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 will end by mid-2010. In real (gold) terms, bonds commenced a secular BEAR market in 2001 that will continue until 2014-2020. (Last update: 09 February 2009)

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

Copper

With reference to the following chart-based comparison of the copper price and the LME copper inventory, we draw your attention to the fact that the upward trends in LME inventory that began in mid-2006, mid-2007 and mid-2008 were accompanied by downward trends in the copper price. This is the relationship we would expect to see between stockpiles and prices given that the copper market tends to live from hand to mouth (today's production feeds tomorrow's consumption).

We now draw your attention to the fact that the aforementioned relationship has completely broken down since the middle of this year in that a strong upward trend in the copper price has occurred alongside a strong upward trend in the LME copper inventory.

Our guess is that the discrepancy of the past few months (a rising price in parallel with rising inventory) results from speculators buying copper in anticipation of a strong global economic rebound at the same time as the industrial consumption of copper is falling relative to production. We expect that the speculators will be proven wrong and that the copper price will drop back to near its December-2008 low of around US$1.50/pound within the next 18 months.

Are we betting on such a bearish outcome at this time?

No. With the Baltic Dry Index (BDI) having just rebounded to a new high for the year and with China's stock market in a short-term upward trend, we don't think this is the right time to be placing such a bet.

The Stock Market

Supporting the case for a lengthy topping process

Fed rate hikes have preceded every major decline in the US stock market over the past 80 years. This doesn't mean that every Fed rate-hiking campaign has been followed by a major stock market decline, because that certainly isn't the case. Rather, it implies that while a Fed rate-hiking campaign will not necessarily bring about a major stock market decline, it could, under the current system, be a prerequisite for such an event. To put it another way, it implies that the probability of a major stock market decline getting started will be very low if monetary policy is either accommodative or becoming increasingly accommodative.

Before going any further, two clarifications are in order. First, once a major stock market decline begins it will usually run its course regardless of the Fed's attempts to prop-up prices. The point is that no major stock market decline has ever STARTED -- at least, not over the past 80 years -- while the Fed has been cutting interest rates or maintaining interest rates at a low level. Second, we are not suggesting that the stock market would trend upward indefinitely in the absence of Fed attempts to tighten monetary policy. Fed rate-hiking campaigns are invariably reactions to signs of an inflation problem, so it is probably more accurate to say that no major stock market decline since the late-1920s ever started until some time after the signs of an inflation problem became so blatant that even the Fed could see them.

Today's official interest rate is effectively zero and the Fed has promised to keep it that way for a considerable period. It seems that the Fed's plan is to maintain an ultra-easy monetary policy until employment begins to pick up, but the reality is that it will only be possible for the Fed to maintain its current stance until an inflation problem becomes undeniable. During the 1970s and early 1980s, for example, the Fed was forced by blatant evidence of an inflation problem to aggressively hike its official interest rate target in parallel with high-and-rising unemployment and a very weak economy.

The idea we are working around to is that the next major stock market decline probably won't start until some time after the Fed begins to hike its interest rate target, which won't happen until after the evidence of an inflation problem becomes obvious to all.

The above statement meshes with our view that the most likely intermediate-term stock market scenario involves the S&P500 Index peaking near its current level, and then, rather than immediately embarking on another major decline, spending up to 12 months oscillating within about 10% of its peak before beginning to trend downward. As well as being consistent with the monetary backdrop, this scenario is in line with the 1937-1942 and 1980-1982 stock market models discussed in previous commentaries.

The counter-argument is that the monetary backdrop doesn't matter because the current stock market rally is only a counter-trend move within the context of the major decline that began in 2007. According to this view of the financial world, the 2009 stock market rally is akin to the first of the counter-trend rebounds that occurred within the major decline of 1929-1932.

We are in full agreement with the idea that the current stock market rally is the counter-trend variety, but the monetary backdrop is always extremely important and today's monetary backdrop is diametrically opposite to that of 1930. This actually makes the long-term outlook for the US economy worse today than it was in 1930, but, at the same time, it means that equity prices are unlikely to collapse the way they did during 1930-1932. Also, the longer the current rally lasts the more implausible the 1930 comparison will become (from a stock market perspective). The reason is that although today's rally has done no more than the 1930 rebound in terms of retracement percentage, it has already lasted almost 3 months longer if measured by the Dow Industrials Index and almost 7 months longer if measured by the NASDAQ100 Index.

Most "fundamental analysis" is trend-following in disguise

We've noticed that many commentators on the financial markets look at the price action and then spin a "fundamental" story that matches the price trend. This, however, is a pointless exercise, because for fundamental analysis to have any value it must be independent of price action. After all, the main investment-related purpose of fundamental analysis is to identify discrepancies between price and value or between perception and reality.

