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   -- Weekly Market Update for the Week Commencing 24th November 2014

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 ended in 2012. In real (gold) terms, bonds commenced a secular BEAR market in 2001 that will continue until 2018-2020. (Last update: 20 January 2014)

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

Market
Short-Term
(1-3 month)
Intermediate-Term
(6-18 month)
Long-Term
(2-5 Year)
Gold N/A Bullish
(26-Mar-12)
Bullish
US$ (Dollar Index) N/A Neutral
(29-Sep-14)
Neutral
(19-Sep-07)
US Treasury Bonds (TLT) N/A Neutral
(18-Jan-12)
Bearish
Stock Market (DJW) N/A Bearish
(28-Nov-11)
Bearish
Gold Stocks (HUI) N/A Bullish
(23-Jun-10)
Bullish
Oil N/A Neutral
(31-Jan-11)
Bullish
Industrial Metals (GYX) N/A Neutral
(15-Sep-14)
Bullish
(28-Apr-14)

Notes:

1. Our short-term expectations are discussed in the commentaries, but except in special circumstances we won't attempt to assign a "bullish", "bearish" or "neutral" label to these expectations.

2. The date shown below the current outlook is when the most recent outlook change occurred.


3. "Neutral" means that we think risk and reward are roughly in balance with respect to the timeframe in question.

4. Long-term views are determined almost completely by fundamentals and intermediate-term views are determined by a combination of fundamentals, sentiment and technicals.

Speculators too bullish on oil

Compared to the prices of other commodities, we think that $70-$75/barrel is a reasonable price for oil at this time. Therefore, from our perspective the sharp decline in the oil price over the past few months has been a catch-up move that has brought this particular commodity into line with commodities in general. There are, however, three reasons to believe that while the oil price could be close to a short-term bottom, it is probably not yet close to an intermediate-term bottom.

Two of these reasons were outlined in the 17th November Weekly Update. They are: 1) unlike the bearish trends in the many other commodity markets, the bearish trend in the oil market is still young, and 2) relative to the Industrial Metals Index, the oil price is still 10%-15% above the level at which it has most often bottomed over the past 10 years. The third reason is sentiment. More specifically, the Commitments of Traders (COT) data indicate that speculators are currently far more bullish on oil's prospects than they have been at previous intermediate-term bottoms.

The following chart from Sharelynx.com illustrates what we are talking about. The chart compares the oil price with the net oil-futures positions of speculators (the red bars) and commercial traders (the blue bars). Notice that speculators a) were briefly net-short oil futures at the major price bottom in Q4-2008, b) were net-long by about 120K contracts at the 2011 and 2012 correction lows, and c) are presently net-long by 255K contracts. The chart's message is that before a sustainable price bottom is put in place there will probably be sufficient additional price weakness to cut the speculative net-long position in oil futures by at least another 50%.

The resilience of speculative bullishness on oil probably stems from the fact that the bearish price trend is young. Whereas speculative capitulation has already happened in other commodity markets, it still lies ahead in the oil market.

The Stock Market

Last Friday was one of the strangest trading days in years. In reaction to a few words from ECB chief Mario Draghi (discussed in the Gold section of this report), the euro plunged and almost everything else in the world went up; not just in euro terms, but in US$ terms. The US stock market was up, European stocks were up, emerging-market equities were up, gold and all of the other metals for which there are liquid futures markets were up, oil was up, and the T-Bond was up. Even the Yen was up!

When was the last time that the S&P500, the T-Bond, the Dollar Index, the Yen and gold were all up on the same day and how many times has it happened over the past 5 years? Anybody know the answer?

We are aware that many articles in the financial press cited a surprise 0.25% rate cut by the People's Bank of China as the main catalyst for Friday's market action. Although fundamentally irrelevant this undoubtedly did put some upward pressure on prices, but the China news arrived during Asian trading and had little effect on the major futures markets. It was the ECB news later in the day that seemed to light a fire under the most important markets.

The S&P500 continues to look bullet-proof and made another new all-time high last Friday, but the US stock market continues to be rife with divergences that signal danger ahead. For example:

1) The NYSE Composite Index (NYA) has still not exceeded its July-September double top.



2) The Bank Index (BKX) is yet to break above its March-2014 high. Moreover, the BKX/SPX ratio is testing its lows of the past few months and is threatening to break to a new 18-month low. Note that a downside breakout by BKX/SPX would be bullish for gold.



3) High-yield bond funds such as JNK and HYG are well below the highs made during June-September of this year.



4) The number of individual stocks making new 12-month highs is remarkably low considering the performances of the senior stock indices.

