank stocks are too richly priced.

Before we dive more deeply into this issue we want to see if the relative weakness persists. If it does it will have implications for other markets, most notably the gold market."

We were right to wait to see if the relative weakness persisted before delving deeper into the possible causes, because all the ground lost by the BKX/SPX ratio during the first three days of last week was recouped during the final two days of the week. In fact, over the course of the week the ratio made a small gain.

Here's a chart showing the current situation. The BKX is still precariously positioned slightly above a vital support level, but its relative performance over the final two days of the week was very good.



With the notable exception of the Bank Index, the important US stock indices pulled back over the final two days of last week. In the cases of the Dow Transportation Average (TRAN) and the Russell2000 SmallCap Index (RUT), the pullbacks followed tests of resistance. As illustrated by the following daily charts, TRAN has resistance at 10800 and RUT has resistance at 1590. Getting above these resistance levels would project new all-time highs within the ensuing month.

We ended the stock market section of last week's Interim Update by noting:

"The biggest short-term threat facing the stock market now is the same as the biggest threat that has faced it since the beginning of the year: higher interest rates. The stock market has become accustomed to a 10-year bond yield in the 2.80%-3.00% range, but it's likely that at some point over the coming three months the 10-year yield will move well above 3.00%. When it does it should usher in the next bout of extreme stock-market volatility."

Interest rates moved higher over the final two days of last week and the 10-year yield is now perilously close to 3.0%. Just as importantly, the 30-year T-Bond price is not far from its February low.

The following chart compares the T-Bond price with the SPX. This chart shows that the sharp January-February decline in the stock market came on the heels of a downside breakout in the T-Bond. Stabilisation of the T-Bond then helped the stock market to stabilise.

We expect that when the resumption of the T-Bond's long-term bearish trend is signaled by a breach of the February low (around 141.5), selling pressure will ramp up in the stock market and the SPX will begin a decline to a new low for the year. Given its position at the end of last week there is a risk that the T-Bond will break below support as soon as this week. However, the odds favour a T-Bond rebound over the coming few weeks.



Tesla (TSLA) Update

The TSLA price made a short-term bottom in the $240s at the beginning of April and then, within the space of only 4 days, rocketed back to former support (now resistance) at $310. It has since consolidated in the $290-$310 range.

It's possible that TSLA's rebound is over and that a decline to a new 12-month low has begun, but it's also possible that the rebound will continue.



We don't understand why so many analysts and investors remain steadfastly bullish on TSLA. After all, it's not like the numerous large risks facing this company have been fully discounted by the stock market, thus creating a situation where the high risk is more than offset by the potential reward. The stock is being valued as if the company were about to become enormously profitable, whereas the main question is: how long will it be before the company's creditors 'pull the plug'?

The stubborn optimism about Tesla's prospects makes it possible for the company's carnival-barker-like CEO to periodically whip-up enthusiasm for the stock. Anyone betting against this stock should keep this in mind and manage risk accordingly. Our suggestion has been (and still is) to limit the loss on a bearish speculation by exiting if the share price achieves consecutive daily closes above $310.

On a related matter, recall that a TSLA April-2018 put option was removed from the TSI List at a large profit in late March. Our exit price of around $13 was far from ideal given that the options traded above $20 at the beginning of April, but note that these options expired worthless last Friday. Consequently, if the options had been held for an additional 3 weeks then a 370% profit would have turned into a 100% loss. On the other hand, IF the stock's sharp decline had continued for 2-3 more weeks, which it could well have done, then the same options potentially could have been exited for a 2,000% profit.

The above paragraph highlights the risks and opportunities associated with options trading. In a fast-moving market, exiting an option position a little early can result in a lot of money being left on the table, but exiting a position a little late can result in a very negative outcome.

One way to balance the risks and opportunities is to scale out of a long option position as its price rapidly rises.

This week's significant US economic events [Notes: 1) The most important events (to the markets) are shown in bold. 2) A list of global economic events can be found HERE]

Gold and the Dollar

Gold

Last week, for the second week in a row, there was a mid-week shift by the Gold True Fundamentals Model (GTFM) into bullish territory that wasn't sustained until week's end. To be more specific, over the final two days of last week there was sufficient relative strength in the banking sector and a sufficient gain in the 10-year TIPS yield to keep the GTFM bearish.