Current Market Situation

In last week's Interim Update we mentioned the bearish divergence that has occurred over the past month between indicators of the stock market's internals (the Advance-Decline Line, for instance) and the senior stock indices. Symptomatic of this divergence is the relatively poor performance of the Russell2000 (R2000) Index since mid September. The R2000 Index is made up of 2000 small-cap stocks.

The following chart shows that the R2000 moved well below its 50-day moving average during the second half of October. It then did no more than rebound to this moving average during the November rally that pushed the senior stock indices to marginal new highs for the year.

The R2000 has support at 550 and at 475. In our opinion, the lower of these support levels defines the maximum downside risk over the coming few months.

Investors treated WalMart (WMT) as a safe haven during the first 11 months of the 2007-2009 stock market decline, causing it to trend upward while the broad market trended downward. Interestingly, and ominously if it is a sign of increasing risk aversion, WMT has again begun to do well on both a relative and absolute basis.

We take WMT's recent strength as another piece of evidence that the broad stock market is close to a top.

This week's important US economic events

Gold and the Dollar

Gold

Current Market Situation

Either gold has entered blow-off mode (not likely, but possible) or it will soon begin to 'correct'. A normal short-term correction would take the gold price down to $1050-$1070.

We are presenting the following weekly charts to counter the increasingly popular idea that gold has entered 'bubble territory'. At the bottom of each chart is a 60-week rate-of-change (ROC) indicator.

The first chart shows that when platinum was peaking in early 2008 its 60-week ROC was 100%, meaning that it had doubled over the preceding 60 weeks.

The second chart shows that when oil was peaking in mid-2008 its 60-week ROC was around 120%, meaning that it had more than doubled over the preceding 60 weeks.

The third and final chart shows that gold's 60-week ROC is presently around 30%, and that gold broke out to the upside from a lengthy basing pattern only 7 weeks ago. It looks 'overbought' on a short-term basis, but does not appear to be remotely close to 'bubble territory'. By way of comparison, when gold was peaking in 1974 its 60-week ROC was above 150%, and when it reached its ultimate peak in January of 1980 its 60-week ROC was in excess of 200%.

Quick note regarding "tungsten gold bars"

A story about gold bars being filled with tungsten has been doing the rounds. We think that this story should be filed under "unadulterated hogwash".

There are very good reasons to be bullish on gold. We wish that some gold bulls would stop giving the rest of us a bad name by spreading ridiculous rumours.

Gold Stocks

The Big Picture

Below is the long-term weekly chart of the Barrons Gold Mining Index (BGMI) that we show from time to time.

One plausible 'big picture' scenario is that the gold sector's current long-term bull market, which began in November of 2000, is following a similar pattern to the bull market that extended from the early-1960s through to 1980. If so, the current bull market will have three major upward legs and we are now in the early part of the bull market's second major upward leg (roughly at the equivalent of 1971).

The comparison with the previous long-term bull market is one reason not to expect a spectacular upside blow-off over the months ahead. To be at the point where a greatly accelerated advance gets underway we would have to be nearing the end of the bull market's third (final) major upward leg.

Another reason to believe that the gold sector's bull market has many years to run, and is therefore not yet close to the point where dramatic upward acceleration will occur, relates to the broad stock market's valuation. As explained in the past, long-term gold bull markets tend to go hand-in-hand with long-term equity bear markets, where a long-term equity bear market is defined as a 1-2 decade period during which equity valuations (not necessarily nominal prices) trend downward. Previous long-term equity bear markets have continued until the average price/earnings ratio has dropped to single digits and the average dividend yield has moved above 5%. Given that today's valuations are more like those found near the tops of long-term bull markets than near the bottoms of long-term bear markets, this suggests that the current equity bear market -- and, by extension, the current gold bull market -- is not remotely close to its end.

Current Market Situation

The HUI's advance from last year's low has been by far the strongest intermediate-term advance of its 9-year bull market. The main reason for the uncommon strength is that gold stocks were pushed down to absurdly low levels relative to gold bullion during last year's panic. The gold sector's crash created one of the biggest discrepancies we've ever seen between the price and the "fundamentals", setting the stage for the huge rebound that has since occurred.

As noted in recent TSI commentaries, there's a significant risk that the HUI is now close to an intermediate-term peak. However, gold stocks are generally still under-valued relative to gold bullion and the recent price action suggests that there is the potential for the overall advance to extend into the first quarter of next year. Also, although it is certainly extended to the upside the HUI is not quite as 'overbought' as it was at the early-June or mid-September highs (to become as 'overbought' as it was at the aforementioned highs the HUI would have to surge to the low-500s this week).