On a long-term basis, the current position of the SPX/USB ratio (the S&P500 Index divided by the T-Bond price) is similar to its position near the major top in Q1-2000. As illustrated by the following weekly chart, there has been a break below the 50-week MA and then a rise to a lower high.

This week's significant US economic events (The most important events are shown in bold)

Date Description
Monday Nov 24 Dallas Fed Mfg Survey
Tuesday Nov 25 Q3 GDP (revised)
Case-Shiller Home Price Index
Consumer Confidence
Wednesday Nov 26 Durable Goods Orders
Personal Income and Spending
New Home Sales
Consumer Sentiment
Pending Home Sales
Thursday Nov 27

All US markets closed

Friday Nov 28 Chicago PMI

Gold and the Dollar

Gold

Why gold's long-term bull market is not over

"We will do what we must to raise inflation and inflation expectations as fast as possible, as our price-stability mandate requires," ECB president Mario Draghi said at a conference in Frankfurt on Friday. Shorter-term inflation expectations "have been declining to levels that I would deem excessively low," he also said.

He went on to say: "There is a combination of policies that will work to bring growth and inflation back on a sound path. If on its current trajectory our policy is not effective enough to achieve this, or further risks to the inflation outlook materialize, we would step up the pressure and broaden even more the channels through which we intervene, by altering accordingly the size, pace and composition of our purchases."

Which means that it is official: Mario Draghi is a complete moron.

We now have the head of the BOJ overtly attempting to trash the Yen and the head of the ECB desperately looking for politically-acceptable ways in which he can trash the euro. This causes the US Fed to temporarily look prudent, but have no fear -- the Fed will start taking new measures to trash the US$ a few months into the next bear market in US equities.

It's not so much that modern central bankers, when faced with a weakening economy, don't know what to do other than create more money in a ridiculous effort to raise prices, as if a higher cost of living is what the average wage earner really needs at a time when the economy is struggling. It's that they genuinely believe that when they take actions designed to depreciate money and distort the price signals upon which investment decisions are based they are acting in the best interests of the broad economy. They are 100% committed to counterproductive policies.

Despite the price action of the past two years, this all but guarantees that gold's long-term bull market is not over.

Current Market Situation

Triple bottoms are rare, so when gold dropped to the vicinity of its June-2013 and December-2013 bottoms in early-October of this year and then rebounded, in the process creating a 'triple bottom' at around $1180, an eventual break below $1180 became likely. At the time we thought that a breach of the 'triple bottom' would wait until the first half of 2015, thus postponing the end of gold's cyclical bear market until then. However, when the breach occurred at the end of October it became more likely that a bear-market bottom would be put in place during October-November of this year. Furthermore, the fact that gold was able to reverse course and move back above $1180 two weeks after breaking below this important support level makes the preceding downside breakout look false. This is evidence that a bear-market bottom is in place.

Silver, on the other hand, is in a weaker position, having broken below major support in September and having subsequently failed to rebound far enough to even test its breakdown. There is therefore no evidence, yet, that silver's bear market is over.

As we've explained in the past, it would not be unprecedented for gold's bear market to end several months earlier than silver's bear market, as this is exactly what happened in 2001. As we've also explained in the past, it is typical for gold to outperform silver during the first two years of a cyclical precious-metals bull market.

The US$ gold price continued to rebound last week and has now achieved consecutive weekly closes above the $1180 (+/- $2) major demarcation level. As noted above, this suggests that the preceding downside breakout was a 'fakeout'.

The gold price has also broken above its 20-day MA, which acted as resistance near the end of the week before last, but reversed downward last Friday after touching its 50-day MA. At a superficial level this suggests that as things currently stand the November rebound in the gold price is no different from the October rebound, which was followed by a multi-week plunge to new bear-market lows. However, with reference to the following daily chart, note the big difference between the performance of the HUI/gold ratio during the October rebound and its performance during the November rebound. This indicates that the rally from the November low will probably evolve into something more substantial than a counter-trend bounce.



With gold not yet close to being 'overbought' on even a short-term basis, we suspect that the market will make some additional headway over the next 1-2 weeks. As noted in previous commentaries, we view $1210-$1240 as a likely range for a multi-week top.

Gold Stocks

How cheap are gold stocks, really?

At its recent low the HUI was trading at the same price at which it traded way back in 2003-2004, when the gold price was $350-$400/oz. On the surface, this suggests that at their recent lows the senior gold-mining stocks that dominate the HUI were absurdly under-valued relative to gold, given that gold was trading at around $1150/oz at the time. Just how extreme was the under-valuation?



According to the article posted HERE, the HUI's under-valuation was so extreme it was completely irrational. For example, the article contains the following statements:

"While gold stocks indeed should've been sold with gold weaker, the magnitude of selling they suffered was far beyond anything justifiable fundamentally. This ultimately culminated in the latest gold-stock capitulation where the HUI plunged to 11.3-year lows! Think about that a second. Gold stocks were just trading at prices not seen since July 2003. Pretty much the entire secular gold-stock bull had been fully erased."

And: "... [the] entire not-widely-followed gold-stock bull was based on the massive fundamental boost to gold-mining profits that gold's own secular bull created. So if the recent gold-stock price levels were righteous, gold too should have been pounded back down towards its mid-2003 levels. Where was gold trading back then? Merely right around $350!"

And: "Do gold stocks deserve to trade today as if gold was at just $350? Heck no! Last week when gold stocks' latest capitulation low was carved, the gold price was up near $1150. That was 3.3x higher than the last time the gold stocks traded at recent levels! It makes no fundamental sense whatsoever for gold stocks to trade as if gold was at $350 when it was actually $1150. Their core fundamentals are now vastly better."

The analysis encapsulated in the above excerpts is superficial and misleading, for two main reasons. First, production costs are vastly higher now than they were in 2003-2004. Second, although the stock prices of the senior gold miners are, on average, not much higher now than they were when gold was trading at $350-$400/oz, their market capitalisations are hundreds of percent higher thanks to massive inflation of share quantities. Consequently, a good argument can be made that the "core fundamentals" are now worse than they were when the gold price was $350-$400.

We'll now consider the specific case of Goldcorp (GG) to back-up our point. During the quarter ended 30th September 2003, GG managed to achieve a net profit of $0.13/share, a net operating margin of 44% and a return on invested capital (ROIC) of 22%. These results were achieved at an average realised sale price of $364/oz. During the quarter ended 30th September 2014 GG's average realised sale price was $1266/oz, but the company reported a net LOSS of $0.05/share and was too embarrassed to highlight the ROIC. Note that there were no large asset writedowns in the latest quarter. GG was simply not profitable at $1266/oz in Q3-2014 after being very profitable at $364/oz way back in Q3-2003. And by the way, from Q3-2003 to Q3-2014 GG's share count rose from 183M to 814M, so although its share price is up by 'only' about 50%, its market cap is up by about 580% over the period in question.

We selected GG for our quick-and-dirty case study because it has been one of the best-managed of the senior gold producers and has had less company-specific problems than some of its brethren. Had we chosen either Barrick Gold (ABX) or Kinross Gold (KGC) our point could have been made even more clearly, because the amount of wealth destroyed by these companies via ill-conceived acquisitions and project developments is mindboggling.

It's important that fundamentals-oriented speculators who buy gold-mining stocks have their eyes wide open and understand the reality of the current situation. There are some good reasons to anticipate large gains in gold-stock prices over the coming 2 years involving a rising gold price, declining production costs and improving sentiment, but at the current gold price and with their current cost structures most gold producers are NOT particularly cheap by traditional valuation standards.

Therefore, don't be hoodwinked by superficial comparisons into believing that gold stocks are now priced for a hundreds-of-dollars-per-ounce lower gold price and, as a consequence, that massive gains lie ahead for gold stocks even if the gold price flat-lines or continues to fall.

Current Market Situation

The gold-mining stocks, as represented on the following chart by the HUI, have been strong relative to gold bullion since the early-November bottoms in gold and the HUI. However, there was a minor bearish divergence between the HUI and gold last Friday, with gold making a marginal new high for the move while the HUI never traded above the high made earlier in the week.

A plausible explanation for Friday's relatively poor performance by the HUI is gold's reversal after touching its 50-day MA. As mentioned above, gold's intra-day reversal from its 50-day MA means that on the surface the November rebound in the gold price now looks like the October rebound in the gold price. There is probably some concern that, as was the case in October, the touch of the 50-day MA will be followed by a plunge to new multi-year lows.

A plunge over the weeks immediately ahead to new multi-year lows is not impossible, but it is unlikely. The main reason is that as also mentioned in the gold section above, the HUI/gold ratio's performance has been far more bullish during the November rebound.

We continue to view 185-190 as a reasonable target-range for the HUI's initial rally.



The Currency Market

The euro fell sharply last Friday in response to Draghi's promise to do whatever it takes to create more "inflation" in the euro-zone, although it didn't make a new low. There could be some follow-through to the downside this week, but we continue to believe that the euro is close to a bottom that will hold for at least three months and that there is a good chance of a tradable euro rally fueled by speculative short-covering.

As a result of last week's price action, the top of the euro's short-term downward-sloping channel is more clearly defined. It is now clear that a daily close above 126 would confirm a trend reversal.



The euro's plunge last Friday pushed the Dollar Index back to, but not through, the high of the preceding week. The Dollar Index closed the 21st November trading session exactly at its 14th November intra-day high.

As a result of last week's price action, we would now take a daily close below 87.2 (up from 86.8) as confirmation of a short-term trend reversal.



As is the case with the euro, last week's price action helped to define the top of the downward-sloping channel for the Canadian Dollar (C$). For a price channel to have any significance it must be defined by at least 5 points -- at least 2 points on one side and at least 3 points on the other side. Due to last Friday's price action, the C$'s short-term downward-sloping channel is now defined by 8 points.

For the C$, a daily close above 89.5 would be a clear signal of a trend reversal.

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 November 2014:

[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]

  *Pretium Resources (PVG) advised that it has hired AMEC to provide the engineering, procurement and construction management (EPCM) services for the Brucejack high-grade gold project in Northern British Columbia. AMEC is an international engineering and project management firm with recently completed mining projects in British Columbia, including New Gold's New Afton Mine. Like PVG's proposed Brucejack mine, New Afton is an underground development.

The initial capex for Brucejack is estimated to be about $750M. If PVG takes the project through construction on its own, that is, if PVG is not acquired by a larger mining company prior to entering the construction phase, it will therefore have to raise about $800M (including working capital). This money would probably raised by issuing debt and equity, but the equity component would be costly if the new shares were issued with the stock price near its current level. Ideally, therefore, PVG's management will wait for improved market conditions before raising the money needed to build the Brucejack mine.

  *True Gold Mining (TGM.V) provided an update on its under-construction Karma gold mine in Burkina Faso. To date, about 40% of the $131M initial capex estimate has been spent or committed, and all aspects of the project are apparently on budget and on schedule for the commencement of production at the end of 2015. Gold production is expected to be 150K ounces in 2016.

The company has more than enough cash and undrawn credit to take the project through to production, so the current low stock price and difficult market environment doesn't create a funding problem for TGM.

One of the most important objectives for TGM over the next few months is to carry out sufficient infill drilling to upgrade the resources at the North Kao deposit from Inferred to M&I status. If this can be done it should enable the mining of North Kao to be incorporated into the overall mine plan, which, based on a recent PEA, would increase the project's NPV(5%) by $70M (about $0.17 per TGM share) assuming a gold price of $1250/oz.

    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 (last Friday's closing price: US$1.06).

2) EDV.TO (last Friday's closing price: C$0.54).

3) EVN.AX (last Friday's closing price: A$0.53).

4) RSG.AX (last Friday's closing price: A$0.24).

5) TGD (last Friday's closing price: US$1.06).

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.

    Updates to Small Stocks Watch List (SSWL)

The SSWL contains stocks that are too small and/or too illiquid to be included in the TSI Stocks List, but appear to have substantial upside potential. Although we don't follow these stocks closely via the TSI commentaries, they could be of interest to risk-tolerant speculators capable of doing their own company research.

Here are some changes and updates to the SSWL membership:

1. Dragon Mining (DRA.AX) and Nevada Sunrise Gold (NEV.V) are, we think, the most interesting stocks in the SSWL at this time. DRA is trading at only 50% of the value of its cash in the bank, but it is producing gold at the rate of 50K-60K ounces/year from operations in Scandinavia and has done a good-enough job of reducing costs that it is now marginally cash-flow positive. NEV owns 21% of the high-potential Kinsley Mountain gold project being explored by Pilot Gold. 21% of Kinsley could end up being worth many times NEV's current market cap.

2. Frontier Rare Earths (FRO.TO) is trading slightly below the value of the cash on its balance sheet, which means that its Zandkopsdrift REE (Rare Earth Elements) project in South Africa is being assigned no value by the stock market. We'll make a decision on whether or not FRO stays in the SSWL based on the results of the Zandkopsdrift PFS, which are scheduled to published in Q1-2015.

3. Geomega Resources (GMA.V) was added to the SSWL in recognition of the potential value of its Montviel REE project in Quebec and the new technology it was developing to separate the different REEs. It has now been removed, because the company's senior management appears to have lost the plot and inexplicably shifted focus to an uninteresting, early-stage gold project.

4. Roxgold (ROG.V), a development-stage gold miner with a small high-grade project in Burkina Faso, has been removed. There is nothing wrong with ROG, but it is now too big for the SSWL. If not for the existence of TGM.V we would consider adding ROG to the TSI Stocks List. TGM.V and ROG.V have gold deposits at similar stages of development in Burkina Faso, but TGM, which is already in the TSI List, offers the better value and the greater growth potential.

Chart Sources

Charts appearing in today's commentary are courtesy of:

http://stockcharts.com/index.html



 
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