-- Weekly Market Update for the Week Commencing 24th August 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.

The BULL market in US Treasury Bonds that began in the early 1980s ended in early-2015, but there will be many years of topping action in bond prices and bottoming action in bond yields before major new trends get underway. (Last update: 29 June 2015)

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 2018 and 2020. (Last update: 29 June 2015)

A secular BEAR market in the US 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 2018 and 2020. (Last update: 29 June 2015)

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 2018-2020. (Last update: 29 June 2015)

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Outlook Summary

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

Basic Gold Market Facts

Everything is obvious with the benefit of hindsight

The meaning of the 6-year low in GLD’s bullion inventory

The 7-Year Cycle

In the 27th July 2015 Weekly Update we discussed the 7-year cycle as it relates to the US stock market. Purely by coincidence or not, beginning in 1966 the S&P500's performance at 7-year intervals (1966, 1973, 1980, 1987, 1994, 2001, 2008) has usually been well-below-average and/or contained an abnormally-large peak-to-trough decline. Our aim was to consider what, if anything, this cycle suggested was in store for S&P500 over the remainder of the year. The main reason for revisiting the topic in today's report is to take a broader view of the cycle.

Taking a broader view of the 7-year cycle is something we first did more than two years ago in the 3rd April 2013 Interim Update. Here's what we wrote back then, including the embarrassing final sentence:

"We don't put a lot of emphasis on cycles, but we also don't completely ignore them. In looking backwards and forwards from the 1987 stock market crash, we recently noticed a 7-year cycle of major turning points and/or financial crises. We aren't claiming that this is an important new discovery, as we are sure that many other people will have previously identified the same cycle.

The cycle begins in 1966, which is when the secular bull market in US equities that started in the 1940s peaked in real terms.

The 7-year anniversary of the 1966 stock market peak occurred in 1973, which is when the US stock market successfully tested its 1966 nominal peak and embarked on a huge 2-year decline. 1973 also ushered in the first oil crisis and one of the worst recessions of the past 100 years.

7 years later, in 1980, some of the biggest trends of the preceding 10-15 years, most notably the long-term bull markets in gold and commodities, came to an end.

The next occurrence of the 7-year cycle was 1987, the year of a spectacular global stock market crash.

Rather than a single dramatic event or turning point, there were a few developments at the 1994 cycle anniversary that when taken together can aptly be described as "major". Specifically, in 1994 there was a) an economic/currency crisis in Mexico that affected markets around the world, b) the Orange County bankruptcy in the US, c) the biggest decline of the past 20 years in the US Treasury Bond market, and d) a stock market correction in the US that resulted in the most bearish sentiment (as measured by Investors Intelligence) of the past 30 years.

The last two anniversaries of the 7-year cycle were the fateful years of 2001 and 2008. All of our readers will remember that 2001 was the year of the most important terrorist attack ever on US soil and a dramatic stock market collapse, and that 2008 was the year of a global financial crisis and one of the worst stock market declines in history.

The 7-year cycle next comes into play in 2015. One possibility is that 2015 will be marked by another global financial crisis and a major peak in the gold market."

In 2015 there's probably not going to be a global financial crisis, although localised economic/financial crises are underway or brewing in various parts of the world (for example, Greece, Ukraine, Brazil and China) and a mini-crisis could be developing in the US high-yield bond market. In addition, there will obviously be nothing like a major peak in the US$ gold price this year, but based on the current state of affairs there's a good chance of a major gold-market turn from down to up. There's also a good chance that the combination of dramatic price declines and extraordinarily negative sentiment has set the scene for major turning points (from down to up) in commodity prices and inflation expectations. And lastly, there remains a realistic possibility that 2015 will usher-in the ultimate high for the cyclical bull market in US equities.