What we hope and expect will happen is that a multi-week pullback will begin very soon (if it didn't already begin last week). We are hoping for such an outcome, despite having substantial exposure to junior gold stocks, because a pullback at this time would give us more clues as to what we can reasonably expect over the months ahead. In particular, a pullback to, say, the HUI's 50-day moving average (now at 433 and rising at the rate of about 8 points per week) and then a rise above the November high would suggest to us that the overall rally was going to last until at least March of 2010.

The following daily chart shows that the HUI is now challenging resistance at 475-480. Just above that lies the resistance defined by the all-time high of March-2008. It really would be extraordinary if the HUI returned to its all-time high within 14 months of its October-2008 crash low.

Currency Market Update

The top section of the following chart shows the Dollar Index and a moving-average (MA) envelope (the envelope is determined by the Dollar Index's 200-day moving average +/- 8%), while the bottom section shows the Dollar Index's 250-day rate of change (ROC). This chart's purpose is to show that a) including the past week, there have only been 7 occasions since 1990 when the 250-day ROC was around -15%, and b) on 5 of the 6 earlier occasions when the Dollar Index found itself in a similar position, a tradable multi-month rally ensued. The lone exception was early-2003, when the Dollar Index could only manage a short bounce before resuming its downward trend.

The next chart shows that the Dollar Index remains within the downward-sloping channel that began to form in June. It also shows that the dollar's downward momentum peaked in June and has been gradually diminishing ever since (as indicated by rising trends for the RSI and the MACD shown at the bottom of the chart).

To signal that a low is in place the Dollar Index would have to break decisively above its channel top. A daily close above 77 would do it.

Although the price action hasn't yet confirmed a low, the potential for a sizeable US$ rebound clearly exists. At the same time, the declining downward momentum and the proximity to major support at 71-74 suggests limited additional short-term downside risk. We have therefore upgraded our short-term US$ outlook to "bullish".

If the Dollar Index has bottomed then its most likely path over the coming months will encompass a rally lasting a few weeks followed by a decline to test the bottom during the first quarter of next year. Such a currency-market outcome would pave the way for a short-term pullback in the gold price followed by a rally to new highs.

The following daily chart shows that the December British Pound has just reversed lower after rebounding to 'test' its early-August peak. Due to its relatively bearish fundamentals, it would make sense for the Pound to be the first major currency to reach an intermediate-term peak during this year's broad-based shift away from the US$. That is, the Pound's price action makes sense if the Dollar Index is in the process of bottoming on an intermediate-term basis. By extension, a surprising (to us) rise to a new 52-week high by the Pound would suggest that the Dollar Index is not as close as we think to an intermediate-term bottom.

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)

The following chart shows the 8-month (and counting) consolidation pattern of Franco Nevada (TSX: FNV). It's hard to argue that gold-related investments are in 'bubble territory' when one of the two premier gold royalty stocks has a chart pattern such as this.

FNV has resistance at C$31 and support at C$27. The FNV warrants (TSX: FNV.WT) are 'buyable' whenever the stock drops to near support.

    New Gold (AMEX: NGD, TSX: NGD). Shares: 387M issued, 471M fully diluted. Recent price: US$3.62

It was announced on Thursday that a Mexican court had nullified the Environmental Impact Statement (EIS) relating to NGD's Cerro San Pedro (CSP) gold/silver mine, leading to the Mexican environmental enforcement agency ordering the suspension of mining at CSP. This 'out of the blue' bad news naturally caused NGD's stock price to tank. Specifically, the stock price fell from US$4.35 to US$3.42 during the hours following the news, before recovering a little to end the week at US$3.62.

The nullification of the EIS is the latest in a series of attempts by a small group of non-locals to disrupt the CSP mine. These attempts began years ago, during the project's construction phase.

NGD is taking the necessary legal actions to address this situation and will almost definitely be able to resume mining in the future, but we have no way of estimating how far in the future. Things could be favourably resolved in a week, or it could drag on for months.

Prior to last week's unexpected development we said that NGD had become fully valued and that a drop to the low-US$3 area would be required to justify new/additional investment. In other words, even without the CSP uncertainty we would not be looking to buy the stock at its current price.

There were good opportunities to sell NGD shares over the past few weeks and there may be a good opportunity to buy them in the not-too-distant future, ideally following a sector-wide correction and some information as to when the CSP issue will be resolved. In the mean time, the appropriate thing to do is...nothing.

    Minefinders Corp. (AMEX: MFN). Shares: 65M issued, 81M fully diluted. Recent price: US$11.36

The following chart shows that junior gold/silver producer MFN has substantial resistance at US$12-$13.50. It would, we think, also be fully valued in the aforementioned range.

We suggest making a partial exit from MFN near the current price and a complete exit above US$13. We will remove MFN from the TSI Stocks List if it trades above US$13.00 between now and year-end.

Chart Sources

Charts appearing in today's commentary are courtesy of: