-- Weekly Market Update for the Week Commencing 24th October 2016

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

"Price inflation" is not the biggest problem

Summary of current thinking/positioning

1) Thinking that short-term bottoms are in place for gold and the associated mining indices, but expecting that the overall corrections will extend into Q1-2017 and that multi-week rebounds from the recent lows will be followed by tests of the lows.

2) Expecting that 2017-2018 will be a very bullish period for commodities, but acknowledging that the early-2016 lows could be tested prior to the start of the aforementioned bullish period. Gradually building up long-term exposure to non-gold commodities and simultaneously hedging against short-term weakness via EEM and USO put options.

3) Thinking that the US stock market has commenced a meaningful 1-2 month decline and positioned for such an outcome via QID call options.

4) Thinking that the Dollar Index is close to a multi-week top, but concerned that following some consolidation it will resume its advance and break upward from its 20-month horizontal range.

5) Maintaining a large cash reserve in recognition of the downside risk in almost all equities (current cash percentage is around 50%), but looking for opportunities to reduce cash and add to gold plus commodity exposure.

No Interim Update this week

Please note that due to our travel schedule there will be no Interim Update this week. We will, however, send out an email alert if necessary.

Commodities

General

Our expectation since the beginning of this year has been for a choppy recovery in commodity prices from major lows during the first quarter. Also, we've speculated over the course of the year that in some commodity markets the recovery will possibly include a test of the Q1-2016 lows before a strong upward trend gets underway.

If there is going to be a test of the Q1-2016 lows it will most likely happen in Q1-2017, although it could happen anytime from November of this year through to mid-2017. The most likely cause of the commodity-price weakness will be an upside breakout and ensuing 2-4 month surge in the Dollar Index, although industrial commodities could also be pressured downward by a stock-market decline.

This year's price action in the commodity markets has generally been in line with our expectations, although it's way too early to declare victory. Not that it ever makes sense to declare victory in the financial markets, since the struggle is never-ending.

Oil

The oil price made a marginal new high for the year last week. It could move a little further into new-high territory (for the year) this week, but in the absence of a pronounced turnaround in the Canadian dollar (C$) a near-term move to new 2016 highs by the oil price should be viewed as a selling opportunity.

In addition to the bearish divergence between oil and the C$, the COT (Commitments of Traders) situation is a reason to be concerned about short-term downside risk in the oil price. The concern is that the speculative net-long position in NYMEX oil futures surged over the past three weeks and is now at its highest level since oil was trading at around $100 in Q3-2014.

A daily close below $49 would be an early-warning signal that oil has commenced a significant downward correction. Once it begins, the correction will probably extend at least as far as the high-$30s.



Natural Gas (NG)

NG was one of the weakest commodity markets during the first two months of this year, but since early-March it has been one of the strongest. We think that the rally from the March low is the beginning of a cyclical bull market but that a short-term top was put in place last week.

There will probably be a few months of consolidation prior to the start of the bull market's second leg.



Copper

Our most recent mention of copper was in the 3rd October Weekly Update, when it was trading at US$2.21. At that time we wrote:

"Considering the price action, the Commitments of Traders data and the performances of other markets, it's likely that the current multi-week rally will end near $2.25 and be followed by a multi-week decline to $2.10 or lower."

The multi-week rally ended at $2.22 (close enough) and the price has since dropped back to $2.09.

As illustrated below, there is trend-line support at the current price of $2.09 and short-term lateral support a little lower at around $2.07. It therefore won't be surprising if a 1-2 week rebound soon gets underway. However, lower prices are likely prior to a sustained turn to the upside.



Taking into account nothing except for the chart pattern, a daily close below $2.07 would suggest that copper was heading for a test of the January-2016 bottom in the $1.90s and a daily close above $2.23 (not expected, but not out of the question) would suggest that the short-term danger had passed.

The Stock Market

Conflicting Sentiment

Apart from a brief burst of fearfulness in the immediate aftermath of the "Brexit" vote in late-June, US stock market sentiment has been complacent over the past 7 months. At no stage has there been the rampant optimism of early-2000, but it has been clear that the average market participant expected nothing bad to happen. This is still the case, despite there being some good reasons to be concerned about downside risk. It's a different story outside the US, though.

The following chart was extracted from an 18th October article at Bloomberg. It is based on a global survey of fund managers with at least $500B of assets under management and reveals that the average cash balance of these fund managers is presently at the highest level since shortly after the September-2001 terrorist attacks. In other words, it seems that on a global basis fund managers are unusually cautious right now.



Sentiment is a contrary indicator, so while the sentiment situation in the US has bearish connotations the sentiment situation outside the US has bullish connotations.

Conflicting Price Action

Sentiment usually follows price. Therefore, considering the different sentiment situations inside and outside the US it is not surprising that the US stock indices look 'toppy' and some important stock indices outside the US appear to be completing long-term bases.

Here is a chart of the US S&P500 Index (SPX) showing important lateral support at 2120. Closing below 2120 would complete a topping pattern.



The SPX has shown remarkable resilience over the past two weeks in that the 'bears' have not only been unable to push it through 2120, they've also had difficulty pushing it down to near 2120. The reason for the difficulty is probably explained by the trend-line drawn on the above chart. This trend-line dates back to the January low and appears to be acting as support.

There's currently a lot at stake, because if the SPX simply closes more than 1% below its present level it will be difficult for any objective technical analyst to argue that the upward trend from the January-2016 bottom is still intact.

Now take a look at the following chart of the EURO STOXX 50 Index (STOX5E). This chart shows a potential basing pattern with resistance at 3100-3150.

If the STOX5E closes more than 3% above its present level it will complete a base capable of supporting a substantial rally.



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

Is it a bull market, yet?

We've seen a lot of commentary in which the author assumes that this year's rally in the gold price is the first rally in a new cyclical bull market. It could well be, but at this stage -- as the saying goes -- the jury is still out. At this stage it's best to reserve judgment, because blindly assuming something that might not be true can lead to large losses.

There are two main reasons that 'the jury is still out'. First and foremost, at no time over the past 12 months have gold's true fundamentals* been definitively bullish. Instead, they have oscillated around neutral. There have been periods, such as February-April of this year, during which the fundamentals had a bullish skew, but after tipping in the bullish direction for at most 3 months they have always tipped in the other direction for a while.

Considering what central banks have been doing to the official forms of money our statement that the fundamental backdrop is not definitively gold-bullish could seem strange. After all, the ECB is firmly committed to asset monetisation and negative interest rates based on the belief that these counter-productive policies are working, and the Federal Reserve is seemingly afraid to take even a small step towards "policy normalisation" despite its targets for employment and "inflation" having been reached more than three years ago. However, gold's fundamentals are determined by confidence, and the general level of confidence is often not determined by sound principles of economics. To put it another way, whether the fundamental backdrop is bullish or bearish for gold is determined by the general perception of what's happening on the economic and monetary fronts rather than what's actually happening. Perception will eventually move into line with reality, but in the meantime years can go by.

Since early-July the true fundamentals have been neutral at best and over the past month they have, on balance, been slightly bearish. However, they are constantly in flux and it currently wouldn't take much to shift them to bullish or make them definitively bearish. In particular, two of the most important fundamental drivers of the gold price are neutral and positioned in a way that they could soon shift decisively in one direction or the other. We are referring to the real interest rate, as indicated on the first of the following charts by the 10-year TIPS yield, and the US yield curve, as indicated on the second of the following charts by the 10yr-2yr yield spread.

The real interest rate would turn decisively gold-bullish if the 10-year TIPS yield were to break downward from its recent 4-month range and decisively gold-bearish if the 10-year TIPS yield were to break upward from its recent 4-month range. The yield curve, which has been gold-bearish for the bulk of the past three years, would turn decisively gold-bullish if the 10yr-2yr yield spread were to break above its September high. As an aside, a break by the 10yr-2yr yield spread above its September high would also be a recession warning and a bearish omen for the stock market.

The price action is the other reason for the uncertainty as to whether this year's rally marked the start of a cyclical bull market. We are referring to the fact that of all the rallies in gold and the gold-mining indices from multi-year lows, this year's rally is most similar to the bear-market rebound of 1982-1983.

The gold rally that began in December of 2015 will differentiate itself from the 1982-1983 bear-market rebound if the gold price closes above its July-2016 peak AND the HUI closes above its August-2016 peak.

Fortunately, you don't need to be a fervent believer in the 'new gold bull market' story to make money from the rallies in gold and gold stocks. You will just be a bit more cautious than the bulls with blind faith.

    *Five of the six "true fundamentals" were mentioned in the September-2015 TSI blog post linked HERE. The sixth is the general trend in commodity prices as indicated by a broad-based commodity index such as GNX.

Current Market Situation

Gold's price action leaves open the possibility that there will soon be a quick decline to support in the low-$1200s to end the short-term downward trend. The main reason to suspect that this is not going to happen and that a short-term bottom was put in place at $1243 on 7th October is the performance of the gold-mining sector.



We caution against expecting much from gold over the remainder of this year. Short-term downside risk is no longer a big concern, mainly because the price action of the past few weeks has substantially reduced the collective net-long position of leveraged speculators in gold futures. The speculative net-long position will probably shrink some more before the correction is over, but it no longer constitutes a threat. At the same time, with the 'true fundamentals' neutral-to-slightly-bearish it isn't likely that the gold price will make a solid break above resistance in the low-$1300s anytime soon.