Commodities

Overview

As a bull market nears its end, extremely-high price forecasts not only become prevalent, they also become generally accepted as reasonable. At least, they don't get laughed at. Almost regardless of how high they are they have a ring of plausibility because they are based on extrapolations of trends that have been in progress for a long time -- trends that everyone has become accustomed to. By the same token, extremely-low price forecasts gain in popularity and become generally accepted as reasonable as a bear market nears its end. Again, this is because the forecasts are based on extrapolations of trends to which everyone has become accustomed. This is relevant because extreme-low commodity price forecasts are now being bandied about and hardly anyone is batting an eyelid.

Oil is the best example. With the oil price having just breached its March-2015 bottom in the low-$40s, sub-$30 price forecasts are common and sub-$20 price forecasts are being taken seriously. Furthermore, fundamental analysts and technical analysts are generally in agreement that the oil price has nowhere to go from here except down. The 'fundamentalists' think that the market will be weighed down by excess supply for a long time to come, whereas the technicians are placing rulers on charts and measuring the distance that the price will have to fall to complete the patterns they perceive. If only markets were that simple!

Oil

We thought that oil was tracing out a bottoming pattern during the first half of this year that was along the lines of either the 1986 bottom (more likely) or the 2009 bottom (less likely). If this view of the oil world had been correct then the decline from the Q2 high should have gone no further than the March low (a successful test of the March low would have been consistent with the 1986 bottoming pattern). However, the following weekly chart shows that the oil price has just broken decisively below its March-2015 low.



On a short-term basis the price action can no longer be compared to the 1986 bottoming pattern, but we continue to like the comparison between the 1980-1986 oil bear market and the 2008-2015 oil bear market.

The similarities between these two periods are most clearly evident when prices are adjusted for "inflation" (US$ depreciation) using the method we first outlined in December-2010. To illustrate what we mean, here's a monthly chart of the inflation-adjusted oil price with the two bear markets indicated.



For the 2008-2015 bear market to match the 1980-1986 bear market in terms of the inflation-adjusted peak-to-trough decline, the price would have to fall to around $33 in current-dollar terms. However, the current bear market has already exceeded the earlier one in terms of momentum (the weekly RSI bottomed at around 15 in 1986 and 10 this year) and duration.

Copper

A couple of weeks ago copper's Commitments of Traders (COT) situation became consistent with a short-term price bottom, but the price has overshot as it did in December-January. The price decline has continued, although momentum has waned and the copper market was resilient in the face of a stock market plunge during the final two days of last week.



The setup is in place for a short-term bottom and at least a 2-4 month rally in the copper price, but additional weakness in the stock market and an associated reduction in economic growth expectations over the coming month could delay the start of a tradable rebound.

Another consideration is that there is a tendency for gold to lead copper by at least two months at important price bottoms. At this stage it looks like the US$ gold price bottomed on 24th July, which, based on how price lows have formed over the past 15 years, suggests that the copper price won't bottom-out until at least the second half of September.

The Stock Market

The US

Current Market Situation

The S&P500 Index (SPX) finally closed below its March low on Thursday 20th August. It then confirmed the breakout by accelerating downward on Friday and ending the week at its lowest level of the year.



We've been anticipating a 10%-20% decline in the SPX that would bottom by mid-October at the latest. Such a decline could be either the first leg of a cyclical bear market or the first meaningful correction since 2011 in an on-going cyclical bull market. Our guess is that it would be the former, but from a practical speculation standpoint it doesn't matter at this time.

As well as being consistent with sentiment, bearish divergences in the market action and the proclivity for the well-known 7-year cycle to usher-in larger-than-usual peak-to-trough declines, a significant downturn during July-October is consistent with a much less well-known cycle. This less well-known cycle was described as follows in the 20th July Weekly Update:

"The US stock market has made an important mid-July peak at 8-9 year intervals beginning in 1990. Prior to last week there didn't appear to be a realistic chance of a mid-July peak this year, but the nearly-straight-up move over the past several days has brought the 8-9 year mid-July cycle into play. For it to remain in play the SPX should start to roll over by the end of this week, although it could make a new high during the first half of the week in reaction to not-as-bad-as-feared earnings news and a further abating of Greece's crisis (Greek banks will apparently re-open on Monday 20th July).

Here are SPX charts illustrating the cycle noted above. The charts show the mid-July peaks of 1990, 1998 and 2007. In both 1990 and 1998 the mid-July peak was followed by a 20% decline to a low in the second week of October, whereas in 2007 the decline from the mid-July peak bottomed in mid-August and was 'only' about 11%."

The SPX was at 2126 at the time and began to roll over soon after, thus keeping the price action in line with the 8-9 year mid-July cycle.

The Dow Industrials Index is already down by 10% from its high and has therefore already achieved the minimum expected decline. However, the SPX is far more important to most market professionals, because it is the dominant US stock index for futures trading and performance benchmarking.

At the end of last week the SPX was down by 7.7% from its high. To extend the decline to 10% it will have to fall to around 1920.

Each person has to manage their own money as they see fit, but here's our very short-term plan:

1) We will take profits on half of our stock-market put options (we have January-2016 QQQ puts) this week if there is significant additional downside. In particular, we intend to exit half of our puts on Monday 24th August if there is sufficient immediate follow-through to take the SPX down to around 1920. In this case we will look for an opportunity to replace the exited puts with some new put options following a rebound in early September.

2) We intend to take no action (that is, we will retain our full put-option position) if the market begins to rebound immediately and doesn't trade significantly below last week's low during the course of this week. This is a possibility because the market is now very 'oversold' on a short-term basis. In this case we will wait for the better put-selling opportunity that will likely arise by early-October.

The US stock market versus gold

Of even greater significance than last week's SPX break below the March low is the SPX/gold ratio's weekly close below its 50-week MA. As illustrated below, SPX/gold hasn't ended a week below its 50-week MA since Q4-2012. This tells us that the recent reversal could have longer-term importance.



China

It will be interesting to see what happens to the Shanghai Stock Exchange Composite Index (SSEC) this week. This is because a) China's government has drawn a line in the sand at 3500, meaning that it is determined to prevent the SSEC from breaking below 3500, b) the SSEC ended last week at this arbitrary line in the sand, and c) Asian stock markets will be under pressure on Monday in response to the sharp declines in US and European stock markets last Friday.

There's no doubt that China's government has sufficient monetary firepower to prevent a break below 3500, but as was recently the case with the Yuan/US$ exchange rate it could decide to let market forces prevail to a minor extent and to start defending a lower level.



FXI is an ETF that holds large-cap Chinese stocks that trade in Hong Kong. It is not being propped-up by China's government, which is why it has broken well below the equivalent of the SSEC's 3500 line in the sand.

FXI has now retraced the entire 2014-2015 surge.



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

Current Market Situation

In last week's Interim Update we wrote:

"There is some resistance at around $1160 and stronger resistance at $1180-$1200 (a range that contains the 200-day MA). If the price breaks above $1135-$1140 within the next few days then our guess is that a 1-2 week top would be put in place at around $1160, but if we were to get several days of consolidation prior to a break above $1140 then our guess is that the $1180-$1200 range would be reached prior to a 1-2 week top."

As it turned out, the gold price immediately broke above resistance at $1135-$1140 in response to a sudden general increase in risk aversion over the final two days of last week and moved directly to resistance at around $1160. We are referring to the resistance defined by the top of the channel shown on the following daily chart. The gold market is now slightly 'overbought' on a short-term basis, so we won't be surprised if this resistance caps the gold rally for 1-2 weeks. However, volatility is increasing throughout the financial world so it would be dangerous to bet on a pullback in the gold price.



In last week's Interim Update we also wrote:

"...in addition to making guesses regarding price targets we can monitor momentum and sentiment indicators.

With regard to the latter the most useful is probably the Commitments of Traders (COT) situation. In particular, the total speculative net-long position (the inverse of the commercial net-short position) in COMEX gold futures should, at a minimum, move back above 100K contracts prior to the gold price making a top that holds for more than 3 weeks."

As at last Tuesday (the date of the latest COT report), with the gold price at $1117 the total speculative net-long position in COMEX gold futures was only 30K contracts. In other words, as at last Tuesday gold's COT situation was still unequivocally bullish. Unfortunately, we'll have to wait until the end of this week to find out the extent to which the speculative net-long position increased in parallel with the $42 price increase over Wednesday-Friday of last week.

Taking into account the changing financial-market backdrop, sentiment indicators and gold's price chart, there could be some consolidation in the gold market over the next 1-2 weeks and there is likely to be significant additional upside over the next month.

Gold in terms of other currencies

Before gold can break out to the upside in terms of the senior currency it will first have to break out to the upside in terms of the 'lesser lights'.

One of the lesser lights of interest is the Australian Dollar (A$). In A$ terms gold bottomed in 2013, successfully tested its 2013 bottom in November-2014, rocketed up from near a 2-year low in November-2014 to a 2-year high in January-2015, and then 'corrected' for about 6 months. Last week's price action provided evidence that the correction is over and a rise to new multi-year highs is underway. If so, this will be very helpful to Australia-based gold producers such as EVN.AX and RMS.AX.



Gold in terms of other commodities

In terms of the basket of commodities represented by the CRB Index, gold made a new all-time high last week. This means that relative to commodities in general, gold is now more expensive than it has ever been.

There's a good chance that gold's relative strength will persist for a few more weeks, but we suspect that the gold/CRB ratio will make its next intermediate-term top within the coming two months.



Gold Stocks

The HUI rose to its 50-day MA last Thursday. It tried to move beyond this resistance on Friday in response to a small extension to gold's rally, but a sharp decline in the broad stock market got in the way. Although weakness in the broad stock market is always supportive for the gold-mining sector over the long-term and can be supportive for the gold-mining sector in the short-term, during large single-day general-market declines it's not uncommon for gold stocks to be sold along with everything else in a rush to cash (and bullion).



We had 145 in mind as an initial upside target for the HUI. Considering that the HUI is not yet close to being 'overbought' on even a short-term basis, resistance at 145 is still a plausible initial target. However, last week's reversal from the 50-day MA could mean that the first leg of the short-term rally ended at 133 on Friday and that there will be a 1-2 week consolidation prior to the next leg. If so, the most realistic target for the second leg would be the 200-day MA (near 160).

There's no good reason to expect that anything more bearish than a 1-2 week consolidation lies ahead for the gold-mining sector. Sentiment certainly remains constructive, momentum indicators are not yet stretched, the fundamental backdrop is likely to become increasingly gold-bullish if the broad stock market continues to weaken, and gold-mining profit margins are going to expand due to the rise in the gold/commodity ratio.

Last Friday was very much a general risk-off day, which explains why GDXJ, a proxy for the relatively-risky junior end of the gold-mining sector, fell by more than the HUI on the day.

GDXJ has important resistance (the 200-day MA and the top of an intermediate-term channel) near $24. This resistance will probably be tested in September.



The Currency Market

The Dollar Index broke below short-term support at 96.3 last Thursday and then underlined the breakdown by accelerating lower on Friday. This price action lends weight to our short-term view that a decline to the low-90s is underway.



At this stage we are operating under the assumption that a decline to the low-90s over the coming month or so would be part of a wide range of consolidation between 90 and 100. We do not expect a solid break below 90. That being said, there is a realistic possibility that a major top was put in place in March when the Dollar Index briefly rose above 100. This possibility is supported by the fact that hardly anyone outside a small group of 'goldbugs' acknowledges it.

In any case, before we spend much time contemplating whether a short-term decline to the low-90s would more likely be part of a wide consolidation range (as currently suspected) or part of a new US$ bear market, we first need to get the short-term decline.

As it almost always does, the Yen rallied when financial-market risk aversion suddenly increased during the second half of last week. The Yen's up-move took it to a very important range of resistance that begins at 82 (the top of the channel drawn on the following daily chart) and ends at 83 (the early-July rebound peak and the 200-day MA). A weekly close above 83 would not only confirm a short-term trend reversal, it would also be evidence that this currency's bear market was over.



A long position in the Yen is the currency-market position with the most attractive short-term risk/reward. In particular, if the shift away from risk that started to become more pronounced over the final two days of last week continues for a few more weeks then the Yen could quickly gain 10% against the US$.

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 21st August 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]

  *Dalradian Resources (DNA.TO) noted an important change of plan in the MD&A that was issued late in the week before last and in a press release issued early last week. As stated in the aforementioned press release: "Originally, the Company planned to release the results of a Pre-feasibility Study ("PFS") in late 2015. The PFS is now being transitioned to a more advanced Feasibility Study ("FS") supported by an expanded infill drilling program and underground exploration (the "Underground Program")."

This change of plan undoubtedly makes sense, but it probably means that the share price won't get as much of a boost from news flow over the next few months as would otherwise have been the case. Specifically, anticipation of and reaction to a positive resource re-estimate and PFS would potentially have added to the demand for DNA shares during September-December of this year, but under the revised plan there won't be another market-moving milestone until the third quarter of next year.

Also, under the revised plan there will almost certainly be another equity financing between now and the next market-moving milestone. The company is cash-rich at the moment, but it is spending money rapidly and will probably look for an opportunity to raise about C$20M within the coming 6 months. Anticipation of this financing could limit the short-term gains in the stock price.

None of this changes our opinion of DNA as an intermediate-term or long-term speculation. It is a well-run company with an exceptional gold deposit and is currently trading at a price that provides scope for huge upside over the coming 12-18 months. For an exploration-stage mining company it also has relatively low risk. However, it now has slightly less appeal as a short-term speculation.

  *Evolution Mining (EVN.AX) announced its intention to make a takeover bid for Phoenix Gold (PXG.AX), a company in which it already has a 20% stake. The bid is roughly half stock, half cash, and at the A$1.00 pre-bid price for EVN shares valued the target company's shares at A$0.12. We estimate that the cash component of the bid would consume about A$22M of EVN's cash -- an amount that is easily manageable.

The reason for the takeover bid is that PXG owns a large tenement package adjacent to the Australian operations of La Mancha Resources, which are in the process of being acquired by EVN. According to EVN's press release, many of the exploration targets identified by PXG are geologically similar to the Frogs Leg and White Foil mines that will soon be owned by EVN.

This is a sensible move. EVN's management would almost certainly have preferred to wait for additional exploration results from PXG and for the La Mancha acquisition to be 'bedded down' before launching a bid for PXG, but a $0.10/share offer by Zijin Mining for PXG prompted an earlier-than-intended move by EVN.

  *Pretium Resources (PVG) reported the third set of results from its 2015 infill and stope-definition drilling program. As usual for the Brucejack project, several of the holes returned extremely high grades (in the 1,000g/t-5,000g/t range) over narrow (0.5m) widths.

The next important (in terms of market-moving ability) company-specific news for PVG will likely be either a takeover bid for the company or the announcement of a construction-financing deal, with the latter having a much higher probability. We suspect that the construction financing will be 80%-85% debt and 15%-20% equity.

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) EDV.TO in the mid-to-high C$0.50s (last Friday's closing price: C$0.61)

2) EVN.AX in the low-A$1 area (last Friday's closing price: A$1.07)

3) PLG.TO at around C$0.40 (last Friday's closing price: C$0.44)

4) SBB.TO (last Friday's closing price: C$0.37)

5) TGD (last Friday's closing price: US$0.30)

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