Almost regardless of what's happening with other fundamental influences, right now the Dollar Index (DX) is the key to a short-term breakout in the US$ gold price. Over the final two days of last week the DX rallied and the gold price pulled back. In the grand scheme of things neither move was significant, in that both the DX and the US$ gold price remain well within their 3-month horizontal ranges (refer to the following chart for details). However, it's a little bearish that the US$ gold price closed below its 20-day MA on Friday 20th April.



Gold market sentiment (as indicated by the COT data) is neutral.

We continue to expect that the gold price will break above resistance in the low-$1360s within the next two months and in doing so will project a rally to at least the mid-$1400s. However, last week's price action suggests that an upside breakout is not imminent.

Silver

A week ago we wrote that a break above $16.90 by the silver price would point to a further rise to around $17.50, but in order for the silver price to go much higher than that the gold price would have to break above resistance in the low-$1360s.

Actually, the next significant resistance for silver is more like $17.80 than $17.50, although the positioning of the channel lines on the following chart is somewhat arbitrary.



A good setup for a large silver rally is not yet in place. In particular, silver-market sentiment is neutral and gold has just generated a minor bearish signal by closing below its 20-day MA. However, both the price action and the sentiment backdrop suggest the potential for an additional $1-$2 of short-term upside in the silver price.

It's important to manage upside risk as well as downside risk, so if the silver price were to pull back to around $16.90 (the top of its recent 2-month trading range) during the coming three days it could make sense to obtain some silver exposure in preparation for either a short-lived $1-$2 surge or the much larger rally that we expect to get underway within the next two months. This could be done by purchasing SLV shares or SLV January-2019 call options or the shares of a junior silver producer/explorer such as GRG.V.

Gold Stocks

The Gold Miners ETF (GDX) ended last Wednesday's and Thursday's trading sessions right at resistance. It then pulled back on Friday.



GDX therefore avoided an upside breakout last week, but there was nothing ominous about Friday's price action. On the contrary, the HUI/gold ratio made a small gain on Friday despite the gold price closing below its 20-day MA. On a very short-term basis, this constitutes a positive divergence.

As illustrated below, the HUI/gold ratio has been trending upward for about 4 weeks.



As long as GDX holds above $22.25 during any further near-term corrective activity it will be well positioned to break above resistance at $23. Note, though, that as things currently stand there is minimal evidence that a sustainable low is in place.

To conclude this section it is worth repeating the following comment from last week's Interim Update:

"As time goes by it is becoming less likely, but the risk of a trend-ending plunge in the gold-mining indices and ETFs to new 12-month lows will remain until the gold price breaks above resistance in the low-$1360s."

The Currency Market

We are becoming increasingly optimistic about the short-term prospects for the commodity currencies, chief among which are the Australian dollar (A$) and the Canadian dollar (C$). The sentiment (COT) situations for these currencies are supportive, as is the rising commodity-price trend.

The following chart shows the strong positive correlation between the C$ and the GSCI Spot Commodity Index (GNX) over a long period. Notice that apart from the first half of 2008, since 2001 there have been no large divergences between the C$ and GNX. Also notice that a small divergence has developed over the past few months, with GNX extending its multi-year upward trend while the C$ trended downward.

The recent divergence almost certainly will close over the next few months, but it could close in two very different ways: via a rally in the C$ or via a decline in GNX. We are expecting the former, but there is a risk that the latter will happen.



Turning to the short-term price action, performance during the final two days of last week was a little more bearish than anticipated. This was especially so for the A$. As illustrated by the following daily charts, the C$ has dropped to its 50-day MA while the A$ has dropped all the way back to its low for the year.

What this means is that we are getting a better buying opportunity than appeared likely a week ago. This is good news for anyone who hasn't yet taken a position or is averaging into a position.

A final point is that there has been an important early-May turning point for the C$ during each of the past three years. There were highs in early-May of 2015 and 2016 and a low in early-May of 2017. This is not what we currently expect to happen, but if the C$ were to fall by enough within the next two weeks to test or breach its March-2018 low it probably would mean that we were getting another important early-May turning point (in this case, from down to up).

Updates on Stock Selections

Notes: 1) To review the complete list of current TSI stock selections, logon at http://www.speculative-investor.com/new/market_logon.asp and then click on "Stock Selections" in the menu. When at the Stock Selections page, click on a stock's symbol to bring-up an archive of our comments on the stock in question. 2) The Small Stock Watch List is located at http://www.speculative-investor.com/new/smallstockwatch.html

Company news/developments for the week ending Friday 20th April 2018:

[Note: AISC = All-In Sustaining Cost, FS = Feasibility Study, FY = Financial Year, IRR = Internal Rate of Return, ISR = In-Situ Recovery, 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%, NSR = Net Smelter Return, P&P = Proven and Probable, PEA = Preliminary Economic Assessment, PFS = Pre-Feasibility Study]

  *Alio Gold (ALO) reported Q1 gold production of 17.6K ounces. This news actually came out on 11th April but accidentally was omitted from last week's TSI commentary.

Q1 guidance was 18K-20K ounces, so the result was below plan. However, the company has maintained its overall 2018 production guidance of 90K-100K ounces.

  *Blackham Resources (BLK.AX) published its quarterly report for the March-2018 quarter. Most of the important information contained in this report had been provided in earlier press releases.

The company produced 20.6K ounces of gold at an AISC of A$1092/oz during the March quarter and has maintained its guidance for the first half of this calendar year at 40K-45K ounces at an AISC of A$1100-$1200. Considering that sustaining capital expenditure should be lower during the June quarter than during the March quarter, we expect that the actual AISC for the half year will be well below the bottom of the aforementioned guidance range.

There are historical tailings at BLK's Wiluna project that are estimated at 37M tonnes averaging 0.71-g/t gold. This implies a gold resource of about 800K ounces. Metallurgical testwork carried out to date indicates gold recovery of 45%-50%, which suggests the potential for BLK to add 350K-400K ounces of relatively low-cost production to its overall mine plan.

The tailings opportunity (called "Wiltails") will have to be confirmed by drilling, additional metallurgical testing and economic studies, but it could give the per-share value a significant boost.

  *Continental Gold (CNL.TO) reported a new batch of results from its 2018 drilling program. The best intercepts were 0.55m of 606-g/t gold and 1.95m of 110-g/t gold. These intercepts have potentially identified new shoots of very high-grade gold on two different veins within part of the M&I resource envelope.

  *Energold Drilling (EGD.V) published its 2017 annual financial results.

Revenue for the year was about C$10M higher than the preceding year. This is clear-cut evidence that EGD's drilling business has turned the corner, but unfortunately the higher revenue did not translate into a better overall financial performance.

EGD's balance sheet remains strong, with adjusted working capital (current assets minus current liabilities and long-term debt) of C$36M. However, this is down by C$9M from the end of the preceding quarter, so the company has continued to bleed cash despite the increasing demand for its services.

The adjusted working capital equates to about C$0.65/share, which suggests that EGD is cheap near its current share price of C$0.41. It must convert its growing revenue into free cash-flow, though, for there to be a large and sustained increase in its stock price.

  *Premier Gold (PG.TO) reported a good overall production result for the March quarter, with lower-than-planned production at the company's 100%-owned Mercedes gold mine in Mexico being more than offset by well-above-plan production at the 40%-owned South Arturo gold mine in Nevada. Total production for the quarter was 30.5K ounces.

This puts PG on track to exceed its 2018 gold production guidance of 85K-95K ounces.

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) ALK.AX (last Friday's closing price: A$0.28)

2) AOI.TO (last Friday's closing price: C$1.24)

3) EGD.V (last Friday's closing price: C$0.41)

4) PG.TO (last Friday's closing price: C$2.64)

5) PRQ.TO (last Friday's closing price: C$1.24)

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://research.stlouisfed.org/