Our guess is that gold will spend most of the time between now and year-end in the $1250-$1300 range, with moves outside this range being short-lived.

Platinum

Platinum is the precious metal with the best intermediate-term risk/reward. This is due to the potential for a supply shock within the next year and the fact that the platinum price is near multi-decade lows in real terms and relative to gold.

Apart from a brief period in 1982, since 1970 the price of platinum has never been lower relative to the price of gold than it is today. The following chart shows platinum relative to gold since 1980. There are plausible scenarios under which platinum could become cheaper, but when you get a chance to buy a useful and much-sought-after commodity near a 50-year low in relative terms and real (inflation-adjusted) terms, it is generally a good idea to grab the opportunity.



We have begun to grab the opportunity and late last week made the first purchase of physical platinum* for our own accounts. We have no idea if the platinum price has hit rock bottom. In fact, if we had to bet one way or the other we'd bet that it will trade lower within the next few months, but there's no good reason to make such a bet. Instead, by taking an initial position (in this case about one-third of a full position) we cover ourselves against the possibility that a substantial rally is about to begin while hoping for a chance to add to the position at lower prices.

With regard to how much lower the price could get, now that support at $950 has given way a test of the December-January lows near $825 is a realistic possibility. However, if a test of the lows of the past 12 months is going to happen it will likely wait until early next year. In the interim there will probably be a multi-week rebound.



    *The simplest way to get exposure to physical platinum is via an ETF. Examples are PPLT on the NYSE and ETPMPT on the ASX.

Gold Stocks

The following two paragraphs from last week's Interim Update are worth repeating:

"The fact that the HUI has quickly made it back to near important former support (now resistance) means the chances have improved that a multi-month bottom was put in place over the past two weeks at 195. In other words, while a quick spike to a new low is still possible, it is now more likely that the 1-2 month rebound that we've been anticipating has begun. As previously explained, this rebound is expected to form part of a corrective process that extends into the first quarter of 2017.

Note that even if a short-term bottom is in place for the HUI it isn't reasonable to expect significant additional gains within the coming few days. This is because the quick rebound to the breakdown area (220-225) is likely to generate a wave of selling by traders who were caught off-guard by the plunge from the 220s down to the 190s. That is, some consolidation is likely over the days ahead even if a 1-2 month rally is underway."

Some consolidation is what we got over the final two days of last week. As illustrated by the daily chart displayed below, the HUI ended the week with two small down-days while remaining above its 20-day MA.



There is likely to be at least one test of the October low, but the historical record suggests that there will be a few more weeks of rallying before the HUI starts making its way back to the 190s.

The HUI has resistance at 220-225 and then at the 50-day MA near 230. In other words, there are significant obstacles immediately ahead that could stop the rally. However, resistance at 250 is the most likely target for the next multi-week top. That's regardless of whether the advance from the January-2016 bottom turns out to be the first leg of a bull market or a strong bear-market rebound.

The Currency Market

The Euro

The ECB's current asset monetisation program has a 'soft' end date of March-2017, but the general expectation is that the program will be extended. Depending on what happens in the meantime, an extension would likely occur via a gradual tapering of the asset purchases. ECB chief Draghi intimated as much in a press conference last week.

One of the major economic problems facing the euro-zone is that Draghi and his ECB cohorts truly believe that their policies are working. It doesn't matter how bad things get, the belief is that they would be even worse if not for the ECB's money-pumping and interest-rate suppression. That's why the situation is hopeless.

Considering the ECB's actions and the fundamental backdrop, the euro has held up remarkably well. There was a marginal downside breakout last Friday when the euro closed below its late-June low, but the following chart shows that it remains well within the confines of the channel that dates back to the March-2015 bottom.

We don't have a strong opinion on what the euro will do over the weeks ahead, but our guess is that it will work its way down to the channel bottom at 106-107.



The Commodity Currencies

We discussed the A$ and the C$, the senior "commodity currencies", in last week's Interim Update. We just wanted to point out that the A$ was unable to sustain last Wednesday's upside breakout and the C$ is now very close to a downside breakout.

Therefore, the currency market is continuing to warn of short-term weakness (meaning: warning of significant downside within the next couple of months, not necessarily the next few days) in the commodity markets. The warning will become stronger if the C$ closes below 74.5 and the A$ closes below 75.0.

Here's an updated chart of the C$.



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 21st October 2016:

[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%, P&P = Proven and Probable, PEA = Preliminary Economic Assessment, PFS = Pre-Feasibility Study]

  *Alkane Resources (ALK.AX), a company with a Feasibility-stage specialty-metals project (the Dubbo Zirconia Project - DZP) and an operating gold mine in Australia, issued its annual report for the financial-year ending 30th June 2016. The balance sheet included in the report showed that ALK had no debt, A$28M of working capital and A$190M (A$0.38/share) of net assets at 30th June.

In FY2017, ALK is expected to produce 65K-72K ounces of gold at an AISC of A$1200-$1300/oz (US$912-$988/oz) and advance its specialty-metals project to a construction decision.

ALK's price is up by more than 150% since the stock was added to the TSI List only three months ago. Some profit-taking would be appropriate for risk-management purposes, but there is additional upside potential associated with the DZP.

  *Euro Sun Mining (ESM.TO) advised that it has been granted an exploration permit for an area called "Stanija" located approximately three kilometres east of the company's Rovina Valley gold-copper project in Romania. The area is considered to be highly prospective for gold-copper porphyry-style mineralisation.

Of greater importance is the pending ratification of the mining license for Rovina Valley. This most likely won't happen until after Romania's legislative elections are held on 11th December, but getting the ratification doesn't appear to hinge on any particular election outcome.

In addition to finalising its mining permit, ESM is working on a feasibility study for Rovina Valley. The FS is expected to take the bulk of next year to complete.

  *Evolution Mining (EVN.AX) announced that it is buying the Marsden copper-gold project from Newcrest Mining. Despite Marsden's sizable global resource comprising 1.5B pounds of copper and 1.1M ounces of gold, the acquisition cost is small. Specifically, EVN is making an upfront of A$3M and has committed to pay an additional A$7M if/when a production decision is made.

The Marsden project is located next to the tenement package for EVN's Cowal gold mine in NSW, Australia. It could enable the life of the Cowal mine to be extended, in that the Cowal milling circuit and associated infrastructure could potentially be used to treat ore from Marsden after the Cowal resource has been depleted.

This is a reasonable deal for EVN.

EVN also published its quarterly report for the September-2016 quarter. There were no surprises in the report, with production (205K ounces) and costs (AISC of A$1060/oz) in line with guidance.

At 30th September the company had A$435M of cash and A$195M of debt, but the balance sheet will undergo a big change this quarter due to the payment of A$880M for the purchase of the Ernest Henry stake from Glencore. Assuming similar cash generation by its operations in Q4-2016 as occurred in Q3-2016, we estimate that EVN will end the year with net debt of around A$550M (for example, A$670M of debt and $120M of cash). Considering EVN's likely future cash-flow, this amount of debt is not a problem.

  *Premier Gold (PG.TO) reported that it produced 30K ounces of gold during the September quarter (its first quarter as a gold producer), which is higher than planned and is therefore a good result. This production comes from PG's JV with Barrick Gold at the South Arturo project in Nevada. PG has a 40% stake in the project and is therefore entitled to 40% of the production.

During the December quarter PG will have two gold-producing assets -- the South Arturo mine and the recently-acquired Mercedes mine. The company's total gold production during 2016 is expected to be 100K-110K ounces, meaning that production is expected to be 70K-80K ounces during the final quarter.

Judging by the performance of PG's shares, there is a lot of concern in the market about the economic viability of the Trans-Canada (TC) gold project in Ontario. This project is a 50/50 JV with Centerra Gold and is in the final stages of a Feasibility Study.

Due mainly to delays in the completion of the FS we also have concerns about the economics of the TC project. However, this project is a much smaller part of PG now than it was a couple of years ago. Furthermore, we think that the current stock price is fully justified by PG's other assets, which should mean that there is now more upside than downside risk associated with the TC project's FS.

  *Petrus Resources (PRQ.TO) reported that it recently drilled three new wells, one of which has been brought into production. The newly-producing well has taken PRQ's total production to 8100 boe/d (barrels of oil equivalent per day), which is roughly what the company was producing before selling its Peace River assets for $30M a few months ago.

With the two other recently-drilled wells soon to be brought on-stream, PRQ expects to end the year with total production of 9000 boe/d.

PRQ's operational performance continues to be good. At the same time, it continues to be ignored by the stock market.

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) AAU near US$1.00 (last Friday's closing price: US$1.25)

2) EVN.AX near A$2.00 (last Friday's closing price: A$2.28)

3) PG.TO (last Friday's closing price: C$3.41)

4) PRQ.TO (last Friday's closing price: C$1.97)

5) RMS.AX (last Friday's closing price: A$0.46)

Note that the above list is limited to five stocks. It will sometimes contain less than five, but it will never contain more than five regardless of how many stocks are attractively priced for new buying.

Chart Sources

Charts appearing in today's commentary are courtesy of:

http://stockcharts.com/index.html
http://research.stlouisfed.org/